Monthly Archives: May 2010

May 28, 2010

The New UK “Financial Services Act 2010” Makes Significant Reforms

On the heels of the passing of “The Financial Services Act 2010,” the United Kingdom’s new coalition government announced that it will not disband the Financial Services Authority – sparing the country’s financial regulator from abolishment. Learn more in this memo in our “European Law” Practice Area.

Sometime today, the UK’s Financial Reporting Council is likely to announce changes to the UK’s “Combined Code on Corporate Governance.”

First DOJ Opinion in ’10 Permits Payment to Foreign Official

Last month, the DOJ issued its first opinion of the year – Opinion Procedure Release No. 10-01 – in which it announced that it would not take enforcement action under the Foreign Corrupt Practices Act against a U.S. company that proposed to pay a foreign official for services the foreign official would provide on behalf of the US company. Learn more in this memo posted in our “Foreign Corrupt Practices Act” Practice Area.

Stayed tuned for this upcoming webcast: “Critical FCPA Diligence in Deals Today.”


– Broc Romanek

May 27, 2010

Posted: Final Version of Senate’s Dodd Bill (and More)

Yesterday, the final version of the Senate’s Dodd bill – the “Restoring American Financial Stability Act of 2010” – was made publicly available. At 1,615 pages, it will take quite some time to print (and read!).

If you’re interested in just the corporate governance and executive compensation portions of the RAFSA, check out this 23-page excerpt courtesy of Davis Polk. Of course, we continue to post memos analyzing the bill in our “Regulatory Reform” Practice Area (here is a 8-pager with a nice side-by-side comparison of the House and Senate bills). And stay tuned for an upcoming podcast on the Senate bill next week if you are more audio-inclined…

The Skinny on “Virtual” Law Firms

In this podcast, David Goldenberg of Virtual Law Partners explains how the “virtual” law firm model works, including:

– What is Virtual Law Partners?
– How is the firm run differently than a typical firm?
– From a client’s perspective, how are services provided any different?
– What led you to the virtual model?
– How do you overcome the challenges of not being physically together?

Smaller Company M&A: The Latest Developments

We have posted the transcript of our recent webcast: “Smaller Company M&A: The Latest Developments.”

– Broc Romanek

May 26, 2010

Say-On-Pay So Far: Wow! A Third Company Fails to Gain Majority Support

As noted in the ISS Blog, KeyCorp became the third company to fail to obtain majority support for its executive pay package at its annual meeting last Friday. The pay package received only 45% support – it received 87% support last year. Here’s the company’s Form 8-K with the voting results.

So KeyCorp joins Motorola and Occidental Petroleum as the first three US companies whose management say-on-pay ballot items didn’t pass. Wow.

Consider the magnitude of this development:

– These three companies are not Wall Street banks where the general public is angry over banker bonuses.

– There were no organized campaigns against the pay packages at these three companies. This was a pure grass roots movement. With organized campaigns, imagine the level of votes.

– Only a few hundred companies have say-on-pay on their ballot this year; a small fraction of the 10,000 that will have it on their ballot next year when Congress makes it mandatory.

– If the Senate provision remains in the final bill changing NYSE Rule 452, say-on-pay will become a “nonroutine” agenda item – and broker nonvotes won’t be available to be cast in favor of pay packages. This means it will become harder to obtain majority support for executive pay packages.

How to Prepare for Mandatory Say-on-Pay

We have just posted the agendas for the “7th Annual Executive Compensation Conference” and the “18th Annual NASPP Conference” to be held in Chicago on September 20-23 (the “7th Annual” is also available via video webcast).

Among the 40-plus panels, we have tailored a special track to help you prepare for mandatory say-on-pay including these panels:

– “Say-on-Pay: The Proxy Solicitors Speak”
– “Say-on-Pay: Successfully Communicating Externally and Internally”
– “The Proxy Advisors & Investors Speak: Their Hot Button Issues and Say-on-Pay”
– “The New Compensation Legislation: What to Do About Say-on-Pay and More”
– “Five Hot Button Compensation Fixes: In Light of Say-on-Pay and More”
– “This Coming Year’s Grants: How to Deal with Last Year’s Inadvertent Gains”
– “The Big Roundtable: Consultants, Directors and Top HR Heads”
– “Directors Speak Their Minds on Executive Compensation”

With Conference registrations going strong – on track to reach nearly 2000 attendees – you don’t want to be caught unprepared as we head into next year. Last year’s Conference sold out a month in advance – and that was without the reality of mandatory say-on-pay hanging over our heads.

Act Now: You have two choices – either attend the “18th Annual NASPP Conference” in Chicago (which includes the ability to attend the “7th Annual Executive Compensation Conference” – or attend the “7th Annual Executive Compensation Conference” by video webcast (which includes the “5th Annual Proxy Disclosure Conference”).

Handicapping the House-Senate Conference Committee Reconciliation

Although we will not officially know the entire composition of the House-Senate Conference Committee that will reconcile the Senate and House versions of a financial reform bill for a few more weeks, we do know that Rep. Barney Frank will head the Committee (as noted in the NY Times’ DealBook) and we do know the twelve Senators that will be included in that Committee (as noted in this Reuters article; this Reuters article identifies likely House members of the Committee even though they won’t be officially named til week of June 7th). Congress – and President Obama – have a goal to wrap up a final bill by the 4th of July recess.

Even though the House’s bill was weaker in the governance area, it is likely that Rep. Frank will push to keep the stronger Senate provisions in the final bill – with some tweaks as noted below – given that very few of the 400-plus proposed amendments to the Dodd bill dealt with governance issues. The real reconciliation debate will center on how financial institutions are regulated (ie. derivatives, “too big to fail”, etc. – see Frank’s comments in these areas yesterday).

Note that Barney Frank wants the Conference Committee negotiations televised.

Barney Frank Speaks: His View of Which Governance Provisions Will Survive Reconciliation

According to this article, Rep. Frank yesterday said that the specific language regarding the proxy access provision was up in the air. He also said that the Senate provision for a self-funded SEC may be tweaked to keep Congress involved somewhat – and he indicated that the House provision to exempt smaller companies from SOX’s internal controls requirement may survive. According to the ISS Blog, Frank said that the Senate’s majority vote requirement could well be stripped out in the final bill.

Below is a piece written by CongressDaily’s Bill Swindell entitled “Frank Sees SEC Self-Funding Language As Ripe for Revision” that covers a number of topics:

A drive to allow the SEC to self-fund its budget by retaining fees it collects will likely have to be modified to allow for greater oversight by appropriators, House Financial Services Chairman Barney Frank said Tuesday. Frank said conference negotiators on legislation to revamp the nation’s financial regulatory system will have to take into account the resistance of appropriators to SEC self-funding because they would lose their power to dictate its budget.

“The Appropriations Committee gets very upset about this. What I am hoping that gets worked out, and it will be with their participation, is a way to do some self-funding, which leaves the Appropriations Committee with a role,” Frank said during a talk at the Compliance Week annual conference. The Senate bill contains the provision, allowing the agency’s chairman to submit a budget to the SEC, but it would automatically get the amount requested. The language was sponsored by Sen. Charles Schumer, D-N.Y., who has argued the agency needs more resources to monitor wrongdoing in the aftermath of the Bernard Madoff and Allen Stanford fraud cases. The House bill set an increase in authorization levels.

The FY10 funding for the SEC was $1.1 billion, a $151 million increase over FY09. It has requested $1.26 billion for FY11. The agency collected $1.5 billion in fees in 2008. “The appropriators are going to push hard to maintain some role, and I think they will be successful,” Frank said. Both bills give the SEC authority to issue rules that would allow shareholders to nominate board of director candidates through increased proxy access. “I think we are at least going to empower the SEC to do it. Beyond that, I’m not sure,” Frank said.

The SEC last year proposed a rule to require companies in some cases to include in their proxy materials the nominations for directors by shareholders, but held off on finalizing the proposal. The U.S. Chamber of Commerce and other business groups question whether the agency has the right to issue rules over corporate governance standards that are enacted at the state level.

The Senate bill, however, includes additional Schumer provisions, such as requiring that directors in uncontested elections receive a majority of the votes cast, or they must tender their resignation. It also would require the SEC to issue rules to require public companies in their proxy statements to disclose why the same or different people serve as chairman and CEO. Frank said he did not know if the additional Schumer provisions could withstand negotiations, though they are a priority for the New Yorker.

Frank expressed some skepticism for a drive to separate the CEO and chairman duties. “In my experience, it hasn’t made a lot of difference if you have looked at the performance, of separating the CEO from the chairman of the board. People say it’s very important. But my guess is that if you threw up the list of major companies, and didn’t tell people which was which, there wouldn’t be [a] way to differentiate by any kind of results and analysis,” he said.

The Senate appointed its conferees Tuesday, with a 7-5 ratio of Democrats to Republicans. Frank said the House will appoint its conferees the week of June 7, and he recommended a party-line ratio of eight to five. “We have an administration that feels strongly about this, and I expect House leadership will be engaged more than they were last year when health care took up much of their time and when they paid us the compliment of trusting us,” Frank wrote to Democratic members of his panel.

“Their greater involvement will not imply a lack of trust, but simply the fact we are down to a very few important issues where the administration will be strongly expressing its view,” he continued. “There is also the fact that the need to keep 60 votes in the Senate will be something of a constraint.”

– Broc Romanek

May 25, 2010

US Supreme Court Denies Textron’s Petition for Writ of Certiorari

Here is news from Stan Keller of Edwards Angell (we are posting memos on this development in our “Work Product” Practice Area):

Yesterday, the U.S. Supreme Court denied the petition for certiorari filed by Textron, leaving the decision in favor of the IRS in the First Circuit in place. What this means, given the split of authority in the Circuits, is unclear – other than that it means continued uncertainty with regard to the protected status of tax workpapers.

Here is more of a drill down: the Supreme Court’s denial of the petition for certiorari filed by Textron leaves in place the en banc decision of the U.S. Court of Appeals for the First Circuit in United States v. Textron, Inc., 577 F.3d 21 (1st Cir. 2009). That decision held that Textron’s tax workpapers, which were shared with its auditor, were prepared in the ordinary course in connection with preparing its annual financial statements and were not case preparation materials prepared “because of” or “for use in” litigation, and thus were not subject to protection from IRS summons under the work product doctrine.

The Supreme Court’s denial of cert. leaves the strict First Circuit test in place, which is in conflict with tests applied in other circuits. For example, the test in the Second Circuit applied in United States v. Adlman, 134 F.3d 1194 (2d Cir. 1998), is whether the materials were prepared “in anticipation of” or “because of possible” litigation. This was the test previously applied by the First Circuit in Maine v. United States Dept. of Interior, 298 F.3d 60 (1st Cir. 2002).

The Fifth Circuit applies a stricter test but still not as strict as the First Circuit’s test in Textron. In United States v. El Paso, 682 F.2d 530 (5th Cir. 1982), the Fifth Circuit required the prospect of litigation to be the “primary motivating factor for the preparation of the documents.” Thus, until clarified by the Supreme Court in another case, we have uncertainty in the status of tax workpapers and other materials shared with auditors, and companies in the First Circuit share such materials with auditors at their peril.

Third-Party Review of Executive Compensation Practices II

In this follow-up podcast on, Greg Taxin of Soundboard Review Services discusses the latest developments for Soundboard Review Services (here is the first podcast), including:

– Soundboard has been quoted in its first proxy this year, for DuPont. Can you tell us what the DuPont board engaged you to do?
– How are investors using the information provided by DuPont in its proxy about your review services? Have investors contacted you?
– Having now done a number of these reviews, can you share any surprising practices you have seen or best practices that are perhaps uncommon?

More on “The Mentor Blog”

We continue to post new items daily on our blog – “The Mentor Blog” – for members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

– 0.3% of Directorships Voted Down in 2009: Will 2010 Be Different?
– Proxy Access: Notes from a Stanford Law Panel
– New Type of Whistleblower: State Securities Regulator Resigns in Protest
– The Problem with IFRS: Little Independence for the IASB
– More on “Earnings Releases: Google’s Site as a ‘Recognized Channel'”

– Broc Romanek

May 24, 2010

Posted: Memos on the “Restoring American Financial Stability Act of 2010”

Even though the Senate has not yet made available the final Dodd bill – reflecting the various amendments adopted during the last few weeks of Senate floor debate – and the final bill is not expected to be released for several days, we have begun posting memos from firms in our “Regulatory Reform” Practice Area. These firms have written their memos based on an assessment of where the bill ended up…

Note that the final tally of proposed amendments exceeded 430 – an average of 4.3 per Senator!

Virginia’s New “Financial Fraud Task Force”

Last week, the USA Today carried this article about a new multi-agency federal task force focused on financial fraud cases – with a priority on securities cases – that will be based in Richmond, Virginia. The US Attorney’s Office in Richmond will coordinate the Task Force with the SEC, CFTC, FBI, US Postal Service and IRS, as well as state law enforcement agencies. The arrangement is described as a partnership born as a “boots-on-the-ground outgrowth” of the interagency Financial Fraud Enforcement Task Force established by President Obama last November.

According to the USA Today article, the government is excited because potential jurors in the Virginia area are perceived to be supportive of government action – and because the federal docket moves cases from indictment to trial in 90 to 150 days, a true “rocket docket.”

How does eastern Virginia have the legal right to handle almost any securities law fraud case? Because the filings from publicly traded companies go to the SEC’s EDGAR computer server in Alexandria, Virginia. The EDGAR servers moved there from DC more than a decade ago. Also, this BusinessWeek article notes that the Federal Reserve in Richmond is one of the primary hubs for wire transfers.

Update on “Carried Interest” Legislation

Here is news from Davis Polk: On May 20, Democratic House and Senate tax writers released a tax extenders package (H.R. 4213) that includes provisions relating to the taxation of carried interest received by investment fund managers.

In general, the proposal would tax carried interest (and gain on the disposition of carried interest partnership interests) as ordinary income and as income subject to self-employment taxes. The new bill is substantially similar to the version originally proposed by Rep. Levin and passed by the House in December, with the following changes.

– The most significant change is that, in the case of partners who are individuals, ordinary income treatment and self-employment tax would apply to only 75% of each item of income comprising the carried interest. For taxable years beginning before 2013, the percentage would be 50% instead of 75%.

– The new version would generally apply to taxable years ending after the date of enactment, which therefore would include calendar year 2010 if the bill were enacted this year. Pursuant to a special provision, however, the new rules would apply only to partnership income for the post-enactment portion of the year (or, if less, partnership income for the entire enactment year). In the case of disposition gains, the new proposal would apply only to transactions occurring after the date of enactment.

– The new version would clarify that gains attributable to a general partner’s own out-of-pocket cash contributions are eligible for capital gain treatment even though those contributions are not subject to management fees or carried interest (and thus are not pari passu with limited partner interests).

– The new version includes various other technical changes. Among other things, these changes would:
o Exclude the disposition of a publicly traded partnership interest by an individual who does not provide investment management services.
o Exclude the contribution of a carried interest partnership interest to an upper-tier partnership if the contributing partner elects to treat the upper-tier partnership as an investment services partnership interest.

– Broc Romanek

May 21, 2010

Shocker! Senate Passes Cloture Motion – and Then Passes the Dodd Bill!

Yesterday afternoon, the US Senate passed a motion for cloture by a vote of 60-40 after failing to get a majority for this motion on Wednesday. Then, the Senate didn’t take advantage of the limited 30 hours of debate that cloture provides – instead it cleared a handful of procedural hurdles and passed the Dodd bill itself (the final bill is not yet available; I will blog when its posted; here’s the rollcall on how each Senator voted).

First, read this news from Ted Allen’s RiskMetrics’ Blog:

After several weeks of debate, the U.S. Senate voted 59-39 this evening to approve Senator Christopher Dodd’s wide-ranging financial reform legislation. The vote was largely along party lines, but four Republicans voted for the bill.

The final text was not immediately available, but the version of the bill brought to the floor included provisions to require majority voting in board elections and annual shareholder votes on executive compensation. The bill also affirmed the authority of the SEC to issue a proxy access rule.

The legislation will have to be reconciled with a narrower reform bill that the House of Representatives approved in December. That bill includes an advisory vote mandate and a proxy access provision, but not majority voting. A joint House-Senate conference likely will be held in June, and Democratic leaders hope to have a compromise bill ready for President Obama to sign by the July 4 holiday.

And more information from this excerpt of a WSJ article (see bottom of this article for bullets about where the Senate and House bills differ):

Sen. Gregg was one of 37 Republicans to vote against the 1,500-page bill. But the legislation ultimately passed with a narrow bipartisan majority. Four Republicans joined with 53 Democrats and the Senate’s two independents in support of the package. Two Democrats voted against the bill, and two senators weren’t present for the vote.

Now Congress will need to reconcile the Senate bill with a companion House package adopted in December on a 223-202 vote, with 27 Democrats joining unanimous Republican opposition.

The outlines of the two bills are largely the same. But there are more than a dozen notable differences that will need to be reconciled during negotiations that are expected to start within days. Despite the differences, the Senate passage virtually ensures that some type of financial regulatory reform will be finalized by this summer.

Leading the negotiations will be House Financial Services Chairman Barney Frank (D., Mass.), who has said he would like to have a compromise package by the end of June.

Insights: Delaware’s Latest Changes to the DGCL

In this podcast, John Grossbauer of Potter Anderson & Corroon provides some insight into this year’s changes to the Delaware General Corporation Law.

From “The Motley Fool,” here’s some great commentary about the ways of the world from Berkshire Hathaway’s Charlie Munger.

More on “The Mentor Blog”

We continue to post new items daily on our blog – “The Mentor Blog” – for members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

– Careers: Three Tips for Younger Lawyers
– Delaware Supreme Court Affirms In Part, Reverses In Part, And Remands Court of Chancery’s Ground-Breaking Decision On Bylaw Amendments, “Stockholders of Record” and “Vote Buying”
– SEC Proposes Large Trader Reporting System
– Special Litigation Committees: Chancellor Chandler Weighs In
– Do You Need to Use Director Nominee Questionnaires?

– Broc Romanek

May 20, 2010

Dodd Bill: Cloture Motion Fails and the Fight Over 300 Amendments Continues

Yesterday, the motion for cloture in the US Senate failed 57-42 regarding the Dodd bill, as noted in this blow-by-blow account in the WSJ. This motion would have limited further debate over the 300-plus proposed amendments to just 30 hours before forcing a vote on the bill (Yes, I said over 300 amendments! That’s an average of more than three per Senator for those playing at home).

This means that the Dodd bill might not be passed this week as expected (see this Washington Post blog) – and so far there has been no Manager’s Amendment, as well as no real way of knowing whether the amendment to kill proxy access and majority voting will be voted upon before the Senate’s tussling ends. Thanks to the folks at Davis Polk and others for helping me sort through the chaos on the Senate floor…

Audit Inspections: Some Countries Refuse to Play Ball with US Regulators

Earlier this week, the PCAOB published this alert that contains a list of foreign issuers where the PCAOB has been denied access to the information necessary to conduct inspections of the audits of those companies (as noted in this Accountancy Age article, this lack of information sharing may hinder a Lehman investigation). In these jurisdictions, the related governments have failed to cooperate with the SEC and PCAOB in coming up with a meaningful inspection process for these audits.

At a recent Investor Advisory Group meeting, investors encouraged the PCAOB to make this list publicly available so investors could determine which audits are not subject to the type of auditing framework that exists for US issuers. Due to this tug of war, there is greater uncertainty over the quality of the independent audits for these companies, including the integrity of their financial statements and their compliance with IFRS.

Posted: The SEC’s Semiannual Regulatory Agenda

Recently, the SEC posted its seminannual regulatory agenda, in which it reports its progress on rulemaking to Congress. From this list, you can see that the SEC has been busy – and will continue to be so. But there are no real surprises to be gleaned from the agenda…

– Broc Romanek

May 19, 2010

Dodd Bill: The Latest on the Regulation D Amendment

As I’ve been blogging, one of the battles in the Senate has been over the future of Regulation D (as strange as that is) – as I blogged yesterday, it looks like there is now closure on that issue for the Dodd bill. Here is the latest from Alan Parness of Cadwalader:

Regarding the proposed amendments to Sections 412 and 926 of S. 3217 introduced by Senators Bond et al last Thursday as SA 4037, such amendments have been supplanted by new amendments introduced on Monday by Senator Bond et al, as SA 4056, and those amendments were passed by voice vote of the Senate that evening. Here’s SA 4056 and its record from the Thomas (Library of Congress) website.

By my read of SA 4056, I noticed only a few minor changes to Sections 412 and 926 from the versions in SA 4037. Note that while the SEC’s initial review and adjustment of the definition of “accredited investor” in accordance with Section 412(b)(1) appears to be optional [“The Commission may undertake a review . . .”], Section 412(b)(2) mandates that the SEC undertake reviews of the definition every 4 years thereafter, but solely as regards the definition of the term in 17 CFR Sec. 230.215 (Rule 215 under the ’33 Act for purposes of the definition of “accredited investor” in Section 2(a)(15)(ii) and, in turn, the Section 4(6) exemption), but not as regards the definition in Rule 501(a) of Reg. D. The version of Section 412 in SA 4037 made no such distinction between the rules.

Of course, what remains to be seen is what the SEC does in accordance with the rulemaking directives of Sections 412 and 926, if those provisions are ultimately enacted in the versions set forth in SA 4056.

Coming Soon: The Next Phase-In for XBRL

Over the next several months, companies will face additional implementation milestones to provide XBRL-tagged financial statements with their SEC filings. For financial statements for periods ending on or after June 15th, the largest companies (ie. first phase-in group) must provide detailed tagging for financial statement notes and schedules as an exhibit to their filings.

Concurrently, all other domestic and foreign large-accelerated filers using US GAAP (second phase-in group) must submit their first XBRL-tagged financial statements. This memo from KPMG summarizes guidance from a recent SEC Staff webcast that covered detailed tagging phase-in requirements, rules about changes in filing status during the three-year phase-in period, and other implementation issues.

May-June Issue: Deal Lawyers Print Newsletter

This May-June issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:

– Loyal to Whom? Recent Delaware Decisions Clarify Common Stockholders Are Primary Beneficiaries of Directors’ Fiduciary Duties
– Recent Trends in Earnout Use: A Cautionary Note
– The Shareholder Activism Report: Recommendations to Consider
– Delaware Chancery Opens Door for Next Gen Poison Pill
– More Takeaways from Selectica

If you’re not yet a subscriber, try a 2010 no-risk trial to get a non-blurred version of this issue on a complimentary basis.

– Broc Romanek

May 18, 2010

Dodd Bill: Heading to “Cloture” and a Vote This Week

A lot of activity in the US Senate late last night, winding up with a motion for cloture (a procedure that limits further debate to 30 hours) that sets up a likely vote tomorrow to limit further debate and pave the way for a final vote on the Dodd bill, potentially by the end of this week, as noted in this Washington Post article.

Many of the 300 proposed amendments won’t be considered before the vote – but the Senate is tackling a fair number of them. Last night, a handful of the amendments were passed by a voice vote. One of these was an amendment from Senators Dodd and Bond that subsumed the amendment that I blogged about yesterday that seeks to preserve Regulation D and Rule 506, as noted in this BusinessWeek article.

As I figure out more details about what was actually passed, I’ll tweet about them – as well as provide an update in this blog manana since I can’t find any specifics as of this morning…

Importance of Enrypted Email

In this podcast, Jim Brashear, General Counsel of Zix Corporation, provides some insight into the importance of encryption (for more info, see his article: “Security of Communications: Heightened Risks for Directors & Executives“), including:

– Why are secure emails important?
– How does encryption work for emails? How simple is the process?
– What does Zix’s service do to facilitate secure communications?

Smaller Company Proxy Disclosures: The Latest Developments

Join us tomorrow for the webcast – “Smaller Company Proxy Disclosures: The Latest Developments” – to hear Mark Borges of Compensia and Dave Lynn of and Morrison & Foerster discuss the expectations of what smaller reporting companies should be disclosing regarding executive compensation practices, which has radically changed over the past few years.

– Broc Romanek

May 17, 2010

Dodd Bill Amendments: A (Partial) Reprieve for Regulation D

A while back, I blogged how Regulation D would get hammered under Section 926 (and Section 412) of the Dodd bill. Joe Wallin of Davis Wright Tremaine reports that Senators Bond, Warner, Brown and Cantwell have proposed an amendment (#4037) to the Dodd bill that would:

– Remove the ridiculous and industry killing 120-day wait period
– Remove the “go back in time” provision, which would have re-adjusted the accredited investor financial thresholds in a way that would have wiped out 2/3rds of existing angel investors qualifying as “accredited investors”
– Exclude the value of an investor’s primary residence in determining whether the investor would meet the net worth standard
– Add a “bad boy” provision to Rule 506 offerings

Even though some groups are excited – like the Angel Capital Association – some still see issues with the amendment. For example, Alan Parness of Cadwalader has these thoughts:

1. Regarding the proposed rewrite of Section 412, I don’t have any particular problem, noting that the current $1 million minimum net worth standard in the SEC’s Rule 501(a)(5) would be in place for 4 years from enactment of the bill.

Obviously, the main question is how many persons would be eliminated as accredited investors under Rule 501(a)(5) if the value of the investor’s primary residence were removed from the net worth calculation (those of you handling public offerings of direct participation programs subject to state filings should be familiar with NASAA’s Guidelines, whereby investor suitability standards include a minimum net worth requirement which excludes the value of the investor’s home, home furnishings and automobiles – see, e.g., Sec. II.B of NASAA’s Omnibus Guidelines at NASAA Reports par. 2322).

2. Regarding Section 926, I’m troubled by the following:

– The preamble to paragraph (2) provides for disqualification of “any offering or sale of securities by a person.” What person or persons will be covered by this provision? It’s not clear whether it would encompass the same people subject to disqualification by the SEC’s Rule 262.

– Paragraph (2)(A) includes only final orders of state securities and insurance regulators, and federal and state banking regulators, as opposed to court orders, and contains no limit as to when the “final order” may have been entered (compare Rule 262, which in most cases imposes a 5-year “look-back” limit). One possible issue would be whether an order is “final” if it’s been issued by the regulator, but is in the process of being challenged by the respondent through administrative or judicial proceedings.

– Paragraph (2)(A)(ii) covers violations of “any law or regulation that prohibits fraudulent, manipulative, or deceptive conduct.” Obviously, the question is what particular conduct is deemed to be “fraudulent, manipulative, or deceptive” under a particular state’s law or regulations. For example, NY Gen. Bus. Law Secs. 352(1) and 352-i provide that any violation of a number of provisions in GBL Article 23-A (NY’s infamous “Martin Act”), constitutes a “fraudulent practice,” including the requirement in Section 359-e(8) that a dealer file a “further state notice” with the NY Department of State for certain offerings (for those of you not familiar with this form, it’s a pointless piece of paper which only serves as a revenue source, and it’s been preempted by ’34 Act Section 15(h)(1) as regards SEC-registered broker-dealers).

Query whether there are provisions under other states’ securities or insurance laws, or federal or state banking laws, or rules thereunder, which deem a violation of a filing, recordkeeping or some other innocuous requirement to be “fraudulent, manipulative, or deceptive.” Further, this provision is an open invitation for states to amend their securities, banking and/or insurance laws or regulations to designate a broad range of violations as “fraudulent, manipulative, or deceptive,” and thereby trigger a disqualification.

– Paragraph (2)(B) contains no time limit on when the particular conviction occurred. Compare the SEC’s Rule 262(a)(3), imposing a 5-year look-back, and Rule 262(b)(1), imposing a 10-year look-back, on the convictions specified in those provisions.

– Unlike the preamble to Rule 262, whereby the SEC may waive any disqualification “upon a showing of good cause,” there is no mechanism provided for waiver of any disqualification under par. (2), whether by the SEC or by the particular state regulator (for reasons of uniformity, I believe granting the SEC authority to grant waivers to be the better approach).

– If, like the SEC’s Rule 262(b), the proposed disqualification from use of Rule 506 may be triggered by reason of a beneficial owner of 10% or more of the issuer’s equity securities being a “bad boy,” that raises a number of practical problems as to how an issuer can be absolutely certain that none of its 10%+ beneficial owners is a “bad boy.”

First, how is “beneficial owner” to be defined for purposes of the disqualification? In similar fashion to SEC Exchange Act Rule 13d-3 or 16a-1(a), or in a different manner? There are many possible variables in that regard. Also, if “beneficial owner” is to include someone owning 10% or more of an issuer’s equity securities indirectly through another person, say, for example, that 20% of the interests in an issuer commencing a Rule 506 offering are owned by an offshore entity. Can the issuer in that case simply rely in good faith on a representation by that entity that no person holding 50% or more of its equity interests is a bad boy? What if that representation proves to be false? Does the issuer pay the price in that case with a loss of the Rule 506 exemption?

Also, one basic issue – does Congress really expect that adding a “bad boy” disqualification will deter the real securities crooks out there? In reality, I believe it will only make the process more cumbersome and expensive for honest issuers who seek to comply with the law by doing their homework and obtaining appropriate certifications (hopefully truthful!) those from the persons covered by the rule, while issuers with “bad boys” running the show will simply proceed along their merry way, either ignoring federal and state securities laws altogether, or claiming reliance on other exemptions without a bad boy disqualifier.

I wonder how many instances can be cited where a state uncovered a “bad boy” lurking behind an issuer for which a Form D was filed, and such person’s involvement or nefarious background was not disclosed to investors (or, worse, such person committed a fraud in the course of the offering), as opposed to cases where a state uncovered a “bad boy” behind an issuer effecting a fraudulent offering which failed to make any filing with the SEC or the state?

3. On the practical side, I also fear that the potential for disqualification under Section 926 could lead to strong-arm tactics by certain state regulators in the course of investigations, forcing respondents to settle for extraordinary remedies in lieu of an order which would disqualify them from future Rule 506 offerings.

Put into the context of issues that have arisen recently in connection with Rule 506 offerings, say a state securities administrator decides to pursue an entity serving as the general partner of various limited partnerships which effected Rule 506 offerings in the state, as well as the entity’s individual principals, on the basis that, despite the absence of any complaints from local investors or other evidence that the offerings might have been fraudulent: (i) notice filings were made later than required by law or rule, (ii) notice filings were not made as required by law or rule, and/or (iii) the issuers refused to submit copies of offering materials for such offerings upon the state’s request.

Facing the state’s threat to issue an order under a statute which deems a violation of any provision of the statute or a rule thereunder to be a “fraudulent practice,” which would disqualify the general partner and its principals from participating in future Rule 506 offerings pursuant to par. (2)(B) of Section 926, and, after concluding that the cost and time required to challenge such an order through the requisite administrative and judicial proceedings would be impractical (let alone the likelihood of success before the local administrative or judicial panels which would hear such a challenge), the respondents capitulate and agree to make a rescission offer to all investors in that state and pay a huge penalty to the state. Unrealistic? I don’t think so.

RiskMetrics’s ISS Reveals All: Full GRId Methodology Now Available

A few weeks ago, RiskMetrics released a fuller explanation – a 193-page technical paper – about how their new GRId governance rating framework will work, updating the outline they issued back in March (here’s ISS’s 8-page summary of GRId). We are posting memos analyzing this new information in our “Governance Ratings” Practice Area.

Last week, The Corporate Library weighed in on the long-standing debate about what governance ratings actually mean to investors, particularly those related to ESG issues (Environmental, Social and Governance).

Navigating Corp Fin’s Comment Process

Join us tomorrow for the webcast – “Navigating Corp Fin’s Comment Process” – to hear former SEC Senior Staffers Linda Griggs of Morgan Lewis & Bockius, John Huber of Latham & Watkins, Dave Lynn of and Morrison & Foerster and Bill Tolbert of Jenner & Block explain the process by which the SEC Staff issues comments as well as provide their practical guidance about how to respond.

We’ve posted some great course materials for this program, including:

– “40 Rules of the Road for Corp Fin’s Review Process” – John Huber and Joel Trotter, Latham & Watkins
– “SEC Comment Letter Trends in 2009” – Dave Lynn, Morrison & Foerster

– Broc Romanek