February 2008


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.

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

CCH Federal Securities Law Reporter

SEC Adopts Smaller Reporting Company Regulatory Relief and Simplification
The SEC approved amendments to its disclosure and reporting regulations to expand the number of companies that qualify for its scaled disclosure requirements for smaller reporting companies. Companies that have less than $75 million in public equity float will qualify under the new rules and companies without a calculable equity float will qualify if their revenues are below $50 million. The amendments move the scaled disclosure requirements from Regulation S-B to Regulation S-K. Release No. 33-8876 at ¶88,029 (ip access user).

Supreme Court Rejects Scheme Liability
The U.S. Supreme Court found that parties involved in a series of allegedly fraudulent transactions who made no public statements or misrepresentations could not be liable to investors in a private action. In rejecting scheme liability in this case, Justice Kennedy wrote that such a theory "does not answer the objection that petitioner did not in fact rely upon respondents' own deceptive conduct." Chief Justice Roberts and Justices Scalia, Thomas, and Alito joined in the majority opinion. Justice Stevens wrote a dissenting opinion, in which he was joined by Justices Souter and Ginsburg. Justice Breyer took no part in the case.

As alleged, a cable provider agreed to pay equipment vendors an inflated amount for television cable boxes in exchange for the vendors returning the additional payments in the form of advertising fees. The cable company improperly capitalized the increased equipment expenses while treating the returned advertising fees as immediate revenue, in order to create the appearance of an increase in the company's operating cash flow and revenue. The complaint alleged that the vendors entered into the sham transactions knowing that the cable company intended to account for them improperly and that analysts would rely on the inflated numbers. As described by the majority, "In effect petitioner contends that in an efficient market investors rely not only upon the public statements relating to a security but also upon the transactions those statements reflect. Were this concept of reliance to be adopted, the implied cause of action would reach the whole marketplace in which the issuing company does business; and there is no authority for this rule." The Court concluded that the acts of the non-speaking parties" which were not disclosed to the investing public, are too remote to satisfy the reliance requirement." The Court also cautioned that such an expansion of fraud liability could "allow plaintiffs with weak claims to extort settlements from innocent companies." This risk could be disruptive to the marketplace, as contracting parties could face increased costs and foreign firms could be deterred from doing business in the United States.

In his dissent, Justice Stevens wrote, "The allegations in this case ? that the [vendors] produced documents falsely claiming costs had risen and signed contracts they knew to be backdated in order to disguise the connection between the increase in costs and the purchase of advertising ? plainly describe 'deceptive devices' under any standard reading of the phrase." Justice Stevens also distinguished the Court's earlier holding in Central Bank of Denver v. First Interstate Bank (1993-94 CCH Dec. ¶98,178 (ip access user)) which precluded private actions for aiding and abetting fraud. According to Justice Stevens, "what the Court fails to recognize is that this case is critically different from Central Bank because the bank in that case did not engage in any deceptive act and, therefore, did not itself violate Section 10(b)." He concluded that "the fact that Central Bank engaged in no deceptive conduct whatsoever --in other words, that it was at most an aider and abettor --sharply distinguishes Central Bank from cases that do involve allegations of such conduct." Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. (US Sup Ct) is reported at ¶94,556 (ip access user).

Commission Allows Foreign Private Issuers to Use IFRS without Reconciliation to US GAAP
The SEC adopted rules to allow foreign private issuers to prepare financial statements in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board without reconciliation to US Generally Accepted Accounting Principals (GAAP). The rules amend Form 20-F, Regulation S-X, and other Securities Act and Exchange Act regulations. Release No. 33-8879 at ¶88,032 (ip access user).

SEC Clarifies Proxy Rules to Facilitate Electronic Shareholder Forums
The SEC adopted amendments to clarify that participation in an electronic shareholder forum that could potentially constitute a solicitation subject to the Commission’s proxy rules is exempt from most of the proxy rules if certain conditions are satisfied. The amendments are intended to remove legal ambiguity that might deter shareholders and companies from pursuing this mode of communication. Release No. 34-57172 at ¶88,043 (ip access user).

SEC Adopts Technical Amendments To Forms MSD, BD, ADV and Related Forms and Rules
The SEC adopted technical amendments to reflect the formation of the Financial Industry Regulatory Authority and to update certain address changes and agencies with which certain forms must be filed. The amendments affect Forms MSD, MSDW, BD, BD-N, BDW, ADV, and ADV-W, as well as related rules under the Exchange and Investment Advisers Act. Release No. 34-57166 at ¶88,042 (ip access user).

7th Circuit Reaches Same Result in Tellabs
The 7th Circuit again found that fraud allegations against Tellabs Inc. raised the required strong inference of scienter under the Private Securities Litigation Reform Act. The U.S. Supreme Court reversed the 7th Circuit panel's earlier decision in June 2007 (Tellabs v. Makor Issues & Rights, Ltd., Inc. (¶94,335 (ip access user)). Applying the high court's more rigorous standard for scienter pleading, the appellate panel again found that the investor allegations were sufficient.

The complaint against Tellabs, a maker of equipment used in fiber optics network, arose from statements made primarily by CEO Richard Notebaert about demand for the company's principal product, a switching system. In its first review of the case, the 7th Circuit concluded that "Instead of accepting only the most plausible of competing inferences as sufficient at the pleading stage, we will allow the complaint to survive if it alleges facts from which, if true, a reasonable person could infer that the defendant acted with the required intent." The Supreme Court rejected the 7th Circuit view, concluding that "To determine whether the plaintiff has alleged facts giving rise to the requisite 'strong inference,' a court must consider plausible non-culpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff. The inference that the defendant acted with scienter need not be irrefutable, but it must be more than merely 'reasonable' or 'permissible' --it must be cogent and compelling, thus strong in light of other explanations. A complaint will survive only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any plausible opposing inference one could draw from the facts alleged." The high court did not determine, however, whether the allegations were actionable under this standard and remanded the case to the appeals court.

Circuit Judges Wood and Sykes, who were on the first panel, were joined by Judge Posner, who wrote for the court. The inferences of non-culpable conduct were "highly implausible" and "very unlikely," according to Judge Posner. He observed "that no member of the company's senior management who was involved in authorizing or making public statements about the demand for the 5500 and 6500 knew that they were false is very hard to credit, and no plausible story has yet been told by the defendants that might dispel our incredulity." The court finally concluded that the inferences of fraudulent intent were cogent. The fact that the allegations were based in part on statements of confidential witnesses was not determinative. Makor Issues & Rights, Ltd. v. Tellabs Inc. (7thCir) is reported at ¶94,560 (ip access user).

CCH Blue Sky Law Reporter

Florida Changes Fingerprint Processing Fee for Associated Persons
The fingerprint processing fee for associated persons was decreased to $42.25 from $47. Also, the associated person licensing fee amount was removed from the rules so that it only appears in the Florida Securities and Investor Protection Act. ¶17,452 (ip access user), ¶17,456 (ip access user).

Hawaii Continues Fee Reduction for Licensees and Investment Companies
The following reduced fees are in effect until October 31, 2008: Broker-Dealers: $150 (initial and renewal); Agents: $37.50 (initial and renewal); Investment Advisers: $75 (initial and renewal); Investment Adviser Representatives: $37.50 (initial and renewal); Investment Companies: $150 (initial); $37.50 (renewal); After October 31, 2008, the following statutory fees take effect: Broker-Dealers: $200 (initial and renewal); Agents: $50 (initial and renewal); Investment Advisers: $100 (initial and renewal); Investment Adviser Representatives: $50 (initial and renewal); Investment Companies: $200 (initial); $50 (renewal). NOTE about Rule 506 offerings: The fee for making an offering under Rule 506 of federal Regulation D is unaffected by the above changes, remaining at $100 as of January, 2005. Note also that the Rule 506 offering fee in the new Hawaii Securities Act to be adopted July 1, 2008 will be $100. ¶20,564 (ip access user), ¶20,566 (ip access user).

Missouri Adopts Increased Income Guidelines in Direct Participation Programs
The income guidelines used to determine suitability in direct participation programs were adjusted upward for inflation. A gross income of $70,000 (up from $45,000) and a net worth of $70,000 (up from $45,000) excluding home, home furnishings and automobiles apply; or a net worth of $250,000 (up from $150,000) excluding home, home furnishings and automobiles applies. ¶35,453 (ip access user).

Hawaii Supreme Court Rejects "Sale of Business Doctrine"
In Fong v. Oh, the Supreme Court of Hawaii held that the Landreth stock characterization test applied to the question of whether the sale of all of the shares of an incorporated business involved a "security" under the Hawaii Uniform Securities Act (Act). The appellants, purchasers of a convenience store, had alleged that the appellee omitted a material fact in connection with the sale of securities when she failed to disclose that a portion of the corporation's income was derived from illegal cigarette sales. Adopting the test originally set forth by the United States Supreme Court in Landreth Timber Co. v. Landreth, the state high court ruled that an instrument constitutes a security where it: (1) bears the label of stock; and (2) possesses the traditional characteristics of stock. The lower court erred, therefore, in holding that the anti-fraud provisions of the Act did not apply to the sale as a matter of law. The decision is reported at ¶74,676.

Aspen Federal Securities Publications

Financial Reporting Handbook, by Michael Young
The latest release, Release 17 (ip access user), is now live on the IRN Corporate Governance Integrated Library. 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.

Capital Markets Handbook, Edited by John C. Burch, Jr. and Bruce S. Foerster
The 2008 Supplement (ip access user) is now live on both the Securities Integrated Library and the International Business Integrated Library on IRN. This supplement includes new information relating to newly established NASD fees for Well Known Seasoned Issuers (WKSIs) as applied to automatically effective S-3/F-3 registration statements; new regulations defining the scope of securities activities that a commercial bank may conduct without registering with the SEC as a securities broker; amendments to NYSE Rule 472 and NASD Rule 2711 establishing different "quiet periods" for IPOs and follow-on offerings as well as 25-day "quiet periods" for all underwriting participants including managers and co-managers; investor attempts to avoid prohibitions under Rule 105 of Regulation M banning the cover of short sales with offered securities and a new provision prohibiting purchase of offered securities by investors that have shorted offered securities during the Regulation M restricted period; expanded treatment of Rule 144A and the PORTAL market, including launch of competitive platforms by Goldman Sachs and by Morgan Stanley; SEC concerns about frequent users of PIPE transactions and about large PIPE offerings; liberalized rule for foreign private issuers to de-register securities and terminate their ‘34 Act reporting obligations; and accession of Japanese ratings agencies to Nationally Recognized Statistical Rating Organization (NRSRO) status

Hot Topic of the Month

This month’s hot topic is Venue. Exchange Act Section 27 provides that criminal proceedings may be brought in any district in which an act or transaction constituting an Exchange Act violation took place. In the case of civil actions brought either to enforce a liability or duty created by the Act or to enjoin a violation of the Act, venue is proper in any district in which an illegal act or transaction occurred; venue is also proper in the district in which the defendant is found, is an inhabitant, or transacts business.

A panel of the 4th U.S. Circuit Court of Appeals recently reversed a dismissal of criminal securities fraud charges on venue grounds, finding that the electronic filing of false documents through the EDGAR website was a material act making the Eastern District of Virginia a permissible venue. The circuit court rejected the defendant’s claims that the electronic transmission of a fraudulent document to a computer server in Alexandria, Virginia, did not constitute a "venue sustaining act," and that the defendant, who did business in Las Vegas, could not have reasonably foreseen that the form filed on EDGAR would be transmitted to the Eastern District of Virginia. The panel concluded that "[b]ecause a material act that constituted the violation occurred in the Eastern District of Virginia, namely the transmission of a fraudulent Form 10-Q into the district, the Eastern District is a proper venue."

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

IPO Vital Signs

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