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July 2012


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. This update includes a preview of IPO Vital Signs, an advanced IPO research analysis tool, for IPO professionals and pre-IPO companies. New this month is a preview of RBsource, an all-in-one online securities law resource, powered by the Securities Redbook. Finally, please see the “Hot Topic of the Month,” for research tips and references to CCH and Aspen source material on point.

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Financial Reform Resources



CCH Federal Securities Law Reporter

SEC Adopts Dodd-Frank Compensation Committee and Advisers Provisions. Implementing Section 952 of the Dodd-Frank Act, the SEC adopted regulations directing the exchanges to establish listing standards requiring each member of a company’s compensation committee to be an independent member of the board of directors. The regulations do not require that exchanges establish a uniform definition of independence. Given the wide variety of issuers that are listed on exchanges, said the SEC, exchanges were given the flexibility to develop independence requirements appropriate for the issuers listed on each exchange. Although this provides the exchanges with flexibility to develop the appropriate independence requirements, the Commission reminded that the independence requirements developed by the exchanges will be subject to review and final SEC approval pursuant to Section 19(b) of the Exchange Act. In addition, when developing their own definitions of independence applicable to compensation committee members, the exchanges must consider relevant factors, including a director’s source of compensation, including any consulting, advisory or compensatory fee paid by the issuer; and whether a director is affiliated with the issuer, a subsidiary of the issuer, or an affiliate of a subsidiary of the issuer. The regulations also direct the exchanges to adopt listing standards providing that the compensation committee may, in its sole discretion, retain or obtain the advice of a compensation adviser. The compensation committee will be directly responsible for the appointment, compensation and oversight of the work of any compensation adviser retained by the committee. Further, each listed issuer must provide for appropriate funding for payment of reasonable compensation, as determined by the compensation committee, to any compensation adviser retained by the committee. Release No. 33-9330 is reported at ¶80,108.

SEC's Application of Rule Was Inconsistent and Arbitrary. A DC Circuit panel set aside a default order entered by the SEC against an executive director of a broker-dealer. The Commission alleged that the director's employer had violated the registration, reporting, and record-keeping requirements over a period of four years. According to the Commission, the broker-dealer, which was based in Moscow and was not registered as a foreign broker, controlled an affiliate in New York through which U.S. institutional investors were solicited to transact in stocks of Russian companies. Because Russian authorities will not execute U.S. requests for service of process, the Enforcement Division served the OIP on the New York affiliate and on the Russian respondents' U.S. counsel. The director's U.S. counsel opposed the Commission's motion to serve the foreign respondents by serving their U.S. counsel, but the administrative law judge ordered that the service be considered effective. While the director did not contend that he was unaware of the SEC proceedings, he did not respond to the OIP, and a default order imposing sanctions on the director and the other respondents was entered. The law judge found that the director had violated Exchange Act Section 15(a) by acting as an unregistered broker and issued a cease and desist order and bar from association and imposed a civil money penalty. The director moved to set aside the order, but both the law judge and the Commission found that he did not file the motion in a reasonable amount of time and that he did not adequately explain his failure to defend the proceedings. On review, the Commission concluded that the neither the default order nor the imposition of sanctions were unjust.

The panel found that the Commission's application of Rule of Practice 155(b) was inconsistent with precedent and arbitrary. Under Rule 155(b), a motion to set aside a default must be made within a reasonable time, state the reasons for the failure to appear or defend, and specify the nature of the proposed defense to the original proceeding. In this case, the Commission declined to consider the director's proposed defenses because he failed to meet the timeliness requirement and failed to satisfactorily explain not defending the OIP. The Commission reasoned that evaluating the merits of the director's defenses "would in effect grant him the hearing that he chose to forego by failing to defend the proceeding." The director argued that the Commission should be required to consider all three elements of Rule 155. According to the panel, the Commission failed to provide either a consistent interpretation of Rule 155 or a justification of "the apparent inconsistency of its application." In its briefs, the Commission discussed every Commission opinion addressing a motion to set aside a default and argued that it declined to consider proposed defenses when the defaulting parties did not timely move to set aside the default or could not justify the failure to answer. The panel stated that none of the cases cited by the Commission actually supported its argument since the Commission did not, in any of the cases, choose to ignore a petitioner's proposed defenses due to the failure to meet the first two requirements of Rule 155(b). The court concluded that the Commission had failed to offer a reasonable explanation for departing from its precedent.

The panel then found that the Commission provided no intelligible standard for what constitutes a reasonable amount of time for filing a motion to set aside a default. Here, the Commission looked to several dates to start the clock, including the date the director was served, the filing of the OIP, and the entry of the default order. The panel determined that the Commission had neither set forth any principled way to determine when the "reasonable time clock" starts running nor stated with any clarity the amount of time a petitioner has to file the motion.

The panel vacated the Commission's order and remanded to the Commission for further proceedings. The panel recommended that, on remand, the Commission carefully review the administrative law judge's analysis, which, the panel stated, was inadequate to support the penalties imposed. According to the panel, the law judge applied a faulty formula to calculate the second-tier civil penalties imposed and failed to determine how many violations occurred and how many violations were attributable to each person. The law judge relied on the conclusory allegations in the OIP, which were insufficient, the panel wrote, to justify the imposition of maximum second-tier penalties without further explanation. Rapoport v. SEC (DCCir) is reported at ¶96,917.

1st Circuit Examines Scienter Requirements. The 1st Circuit reviewed the question of scienter in a case arising from statements that a parent company, Textron, made about the financial condition of its subsidiary, Cessna Aircraft. Textron made public statements assuring its investors of the strength and depth of the backlog of orders and Cessna's "unusually low cancellations" during 2008. Senior management stated that the levels of cancellations at that time "are not even noteworthy." Three months later, Textron reported substantial cuts to Cessna's production levels due to few orders, a high number of cancellations, and "an unprecedented number of deferrals" of delivery dates by customers.

The court initially examined the district court’s finding that the alleged misstatements were not material, and observed that summary judgment, rather than a Rule 12(b)(6) motion, would likely be a more appropriate instance "to decide whether such details are of marginal interest or so important that Textron's statements were misleading without them."

However, the court found that it did not need to reach the materiality issue because it concluded that the plaintiffs’ scienter pleadings failed. According to the court, "nothing in the complaint suggests that any of the named officers believed, or was recklessly unaware, that the backlog's significance had been undermined by weakened underwriting standards, sales to intermediates, or any of the other flaws on which the plaintiffs rely." In addition, the questionable materiality of the practices, depending importantly on matters of degree and detail, "deprives any inference of scienter of forward momentum that would be helpful to plaintiffs." Warnings by subordinates or expressions of concern by executives were also notably absent, observed the court. Finally, the court recognized that the officers may have been overly optimistic or extravagant in their descriptions, but "negligence or puffing are not enough for scienter." Automotive Industries Pension Trust Fund v. Textron Inc. (1stCir) is reported at ¶96,908.

2nd Circuit Considers Exceptions to Section 16(b) Liability. A 2nd Circuit panel affirmed a district court's finding of liability for profits realized by a limited partnership in short-swing insider trading. In 2003, the partnership had purchased a promissory note from the plaintiff corporation which it exchanged in 2004 for a note with the same face value, but different terms. The partnership then converted the note into shares of common stock which were sold in the open market. The corporation claimed that these were short-swing sales and sought disgorgement of the profits realized through the sales. The district court found that the partnership's transactions were covered by Exchange Act Section 16(b), which requires insiders to disgorge profits earned in short-swing trading. According to the court, the note was sufficiently different from the earlier note to constitute a new note for Section 16(b) purposes, and the conversion of the note at a floating price constituted a Section 16(b) purchase.

On appeal, the partnership argued that the transactions were within the scope of the "debt" and "borderline transaction" exceptions to Section 16(b) liability. Section 16(b)'s prohibition on short-swing trading does not apply to transactions involving securities acquired "in connection with a debt previously contracted." The partnership argued that the 2004 note was acquired in satisfaction of a debt owed as a result of the corporation's default on the 2003 note. The panel, however, was not persuaded, citing precedent indicating that the debt at issue must be a matured debt, and the debt for which the 2004 note was acquired was not matured. The court found that the maturity date specified in the 2003 note was not accelerated by the default and was thus not matured at the time of the transactions. Under the terms of the note, acceleration was optional for the type of default that occurred, and the partnership never demanded acceleration or prepayment. Accordingly, the district court did not err in rejecting the applicability of the debt exception.

The panel then concluded that the "borderline transaction" exception also did not apply. Borderline transactions are those that do not realize short-swing profits based upon access to inside information. Here, the partnership contended that it was impossible for it to gain any advantage from inside information because the acquisition of the 2004 note was the product of negotiation between the partnership and the corporation and both parties had access to the same information. The panel disagreed, noting that it had specifically rejected that argument in a previous case and that the exception is limited to involuntary transactions where the statutory insider has no access to insider information. In this case, the partnership could not show that the possibility of speculative abuse was nonexistent, and since it had access to inside information, the borderline exception did not apply.

Next, the acquisition of the 2004 note was a "purchase" of securities for the purposes of Section 16(b). The 2004 note extended the maturity date of the earlier note, which, according to an SEC interpretive release, is deemed for the purposes of Section 16 to be a redemption of the old security and the grant of a new one. Moreover, the panel found that the terms of the 2004 note were materially altered from the 2003 note such that the 2004 note was a new security.

To explain its conclusion, the panel then addressed what it called the "unsettled issue" of hybrid derivative securities under Section 16(b). This case dealt with a hybrid option having both fixed and floating price features, a situation in which district courts in the 2nd Circuit have taken varying approaches. The panel preferred a "bifurcated" approach in which "the acquisition of a hybrid instrument that allows for the purchase of shares constitutes a Section 16(b) purchase of the minimum number of shares that could be acquired if exercise were at the fixed price; conversion of the instrument at a lower floating price is a separate Section 16(b) purchase of any additional shares acquired based on the difference between the fixed price and the floating price." The panel found that the district court correctly held that the both the acquisition and conversion of the 2004 note constituted separate Section 16(b) purchases that were matchable with later sales.

Finally, the panel held that all of the defendants were liable for disgorgement of the profits earned on the transactions at issue. The partnership argued that disgorgement should be limited to the pecuniary interest in the profits held by the managing member of one of the partners because he was delegated sole voting and investment power and was thus the sole beneficial owner of the securities. The panel disagreed, stating that this argument was inconsistent with basic principles of agency law. Therefore, both of the general partners and the managing member were beneficial owners and subject to disgorgement of the profits realized by the partnership. Analytical Surveys, Inc. v. Tonga Partners, L.P. (2ndCir) is reported at ¶96,903.

Second Circuit Allows S-K Item 303 Claim Against Chip Maker to Proceed. In a second look at a case arising from allegedly undisclosed defects in semiconductor chips, the 2nd Circuit allowed claims of Securities Act Sections 11, 12(a)(2) and 15 violations to move forward. The court found that the allegations stated a claim for failure to comply with the disclosure requirements of Regulation S-K Item 303. Under this provision, registrants must discuss in the MD&A section "any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations."

The issuer, Ikanos Communications Inc., manufactured programmable semiconductors for sale to equipment manufacturers for telecommunications carriers. Ikanos learned in January 2006 that there were quality issues with some of its chips that caused the networks operated by end users to fail. The company conducted a secondary stock offering in March 2006. The registration statement and prospectus did not specifically disclose the defect at issue. Rather, the documents stated in general terms that its "highly complex products…frequently contain defects and bugs." Ikanos eventually had to pay to replace at its expense all of the units sold to two of its largest customers.

The appellate court emphasized that when "viewed in the context of Item 303's disclosure obligations, the defect rate, in a vacuum, is not what is at issue. Rather, it is the manner in which uncertainty surrounding that defect rate, generated by an increasing flow of highly negative information from key customers, might reasonably be expected to have a material impact on future revenues." Two allegations in the complaint were crucial to the court's decision. The first was that Ikanos was receiving regular and increasing numbers of complaints from two customers that represented more than 70 percent of the company's revenues. The second was that Ikanos knew when it was receiving the complaints that it would be unable to determine which chip sets contained defective chips, and that all of the chip sets sold to these major customers would have to be replaced.

The court concluded that the "reasonable and plausible inferences from these allegations are not simply that Ikanos quite possibly would have to replace and write off a large volume of chip sets, but also that it had jeopardized its relationship with clients who at that time accounted for the vast majority of its revenues." The court stated that "Item 303's disclosure obligations, like materiality under the federal securities laws' anti-fraud provisions, do not turn on restrictive mechanical or quantitative inquiries." In light of the allegations concerning known defects in sales to major customers, the court found that the generic discussion of bugs and defects was inadequate. Panther Partners Inc. v. Ikanos Communications, Inc. (9thCir) is reported at ¶96,830.


CCH Blue Sky Law Reporter  

Florida Reduces Fingerprint Card Processing Fee. The fingerprint card processing fee for associated person applicants was reduced to $40.50, from $43.25, for applications received on or after May 29, 2012. ¶17,562.

Kansas Waives Surety Bond Requirement for Investment Advisers. Investment advisers having custody of, or discretionary authority over, their clients’ funds or securities are no longer required to maintain a surety bond. The minimum $35,000 surety bond requirement was waived by administrative order of the Kansas Securities Commissioner. ¶26,647.

Kentucky Adds Inspection Fees for IAs with AUM Exceeding $20 Million and for Firms Employing Issuer-Agents. Fees paid to the Kentucky Department of Financial Institutions’ for its staff to examine investment advisers with assets under management above $20 million were adopted to cover the higher threshold advisers subject to state rather than federal regulation in light of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Investment advisers (IAs) with assets under management (AUM) of between $20 and $30 million pay $350; IAs with AUM of between $30 and $45 million pay $450; IAs with AUM of between $45 and $60 million pay $550; IAs with AUM of between $60 and $75 million pay $650; and IAs with AUM exceeding $75 million pay $750. The fee for examining broker-dealers and firms employing issuer-agents is $35 per working hour up to a total maximum fee of $1,000. NOTE: A fee is not charged for training hours on an examination. ¶27,430.

Missouri No-Action Letters Extend Section 203(b)(3) De Minimis Exemption for Advisers. The de minimis registration exemption for investment advisers under Section 203(b)(3) of the Investment Advisers Act of 1940 (Advisers Act), although eliminated at the federal level by the Dodd-Frank Act, was extended by the Missouri Securities Division until the sooner of May 13, 2013 or the adoption of the Division’s proposed private fund adviser exemption. The Division’s latest advisory release on May 17, 2012 reiterates from recent no-action letters the extension of the exemption at Missouri securities rule 30-51.180 (6) for Missouri investment advisers that either: (1) previously qualified for the Missouri registration exemption at former Section 203(b)(3) of the Advisers Act; (2) were granted no-action letter relief by qualifying for the investment adviser registration exemption at former Section 203(b)(3) of the Advisers Act; or (3) are currently exempt from investment adviser registration under Section 203(l) of the Advisers Act for advisers that advise only venture capital funds. ¶35,600I.

Rhode Island Adopts Exemption for Private Fund Advisers. An exemption from investment adviser registration was adopted for private fund advisers by the Rhode Island Division of Securities. ¶50,400A.

Washington Adopts Mortgage Paper Securities Rule Amendments…Rules providing an optional method for registering mortgage paper securities were amended by the Washington Department of Financial Institutions. The rules strengthen investor suitability requirements, revise the calculation of the number of investors that may participate in a loan, establish requirements for participation agreements, revise net worth and bonding requirements, revise provisions regarding escrow accounts and escrow agreements, establish requirements for servicing agreements, codify the requirement for a disclaimer in advertisements, clarify the fiduciary duties of a mortgage broker-dealer, include additional dishonest and unethical practices, clarify the requirements for appraisals, clarify investors’ rights to receive information and access records concerning their investments, and update recordkeeping requirements. ¶61,701A through ¶61,704E.

…And Updates Statutory References in Rule Definitions. The statutory references in various definition rules were updated. ¶61,534G, ¶61,616BB, ¶61,621L, ¶61,622B, ¶61,701, ¶61,701A, and ¶61,752.

Colorado: Joint Venture Interests Constituted Securities. In Joseph v. Mieka Corp., the Colorado Court of Appeals held that substantial evidence supported a finding by the Commissioner of Securities that general partnership interests in a joint venture to develop an oil and gas lease constituted securities under the Colorado Securities Act (Act). The Commissioner had found that the interests constituted investment contracts, and were thus securities, because they involved investment transactions in a common enterprise whereby the purchasers were led to expect profits solely from the efforts of the promoter or a third party. Although the respondents disagreed with the Commissioner’s finding that the general partnership was illusory because any profits were expected to come primarily from the efforts of others, extensive findings concerning the economic realities of the joint venture showed that the agreement lacked the hallmarks of a bona fide general partnership.

Specifically, the appellate court observed that the investors lacked the right or ability to vote on the admission or exclusion of new investors; investors could not bind the joint venture; and no votes or other actions had been taken by investors concerning management decisions even though the joint venture was under way. Moreover, although the joint venture agreement allowed for removal of the operator, the percentage of votes required precluded the investors themselves from executing removal. Finally, the respondents did not inquire into or assess investors’ specific knowledge or sophistication concerning the joint venture activity or oil and gas development. Rather, the respondents had solicited a large number of investors with whom they had no prior relationship. Accordingly, substantial evidence existed in the record to support the Commissioner’s decisions that the joint venture was an illusory general partnership and, therefore, interests in it were investment contracts. Joseph v. Mieka Corp. will be published in a forthcoming Report at ¶74,980.


Aspen Federal Securities Publications  

The Regulation of Corporate Disclosure, Third Edition, by J. Robert Brown, Jr. The latest release, 2012-2 Supplement, is available online. This complete and up-to-date handbook on the issue of corporate disclosure covers the impact of the federal securities laws on both informal communications and the process of communicating with shareholders. The 2012-2 Supplement updates case law in Chapter 1, including relating to pleading requirements, specifically updating the discussion of the “strong inference” requirement as considered by the Supreme Court in Tellabs v. Makor, and adding a subsection on corporate versus individual scienter; further updates Chapter 2 on the regulatory environment for corporate disclosures, including further analysis of recent cases relating to reliance and third parties, fraud on the market, and loss causation; updates the analysis of MD&A requirements to discuss exposure to sovereign debt and cybersecurity—topics recently identified as noteworthy in guidance issued by the Staff of the SEC's Division of Corporation Finance; further refines the Chapter 2B discussion of the use of disclosure by the SEC in the area of corporate governance, including: requirements under the Dodd-Frank Act relating to board composition and structure, disclosures relating to independence of board members, and the recent SEC rules on required disclosures for U.S. mine operators relating to mine safety issues; updates Chapter 10A regarding counsel's disclosure obligations, including refining the discussion on requirements for reporting violations and use of “qualified legal compliance committees”; includes relevant case law and regulatory updates in various sections of Chapter 3, Chapter 11, and Chapter 12.

Corporate Legal Compliance Handbook, Second Edition, Edited by Theodore L. Banks, Frederick Z. Banks. The latest release, the 2012 Supplement, is now available online. In this publication, leading experts on key compliance subjects share their expertise to enable attorneys—both in-house and outside the corporation—to develop an effective compliance programs for the companies they advise. The 2012 Supplement  includes continuing coverage of the Dodd-Frank Act including a discussion of the Consumer Financial Protection Bureau and executive compensation; a new chapter on the interplay of corporate social responsibility and compliance; a revised chapter on the corporate ombuds—an informal alternative for resolving disputes and conflict in the workplace; an expanded chapter on how a compliance officer should identify the legal and ethical risks that face the company; an updated chapter on the challenges that international activities present for compliance; a revised chapter on attorney-client privilege that has been expanded to include a new section on attorney responsibilities, especially under the Sarbanes-Oxley Act; recent decisions on the relevance of compliance programs to corporate criminal antitrust liability; updated information on conflicts in the role of Chief Compliance Officer; expanded analysis of the factors involved in instilling a culture of ethics as part of compliance and ethics programs; updated discussion of how to measure the effectiveness of a compliance program; a new discussion of complying with the Sentencing Guidelines; and expanded coverage of copyrights, specifically domain names and other resources.

Financial Reporting Handbook, by Michael Young. The latest release, Release 35, 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.

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.

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A new research tool powered by the Securities Redbook (Securities Act Handbook), RBsource offers you securities laws, rules, regulation and forms together with related SEC guidance and interpretations. With RBsource, you will have SEC guidance related to a specific law, regulation or rule at your fingertips without the need of further searching or browsing. RBsource uniquely associates related content, going beyond the limits of standard searching making research more streamlined and productive. This intuitive research tool will drastically reduce your research time and provide the unparalleled confidence expected from the trusted Securities Act Handbook.

SEC Rulemaking Activity

  • 33-9330—Listing Standards for Compensation Committees (June 20, 2012).

New Exchange Act Rule 10C-1 implements the compensation committee independence listing standards mandated by Dodd-Frank Act Section 952. National securities exchanges and associations must adopt or amend their listing standards to comply with Rule 10C-1. The rule is effective July 27, 2012. The exchanges and associations must submit proposed rules or amendments to the SEC by September 25, 2012. The Commission must approve these rules or amendments by June 27, 2013.

Note: The Federal Register version of Release No. 33-9330 states that rules of the exchanges and associations must be approved by June 27, 2012. This date is clearly in error and may be revised in a future release (See 77 FR 38422).

Additionally, issuers must comply with revised Item 407 of Regulation S-K in any proxy or information statement for an annual shareholders’ meeting (or special meeting in lieu of an annual meeting) at which directors will be elected that occurs on or after January 1, 2013.

  • 34-67215— Order Granting a Limited Exemption from Exchange Act Rule 10b-17 to Certain Actively Managed Exchange-Traded Funds Pursuant to Exchange Act Rule 10b-17(b)(2) (June 19, 2012).

The Commission, by the Division of Trading and Markets, granted a conditional exemption from Exchange Act Rule 10b-17(b) to issuers of actively managed exchange-traded funds (ETFs). The rule requires issuers to provide timely notice of information regarding dividend and other distributions. Issuers must still comply with the other components of Rule 10b-17, and the information that is the subject of the exemptive order must be provided to the national securities exchange where the ETF shares are registered as soon as practicable before trading begins on the ex-dividend date, but not later than the time when the exchange last accepts such information on the day prior to the ex-dividend date. The order explicitly reminded issuers of their obligations under the Commission’s anti-fraud and anti-manipulation rules, especially Exchange Act Section 10(b) and Rule 10b-5.

  • IA-3418—Political Contributions by Certain Investment Advisers: Ban on Third-Party Solicitation; Extension of Compliance Date (Jun. 8, 2012).

The release extended the compliance date of the Investment Adviser Act ban on third-party solicitation. Specifically, the instant amendment is effective June 11, 2012, but the effective date of the ban on third-party solicitation under Investment Advisers Act Rule 206(4)-5 remains September 13, 2010. The compliance date, however, was extended until nine months after the compliance date of a final rule for the registration of municipal advisers. The Commission will then issue a new compliance date for the ban on third-party solicitation.

The Road Ahead—JOBS Act Rulemaking

The Jumpstart Our Business Startups (JOBS) Act, which became law April 5, 2012, requires the Commission to engage in several rulemakings. In the near term, the SEC must adopt rules to implement Title II within 90 days after enactment. As of publication, the Commission had not proposed any JOBS Act rules. SEC rules implementing Title II may be proposed with a brief comment period, as final rules, or as interim final temporary rules to allow for public comment. In any event, the rules are due on or about July 4, 2012.

Title II directs the Commission to remove the ban on general solicitation or general advertising stated in Securities Act Rule 502(c) of Regulation D for offers and sales of securities made under Rule 506 of Regulation D. Amended Rule 506 must require all purchasers of these securities to be accredited investors. The rules also must require an issuer to take reasonable steps to verify the accredited investor status of any purchasers using methods to be determined by the Commission. Rule 506 must continue to be treated as issued under Securities Act Section 4(2).

Title II also requires the Commission to amend Securities Act Rule 144A(d)(1) to provide that securities sold under the revised exemption may be offered (including by general solicitation or advertising) to persons who are not qualified institutional buyers (QIBs), but these securities may be sold only to persons the seller (or any person acting on the seller’s behalf) reasonably believes are QIBs.

RBsource will update securities regulations affected by the JOBS Act when the SEC adopts the required rules.

Hot Topic of the Month

This month's hot topic is insider trading. While the antifraud provisions of the Exchange Act do not mention "insiders" or explicitly require persons with material inside information to disclose that information in a securities transaction, the courts and the SEC nonetheless consider trading on inside information a type of prohibited deceptive conduct. Analysis of Rule 10b-5 insider trading liability, however, differs significantly from that applicable to a traditional Rule 10b-5 fraud case. Although the essential elements of Rule 10b-5 liability also apply in the context of insider trading, the analysis of insider trading liability places particular emphasis on the defendant's status and on the breach of a duty.

Generally, a person is liable under Rule 10b-5 for insider trading if he or she: (1) is an "insider," a "tippee," or a non-insider who misappropriates inside information; and (2) directly or derivatively breaches a fiduciary duty by trading on or tipping material, nonpublic information. An insider is someone who possesses material information concerning securities that is not possessed by others trading in the securities, and a tippee is someone who receives a tip from an insider and subsequently trades in securities to which the tipped information relates.

Liability for insider trading under the "classical theory" is based on the defendant's corporate position, such as officer, director, or controlling shareholder, or on a temporary insider's receipt of information in the course of performing a service for the company. Under the "misappropriation theory" of liability, non-insiders who misappropriate material, nonpublic information for securities trading purposes in breach of a duty of loyalty and confidentiality to the source of the information are liable under Rule 10b-5. Also, liability as a tipper or tippee is based on the flow of information from a person who breaches a fiduciary duty to a person who has knowledge of the breach.

In 2000, the Commission adopted Rule 10b5-1 to clarify the issue of when insider trading liability arises in connection with a trader's "use" or "knowing possession" of material nonpublic information. Rule 10b5-1 provides that, for purposes of insider trading liability, a person trades on the basis of material nonpublic information if a trader is aware of the material nonpublic information when making the purchase or sale. The rule also sets forth several affirmative defenses or exceptions to liability. Rule 10b5-2 was adopted to address the issue of when a breach of a family or other non-business relationship may give rise to liability under the misappropriation theory of insider trading. Finally, Section 20A provides a private right of action for persons who sold or purchased a security at the time that a defendant violated an Exchange Act provision or rule by purchasing or selling a security while in possession of material, nonpublic information

We publish related information in a wide range of resources (e.g., Federal Securities Law Reporter, SEC Today, etc.), and document types (laws, regulations, releases, newsletter articles, treatise discussion, Insights – Amy L. Goodman, etc.). For example:

  • Federal Securities Law Reporter