March 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.

 

CCH Federal Securities Law Reporter

SEC Proposes Amendments to Safe Harbor for Issuer Repurchases. The SEC published a release proposing amendments to Exchange Act Rule 10b-18 to modernize its safe harbor provisions. Rule 10b-18 provides a safe harbor from liability for manipulation when issuers repurchase their common shares in accordance with specified conditions on the manner, timing, price and volume of the repurchase. Under the current rule, the failure to meet any of the four conditions with respect to a repurchase will disqualify all of the Rule 10b-18 purchases from the safe harbor for the day. The proposed amendments would modify the opening timing condition, relax the price condition for certain volume-weighted average price transactions, limit the disqualification provision in fast moving markets under certain specific conditions, and modify the "merger exclusion" provision to extend the time in which the safe harbor is unavailable in connection with an acquisition by a special purpose acquisition company. Release No. 34-61414 at ¶88,850 (IntelliConnect) (IRN) (ip access user).

Guidance on Climate Change Issued. The SEC issued an interpretive release on climate change aimed at more consistent disclosure. The release states that companies should be aware of potential indirect consequences of legal, technological, political or scientific developments that may create new opportunities or risks. They should also consider the actual or potential impact on their business, such as the possibility for increases in insurance claims in coastal regions as a result of severe weather or changes in sea levels. Release No. 33-9106 ¶88,853 (IntelliConnect) (IRN) (ip access user).

5th Circuit Remains a Challenge to Securities Class Action Plaintiffs. A recent panel decision involving fraud claims against Halliburton again demonstrates the challenges class action plaintiffs face in the 5th Circuit. While all fraud plaintiffs must plead loss causation under the Supreme Court's Dura decision, they must prove loss causation in the 5th Circuit at the class certification stage. As Senior Circuit Judge Reavley wrote in his Halliburton opinion, in order to obtain certification, potential class action plaintiffs must prove "that the corrected truth of the former falsehoods actually caused the stock price to fall and resulted in the losses." This requires a showing by a preponderance of the evidence that "a loss occurred from the decline in stock price because the truth made its way into the marketplace, rather than for some other reason, such as a result of changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other factors independent of the fraud.""

The 5th Circuit panel initially rejected the plaintiffs' argument that its 2007 Oscar Private Equity Investments v. Allegiance Telecom, Inc. decision was wrongly decided because a panel of the court could not overrule a precedential decision by a previous panel absent an intervening contrary or superseding decision by the court en banc or the Supreme Court. The court then concluded that the plaintiffs failed to show a specific stock price drop that was necessarily related to the alleged misstatements and any corrective disclosures. As described by the court, the negative information available in the marketplace involved "non-culpable changes in market conditions and the competitive environment that Halliburton faced," and the plaintiffs failed to differentiate this information from any allegedly culpable statements. Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co. (5thCir) will be published in a forthcoming Report at ¶95,611.

2nd Circuit Affirms Fund Conflicts Dismissal. The 2nd Circuit upheld the dismissal of actions brought by shareholders of two mutual funds affiliated with Morgan Stanley. According to the complaints, the Morgan Stanley broker-dealers affiliated with the funds suffered from internal conflicts of interest. Because the fund managers relied on these broker-dealers' stock research, the broker-dealer conflicts allegedly increased the risk to investors in the funds.

The district court (SD NY) found that the shareholders failed to plead the existence of any material omissions or misstatements, and the 2nd Circuit agreed. The appeals panel, relying in part on an amicus brief filed by the SEC, held that the funds were not required to disclose on Form N-1A that they invested in companies which might have an investment banking relationship with fund affiliates. The instructions to the form were not independent sources of disclosure, advised the SEC. Rather, they were intended to provide funds with general guidance as to the nature of the information they should provide in responding to specific disclosure items.

The SEC also advised the court that it considered the breakdown of the "Chinese Wall," or "information barrier," between Morgan Stanley and the funds to be a generic risk rather than a specific risk that the funds' investment objectives included enhancing an affiliated entity's investment banking business. While funds would be required to disclose such particular intentions, the Commission advised that "the danger that analyst reports (whether from affiliated or unaffiliated analysts) will be tainted by undisclosed conflicts of interest or actual corruption is but one of an indefinitely large number of factors that could cause a fund (or any other investor) to purchase overpriced securities, and it would not be useful to investors to require an attempt to set all of those forth in the prospectus."

The panel concluded that the funds had no duty to disclose "the entire corpus of their knowledge" concerning Morgan Stanley's business. Mandatory disclosures under Form N-1A did not obligate defendants to make disclosures relating to "the commonly understood risks associated with securities research." In re Morgan Stanley Information Fund Securities Litigation (2nd Cir) is reported at ¶95,585 (IntelliConnect) (IRN) (ip access user).

State Claims Against Hedge Funds Survive SLUSA Challenge. The Securities Litigation Uniform Standards Act did not preempt state claims against the directors and administrators of two defunct hedge funds. The shares issued by the British Virgin Island-based funds were not "covered securities" under the Uniform Standards Act. According to the fund defendants, however, the Uniform Standards Act preempted the state claims because a portion of the funds' portfolios included, or purported to include, covered securities.

Judge Shira Scheindlin of the Southern District of New York wrote that only the alleged misrepresentations by the defendants were relevant to Uniform Standards Act preemption analysis. She concluded that the alleged misstatements concerned only the valuation of the funds and were not made in connection with the purchase or sale of covered securities.

Judge Scheindlin recognized that the Supreme Court interpreted the "in connection with" requirement rather broadly in the 2006 Merrill Lynch v. Dabit case, in which the high court found that "holder" claims as well as those by buyers and sellers were preempted if the fraud "coincided" with a scheme involving covered securities). However, she concluded that such an application of the Uniform Standards Act to this case "stretches the statute beyond its plain meaning." Congress, and not the courts, should decide whether the statute applied to statements made in connection with the purchase or sale of shares of unregistered hedge funds. Pension Committee of the University of Montreal Pension Plan v. Banc of America Securities, LLC (SD NY) will be published in a forthcoming Report at ¶95,605.

Broker-Dealer Unaware of Madoff's Fraud. The SEC's claims for securities fraud against a three officers of a broker-dealer that participated in the Bernard Madoff Ponzi scheme were dismissed. The SEC claimed that Mr. Madoff paid the broker-dealer to recruit prospective clients for his investment advisory business. The SEC also brought claims for aiding and abetting that were dismissed in part.

The fraud claims were dismissed after the district court (SD NY) found that the officers did not know of, or recklessly disregard, Mr. Madoff's fraud. The court found that the complaint failed to allege any facts putting the officers on notice of the fraud, stating that "Madoff fooled the defendants as he did individual investors, financial institutions, and regulators." According to the court, the fact that the broker was compensated for referring clients did not show a fraudulent motive because the referrals were a normal part of the broker's business and because the broker had nothing to do with the clients' investments. The fact that the Madoff firm requested secrecy in its marketing did not give notice of fraud because the secrecy was itself a marketing tactic that projected exclusivity. Finally, regulatory violations and accounting irregularities were not, by themselves, enough to show that the broker had notice of the fraud.

The court then found that the SEC failed to allege that the officers aided and abetted the Madoff firm's fraud through knowing of its violation of registration and compensation rules but nevertheless continuing to refer clients. The court stated that the SEC did not allege misconduct by the broker aimed at enabling the rule violations but only that they continued their routine business with the adviser. The court found, however, that one of the officers aided and abetted the broker-dealer's failure to correct its inaccurate Form BD and amendments. The officer substantially assisted the violation because he had the duty and authority to see that the filings were corrected yet failed to do so over the six years that the broker's filings were allegedly inaccurate. SEC v. Cohmad Securities Corp. (SD NY) is reported at ¶95,595 (IntelliConnect) (IRN) (ip access user).

CCH Blue Sky Law Reporter

Kentucky Sets Forth Minimum Recommended Disclosures for Switching Transactions. Minimum recommended disclosures for "switching transactions," activities involving an investor's moving from one product to another such as from one mutual fund to another, one variable annuity to another, or from a mutual fund to a variable annuity, or the marketing of indexed annuities as a replacement for any security are set forth by the Kentucky Securities Division. The minimum recommended disclosures include clearly identifying the investment being bought and sold, by indicating the full name of the product; the type of share or option; the surrender charges, redemption fees and other costs in both dollar amounts and percent of investment value of the product being sold; and the receipt of any commissions from the switch. ¶27,609 (IntelliConnect) (IRN) (ip access user)

Mississippi Issues Temporary Rules to Align with New Act. 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, were issued by the Mississippi Securities Division, effective January 1, 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)

Utah Adopts Exemption from IA and IA Rep. Licensing. An exemption from licensing for investment advisers and investment advisers representatives was adopted by the Utah Securities Division, along with an amendment to the number of working days the disclosure statement for a coordination registration must be filed with the Division to take effect in the State, the elimination of references to notification registration and the repeal of a definitions rule. ¶57,402E (IntelliConnect) (IRN) (ip access user)

Transfer of Farm Assets for Corporate Stock Involved "Sale for Value." The Utah Court of Appeals has held that a transfer of farm assets by a limited liability company in exchange for shares of corporate stock constituted the sale of a security under the Utah Uniform Securities Act (Act). In State v. Johnson, the defendant contended that the transfer of the farm assets did not involve a "sale for value" on the part of the corporation because: (1) the transaction merely represented a change in the form of ownership of the farm assets; and (2) the farm assets were so encumbered as to be valueless. The appellate court concluded, however, that the section of the Act defining the term "sale" revealed the express intent of the legislature that the statute should govern similar asset transfers. The transaction met the definition of a "sale for value" because the transfer of the farm assets conferred indirect benefits on the corporation, including an enhanced ability to borrow and raise capital. As sufficient evidence in the record supported the jury's finding that the property had a value of at least $10,000, the defendant's conviction for second degree felony securities fraud was upheld. State v. Johnson is reported at ¶74,808 (IntelliConnect) (IRN) (ip access user)

Aspen Federal Securities Publications

Broker-Dealer Law and Regulation, Fourth Edition, by Norman S. Poser and James A. Fanto. The 2010 Supplement (IntelliConnect) (IRN) (ip access user) is now available online. This is an authoritative analytical and practical guide for advising clients on their rights, duties, and liabilities under today’s complex securities regulations. It provides reliable guidance on the latest federal and state law governing private litigation and arbitration between broker-dealers and their customers, as well as regulation by the SEC and the SROs. The 2010 Supplement includes continuing coverage of the financial crisis, and self-regulatory and legal responses to problems revealed in broker-dealers as a result of the crisis; a detailed review of the Obama Administration’s plan for financial regulatory reform and implementing legislation; discussion of revisions to disclosure on Forms U4 and U5 relating to, among other things, written customer complaints regarding a registered representative’s involvement in sales practice violations; discussion of broker auditing, reporting, and examination issues arising from the Madoff scandal and of the likely changes to examinations as a result of SEC and FINRA deficiencies revealed in the scandal; in-depth coverage of the Federal Trade Commission’s “Red Flags Rule” and the duties that it imposes upon broker-dealers, as well as the finalized Regulation S-AM; review of developments in compensation in the financial industry as a result of emergency legislation and rulemaking in response to the financial crisis and a discussion of possible changes in compensation practices in the brokerage industry; review of recently revised NASD Rule 2720; account of the failures of the SEC Enforcement Division relating to broker-dealers and the reforms to that Division; an overview of the proposed Investor Protection Act of 2009; the impact of the Supreme Court's Dura Pharmaceuticals decision on plaintiffs in Rule 10b-5 actions; an examination of the Supreme Court’s decision in Vader v. Discover Bank, broadening the jurisdiction of the federal courts in disputes covered by the Federal Arbitration Act; changes in FINRA arbitration procedures; discussion of whether arbitrators have the authority to award attorneys’ fees despite an agreement by the parties; and new decisions concerning the continued viability of “manifest disregard of the law” as a ground for vacating an arbitration award.

The Regulation of Corporate Disclosure, Third Edition, by J. Robert Brown, Jr. The latest release, 2010-2 Supplement (IntelliConnect) (IRN) (ip access user), is available online on the Corporate Governance Integrated Library. 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. This supplement adds new subsections including “Web Posting,” “Voting Results” as part of the general discussion of “Periodic Reporting Requirements,” and a new section specifically addressing Regulation FD; updates the discussion of fraud on the market; updates Chapter 2B to discuss recently adopted SEC rules (effective February 28, 2009) that address a public company’s corporate governance, compensation, and risk policies and practices by requiring enhanced disclosure in the following areas: qualifications and experience of directors and director nominees; consideration of diversity in the director nomination process; the board’s leadership structure and the board’s role in the oversight of risk; compensation policies and practices for all employees as they relate to risk management practices and risk-taking incentives; and services provided to the company by compensation consultants; and updates Chapters 10 and 11, including discussion of recent relevant case law.

Hot Topic of the Month

This month’s hot topic is the forfeiture of bonuses and profits, or clawbacks. The Sarbanes-Oxley Act requires certain officers to forfeit profits realized on company stock sales, or bonuses received from the company, while management is misleading the public and regulators about the company's financial condition. Section 304 of the act provides that, in the case of accounting restatements that result from material non-compliance with SEC financial reporting requirements, the chief executive officer and chief financial officer must disgorge bonuses and other incentive-based compensation and profits on stock sales, if the non-compliance results from misconduct. The required disgorgement applies to amounts received for the 12 months after the first public issuance or filing of a financial document embodying such financial reporting requirement. The SEC may, however, exempt any person from this requirement as it deems necessary and appropriate.

Courts which have addressed the issue have found that Section 304 does not create a private right of action for shareholders and is enforceable only by the SEC. For example in In re iBasis, Inc. Derivative Litigation (DC Mass 2007), the court found that shareholders who filed a derivative action failed to assert a viable federal claim in an action alleging the backdating of stock option grants. In determining that there was no private right of action under Section 304, the court found that "the statutory structure of [Sarbanes-Oxley], the nature of the penalty provision, and precedent from other courts" indicated that Congress did not intend to provide for private enforcement of the section.

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

SEC Docket (e.g., Litigation Release No. 21149; AAER No. 3025 (First enforcement action brought solely under Section 304) (IntelliConnect) (IRN) (ip access user))

Insights – Amy L. Goodman (e.g., "No Private Right to Compel Disgorgement under Sarbanes-Oxley Section 304" (January 2009)
(IntelliConnect) (IRN) (ip access user); "'Clawbacks' of Executive Compensation" (August 2008) (IntelliConnect) (IRN) (ip access user))

SEC Today (e.g., Experts Discuss Current Issues in Executive Compensation at Corporate Counsel Institute (9-21-09) (IntelliConnect) (IRN) (ip access user))

Securities Regulation – Loss & Seligman (e.g., Chapter 6.F.4 (IntelliConnect) (IRN) (ip access user))

SEC Answer Book – Levy (e.g., Question 16:29 (IntelliConnect) (IRN) (ip access user))

Jim Hamilton’s World of Securities Regulation (e.g. 1-10-10)

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:

#1001 IPO Offerings

Evaluate IPO professional firms (“IPO Team Members”) by IPO activity for the past 12 months.

Review IPO Team Members by fourteen characteristics

  • Offer Date
  • SIC Code
  • Ticker Symbol
  • Exchange
  • Offer Price
  • Number of Shares
  • Gross Spread
  • Offer Amount
  • Market Capitalization
  • Revenue
  • Net Income
  • Net Worth
  • Days in Registration
  • Estimated Out-of-Pocket Expenses

Tip! Scroll left to right, and re-sort the table of data by clicking a column heading. Re-arrange a "professional" column in alphabetical order and scroll to see a particular firm’s activity.