In response to a question posted in our Q&A Forum, I have posted several questionnaires that you can use both internally and for third-parties in our “Conflict Minerals” Practice Area. Meanwhile, the Elm Group alerted me to:
– Comments from EU Commissioner for Trade Karel De Gucht provide a six-point framework for the EU’s conflict minerals directive still under development.
– NGOs Enough and Responsible Sourcing Network, along with Socially-Reponsible Investment firms, published their expectations and specific recommendations for SEC filings on conflict minerals.
– A NY Times article exposing flaws in CSR audit practices – and a LinkedIn discussion explores the potential foreshadowing for conflict minerals audits.
Also see the answers in response to Topic #7765 in our “Q&A Forum” for some practical advice about how to handle the questionnaires (remember you can search by key word or topic number with the search tool in our Forum)…
A preliminary statement of issues filed by the National Association of Manufacturers, the Chamber of Commerce and the Business Roundtable on August 13 provided a glimpse of the arguments that will be made in their appeal of the district court decision to uphold the SEC conflict mineral rules, which we previously discussed here.
The appellants plan to address several areas where they believe the Commission erred in its conclusions and acted in an arbitrary and capricious manner. This includes the SEC’s conclusion that it lacked authority to adopt a de minimis exception, interpreting the statutory language “did originate” to mean “reason to believe, and including non-manufacturers who contract for the manufacture of products. In addition, the appellants intend to question the merits of providing a shorter transition period for larger companies, since larger companies will have to depend on smaller companies to comply with the rule. The adequacy of the economic analysis and free speech arguments also will be made.
Meanwhile, Ning blogs that a group of 44 investors, including many socially responsible funds, recently sent a letter to Chair White urging the SEC to defend the resource extraction rules that were struck down by the courts. However, the SEC stated that it won’t appeal (as the deadline for appealing was crossed) – the SEC intends to rewrite the rules instead.
Today, Conflict Minerals; Tomorrow, Conflict Wood and Conflict Water?
Loving this news brief from Cooley’s Cydney Posner: According to this article in Compliance Week, “New Breed of Regulations Won’t End With Conflict Minerals,” the Dodd-Frank provisions regarding conflict minerals and related SEC regulations may well just be the beginning of an onslaught of social-activist-driven legislation related to foreign conflicts and sustainability. (Legislation? Congress? Huh? ) Of course Congress is not the only source of legislation; state and international legislators also step in from time to time. Moreover, companies are often pressured by activists directly or indirectly to take action or cease certain conduct.
Below are some of the potential “problem materials” identified in the article that may hit the radar of legislators or regulators:
– ‘Blood Diamonds’: The sale of “blood diamonds” to finance violent rebel groups, particularly in Africa, was the impetus for development of the “Kimberley Process,” which provides conflict-free certifications intended to eliminate the use of blood diamonds. The Clean Diamond Trade Act, signed into law by President Bush in 2003, provided for U.S. participation in the Kimberley Process. However, the article reports that there have been “growing complaints… that the Kimberl[e]y Process is failing in its effort, [and, as a result,] additional regulations might lurk in the future.”
– ‘Death Metal’: Tin mined in Indonesia, particularly the Bangka Island region, “is controversial, not just because of ongoing human rights concerns, but for environmental reasons as well.” Military and police violence in the area “have long been concerns for human rights groups.” In addition, environmental protestors have targeted a number of electronics manufacturers regarding damage done to tropical rainforests from tin mining in the country.
– Palm Oil: Producers of palm oil, which is produced in Indonesia and elsewhere, are also under the gun for “environmental destruction and the abuse of human rights,” including alleged widespread child labor, human trafficking, violence against workers and slavery. Palm oil and its derivatives are found in many products, including cooking oil, soap, lipstick and fuel.
– Wood: According to the article, sustainability issues, such as biodiversity and deforestation, are becoming more prevalent in connection with the use of wood: “[w]here companies get their wood, and how they ensure that proper reforestation programs are in place, is a growing concern.” Furniture manufacturers have been under pressure from activists to bolster use of certified timber and avoid illegal logging.
– Cobalt: The article speculates that cobalt may eventually be added to the list of the four conflict minerals currently regulated under Dodd-Frank. Apparently, the DRC is the largest producer of the world’s cobalt supply, and the Enough Project, concerned regarding unsafe working conditions and child labor, estimates that 60% of that production comes from illegal mines. Cobalt is used as a blue pigment in many paints and is widely used as a component of lithium ion batteries, in tool construction and for artificial joints and limbs.
– Dirty Water: According to a commentator cited in the article, “‘[a] lot of people are talking about water footprints; it is not only about carbon footprints anymore…. Water is the reason for several wars around the world. There isn’t a lot of public reporting about that yet because companies really need to think about it before they announce all the problems they are causing with their water use.'”The article also suggests that, in addition, numerous other physical commodities could easily become subject to this type of regulation, including cotton, leather and some food items.
Poor sourcing practices may also lead to future legislation. For example, poor factory conditions, as illustrated by recent reports of harsh working conditions, including employee suicides in China and the fire at and collapse of a garment factory in Bangladesh, are of grave concern The article reports that “many retailers agreed to sign onto a legally binding European accord that requires retailers fund fire safety and building improvements at the Bangladesh factories they employ. A non-legally-binding effort spearheaded in the U.S. for its companies has been less successful…. Although federal legislation to force an EU type of agreement is unlikely, expect to see shareholder activists push a similar agenda.”
The article speculates that we may also see rules for public companies regarding human trafficking and slavery, based perhaps on the California Transparency in Supply Chains Act, which requires many companies doing business in California to disclose efforts they have taken to eradicate human trafficking and slavery from their direct supply chains for tangible goods offered for sale. The law applies to retail sellers and manufacturers with annual worldwide gross receipts exceeding $100 million that do business in California.
The article suggests that, in light of “the lengthy list of supply chain issues that could eventually spur new regulations, companies may want to leverage their ongoing conflict minerals efforts to gear up for what is to come.” That doesn’t mean, as one commentator noted, buying “a new technology solution for all upcoming legislation…. Instead, especially larger companies, should look to maintain a broader compliance perspective, and conflict minerals demands ‘should be seen as part of the bigger change in the regulatory environment.'” Companies may want to focus on these issues from a larger perspective as questions of risk management.
Tune in tomorrow for the 75-minute webcast – “Reg D Offerings: What Is Happening Now” – to hear WilmerHale’s Meredith Cross, Morrison & Foerster’s Dave Lynn, Calfee’s John Jenkins, Western Reserve Partners’ Dave Mariano and SecondMarket’s Annemarie Tierney analyze the SEC’s new rules and how market practice will likely develop in their wake.
SEC Brings First Reg FD Case In Nearly Two Years
On Friday, the SEC brought this enforcement case against the former investor relations head of First Solar, after he indicated in phone conversations with some analysts and investors that the company was unlikely to receive a much-anticipated loan guarantee from the Department of Energy. When First Solar broadly disclosed this material information in a press release the next morning, its stock price dropped 6%.
As noted by Davis Polk’s Ning Chiu in this blog, the SEC decided not to bring any action against First Solar because of the company’s “extraordinary cooperation.” The SEC determined that, prior to this violation, the company “cultivated an environment of compliance through the use of a disclosure committee that focused on compliance with Regulation FD.” The SEC’s press release noted that the company immediately discovered the selective disclosure and promptly issued a press release the next morning – and reported the misconduct to the SEC. The company also undertook remedial actions, including conducting additional Regulation FD training. The former IRO agreed to pay $50,000 to settle the SEC’s charges (see this Dick Johnson blog entitled “Reg FD: Does $50,000 get your attention?“).
SEC Issues Second Wave of Whistleblower Program Awards
As noted in this memo posted in our “Whistleblowers” Practice Area, the SEC recently announced that it expects to pay a combined $125,000 (which is 15 percent of monetary sanctions collected) to three whistleblowers who helped the SEC and DOJ stop the CEO of a sham hedge fund.
Meanwhile, this Courthouse News Service article notes that a SEC attorney in the New York regional office has sued the agency, alleging that the Commission retaliated against her after she complained that a supervisor blocked efforts to investigate investment managers.
As noted in this memo, this November, in Lawson v. FMR LLC, the Supreme Court will hear argument on whether “whistleblowers” employed by a privately held contractor or subcontractor of a publicly traded company are protected from retaliation by Sarbanes-Oxley. The Court granted certiorari to review the judgment of the U.S. Court of Appeals for the First Circuit in a case involving two self-proclaimed whistleblowers employed by private contractors performing services for publicly traded mutual funds.
As you know, I like to try out new ways to communicate – and so I am launching a series of spreecasts. It’s a cool new communication platform – you will be able to watch the speakers on video – while also being able to chat with others and ask questions of the speakers. Here are FAQs about how it works – but the upshot is you have to register for Spreecast first (although it is possible to watch without registering if you close a prompt). Simply sign up by using an email address by clicking the “Or sign up via email” link in the upper right hand side of the site (it’s in small print under the “Connect with Facebook” logo).
Reminder: Act Now for “End-User Exception” for Swaps Activities
Here is a reminder from this Gibson Dunn blog that starting on Monday, new CFTC rules will take effect for non-financial companies that use swaps to hedge or mitigate commercial risk. These rules will require the clearing of interest rate swaps and credit default index swaps unless an exception is available. One such exception is the “end-user exception,” and public companies planning to rely on this exception must take certain governance steps. These include obtaining approval from the board of directors or an appropriate committee to enter into swaps exempt from clearing.
Last week, Helen of Troy became the 59th company to fail its say-on-pay in ’13 – see the Form 8-K – with only 12% support, the 2nd lowest level this year.
And then we have Capstone Turbine who appears to be the 60th company with only 48% support – although its Form 8-K doesn’t quite characterize it either way, as it just provides the share data. However, the company’s proxy statement (pg. 2) states that abstentions have the effect of an against vote.
Thanks to Karla Bos of ING for the heads up on these!
Corp Fin Deputy Director Paula Dubberly has announced that she will soon be “retiring” – Paula is still young so I’m sure we will see her in our field in some capacity.
I have a soft spot in my heart for Paula. You probably wouldn’t be reading this if it wasn’t for her. Paula was my supervisor when I returned to the SEC for my second stint. She was a great leader who taught you much and fostered your development. She made the effort to champion me – something rare both in and outside the government . She has done that for many Staffers – reflected by the fact that many in Corp Fin leadership positions today used to work for Paula. Beyond that, Paula takes the time to really care about all those that work for her, including the support staff.
Paula also was the model SEC Staffer in that she firmly believes in the mission of the agency. Her breadth of knowledge is pretty remarkable – the range of rulemakings she has guided over the years is incredibly wide, from executive pay to asset-backed securitization. I’m sad to see her go as I know she will be missed by the Staff – but wish her luck on the next chapter in her life…
Study: 11 Years of Audit Fees
As noted in this study posted in our “Audit Fees” Practice Area, Audit Analytics found that for 2012 the ratio of audit fees over revenue was the lowest since 2004, the lowest since the implementation of Section 404, including:
– Non Audit Fees as Compared to Audit Fees: In 2002, non-audit fees represented 51% of the total fees paid by research population of accelerated filers, but after three years of steady decline non-audit fees appear to have leveled off at about 21% of total fees. To some extent, the drop in non-audit fees as compared to audit fees is attributable to the Auditor Independence Rules adopted by the SEC in 2001, which precluded the principal independent accountant from performing certain non-audit services to ensure auditor independence when performing the independent audit.
– Non-Audit Fees as a Percentage of Revenue: During 2002, the cost of non-audit fees paid by the research population for every million dollars in revenue was $387. After four years of substantial declines, the population paid only $146 of non-audit fees for every million dollars in revenue during 2006. Thereafter, for the next six years, the value leveled off somewhat with an overall gradual decline. The 2012 figure was the second lowest value calculated for the eleven years under review: $134 for every million dollars in revenue.
– Audit Fees as a Percentage of Revenue: The ratio of audit fees over revenue peaked in 2004 & 2005, when, for both years, the average amount of audit fees paid per $1 million of revenue was $592. After three consecutive years of decline the figure increased slightly in 2009, but the uptick is due to a decrease in revenues instead of an increase in fees. After another three years of decline, 2012 experienced the lowest value since 2004 (since the implementation of SOX 404): $472 of audit fees for every million dollars in revenue. The fees declined despite the extra work demanded of the auditors during the same period when more and more companies were required to obtain auditor attestations pursuant to SOX 404(b).
More on “The Mentor Blog”
We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net 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:
– Experiment: Paying Auditors From a Central Fund
– Crisis Management 101
– Delaware Chief Justice Discusses Emerging Law
– Disclosure of Material, Non-Public Information in Surveys?
– Even More on “Director Access to Attorney-Client Privileged Communications”
When you visit the 9-11 Pentagon Memorial, I highly recommend that you do it at night. Much less crowded – and much more powerful. This photo doesn’t do it justice…
How to Visit the Supreme Court
Another cool thing to do in DC is visit the Supreme Court (as well as the Library of Congress adjacent to it – and then walk the short tunnel from there to the Capitol). Although SCOTUS won’t be in session during our conference week, it’s still worthwhile – particularly the half-hour tour in the actual courtroom that happens on the half hour every hour (described as a “courtroom lecture”).
By the way, here’s a preview by Lois Yurow about three consolidated cases arising from Stanford’s Ponzi scheme that will be heard by SCOTUS…
The Supreme Court’s Basketball Court
Most lawyers know that a basketball court resides directly over the courtroom. The hoops court has been labeled with the moniker as the “Highest Court in the Land.” Here is a note that I received from a member about it:
Regarding your tweet about the basketball court, when I was in college, Justice White gave a lecture at my school. In Bob Woodward’s book about the Court – “The Brethren” – he talks about White playing basketball on that basketball court with his clerks. At a reception after his lecture, a couple of us asked Justice White about that and he confirmed that he used to do that, but that he had better judgment now that he was in his 70s (this was in 1983). Justice White was a very gracious and very modest guy – even in his 70s, I’m sure he could kick the butts of most of his clerks in just about any athletic endeavor you can name.
“Whizzer” White’s a football legend, but what many people don’t know is that he was also the star of Colorado’s basketball team – and led them to the finals of the very first NIT at the Garden in 1938. Here’s an old LA Times article referencing his basketball prowess.
On Friday, the SEC issued its 1st fee advisory for 2014 (along with this methodology). Right now, the filing fee rate for Securities Act registration statements is $136.40 million (the same rate applies under Sections 13(e) and 14(g)). Under the fee advisory, this rate will dip to $128.80 per million, a 6% drop. Nice to see a reduction after last year’s hefty price hike.
As noted in the SEC order, the new fees will go into effect on October 1st like the last two years (as mandated by Dodd-Frank) – which is a departure from years before that when the new rate didn’t become effective until five days after the date of enactment of the SEC’s appropriation for the new year – which often was delayed well beyond the October 1st start of the government’s fiscal year as Congress and the President battled over the government’s budget.
Here’s an excerpt from Cooley’s Cydney Posner from this news brief:
You might recall that, among many changes designed to enhance audit accountability and transparency, the PCAOB had contemplated requiring the audit engagement partner to sign his or her name to the audit report. However, concerns were raised that a signature requirement would minimize the firm’s accountability and role in conducting the audit. As a result, in 2011, the PCAOB proposed instead that registered accounting firms be required to disclose in the audit report the name of the engagement partner responsible for the most recent period’s audit and the names of other accounting firms and other persons not employed by the auditor that took part in the audit (including the internal control audit). This article in Compliance Week reports that the PCAOB is now planning to move forward on the proposal in September, although it is not known whether the PCAOB will issue a final standard or revise its current proposal.
Investors had originally advocated that engagement partners be required to sign the audit report – similar to the signing of certifications by CEOs and CFOs and common practice in the UK–to reinforce their “ownership” of audit reports. According to the article, given the demise of the signature requirement, investors are now “even more fervent in their call for the engagement partner’s name.” They point to the allegations of insider trading by one Big Four engagement partner, as well as “a recent academic study by a former member of the PCAOB’s own Standing Advisory Group show[ing] that the signature requirement adopted in the United Kingdom has been followed by an improvement in some key indicators of audit quality. Those include a reduction in abnormal accruals, an easing on the part of preparers to try to meet earnings targets, and an increase in the issuance of qualified audit reports. The study also points out a significant increase in audit cost after the signature requirement took effect. The study doesn’t establish a cause-and-effect link to the signature requirement, but [the study’s] author…speculates that people act differently when they know they are going to be publicly identifiable.” (An excerpt from the paper is copied below.)
Needless to say, most audit firms are opposed to the proposal, protesting “that even naming engagement partners would not improve audit quality or increase the auditor’s sense of accountability for the audit opinion, but would still expose them to added liability because they would be deemed ‘experts’ under SEC rules, therefore assumed to have certified the contents of the report. Their naming in the report would also complicate subsequent registration statements, firms said.” The audit firms were concerned that the engagement partners named might be viewed to have individually prepared or certified part of the registration statement and could be required to separately consent, resulting in exposure to “significant increased liability for engagement partners….” One of the Big Four firms protested that naming the engagement partner could lead “the trial bar in litigation or … others [to] associate the name with other publicly available information.” Other audit firms argued that the proposal would be ineffective and would not “stop certain rogue individuals from doing what they want to do”; the real “solution lies in more education about the appropriate conduct of audit engagements and the independence and ethics of accountants.”
One of the Big Four took a different approach, supporting the proposal if the PCAOB “could engage the SEC to address the liability issue.” While the firm doesn’t “see how the proposal would improve audit quality or give investors useful information, but they support the objective to increase transparency. In fact, they suggest the board take the naming of key auditors a little further. ‘In addition to naming the engagement partner responsible for the audit, a member or members of firm leadership should also be named in the audit report….Examples could include the firm’s audit/assurance leader and/or CEO/senior partner. Including the name and/or names of firm leadership will convey to the users of the financial statements that the accounting firm as a whole takes responsibility for the audit and alleviate any misimpressions that the audit report is the product of the engagement partner rather than the firm.'”
Also see this blog by David Scileppi that analyzes a variety of PCAOB proposals (and see my entry on “The Mentor Blog” from yesterday)…
Regulators Propose New Risk Retention Rule
In this blog, Steve Quinlivan notes that six federal agencies have issued a notice revising a proposed rule requiring sponsors of securitization transactions to retain risk in those transactions. The new proposal revises a proposed rule the agencies issued in 2011 to implement the risk retention requirement in Dodd-Frank.
Pranks: Warming Up for the Long Weekend
Here’s a hilarious prank at a NBA basketball game in this video. I think it is a copy cat of these two pranks that two friends did to each other – this prank that led to this one.
Companies listing on the NYSE in connection with an IPO, carve-out or spinoff transaction will have a one-year transition period to comply with the NYSE internal audit requirements. The SEC approved the proposed NYSE rule change on August 22, 2013.
Section 303A.07(c) of the NYSE requires a listed company to have an internal audit function to provide management and the audit committee with ongoing assessments of the listed company’s risk management processes and system of internal control. In July, NYSE proposed a one-year transition period for IPO, carve-out and spinoff companies to be consistent with the one-year transition period currently available to any company transferring from another national securities exchange.
Other national securities exchanges do not have a similar internal audit requirement, although Nasdaq had previously proposed adopting one. Nasdaq withdrew its proposal after comment letters to the SEC indicated a high degree of concern, as we previously discussed, primarily related to potential costs. According to one report, 40% of Nasdaq-listed companies with market capitalization between $75 million and $250 million do not have an internal audit function. Nasdaq is planning to resubmit the proposal.
Since the NYSE rules have specific requirements making the audit committee responsible for oversight of the internal audit function, several corresponding changes are being made to the audit committee standards, and the committee charter, for any company that wants to avail itself of this transition period, including:
– The audit committee will assist board oversight of the design and implementation of the internal audit function.
– The audit committee must meet periodically with the company personnel primarily responsible for the design and implementation of the internal audit function.
– The audit committee must review with the independent auditor a discussion of management’s plans with respect to the responsibilities, budget and staffing of the internal audit function and the company’s plans for the implementation of the internal audit function.
– The audit committee should review with the board management’s activities with respect to the design and implementation of the internal audit function.
SEC Takes Oddly Aggressive Stance on Payment of Monetary Sanctions
When Mary Jo White was installed as the SEC’s chair in April, I had little doubt she would be well-suited for her new role. She is extremely well regarded in the securities bar, and doubts about “ties to Wall Street” compromising her effectiveness seemed overblown to me. I wondered, though, whether her tenure would change the Commission dramatically from that of her predecessor, Mary Schapiro. But four months in, the record has tangible evidence of real changes. Since she’s arrived:
– She has announced, and implemented in the form of a case against Philip Falcone and Harbinger Capital Partners, a policy change that will in some settled cases compel defendants to admit wrongdoing;
– The SEC has re-committed itself to pursuing accounting fraud matters against public companies, and created a task force to root them out;
– She has pushed the staff to write rules mandated by the JOBS Act and actually lifted the general solicitation ban for offerings under new Rule 506(c).
Last week brought another example. On Friday, the SEC filed an action in the Eastern District of New York to enforce an administrative order requiring payment of monetary sanctions that was all of six days old.
The underlying case arose from an alleged fraud at a small hedge fund. According to the SEC, Anthony Vicidomine misappropriated $189,000 from the North East Capital Fund in the form of unearned “incentive fees” and used the money to pay his own personal expenses. Vicidomine also allegedly made misrepresentations about his own investment in the fund, his use of procedures to mitigate investors’ risk of loss, and an independent audit of the fund. Vicidimone and North East Capital settled their case with the SEC on August 16th with an order to pay $346,000 in monetary sanctions within three days.
As it turns out, the SEC wasn’t kidding. But Vicidimone didn’t pay the judgment in three days. He didn’t pay the judgment in four or even five days. On the sixth day, Mary Jo White’s SEC had had enough, and sued in Brooklyn federal court to put an end to that nonsense. As the Commission’s application said on Friday, “The deadline for payment has passed, yet Respondents have not paid a cent.”
I have to say, this seems odd to me for several reasons. First, the SEC frequently requires payments to be placed in escrow before approving settlements, though it must not have done so here. Second, while the guidelines can shift with different Commissioners, the SEC has sometimes waived financial penalties against defendants who truly cannot pay them. It’s not a popular policy within the SEC, but it can allow cases to be resolved more quickly when defendants are plainly tapped out and will not be able to cover the losses they’ve caused. Third, when payments have not been escrowed but are still compelled, the Commission typically gives ten days to send a check covering the amount.
I don’t think I’ve seen a case where the SEC gives three days to pay, sees nothing, and files an action in federal court six days later to enforce the judgment. It almost makes me wonder if the Commission is trying to send a signal: ignore our orders and we’ll sue you again and get a federal judge to sort out the mess.
Last week, the plaintiffs in the Delaware Chancery exclusive forum bylaw case – Boilermakers Local 154 Retirement Fund and Key West Police & Fire Pension Fund – filed a notice of appeal to the Delaware Supreme Court. No word on timing of the appeal process…
More on “The Mentor Blog”
We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net 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:
– New Standards for Judicial Approval of Deferred Prosecution Agreements
– FASB Proposes Going Concern Disclosure
– New SEC Case Emphasizes Importance of Internal Controls
– Compliance Training: True Entertainment Rather Than Forced…
– “End-User Exception” for Swaps: Governance Action Items for Companies
A long while back, I conducted a poll regarding which nomenclature is most used by members when referring to Corp Fin’s “Compliance & Disclosure Interpretations.” Here are the results:
That’s good news as it aligns with what the Staff has been using when out speaking. Here is a comment that I received from a member:
Both CD&I and C&DI are jargon that obscure rather than illuminate meaning. “Staff Interps” is a better short-hand reference that is more consistent with the SEC’s Plain English initiative, and is easier to vocalize. Imagine you are training a new associate but in a hurry. Telling him or her to check the Staff Interps provides a lot more direction that “go to the CD&Is.”
The Investment Adviser Association (IAA) and the Investment Company Institute (ICI) have written to the SEC, arguing against the rulemaking petition submitted by the NYSE, the Society of Corporate Secretaries and Governance Professionals, and the National Investor Relations Institute to change the deadline for 13F filings from 45 after the last day of each calendar quarter to two business days after the last day of each calendar quarter. We previously discussed the petition.
The letters claim that the deadline change would increase free-riding, by allowing other investors to capitalize on investment managers’ investment ideas or replicate successful proprietary trading strategies. Forcing the disclosure of this information earlier could also lead to front-running, trading for one’s own account ahead of trading for clients’ accounts in order to take advantage of advance knowledge of pending trades or otherwise profiting from anticipating fund trades. Larger funds with concentrated portfolios, funds that specialize in thinly traded stocks or when an extended time is needed to build or reduce positions could be especially vulnerable to front-running, the letters stated. Vanguard’s comment letter focused on the risks of front-running as well, and argues that the two-day reporting period would benefit short-term hedge funds or speculators at the expense of long-term investors, including mutual fund shareholders. IAA predicts that requests for confidential treatment would “increase drastically, perhaps by thousands each quarter.”
Advances in technology do not eliminate the operational components necessary to fully reconcile trades, including identifying and resolving different valuations allocated to the same securities in the same firm, and makes the proposed two-business-day reporting “virtually impossible in practice,” according to IAA. In addition, both organizations assert that the purpose of the 13F reporting system is not to help issuers identify their shareholders, but rather to create uniform reporting standards and centralize databases for investment managers. They recommend that issuers use other existing mechanisms to better communicate with shareholders, given the risk of expanding predatory trading practices if the petition succeeds.
More than 70 letters in support of the petition, with the vast majority from issuers following largely the same form, have also been filed.
An Australian Judge Holds a Whole Board Liable
How best to whip a board into shape? This excerpt from this old Agenda article gives us some pretty remarkable food for thought:
The Federal Court of Australia handed down a remarkable ruling last June that hasn’t gotten much exposure in the U.S. A judge there decided that an entire corporate board plus the CFO had breached their duties when they overlooked a huge mistake in the company’s financial statement.
Directors were held liable even though their external auditor had also missed the errors. The court decided that the embarrassing judgment was punishment enough and imposed only small penalties, and only on a few board members.
Well over a year after the enactment of the JOBS Act, we still await movement on the SEC’s rulemaking under Title III, which provides the framework for exempt crowdfunding offerings to non-accredited investors, subject to a $1 million cap over a rolling 12-month period and dollar limits based on an investor’s financial position. As this Washington Post article notes, the SEC Staff has indicated that crowdfunding rules can be expected sometime this fall, however these would presumably be proposed rules, meaning that final rules could not be expected until well into 2014 at the earliest when you factor in the need for FINRA to also create a regulatory system for funding portals. As a result, the ability to do exempt crowdfunding offerings remains limited, except that many are anticipating the ability to do more accredited investor-only crowdfunding offerings once general solicitation is permitted under Rule 506 after the September 23, 2013 effective date of those JOBS Act mandated rule changes.
Meanwhile, the SEC’s proposed amendments to Regulation D and Form D in response to investor protection concerns arising from lifting the ban on general solicitation have been drawing fire as not being faithful to the JOBS Act’s goal of promoting capital formation. As noted in this letter from AngelList CEO Naval Ravikant, “[t]he proposed rules appear to be tailored to how Wall Street raises funds, not the startup community.” Ravikant goes on to note the significant consequences for startups of instituting a 15-day in advance filing requirement for Form D, as well as the temporary requirement to file written solicitation material and legending requirements. Founders of startups, angel investors and others in that community have echoed this sentiment in the comment file.
Despite the delays and debate, crowdfunding still goes on – either to accredited investors behind password walls or in transactions that don’t involve the offer and sale of a security. It has proven itself to not be just another internet-age fad, so it remains to be seen whether some workable securities laws can be implemented to make it a viable alternative for capital raising.
EB5 Visa Programs: Another Beneficiary of General Solicitation
One area of capital raising that has not, until recently, received a great deal of attention is the EB5 Visa program, which was created by Congress back in 1990 as a means to spur capital investment in the United States. Under the program, foreign nationals can get access to a green card by investing in certain projects that are targeted to create jobs and encourage economic development. In many cases, the regional centers that raise money under EB-5 programs have relied on a combination of Regulation S and Rule 506 of Regulation D as exemptions from registration under the 1933 Act, and as a result their marketing activities to foreign nationals was limited by the prohibition on general solicitation and general advertising, as well as the prohibition on directed selling efforts.
With the adoption of Rule 506(c) as a new alternative for exempt offerings, EB-5 investments could be marketed more freely in the United States to foreign nationals who are located here, which could provide a significant new source of capital for these projects. Due to the requirements for qualifying as an EB-5 program, much of the capital is directed into real estate projects, including public-private partnerships developing infrastructure projects. With lingering investor protection concerns around this market, I expect to continue to see a focus by the SEC and the USCIS on maintaining investor protections and combatting fraud, particularly given that a person’s immigration status and investment are both tied up in these types of offerings.
The SEC’s New Admission Policy in Enforcement Cases: Collateral Consequences
Last week, I mentioned how the SEC’s new policy requiring admission of misconduct was implemented in a case against Harbinger and Philip Falcone. In The D&O Diary blog, Kevin LaCroix notes some of the important collateral consequences that admission of guilt may have, including with respect to D&O insurance.
