Securities and Financial Sector Legal Review

Corporate Governance Update – January 2015

Posted in Corporate Governance

1) SEC Grants Second Bad Actor Waiver with Conditions

On January 27th, the Securites and Exchange Commission granted Oppenheimer a bad actor waiver under Rule 506(d).  The Commission’s order says “Oppenheimer will comply with the conditions stated in its December 10, 2014 waiver request letter, including that it will retain a law firm to review its policies and procedures relating to Rule 506 offerings, and that it will adopt improvements or changes, both as private placement agent in its investment banking business and as issuer and as compensated solicitor in its wealth management business. Oppenheimer’s waiver is also conditioned upon its completing firm wide training for all registered persons on compliance with Rule 506 of Regulation D.”

2) Corp Fin Issues New CDI of Regulation S-T (Addressing Non-Searchable Graphics or Images in Filings)

New CDI 118.01 of Regulation S-T addresses whether a filing can ever contain graphics or images that include non-searchable information. The answer generally is yes, if the filer also presents the same information as searchable text or in a searchable table within the filing.

3) Corp Fin Issues New CDI of Regulation S

New CDI 279.01 addresses whether restricted securities acquired in a Rule 144 transaction (other than Rule 144(a)(3)(v)) from an issuer that was a foreign private issuer at the time of the acquisition (but is now a domestic issuer) may be resold in an offshore transaction under Rule 904 without regard Rule 905. The  answer is, Yes. Rule 905 only applies to equity securities that, at the time of issuance, were those of a domestic issuer.

4) Corp Fin Issues No-Action Response for Abbreviated Tender or Exchange Offer Periods for Non-Convertible Debt Securities

The Staff granted a no-action letter whereby it agreed to not recommend enforcement actions when debt tender offers meeting certain guidelines is held open for as short as 5 business days.

5) SEC Announces Charges Against Standard & Poor’s for Fraudulent Ratings Misconduct

The Commission announced a series of federal securities law violations by Standard & Poor’s Ratings Services involving fraudulent misconduct in its ratings of certain commercial mortgage-backed securities (CMBS).

6) Failure to Make Reg S-K Item 303 Disclosure Can Lead to Section 10(b) Claim

On January 12th, the U.S. Court of Appeals for the Second Circuit ruled, in Stratte-McClure v. Morgan Stanley, that a failure to make a disclosure required by Item 303 of Reg. S-K is an omission that can serve as a basis for a Section 10(b) securities fraud claim, but only if the other requirements to state a Section 10(b) claim – such as materiality and scienter – have been met.

7) Updated Financial Reporting Manual to Make Accounting Standards Update No. 2014-17 Conforming Changes

On January 12th, the Division of Corporation Finance indicated that it recently updated its Financial Reporting Manual to conform it to the issuance of Accounting Standards Update No. 2014-17, Business Combinations (Topic 805): Pushdown Accounting, a consensus of the FASB Emerging Issues Task Force and rescission of SAB Topic 5.J.

DOJ and S&P Reach $1.38 Billion Settlement Agreement

Posted in Mortgage-Backed Securities, Securities Fraud and Class Actions

mortgageapplicationwithhouseThe Department of Justice (“DOJ”) announced that it had reached a landmark $1.375 billion settlement with the rating agency Standard & Poor Financial Services LLC (“S&P”).  The settlement resolves claims brought by the DOJ in 2013 and 19 states that S&P defrauded investors in residential mortgage-backed securities (“MBS”) and collateralized debt obligations (“CDO”).  The lawsuits alleged that investors suffered financial losses because S&P issued inflated ratings on MBS and CDO and that S&P falsely represented that its ratings were uninfluenced by S&P’s business relationships with the investment banks that issued the securities.

According to a press release from the DOJ:

Half of the $1.375 billion payment – or $687.5 million – constitutes a penalty to be paid to the federal government and is the largest penalty of its type ever paid by a ratings agency.  The remaining $687.5 million will be divided among the 19 states and the District of Columbia.  The allocation among the states and the District of Columbia reflects an agreement between the states on the distribution of that money.

In its agreed statement of facts, S&P admits that its decisions on its rating models were affected by business concerns, and that, with an eye to business concerns, S&P maintained and continued to issue positive ratings on securities despite a growing awareness of quality problems with those securities. S&P acknowledges that:

  • S&P promised investors at all relevant times that its ratings must be independent and objective and must not be affected by any existing or potential business relationship;
  • S&P executives have admitted, despite its representations, that decisions about the testing and rollout of updates to S&P’s model for rating CDOs were made, at least in part, based on the effect that any update would have on S&P’s business relationship with issuers;
  • Relevant people within S&P knew in 2007 many loans in RMBS transactions S&P were rating were delinquent and that losses were probable;
  • S&P representatives continued to issue and confirm positive ratings without adjustments to reflect the negative rating actions that it expected would come.

Under the settlement agreement, S&P did not admit any wrongdoing or that it violated any laws.

For additional commentary and analysis, see S&P, U.S. Said to Announce $1.4 Billion Settlement Tuesday, S&P to Pay $1.4 Billion to Settle U.S. Charges, S&P Will Pay Nearly $1.4 Billion to Settle Financial Crisis Litigation, How the Justice Department, S&P Came to Terms, and Critics Blast Justice Department’s S&P Settlement.

Corporate Governance Update – December 2014

Posted in Corporate Governance

1) SEC Announces Program to Facilitate Analysis of Corporate Financial Data

On December 30th, the SEC issued this press release that announced the launch of a pilot program to facilitate investor analysis and comparisons of public company financial statement data through “structured data sets.”

2) PwC Releases Report on Director and Investor Views on Trends Shaping Governance and Board of the Future 

The report compares the results of two surveys conducted in the summer, one of which was an investor survey and the other was a director survey. This new report cites notable differences in opinion, such as:

Investors are much more skeptical than directors about impediments to replacing underperforming directors.

  • Investors are more skeptical about overcoming board diversity challenges. 85% of investors believe there are impediments to increasing gender diversity compared to just 14% of directors.
  • Board composition and performance are receiving increased scrutiny. Both investors and directors sense this trend and express even more concern about lower levels of voting support for director nominees than last year.
  • 99% of directors say they understand their company’s risk appetite at least moderately well, compared to only 61% of investors who believe they do.

3) ISS Issues 20 FAQs on “Equity Plan Scorecard”

On December 22nd, ISS issued 20 FAQs on its new Equity Plan Scorecard

4) ISS Issues 9 FAQs on Independent Chair Policy

On December 22nd, ISS issued 9 FAQs on its new “Independent Chair Policy.”

5) NYSE Proposes to Delist Companies for Late 10-Q Filings

The NYSE proposed to amend its continued listing requirements relating to the late filing of a company’s annual report with the SEC (set forth in Section 802.01E or the Late Filer Rule) of the Listed Company Manual. As amended, the Late Filer Rule will (i) expand the rule to impose a maximum period within which a company must file a late quarterly report on Form 10-Q in order to maintain its listing and (ii) clarify the NYSE’s treatment of companies whose annual or quarterly reports are defective at the time of filing or become defective at some subsequent date.

6) NASAA Unveils Online Filing System for State Form D Filings

On December 15th, the North American Securities Administrators Association, Inc. (NASAA) unveiled its Electronic Filing Depository (EFD) for use in connection with state Form D filings in Rule 506 offerings.

7) Recent Insider Trading Decision Makes It Harder to Bring Cases in 2nd Circuit

On December 10th, the Court of Appeals for the Second Circuit issued a decision dismissing indictments against two defendants in United States v. Newman. The Court ruled that the government must prove that a remote tippee knows of the personal benefit received by a tipper in exchange for disclosing nonpublic information and the Court held that the government must prove that the personal benefit is “of some consequence.” As a result, in this case the benefits alleged by the government were not sufficient to support a conviction.

8) NASDAQ Listing Fee Increase and Structure Change

A new fee structure and increased fee rates for the Nasdaq Global Select, Global and Capital Markets will become effective on January 1, 2015, subject to several transition provisions.  All companies that list securities on these Nasdaq markets after January 1, 2015 will be subject to the all‑inclusive annual fee, subject to transitional relief for companies that apply to list on Nasdaq prior to January 1, 2015 but complete their listing after that date. Effective January 1, 2018, all Nasdaq-listed companies will be subject to the all‑inclusive annual fee.

Companies that are listed on the Nasdaq Global Select, Global or Capital Markets before January 1, 2015 and want to opt into the all‑inclusive annual listing fee structure for 2015 must complete and file the opt-in form available through the NASDAQ OMX Listing Center not later than December 31, 2014. Companies should be aware that this election is irrevocable. Companies that do not opt into the all‑inclusive annual fee will continue to be billed under the current annual fee structure for 2015, and will also continue to be subject to additional fees for listing additional shares, corporate actions and other Nasdaq regulatory fees, as applicable. Nasdaq‑listed companies should compare their current and anticipated listing and other fees under the current fee structure (using the new fee rates) with the fees payable under the new all‑inclusive fee structure to determine whether they might benefit from opting into the all‑inclusive fee structure. Further information is available in the Nasdaq Continued Listing Guide.

9) Federal Court Rules Against Corp Fin No-Action Response in Shareholder Proposal Context

The U.S. District Court for the District of Delaware determined that Wal-Mart should not have excluded a shareholder proposal from its 2014 proxy statement, even after the Company receivied a favorable SEC no-action letter.  The proposed related to an amendment to the Compensation, Nominating and Governance Committee charter to add oversight of implementation of policies that would evaluate whether Wal-Mart should sell a product that endangers public safety, has the substantial potential to impair Wal-Mart’s reputation or would be considered offensive to the values that are integral to the Wal-Mart’s brand. Trinity wanted the committee to consider whether or not the company should sell guns equipped with magazines holding more than 10 rounds of ammunition.

10) SEC Grants Whole Foods No-Action Request

The SEC granted Whole Foods no-action request yesterday allowing the company can exclude a 3%/3-year shareholder proposal and instead place the company’s own 9%/5-year proposal on the ballot. In allowing exclusion, the SEC relied on the Rule 14a-8(i)(9) counter-proposal basis.

11) House Passes Disclosure Modernization and Simplification Act

HR 4569 directs the SEC to study ways to simplify financial reporting for small and emerging growth companies and would permit public companies to include a summary page of all material information in 10-Ks.

12) House Passes SBIC Advisers Relief Act

HR 4200 amends ’40 Act to reduce regulation of advisers to Small Business Investment Companies, which are professionally-managed investment funds that finance small businesses.

Corporate Governance Update – October 2014

Posted in Corporate Governance

1) Former CFO Sues Walgreens for Defamation Over Earnings Forecast Error

In this Chicago Tribune article, it’s reported that a former Walgreens CFO has sued the company for blaming him for an earnings forecast error – a $1 billion error for which he was terminated.

2) Six Federal Agencies Jointly Approve Final Risk Retention Rule

On October 22, 2014, six federal agencies approved a final rule requiring sponsors of securitization transactions to retain risk in those transactions. The final rule implements the risk retention requirements in the Dodd-Frank Wall Street Reform and Consumer Protection Act.  A copy of the final rule can be accessed here.

3) SEC Approves PCAOB’s Related Party Transaction Changes

On October 21, 2014, the SEC issued an order approving the Public Company Accounting Oversight Board’s (“PCAOB”) new related-party transaction standards. Notably, the SEC retained the PCAOB’s proposed effective date – so the new standards will become effective for audits for fiscal years beginning on and after December 15, 2014.

4) SEC Statistics

On October 16, 2014, the SEC released the statistics for the activities of its Enforcement Division for the agency’s 2014 fiscal year, noting a “record” number of enforcement actions in 2014 involving a “wide range of misconduct” and including a “number of first-ever cases.” An analysis of the information released by the SEC that was produced by Kevin LaCroix at RT ProExec can be found here.

5) SEC Staff Goes After “Unregistered Securities” Brokers

The Division of Trading & Markets issued this set of FAQs – and OCIE issued this Risk Alert – to remind brokers of their obligations when they sell unregistered securities on behalf of clients, such as when founders and employees sell their initial stakes in companies that have gone public or when investors sell securities in public companies that were acquired in private placements. This twin sets of Staff guidance was accompanied by the announcement of an enforcement action against E*Trade for improperly selling billions of shares of penny stocks through such unregistered offerings. Stan Keller notes that while this doesn’t deal with lawyers and no registration opinions, including resales, the guidance has relevance for lawyers.

6) SEC and FINRA Warn Investors About Penny Stock Scams Hyping Dormant Shell Companies

On October 30, 2014, The SEC’s Office of Investor Education and Advocacy and the Financial Industry Regulatory Authority (FINRA) issued an alert warning investors that some penny stocks being aggressively promoted as great investment opportunities may in fact be stocks of dormant shell companies with little to no business operations. A copy of the press release can be found here.

Corporate Governance Update – September 2014

Posted in Corporate Governance, Enforcement Actions and Investigations, False Claims Act and Whistleblower Litigation

1) SEC Launches Section 16 and Schedule 13D Enforcement Initiative

In early September, the SEC announced charges against 28 officers, directors, or major shareholders for violating federal securities laws requiring them to promptly report information about their holdings and transactions in company stock (Section 16(a) reports and Schedules 13D and 13G). Six publicly-traded companies were charged for contributing to filing failures by insiders or failing to report their insiders’ filing delinquencies. Those companies settled allegations that they failed to disclose their insiders’ Section 16(a) violations as required by Item 405 of Regulation S-K.

2) World’s Leading Institutional Investors Managing $24 Trillion Call for Carbon Pricing, Ambitious Global Climate Deal

Prior to the recent Climate Summit at the United Nations to spur climate action and facilitate a global climate agreement in 2015, nearly 350 global institutional investors representing over $24 trillion in assets issued a statement calling on government leaders to provide stable, reliable and economically meaningful carbon pricing that helps redirect investment commensurate with the scale of the climate change challenge, as well as develop plans to phase out subsidies for fossil fuels.

3) SEC Grants Bad Actor Waivers to Citigroup

The SEC granted Citigroup waivers from restrictions that would have restricted a range of the bank’s activities, including selling investments in hedge funds to individuals, following a recent securities-fraud settlement. In August, the SEC completed a $285 million settlement with Citigroup over the sale of certain collateralized debt obligations to clients in late 2006 and early 2007. Under the SEC’s bad actor rule, parties with a “a relevant criminal conviction, regulatory or court order, or other disqualifying event” are restricted from participating in a private offering. The rule, adopted last year, is part of the 2010 Dodd-Frank regulatory changes.

Citigroup told clients in August it was working with the SEC to resolve the restrictions over the bank’s sale of hedge funds. The SEC granted Citigroup its request for a waiver to resume selling so-called private fund investments, accepting the bank’s arguments that its $285 million settlement didn’t involve intentional misconduct or a large number of employees. The SEC grants waivers to let firms conduct normal business, as long as the waiver is seen as being in the public’s interest. The SEC also allowed Citigroup to retain its “WSKI” status, removing a restriction that applied to the bank given the SEC’s finding that Citigroup violated antifraud provisions of U.S. securities laws. Firms found to have violated those laws typically have their status revoked for three years but are granted the option of appealing the decision.

The waivers can be found here and here.

4) Council of Institutional Investors Wants Proxy Disclosure of Board Evaluation Process

In its report, “Best Disclosure: Board Evaluation,” surveyed CII members said they value detailed disclosure of the board evaluation process when deciding on director elections. CII makes clear that investors do not expect information about the results of the actual evaluations, but believe that the process discussion “…is an indication that a board is willing to think critically about its own performance on a regular basis and tackle any weaknesses.”

5) SEC Announces Largest-Ever Whistleblower Award

On September 22nd, the SEC announced an expected award of more than $30 million to a whistleblower who provided key original information that led to a successful SEC enforcement action. The award will be the largest made by the SEC’s whistleblower program to date and the fourth award to a whistleblower living in a foreign country, demonstrating the program’s international reach.


Corporate Governance Update – August 2014

Posted in Corporate Governance

SEC Fee Rate Advisory #1 for Fiscal Year 2015

The SEC announced that in fiscal year 2015 the fees that public companies and other issuers pay to register their securities will be set at $116.20 per million dollars, representing a 10% drop from the current filing fee rate of $128.80 per million dollars.  The SEC order can be reviewed here.

SEC Announces $300,000 Whistleblower Award to Audit and Compliance Professional Who Reported Company’s Wrongdoing

The SEC announced a whistleblower award of more than $300,000 to a company employee who performed audit and compliance functions and reported wrongdoing to the SEC after the company failed to take action when the employee reported it internally.  It’s the first award for a whistleblower with an audit or compliance function at a company.

SEC Adopts Asset-Backed Securities Reform Rules

The SEC announced that it has adopted new rules for asset-backed issuers governing the disclosure, reporting, and offering process for asset-backed securities (ABS) to enhance transparency, better protect investors, and facilitate capital formation in the securitization market.

SEC Adopts Credit Rating Agency Reform Rules

The SEC announced that it has adopted new requirements for credit rating agencies to enhance governance, protect against conflicts of interest, and increase transparency to improve the quality of credit ratings and increase credit rating agency accountability.  The new rules and amendments, which implement 14 rulemaking requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act, apply to credit rating agencies registered with the SEC as nationally recognized statistical rating organizations (NRSROs).

SEC Charges Bank of America with Fraud in RMBS Offering

The SEC charged Bank of America and two subsidiaries with defrauding investors in an offering of residential mortgage-backed securities (RMBS) by failing to disclose key risks and misrepresenting facts about the underlying mortgages. (Press release and complaint)

The SEC alleges that Bank of America failed to tell investors that more than 70 percent of the mortgages backing the offering originated through the bank’s “wholesale” channel of mortgage brokers unaffiliated with Bank of America entities.  Bank of America knew that such wholesale channel loans presented vastly greater risks of severe delinquencies, early defaults, underwriting defects, and prepayment.  Bank of America only selectively disclosed the percentage of wholesale channel loans to a limited group of institutional investors.  Bank of America never disclosed this material information to all investors and never filed it publicly as required under the federal securities laws.

SEC Announces Award for Whistleblower Who Reported Fraud to SEC After Company Failed to Address Issue Internally

The SEC announced an award of more than $400,000 for a whistleblower who reported fraud to the SEC after the company failed to address the issue internally.

SEC Investor Alert on Unregistered Offerings

The SEC’s Office of Investor Education and Advocacy published an alert regarding unregistered offerings, entitled “10 Red Flags That an Unregistered Offering May be a Scam.” When Rule 506(c) of Regulation D was adopted pursuant to Title II of the JOBS Act, many feared that the rule would facilitate scammers trying to use the lifting of the general solicitation ban as a way to reach more potential victims.  This new investor alert is directed at educating investors about scams involving private placements and unregistered offerings, not just those involving a general solicitation.

SEC Announces Settled Proceedings for CEO and CFO Violations of SOX Internal Control and Certification Provisions

The SEC announced partially settled administrative proceedings against the CEO and former CFO of a company for violating the SOX internal control and certification provisions. The SEC alleges that the CEO and former CFO represented in a management’s report on internal controls that the CEO participated in management’s assessment of the company’s internal controls, when he didn’t actually participate in the evaluation. Moreover, the CEO and former CFO were alleged to have each certified that they had disclosed all significant deficiencies in internal controls to the outside auditors, when they allegedly misled the auditors about their controls by withholding from the auditors information about inadequate inventory controls and improper accounting practices.  It is not often in the years since SOX was enacted that these sort of standalone internal control/certifications cases are brought. Typically charges on these points are incidental to a much larger case relating to accounting failure.

SEC Publishes Investor Alert Regarding False and Misleading Stock Information Spread via Social Media

The SEC’s Office of Investor Education and Advocacy published an Investor Alert warning that promoters may use social media channels to spread false and misleading information about stock, mostly penny stocks.  Use of social media enables promoters to reach larger numbers of individuals with minimum effort and at a relatively low cost.  The alert provides tips as to how to spot the red flags of a social media based investment fraud.

      I.        LEGAL UPDATES

Delaware Extends Inspection Rights to Privileged Internal Investigation Documents

The Delaware Supreme Court in Wal-Mart v. Indiana Electrical Workers Pension Trust Fund – approved granting shareholders the right to inspect privileged and confidential internal investigation materials upon showing “good cause.”

American Meat Institute and the Conflict Minerals Rules

The U.S. Court of Appeals for the District of Columbia Circuit issued an en banc opinion in the appeal of American Meat Institute vs. U.S. Department of Agriculture, upholding a Department of Agriculture rule requiring “country of origin” labeling for meat products.  The outcome of this case may give the SEC hope that the Court will reverse the three-judge panel’s holding that the Dodd-Frank Act conflict minerals disclosure rules violate the First Amendment in National Association of Manufacturers, et al., v. Securities and Exchange Commission.  This is because a central issue with regard to the standard for review in the National Association of Manufacturers case was also at issue in American Meat Institute.

    II.        OTHER

Broadridge Publishes 2014 Proxy Season Statistics

Broadridge released its 2014 proxy season statistics. Most were in line with recent years, except mobile voting grew to over 1.5 million shareholders, a 300% increase over since ’12 and 70% from ’13.

PwC and IRRC Report on Cybersecurity Disclosures

A report released by PwC and the Investor Responsibility Research Center Institute indicates that while companies must disclose significant cyber risks, “those disclosures rarely provide differentiated or actionable information.” The report goes on to examine key cybersecurity threats to corporations and provides information to investors for the purpose of evaluating investment risk, business mitigation strategies, and the quality of corporate board oversight.

Updated AICPA Comfort Letter Guidance

The American Institute of Certified Public Accountants issued SAS 129, which amends the guidance in SAS 122 on comfort letters. The amendment addresses the auditor’s responsibilities when engaged to issue comfort letters to requesting parties in connection with a nonissuer entity’s financial statements included in a registration statement or other securities offerings. Through this amendment, the AICPA is seeking to address unintended changes to previous practices as a result of its Clarity Project (not to be confused with the FASB Simplification Initiative). The amended comfort letter guidance is effective for comfort letters issued on or after December 15, 2014, but early implementation is encouraged

Corporate Governance Update – July 2014

Posted in Corporate Governance

Associate Raxak Mahat co-authored this article.

1. SEC Charges Company CEO and Former CFO With Hiding Internal Controls Deficiencies and Violating Sarbanes-Oxley Requirements

On July 30, 2014, the SEC announced charges against the CEO and former CFO of QSGI Inc., a Florida-based computer equipment company for misrepresenting to external auditors and the investing public the state of its internal controls over financial reporting. The SEC’s Enforcement Division alleges that CEO Marc Sherman and former CFO Edward L. Cummings (i) misrepresented in a management’s report accompanying the fiscal year 2008 annual report for QSGI Inc. that Sherman participated in management’s assessment of the internal controls, (ii) improperly certified that they had disclosed all significant deficiencies in internal controls to the outside auditors, and (iii) withheld from auditors and investors that Sherman and Cummings participated in a series of maneuvers to accelerate the recognition of certain inventory and accounts receivables in QSGI’s books and records by up to a week at a time.

2. Chamber Releases Disclosure Effectiveness Recommendations

On July 30, 2014, the U.S Chamber of Commerce’s Center for Capital Markets Competitiveness released a set of recommendations for the SEC as the agency considers how to make disclosure more effective. The report contains both near-term and long-term recommendations for improvement, and among the near-term recommendations are suggestions to address identified reporting requirements that are obsolete or duplicative of other disclosures (e.g., Item 101 of S-K disclosure of acquisitions, financial disclosure by geographic region, disclosure of where an investor can get copies of filings). Longer-term improvements suggested by the Center include addressing the problem of duplication among SEC filings, modernizing the presentation and delivery of public company reports, and reforming disclosures for CD&A and MD&A.

3. SEC Adopts Money Market Fund Reform Rules

On July 23, 2014, the SEC adopted amendments to the rules that govern money market mutual funds. The new rules require a floating net asset value (NAV) for institutional prime money market funds, which allows the daily share prices of these funds to fluctuate along with changes in the market-based value of fund assets and provide non-government money market fund boards new tools – liquidity fees and redemption gates – to address runs.

4. ISS Releases Survey for 2015 Policy Updates

On July 17, 2014, Institutional Shareholder Services Inc. (ISS), the most influential proxy advisory firm, opened its annual survey ahead of updating its policies. The survey closes on August 29th – and then the results are released a few weeks later. There is also an open 30-day comment period in October, with the final policy updates arriving sometime in November.

5. FASB Publishes Proposal to Eliminate Extraordinary Items from US GAAP

On July 15, 2014, the Financial Accounting Standards Board (FASB), issued an exposure draft of a proposed Accounting Standards Update (ASU) that would eliminate the concept of extraordinary items from US GAAP. The proposed ASU is part of a simplification initiative by the FASB to identify, evaluate and improve areas of US GAAP for which cost and complexity can be reduced, while maintaining or improving the usefulness of the information provided to users of financial statements.

6. SEC Charges Ernst & Young With Violating Auditor Independence Rules in Lobbying Activities

On July 14, 2014, the SEC charged Ernst & Young LLP with violations of auditor independence rules. The SEC’s order instituting a settled administrative proceeding found that an Ernst & Young subsidiary lobbied congressional staff on behalf of two audit clients. Such lobbying activities were impermissible under the SEC’s auditor independence rules because they put the firm in the position of being an advocate for those audit clients. Despite providing the prohibited legislative advisory services on behalf of the clients, Ernst & Young repeatedly represented that it was “independent” in audit reports issued on the clients’ financial statements. Ernst & Young agreed to pay more than $4 million to settle the charges.

7. FINRA Clarifies Filing Requirements under Rule 2210 for Certain Research Reports and FWPs

On July 11, 2014, FINRA issued Regulatory Notice 14-30, announcing that the SEC has approved amendments to FINRA Rule 2210 (Communications with the Public) that: (i) exclude from Rule 2210’s filing requirements research reports concerning only securities listed on a national securities exchange and (ii) clarify that free writing prospectuses that are exempt from filing with the SEC are not subject to Rule 2210’s filing or content standards, while the filing and content requirements of Rule 2210 do apply to free writing prospectuses required to be filed with the SEC pursuant to Securities Act Rule 433(d)(1)(ii). These amendments were effective immediately.

8. SEC Issues New C&DIs on Accredited Investor Definition and Rule 506(c) “Reasonable Steps” Verification Safe Harbors

On July 3, 2014, the SEC issued new compliance and disclosure interpretations (C&DIs) on the definition of accredited investor under Rule 501(a) and the safe harbors for taking “reasonable steps” to verify accredited investor status under Rule 506(c).

9. NASAA Proposes Model State Rule for Electronic Filing of Form D and Other Documents with State Securities Regulators

The North American Securities Administrators Association (NASAA) sought comment on a proposed model rule that would require issuers to electronically file SEC Form D and other state securities registration and notice filing materials with state securities administrators through a new multi-state electronic filing system currently being developed by NASAA.


Update: Judge Rakoff Approves Citigroup-SEC Settlement

Posted in Mortgage-Backed Securities, Notable Decisions

One final development in the Citigroup-SEC settlement saga.  Today, Judge Rakoff approved the $285 million proposed settlement of the SEC’s charges against Citigroup in connection with certain mortgage-backed securities transactions.  This follows the Second Circuit’s decision on June 4th to vacate Judge Rakoff’s decision that rejected the settlement.  In that 2011 decision, Judge Rakoff criticized the Citigroup-SEC settlement on a number of grounds, including that it allowed Citigroup to avoid admitting guilt.  He was no less critical of the Second Circuit in his opinion approving the settlement, stating that the Court of Appeals “has now fixed the menu, leaving this Court with nothing but sour grapes.”

The case is U.S. Securities and Exchange Commission v. Citigroup Global Markets Inc., U.S. District Court for the Southern District of New York, No. 11-cv-7387.  For additional commentary and analysis, see Judge Rakoff Says 2011 S.E.C. Deal With Citigroup Can Close, Approval of SEC-Citigroup Deal Leaves Rakoff With a Case of ‘Sour Grapes’, and U.S. Judge Reluctantly Approves SEC-Citigroup $285 Million Deal.

Corporate Governance Update – June 2014

Posted in Corporate Governance

1. SIFMA Guidance on Accredited Investor Verification

Last week, the Securities Industry and Financial Markets Association (SIFMA) issued guidance to registered broker-dealers and investment advisers on some accredited investor verification methods. The guidance includes a form of a Rule 506(c) accredited investor questionnaire as well as a form of written confirmation.

2. SEC Announces Fraud Charges Against Three Former Regions Bank Executives in Accounting Scheme

The Securities & Exchange Commission announced fraud charges against three former senior managers of Regions Bank for intentionally misclassifying loans that should have been recorded as impaired for accounting purposes. The SEC also entered into a deferred prosecution agreement with Regions Financial Corp., which substantially cooperated with the agency’s investigation and undertook extensive remedial actions. Regions will pay a total of $51 million to resolve parallel actions by the SEC, Federal Reserve Board, and Alabama Department of Banking.

3. SEC Charges Former Brokers with Trading Ahead of IBM-SPSS Acquisition

The SEC charged two additional brokers with trading on inside information ahead of the $1.2 billion acquisition of SPSS Inc. in 2009 by IBM Corporation. The SEC alleged that former brokers Benjamin Durant III and Daryl M. Payton illegally traded on a tip about the acquisition from Thomas C. Conradt, a friend and fellow broker in the New York office of a Connecticut-based broker-dealer. The SEC complaint, filed in federal court in Manhattan, seeks return of alleged ill-gotten trading gains of approximately $300,000, with interest, financial penalties, and permanent injunctions. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Durant and Payton. The SEC previously charged that Conradt and David J. Weishaus, another fellow broker and tippee, traded on confidential information that Conradt received from his roommate, Trent Martin, a research analyst who misappropriated it from an attorney working on the transaction. Martin, Conradt, and Weishaus settled with the SEC and pled guilty last year to related criminal charges in the matter.

4. SEC Adopts Cross-Border Security-Based Swap Rules

The SEC adopted the first of a series of rules and guidance on cross-border security-based swap activities for market participants. The new rules will be key to finalizing the remaining proposals. The rules will be effective 60 days after their publication in the Federal Register.

5. SEC Charges Hedge Fund Advisory Firm and Others in South Florida-Based Scheme to Misuse Investor Proceeds

The SEC charged a West Palm Beach, Fla.-based hedge fund advisory firm and its founder with fraudulently shifting money from one investment to another without informing investors. The firm’s founder and another individual later pocketed some of the transferred investor proceeds to enrich themselves.

6. SEC to Bring More Insider Trading Cases in Administrative Proceedings?

As noted in a recent Reuters article, the SEC is looking to bring more insider trading cases “as administrative proceedings in appropriate cases,” Andrew Ceresney, head of the SEC enforcement division, told the District of Columbia Bar. “We have in the past. It has been pretty rare. I think there will be more going forward.”

7. The SEC’s First Whistleblower Retaliation Case

The SEC has brought its first whistleblower retaliation case against Paradigm Capital Management, Inc. for engaging in prohibited principal transactions and then retaliating against the employee who reported the trading activity to the SEC. This is the first time the SEC has filed a case under its new authority to bring anti-retaliation enforcement actions. The SEC also charged the firm’s owner with causing the improper principal transactions.

8. PCAOB Adopts “Related Parties & Unusual Transactions” Auditing Standard

The PCAOB recently adopted Auditing Standard #18 that expands audit procedures required to be performed with respect to three important areas: (1) related party transactions; (2) significant unusual transactions; and (3) a company’s financial relationships and transactions with its executive officers. The standards also expand the required communications that an auditor must make to the audit committee related to these three areas. They also amend the standard governing representations that the auditor is required to periodically obtain from management. The standard and amendments require SEC approval. If approved, they will become effective for audits of financial statements for fiscal years beginning on or after December 15, 2014, including reviews of interim financial information and may be revised for small reporting companies.

9. SEC Charges Bitcoin Entrepreneur With Offering Unregistered Securities

The SEC announced that is has charged the co-owner of two Bitcoin-related websites for publicly offering shares in the two ventures without registering them. A SEC investigation found that Erik T. Voorhees published prospectuses on the Internet and actively solicited investors to buy shares in SatoshiDICE and FeedZeBirds. But he failed to register the offerings with the SEC as required under the federal securities laws. Investors paid for their shares using Bitcoin, a virtual currency that can be used to purchase real-world goods and services and exchanged for fiat currencies on certain online exchanges. The profits ultimately earned by Voorhees through the unregistered offerings totaled more than $15,000.


Update – The Middle Road Taken: The Supreme Court’s Halliburton II Decision

Posted in Securities Fraud and Class Actions

On June 23, 2014, the Supreme Court issued its Decision in Halliburton v. Erica P. John Fund (“Halliburton II”). The decision upholds the Court’s prior Basic v. Levinson decision allowing the fraud on the market theory that presumes reliance, however; the Court agreed with Halliburton that defendants could rebut the presumption pre-class certification with evidence that an alleged misrepresentation did not actually affect the stock price. According to Law360, the decision “will likely make it somewhat more difficult for plaintiffs to bring securities class actions, but it stopped short of closing a major door.”

Chief Justice Roberts delivered the opinion of the Court, joined by Justices Kennedy, Ginsburg, Breyer, Sotomayor and Kagan.  Justice Ginsburg filed a concurring opinion, in which Justices Breyer and Sotomayer joined.  Justice Thomas filed an opinion concurring in the judgment, which Justices Scalia and Alito joined.

By way of background, Plaintiffs alleged that Halliburton “made a serious of misrepresentations regarding its potential liability in asbestos litigation, its expected revenue from certain construction contracts, and the anticipated benefits of its merger with another company – all in an attempt to inflate the price of its stock,” which dropped after Halliburton made a series of corrective disclosures.  Plaintiffs filed a motion to certify a class, which the District Court denied.  This District Court (which was affirmed by the Fifth Circuit) found that Plaintiffs must prove “loss causation,” that is, a “causal connection between the defendants’ alleged misrepresentations and the plaintiffs’ economic losses in order to invoke Basic [v. Levinson]’s presumption of reliance and obtain class certification.”  In its 2011 opinion, the Supreme Court vacated the judgment, finding that nothing in Basic justified the Fifth Circuit’s requirement that Plaintiffs prove loss causation at the class certification stage.  On remand, Halliburton argued that it had presented the absence of any price impact caused by its misrepresentations, and thus, investors would have to prove reliance on an individual basis rather than take advantage of Basic, which should defeat certification of the class.  The District Court rejected this argument, and the Fifth Circuit affirmed, finding that Halliburton’s price impact evidence could be used at trial on the merits, but that Halliburton could not use such evidence at the class certification stage.

In its 2014 Decision, the Supreme Court considered Halliburton’s request to overrule Basic’s presumption of reliance and “to instead require every securities fraud plaintiff to prove that he actually relied on the defendant’s misrepresentation in deciding to buy or sell a company’s stock.”  Halliburton advanced several arguments that Basic should be overruled, principal among them the “efficient capital markets hypothesis.” Essentially, Halliburton argued that Basic’s view of the market efficiency (that prices of shares traded on developed markets reflect all publicly available information, including any material misrepresentations) is “no longer tenable.”  According to Halliburton, empirical evidence suggests capital markets are not fundamentally efficient. This evidence, citing to recent crashes, suggests that information affecting a stock price is not immediately incorporated into stock price. The Supreme Court declined to disturb Basic, finding it rested on a “modest” premise.  As the Court held, “[e]ven the foremost critics of the efficient-capital markets hypothesis acknowledge that public information generally affects stock prices.”

While the Supreme Court kept the Basic presumption alive, it did give defendants a weapon.  Overruling the Fifth Circuit, the Supreme Court held that defendants should be able to defeat the presumption at the class certification stage through evidence that the alleged misrepresentation did not affect the stock price – so-called “price impact evidence.”  The Court held:

The fact that a misrepresentation “was reflected in the market price at the time of [the] transaction” – that it had price impact – is “Basic’s fundamental premise.”  Halliburton I, 563 U.S. at __ (slip op., at 7).  It thus has everything to do with the issue of predominance at the class certification stage.  That is why, if reliance is to be shown through the Basic presumption, the publicity and market efficiency prerequisites must be proved before class certification.  Without proof of these prerequisites, the fraud-on-the-market theory underlying the presumption completely collapses, rendering class certification inappropriate.  But as explained, publicity and market efficiency are nothing more than prerequisites for an indirect showing of price impace. There is no dispute that at least such indirect proof of price impact “is needed to ensure that the questions of law or fact common to the class will ‘predominate.’”  Amgen, 568 U.S. at __ (slip op., at 10) (emphasis deleted); see id., at __ (slip op., at 16-17).  That is so even though such proof is also highly relevant at the merits stage

Accordingly, the Court held that Defendants may introduce either “direct” or “indirect” price impact evidence at the class certification stage. Practicallly speaking, this means both sides will rely on experts and price impact studies, which will likely increase costs, and potentially serve as a deterrent to plaintiffs.  As Justice Ginsburg wrote in her concurring opinion, “[t]he Court’s judgment, therefore, should impose no heavy toll on securities-fraud plaintiffs with tenable claims.”  It may, however, result in fewer cases brought by plaintiffs with weaker claims.

In the few days since the decision came out, there has been significant commentary on its reasoning and likely effects.

While the Supreme Court took a “middle road,” many wonder if this created more confusion.  Professor Charles Korsmo of Case Western Reserve University School of Law told the Volokh Conspiracy that the decision “renders an already confused area of the law even more convoluted…”  Among other things, he observed that “[t]he dispute is almost never over whether there actually was a stock drop; it is over whether the company fraudulently concealed the negative information.”

Law 360 noted that the decision leaves open what exactly must be proven to show price impact or the lack thereof:

Price impact studies ultimately will be a tool defendants use to try to defeat claims at the class certification stage, so questions about what exactly defendants need to prove will have to be answered, according to Boris Feldman, a partner at Wilson Sonsini Goodrich & Rosati PC. Is it enough for the defendant to show no price impact followed the false statement? Or will they also have to show there was no impact when the corrective disclosure was made?

The real winners here may be the experts.  Costs will likely increase on both the plaintiff and defendant side to reflect the costs of preparing “price impact studies” at the pre-certification stage.  Beyond the costs of an expert price impact study, commentators also raised the spectre of increased discovery costs. Reuters columnist Alison Frankel, spoke to David Boies, attorney for the Halliburton II plaintiffs. She reported,

Moreover, Boies pointed out, defendants who decide to raise price impact arguments to oppose class certification will have to face shareholders’ discovery demands on the merits of their defenses. That’s going to expose defendants to depositions and documents requests they won’t welcome, he said. “Plaintiffs are going to get a whole lot more information at the class certification stage,” Boies said.

In anticipating of the decision, D&O insurers already began taking action.  As Law 360 reported,

Anticipating a so-called middle-of-the-road ruling in Halliburton, American International Group Inc. had already offered D&O policyholders an “event study endorsement” that will apply a $0 retention toward the cost of class certification event studies — critical tools used in securities litigation to measure an isolated stock price movement.


A representative for AIG said the Halliburton ruling has not impacted the company’s new policy provision. The decision to provide full, upfront coverage for costs of a class certification event study can be seen as a bet on AIG’s part that the Supreme Court’s decision, though tempered, is likely to benefit at least a few defendants battling securities class actions, experts say.