Federal Securities Law Reporter

SEC proposes recordkeeping rules for security-based swap dealers. The SEC has voted to propose new recordkeeping, reporting, and notification requirements for security-based swap dealers (SBSDs) and major security-based swap participants (MSBSPs). The proposed rules also establish recordkeeping requirements for broker-dealers with respect to their security-based swap activities since the SEC anticipates that a number of broker-dealers will be registered as SBSDs or potentially as MSBSPs, and some broker-dealers that are not registered as either SBSDs or MSBSPs may engage in security-based swap activities. The proposal also includes a capital charge provision to the proposed capital rule for certain SBSDs, and technical amendments to the broker-dealer recordkeeping, reporting, and notification rules. The comment period will remain open until July 1, 2014.

The proposed new rules are modeled on the existing broker-dealer rules and on the FOCUS report since SBSDs and MSBSPs are expected to operate in the financial markets and effect transactions in a similar manner to how broker-dealers operate. However, since stand-alone SBSDs and MSBSPs will not engage in the same range of activities permitted for broker-dealers, the proposed requirements for these entities are narrower in scope than those applicable to broker-dealer SBSDs and MSBSPs.

The proposed requirements for bank SBSDs and MSBSPs are narrower in scope than those applicable to stand-alone SBSDs and MSBSPs since these entities are subject to existing recordkeeping and reporting requirements that are administered by their prudential regulators. Their prudential regulators, rather than the SEC, will administer these entities’ capital, margin, and other prudential requirements. The SEC will monitor compliance with the proposed capital and margin rules applicable to nonbank SBSDs and MSBSPs. Release No. 34-71958 is reported at ¶80,609.

SEC seeks additional comment on 2010 target date fund proposal. The SEC has reopened the comment period on rule amendments proposed in 2010 that would require marketing materials for target date retirement funds to include an asset allocation glide path. In 2013, the Commission’s Investor Advisory Committee (IAC) recommended that the Commission develop a glide path illustration for target date funds based on a standardized measure of fund risk in connection with the proposed asset allocation glide path illustration. The SEC is now seeking comment on this recommendation, in addition to the original proposal. Comments are due on or before June 9, 2014.

The Commission decided to reopen the comment period to allow commenters to address the IAC’s recommendations and to provide additional comment on any other matters related to the proposal. In the proposal, the SEC asked for comment on whether the proposed disclosure of asset allocation would adequately convey the risks associated with a target date fund and whether the rules should require disclosure of a risk rating based on a scale or index that could be compared to other funds. The Commission expanded its request for comment on whether it should develop a glide path illustration for target date funds based on a standardized measure of risk and on the materials in which the illustration should be included. Specifically, the SEC also seeks comment on the degree to which managers of target date funds use measures of risk as part of their investment strategy, whether quantitative measures of risk exist that would be useful to investors and whether they should be based on a standardized methodology, and the effects that the proposed changes and the recommendations may have on both portfolio management and investors. Release No. 33-9570 is reported at ¶80,605.

Comment period on two asset-backed securities proposals extended. The SEC has further extended the comment deadline on proposals related to asset-backed securities contained in Release No. 33-9117 (April 7, 2010), and Release No. 33-9244 (July 26, 2011). The comment period, which was set to expire on March 28, after the extension issued in Release No. 33-9552 (February 4, 2014), will now end April 28, 2014.

The Commission said it believes the extension will allow the public to provide more comprehensive comments on the approach for the dissemination of potentially sensitive asset-level data outlined in a February 25 staff memorandum. The extension was requested by Ally Financial Inc., Bank of America, CNH Industrial Capital America, Ford Motor Credit Co., and others. Release No. 33-9568 is reported at ¶80,601.

Scheme “in connection with” sale not actionable under RICO. A lower court properly dismissed RICO claims against a bank and related entities because the scheme’s alleged misrepresentations and omissions were made “in connection with” the purchase or sale of securities. Such claims, which are actionable under the federal securities fraud laws, are not actionable under RICO according to the PSLRA.

César A. Calderón Serra and Teresita Palerm Nevares borrowed money from Banco Santander Puerto Rico. A subsidiary of the bank, Santander Securities (Santander), makes money by selling and buying securities for its customers. The Calderóns used money borrowed from the bank to buy and trade securities through Santander Securities. According to the Calderóns, the arrangements violated the margin requirements of Regulation U, which imposes credit restrictions to ensure that a buyer has used some of his or her own funds to invest. The Calderóns invested almost $9 million in trades, and suffered losses of $3 million. They sued the bank, Santander Securities, and related parties, alleging that they were enticed by the bank to borrow money to buy and trade securities through Santander and that the bank concealed that the arrangement violated Regulation U. They alleged that it was an unlawful scheme under the Racketeer Influenced and Corrupt Organizations Act (RICO). A federal district court dismissed the RICO claim, stating that the claim was based on conduct that would have been actionable as securities fraud. They appealed.

The Private Securities Litigation Reform Act (PSLRA) generally bars private plaintiffs from bringing RICO claims based on “any conduct that would have been actionable as a fraud in the purchase or sale of securities.” The appellate panel noted that most federal securities fraud claims arise under Exchange Act Sec. 10(b) and Rule 10b-5, which require that the alleged fraud be made in “connection with the purchase or sale of a security.” In this case, if the scheme alleged by the plaintiffs were made in connection with the purchase or sale of a security, it would not be actionable under RICO.

The panel cited precedent concerning factors that can satisfy the required transactional nexus under Rule 10b-5. Its non-exhaustive list included: “(1) whether a securities sale was necessary to the completion of the fraudulent scheme; (2) whether the parties’ relationship was such that it would necessarily involve trading in securities; [and] (3) whether the defendant intended to induce a securities transaction.”

The panel noted that according to the plaintiffs’ complaint, the purpose of the scheme was to make loans and to sell securities, rendering the sale of securities necessary to the scheme. It was also obvious from the complaint that the relationship between the parties involved the trading in securities. Furthermore, the complaint also alleged that the scheme was designed to produce benefits for the bank and for Santander in the form of interest, benefits, and commissions, which indicated that the defendants did intend to induce a securities transaction, the panel said.

The panel also pointed to precedent, which held that fraudulent conduct is “in connection with” the purchase or sale of securities if it is “material to the decision…to buy or sell a covered security.” The plaintiffs here, the panel observed, had acknowledged and had even based part of their claim on the notion that the alleged omissions were material to their decision to purchase securities; the complaint had stated that, absent misrepresentations and omissions, they would have bought fewer, if any, securities, the panel observed.

Because the alleged fraudulent conduct was made “in connection with” the purchase or sale of securities, it was actionable under securities fraud and was not a proper RICO claim under the PSLRA, the panel concluded, affirming the district court’s dismissal of the claim. The panel also affirmed the district court’s dismissal of the complaint as to two defendants for failure of service, finding that the lower court did not abuse its discretion. Serra v. Banco Santander Puerto Rico (1stCir) is reported at ¶97,902.

Drug company believed it had permission to analyze subset. A 6th Circuit panel has affirmed a district court judgment that a company did not “bait-and-switch” the test populations for a drug under development. Investors claimed that BioMimetic Therapeutics, Inc., (BMTI) misrepresented the results of clinical trials of its key product and the prospects of its approval by the FDA. The circuit court found that the complaint failed to plead a strong enough inference of scienter.

The complaint alleged that BMTI misled investors about the prospects for FDA approval of its flagship product, Augment, a combination device and drug used for bone grafting in the treatment of foot and ankle bone defects. When the FDA approved Augment for clinical trials, the study group included individuals who did not receive the treatment. BMTI then submitted a revised protocol that proposed excluding those individuals who could not be treated. The FDA approved the revised protocol, but advised BMTI to analyze the full study population.

In October 2009, after the clinical trials were concluded, BMTI issued a press release stating that Augment was effective when a subset of the study population was analyzed, but not when the analysis was conducted on the full population. In a conference call later that day, BMTI officers asserted that the subset’s results were more relevant and that excluding certain patients had not biased the study. In subsequent discussions with the company, the FDA questioned the switch and later released a briefing document to the public expressing its concerns. In January 2012, the FDA issued a “non-approvable” letter stating that Augment would not be approved unless BMTI provided more information about the trials given the differences in study populations.

The investors argued that BMTI engaged in a “bait-and-switch” by representing that it was using an FDA-approved study population when it had actually switched populations. The complaint alleged further that BMTI was aware of numerous deficiencies in Augment’s clinical trials, but its statements to investors were fraudulently optimistic about the device’s prospects for FDA approval. The district court held that the complaint failed to raise an inference of fraudulent intent or recklessness at least as compelling as any opposing inference. According to the court, BMTI had a basis for telling investors that it had permission to analyze a subset of the population because the FDA had approved the revised protocol.

On appeal, the investors identified a number of allegedly misleading statements casting a favorable light on Augment’s clinical trials and chances for success. The investors argued that these statements were misleading because BMTI knew that the FDA expected results based on the larger study population. Other statements referring to the study population were allegedly false because BMTI knew that it was not using the approved population.

The panel concluded that the complaint failed to give rise to a strong inference of scienter. Looking at the pleadings holistically, the panel concluded that a reasonable person would conclude that the inference of scienter was not as strong as the opposing inference. “BioMimetic could legitimately believe,” the court wrote, “that the statistically significant results it achieved based on an analysis of the [subset] population would be sufficient to obtain approval by the FDA.” The court stated that all of the alleged misstatements were consistent with the interpretation that BMTI believed that the FDA had approved its use of the subset. While BMTI may have been mistaken, there were no facts showing that the company did not believe that it had permission to use the subset analysis at the time it spoke to investors.

According to the court, while the FDA made it clear in a May 2007 letter that it expected an analysis of the entire population as well as the subset, there was no indication that the primary effectiveness analysis was to be conducted on the entire population. The letter did not mention what would be the benchmark for success and was mainly concerned with how the study population would be defined. Later statements by the FDA during the class period were similarly ambiguous. The court noted several other factors indicated that BMTI was rightfully optimistic, including that the FDA had previously approved other devices based on analyses of subsets and that BMTI had earlier obtained approval for a product containing the same drug as Augment. Kuyat v. BioMimetic Therapeutics, Inc. (6thCir) is reported at ¶97,907.

Blue Sky Law Reporter  

Vermont proposes small business offering exemption. Issuers could claim the Vermont Small Business Offering Exemption (VSBOE), exempting themselves from Vermont securities registration and advertising filing requirements and their issuer-agents from Vermont agent registration requirements, provided: (1) the issuers are Vermont-organized business entities registered with the Vermont Secretary of State; (2) the transaction meets the federal Securities Act, Sec. 77c(a)(11) intrastate offering exemption; and (3) the issuers do not accept more than $10,000 from any single purchaser unless the purchaser is a Regulation D Rule 501 defined “accredited investor.” Additionally, broker-dealers not having a place of business in Vermont would be exempt from Vermont’s broker-dealer registration requirements to the extent the broker-dealers limit their Vermont activities to VSBOE transactions. ¶58,407.

Washington proposes securities manual name change from Moody’s to Mergent’s. The name of the recognized manual for the nonissuer transaction exemption by registered broker-dealer salespersons would be changed from Moody’s to Mergent’s by the Washington Department of Financial Institutions, to reflect the manual’s current name. ¶61,530.

Life settlements were investment contracts under Texas law. In State v. Life Partners Holdings, Inc., the Texas Court of Appeals held that life settlements were subject to regulation as securities under the Texas Securities Act (Act). The State of Texas had brought an enforcement action against the issuer and two senior executives for allegedly engaging in fraudulent activities in connection with the sale of securities. Although the trial court had denied the state’s request for injunctive relief, holding that the defendants’ products were not securities, recent precedent from the Texas and federal courts has held that life settlements are "investment contracts" and thus meet the definition of a "security." In addition, the products did not fall within an exclusion under the Act for insurance policies because the issuer was not subject to the supervision or control of the state insurance commission. Accordingly, the defendants’ business practices constituted the sale of securities under Texas law. The decision is reported at ¶75,062.

 

Aspen Federal Securities Publications  

Regulation of Securities: SEC Answer Book, Fourth Edition, by Steven Mark Levy. The 2014-2 Supplement is now available online. 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. The 2014-2 Supplement features new sections on Pay Ratio Disclosure (Chapter 9); Rule 144A Equity Offerings (Chapter 15); Shareholder Litigation Involving Mergers and Acquisitions (Chapter 21); and SEC as Defendant (Chapter 21). The 2014-2 Supplement also includes a variety of other timely topics, including: What is the current status of the Regulation D limited-offering exemptions, Rules 504, 505, and 506, including the new, alternative version of Rule 506 allowing general solicitation and advertising (Q 1:19)? How did the Volcker rule finally turn out as implemented by rules issued by the SEC and four other federal agencies (Q 4:55.5)? What are typical features of well-drafted risk factor disclosure (Q 4:112)? What specialized disclosure requirements apply to oil and gas producing activities, roll-up transactions, and Iran-related activities (Q 4:119.25, Q 4:119.35, and Q 4:119.40)? Does the term “beneficial ownership” encompass the relationship between tipper and tippee of insider information (Q 6:45.5)? Where do political intelligence firms fit in the landscape of insider trading laws (Q 18:46)? Does Dodd-Frank whistleblower anti-retaliation protection extend to individuals who do not make disclosures to the SEC (Q 20:42)? How did the SEC change its policy on no-admission-of-fault settlements in response to criticism that it was too lenient on companies implicated in the financial crisis (Q 21:4.5)? Why has merger litigation become a fact of life for companies involved in acquisition deals, and why do companies settle M&A lawsuits, even the weakest ones, rather than fight (Q 21:109 and Q 21:114)? Can investors hold the SEC liable for losses caused by the SEC’s own negligence or incompetence, such as negligent failure to investigate Bernard Madoff (Q 21:115)? What are the nuances of the SEC’s customer protection rule, Rule 15c3-3, requiring broker-dealers to protect customer funds and securities (Q 22:27)? How are municipal advisors regulated after Dodd-Frank (Q 23:56)?

Financial Reporting Handbook, by Michael Young. The latest release, Release 40, is 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.

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

 

Tip! Click on For the period at the top of the table to open a calendar function and use the drop down boxes to select a date range, then click the [REFRESH] button to update the Vital Sign table of data. After the table is updated you can click [CLOSE] to close the calendar function and maximize the viewable area.
Click on blue numbers to drill down for more information. Click Column headings to re-sort the table’s data. 

RBsource

A new research tool powered by the Securities Redbook (Securities Act Handbook), RBsource offers you securities laws, rules, regulations 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

• 34-71958—Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers; Capital Rule for Certain Security-Based Swap Dealers (April 17, 2014).

The SEC proposed recordkeeping requirements for securities-based swap dealers and others under its Dodd-Frank Act authorities. Comments are due by July 1, 2014.

• 33-9570— Investment Company Advertising: Target Date Retirement Fund Names and Marketing (April 3, 2014).

Under these recently proposed rules, the SEC would clarify disclosure requirements for key aspects of target date retirement funds that are now poorly understood by many investors. Comments are due by June 9, 2014.

The Road Ahead

Upcoming rulemaking activity will continue to reshape the securities regulation landscape. The items below are a selection of expected near-term regulatory actions. The SEC’s schedule is subject to change at any time. RBsource includes daily updates to securities regulations affected by final Commission action.
Two weeks ago, a three-judge panel of the U.S. Court of Appeals for District of Columbia upheld much of the SEC’s conflict minerals rule, while also finding that a requirement in Exchange Act Sec. 13(p)(1)(A)(ii) and (E), and the SEC’s conflict minerals rule, failed to satisfy the narrow tailoring required by the First Amendment. As a result, the circuit court partially reversed the prior district court opinion upholding the SEC’s conflict minerals rule (National Association of Manufacturers v. SEC, April 14, 2014, Randolph, A.; National Association of Manufacturers v. SEC, July 23, 2013, Wilkins, R.).

The circuit court reached this conclusion after it rejected the SEC’s argument that the rational basis test should apply to what the agency said were factual disclosures. But the court also did not formally decide that strict scrutiny or the Supreme Court’s Central Hudson test applied. As a result, the provision at issue was constitutionally infirm to the extent the law and the SEC’s rule require a company to report to the SEC and state on its website that any of its products have “not been found to be ‘DRC conflict free.’”

A separate opinion filed by Judge Sri Srinivasan took issue with the timing of the court’s First Amendment holding. Judge Srinivasan would have preferred that the court defer the First Amendment ruling pending the outcome of an en banc hearing in another case that raises a similar issue.

SEC Commissioners Daniel M. Gallagher and Michael S. Piwowar this week issued a joint statement urging the SEC to stay the entire conflict minerals rule until the courts reach a final decision. Both commissioners said the district court should invalidate the entire rule on remand. A court finding that the rule is invalid, said the commissioners, also would let Congress take a second-look at Dodd-Frank Act Sec. 1502.

The circuit court’s conflict minerals opinion, while resolving much of that case, left open many issues regarding how companies should prepare for their first reports, which are due in little more than one month. It is still possible that the SEC or the circuit court may stay the conflict minerals rule, or the parties in that case could participate in the related case of American Meat Institute v. AGRI, for which oral argument before the D.C. Circuit is scheduled on May 19, 2014.
At least one company has filed a Form SD and conflict minerals report with the SEC. While many experts urge companies to go ahead with their preparations to make any required filings, they also urge companies to be cautious about filing too far ahead of the impending deadline because of the possibility the SEC or the courts may clarify companies’ filing duties.

Hot Topic of the Month

This month's hot topic is the whistleblower provisions of the securities laws. The Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act") repealed a former Exchange Act provision authorizing monetary rewards for information leading to the recovery of civil penalties for insider trading violations, and created a broader program for making monetary awards to whistleblowers. Under Section 21F, the Commission may use funds collected as sanctions in judicial or administrative proceedings to pay rewards for original information about a violation that leads to a successful enforcement action.

The Commission adopted final rules implementing the program that became effective in August 2011. The rules define a "whistleblower" as a person who provides information to the SEC relating to a possible violation of the securities laws that has occurred, is ongoing, or is about to occur. Original information must be based upon the whistleblower's independent knowledge or independent analysis, not already known to the Commission and not derived exclusively from certain public sources. Under these rules, whistleblowers also receive greater protections from retaliation. A whistleblower who provides information to the Commission is protected from employment retaliation if the whistleblower possesses a reasonable belief that the information he or she is providing relates to a possible securities law violation that has occurred, is ongoing, or is about to occur.

In its annual report on the Dodd-Frank Whistleblower Program for the Fiscal Year 2013, the Commission revealed that the Office of the Whistleblower received 3,238 tips during FY 2013 (237 more than FY 2012). The three issues most cited by those making whistleblower filings were corporate disclosures and financials, offering fraud, or manipulation; insider trading was the next most frequently cited reason for making a filing.

Four whistleblowers received awards totaling $14,831,965 64 in FY 2013. One of these was the recipient of the largest award to date: over $14 million for information leading to a Commission enforcement action that recovered substantial investor funds. In April 2014, the SEC announced that the first person who received an award under the whistleblower program will receive another payout after the SEC collects additional funds in the case. The whistleblower received nearly $50,000 in 2012 for helping the SEC stop a multi-million dollar fraud. At the time, the award represented 30 percent of the amount the SEC had collected in its enforcement actions against the perpetrators of the scheme. Thirty percent is the maximum percentage payout allowed under the whistleblower law.

In March 2014, the U.S. Supreme Court ruled in Lawson v. FMR LLC that Sarbanes-Oxley Act Sec. 806, codified at 18 U.S.C §1514A, extends whistleblower protection to employees of privately held contractors and subcontractors who perform work for public companies. Writing for the Court, Justice Ginsburg said that nothing in the statutory language confines the class of employees protected to those of a designated employer. "We presume the operative language means what it appears to mean: A contractor may not retaliate against its own employee for engaging in protected whistleblowing activity," Justice Ginsburg wrote.

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

• Exchange Act Section 21F at ¶26,423ZA
• Dodd-Frank Act Section 922 at ¶58,168
• Dodd-Frank Act Section 929A at ¶58,176
• Sarbanes-Oxley Act Section 806 at ¶62,907
• Lawson v. FMR LLC (US Sup Ct) is reported at ¶97,838
• CCH Explanations (e.g., ¶62,991.093)
• Report letters (e.g., 3-27-14, "SEC reporting not a prerequisite to whistleblower protection" (discussing Khazin v. TD Ameritrade Holding Corp. (DC NJ) at ¶97,851)

• Dodd-Frank Wall Street Reform and Consumer Protection Act: Law, Explanation and Analysis (e.g. ¶4060)
• SEC Today (e.g., "Enforcement Panel Reviews Insider Trading and Whistleblowers" (10-22-13) and "SEC Awards Three Whistleblowers and Denies a Fourth" (6-14-13))
• SEC Division of Enforcement Manual (e.g., "Tips, Complaints, and Referrals §2.2.1.2)
• Regulation of Securities: SEC Answer Book – Levy (e.g., Question 20:1, et seq.)
• Jim Hamilton’s World of Securities Regulation