April 2010

From the editors of CCH Federal Securities Law Reporter, CCH Blue Sky Law Reporter and the securities publications of Aspen Publishers, this update describes important developments covered in these publications, as well as timely topics of interest generally to federal and state securities practitioners. Also included is a “Hot Topic of the Month,” with research tips and references to CCH and Aspen source material on point. Finally, this update includes a preview of IPO Vital Signs, an advanced IPO research analysis tool, for IPO professionals and pre-IPO companies.

To view past issues of the Securities Update, please visit http://business.cch.com/updates/securities.

If you have questions or comments concerning the information provided below, please contact me at rodney.tonkovic@wolterskluwer.com.

Financial Crisis Resources

CCH Federal Securities Law Reporter

SEC Adopts Alternative Uptick Rule for Short Sales. The SEC adopted amendments to Rules 200(g) and 201 of Regulation SHO that will restrict short selling in instances where a company’s shares drop 10 percent or more in value in one day. Under the new rule, a circuit breaker will be triggered any time a stock declines 10 percent in one day and short selling will be permitted in that security only if the price is above the current national best bid. Once the circuit breaker has been triggered, the rule would apply to short sale orders in that security for the remainder of the day and the following day. The alternative uptick rule will apply to equity securities that are listed on a national securities exchange, whether traded on an exchange or in the over-the-counter market. Under the rule, trading centers will be required to establish, maintain and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a prohibited short sale. Once the circuit breaker is triggered, long sellers will have preferred access to the bid price and will be permitted to sell their shares ahead of any short sellers. Release No. 34-61595 is reported at ¶88,872. (IntelliConnect) (IRN) (ip access user).

Commission Amends Money Market Fund Rules. The SEC published a release amending the rules for money market funds. The rules require money market funds to have a minimum percentage of their assets in highly liquid securities which can be readily converted into cash to pay redeeming shareholders. All money market funds must have at least 30 percent of their assets in cash, U.S. Treasury securities, government securities with remaining maturities of 60 days or less or securities that convert into cash within one week. The amended rules also impose new restrictions on the purchase of illiquid securities and create new limits on the acquisition of lower quality, or second tier securities. Funds will be required to develop procedures to identify investors whose redemption requests may pose a risk to the funds in order to anticipate the likelihood of large redemptions. The rules also expand the ability of an affiliate to purchase distressed assets to protect a fund from losses. Release No. IC-29132 is reported at ¶88,868. (IntelliConnect) (IRN) (ip access user).

SEC Adopts E-Proxy Amendments. Amendments to the SEC’s e-proxy rules highlighted a series of measures announced by the Commission to educate investors about proxy voting and to support greater investor participation in corporate elections. The changes to the proxy rules are intended to clarify and provide additional flexibility regarding the format of the notice of internet availability sent to shareholders and to permit issuers and other soliciting persons to better communicate with shareholders by including explanatory materials regarding the use of the notice and access proxy rules and the voting process. The amendments also revise the timeframe for delivering a notice to shareholders when a soliciting person other than the issuer relies on the notice and access proxy rules, and permit mutual funds to accompany the notice with a summary prospectus. Release No. 33-9108 is reported at ¶88,866. (IntelliConnect) (IRN) (ip access user).

10th Circuit: Protective Orders Precluded Sharing Information. A 10th Circuit panel found that the U.S. Attorney’s Office improperly disclosed confidential information to the IRS in violation of two protective orders. These orders were entered to safeguard personal financial information provided to a receiver in an SEC enforcement action by the victim of a securities fraud scheme. The IRS then obtained the information from the U.S. Attorney in the course of an investigation into possible tax avoidance by the investors in the scheme.

Dr. Richard Gerber invested money with Merrill Scott & Associates under a nominee arrangement promising large tax savings. The SEC subsequently sued Merrill Scott for securities fraud. A receiver in the SEC took charge of Dr. Gerber’s assets. In order to recover these assets, Dr. Gerber agreed to provide certain personal and confidential financial information to the receiver. The district court entered two protective orders to safeguard the confidentiality of this information, which found its way into the hands of the IRS. The initial protective order provided that all confidential information supplied by Dr. Gerber, including documents and deposition testimony, would be used solely for the purpose of litigating the SEC action and related litigation commenced by the receiver or the SEC, and for no other purpose, including “any other legal proceedings. The order did provide, however, that it could be disclosed to the U.S. Attorney. The second protective order included similar language that it would be “used solely for purposes directly related to this action. After obtaining the confidential information from the U.S. Attorney’s office, the IRS issued a number of third-party administrative summonses to banks, law firms, and brokerages concerning Dr. Gerber’s tax liability. In response, Dr. Gerber filed a motion with the district court for return of all documents allegedly disseminated in violation of the protective orders. In ruling against Dr. Gerber, the district court relied in part on the SEC’s alleged “statutory and regulatory obligation to share information with other governmental law enforcement agencies.

The 10th Circuit rejected this conclusion as an abuse of discretion. While the alleged obligation was reflected in the plain language of the orders permitting sharing of information with specified agencies for limited purposes, the court found that “it will not support the nearly unlimited construction placed on it by the government. The assertion of a law enforcement purpose is insufficient, without more, to justify actions in derogation of a valid protective order. The statutory provisions allowing the SEC to share information, including Securities Act Section 20(b) and Exchange Act Sections 21(d)(1) and 24(c) are permissive rather than mandatory, noted the court. The permissive nature of the SEC’s ability to share information did not provide an extrinsic limit on the SEC’s ability to enter into binding protective orders. “The SEC can certainly make a discretionary decision to forego its opportunity to share documents with others, including law enforcement agencies, stated the 10th Circuit.

Arguments that the U.S. Attorney could not be bound by the orders because it was not a party to the proceedings also failed. While in general a non-party is not bound by a protective order, the court stated that these orders clearly contemplated that the U.S. Attorney would only receive the information in question pursuant to their terms. As stated by the court, “we therefore cannot accept the government’s argument that would permit it unlimited use of the confidential information simply by passing it through the U.S. Attorney.The panel also observed that a showing of extraordinary or unusual circumstances is generally necessary in order to permit the government to benefit from access to confidential information provided pursuant to a protective order. The government failed to identify the presence of such unusual or extraordinary circumstances in this case, concluded the court. SEC v. Merrill Scott & Associates (10thCir) is reported at ¶95,649 (IntelliConnect) (IRN) (ip access user).

Court Construes Sarbanes-Oxley Whistleblower Protections. In deciding that an employee of the American Medical Association was not protected by the whistleblower protections of Section 806 of Sarbanes-Oxley, a Seventh Circuit panel rejected the notion that the phrase “contractor, subcontractor, or agent in Section 806 means anyone who has any contact with a company that issues securities under SEC regulations.

The statute extends its protection to SEC registered companies or those required to file reports with the SEC and their contractors, subcontractors or agents. It was conceded that the AMA was not an SEC issuer or filer. But the employee believed that an investigation by a “team of bloodhounds at the Department of Labor might turn up facts showing that the AMA is a contractor, subcontractor, or agent covered by Section 806.

While noting the employee’s belief that it would improve enforcement of Sarbanes-Oxley if the Secretary were more aggressive in nosing out violations, the panel said that the federal courts are not in the business of inventing procedures that agencies must follow. It is enough to enforce the statutes and regulations on the books. An agency must be allowed the authority to decide where its investigative and prosecutorial resources are best applied. Further, in the court’s view, the phrase “contractor, subcontractor, or agent refers to entities that participate in the company’s activities, and not, as the plaintiff argued, to any entity who has any contract with an issuer of securities. The idea behind such a provision, reasoned the panel, is that covered firms cannot retaliate against whistleblowers by employing contractors to act on their behalf. Fleszar v. US Department of Labor (7thCir) is reported at ¶95,647 (IntelliConnect) (IRN) (ip access user).

Court Allows Proposal Exclusion in Narrow Order. Apache Corp., a Texas-based energy company, may exclude a shareholder proposal submitted by John Chevedden from its proxy materials, according to a federal district court (SD Tex). In a narrowly-drawn opinion, Judge Lee H. Rosenthal wrote that Rule 14a-8 “does not necessitate a complete surrender of a corporation’s rights during proxy season...[a]lthough this court concludes that Rule 14a-8(b)(2) is not as restrictive as Apache contends, on the present record, Chevedden has failed to meet the rule’s requirements.” The court did, however, deny Apache’s request for an award of attorney fees and costs.

Rather than seeking staff permission to leave out his proposal, Apache Corp. notified the SEC that it intended to exclude the measure, and then sued Mr. Chevedden in federal district court. As alleged, Mr. Chevedden was not eligible to submit proposals because neither he, his introducing broker, nor the securities’ custodian was a record holder of Apache stock. A key issue in the case was presented by a 2008 no-action letter to Hain Celestial Group Inc. concerning another Chevedden proposal on similar facts. The staff concluded that “we are now of the view that a written statement from an introducing broker-dealer constitutes a written statement from the “record” holder of securities, as that term is used in Rule 14a-8(b)(2)(i).” Apache urged the court to disregard this staff interpretation, referring to it as a “rogue” letter. Judge Rosenthal wrote that the staff position in Hain Celestial was more consistent with the text of Rule 14a-8(b)(2) than the restrictive position Apache advanced, that the rule required confirming letters from the Depository Trust Co. or Cede & Co. The court also rejected Apache’s claims that the staff had retreated from its Hain Celestial position.

The case turned on the narrow issue of whether the one timely letter from Ram Trust Services, or RTS, which Mr. Chevedden asserted was his “introducing broker,” was sufficient. The court concluded that “the inconsistency between the publicly available information about RTS and the statement in the letter that RTS is a “broker” underscores the inadequacy of the RTS letter, standing alone, to show Chevedden’s eligibility under Rule 14a-8(b)(2).” Judge Rosenthal stated that Chevedden’s interpretation of the rule would require companies to accept any letter purporting to come from an introducing broker that names a DTC participating member with a position in the company, regardless of whether the broker was registered or if there were valid reasons to believe the letter was unreliable as evidence of the shareholder’s eligibility. The court emphasized that it was not ruling on what to submit to comply with Rule 14a-8(b)(2). “The only ruling is that what Chevedden did submit within the deadline set under that rule did not meet its requirements,” concluded the court. Apache Corp. v. Chevedden (SD Tex) is reported at ¶95,632 (IntelliConnect) (IRN) (ip access user).

CCH Blue Sky Law Reporter

Florida Adopts Review of Associated Person Applicants’ Law Enforcement Record. The law enforcement records of associated person applicants who have been found guilty of, or who have pled guilty or nolo contendere to, certain crimes will be reviewed by the Office of Financial Regulation to determine their eligibility to register in Florida. Applicants will be disqualified from registration for certain periods based upon criminal convictions, pleas of nolo contendere, or pleas of guilt, whether or not there was an adjudication. Class A crimes (felonies) involving fraud, dishonesty or any other acts of moral turpitude will disqualify applicants from associated person registration for 15 years while Class B crimes (misdemeanors) will disqualify applicants from registration for five years. Disqualification periods may be extended for applicants having committed multiple Class A or B crimes but can also be reduced with mitigating factors. Applicants have the burden to prove they’re entitled to register when their disqualifying periods expire. ¶17,452A (IntelliConnect) (IRN) (ip access user).

Michigan’s Transition Orders Conform to New Act. Michigan adopted four transition orders, the fourth order effective March 10, 2010, to conform various provisions of the State’s existing rules to its Uniform Securities Act that took effect October 1, 2009. The Michigan Office of Financial and Insurance Regulation is releasing administrative orders to indirectly conform its rules to the new Act rather than undergoing the more direct but lengthy process of proposing new rules and amendments to its existing rules. The fourth transition order allows issuers to forego filing a separate consent to service of process when they file new Form D because the built-in consent to service of process in new Form D meets this requirement. Other provisions clarify the custody requirement for investment advisers, as well as the application and exam requirement and waivers for investment adviser representatives. ¶32,666 will be published in a forthcoming Report.

Mississippi Temporary Rules Set to Become Permanent. Temporary rules pertaining to broker-dealers, agents, investment advisers, investment adviser representatives and federal covered investment advisers, and to federal covered securities, registration of securities and exemptions from securities registration, will be made permanent by the Mississippi Securities Division, effective April 8, 2010, to coordinate with the new Mississippi Uniform Securities Act that took effect on January 1, 2010. Much of the substance of the old rules continues with the temporary rules so that many of the rule amendments are nonsubstantive, updating statutory references to reflect new Act section numbers or changing rule section and subsection nomenclature. Please note that some of the CCH paragraph numbers now attach to different rules than the rules they previously attached to. ¶34,433 (IntelliConnect) (IRN) (ip access user) - ¶34,487 (IntelliConnect) (IRN) (ip access user).

“Private Security Exemption” Required Proof of Preexisting Relationship. In People ex rel. DuFauchard v. O’Neal, the California Court of Appeal held that the “private security exemption” was unavailable under the California Corporations Code where the offerors lacked a preexisting relationship with the investors. In affirming the ruling below, the appellate court reasoned that the testimony of each investor was sufficient to support the trial court’s conclusion that each of the nine investors did not have a business or personal relationship with the offerors such as would enable a reasonably prudent purchaser to be aware of the character, business acumen, and general business and financial circumstances of the person with whom such a relationship existed. Accordingly, the trial court did not err in ruling that the defendant’s sales of “principal investment agreements” were not exempt under the Corporations Code.

The appellate court also rejected the defendant’s contention that privity was required for an administrative enforcement action brought under the Corporations Code. Although the defendant argued that he could not be held liable for violations unless he was in privity with the investors, the privity requirement found in the civil enforcement provision of the Corporations Code has no bearing on administrative actions, the appellate court stated. The Commissioner may bring an administrative action seeking injunctive relief whenever it appears that “any person has engaged or is about to engage in any act or practice considered a violation.” Moreover, the Corporations Code contains no limitation that the Commissioner may seek restitution only on behalf of those in privity with the violator. Rather, the Commissioner may seek restitution on behalf of any person injured by the violation. People ex rel. DuFauchard v. O’Neal is reported at ¶74,812 (IntelliConnect) (IRN) (ip access user).

Aspen Federal Securities Publications

Financial Reporting Handbook, by Michael Young. The latest release, Release 26, (IntelliConnect) (IRN) (ip access user) is now available online. This reference provides quick access to critical aspects of financial reporting. In addition to covering the Sarbanes-Oxley Act, SEC rules and regulations, standards of the Independence Standards Board and the AICPA and requirements of the New York Stock Exchange, NASDAQ, and the American Stock Exchange, the Financial Reporting Handbook tackles important underlying themes such as the centrality of the audit committee, the individual responsibility of executives, and the integrity of the outside auditor.

Raising Capital: Private Placement Forms & Techniques, Third Edition, by J. Robert Brown, Jr., The Late Herbert B. Max. The 2010 Supplement (IntelliConnect) (IRN) (ip access user) is now available online. This unique resource provides practice tested forms and up-to-date expert guidance for successfully launching private placement investment transactions. The authors illustrate a variety of proven techniques for raising capital and explain ways to accommodate the investor’s demands for protection while maintaining the flexibility necessary for efficient operation and growth in today’s business and regulatory environment. This latest update contains a new chapter addressing the Troubled Asset Relief Program (TARP). The overview of the new chapter contains discussion and analysis of: TARP requirements; modification by the American Recovery and Reinvestment Act (ARRA); and coverage of related Department of the Treasury regulations. This new chapter also contains 36 forms including agreements, certificates, and sample contract clauses. Also included in this update is a completely revised chapter on Registration Rights (SEC Filings) and now includes the following agreements: Registration Rights Agreement (Demand and Piggyback Rights); Registration Rights Agreement (Mandatory Registration); Registration Rights Agreement (Shelf Registration; Piggyback Registration Rights; Hedging Transactions); and Registration Rights Agreement: “Shelf” Registration for Shares Issued Upon Conversion of Note. The updated chapter also contains a variety of clauses and resolutions relating to registration rights.

Hot Topic of the Month

This month’s hot topic is shareholder proposals. A shareholder proposal is a shareholder’s recommendation that a company and/or its board of directors take an action, which the shareholder intends to present at a shareholder meeting. Exchange Act Rule 14a-8 dictates when a company must include shareholder proposals in its proxy materials issued before an annual or special shareholder meeting. A registrant that receives a shareholder proposal within the prescribed time before the solicitation must include the proposal in its proxy statement, identify the proposal in the form of proxy, and give recipients of the proxy material a means by which to vote on the proposal, if the proposing shareholder meets the eligibility conditions and if the proposal does not fall within any enumerated ground for exclusion.

Rule 14a-8 enumerates thirteen substantive grounds on which management may exclude proposals. Exclusion is proper, for example, if the proposal: would require the registrant to violate state, federal, or foreign law; concerns the election of directors; violates the SEC’s proxy rules, including the anti-fraud rule; or concerns matters that relate to the registrant’s ordinary business operations. The company has the burden of showing that it is entitled to exclude the proposal and must submit to both the SEC and the proponent copies of the proposal, an explanation of the reasons why the company believes that exclusion is proper and a supporting opinion of counsel, in the case of grounds based on state or foreign law.

The SEC’s Division of Corporation Finance recently updated its compliance and disclosure interpretations under Form 8-K to explain how an issuer should calculate the four-business day filing period for Item 5.07. Item 5.07 requires companies to disclose the voting results of matters submitted to a shareholder vote. The C&DI on Form 8-K advises that, pursuant to Instruction 1 to Item 5.07 the date on which the shareholder meeting ends is the triggering event. Day one of the four-business day filing period is the day after the date on which the shareholder meeting ends. For example, if the meeting ends on Tuesday, day one would be Wednesday, and the four-business day filing period would end on Monday.

We publish information in a wide range of resources (e.g., Federal Securities Law Reporter, SEC Today, Securities Regulation - Loss & Seligman, etc.), and document types (cases, laws, regulations, newsletter articles, treatise discussion). For example:

Federal Securities Law Reporter

o Exchange Act Rule 14a-8, at ¶24,012 (IntelliConnect) (IRN) (ip access user)

o Form 8-K at ¶31,001 (IntelliConnect) (IRN) (ip access user)

o No-Action Letters (e.g., Bank of America at ¶76,440 (IntelliConnect) (IRN) (ip access user)

o Report letters (e.g., 2-18-09, “Staff Updates Interpretations on Form 8-K and Regulation S-K Disclosures” (IntelliConnect) (IRN) (ip access user))

o Apache Corp. v. Chevedden (SD Tex) at ¶95,632 (IntelliConnect) (IRN) (ip access user)

o CCH Explanations (e.g., ¶24,030.070 (IntelliConnect) (IRN) (ip access user) and ¶24,151.065 (IntelliConnect) (IRN) (ip access user))

SEC Today

o Shareholder Proposals on the Environment May Not Be Omitted From Proxy Materials (2-1-10) (IntelliConnect) (IRN) (ip access user)

o SEC Adopts New Proxy Disclosure and Safeguards for Investor Assets (12-17-09) (IntelliConnect) (IRN) (ip access user)

o Staff Modifies Approach to No-Action Letters Relating to Risk and CEO Succession (10-29-09) (IntelliConnect) (IRN) (ip access user)

Insights – Amy L. Goodman (e.g., “SEC Staff Provides Additional Guidance Regarding Shareholder Proposals” (October 2004) (IntelliConnect) (IRN) (ip access user)
Securities Regulation – Loss, Seligman & Paredes (e.g., Chapter 6.C.4 (IntelliConnect) (IRN) (ip access user))

Jim Hamilton’s World of Securities Regulation (http://jimhamiltonblog.blogspot.com/ e.g., 3-11-10)

IPO Vital Signs

IPO Vital Signs, an advanced IPO research analysis tool, assists IPO professionals and pre-IPO companies satisfy their most challenging research needs and answers hundreds of mission critical questions for all the players in the IPO process. IPO Vital Signs’ tabular data analyses focus on issues surrounding client advisement, deal negotiation, and prospectus disclosure.

IPO Week in Review, a weekly e-newsletter to keep professionals up to date with recent filing and going public activity, is an important element of the IPO Vital Signs system or is available by separate subscription. Coverage includes a monthly feature article on recent trends in going public in the U.S.

To see how an IPO Vital Sign works click on the Vital Sign title below: