Corporate & Financial Weekly Digest

SEC Reopens Comment Period for Proposed Amendments to Broker-Dealer Financial Responsibility and Related Rules

Daren R. Domina — Fri, 11 May 2012 10:36:33 -0500

Co-authored by Tanja Samardzija.

On March 9, 2007, the Securities and Exchange Commission proposed amendments to its net capital, customer protection, books and records and notification rules for broker-dealers. The firm previously summarized these proposed amendments in the March 16, 2007 edition of Corporate & Financial Weekly Digest.

The SEC did not act on the rule amendments, but it is now reopening the public comment period for the proposed amendments. Comments should be received on or before June 8, 2012.

To view the notice regarding the reopening of comment period, click here.

NASDAQ Proposes to Institute an Excess Order Fee

Daren R. Domina — Fri, 11 May 2012 10:34:32 -0500

Co-authored by Tanja Samardzija.

The NASDAQ Stock Market (NASDAQ) has proposed to adopt an excess order fee commencing on June 1. This fee is intended to reduce the number of non-actionable orders submitted to the NASDAQ market, and thus promote greater order interaction, increase the quality of NASDAQ market data and prevent potentially abusive trading practices.

NASDAQ will base the excess order fee on an order entry ratio. In general, the order entry ratio will be the ratio between (i) entered orders, weighted by the distance of the order from the national best bid or offer, and (ii) orders that execute in whole or in part. The excess order fee will be imposed on market participant identifiers with an order entry ratio of more than 100. The order entry ratio will be calculated, and the excess order fee will be imposed, on a monthly basis.

To view the notice of filing of the proposed rule change, click here. To view Exhibit 5 for the language of proposed rule change, click here.

Second Amendment to Effective Date for Swap Regulation

Kevin M. Foley — Fri, 11 May 2012 10:32:13 -0500

Co-authored by Blake J. Brockway.

On May 10, the Commodity Futures Trading Commission issued a notice of a proposed second amendment that extends the CFTC’s prior grant of temporary relief from certain swap-related provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The proposed amendment includes four changes. First, the definitions of the terms “swap dealer,” “major swap participant,” and “eligible contract participant” are excluded from the proposed order, because they were defined on April 18. Second, the CFTC proposes to extend the effective date for swap regulation from July 16 to December 31 or until the CFTC’s rules and regulations go into effect. The amended order also provides that agricultural swaps may be cleared in the same manner as any other swap without the need for additional guidance from the CFTC. Finally, the relief for exempt commercial markets (ECM) and exempt boards of trade (EBOT) previously granted by the Commission will expire on the effective date of the designated contract market (DCM) or swap execution facility (SEF) rules, whichever is later, unless the ECM or EBOT files a DCM or SEF application on or before the effective date of the DCM or SEF final rules, in which case the relief will remain in place during the pendency of the application.

The proposal will be published in the Federal Register for a 14 day comment period.

Click here for more information.

CFTC Issues Draft of 2012 Rulemaking Schedule

Kevin M. Foley — Fri, 11 May 2012 10:29:30 -0500

Co-authored by Blake J. Brockway.

On May 10, Commodity Futures Trading Commission Commissioner Scott O’Malia released a draft of the CFTC’s 2012 rulemaking schedule. The schedule contains a list of the earliest potential dates (ranging from May through the Fall) for consideration of a variety of CFTC rules including several remaining Dodd-Frank Wall Street Reform and Consumer Protection Act rules. For example, the product definitions and end-user exemption rules are slated for consideration as early as June; Core Principle 9 for designated contract markets and core principle rules for swap execution facilities may be considered as early as July; and the Volcker Rule and registered entity governance and conflicts of interest requirements may be considered as early as the Fall.

The full CFTC rulemaking schedule is available here.

Financial Statements and Settlement Negotiations of Cooperating Witnesses in SEC Action Not Discoverable by Defendants

Emily Stern — Fri, 11 May 2012 10:28:45 -0500

Co-authored by Dean N. Razavi.

The U.S. District Court for the Southern District of New York last week denied defendants Rajat Gupta and Raj Rajaratnam’s motion to compel documents concerning settlement negotiations between the Securities and Exchange Commission and various cooperating witnesses. The defendants argued that settlement negotiations were relevant to prove that the cooperators had an incentive to lie. Financial statements provided by the cooperators to the SEC, which demonstrated the cooperators’ ability to pay any fines or penalties imposed by the SEC, would also speak to bias. The court rejected the motion, relying heavily on the SEC’s willingness to produce the settlement agreements themselves. These agreements, rather than the negotiations surrounding them, were sufficient for the defendants to argue that the cooperating witnesses were biased; the cooperators had not made any “Wells” submissions or any other statements that would include fact admissions, and negotiations were more likely to reflect lawyer arguing and “puffery” rather than substantive evidence related to bias. Further, the court held that the financial statements would only be made available to the defendants if they were able to make a threshold showing that the witness lied to the SEC to procure a better deal.

Securities and Exchange Commission v. Gupta, No. 11 Civ. 7566 (JSR) (S.D.N.Y. May 1, 2012).

State Claims Related to Renewal of FEMA "Write Your Own" Floor Insurance Programs are Federally Preempted

Emily Stern — Fri, 11 May 2012 10:25:22 -0500

Co-authored by Dean N. Razavi.

The U.S. Court of Appeals for the Fifth Circuit last week held that any state claim related to the Federal Emergency Management Agency’s (FEMA) “Write Your Own” (WYO) flood insurance program is preempted by federal law if it is based on events which took place while the insured was already covered. The plaintiff, James Grissom, purchased WYO flood insurance from Liberty Mutual, and alleged that, when he applied for renewal, Liberty Mutual failed to disclose that the plaintiff was eligible for a preferred rate policy. Liberty Mutual defended that the plaintiff’s negligent misrepresentation claim was preempted by the National Flood Insurance Act, which establishes WYO insurance. WYO allows private insurers to issue flood insurance policies in their own names, underwritten by the Federal government. FEMA regulations govern the methods by which these carriers adjust and pay claims.

In prior cases, the Fifth Circuit established the rule that state law claims arising from “claims handling” by a WYO insurer are preempted, whereas “procurement-based” state law claims are not. The plaintiff argued that his claim was based on his renewal application, which should be considered “procurement-based.” The court held that the plaintiff’s negligent misrepresentation claim was a “claims handling” claim because the plaintiff was insured at the time of the interaction between the plaintiff and Liberty Mutual. “ If the individual is already covered and in the midst of a non-lapsed insurance policy, the interactions between the insurer and insured, including renewals of insurance, are ‘claims handling’ subject to preemption.” This bright line rule officially fixes in place the difference between preempted and non-preempted claims by requiring the court to consider the insured’s status at the time the claim arose.

Grissom v. Liberty Mutual Fire Insurance Co., No. 11-60260 (5th Cir. April 30, 2012).

SEC Issues Additional Guidance on Emerging Growth Companies

Robert J. Wild — Fri, 04 May 2012 12:02:17 -0500

Co-authored by Kari E. Hoelting.

On May 2, the Division of Corporation Finance of the Securities and Exchange Commission published an additional set of frequently asked questions (FAQs) regarding Title I of the Jumpstart Our Business Startups Act (JOBS Act), which was enacted on April 5. Title I of the JOBS Act includes reforms intended to facilitate capital raising by “emerging growth companies” (EGCs), such as allowing EGCs to submit draft registration statements on a confidential basis to the SEC. Title I of the JOBS Act became operative upon enactment.

Which companies can qualify as EGCs?

Total annual gross revenues for the most recently completed fiscal year is used to determine whether a company qualifies as an EGC. The calculation of total annual gross revenues of a financial institution includes gross revenues of traditional banking activities but not gains and losses on dispositions of investment portfolio securities (consistent with the approach set forth in Securities Exchange Act Rule 12b-2 for determining smaller reporting companies).

In general, all non-convertible debt securities issued over the prior three-year period, whether outstanding or not, count towards the $1 billion debt limit for purposes of determining whether a company has lost its ECG status. An issuer is not required to count debt securities issued in an A/B debt exchange offer; only the initial placement under Rule 144A is counted.

The effective date of the definition of ECG focuses on whether the first sale of common equity securities pursuant to an effective registration statement occurred on or before December 8, 2011. Accordingly, a sale of debt securities pursuant to an effective registration statement would not affect an issuer’s qualification as an ECG. Also, an ECG may use the confidential submission process to submit a draft registration statement for an A/B debt exchange offer on Form S-4 or on Form F-4, so long as the company’s initial public offering of common equity securities has not yet occurred.

If no other disqualifying condition occurs earlier, an issuer will lose its ECG status on the last day of the year which included the fifth anniversary of the first sale of common equity securities pursuant to an effective registration statement. An issuer may not regain ECG status after losing it pursuant to the disqualification provisions of the Securities Act of 1933.

If a predecessor is not eligible to be an ECG because its first sale of common equity securities occurred on or before December 8, 2011, then its successor is also not eligible. Neither an asset-backed securities issuer nor an investment company registered under the Investment Company Act may qualify as an ECG. However, because business development companies (investment companies that are not required to register under the Investment Company Act but are regulated pursuant to Sections 55 through 65 of the Investment Company Act) are generally subject to the disclosure and other requirements exempted by Title I, they can qualify as an ECG.

How should an EGC make its filings with the SEC?

The SEC will publicly release its comment letters and issuer responses no earlier than 20 business days following the effective date of the registration statement. Although confidential treatment will be afforded to response letters, an ECG should identify information for which it intends to seek confidential treatment under the procedures of Rule 83 upon public filing of its response letters on EDGAR.

An ECG that is not also a smaller reporting company is not permitted to comply with the smaller reporting company version of management’s discussion and analysis, despite the fact that an ECG is expressly permitted to comply with the smaller reporting company version of compensation disclosures under Regulation S-K,

What are the financial statement disclosure requirements applicable to EGCs?

EGCs must comply with XBRL requirements.

For an ECG that is not a smaller reporting company, three years of audited financial statements are required to be included in the company’s Form 10-K or Form 20-F. An ECG will only be required to include two years of audited financial statements in its registration statement for its initial public offering of common equity securities and its first Form 10-K or Form 20-F following such initial public offering will only be required to include the earliest audited period presented in connection with its initial public offering. An ECG may present its earnings to fixed charges for the same number of years for which it provides selected financial data disclosures in a registration statement.

An ECG can take advantage of an extended transition period for complying with any “new or revised” financial accounting standard, where “new or revised” accounting standard refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after the effective date of the JOBS Act.

If a foreign private issuer that reconciles its home country GAAP financial statements to U.S. GAAP otherwise qualifies as an ECG, the foreign private issuer may take advantage of the extended transition period for complying with new or revised financial accounting standards in its U.S. GAAP reconciliation.

ECG companies that choose to take advantage of the extended transition period for complying with any new or revised financial accounting standard must still comply with those accounting standards that exclude from their scope nonpublic entities.

If an ECG initially decides to take advantage of the extended transition period for complying with new or revised financial accounting standards, it may later decide to opt in and comply with the financial accounting standard effective dates applicable to non-EGCs. Any decision to opt in should be prominently disclosed in the first periodic report or registration statement following the company’s decision; the disclosure should state that such decision is irrevocable.

An ECG is required to include any restatement disclosures in its financial statements until its financial statements are updated for the next annual period.

Notwithstanding Section 7(a)(2)(A) of the Securities Act of 1933 which allows an ECG to only include two years of audited financial statements in its registration statement for its initial public offering, an ECG that is a first-time adopter of IFRS must still comply with Paragraphs 6 and 21 of IFRS 1, First-time Adoption of International Financial Reporting Standards, and present the required three statements of financial position.

Click here to read the FAQs.

CFTC Issues Proposed Interpretative Statement

Kevin M. Foley — Fri, 04 May 2012 11:56:04 -0500

Co-authored by Blake J. Brockway.

On May 1, the Commodity Futures Trading Commission, by a vote of 5-0, issued a proposed interpretative statement that would exempt foreign regulators from certain indemnification and confidentiality provisions of the Commodity Exchange Act (CEA).

Section 21(d) of the CEA provides that, before a swap data repository (SDR) may share data or information with a domestic or foreign regulator, the regulator must enter into a written agreement with the SDR to abide by the confidentiality requirements in the CEA and to indemnify the SDR and CFTC from any litigation expenses that may be incurred for any purported failure of the regulator to comply with the confidentiality agreement.

The CFTC is proposing to interpret section 21(d) to provide that its provisions would not apply to a foreign regulator that has a sufficient independent regulatory interest in obtaining the data even if that data has also been reported to the SDR pursuant to the CEA or CFTC regulations.

The CFTC accordingly proposes to interpret section 21(d) such that a registered SDR would not be subject to the confidentiality and indemnification requirements if: (i) the SDR is also registered, recognized or otherwise authorized in a foreign jurisdiction’s regulatory regime; and (ii) the data sought by a foreign regulatory authority has been reported to the SDR pursuant to the foreign jurisdiction’s regulatory regime.

The proposal will be in the Federal Register for a 30 day comment period.

Click here for more information.

CFTC to Hold Public Meeting to Consider a Final Rule

Kevin M. Foley — Fri, 04 May 2012 11:54:05 -0500

Co-authored by Blake J. Brockway.

The Commodity Futures Trading Commission will hold a public meeting on May 10 at 9:30 a.m. (EST) to consider the following rule on Core Principles and Other Requirements for Designated Contract Markets and a Proposed Order Amending the Effective Date for Swap Regulation.

Information regarding the open meeting may be found here. The original proposed rule and order may be found using the following links:

(1) Core Principles and Other Requirements for Designated Contract Markets; and
(2) Proposed Order Amending the Effective Date for Swap Regulation

CME Issues Advisory Notice Regarding the Termination of Temporary Waiver of Annual Application for Position Limits Exemption

Kevin M. Foley — Fri, 04 May 2012 11:47:46 -0500

Co-authored by Blake J. Brockway.

On April 30, CME Group issued a Market Regulation Advisory Notice related to the termination of its previously issued temporary waiver of the otherwise required annual application for exemptions from position limits. Pursuant to CME Group Rule 559, a person who has been authorized to exceed position limits must file an updated application on an annual basis. On December 20, 2011, CME Group issued a temporary waiver of this requirement in anticipation of the CFTC’s new position limit rules, which would separately require market participants to submit applications for exemptions. The temporary waiver is set to expire on May 31, 2012. CME Group is not offering an extension to the waiver, because the majority of the CFTC’s position limit and exemption regulations have not become effective and the effective date is not yet known.

Market participants that are currently operating under an exemption from speculative position limits that would have expired on or before May 31 must submit updated position limit exemption applications by May 31 in order to continue holding positions that exceed the speculative position limit after that date. Any market participant that relied on the temporary waiver and has not filed an updated annual application due between December 20, 2011 and May 31, 2012, must file such an application no later than May 31, 2012.

Notwithstanding the termination of the temporary waiver, all market participants currently operating under the terms of an Exchange-granted exemption from speculative position limits remain bound by, and must comply with, all relevant terms and conditions of such exemptions and Exchange rules.

Click here for more information.

Tenth Circuit Court of Appeals Denies Attempt to Withdraw Fifth Amendment Invocation

William M. Regan — Fri, 04 May 2012 11:46:56 -0500

Co-authored by Joseph E. Gallo.

The U.S. Court of Appeals for the Tenth Circuit recently addressed the question of when a defendant can withdraw an invocation of the Fifth Amendment right to refrain from making self-incriminating statements.

Defendant Brian Smart was a fund manager accused by the Securities and Exchange Commission of operating a Ponzi scheme. During the SEC’s initial investigation and again later in the litigation discovery process, Smart invoked the Fifth Amendment and refused to answer the SEC’s questions. The SEC moved for summary judgment, asking the District Court to draw an adverse inference against Smart as a result of his Fifth Amendment invocations. Smart moved to withdraw his Fifth Amendment assertion, arguing that he did not realize what the ramifications of that assertion would be. The District Court denied Smart’s motion to withdraw, drew an adverse inference, and awarded summary judgment to the SEC.

The Tenth Circuit held that the District Court did not abuse its discretion in refusing to allow Smart to withdraw his Fifth Amendment assertion. Relying on cases from the Fifth and Second Circuits, the Court emphasized that the decision to allow withdrawal is fact-dependent. In general, courts should be inclined to permit withdrawal where the opposing party would not suffer undue prejudice. On the other hand, courts should not permit withdrawal if “the litigant is trying to abuse, manipulate, or gain an unfair strategic advantage over opposing parties [by invoking the Fifth amendment].”

In this case, the defendant had invoked the Fifth Amendment during a pre-suit deposition, failed to attend his litigation deposition, and ignored attempts by the SEC to reschedule further depositions. The Court also found that because Smart made his Fifth Amendment assertion early in the investigatory process and only attempted to withdraw it after the SEC moved for summary judgment, he had ample time to determine the consequences of his assertion. Given the Defendant’s apparent use of the Fifth Amendment for improper strategic reasons, the Tenth Circuit upheld the District Court’s decision to deny Defendant’s motion to withdraw his Fifth Amendment assertion.

S.E.C. v. Smart., No. 11-4134, 2012 WL 1450424 (10th Cir. Apr. 27, 2012).

Idaho District Court Holds That Arbitration Requirement is Subject to Limited Judicial Review

William M. Regan — Fri, 04 May 2012 11:44:54 -0500

Co-authored by Joseph E. Gallo.

The United States District Court for the District of Idaho held that, under Ninth Circuit law, an arbitration award is judicially reviewable under the Federal Arbitration Act even where the arbitration agreement at issue contained language describing the arbitrator’s award as “final and binding” and not subject to appeal.

The arbitration award in this case arose out of a real estate dispute between investors and a real estate investment company known as DBSI, Inc. Subsequent to some initial court filings, the District Court ordered the parties to commence binding arbitration in accordance with an agreement between the parties requiring that all disputes be arbitrated pursuant to the rules and procedures of the American Arbitration Association. The arbitrator conducted an evidentiary hearing and issued a damages award in favor of the investors. The investors moved to confirm the award, while DBSI filed a motion to vacate.

The investors argued that DBSI waived its right to judicial review of the arbitration award. In particular, the investors pointed to language in the parties’ contract providing that “[a[ny award rendered…shall be final and binding on each and all of the parties” and that the parties were “waiving their judicial rights to discovery and appeals.”

The District Court first observed that while the Second and Eleventh Circuit had held that parties could not contractually agree to foreclose all judicial review of an arbitration award, the law in the Ninth Circuit was less clear. In particular, the Court noted that at least one Ninth Circuit case in dicta indicated that parties’ could contractually agree to eliminate all judicial review if such an intent was clear from the terms of the arbitration agreement.

In the present case, the District Court held that the “final and binding” language and appellate waiver were not sufficiently clear to permit the arbitration award to escape all judicial review (e.g. for an arbitrator’s abuse of authority, bias or manifest disregard of the law).

To eliminate all judicial review, the Court suggested the parties use language making clear that the arbitrator’s decision shall be “non-reviewable” or “final and unreviewable for error of law or legal reasoning of any kind.”

Swenson, et. al. v. Bushman Investment Properties, et. al., No. 10-cv-00175-ELJ, 2012 WL 1488346 (D. Idaho Apr. 27, 2012).

FSA Fines and Imposes Prohibition On Compliance Officer for Client Money Breaches and Fines Firm

Edward Black — Fri, 04 May 2012 11:41:29 -0500

On May 1, the UK Financial Services Authority (FSA) published the final notices it had issued to David Thornberry and Christchurch Investment Management Ltd (Christchurch) for failings in relation to client money segregation.

The FSA found that both Christchurch and David Thornberry had insufficient knowledge and oversight of compliance with the FSA’s client money rules. This led to serious breaches of the FSA client asset rules (CASS) which lasted from November 2007 until May 2010. Specific failures included failing to put in place adequate trust documentation for any of Christchurch’s 227 client bank accounts, which put client money at risk in the event of the firm’s insolvency.

The FSA fined Mr. Thornberry £11,550 (approximately $18,700) and prohibited him from acting as a compliance officer or having responsibility for client money or assets. This is the first time the FSA made such a prohibition order on an individual. The FSA fined Christchurch £26,000 (approx. $42,100). Christchurch and Thornberry agreed to settle at an early stage and therefore the financial penalties were reduced by 30%.

Richard Sutcliffe, head of the FSA’s Client Assets Unit stated:

“Christchurch’s failure to engage properly with the client assets rules is unacceptable. A firm must have adequate systems and controls in place to demonstrate that it complies with the CASS rules at all times. Otherwise clients are exposed to significant risks in the case of insolvency, fraud or poor handling of client money.”

For more information, click here.

SEC Issues Exemptions from Large Trader Reporting Rule

Daren R. Domina — Fri, 27 Apr 2012 10:17:17 -0500

Co-authored by Tanja Samardzija.

On April 20, the Securities and Exchange Commission issued an order temporarily exempting broker-dealers from the recordkeeping, reporting and monitoring requirements set forth in Rule 13h-1 of the Securities Exchange Act of 1934 (the Large Trader Reporting Rule) that were scheduled to take effect on April 30, 2012. The order also permanently exempts certain transactions from the definition of “transaction” under the Large Trader Reporting Rule, but only for purposes of determining whether a person is a “large trader.”

Generally, the order exempts registered broker-dealers from the Large Trader Reporting Rule’s recordkeeping and reporting requirements until May 1, 2013. Notwithstanding the foregoing, clearing broker-dealers for large traders that (a) are U.S.-registered broker-dealers or (b) trade via sponsored access arrangements are temporarily exempted from such recordkeeping and reporting requirements only until November 30, 2012. In addition, the order provides an exemption to all registered broker-dealers from the Large Trader Reporting Rule’s monitoring requirements, pursuant to which such broker-dealers are required to monitor their customers’ accounts for unidentified large traders, until May 1, 2013.

In its order, the SEC also permanently exempts certain transactions from the definition of “transaction” for purposes of the large trader identifying activity level calculation. The Large Trader Reporting Rule already excludes certain transactions from the identifying activity level calculation, which are not “effected with an intent that is commonly associated with the arm’s-length trading of securities in the secondary market and therefore would not fall within the types of transactions that are characterized by the exercise of investment discretion” for purposes of the Large Trader Reporting Rule. In addition to those transactions currently excluded, the following transactions are now excluded from the definition of “transaction” pursuant to the SEC’s order:

any transaction that is part of an offering of securities by or on behalf of an issuer, or by an underwriter on behalf of an issuer, or an agent for an issuer, whether or not such offering is subject to registration under the Securities Act of 1933, regardless of whether such transaction is effected through the facilities of a national securities exchange; and
sales of securities by a selling shareholder in connection with an initial public offering or in a registered secondary offering if such selling shareholder is a current or former employee of the issuer and the securities being sold were acquired as part of the person’s compensation as an employee of the issuer.

This limited exemption is meant to reduce the burden on issuers and selling shareholders who would not otherwise meet the definition of large trader in the absence of the transactions listed above, since these transactions typically are “infrequent in nature and are distinguishable in character from the secondary market activity” on which the Large Trader Reporting Rule focuses.

Click here to read SEC Release No. 34-66839.

CBOE - New Order Origin Code for FLEX Options

Daren R. Domina — Fri, 27 Apr 2012 10:15:13 -0500

Co-authored by Tanja Samardzija.

The Chicago Board Options Exchange (CBOE) has begun to transition the electronic trading capabilities of its existing FLEX options trading system (CFLEX 1.0) to its CBOEdirect trade engine. CBOE is effecting this transition by rolling out CFLEX 2.0. CBOE will initially make two classes of FLEX options available for trading on CFLEX 2.0 – the SPX and SPY. These two classes moved to CFLEX 2.0 on April 24. Additional classes will begin moving from CFLEX 1.0 to CFLEX 2.0 over the next one to three weeks.

A key difference between CFLEX 1.0 and CFLEX 2.0 is that a new order origin code applies to FLEX options for non-trading permit holder broker-dealers, i.e., order origin code “D”. On CFLEX 1.0, orders and responses for the account of non-trading permit holder broker-dealers use the origin code “C”. It is important to note that the new order origin code “D” pertains to FLEX options only.

Click here for CFLEX 2.0 rollout schedule, and click here for CBOE order origin code requirements.

Absence of Contract Bars Investment Advisers Act Claim by Private Plaintiff

Bruce M. Sabados — Fri, 27 Apr 2012 10:14:07 -0500

Co-authored by Elizabeth D. Langdale.

The United States District Court for the District of Utah recently found that a failure to allege a contractual relationship barred the plaintiffs’ Investment Advisers Act (the Act) claim as a matter of law.

The plaintiffs invested $1.65 million in a Ponzi scheme conducted by defendant Brian J. Smart. The plaintiffs alleged that Smart’s co-defendants Frank Winger, AIM Winger Corporation, and AIM Winger LLC, et al. (collectively, the Winger Defendants) failed to supervise Smart and aided and abetted Smart’s violations of Section 206 of the Act. The Winger Defendants moved to dismiss the claim, arguing that because the only remedy available to private plaintiffs under the Act is to void an investment advisers contract, and the plaintiffs alleged no contract with the Winger Defendants, the plaintiffs had not stated a valid claim.

The District Court agreed and granted the Winger Defendants’ motion to dismiss. It found that because the plaintiffs had not alleged a contractual relationship with the Winger Defendants, the plaintiffs could not state a claim for aiding and abetting a violation of the Act.

Padilla, et al., v. Winger, et al., No. 2:11 CV 897 (D. Utah Apr. 20, 2012)

District Court Considers Defendants' Challenge to SEC's Motion for Final Judgment

Bruce M. Sabados — Fri, 27 Apr 2012 10:08:37 -0500

Co-authored by Elizabeth D. Langdale.

The Securities and Exchange Commission filed an enforcement action against defendants Robert D. Orr and Leland G. Orr alleging massive financial fraud. As a result of the enforcement action, the court signed judgments of permanent injunctions against the defendants, with the defendants’ consent. As part of this consent decree, the defendants agreed to pay disgorgement, prejudgment interest on the disgorgement amount and civil penalties, in amounts to be determined by the court upon a subsequent motion by the SEC. The SEC filed its motion seeking the above monetary penalties, and defendants opposed the motion.

In opposing the motion, the Orrs disputed the accuracy, completeness and truthfulness of allegations in the SEC’s underlying complaint. The District Court rejected the defendants’ arguments, finding that by entering into a consent decree, the defendants had waived their right to litigate the issues involved in the underlying case.

In addition, the Court found that the defendants offered no evidence demonstrating that they were entitled to a reduction in the amount of disgorgement. The Court also found that because the defendants previously consented to an award of prejudgment interest, they were barred from challenging the equities of awarding prejudgment interest on the disgorgement amount. Finally, the Court exercised its “equitable discretion to fashion appropriate civil penalties” and, giving weight to the defendants’ efforts at “stepping into the gap and risking their own money and time to address unfolding and growing financial crises,” reduced the amount of civil penalties sought by the SEC. In sum, the defendants were ordered to pay nearly $1.24 million in disgorgements and prejudgment interest, and $68,000 in civil penalties.

SEC v. Robert D. Orr, Leland G. Orr, Michael S. Lowry, Michael S. Hess, Kyle L. Garst, and Travis W. Vrbas, No. 11-2251-SAC (D. Kan. Apr. 17, 2012)

SEC Staff Issues Observations on MD&A and Accounting Policy Disclosures of Smaller Financial Institutions

Jeffrey M. Werthan — Fri, 27 Apr 2012 10:07:51 -0500

On April 20, the Division of Corporation Finance of the Securities and Exchange Commission issued guidance with respect to certain matters relating to management's discussion and analysis and certain accounting policies of smaller financial institutions. Staff stated that "we frequently issue comments on several topics that impact Management’s Discussion and Analysis (MD&A) and accounting policy disclosures. We are issuing this guidance to summarize our observations on such matters in order to assist smaller financial institutions in enhancing the disclosure they provide investors in the reports they file with the Commission."

The guidance relates to the following topics: allowance for loan losses, charge-off and non-accrual policies, commercial real estate, impairment based on collateral value, credit risk concentrations, troubled debt restructurings and modifications, other real estate owned, deferred taxes, and FDIC-assisted acquisitions.

For more information, click here.

SEC Issues Additional Guidance on Emerging Growth Companies

Robert L. Kohl — Fri, 20 Apr 2012 10:51:42 -0500

Co-authored by Daniel J. Silverthorn.

On April 16, the Division of Corporation Finance of the Securities and Exchange Commission published an additional set of frequently asked questions (FAQs) regarding Title I of the Jumpstart Our Business Startups Act (JOBS Act), which was enacted on April 5. Title I of the JOBS Act includes reforms intended to facilitate capital raising by “emerging growth companies” (EGCs), such as allowing EGCs to submit draft registration statements on a confidential basis to the SEC. Title I of the JOBS Act became operative upon enactment.

Which companies can qualify as EGCs?

An EGC is defined under securities laws as an issuer with “total annual gross revenues” of less than $1 billion during its most recently completed fiscal year. The FAQs make clear that the phrase “total annual gross revenues” means total revenues as presented on the income statement presentation under U.S. GAAP (or IFRS, if applicable). If the financial statements for the most recent year included in the registration statement are those of the predecessor of the issuer, the predecessor’s revenues should be used when determining if the issuer meets the definition of an EGC.

An issuer is not an EGC if the first sale of common equity securities of such issuer pursuant to an effective registration statement occurred on or before December 8, 2011. According to the FAQs, the phrase “first sale of common equity securities” includes a company’s initial primary offering of common equity securities for cash as well as an offering of common equity pursuant to an employee benefit plan or a selling shareholder’s secondary offering on a resale registration statement. Even if the issuer had a registration statement declared effective on or before December 8, 2011, so long as the first sale of common equity securities occurs after December 8, 2011, an issuer may qualify as an EGC.

The FAQs state that the SEC will apply the following general principles for determining EGC status:

A company must qualify as an EGC at the time of submission in order to submit a confidential draft registration statement, or any amendment thereto. If a company ceases to qualify as an EGC while undergoing the confidential review of its draft registration statement, it would need to file a registration statement to continue the review process and comply with current rules and regulations applicable to companies that are not EGCs.
A company’s status at the time of the initial filing date of its registration statement (not the date of the initial confidential draft submission) will determine the requirements for the contents of that registration statement. If a company files its registration statement at a time when it qualifies as an EGC, the disclosure provisions for EGCs would continue to apply through effectiveness of the registration statement even if the company loses its EGC status during registration. Conversely, if a company submits a draft registration statement for confidential review at a time when it qualifies as an EGC, but files its initial registration statement at a time when it does not qualify as an EGC, then the initial registration statement would need to comply with the requirements applicable to registration statements filed by companies that are not EGCs.
A company would need to determine whether it qualifies as an EGC at the time it engages in “test-the-waters” communications pursuant to Section 5(d) of the Securities Act of 1933.

How should an EGC make its filings with the SEC?

The FAQs provide that the issuer should disclose that it is an EGC on the cover page of its prospectus. An issuer that qualifies as an EGC may amend its registration statement (in a pre-effective amendment to a pending registration statement or in a post-effective amendment) to provide the scaled disclosure available to EGCs if the registration statement was initially filed prior to April 5 (the date of enactment of Title I of the JOBS Act). An EGC that completed its initial public offering after December 8, 2011 and prior to April 5 may file its next periodic report using the scaled disclosure provisions in Title I. Other than for certain specified purposes, an EGC is permitted to decide to follow only some of the scaled disclosure provisions for EGCs.

The SEC will not object if a foreign private issuer that qualifies as an EGC complies with the scaled disclosure provisions available to EGCs to the extent relevant to the form requirements for foreign private issuers, but if the foreign private issuer chooses to take advantage of any benefit available to EGCs, then it will be treated as an EGC and will be required to publicly file its confidential submissions at least 21 days before its road show.

What are the financial statement disclosure requirements applicable to EGCs?

Title 1 provides that an EGC need not present more than two years of audited financial statements in a registration statement for an initial public offering of its common equity securities. According to the FAQs, the SEC will not object if an EGC presenting two years of audited financial statements in its initial public offering registration statement limits the number of years of selected financial data under Item 301 of Regulation S-K to two years as well. The SEC will also not object if, in subsequent registration statements, an EGC does not present audited financial statements for any period prior to the earliest audited period presented in connection with its initial public offering of common equity securities.

Title 1 provides that an EGC must choose whether it will take advantage of its EGC status for purposes of its financial statements at the time the company is first required to file a registration statement, periodic report, or other report with the SEC and to notify the SEC of such choice. An EGC should notify the SEC of its choice in its initial confidential submission, as that choice will inform the SEC’s review of the financial statements in the draft registration statement. EGCs that currently are in registration or are subject to Exchange Act reporting should make and disclose their choice in their next amendment to the registration statement or in their next periodic report. In addition, for any recently issued accounting standard that will apply to its financial statements, an EGC that chooses to take advantage of the extended transition period for complying with new or revised accounting standards should disclose the date on which adoption is required for non-EGCs and the date on which the EGC will adopt the recently issued accounting standard, assuming it remains an EGC as of such date.

Finally, the FAQs provide that if an EGC is filing a registration statement that includes other entities, and securities laws require disclosure of three years of financial statements for such other entities, the SEC will not object if the EGC presents only two years of financial statements for these other entities in its registration statement.

Click here to view the complete text of the April 16 FAQs.

CFTC Adopts Final Rules Defining Swap Dealer, Major Swap Participant, and Eligible Contract Participant

Kenneth M. Rosenzweig — Fri, 20 Apr 2012 10:50:31 -0500

Co-authored by Blake J. Brockway.

On April 18, the Commodity Futures Trading Commission and Securities and Exchange Commission adopted final rules defining swap dealer, major swap participant, and eligible contract participant under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The final rules define “swap dealer” as any person who: (i) holds itself out as a dealer in swaps; (ii) makes a market in swaps; (iii) regularly enters into swaps with counterparties as an ordinary course of business for its own account; or (iv) engages in activity causing itself to be commonly known in the trade as a dealer or market maker in swaps. The rule excludes persons that enter into swaps for their own account but not as a part of a regular business, insured depository institutions to the extent that they offer to enter into swaps with a customer in connection with originating a loan with that customer, certain hedging swaps, and swaps between majority-owned affiliates.

The rules also provide a de minimis exemption for persons who have over the past 12 months entered into swaps and security-based swaps that are credit default swaps with a notional value of less than $3 billion and swaps with “special entities,” as defined in the Commodity Exchange Act (CEA), with a notional value of less than $25 million. During a phase in period that will last a maximum of five years, the de minimis threshold applicable to swaps and security-based swaps that are credit default swaps will effectively be $8 billion, with the same $25 million limitation for swaps with special entities. For other types of security-based swaps, the final de minimis threshold and the de minimis threshold that applies during the phase in period will be $150 million and $400 million, respectively.

“Major swap participant” has been defined to mean a person who satisfies any one of the following criteria: (i) a person that maintains a “substantial position” in any of the major swap categories, excluding positions held for hedging or mitigating commercial risk and positions maintained by certain types of employee benefits plans for hedging or mitigating the risk of the plan; (ii) a person whose outstanding swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. banking or financial system, or (iii) any financial entity that maintains a “substantial position” in any major swap category and is highly leveraged relative to the amount of capital such entity holds and that is not subject to capital requirements established by an appropriate Federal banking agency.

Under the rules, a position qualifies as a “substantial position” if it meets either of two tests. The tests are applied based on a person’s swap positions in each of four major categories: rate swaps, credit swaps, equity swaps, and other commodity swaps. Under the first test, a person has a substantial position if it has a daily average current uncollateralized exposure of at least $1 billion in credit, equity or commodity swaps or $3 billion for rate swaps. Under the second test, a person has a substantial position if its daily average current uncollateralized exposure plus potential future exposure in credit, equity or commodity swaps exceeds $2 billion or $6 billion in rate swaps. The final rules provide specific procedures for calculating average daily uncollateralized exposure.

The definition of “eligible contract participant” (ECP) was expanded to include swap dealers, security-based swap dealers, major swap participants, and major security-based swap participants. The rules also implement a look through requirement for commodity pools that effect transactions in so-called “retail forex transactions.” Under these provisions, a commodity pool that is a counterparty to retail forex transactions generally will not qualify as an ECP if any participant in the pool is not itself an ECP. However, this rule will not apply if: (i) the pool is not formed for the purpose of evading sections 2(c)(2)(B) and 2(c)(2)(C) of the CEA or related rules, regulations or orders; (ii) the pool has total assets exceeding $10,000,000; and (iii) the pool is formed and operated by a registered CPO or by a CPO who is exempt from registration pursuant to CFTC Regulation 4.13(a)(3).

Click here for the CFTC Fact Sheet and Questions and Answers on the final rule.
Click here for the SEC fact sheet.