October 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 Reform Resources

  

 

 

CCH Federal Securities Law Reporter

SEC Adopts Temporary Rule for Municipal Adviser Registration. The SEC has adopted an interim final temporary rule to enable municipal advisers to satisfy the requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act that they register with the Commission by October 1, 2010. Temporary Rule 15Ba2-6T will expire on December 31, 2011, which will give the SEC time to consider a final permanent registration program for municipal advisers and to seek public comment before its adoption. The Dodd-Frank Act makes it unlawful for municipal advisers to provide certain advice or solicit municipal entities without registering with the SEC, effective October 1. The SEC adopted Rule 15Ba2-6T to permit municipal advisers to temporarily satisfy the registration requirement. The rule will ensure that relevant information is available to the public and to municipal entities and allow municipal advisers to continue their business. Release No. 34-62824 at ¶89,099 (IntelliConnect) (IRN) (ip access user).

 

SEC Proposes New Disclosure Rules for Short-Term Borrowings. The SEC is seeking comment on proposed rules designed to give investors a better picture of a company’s liquidity, leverage position and funding risks. The proposal addresses concerns that certain companies engage in so-called “window dressing” in which they mask their actual liquidity and leverage position by incurring significant short-term borrowing during reporting periods and then reduce those amounts just before a period-end in order to show less leverage in the amounts they report. The SEC also issued interpretive guidance to remind companies of the current disclosure requirements in MD&A related to critical liquidity matters. The guidance makes clear that companies cannot use financing structures that are designed to mask their reported financial condition.

The SEC’s rules currently require companies to disclose their short-term borrowings at the end of a reporting period, other than bank holding companies which must disclose annually the average and maximum amounts of short-term borrowings outstanding during the year. The proposed rules would define short-term borrowings as amounts that are payable for short-term obligations that include federal funds purchased and securities sold under agreements to repurchase, commercial paper, borrowings from banks, borrowings from other financial institutions or any other short-term borrowings that are reflected on the registrant’s balance sheet. Under the proposal, companies would be required to provide quantitative information in their MD&A for each type of short-term borrowing, including the amount outstanding at the end of the reporting period and the weighted average interest rate on the borrowings, the average amount outstanding during the period and the weighted average interest rate on those borrowings, and the maximum amount outstanding during the period. Companies would have to describe the business purpose for their short- term borrowing arrangements and the importance of the arrangements to their liquidity. Financial companies and non-financial companies would be subject to different disclosure requirements. Release Nos. 33-9143 and 33-9144 at ¶89,106 and ¶89,107.

 

Sarbanes-Oxley 404(b) Exemption Adopted for Smaller Issuers. The Securities and Exchange Commission adopted a final rule to implement Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 989G affords small issuers an exemption from the internal controls auditor attestation requirement of Section 404(b) of the Sarbanes-Oxley Act of 2002. Section 404(b) requires registered public accounting firms that prepare or issue audit reports for an issuer to attest to, and report on, the assessment made by the issuer’s management of the company’s internal controls. Previous SEC rules required a non-accelerated filer to include an attestation report in its annual report for years ending on or after June 15, 2010. Section 989G of the Dodd-Frank Act added Sarbanes-Oxley Act Section 404(c) to exempt from the attestation requirement smaller issuers that are neither accelerated filers nor large accelerated filers under Exchange Act Rule 12b-2. The Commission removed the requirement that a non-accelerated filer include an attestation report from a registered public accounting firm in its annual report. Release No. 33-9142 at ¶89,104.

 

Fifth Circuit Reinstates SEC Insider Trading PIPE-Related Enforcement Action. In an SEC enforcement action alleging insider trading in a PIPE-related case, a Fifth Circuit panel said that it was plausible that the company's largest shareholder agreed not to trade on inside information about the PIPE offering when he agreed to keep the information confidential. the district judge ruled that the agreement required to invoke the misappropriation theory of insider trading liability must include both an obligation to maintain the confidentiality of the inside information and not to trade on or otherwise use the information. Thus, the appeals court vacated the district court's dismissal of the enforcement action and allowed the SEC to go forward.

In this action, the SEC alleged that, after the shareholder agreed to maintain the confidentiality of inside information concerning the offering, he sold his stock in the company without first disclosing to the company that he intended to trade on this information, thereby avoiding substantial losses when the stock price declined after the PIPE was publicly announced. As the PIPE offering progressed toward closing, the company decided to inform the shareholder of the offering and to invite him to participate.

The CEO prefaced the call by informing the shareholder that he had confidential information to convey to him, and the shareholder agreed that he would keep whatever information the CEO intended to share with him confidential. The CEO, in reliance on this agreement, told the shareholder about the PIPE offering. The shareholder reacted angrily to this news, stating that he did not like PIPE offerings because they dilute the existing shareholders. Several hours after they spoke by telephone, the CEO sent the shareholder a follow-up email in which he provided contact information for the investment bank conducting the offering. The shareholder then contacted the sales representative, who supplied him with additional confidential details about the PIPE. One minute after ending this call, the shareholder telephoned his broker and directed the broker to sell all 600,000 of his shares, thereby avoiding losses in excess of $750,000 by selling prior to the public announcement of the PIPE.

The district court found that the complaint asserts no facts that reasonably suggest that the CEO intended to obtain from the shareholder an agreement to refrain from trading on the information as opposed to an agreement merely to keep it confidential. But the appeals panel found that the SEC allegations, taken in their entirety, provide more than a plausible basis to find that the understanding between the CEO and the shareholder was that he was not to trade, that it was more than a simple confidentiality agreement.  The panel said that it was at least plausible that each of the parties understood, if only implicitly, that the company would only provide the terms and conditions of the PIPE offering to the shareholder for the purpose of evaluating whether he would participate in the offering, and that the shareholder could not use the information for his own personal benefit. SEC v. Cuban (5thCir) is reported at ¶95,864.

 

District Court Erroneously Applied Bespeaks Caution Doctrine.  A 2nd Circuit panel affirmed in part a district court's dismissal of a complaint for failure to state a claim under the Securities Act. Investors in a brokerage firm asserted that they had purchased shares during an IPO as a result of false and misleading statements made in the registration statement and prospectus. Specifically, the statements concerned the firm's risk management policies and procedures, which, it was later acknowledged, did not prevent a representative from entering unauthorized contracts and exceeding his trading limit, resulting in a $141.5 million loss when the positions had to be liquidated. When this news reached the markets, it resulted in a two-day market capitalization loss of over $1.1 billion.

The panel concluded that the district court erroneously applied the bespeaks caution doctrine in dismissing the claim that the prospectus and registration statement exaggerated risk-management measures. According to the panel, the allegation concerned the applicability of the firm's risk management system to employee accounts, an omission of a present fact to which the bespeaks caution doctrine did not apply. The district court, stated the panel, applied the doctrine too broadly in applying it to any statement that could be characterized as the non-disclosure of a risk "regardless of whether the statement looked to the future or was rooted in the known present." The bespeaks caution doctrine, the panel elaborated, "does not apply insofar as those characterizations communicate present or historical fact as to the measures taken." The panel then remanded the remaining allegations to the district court to be analyzed under the described standard.

The panel then affirmed in part the claim that the prospectus and registration statement failed to disclose deficiencies in the firm's controls of client accounts. The panel found to be "sound" and affirmed the district court's conclusion that statements regarding access to customer accounts were not misleading because the investors could not demonstrate loss causation, as the unauthorized trade at issue occurred in a non-client account. The panel noted, however, that there existed deficiencies in risk management that also affected customer orders taken by telephone. The panel therefore vacated and remanded the dismissal of the allegation that telephone orders were not subject to risk management. Iowa Public Employees' Retirement System v. MF Global, Ltd. (2ndCir) is reported at ¶95,855.

 

Company Believed Deal Would Close as Originally Negotiated. A 2nd Circuit panel issued a summary order affirming a district court's dismissal of a securities fraud action. The case arose out of a failed merger in which a party sought to renegotiate the purchase price and later repudiated the merger agreement. The investors alleged that the company had a duty to disclose that the other party sought renegotiations and had made material misstatements indicating that the deal would close as originally negotiated. The investors alleged further that the company concealed the problems in order to stabilize the price of its stock. The district court dismissed the complaint after finding that it failed to adequately allege scienter. The panel found it more likely than not that the company believed that the deal would close as originally negotiated. According to the panel, the record indicated that both parties acted in a manner showing that they were diligently working to close the transaction and that the company believed that the deal would go through. Accordingly, the panel found that the investors failed to set forth an inference of scienter at least as compelling as any competing inference that could be drawn from the facts. First New York Securities LLC v. United Rentals Inc. (2ndCir) is reported at ¶95,847 (IntelliConnect) (IRN) (ip access user).

 

Amended Complaint Failed to Plead Falsity or Scienter With Particularity. In an unpublished opinion, a 9th Circuit panel found that an amended complaint did not cure the deficiencies of the original and affirmed the district court's dismissal of the action. Investors in a soda company alleged that stock prices had been inflated as a result of the company overstating the number of stores that had agreed to carry the company's products, overstating its ability to capitalize on retail connections and failing to reveal problems encountered in introducing the product nationwide. The district court found that amendment would be futile because the failure of expected revenues to appear was not solely explainable by fraud and could be more plausibly attributed to poor planning or difficulties encountered in attempting to bring a niche brand nationwide.

In affirming the judgment, the panel found that the complaint failed to plead either falsity or scienter with the required particularity. The panel found that the complaint mischaracterized the company's statements, which were more overoptimistic than false, and that the only allegation that was not conclusory, that an officer had received sales data from retailers, was not stated with particularity sufficient to give rise to an inference of scienter. A dissenting judge accused the majority of misperceiving the company's obligations to potential investors and argued that the company had deliberately inflated its qualifications. In re Jones Soda Co. Securities Litigation (9thCir) is reported at ¶95,846 (IntelliConnect) (IRN) (ip access user).

 

 

CCH Blue Sky Law Reporter  

California Mandates IAs to Use SEC New Form ADV Part 2 in 2011. Investment adviser applicants for licensing in California must include the SEC’s newly adopted Part 2 of Form ADV with their application submitted electronically through the IARD on or after January 1, 2011. Similarly, California-licensed investment advisers will need to include new Part 2 with their next annual renewal filing of Part 1 of Form ADV through the IARD on or after January 1, 2011 that is required within 90 days of their fiscal year-end. ¶12,668 (IntelliConnect) (IRN) (ip access user).

 

Colorado Proposes BD, Sales Rep. and IA/IA Rep. Rule Amendments. Adding new solicitation and custody rules for investment advisers, modifying licensing exam requirements for sales and investment adviser representatives, providing a time frame for abandoning licensing applications, and changing NASD to FINRA to reflect the current name of the organization would be proposed by the Colorado Securities Division. Also, “Mergent” would replace “Moody’s” to reflect the current name of the stock rating organization. A public hearing on the proposed rule changes was held on September 15.  ¶13,429 (IntelliConnect) (IRN) (ip access user) through ¶13,450 (IntelliConnect) (IRN) (ip access user).

 

Florida Adopts Review of Dealer, Issuer-Dealer and Investment Adviser Applicants' Law Enforcement Records…The law enforcement records of applicants for dealer, issuer-dealer and investment adviser registration who have been found guilty of, or who have pled guilty or nolo contendere to, certain crimes will be reviewed by the Office of Financial Regulation to determine their eligibility to register in Florida. ¶17,451A (IntelliConnect) (IRN) (ip access user).

 

…Proposes Electronic Filing of Licensing and Securities Registration Applications …As proposed by the Florida Office of Financial Regulation, licensing applications for FINRA and non-FINRA member broker-dealers, issuer-dealers, Canadian dealers, federal covered and state investment advisers and their associated persons, as well as securities registrations and the applicable fees would be filed electronically. Other registration and post registration requirements would be amended and the date on various Florida securities forms would be updated to reflect the most current version of the form. ¶17,426 (IntelliConnect) (IRN) (ip access user).

 

…And Proposes Disciplinary Guidelines. Disciplinary guidelines applicable to each ground for which disciplinary action may be taken against an individual or firm were proposed by the Florida Office of Financial Regulation. ¶17,541 (IntelliConnect) (IRN) (ip access user).

 

Illinois Proposes Rules Regulating IA Advertising and Client Information. Investment advisers registered or required to be registered in Illinois would be prohibited from using advertisements that contain untrue statements of material fact or that are misleading, and would also be required to have a written consumer privacy policy to protect their clients’ information, under rules proposed by the Illinois Securities Department. ¶22,690C (IntelliConnect) (IRN) (ip access user) and ¶22,690D (IntelliConnect) (IRN) (ip access user).

 

Iowa Proposes Broker-Dealer, Agent and Investment Company Rule Changes. Rule changes proposed by the Iowa Securities Bureau would include amending broker-dealer registration requirements, increasing agent fees and mandating investment companies to submit their notice filings electronically. A public hearing on the proposed changes was held September 3, 2010. ¶25,401 (IntelliConnect) (IRN) (ip access user), ¶25,410 (IntelliConnect) (IRN) (ip access user),¶25,412 (IntelliConnect) (IRN) (ip access user), ¶25,418 (IntelliConnect) (IRN) (ip access user), ¶25,460 (IntelliConnect) (IRN) (ip access user).

 

OregonTemporarily Adopts Dodd-Frank Accredited Investor Definition. Oregon's accredited investor definition excludes the value of an investor's primary residence from the $1 million net worth calculation to reflect the modification of the federal "accredited investor" definition under the Dodd-Frank Wall Street Reform and Consumer Protection Act. This definition is temporarily effective from August 3, 2010 to January 30, 2011 and simultaneously proposed for permanent adoption. ¶47,553 (IntelliConnect) (IRN) (ip access user).

 

Texas Adopts Dealer and IA Exam and Supervisory Requirements. Rule provisions amending the exam requirements for securities dealer and agent applicants, the supervisory requirements for dealers and investment advisers and certain Texas forms were adopted by the Texas Securities Board. ¶55,591 (IntelliConnect) (IRN) (ip access user) through ¶55,595I (IntelliConnect) (IRN) (ip access user).

 

Utah Updates Stock Exchange Names. The names of the national stock exchanges for purposes of exemption were updated by the Utah Securities Division to reflect current federal securities law. Securities listed on the New York Stock Exchange, NYSE Amex Equities, NASDAQ Global, NASDAQ Global Select, NASDAQ Capital Market, Chicago Board Options Exchange or Philadelphia Stock Exchange are exempt from registration. Securities listed on the Chicago Stock Exchange or Tier II of the Philadelphia Stock Exchange are exempt from registration but only for nonissuer transactions effected by or through a licensed broker-dealer. ¶57,410 (IntelliConnect) (IRN) (ip access user).

 

Washington State Proposes Dodd-Frank Accredited Investor Definition. Washington State’s accredited investor definition would be amended to exclude the value of an investor’s primary residence from the $1 million net worth calculation to reflect the modification of the federal “accredited investor” definition under the Dodd-Frank Act. ¶61,752 (IntelliConnect) (IRN) (ip access user).

 

Wisconsin Adopts Annual Rules Revision. The primary focus of Wisconsin's 2010 annual rules revision, effective October 1, 2010, pertains to investment adviser solicitation activities based on language developed by the NASAA IA Regulatory Policy and Review Project Group. ¶64,586 (IntelliConnect) (IRN) (ip access user) and ¶64,593 (IntelliConnect) (IRN) (ip access user).

 

Complaint Failed to Allege “Participation” in Unlawful Aftermarket Sales. In Grand v. Nacchio, the Supreme Court of Arizona held that the plaintiff investor failed to state a claim for securities fraud under the Arizona Securities Act (Act) because the defendants had not "participated in" the allegedly unlawful sales. The complaint alleged that the defendants had fraudulently overstated the earnings of one of the joint venturers of the issuer, and that the plaintiff would not have purchased the shares in the aftermarket had the fraud been disclosed. Although the allegations of the defendants' misrepresentations and omissions would have stated a claim for inducement under the Act, the state high court observed that the plaintiff had explicitly disavowed an inducement theory in order to rely entirely on the contention that the defendants had "participated in" the aftermarket sales. The allegations did not describe "participation" in illegal sales, however, because the complaint alleged no relationship whatsoever between the sellers of the aftermarket shares and the defendants. Moreover, the complaint did not allege that the defendants played any role in the transactions between the investor and the sellers after persuading the investor to purchase the shares. Even if the defendants benefitted substantially from the aftermarket stock purchases, the court reasoned, a financial interest alone did not establish that they participated in the sales. Accordingly, the trial court properly dismissed the plaintiff's claims for securities fraud and control person liability under the Act. Grand v. Nacchio is reported at ¶74,862 (IntelliConnect) (IRN) (ip access user).

 

Aspen Federal Securities Publications  

A Practical Guide to Section 16: Reporting and Compliance, Fourth Edition, edited by Stanton P. Eigenbrodt. The 2011 Supplement (IntelliConnect) (IRN) (ip access user) is available online on the Corporate Governance Integrated Library. This publication contains complete information on reporting and filing procedures to comply with the complex shareholder, SEC, public disclosure, and stock exchange requirements. This latest update includes a significant revision to Chapter 1, An Overview of the Rules Under Section 16 of the Securities Exchange Act; updated Chapter 3, The Reporting Scheme; and current updates to the SEC’s Compliance and Disclosure Interpretations, Exchange Act Section 16 and Related Rules and Forms (which are included as Appendix 8).

 

Hot Topic of the Month

This month’s hot topic is executive compensation. Since 2006, SEC rules have required that all elements of executive compensation be disclosed and that a total individual compensation number be provided for the top five senior officers and all directors. The requirements apply to disclosure in proxy and information statements, periodic reports, current reports and other filings under the Exchange Act and to registration statements under the Exchange Act and the Securities Act. The overall goal of the executive and director compensation disclosure rules are to provide investors with a clearer, better organized, and more complete picture of compensation to principal executive officers, principal financial officers, and the highest paid executive officers and directors.

In late 2009, the SEC made significant revisions to certain provisions of Regulation S-K concerning compensation disclosure. The amendments require registrants to make new or revised disclosures about compensation policies and practices that present material risks to the company, and stock and option awards of executives and directors. The Commission also modified some corporate governance concerns, including disclosure requirements for director qualifications and the use of compensation consultants.

The Dodd-Frank Act has instituted an array of measures reforming the compensation and governance practices of public companies and financial institutions. Among other measures, the legislation requires a shareholder advisory vote on executive compensation ("say on pay"), greater independence of compensation committees, and disclosure of hedging by directors and employees. In addition, the legislation authorizes SEC rulemaking on shareholder access to proxy materials.

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

• Federal Securities Law Reporter

• Report letter, "Schapiro Asks for Industry's Help in Implementing Dodd-Frank Provisions" (8-4-10) (IntelliConnect) (IRN) (ip access user)
• Release No. 9089, Proxy Disclosure Enhancements, at ¶88,827 (IntelliConnect) (IRN) (ip access user)
• Release No. 8732, Executive Compensation Disclosure, at ¶87,620 (IntelliConnect) (IRN) (ip access user)
• Dodd-Frank Act Sections 951 – 956, at ¶58,225 (IntelliConnect) (IRN) (ip access user) – ¶58,320 (IntelliConnect) (IRN) (ip access user)
• Dodd-Frank Act Sections 971 – 972, at ¶58,240 (IntelliConnect) (IRN) (ip access user) and ¶58,241 (IntelliConnect) (IRN) (ip access user)
• Regulation S-K, Item 402, at ¶71,402 (IntelliConnect) (IRN) (ip access user)
• CCH Explanations (e.g., ¶71,301 (IntelliConnect) (IRN) (ip access user))

• Dodd-Frank Wall Street Reform and Consumer Protection Act: Law, Explanation and Analysis (e.g. ¶4290 (IntelliConnect) (IRN) (ip access user) and ¶4305 (IntelliConnect) (IRN) (ip access user))
• Insights – Amy L. Goodman (e.g. "Executive Pay Reform Poses Complex Risks for Compensation Committees" (October 2009) (IntelliConnect) (IRN) (ip access user)
• Securities Regulation – Loss & Seligman (e.g., Chapter 2.D.2.k (IntelliConnect) (IRN) (ip access user))
• A Practical Guide to SEC Proxy and Compensation Rules – Goodman, Olson, & Fontenot (e.g., Chapter 1:01 (IntelliConnect) (IRN) (ip access user)
• Jim Hamilton’s World of Securities Regulation (http://jimhamiltonblog.blogspot.com/) (e.g., 8-9-10)

IPO Vital Signs