January 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 Approves Enhancements to Proxy Disclosure. The SEC adopted rule and form changes intended to enhance the information provided in proxy solicitations and in other forms filed with the SEC. Beginning in the upcoming annual reporting and proxy season, the new rules will improve corporate disclosure regarding risk, compensation and corporate governance matters when voting decisions are made. The amendments require registrants to make new or revised disclosures about several issues, including compensation policies and practices that present material risks to the company, stock and option awards of executives and directors, director and nominee qualifications and legal proceedings, board leadership structure, the board’s role in risk oversight, and potential conflicts of interest of compensation consultants that advise companies and their boards of directors. The new rules also require quicker reporting of shareholder voting results. Release No. 33-9089 at ¶88,827 (IntelliConnect) (IRN) (ip access user).

SEC Issues Release Amending NRSRO Rules. The SEC published rule amendments that are designed to improve the quality of ratings issued by nationally recognized statistical rating organizations. The amendments require more credit ratings history, which must be reported in XBRL format for 10 percent of the ratings in each class for which the NRSRO has registered and for which it has issued 500 or more credit ratings paid for by the issuer, underwriter or sponsor of the securities being rated. The disclosure about these issuer-paid credit ratings must be made no later than six months after a ratings action is taken. The SEC also adopted a requirement that NRSROs disclose ratings action histories for all credit ratings that were initially determined on or after June 26, 2007. NRSROs that seek access to information provided by an arranger to a hired NRSRO and made available to other NRSROs will be required to furnish the SEC with an annual certification that the NRSRO is accessing the information solely to determine credit ratings and will determine a minimum number of credit ratings using that information. The SEC also proposed rule amendments and a new rule that would require an NRSRO to furnish a new annual report which describes the steps taken by the firms designated compliance officer during the fiscal year with respect to compliance reviews. The proposals would also require NRSROs to disclose additional information about sources of revenue on Form NRSRO. Release Nos. 34-61050 (final) and 34-61051 (proposal) at ¶88,814 (IntelliConnect) (IRN) (ip access user) and ¶88,815 (IntelliConnect) (IRN) (ip access user).

Dura Loss Causation Standard Inapplicable in Criminal Case. A 9th Circuit panel declined to apply the loss causation standard required in private securities actions under the U.S. Supreme Court's decision in Dura Pharmaceuticals, Inc. v. Broudo (¶93,218) to a sentencing determination following a criminal conviction. According to the appellate court, the primary policy rationale of the Dura decision did not apply in a criminal context. In addition, the application of the civil rule to a criminal sentencing would result in a conflict with the applicable federal sentencing guidelines.

The panel noted that the Supreme Court in Dura was concerned principally with the plaintiff's ability to show actual loss caused directly by the fraudulent conduct. In criminal sentencing, however, the court gauges the amount of loss caused or the harm that society as a whole suffered from the defendant's fraud. The question of whether any particular individual suffered actual loss is not usually an important consideration in criminal fraud sentencing, stated the court. According to the court, a defendant may have caused aggregate loss to society in the amount of the fraud-induced overvaluation even if various individual victims' respective losses cannot be precisely determined or linked to the fraud.

In addition, the panel observed that the application of Dura would conflict with the flexible approach to loss calculation in criminal sentencing found in the federal sentencing guidelines. According to the commentary to the guidelines, "the court need only make a reasonable estimate of the loss, given the available information. This estimate, for example, may be based on the approximate number of victims and an estimate of the average loss to each victim, or on more general factors, such as the nature and duration of the fraud and the revenues generated by similar operation." The "relevant conduct" provision in the guidelines requires a defendant's sentence to be based on "all harm that resulted from the acts or omissions," even if the specific losses of particular individuals cannot be identified. The appeals panel did, however, question the lower court's loss causation methodology. Although the guidelines allow courts to employ various methodologies to approximate loss, "the fact that the court need only make a reasonable estimate of the loss does not obviate the requirement to show that actual, defendant-caused loss occurred." The 9th Circuit described the lower court's examination of the effect on the stock value of other unrelated companies after accounting irregularities were disclosed to the market as "counterfactual". This method "leaves us with little confidence that the government demonstrated, by the applicable standard of proof that shareholder loss occurred, let alone that approximately $2.1 million of loss occurred," stated the court.

The panel remanded the case to the district court to determine how much of the shareholders' loss was actually caused by the defendant's fraud. While the appellate court did not dictate the exact method the district court must use, the panel stated that whatever method is chosen should attempt to gauge the difference between the company's share price as inflated through fraudulent representation and what that price would have been absent the misrepresentation. U.S. v. Berger (9thCir) is reported at ¶95,533 (IntelliConnect) (IRN) (ip access user).

Second Circuit Upholds Short Sale Antitrust Preemption. A 2nd Circuit panel affirmed (In re Short Sale Antitrust Litigation) a decision by the U.S. District Court for the Southern District of New York that an antitrust claim against several brokerage firms involved in short selling was preempted by the securities laws. The class members acted as sellers in short-sale securities transactions and alleged that the brokerage firms conspired to charge short sellers artificially inflated fees in connection with securities borrowing for the sales in violation the antitrust laws. In determining that the antitrust claim was preempted, the appellate court applied the analysis used by the U.S. Supreme Court in its 2007 decision, Credit Suisse Securities (USA) LLC v. Billing.

The 2nd Circuit found that within the short sale context at issue, the antitrust laws were clearly incompatible with the securities laws. The court reached this conclusion because short selling is an area of conduct squarely within the area of securities regulations, the SEC has clear and adequate authority to regulate the area and is engaged in active and ongoing regulation, and there is a serious conflict between the antitrust and securities regulatory regimes. The appellate panel found that the Commission had sufficient regulatory authority over short sales under Exchange Act Section 10(a). The plaintiff, referring to the legislative history of that provision, argued that Section 10(a) was intended only to regulate the manipulation of share prices through short selling. However, according to the appeals panel, "nothing in the wording of Section 10(a) so limits its reach and the SEC has interpreted Section 10(a) as a grant of "plenary authority" to regulate short sales." Regulation SHO and the SEC's recent short sale roundtable evidenced the agency's ongoing regulation of short sales. While conceding that the roundtable and the regulation did not focus specifically on the regulation of borrowing fees, the court found that "it is enough for this purpose that the SEC's ongoing regulation is focused on the role of the prime brokers in short selling."

Finally, the court found that actual and potential conflicts existed between the antitrust and securities regulatory schemes. An actual conflict existed because antitrust liability would inhibit brokers from engaging in other conduct that the SEC currently permits and that benefits the efficient functioning of the short selling market. There was also a potential conflict because the SEC in the future may decide to regulate the borrowing fees charged by brokers. In re Short Sale Antitrust Litigation (2ndCir) is reported at ¶95,539 (IntelliConnect) (IRN) (ip access user).

2nd Circuit Upholds Sanctions Against Official in "Finder's Fee" Fraud. A 2nd Circuit panel upheld an order by the U.S. District Court for the District of Connecticut imposing sanctions against William A. DiBella, the former majority leader of the Connecticut State Senate, and his consulting firm, North Cove Ventures, L.L.C. The SEC charged Mr. DiBella and the firm with aiding and abetting Paul J. Silvester, the former Connecticut state treasurer, in a fraudulent investment scheme.

As alleged, Mr. Silvester had invested $75 million in state pension funds with Thayer Capital Partners, a Washington, D.C.-based private equity firm, and arranged for Thayer Capital to pay Mr. DiBella a percentage of the investment, though he did not do work to justify the payment. The district court ordered Mr. DiBella to disgorge $374,500 in ill-gotten gains and to pay $307,127.45 in prejudgment interest. In addition, the trial court imposed a civil penalty of $110,000.

The appellate panel rejected Mr. DiBella's argument that there were no violations for him to aid or abet because the treasurer had no fiduciary duty to disclose information concerning the investments and payments, and that the Investment Advisers Act did not apply because the case involved a state government and a state pension fund. According to the 2nd Circuit, Connecticut state law defined the treasurer as a fiduciary of the fund with duties to disclose the actions to at least the relevant legislative committee. The court also found that the Investment Advisers Act was applicable because Thayer Capital, and not the state, was the alleged violator. The SEC has also filed an application in the district court for a contempt order against Mr. DiBella for his failure to pay in the amounts entered by the trial court. SEC v. DiBella (2ndCir) is reported at ¶95,528 (IntelliConnect) (IRN) (ip access user).

CCH Blue Sky Law Reporter

Missouri Clarifies How Litigating Parties Must File Documents with the Securities Commissioner. Parties litigating cases before the Securities Commissioner must file an answer to a petition, motion for a continuance and/or other documents with the Commissioner's office, signed and dated, by mail delivery or carrier, or by fax. Documents are not considered "filed" until they are received in the Commissioner's office. Emailing documents to the Commissioner's office is not an approved format unless the Commissioner provides an email address for the specific purpose of receiving a document. ¶35,599 (IntelliConnect, IRN, ip access user).

Virginia Amends Issuer-Agent Exam Requirement. The exam requirement for issue-agents was amended by the Virginia State Corporation Commission, along with changes to certain internal references in an investment adviser/investment adviser representative dishonest, unethical practice rule. Any individual registered as an issuer-agent in any state jurisdiction within the two years immediately preceding the date the individual files a licensing application in Virginia is not required to comply with the State's issuer-agent exam requirement. Certain rule section numbers in an unethical, dishonest practice rule for investment advisers and investment adviser representatives were changed to refer to the recently adopted investment adviser custody rule. ¶60,417 (IntelliConnect, IRN, ip access user). ¶60,458XX (IntelliConnect, IRN, ip access user).

Wisconsin Adopts Rule Changes for Annual Revision. Wisconsin adopted rule changes for its 2009 annual revision to align statutory cross references with sections of the new Wisconsin Securities Act that took effect January 1, 2009, and to amend provisions pertaining to Rule 506 offerings, institutional investors, exemptions from securities registration, prospectuses, broker-dealer/agent/investment adviser/investment adviser representative exam requirements, supervised persons of noticed federal covered investment advisers, and investment adviser/investment adviser representatives forms. ¶64,502 (IntelliConnect, IRN, ip access user), ¶64,511 (IntelliConnect, IRN, ip access user), ¶64,512 (IntelliConnect, IRN, ip access user), ¶64,514 (IntelliConnect, IRN, ip access user), ¶64,543 (IntelliConnect, IRN, ip access user), ¶64,561 (IntelliConnect, IRN, ip access user), ¶64,581 (IntelliConnect, IRN, ip access user), ¶64,585 (IntelliConnect, IRN, ip access user), ¶64,593 (IntelliConnect, IRN, ip access user), ¶64,651 (IntelliConnect, IRN, ip access user).

Criminal Conviction Did Not Require Proof of Specific Intent. The Supreme Court of Tennessee has held that the legislature's inclusion of the term "willfully" in the Tennessee Securities Act (Act) did not require specific knowledge of an illegal act in order to support a conviction for a criminal violation of the Act's provisions. In State v. Casper, the defendant had been convicted at trial of fifteen counts of selling securities as an unregistered broker-dealer or agent through his business, an unchartered "trust company" that received finders fees for sales of preferred stock while marketing living trusts and estate planning services to seniors. An intermediate appellate court had overturned the convictions, however, concluding that the legislature had only intended to criminalize the selling of securities by an unregistered broker-dealer when the person is aware that his or her conduct is prohibited by law.

Reversing the decision below, the state high court ruled that proof that the defendant acted deliberately and was fully aware of his conduct was sufficient to warrant a conviction under the statute. The court reasoned that its interpretation of the term "willfully" in the securities context was consistent with both the terms of the Uniform Securities Act of 1956 (Uniform Act), on which the Tennessee statute is based, as well as the majority of other jurisdictions that have construed statutes based upon the Uniform Act. Moreover, the interpretation complied with the remedial purpose of the Tennessee securities laws, the court stated. Federal court decisions relied on by the lower court were inapposite because their interpretation of "willfully" in the context of federal tax and anti-structuring statutes did not share the "particular context" of the securities laws. As there was ample evidence in the record that the defendant knew both that he was selling securities and that he was not registered as a broker-dealer or agent, the court reinstated the defendant's convictions. State v. Casper is reported at ¶74,799 (IntelliConnect, IRN, ip access user).

Aspen Federal Securities Publications

Capital Markets Handbook, Edited by John C. Burch, Jr. and Bruce S. Foerster. The 2010 Supplement (IntelliConnect) (IRN) (ip access user) is now is available online. This supplement includes new information regarding the highlights (or low-light) of the sub-prime melt down of 2007; the panic of September 2008; the global credit squeeze/freeze of 2008-2009; IDEA (Interactive Data Electronic Applications) an eventual successor to EDGAR; complete update to the Capital Formations Alternatives Chart; an expanded treatment of “At the Market Offerings”; changes in the Qualified Independent Underwriter/Conflicts Rule; FINRA Rule 5190 regarding notification requirements under Regulation M; a new trading platform for Rule 144A securities; amendments to Rule 415 allowing smaller companies quicker access to the capital markets by permitting them to register primary offerings on Form S-3/F-3; Regulation FD issues in PIPE Offerings; amendments to Rule 144 affecting holding periods for non-affiliates; additions and updates to the credit-ratings agency appendix; additions to the compendium of service marked derivative securities; and an amended and expanded Glossary.

Financial Reporting Handbook, by Michael Young. The latest release, Release 25, will soon be 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.

Derivatives Regulation, by Philip McBride Johnson, and Thomas Lee Hazen. The 2010 Cumulative Supplement (IntelliConnect) (IRN) (ip access user) is now available online. Derivatives Regulation comprehensively covers the Commodity Exchange Act along with all other relevant aspects of the regulation of securities that have an impact on the derivatives markets. It covers the full range of emerging regulatory, reporting, and legal issues surrounding derivatives and related instruments. The 2010 Cumulative Supplement includes: developments with respect to security futures, i.e., listing requirements, evaluation of the security futures market, and impact of the Commodity Futures Modernization Act; developments with respect to other equity derivatives; developments in identifying a futures contract; developments in jurisdiction over credit default swaps and other over the counter derivatives; hedging “event” risk; the applicability of the commodities laws to forex dealers; a new subsection on swap transactions; and antifraud developments.

Audit Committees: Regulation and Practice, Second Edition, edited by Gerald S. Backman, Anne Marie Salan and Robert L. Messineo. Audit Committees: Regulation and Practice includes all the materials one would need in order to create, maintain, advise and/or serve on a well-functioning audit committee, including: relevant provisions of the Sarbanes-Oxley Act; SEC rules and regulations impacting audit committee independence, duties, powers and disclosures; and listing standards of the New York Stock Exchange, NASDAQ and the American Stock Exchange relating to audit committee composition, responsibilities and functions. It also contains an illustrative selection of “best practices” for audit committee chairs and members. The 2010 Supplement (IntelliConnect) (IRN) (ip access user) is the second part in the development of the Third Edition, which will be completed in 2010. This supplement comprises a completely new Chapter 6, Auditor Independence, which includes an overview of the subject, two sample audit committee pre-approval policies regarding services to be provided by the independent auditor, the pertinent SEC and PCAOB rules, and relevant SEC and PCAOB releases and guidance; and expansion of the section on Disclosure Requirements Concerning Audit Committees (Section 4.1) to cover disclosures regarding the independent auditor. Other developments include expanded discussion of the SEC rules concerning disclosures regarding the independent auditor and related SEC guidance; the revised Nasdaq Stock Market listing standards regarding audit committees and related interpretative material, as included in the recent codification of Nasdaq’s rules; and the revised Nasdaq Stock Market listing standards regarding codes of conduct and related interpretive material, as included in the recent codification of Nasdaq’s rules.

Regulation of Securities: SEC Answer Book, Third Edition, by Steven Mark Levy. This practical guide aids the reader in understanding and complying with the day-to-day requirements of the federal securities laws that affect all public companies. Using a question-and-answer format similar to that which the SEC has embraced, this guide provides clear, concise, and understandable answers to the most frequently asked securities compliance questions. This latest update contains a completely rewritten Chapter 9, Tender Offers, with expanded coverage of fraud, insider trading, issuer repurchases, security holder protections, pre-commencement communications, dissemination of Schedule TO information, the all-holders and best-price rules, cross-border transactions, mini-tender offers, state anti-takeover legislation, and board fiduciary duties when responding defensively to a hostile takeover. The 2010-1 Supplement (IntelliConnect) (IRN) (ip access user) also includes a complete rewriting of sections in Chapter 11 dealing with Regulation FD (Fair Disclosure) and Regulation G (disclosure of non-GAAP financial measures). Other updates include a wide range of additional timely topics, including: federal preemption of state regulation with respect to securities offerings made pursuant to Regulation D exemptions; guidance for determining whether an acquisition of securities qualifies as “in the ordinary course of business” for purposes of filing Schedule 13G; criteria for excluding a shareholder proposal that would have the board amend the articles of incorporation; procedures for requesting a retention copy of an SEC formal order of investigation; making the most of the Wells process in an SEC investigation as a means to induce the staff to pursue lesser violations, seek milder penalties, or even drop the matter altogether; control person liability for corporate securities violations; and the workings of the Fair Fund program for compensating injured investors.

Hot Topic of the Month

This month’s hot topic is shareholder derivative actions. Actions brought by shareholders for damages on behalf of the corporation are subject to special considerations, for example, provisions of the Federal Rules of Civil Procedure, as well as usual matters pertaining to an antifraud claim. In such an action, significant issues include whether the corporation, by imputation, should be considered to know what the officers and directors knew, whether a proper demand was made that the corporation initiate the litigation and the effect to be given to the decision of a committee that the litigation should not be initiated or maintained.

A key ingredient in the determination of demand futility is the independence of the board of directors. As a general rule, a director with a financial stake in the transaction being challenged by the shareholder will not be considered independent for purposes of dealing with a challenge to that transaction. Financial interest, however, is not the only test used to measure the disinterestedness of corporate directors. Additionally, the business judgment rule is a feature of state law that frequently appears in federal securities litigation brought as a derivative action with respect to the protection afforded to judgment calls made by officers and directors in the conduct of the corporation's business. Absent specific allegations of self dealing or bias on the part of a majority of the board, mere approval or acquiescence in the alleged objectionable acts is insufficient to render demand futile.

The U.S. Supreme Court has ruled that there can be no universal federal demand rule. Rather, the Court said that the demand futility exception must be applied as it is defined by the law of the state of incorporation. According to the Court, to superimpose a federal demand rule over state corporate doctrine would upset the balance the states have struck between individual shareholder power and the power of directors to control corporate litigation.

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

Federal Securities Law Reporter

· Report letter, "Derivative Plaintiffs Successfully Excuse Demand" (12-9-09) (IntelliConnect) (IRN) (ip access user); "Director's Fiduciary Duty Did Not Give Derivative Standing" (2-20-08) (IntelliConnect) (IRN) (ip access user)

· In re Nutrisystem, Inc. Derivative Litigation (ED Pa), at ¶95,545 (IntelliConnect) (IRN) (ip access user)

· Bader v. Blankfein (2ndCir) will be published in a forthcoming Report at ¶95,550.

· CCH Explanations (e.g., ¶22,789 (IntelliConnect) (IRN) (ip access user))

Insights – Amy L. Goodman (e.g., “California Supreme Court Requires Continuous Ownership to Maintain Standing in Shareholder Derivative Actions” (August 2000) (IntelliConnect) (IRN) (ip access user); “Tooley v. Donaldson: Simplifying the Direct/Derivative Distinction” (July 2004) (IntelliConnect) (IRN) (ip access user)
Regulation of Securities: SEC Answer Book – Steven Mark Levy (e.g., Q 16:60 (IntelliConnect) (IRN) (ip access user)
Jim Hamilton’s World of Securities Regulation (e.g., "Failure to Disclose Receipt of Wells Notice Does Not Support Demand Futility" (5-5-08)

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: