Wednesday, May 18, 2022

IOSCO report says fair access to market data should be concern for world’s regulators

By John Filar Atwood

In a final report that was 17 months in the making, the International Organization of Securities Commissions (IOSCO) has offered several recommendations to global regulators to consider as they review the regulation of market data. The recommendations address the availability of pre-trade and post-trade data, fair access, and potential consolidation of available data.

IOSCO began looking into market data issues in 2020 in response to concerns raised by its members regarding what data is needed for trading, the uses of market data, and equitable and timely access to the data. The group published a preliminary report in December 2020 and requested feedback and potential solutions to some of these market data concerns. IOSCO received 39 comment letters that it reviewed as part of its preparation of the final report.

As context for the report, IOSCO noted that as secondary markets have evolved to become largely electronic, the market data needs and means to access that data have also changed for many market participants. Even with those changes, market data remains an essential element of efficient price discovery, and market participants need it to make investment, order routing and trading decisions, the group said. Market data also is needed for market participants to comply with various regulatory requirements, including risk management, best execution and order protection rules, IOSCO added.

Recommendations. Based on its review of the issues, and comments received on its draft report, IOSCO developed three recommendations for regulators when reviewing the regulation of market data provided by trading venues or OTC markets. First, IOSCO emphasized the importance of pre-trade data and post-trade data in promoting transparency of trading.

IOSCO said that regulators should consider the elements of market data that are necessary to facilitate the ability of all market participants to effectively and fairly participate in secondary markets and to make informed investment, order routing and trading decisions. It added that regulators should be mindful that the needs of market participants may differ depending on factors such as, participants’ business model, market structure in a particular jurisdiction, or the type of participants in the market.

Fair access. The group’s second recommendation focuses on fair access to data. This may cover issues such as market data pricing, connectivity terms and pricing, and contractual arrangements, IOSCO said. It reminded regulators that market data is not interchangeable in all cases, and where appropriate, helping to ensure fair access across different execution venues is an important consideration. Access to free or delayed data for some participants also may be a useful consideration for regulators, the group noted.

Finally, IOSCO suggested that, where appropriate, regulators should consider whether various pieces of market data can be consolidated. According to IOSCO, consolidation may improve access to market data and may help reduce costs, identify liquidity and compare execution quality in jurisdictions where there may be fragmented liquidity.

Tuesday, May 17, 2022

Warren, Porter seek answers about corporate business dealings in secondary markets to avoid sanctions

By Colleen M. Svelnis, J.D.

Senator Elizabeth Warren (D-Mass), a member of the Senate Banking, Housing, and Urban Affairs Committee, and Rep. Katie Porter (D-Calif) have sent letters to the CEOs of Goldman Sachs and JPMorgan Chase, seeking information on how the banks may be profiting off of Russia’s invasion of Ukraine. According to the lawmakers, the volume of Russian corporate-debt trades is at two-year high, despite historic U.S. sanctions against Russia.

The letter cautions that large financial institutions may be cashing in on Russia’s war in Ukraine, with the volume of Russian corporate debt trades reaching a two-year high in March 2022. The letter requests answers from the banks about the scope of their trades in Russian debt since the invasion of Ukraine and the clients that they are helping profit from the invasion. The members of Congress called out the banks for exploiting sanctions loopholes that allow them to continue to profit from business dealings with Russian debt in the secondary markets. Despite the sanctions that the United States imposed on the Russian economy and Russian elites, the legislators write that several large financial institutions have maneuvered to exploit loopholes that allow them to continue to trade in Russian sovereign debt in secondary markets.

Warren and Porter warn that major financial institutions are “getting in on the action of the flailing Russian economy,” trading “dirt-cheap Russian government or corporate bonds along with credit-default swaps, […] insurance on the potential default of a borrowers.” And they accuse JP Morgan and Goldman Sachs of engaging in the sales and trades of Russian debt on the secondary market. The letter cites recent reports indicates Goldman Sachs is buying up Russian debt securities at low prices and reselling these to American hedge funds, providing cover for other financial institutions seeking to profit from war. Additionally, the letter states that JP Morgan has similarly taken advantage of the war in Ukraine by brokering deals for private Russian corporations with ties to the Russian government.

Warren and Porter state that the international community has “stepped up efforts to wage a ‘maximum pressure’ campaign on Putin’s regime to end its aggression in Ukraine, freezing Russian foreign exchange reserves and limiting imports of Russian oil.” These measures have succeeded in squeezing Russia’s economy and its access to funds. However, despite these measures, the volume of Russian corporate-debt trades is at a two-year high, doubling the average daily value of trades from the same time frame in 2020.

The maneuvering highlighted in the letter is legal under the sanctions put forward by the U.S. Treasury because trading in the secondary markets is not prohibited so long as counterparties to the transactions are not sanctioned entities, and so long as the Russian sovereign debt being traded was issued prior to March 1, 2022. However, Warren and Porter cautioned that it may “undermine the work of the U.S. Treasury and the international community.”

The letters seek the following information by May 24, 2022:
  1. What kinds of trades and investments in Russian debt has Goldman Sachs and JP Morgan facilitated since the start of the Russian invasion of Ukraine on February 24, 2022?
  2. Please list the total value of these trades, broken down by type of trade.
  3. What is the total value of Goldman Sachs and JP Morgan’s profits for all trades in Russian debt since February 24, 2022?
  4. Please list all clients involved in trades of Russian government and corporate debt since February 24, 2022, including the data and type of trade, the amount of the trade, and the client’s profit from the trade.
  5. Has Goldman Sachs and JP Morgan recommended or advised clients that they could maintain their anonymity in these trades, or have they facilitated efforts to do so?
  6. How does Goldman Sachs and JP Morgan ensure that its trades and its clients trades involving Russian debt are compliant with the U.S. sanctions regime?
  7. Are you reporting the identity of any of your clients that are involved in trades of Russian debt to OFAC or other regulators?

Monday, May 16, 2022

Director Grewal cautions defense bar on delaying tactics

By Mark S. Nelson, J.D.

SEC Enforcement Director Gurbir Grewal, speaking to an audience at the Securities Enforcement Forum West 2022, urged the defense bar to avoid engaging in litigation tactics that serve only to lengthen SEC investigations and which are unlikely to change the SEC's decision on whether or not to bring a case. Grewal also emphasized that cooperation credit requires more proactive conduct on the part of a potential respondent than merely not obstructing an SEC investigation.

Two sides to enforcement. Although much of Grewal’s remarks focused on litigation tactics by the defense bar, he began his remarks by briefly addressing a related concern that the SEC is not moving fast enough to bring enforcement cases. According to Grewal, he has sought to speed the pace at which the SEC pursues enforcement matters and cited the agency’s recent charges against Archegos Capital Management as an example. That case involved allegations that family office owner Sung Kook (Bill) Hwang and Archegos used margined total return swaps to manipulate the prices of the underlying securities and then misled investors about the scheme.

“The public needs to know when they read a news story about corporate malfeasance that we will move quickly to investigate what happened and hold wrongdoers accountable, even in the most complex cases,” said Grewal.

With respect to the pace of SEC investigations, Grewal spent much of his time remarking on how differently the defense bar and SEC staff approach investigations and litigations. While questioning some defense tactics, Grewal also noted that experienced defense counsel can sometimes persuade the SEC. Said Grewal: “That’s because one of the most valuable qualities an effective defense lawyer can have is credibility with the staff. We’ve all experienced this firsthand—that close call when it’s counsel’s credibility that carries the day and drives a fair and timely resolution.”

But with respect to perceived problematic defense tactics, Grewal emphasized ongoing issues with document production, investigative testimony, attorney conflicts, and assertions of attorney-client privilege.

Grewal said defense tactics regarding document production often lengthen investigations. “That said, too often, we see defense counsel—sometimes even including Enforcement alums—engage in conduct that seems to have little purpose other than to delay our investigations,” said Grewal.

On the topic of investigative testimony, Grewal suggested that defense counsel can bolster their credibility by acknowledging the inapplicability of the Federal Rules of Evidence. “When experienced counsel, who are well aware that the Federal Rules of Evidence do not apply in our investigative testimony, repeatedly interrupt testimony to lodge hearsay or other inapplicable objections, trust can be eroded,” said Grewal.

In the case of SEC staff, Grewal said “[i]n short, we will not play games during our investigations, negotiations, or litigations.” Grewal said this approach applied to Wells notices, “threatening potential charges to gain leverage in negotiations,” admissions (“Admissions are not a bargaining chip”), and settlement demands.

When speaking of Wells notice, Grewal elaborated: “If we tell you we plan to recommend charges, it means that we are prepared to litigate any resulting action, pending careful consideration of any Wells submission.”

Grewal also suggested that while there is some room for negotiations regarding settlement demands, there may not be all that much room. “This doesn’t mean that our opening offer is our final offer, but it does mean that our offer is the product of rigorous thought about the appropriate outcome,” said Grewal. “It’s calibrated to the case and the conduct. And while there may be some flexibility in certain aspects of it – and yes, on occasion, we may get our initial ask wrong, you should not assume that everything is subject to negotiation.”

Cooperation credit. Grewal observed that respondents to SEC investigations can take proactive, affirmative steps to obtain cooperation credit that may reduce or eliminate penalties. The Seaboard report, Grewal said, offers a framework for obtaining cooperation credit, but it does not offer an exhaustive list of all actions that may result in credit. Grewal then suggested a few ways in which credit may be obtained:
  • Provide documents or make witnesses available on an expedited basis.
  • Highlight “hot” documents or provide translations of key documents.
  • Identify documents the SEC likely would be interested in even if the documents would not be subject to a subpoena.
  • Make the most of presentations to SEC staff rather than merely engaging in advocacy.
If a client may have engaged in a violation tell the client to “own that violation and work in good faith to remedy it.”

Grewal noted, however, that in his view of cooperation credit the cooperation cannot be merely acting in a manner that does not obstruct an SEC investigation because more affirmative conduct is required to obtain credit.

Friday, May 13, 2022

House once again passes M&A broker bill, also seeks to protect seniors

By Mark S. Nelson, J.D.

The House passed the Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act of 2021 (H.R. 935) by a vote of 419-0. The bill would provide statutory authority for certain persons to engage in the business of effecting securities transactions solely in connection with the transfer of ownership of an eligible privately held company. The bill, which the House has passed previously in various forms, would mostly codify existing SEC no-action guidance on M&A brokers. If it becomes law, the provisions in the bill would become effective 90 days after enactment. The House also passed the Empowering States to Protect Seniors from Bad Actors Act (H.R. 5914) by a vote of 371-48.

M&A brokers. The Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act would create an exemption from the broker-dealer registration requirement under federal securities laws for mergers and acquisition brokers. As a result, M&A brokers would be allowed to facilitate transactions involving eligible privately-held companies.

“Small businesses need to grow and have to do a couple of different things to be successful. For some that means they need to consolidate; some may need to restructure and try to recover from the challenges that have been exacerbated by the pandemic or the economy or whatever it might be; and sometimes it may be a family succession plan that is happening within those small businesses,” said Rep. Huizenga, the bill’s sponsor, as the bill was debated for the third time since it was first introduced several Congresses ago. Representative Huizenga added that “[t]hese innovators, entrepreneurs, and risk takers are critical to our country’s economic growth and prosperity. We need to level the playing field that gives an unfair advantage to those Wall Street big guys” (See, Congressional Record, May 10, 2022, p. H4748).

According to the bill’s definition of “M&A broker,” such person must reasonably believe that: (1) upon consummation of the transaction, any person who acquires the securities/assets of an eligible privately-held company will control and actively manage the company; and (2) any person who is offered securities in exchange for the securities/assets of an eligible privately-held company will, before the transaction is consummated, receive or have reasonable access to, the company’s most recent fiscal year-end financials, any related statement from the independent accountant (if the financials are audited), a balance sheet dated no more than 120 days before the offer date, and information about the business, its management, and any material loss contingencies.

For purposes of the bill, “eligible privately-held company” would mean a company with: (1) no securities registered or required to be registered under Exchange Act Section 12; and (2) EDBITDA less than $25 million and/or gross revenues less than $250 million. The Commission would have authority to alter the dollar amounts in the definition of “eligible privately-held company.” Moreover, the dollar amounts would have to be adjusted for inflation every five years after enactment.

The bill also contains a list of activities that would require registration as a broker-dealer because they are outside the scope of the proposed exemption for M&A brokers. Non-exempt activities would include many of the sine qua non of a broker-dealer, such as maintaining custody of or transmitting funds or securities to be exchanged by parties to a transaction involving an eligible privately-held company. Lastly, the bill would deny the exemption to any person who has been barred or suspended from associating with a broker-dealer under federal or state law.

Senior investors. The Empowering States to Protect Seniors from Bad Actors Act, sponsored by Rep. Josh Gottheimer (D-NJ), would amend Dodd-Frank Act Section 989A to create a grant program to be administered by a task force overseen by the SEC. The task force would make competitive grants to eligible entities, which consist of state securities and insurance commissions (or their equivalents), for the purpose of funding efforts to combat financial fraud perpetrated against seniors.

Grants made by the task force would not be permitted to exceed $500,000 (the maximum amount would be adjusted for inflation annually). Grant recipients could, in consultation with the task force, make subgrants. The bill would appropriate $10,000,000 for each of fiscal years 2023 to 2028.

Representative Gottheimer has recently pitched the Empowering States to Protect Seniors from Bad Actors Act, along with the National Senior Investor Initiative Act (Senior Security Act) of 2021 (H.R. 1565), which passed the House last year, as part of what he calls a “Senior Security Strategy.”

“Millions of seniors across the country, including my own mother, have been the victims of financial scams, and far too many have been cheated out of their retirement savings. Every few weeks, when I get a call from someone who fell prey to a shameless huckster, there’s often a robocall somewhere involved in that scam,” said Rep. Gottheimer via press release. “Our seniors should be spending time with their kids, grandkids, and friends—not staying up late at night worrying about whether someone is preying on their retirement nest egg. Seniors need a cop on the beat and we’re here today to do something about it.”

Thursday, May 12, 2022

Gensler declares new 'new era' in security-based swap market

By Rodney F. Tonkovic, J.D.

SEC Chair Gary Gensler spoke on May 11 before the annual meeting of the International Swaps and Derivatives Association. He observed that security-based swaps occasionally move from the corners of the markets to front and center, and their role in past and present "market jitters" helps inform how he thinks about them. In his remarks, Gensler highlighted the SEC's recent initiatives and proposals aimed at reducing risk, increasing transparency, and strengthening the integrity of the derivatives market.

A decade ago, as CFTC Chair, Gensler referred to the regulatory response to the 2008 financial crisis as a "new era for the swaps marketplace." He explained that a form of security-based swaps played an important role in the crisis as banks used credit default swaps to hedge their bank loan portfolios—"or so they thought." That swap market is relevant today, and Gensler noted the SEC's fraud charges against Archegos Capital Management based on manipulating stock prices using total return swaps. Gensler said that the role of security-based swaps in past and present "market jitters" helps inform how he thinks about them.

New new era. In his remarks before the ISDA, Gensler said that "we are embarking on yet another 'new era.'" While the CFTC has authority over the bulk of the swaps market, the SEC oversees security-based swaps. Many reforms have been made, Gensler said, but the Commission has work to do to update rules for the marketplace and fulfill its obligations under Dodd-Frank.

Risk reduction. The reforms to the swaps market reduce risk in two ways, Gensler continued. First, dealers must register with the SEC, meaning that they also must have key controls and cushions against losses; at the time of these remarks, there were 47 conditionally registered security-based swap dealers. The second part of the Dodd-Frank risk reduction scheme was central clearing, and the Commission regulates three clearinghouses for security-based swaps.

Transparency. Next, Dodd-Frank also called for more transparency in the security-based swaps market. To that end, Gensler pointed to a proposed framework for the registration of security-based swap-execution facilities that would harmonize with the CFTC's established and successful framework. If entities that register as security-based facilities are also registered as such with the CFTC, it would facilitate efficiencies for market participants, he said.

The Commission has also made efforts toward post-trade transparency, with two initiatives already implemented—that is, new rules on reporting of security-based swap data and the dissemination of data to the public—and a recent proposal on public reporting of large security-based swap positions.

Market integrity. Turning briefly to the topic of market integrity, Gensler highlighted two proposals intended to enhance the integrity of the security-based swap market. First, a re-proposed Rule 9j-1 would prevent fraud in connection with security-based swap transactions. In the same proposal is a prohibition against the coercion, misleading, or otherwise interfering with an SBS entity's chief compliance officer.

Crypto and complex products. Gensler then touched on the intersection of crypto assets with derivatives. Here, he reiterated the SEC's position that most crypto tokens are investment contracts and if a swap is based upon a crypto asset that is a security, then that is a security-based swap and subject to the SEC's rules. Platforms that offer securities-based swaps also must work within the securities regime, he added.

Finally, Gensler addressed the use of derivatives within structured and so-called complex products. The use of derivatives touches many parts of the markets, he said, and these investment products can pose risks even to sophisticated investors. Gensler said that he has asked the Division of Investment Management and Division of Examinations to take a "renewed and focused look at the use of derivatives by registered investment companies so that they’re compliant with our rules."

Wednesday, May 11, 2022

Law firm financial pros explore targets and priorities on the road to increased profitability at industry summit

By Brad Rosen, J.D.

Law firms globally are increasingly embracing profitability metrics as part of their long-term strategies and daily operations. Still, embarking on this journey often meets with stakeholder resistance and raises a host of delicate issues, as well as other challenges.

Ken Crutchfield, a Vice President at Wolters Kluwer Legal & Regulatory, U.S, recently led an industry panel, Choosing Targets and Prioritizing Profitability Projects and Initiatives, focusing on these issues at the ARK Group’s 11th Annual Law Firm Profitability Summit held in Chicago, Illinois.

Crutchfield was joined by a lineup of legal industry financial leaders who generously shared their insights, experiences, and an array of best practices for incorporating profitability into a law firm setting. Those panelists included Jacqueline Bosma, CFO, McCarter & English, LLP, Keith Maziarek, Director of Pricing and Legal Project Management, Katten Muchin Rosenman LLP., and Sam Davenport, Director, Business Innovation and Finance, Davis Wright Tremaine LLP.

You can read more about the panel discussion here.

Tuesday, May 10, 2022

Company executives address SEC Small Business Advisory Committee on climate

By Jay Fishman, J.D.

The SEC Small Business Capital Formation Advisory Committee held a virtual meeting on Friday May 6, 2022, inviting three guests to speak about the potential effects of the Commission’s March 21 2022 proposed climate-related disclosure rule amendments on small businesses.

While the proposal remains out for public comment: (1) Chair Gary Gensler made opening remarks; (2) Commissioner Hester Peirce made subsequent remarks; (3) Corporation Finance as Deputy Director for Legal and Regulatory Policy, Erik Gerding set forth the proposal’s fine points; (4) Betty Huber, partner and global co-chair of ESG Practice at Latham & Watkins in New York; and Thomas Sonderman and Steve Manko, CEO and CFO of SkyWater Technology, respectively, in Bloomington Minnesota addressed the pros and cons of the proposal; and (5) advisory committee member Carla Garrett, a corporate partner for Potomac Law Group PLLC in Washington, DC turned the guest speakers’ remarks into recommendations to present to the full Commission.

Chair Gensler. Chair Gensler’s now-famous remark since March 2, which lends support for the proposal, is “investors get to choose what risks to take, so long as the company they’re investing in fully discloses those risks.” Gensler supports the proposal “because, if adopted, it would provide investors with consistent, comparable, and decision-useful information for making their investment decisions and would provide consistent and clear-reporting obligations for issuers.” But therein lies the rub: the guest speakers are not sure the current proposed rule amendments will accomplish Gensler’s goal without the Committee considering certain factors the speakers touch on in their remarks.

Commissioner Peirce. Commissioner Peirce’s main concern with the proposal is that it will inadvertently affect private companies (which the proposal does not apply to) when public companies that are required to comply must turn to the private entities, e.g. their suppliers, for those entities’ climate disclosures.

Erik Gerding explains the proposal. Gerding was quick to reiterate from Peirce’s remarks that the proposal applies only to public companies subject to Exchange Act reporting requirements and not also to private companies. Generally, the proposed rule amendments would require domestic or foreign company registrants to include certain climate-related information in their registration statements and periodic reports, including Form 10-K. The information for inclusion would be:
  • Climate-related risks and their actual or likely material impacts on the registrant’s business, strategy, and outlook;
  • The registrant’s governance of climate-related risks and relevant risk management processes;
  • The registrant’s greenhouse gas emissions (GHG), which, for accelerated and large accelerated filers and respecting certain emissions, would be subject to assurance;
  • Certain climate-related financial statement metrics and related disclosures in a note to its audited financial statements; and
  • Information about climate-related targets and goals, and transition plan, if any.
Pertaining to emissions, Gerding said there are three types stated in the proposal—Scopes 1, 2 and 3—where Scope 1 is a registrant’s direct GHG emissions; Scope 2 is a registrant’s indirect emissions from purchased electricity and other energy forms; and Scope 3 consists of indirect emissions from upstream and downstream activities in a registrant’s value chain, if material, or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions.

Gerding noted that some companies have independently begun providing disclosures because their investors have asked for them while other companies have not done so, but that companies without target plans are not required to provide them under the proposal.

The last important piece of Gerding’s explanation concerned the proposal permitting climate disclosure exclusions, safe harbors, and carve outs for certain companies (especially from having to provide Scope 3 emissions) as well as allowing a phased-in approach for compliance overall. But the Committee asked the guests to provide their thoughts on the pros and cons of the entire proposal.

Betty Huber’s remarks. Betty Huber proclaimed that the companies she represents are concerned about the audit challenges that climate disclosures pose to their line items on financial statements. Clients specifically tell her that the information being requested can be very subjective because, for example, whether a severe weather event or a wildfire constitutes a climate event for disclosure has not been clearly defined.

Additionally, Huber declared her fear that the approximate $150,000 to millions of dollar cost to provide this data (depending on the company’s size) would be too much for many of them, rendering emerging growth companies particularly unable to raise capital and unable to get a loan when the bank discovers their failure to disclose climate risks to potential investors.

Lastly, Huber remarked upon: (a) a timing issue, namely that many companies will be unable to provide the required data by the time their Form 10-K filing is due; (b) the Private Securities Litigation Reform Act (PSLRA) safe harbor for forward looking statements and other disclosures does not apply to initial public offerings (IPOs), which would prevent private companies mandated to make climate disclosures from going public; and (c) the cost and timing issues would apply not only to a company’s initial reporting but to their ongoing reporting as well, making this too heavy a burden for many companies, especially start-ups, to bear continuously.

Tom Sonderman’s comments. As CEO of a greatly in demand semi-conductor manufacturing company that has been public only a year, Tom Sonderman emphasized that while his company, SkyWater, is very pro-ESG and has gone out of its way to provide these disclosures to customers, the timing of the SEC proposal may be wrong unless it really provides emission exclusions for many small businesses and allows a very long phased in approach for compliance.

Using SkyWater as an example, he said that customer demand for semi-conductors came during the Covid-19 pandemic when the company lost a rather significant portion of its workforce, leaving fewer employees to make semi-conductors or compile financial statements that comply with rulemakings like the SEC’s. Sonderman, therefore, stressed that a “one-size-fits-all policy” will not work for all small companies because many will be unable to absorb the compliance costs.

Steve Manko’s concerns. Steve Manko began his remarks by suggesting that the SEC modify existing rules on risk factors rather than proposing a brand new exacting rule that may be too difficult for many small businesses to abide by. As SkyWaters’ CFO, he also stated that the company’s audit expense has gone up since it went public, and that SkyWater’s Form 10-K containing the Commission’s mandated proposed disclosures would also need to be audited, raising that cost even further. He proclaimed, moreover, that requiring numerous climate disclosures on Form 10-K will severely distract many small companies from their main mission—capital raising—which is also one of the SEC’s missions. Manko also remarked that you can’t just look at a company’s size as an indicator of whether it will be able to comply with the disclosure requirement: the ability to comply could have just as much to do with what industry the company is in.

Huber too suggested in her earlier provided remarks that customized rules for companies in different industries might be the best approach even though such a rulemaking might be too voluminous to set forth. Manko lastly mentioned, like Huber, that forward looking disclosure statements are typically subjective, subject to judgment and not consistent across companies to serve the Commission’s purpose to create a harmonized disclosure framework for all U.S. companies and for U.S. companies compared to European Union and other foreign companies.

Recommendations for Commission consideration. When the guest speakers adjourned the meeting, advisory members Jeffrey M. Solomon - CEO, Cowen, Inc. New York, NY; Sara Hanks - CEO and co-founder, CrowdCheck, Inc. Alexandria, VA; Brian Levey - chief business affairs and legal officer, Upwork Inc., Mountain View, CA; Kesha Cash, founder and general partner, Impact America Fund in Oakland, CA and newly appointed member Donnel Baird, founder of BlocPower, a startup that markets, finances, and installs solar and energy efficiency technology to help houses of worship, and the non-profits, agreed to formalize for the Commission the recommendations from the guest speakers that Committee member Carla Garrett summarized as follows:
  1. Climate disclosure requirements are important to investors and should be made consistent across U.S. companies;
  2. Climate disclosure requirements should be consistent with disclosure requirements in other countries;
  3. Cost-benefit analysis is important to a company and should, therefore, be undertaken;
  4. Companies should be given time to comply;
  5. Companies should be subject to safe harbors;
  6. Consider how disclosure requirements deter companies from going public;
  7. Consider how disclosure requirements inadvertently affect private companies;
  8. Consider getting rid of the proposal’s attestation requirement;
  9. Consider differentiating the disclosure requirements by the industry the company is in;
  10. Consider having information disclosed later than the Form 10-K filing due date; and
  11. Incentivize registrants for compliance with climate disclosure requirements by reducing or waiving their other costs such as registration fees.

Monday, May 09, 2022

FINRA fines Wefunder and StartEngine portals for crowdfunding violations

By Mark S. Nelson, J.D.

Wefunder Portal, LLC and StartEngine Capital LLC agreed via Letters of Acceptance, Waiver, and Consent to settle charges by FINRA that both firms violated federal securities regulations and FINRA rules for crowdfunding portals. Wefunder allegedly allowed crowdfunding offerings to become oversubscribed in excess of offering limits and then shifted excess investment funds to other exempt offerings. StartEngine allegedly allowed issuers to post misleading communications on its website. Wefunder agreed to, among other things, pay a fine of $1.4 million to resolve the matter, although without admitting or denying FINRA’s allegations. StartEngine agreed to pay a $350,000 fine without admitting or denying FINRA’s allegations (Wefunder Portal, LLC, FINRA Letter of Acceptance, Waiver, and Consent No. 2021071940801, May 4, 2022; StartEngine Capital LLC, FINRA Letter of Acceptance, Waiver, and Consent No. 2017055183101, May 4, 2022).

“Funding portals perform an important gatekeeping role for securities that are offered to investors under Regulation CF, the crowdfunding exemption from securities registration,” said Jessica Hopper, Executive Vice President and Head of FINRA’s Department of Enforcement, via press release. “Today’s actions highlight FINRA’s vigilance over this developing area of securities regulation and our unrelenting focus on investor protection.”

Wefunder. The SEC’s Regulation Crowdfunding imposed offering limits on small, crowdfunded securities offerings. According to FINRA, Wefunder routinely allowed offerings on its platform to accept funds above the regulatory limit. FINRA offered as an example, one such crowdfunding offering in which Wefunder allowed the offering limit to be exceeded and then identified accredited investors who had invested in the crowdfunding offering and told those investors that their investments had been moved into another exempt offering under Regulation D. Wefunder then transferred the excess funds that were held in a crowdfunding escrow account to a Regulation D account in the name of Wefunder’s parent. FINRA said Wefunder engaged in similar conduct in a total of 39 offerings.

As a crowdfunding portal, Wefunder was subject to the requirements of Regulation Crowdfunding and FINRA’s similar rules for crowdfunding and crowdfunding portals. Specifically, FINRA alleged that Wefunder’s conduct violated FINRA Rule 200(a), which requires firms to observe high standards of commercial honor and just and equitable principles of trade.

Moreover, FINRA alleged that Wefunder failed to return funds to investors regarding cancelled or oversubscribed offerings and allowed funds to remain in dormant escrow accounts. Wefunder’s website also allegedly contained misleading communications.

Lastly, FINRA alleged that Wefunder lacked a reasonable supervisory system to monitor communications and track investments made via its platform. FINRA alleged that Wefunder’s tracking systems consisted of a labor-intensive, manual process handled primarily by one overwhelmed individual who lacked a basic understanding of finance. Said FINRA: “Wefunder realized this to be the case, as reflected in an internal email from May 2021, where one officer wrote to another that his ‘trying to do everything himself’ was failing the team.”

As a result, Wefunder agreed to be censured and pay a $1.4 million fine. Wefunder also must abide by an undertaking that requires the firm to engage an outside consultant who will review Wefunder’s compliance with federal securities regulations and FINRA rules.

StartEngine. FINRA also penalized StartEngine Capital LLC for violating rules applicable to crowdfunding portals. In addition to posting misleading investment trackers on its website and failing to supervise issuer communications, FINRA alleged that StartEngine allowed two issuers to post misleading communications.

In one instance, StartEngine allegedly allowed an issuer to post that its robot “can do just about anything” and that retail sales of the robot were imminent. That offering raised $200,000. In another instance, StartEngine allegedly allowed an issuer to post an unrealistic time frame for when the issuer’s professional basketball team would begin playing games. In both instances, FINRA alleged that SmartEngine knew or had reason to know the postings were false or misleading. StartEngine agreed to be censured and to pay a fine of $350,000.

The matters are No. 2021071940801 and 2017055183101.

Friday, May 06, 2022

PCAOB updates standard-setting and research agendas

By Elena Eyber, J.D.

The PCAOB released an update to its standard-setting and research agendas. The standard-setting and research agendas are intended to further the PCAOB’s objective of advancing audit quality to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports. The PCAOB will update the agendas at least semi-annually to provide the latest information on the status and timing of the PCAOB’s standard-setting and research projects.

Standard-setting projects. Through the standard-setting agenda, the PCAOB expects to strengthen auditing, quality control, and other professional practice standards in a number of targeted areas: audit firm use and oversight of other auditors, audit firm quality control systems, and audit firm transparency. In addition, the standard-setting agenda also represents the PCAOB’s priority of strengthening requirements for the audit of financial statements and modernizing and streamlining existing interim standards to reflect the impact of technological changes to financial reporting and audit practice as well as the audit profession’s evolution over time.

The standard-setting agenda sets forth six short-term projects where the PCAOB’s action is expected during the coming 12 months. In addition to the existing projects on Other Auditors and Quality Control, the PCAOB expects to take up Noncompliance with Laws and Regulations (NOCLAR), an Attestation Standards Update, Going Concern, and Confirmations. The PCAOB also added four mid-term projects to its standard-setting agenda: Substantive Analytical Procedures, Fraud, Interim Ethics and Independence Standards, and Interim Standards. While formal action is not expected on these projects in the coming 12 months, the PCAOB is actively engaged in furthering these projects.

Research projects. The PCAOB also is actively researching certain topics that will inform PCAOB’s standard-setting agenda and will enable it to respond quickly to changes in the audit environment, including changes resulting from advances in the use of data and technology in the preparation and audit of financial statements.

Status and timing of projects. To protect the interest of investors and provide transparency, the PCAOB will inform stakeholders about the PCAOB’s active projects and the anticipated timeline of the completion of each project. The agendas will change as needed in response to developments from PCAOB oversight activities; engagement with investors and other stakeholders, including through PCAOB advisory groups; discussion with the SEC; observations of the work of other standard-setting bodies; and other relevant inputs. The PCAOB will be seeking input on the agendas from its advisory groups at their inaugural meetings later this year. The PCAOB will update the agendas at least semi-annually to provide the latest information on the status and timing of the PCAOB’s standard-setting and research projects.

Thursday, May 05, 2022

Russian invasion disclosure should consider cyber, supply chain issues, staff says

By John Filar Atwood

The Division of Corporation Finance has issued a sample comment letter to help companies determine what kinds of issues they may need to discuss in their disclosure about the impact of Russia’s invasion of Ukraine. The staff said that it expects to see detailed disclosure from companies on the issue, including direct or indirect exposure to Russia, Belarus, or Ukraine and potential cybersecurity and supply chain risks.

General disclosure. In the sample letter, the staff stated that in addition to disclosing the direct or indirect impact of the invasion, a company should discuss the any impact resulting from sanctions, limitations on obtaining relevant government approvals, currency exchange limitations, or export or capital controls. The staff advised that this should include the impact of any risks that may impede the company’s ability to sell assets located in Russia, Belarus, or Ukraine, including due to sanctions affecting potential purchasers.

Disclosure should discuss any impact from the reaction of a company’s investors, employees, customers, and other stakeholders to any action or inaction arising from the invasion, including the payment of taxes to Russia, according to the staff. A company also should consider the effect of Russia or another government nationalizing the company’s assets or operations in Russia, Belarus, or Ukraine. If a company determines that these matters are not material, it should discuss how it arrived at that conclusion.

Cybersecurity. The staff advised that a company should describe the extent and nature of the role of the board of directors in overseeing risks related to the invasion. According to the staff, this could include risks related to cybersecurity, sanctions, employees and suppliers based in affected regions, and risks connected with ongoing or halted operations or investments in affected regions. The staff said that disclosure should include, to extent material, any new or heightened risk of potential cyberattacks by state actors or others since the invasion, and whether the company has taken actions to mitigate the possible risks.

In the MD&A disclosure, the staff reminded companies to disclose any material known trends or uncertainties related to the invasion. These could include impairments of financial assets or long-lived assets; declines in the value of inventory, investments, or recoverability of deferred tax assets; the collectability of consideration related to contracts with customers; and modification of contracts with customers, the staff stated.

Accounting estimates. The staff advised companies to enhance critical accounting estimate disclosures with both qualitative and quantitative information. Companies should discuss why the critical accounting estimate is subject to uncertainty, including any new uncertainties related to the estimate, and the method used to develop the estimate and the significant assumptions underlying its calculation, the staff stated.

Companies should disclose the degree to which the critical accounting estimate and the underlying significant assumptions have changed over the current period or since the last assessment, along with the sensitivity of the reported amount to the method and assumptions underlying its calculation.

Supply chain issues. The staff said that a company should discuss any material impact of import or export bans resulting from the invasion on any products or commodities, including energy from Russia, used in its business. It also expects to ask for disclosure on whether and how business segments, products, lines of service, projects, or operations are materially impacted by supply chain disruptions.

Supply chain-related disclosure should include whether a company expect to suspend the production, purchase, sale, or maintenance of certain items, and possibly experience higher costs due to constrained capacity or increased commodity prices or challenges sourcing materials, the staff stated. According to the staff, a company also should discuss whether it expects surges or declines in consumer demand for which it is unable to adequately adjust its supply.

If a company expects to be unable to supply products at competitive prices or at all due to export restrictions, sanctions, or the invasion, that should be disclosed the staff said. A company also should discuss whether it expects to be exposed to supply chain risk in light of the invasion and/or related geopolitical tension or plans to “de-globalize” its supply chain, the staff added.

Non-GAAP measures. The staff indicated that it will comment if a company adjusts its revenues to add an estimate of lost revenue due to the invasion. In the staff’s view, recognizing revenue that was not earned during the period presented can result in the use of an individually tailored revenue recognition and measurement method which may not be in accordance with Rule 100(b) of Regulation G. In this case, the staff will ask a company to remove the adjustments.

If a company adjusts for certain expenses related to its operations in Russia, Belarus, and/or Ukraine that appear to be normal and recurring to its business, the staff expects the company to disclose the nature of the expenses. Further, a company should explain how it considered Question 100.01 of the C&DI for Non-GAAP Financial Measures, and why it believes the expenses excluded from non-GAAP measures do not represent normal, recurring operating expenses.

The staff noted that the sample comments are not an exhaustive list of potential issues that may arise, and that actual comments it issues to a company will depend on that entity’s specific facts and circumstances.

Wednesday, May 04, 2022

SEC report shows progress on DEI, but small sample size

By Anne Sherry, J.D.

Virtually all the companies that voluntarily reported their diversity practices to the SEC Office of Minority and Women Inclusion (OMWI) consider diversity and inclusion in their recruiting practices, according to a report newly published by the SEC. OMWI sees hope in the responses, although it acknowledges that the response rate was very low, with less than 10 percent of companies deciding to self-report. The SEC and OMWI described their goal of improving the response rate through outreach and awareness campaigns aimed at stating the business case for diversity, equity, and inclusion (DEI).

In January 2020, OMWI invited 1,263 regulated entities to participate in the SEC’s 2020 Diversity Assessment Report process. The SEC received 59 responses covering 118 regulated entities—about 9 percent of those invited. OMWI acknowledged that the voluntary nature of the project means it cannot draw inferences as to the entities that did not respond, but said that identifying trends among those that did respond is valuable in identifying DEI strengths and opportunities for improvement.

Those strengths include the fact that 98 percent of reporting entities consider diversity and inclusion as part of their strategic plans for recruiting, hiring, retaining, and promoting employees. Most entities also have a diversity and inclusion policy, take proactive steps to promote a diverse pool of candidates to the board, and/or publish information about their DEI efforts on their website.

As for areas of improvement, OMWI observed that just over half of the respondents maintain a list of qualified minority- and women-owned businesses that may compete for upcoming contracts, and only 45 percent of entities have a supplier diversity policy. Accordingly, supplier diversity may present the greatest opportunity for improvement.

Improving response rates. In the Diversity and Assessment Report and its annual report to Congress, OMWI said that the biggest challenge in assessing diversity policies and practices is getting the regulated entities to share information about their self-assessments. The SEC engages with external stakeholders about the importance of DEI during regulatory events and conferences. OMWI also plans to hold outreach and awareness campaigns in 2022 aimed at illustrating the importance of DEI and the attendant value of submitting self-assessments to the SEC. At one of the planned events, executives from two regulated entities will highlight the business case for participating in the diversity assessment process. OMWI also plans to increase the technical support it offers during the FY 2022 diversity assessment collection and to engage in listen-and-learn sessions to allow entities to discuss their concerns and ways to increase response rates.

OMWI Director Pamela Gibbs said, “By providing this framework for self-reflection, we engage regulated entities in a deeper analysis and understanding of the leading practices and policies for advancing workforce and supplier diversity. But to effectively help them achieve their diversity and inclusion objectives, we need greater participation in this self-assessment process."

DEI at the SEC. OMWI also works in close collaboration with all SEC divisions and offices as part of its role in guiding the agency to improve diversity and inclusion within its own ranks. OMWI’s annual report to Congress details the progress the Commission has made on DEI. The percentages of SEC supervisors and managers who are Black, Hispanic or Latino, and Asian have each increased over the past three years, with nearly 27 percent of supervisors and managers identifying as minorities. Nearly half of Senior Officers at the Commission are women, and the agency awarded nearly 40 percent of its contracts to Minority Women Owned Businesses. Nearly half of new hires at the SEC identified as minorities. SEC Chair Gary Gensler stated his belief “that a diverse SEC workforce helps promote fairness and inclusion in the financial services industry.”

Tuesday, May 03, 2022

FINRA sees continued decline in number of registered firms and representatives

By John Filar Atwood

In its latest annual industry snapshot, FINRA reported that the total number of registered firms continued its steady five-year decline, from 3,726 in 2017 to 3,394 in 2021. Similarly, the number of registered representatives dropped to 612,457 from its recent high of 630,235 in 2017. The aggregate revenues for registered firms trended upward in 2021, reaching $391 billion, slightly better than the recent best of $388 billion in 2019.

FINRA reported the numbers in its industry snapshot report, which is designed to increase public awareness and understanding of FINRA-registered firms and individuals. The statistical report provides a high-level overview of the industry, and only reports data in the aggregate to protect the confidentiality of individual firms.

FINRA regulates brokerage firms doing business with the public in the U.S. Of the 3,394 FINRA-registered firms in 2021, 2,914 were registered just as broker-dealers and 480 were dually registered as broker-dealers and investment advisers. In the report, FINRA noted that the number investment adviser-only firms in 2021 was 31,669.

Mostly small firms. The majority of FINRA’s oversight is with small firms, as they comprise 3,048 of the total number of registered firms. Mid-sized firms slightly outnumbered large firms in 2021 at 185 and 165, respectively.

Of the more than 612,000 registered representatives overseen by FINRA in 2021, 81 percent (510, 191) worked in large firms. Mid-sized firms accounted for eight percent of the total (51,008) and small firms employed 10 percent (64,864) of the representatives. According to the report, in 2021 43,896 representatives left the industry, and 38,822 entered the business.

Total revenues. The trend in total revenues generally has been upward in recent years for registered firms, FINRA reported. In 2017, firms totaled $305.7 billion in revenues with $268,632 in expenses. After a slight decline from $388 billion in 2019 to $362 billion in 2020, revenues rose to $398.5 billion in 2021 with $306.8 billion in expenses. The $91.7 billion in net income was the highest reported level in recent years.

FINRA noted that the report included several new data points, including information about special purpose acquisition companies, customer margin debt, and the Consolidated Audit Trail. Other newly-added sections of the report are American Depository Receipt activity, excess net capital by firm size; Reg. NMS stock trading by product type, and geographic distribution of registered individuals.

Monday, May 02, 2022

SEC’s Investor Advocate pushes NYSE, Nasdaq for tougher SPAC listing standards

By John Filar Atwood

SEC Investor Advocate Rick Fleming has asked the NYSE and Nasdaq to join the Commission in enhancing protections surrounding special purpose acquisition companies (SPACs) by putting in place tougher listing standards for SPACs. Fleming expressed “significant reservations” about the current listing regime, and asked the exchanges to prohibit the consummation of a SPAC business combination when SPAC shareholders exercise their conversion rights for more than 50 percent of the shares.

In separate letters to the NYSE and Nasdaq, he indicated that the SEC’s Office of the Investor Advocate has been monitoring the experience of investors in exchange-listed SPACs in recent years, and is concerned about substantial rise in the occurrence of “empty voting.” This is a practice by which companies go public through a SPAC business combination even though the majority of the SPAC’s shareholders have, by redeeming their shares for cash, expressed a lack of faith in the future of the company.

Recent problem. Fleming noted that this did not used to be a problem because of the existence of listing standards specifically tailored to SPACs. These included the right to vote for the proposed business combination, the right of dissenters to convert their shares back to cash, and on the NYSE the requirement that the business combination could not go forward if more than 40 percent of shareholders converted their shares to cash. If enough shareholders voted against the deal, he noted, there was no way for SPAC sponsors to finalize a poorly-received business combination.

That all changed with allegations of abusive hedge fund practices in the shareholder voting process, he said. In looking for ways to remove the ability of hedge funds to take advantage of SPACs and their investors, exchanges decided to enhance investor conversion rights at the expense of voting rights, according to Fleming. They removed the 40-percent restriction in favor of registration statement risk disclosures, and made it possible for all SPAC shareholders to receive their money back.

High redemption rates. The result of those changes, Fleming said, was to open the floodgates for companies to go public even though the majority of SPAC IPO investors redeem their shares. He cited recent market reports that found that SPAC redemption rates have jumped to over 80 percent in recent months.

The percentage has risen so high, Fleming suggested, in part because investors in a SPAC IPO are usually given warrants in addition to common shares, and the warrants retain value only if the business combination is completed. As a result, investors have an incentive to vote in favor of a merger, because they retain their warrants, even if they believe it is a bad deal. Fleming added that some commenters believe this SPAC structure amounts to a “fatal flaw” because shareholders that vote for a proposed deal but still redeem their shares for cash have separated their vote from their economic interest.

50 percent threshold. Fleming asked the exchanges to change their listing standards to reinstate a conversion right threshold, although he would like to see it set at 50 percent rather than the previous 40 percent level. It would be better for all parties, including SPAC sponsors, investors, and the listing exchanges, if the SPAC business model were sustainable, he argued, and the exchanges are in a unique position to move the industry back to this more sustainable path quickly.

Fleming acknowledged the financial innovation behind exchange-listed SPACs and their potential to bring more private issuers into the public market, especially those that might not have been well served by a traditional IPO. However, he recommended listing standard changes due to his doubts about the current system that allows for empty voting and otherwise permits significant conflicts of interest.

Fleming expressed his view that the recommended action needs to be implemented by all exchanges that list SPACs. Otherwise, it would incentivize a “race to the bottom” among the exchanges, which was part of the NYSE’s justification for eliminating the conversion threshold in the first place, he concluded.

Friday, April 29, 2022

House sends judicial insider trading disclosure bill to president

By Mark S. Nelson, J.D.

The House passed the Courthouse Ethics and Transparency Act (S. 3059) by voice vote, thus sending the bill, which previously had also passed the Senate by voice vote, to the White House for the president’s signature. The bill was introduced in response to news media revelations that some federal judges had heard litigated cases in which they or their family members had financial stakes in one or more of the litigants. The Senate version of the bill emerged with bipartisan support after Congressional hearings probed the depth of the problem, ultimately finding existing laws to be insufficient to prevent ethical abuses by federal judges. Legislation to further strengthen similar safeguards for members of Congress and the executive branch are ongoing.

STOCK Act for federal judges. The Courthouse Ethics and Transparency Act is based on the Representative Louise McIntosh Slaughter Stop Trading on Congressional Knowledge (STOCK) Act, which imposed on members of Congress and certain executive branch officials requirements to publicly disclose their financial holdings. The Courthouse Ethics and Transparency Act would amend the Ethics in Government Act of 1978 to explicitly include federal judicial officers, bankruptcy judges, and magistrate judges among those government officials subject to financial disclosure requirements. The inclusion of federal judges under the Ethics in Government Act would be effective 90 days after enactment.

Within 180 days of enactment, the Administrative Office of the U.S. Courts must create a searchable database to enable public access to any report required to be filed by a federal judicial officer, bankruptcy judge, or magistrate judge. The Administrative Office of the U.S. Courts also must make a federal judge’s report available on the database 90 days after the report is required to be filed. Reports must be made publicly available in a full-text searchable, sortable, and downloadable format.

Consistent with existing law, however, the Courthouse Ethics and Transparency Act would not require the immediate and unconditional availability of reports filed by an individual if the Judicial Conference finds, after consulting the U.S. Marshals Service, that revealing personal and sensitive information could endanger that individual or a family member of that individual. Moreover, a report could be redacted only to the extent necessary to protect the individual who filed the report or a family member of that individual and only for as long as the danger to the individual exists.

Bipartisan support for bill. Although efforts to strengthen the STOCK Act regarding members of Congress remain ongoing, those same members have united in a show of bicameral and bipartisan support for imposing additional financial disclosure requirements on federal judges. What would become the Courthouse Ethics and Transparency Act emerged from an accelerated lawmaking process that spanned a mere seven months beginning with a House hearing in October 2021 that was inspired by an article on federal judges that had appeared in The Wall Street Journal. The House passed its version of the bill in December 2021 by a vote of 422-4, while the Senate passed its version in February 2022.

During the interim period between the House hearing and passage of the Senate version of the Courthouse Ethics and Transparency Act, U.S. Supreme Court Chief Justice John Roberts, in his 2021 year-end report, acknowledged that some federal judges had violated ethics rules as reported by The Wall Street Journal, but he also sought to contextualize media reports by emphasizing that those judges’ ethical lapses represented only a small fraction of recusal decisions made by federal judges in several millions of federal cases litigated during the article’s study period. During this same time, the Presidential Commission on the Supreme Court of the United States also weighed-in on judicial ethics, while the early impact of media revelations about failures to recuse began to appear in several private federal lawsuits (For more on these developments, see the Insider Trading section in Mark S. Nelson, 2022 Congressional preview: China, insiders, and stablecoins remain likely topics , January 12, 2022, pp.8-15).

Representative Deborah Ross (D-NC), the author of the House version of the bill, commented via press release shortly after the House passed the Senate version of the bill. “Our judicial system was founded on the principle of blind justice,” said Rep. Ross. “Yet, recent reporting revealed that federal judges have ruled on scores of cases in which they had a personal financial interest. The enactment of our Courthouse Ethics and Transparency Act will improve transparency, accountability, and public faith in the ability of our courts to carry out fair, impartial justice.”

Democratic floor manager Rep. Hakeem Jeffries (D-NY) told members the bill aligns federal judges’ financial disclosure obligations with those of members of Congress and senior members of the executive branch. He also noted that the bill explicitly includes judicial officers, those persons traditionally thought of as federal judges, as well as bankruptcy judges and magistrate judges. With respect to the creation of the required database, Rep. Jeffries said that lawmakers expected the Administrative Office of the U.S. Courts to set a date certain for launching the database and not to use its authority under the bill to delay that launch.

Representative Darrell Issa (R-Calif), the Republican floor manager and co-sponsor of the House version of the bill, sought to counter what he characterized as judicial branch pushback based on a separation of powers theory about Congressional authority to regulate courts. According to Rep. Issa, only Congress can initiate transparency and accountability laws because neither the executive nor the judicial branch can pass laws and, thus, Congress is not interfering with the judicial branch by extending STOCK act requirements to federal judges.

Representative Issa also said he hoped that courts will recognize that Congress had no choice but to legislate because lawmakers were faced with clear examples of the absence of transparency by some federal judges. Still, Rep. Issa said he did not foresee more federal judge recusals, although he said attorneys will have needed information when representing clients before federal judges and that the bill empowers the public to view information about federal judges that is not private information.

Senator John Cornyn (R-Texas), co-sponsor of the Senate version of the Courthouse Ethics and Transparency Act remarked: “One of the bedrocks of American democracy is our independent judiciary, and it is imperative that federal judges are held to the same standard of transparency as other federal officials under the STOCK Act. This legislation will help bring potential conflicts of interest to light and bolster public trust in our judicial system, and I’m glad it is on its way to the President’s desk.”

Fellow co-sponsor, Sen. Chris Coons (D-Del), echoed Sen. Cornyn’s remarks: “This law will help protect our legal system from conflicts of interest by increasing transparency around federal judges’ financial interests. It’s an important step toward ensuring equal justice under the law.”

Thursday, April 28, 2022

Gensler calls for greater transparency, resiliency in fixed-income markets

By Lene Powell, J.D.

In remarks at City Week, SEC Chair Gary Gensler outlined targeted initiatives to improve transparency, resiliency, integrity, and access in fixed-income markets. Possible enhancements include expanding and speeding up trade reporting, broadening regulation of trading platforms, and making changes relating to fund liquidity, central clearing and registration of proprietary traders.

“Together, through driving greater transparency, modernizing rule sets for electronified platforms, and enhancing financial resiliency, we can help investors and issuers in the bond markets get the same benefits as many other parts of our capital markets,” said Gensler.

Vast and changing markets. There are no “meme” bonds and the fixed-income markets do not get as much media attention as stocks, but they are incredibly important, said Gensler. Together, the fixed income markets represent about half of the capital markets that the SEC oversees, making them just as big as the equity markets. This includes the $23 trillion Treasury market, $14 trillion of asset-backed securities, $10 trillion of corporate bonds, and $4 trillion of municipal bonds. The non-Treasury fixed income markets are more than 2.5 times larger than the commercial bank lending market, said Gensler.

The fixed income markets have seen significant changes over time, including increased securitization and electronification and a shift in bond ownership to registered investment companies. With these changes, Gensler sees areas ripe for improvement and modernization.

Transparency. According to Gensler, academic research overwhelmingly finds that post-trade transparency improves efficiency and competition, but information reported in the fixed-income markets has not kept up with market changes and technological advances.

Gensler offered suggestions to improve transparency:
  • Shorten the time by which market participants must report transactions to TRACE and the MSRB from 15 minutes to one minute;
  • Bring foreign sovereign bonds into TRACE. In the chairman’s view, the value of such a move is shown by the European Union’s debt crisis and Russia’s invasion of Ukraine;
  • FINRA could consider allowing the investing public to see TRACE data on individual Treasury transactions. Currently this information is reported but not publicly disseminated. Gensler believes it would also be helpful for FINRA to consider codifying their existing dissemination protocols;
  • Reporting on (1) the trading protocol and platform fees paid to do a trade, and (2) the “spread” relative to Treasuries, when that is the agreed-upon term of trade.
Platforms. Gensler believes it is important to consider revising the SEC’s rules to reflect the increased use of electronic trading platforms in fixed income markets. In January, the Commission proposed a new definition for “exchange” that would cover additional fixed income platforms as well as some systems that bring together buyers and sellers for other securities asset classes. In addition, Gensler has asked staff to consider ways to increase fair access to electronic trading platforms that would fall within the expanded definition of “exchange,” with the goal of making the benefits of these systems more widely available to investors.

With a view toward increasing pre-trade transparency on platforms, Gensler has asked staff to consider how quotes and pre-trade price information might be more broadly accessible, such as by updating Regulation ATS. Gensler further noted that in 2020, the Commission amended Rule 15c2-11 of the Exchange Act, which governs the publication or submission of quotations by dealers outside of national securities exchanges. This rule applies to most fixed income dealers, said Gensler.

Resiliency. Gensler pointed to several events raising issues of financial stability, including the start of the Covid crisis. In March 2020, prime money market funds, municipal bond funds, and taxable bond funds saw significant outflows as investors evaluated their liquidity and investment needs in response to the pandemic. There were also challenges in the Treasury market, said Gensler.

More recently, central banks have started to transition from an accommodating to a tightening policy stance in the midst of uncertain geopolitical events.

“In such times of uncertainty and transition, we don’t want the market to be ‘exciting’ for the wrong reasons, as Ian Fleming might have put it,” said Gensler.

Gensler noted that the SEC recently proposed amendments to rules governing money market funds, a key segment of the short-term funding markets. Gensler has asked staff for recommendations regarding the fund liquidity rule, fund liquidity risk management, and fund pricing of liquidity costs. He has also asked staff for recommendations around strengthening central clearing in Treasuries, both cash and repos. This could include better facilitating customer clearing, enhancing risk management of the clearinghouses, and broadening the scope of central clearing," said Gensler.

Further, the SEC has proposed to further define the kinds of activities that would cause proprietary trading firms and others that engage in certain liquidity providing activities to register with the SEC as dealers. Finally, last fall the SEC proposed to shorten the trade settlement cycle, which would cover many kinds of fixed income securities.

In closing, Gensler said that while the bond markets do not need to be as “exciting” as James Bond, he thinks the SEC can make them better for issuers and investors alike.

Wednesday, April 27, 2022

Regulation Tracker: Upcoming SEC and CFTC comment deadlines and effective dates

A weekly feature of Securities Regulation Daily, our Regulation Tracker provides subscribers with a table of proposed rule comment dates and final rule effective and compliance dates for SEC and CFTC rulemaking.

Recent SEC activity includes the following:

Swap execution. The SEC proposed rules creating a regulatory regime for security-based swap execution facilities. Proposed Regulation SE (17 CFR 242.800 through 835) establishes a process for SBSEF registration and regulation, establishes execution methods, implements the 14 core principles for these entities spelled out in Exchange Act Section 3D(d) and addresses cross-border matters and conflicts of interest. A registered SBSEF must, among other requirements, register with the Commission on Form SBSEF and submit filings for rule and rule amendments and for product listings. The proposed rules affirm that an SBSEF is also a broker under the Exchange Act but exempt it from certain broker requirements.

SPACS. The SEC proposed new rules and amendments concerning disclosures related to SPACs, shell companies, and projections. New subpart 1600 of Regulation S-K would set forth specialized disclosure requirements in connection with initial public offerings by SPACs and in connection with de-SPAC transactions. The release also proposes amendments to forms and schedules to align the disclosures provided in de-SPAC transactions with those in traditional public offerings. A new Article 15 of Regulation S-X would more closely align the financial statement reporting requirements in business combinations involving a shell company and a private operating company with those in traditional initial public offerings; new rule 145a would provide shell company shareholders with protections under the Securities Act. The new rules also address issues relating to projections made by SPACs and their target companies. Finally, the proposed rule would provide a safe harbor from the Investment Company Act's definition of "investment company" for SPACs satisfying certain conditions.

Technical amendments. The SEC adopted technical amendments to correct typographical errors and erroneous cross-references, and to clarify instructions. Corrections are made to rules and forms under the Securities Act, the Investment Company Act, and the Investment Advisers Act. Several of the amendments update or correct cross-references to rules or provisions. The release also updates a number of forms to clarify instructions and to make typographical and other corrections, including removing outdated information.

Dealer-trader definition. The SEC proposed rules regulating significant market participants as "dealers." The rules would require certain market participants to register with the SEC, become members of a self-regulatory organization (SRO), and comply with federal securities laws and regulatory obligations, including as applicable, SEC, SRO, and Treasury rules and requirements. In particular, the proposal addresses firms that assume certain dealer functions, including proprietary (or principal) trading firms. New Exchange Act rules 3a5-4 and 3a44-2 would further define the phrase "as a part of a regular business" in Sections 3(a)(5) and 3(a)(44) of the Act to identify certain activities that would cause persons engaging in such activities to be "dealers" or "government securities dealers" and subject to the registration requirements of Sections 15 and 15C of the Act, respectively.

References to credit ratings. The SEC proposed amendments that would remove references to credit ratings from Regulation M. Rules 101(c)(2) and 102(d)(2) currently except nonconvertible debt securities, nonconvertible preferred securities, and asset-backed securities that are rated investment grade by at least one NRSRO. The amendments propose to eliminate the Rule 102 exception. For the Rule 101 exception, the proposal would replace the credit-rating requirement with requirements that the nonconvertible debt securities and nonconvertible preferred securities meet a specified probability of default threshold, and that the asset-backed securities be offered pursuant to an effective shelf registration statement filed on the Commission’s Form SF-3.

Climate-related disclosures. The SEC issued proposed rule amendments to requiring climate-related information. Domestic and foreign registrants would be required to include certain climate-related information in registration statements and periodic reports, including: governance and risk management; the likelihood of a material impact by identified risks on the registrant’s business and financial statements; effects of identified risks on the registrant’s strategy, business model, and outlook; and the impact of climate-related events and transition activities on the line items of a registrant’s consolidated financial statements. A registrant would also be required to disclose its direct and indirect greenhouse gas emissions (Scope 1 (direct), Scope 2 (indirect), and Scope 3 (upstream and downstream activities)). The proposed rules would include a phase-in period for all registrants, with the compliance date dependent on the registrant’s filer status, and an additional phase-in period for Scope 3 emissions disclosure.

EDGAR update. The SEC has adopted amendments to the EDGAR Filer Manual. The updates to Filer Manual, Volume I: "General Information," Version 40 (March 2022) will be amended to add a link to the Glossary of Commonly Used Terms, Acronyms, and Abbreviations. Amendments to Volume II: "EDGAR Filing," Version 61 (March 2022) and related rules and forms reflect changes including: a new submission form type to EDGARLink Online: 497VPSUB; updates to allow filers to pay filing fees via credit card, debit card, and Automated Clearing House (ACH) debit payment methods; support for the 2022 Variable Insurance Product (VIP) Taxonomy; and a new "Filing pursuant to a Commission substituted compliance order" check box. The EDGAR system was upgraded on March 21, 2022, and the updated Filer Manual volumes are incorporated by reference into the Code of Federal Regulations.

Cybersecurity incident reporting. The SEC proposed rule amendments requiring public companies to report cybersecurity incidents. The proposal would add Item 1.05 to Form 8-K (and make related amendments to other rules and forms) requiring the disclosure of a material cybersecurity incident within four business days after an incident is determined to be material; new Item 106(d) of Regulation S-K would require updated disclosures of previously disclosed incidents. New Item 106 would also require a registrant to describe its policies and procedures for managing risks from cybersecurity threats and to make disclosures regarding the board and management's role and expertise in assessing and managing those risks. Amendments to Item 407 of Regulation S-K and Form 20-F would require disclosure regarding board member cybersecurity expertise.

CAT amendments. The Commission published notice of proposed amendments to the National Market System Plan Governing the Consolidated Audit Trail. The amendment would require CAT reporting firms to report “buy to cover” information to CAT. The proposed amendments also include a provision requiring each reporting firm to indicate where it is asserting use of the bona fide market making exception under Regulation SHO. The amendments are proposed in conjunction with Release No. 34-94313: Short Position and Short Activity Reporting by Institutional Investment Managers (February 25, 2022).

Short sale disclosure. The SEC proposed a new rule and form intended to increase the availability of short sale related data. Under new Exchange Act rule 13f-2, institutional investment managers that meet or exceed a specified reporting threshold would be required to file confidential Proposed Form SHO with the Commission via EDGAR, within 14 calendar days after the end of each calendar month, with regard to each equity security and all accounts over which the thresholds are exceeded. Proposed Rule 205 of Regulation SHO would establish a new "buy to cover" order marking requirement if the purchaser has any short position in the same security at the time the purchase order is entered.

Private fund advisers. The SEC proposed rules enhancing the regulation of private fund advisers. The rules would require registered private fund advisers to provide investors with quarterly statements detailing information about private fund performance, fees, and expenses. The advisers would also be required to obtain an annual audit for each private fund. Next, all private fund advisers would also be prohibited from providing certain types of preferential treatment that have a material negative effect on other investors; other types of preferential treatment are prohibited unless disclosed to investors. Certain activities and practices (e.g., certain fees, expenses, reimbursements, and clawbacks) would also be barred. The proposal would require obtaining a fairness opinion in connection with an adviser-led secondary transaction. Additional conforming amendments would be made to the books and records and compliance rules.

Regulation ATS. The SEC proposed amendments to include Treasury markets platforms within Regulation ATS. First, the proposed amendments would expand Regulation ATS for alternative trading systems that trade government securities, NMS stock, and other securities. The proposed amendments would no longer exempt from Regulation ATS those ATSs that limit securities activities to government securities or repurchase agreements or reverse repurchase agreements on government securities and register as broker-dealers or are banks. The proposal would also require the ATSs to file additional public disclosures, depending on whether they trade government securities, NMS stock, or other types of securities. In addition, all ATSs subject to the Fair Access Rule would need to have written standards for granting, limiting, or denying access to their services. The proposal also expands Regulation SCI to government securities, applying it to ATSs that meet certain volume thresholds in U.S. Treasury Securities or Agency Securities. The proposed amendments would also include Communication Protocol Systems within the definition of "exchange" by amending "exchange" under Rule 3b-16 to include systems that offer the use of non-firm trading interest and communication protocols to bring together buyers and sellers of securities.

Filing fee disclosure and payment. The SEC adopted amendments modernizing filing fee disclosure and payment methods. The amendments affect most fee-bearing forms, schedules, statements, and related rules to require each fee table and accompanying disclosure to include all required information for fee calculation in a structured format. The amendments also add the option for fee payment via Automated Clearing House and debit and credit cards and eliminate the option to pay via paper checks and money orders. With the amendments, filers will find filing fee information in a single location with a structured format that will allow for the quick identification and correction of errors while eliminating the need for filers to enter duplicate fee information in the header and the body of the filing, to avoid the possibility of inconsistent data entry.

Please see the SEC Regulation Tracker for proposal comment deadlines and final rule compliance dates.

Please see the CFTC Regulation Tracker for final CFTC rule compliance dates.

Tuesday, April 26, 2022

Ukrainian Bar Association asks SEC to require disclosure of Russia/Belarus business dealings

By John Filar Atwood

The Ukrainian Bar Association has asked the SEC to adopt a rule to require public companies to disclose their business dealings in and with Russia and Belarus and any other jurisdiction supporting Russia in its war with Ukraine. The association believes the disclosure requirements may compel some issuers to discontinue business in and with Russia due to business and reputational risks, as well as increased costs due to sanctions, currency, and logistical constraints.

In a rulemaking petition, the group asked that the required disclosure include, but not be limited to, direct and indirect sales to Russia, direct and indirect purchases from Russia, ownership of assets in Russia, and stakes in entities registered in Russia. Issuers should be required to conduct due diligence about their customers and suppliers to ensure that their disclosures include amounts of indirect sales and purchases to and from Russia that can be reasonably ascertained through examination of respective supply chains, the association believes.

The association acknowledged that the U.S. has led a global swell of economic sanctions against Russia and Belarus in response to Russia’s aggression, including blocking measures against large banks and targeting individuals and entities with close ties to Vladimir Putin and the Russian military. The group noted, however, that despite the sanctions many public companies have chosen to continue to business in and with Russia.

Rationale for disclosure. The association believes the requested disclosure would inform investors about the risks and costs of continuing to operate in a heavily sanctioned market ruled by a government moving to nationalize industry. Disclosure will enable investors and regulators to ensure that issuers are meeting the complex sanctions that apply to operations in the Russian market, the group argued. Moreover, with Russia threatening counter-sanctions against issuers that do not continue fully their operations within Russia, the disclosure would help investors understand the full cost of doing business in Russia, according to the association.

Even if the business in or with Russia is considered immaterial by companies based on monetary or other measurements, the group believes that business dealings with or in Russia represents material information. Specifically, the association expects that the requested disclosure will enable shareholders and investors to:
  • Understand the exposure of issuers to costs and reputational risks associated with operating in or trading with a country ruled by an unpredictable authoritarian regime subject to numerous and growing international sanctions;
  • Ensure that their investments are in no way associated with or contributing to the financing of the war, and are not in violation of imposed sanctions;
  • Understand exposure of issuers to boycotts by customers, employees and investors stemming from their persistent engagement in business within or with Russia;
  • Understand exposure of issuers to risks that employees of its Russian operations face given the increasingly authoritarian nature of the regime;
  • Assess quality of issuer management and boards of directors, including their ability to make rational long-term decisions, and their ability to follow announced business strategy, values and codes of conduct; and
  • Obtain information that would enable shareholders to exercise their rights to submit shareholder proposals and/or engage with companies about their ongoing business in and with Russia.
Material not moral decision. The association said that its petition is about material disclosures, not about moral and values-based decisions or enforcement. The proposal does not seek to require companies to become moral arbiters, the group added.

Having said that, the association did point out the rise in businesses taking a position on ESG issues, with investors increasingly expecting businesses to be responsible corporate citizens. The group conceded that these issues are outside of the Commission’s purview at the moment, which is why its rulemaking petition is focused on the need for the disclosure of material information for the assessment of financial, business, and reputational risks stemming from investing in securities of companies engaged in business in or with Russia.

Not unprecedented. In support of its petition, the association noted that in an effort to increase sanctions against Iran for the country’s pursuit of a nuclear program and human rights abuses, Congress passed the Iran Threat Reduction and Syria Human Rights Act of 2012. The law’s requirement that public companies disclose whether they had knowingly engaged in certain activities or transactions related to Iran is similar to what the association is now requesting, the group stated.

The association also cited the Dodd-Frank Act’s required conflict minerals disclosure as further precedent. Congress enacted that section of the Dodd-Frank Act, the group argued, in response to the trade of conflict minerals by armed rebels engaging in conflict in the Democratic Republic of Congo and adjoining countries. Like its proposed rulemaking, the association believes that both the conflict minerals and Iran disclosures allow investors to decide not to support governments and organizations engaging in sanctionable behaviors by choosing not to invest or purchase products or services from those companies.

Given this legislative history relating to global conflicts, the association indicated that it intends to petition the U.S. Congress to pass legislation that requires companies to disclose any dealings in and with Russia with an objective of discouraging such activity by raising its cost and publicity.

Monday, April 25, 2022

A lot of dough: Domino's accountant gets extra-large insider trading penalty

By Rodney F. Tonkovic, J.D.

A district court approved a nearly $2 million civil penalty against a former accountant at Domino's pizza charged with insider trading. The Commission alleged that the accountant traded ahead of a dozen earnings announcements and pocketed almost $1 million in illicit profits. Without admitting or denying the allegations, the accountant agreed to pay a $1,921,394 civil penalty and to a suspension from practice (In the Matter of Bernard L. Compton, Release No. 34-94769, April 21, 2022).

According to the Commission's complaint, Bernard L. Compton worked as an accountant at the corporate office of Domino's Pizza, Inc., from 2005 to 2021. Between 2015 and 2021, he held the position of Program Leader. In this position, Compton was responsible for preparing financial reports of revenues, profits, and earnings-per-share for use by Domino’s senior management.

Extra sauce. Because of his position, Compton had access to internal data used to prepare summaries of Domino's financial performance. This information included confidential financial data not yet publicly-released. Using this material, nonpublic information, Compton traded ahead of a dozen of Domino's earnings announcements between 2015 and 2020, making $960,697 from the illicit trades.

Specifically, the Commission said that Compton frequently bought "out-of-the-money" options. The options were purchased in seven different brokerage accounts belonging to himself and members of his family. He then sold them at a profit after the financial performance data was made public

"The SEC investigation uncovered that Compton allegedly accessed and reviewed Domino’s confidential data to prepare financial performance reports for senior management," said Joseph G. Sansone, Chief of the SEC’s Market Abuse Unit. "Using innovative analytical tools, SEC staff exposed the defendant’s repeated misuse of this inside information and are now holding him accountable."

Final judgment. The court for the Eastern District of Michigan entered a final judgment order against Compton on April 19, 2022. Compton is permanently enjoined from violating the antifraud provisions of the Exchange Act and will pay a civil penalty in the amount of $1,921,394. Compton also agreed to be suspended from appearing and practicing before the SEC as an accountant, which includes not participating in the financial reporting or audits of public companies.

The release is No. 34-94769.

Thursday, April 21, 2022

Use of unregistered firms results in PCAOB sanctions for two auditors

By John Filar Atwood

The PCAOB has imposed $50,000 fines and other penalties against two auditors that used unregistered accounting firms to help them conduct issuer audits. In one instance, the unregistered firm, which is based in Hong Kong, had tried to register with the PCAOB but was unable to complete the process due to information-sharing restrictions imposed by China. Both auditors agreed to settle without admitting or denying the allegations.

Failure to supervise. One action was brought against WWC, P.C. for using its Hong Kong affiliate (WWC-Hong Kong) in ten issuer audits. According to the PCAOB, WWC allowed WWC-Hong Kong to exceed the level of participation requiring registration with the Board and thereby failed reasonably to supervise the Hong Kong firm in a manner designed to prevent violations of the Sarbanes-Oxley Act and PCAOB rules.

Specifically, WWC took no steps to ensure that WWC-Hong Kong’s participation would be consistent with PCAOB registration requirements. The PCAOB noted that in 2014 WWC-Hong Kong took steps to register with the Board, but did not complete the registration process after concluding that it would be unable to provide certain necessary information. Consequently, WWC-Hong Kong remained unregistered and was not permitted to play a substantial role in the preparation or furnishing of an issuer audit report.

For failure to supervise its unregistered affiliate, the PCAOB censured WWC, imposed a $50,000 civil penalty, and ordered WWC to take steps to improve its quality control policies and procedures. The PCAOB said that the WWC matter is the first in which it imposed sanctions for a failure reasonably to supervise an unregistered firm.

Unregistered Chinese firm. In the second matter, the PCAOB determined that JLKZ CPA LLP, under an arrangement with an unregistered Chinese accounting firm, issued two audit reports despite knowing that the personnel of the unregistered firm acted as the engagement partner, audit staff, and engagement quality reviewer for the audits. Moreover, the unregistered firm received most of the audit fees.

The PCAOB determined that because the Chinese firm, not JLKZ, performed the underlying audits, JLKZ was not in a position to express an opinion on the two audits in question. By doing so JLKZ violated AS 3101, the Board stated. The PCAOB further determined that JLKZ’s managing partner directly and substantially contributed to the firm’s violations.

The Board imposed a $50,000 penalty jointly and severally on JLKZ and its managing partner, censured them, and restricted for two years JLKZ’s ability to accept new issuer or broker-dealer audit engagements. According to the PCAOB, this represents the first time the Board has imposed sanctions against a firm for issuing an audit report where a separate, unregistered firm conducted the underlying audit.