Source: http://jimhamiltonblog.blogspot.com/2010_06_01_archive.html
Timestamp: 2014-07-29 18:49:40
Document Index: 486573066

Matched Legal Cases: ['§10', '§10', '§10', '§10', '§10', '§10', '§10', '§10', '§10', '§ 7107', '§ 922', '§ 929', '§ 929', '§ 7215', '§ 929', '§ 7211', '§ 922', '§ 7216', '§ 922', '§ 7220', '§ 922', '§ 7106', '§ 7105', '§ 995', '§ 7403', '§ 7404', '§ 7209', '§ 7501', '§ 7507', '§ 7508', '§ 7421', '§ 7304', '§ 7414', '§ 982', '§ 3303', '§ 7606']

Jim Hamilton’s World of Securities Regulation: June 2010
Conference Committee Reconvenes to Deal With PAYGO and Adjourns Again
House-Senate conference on the financial reform legislation reconvened today to deal with the objection of key Republican Senators to Title XVI of the legislation, which complied with the Statutory Pay-As-You-Go Act by establishing a financial crisis assessment regime, with an attendant fund housed in Treasury. Under Title XVI, the Financial Stability Oversight Council would have imposed special assessments on a range of financial companies and hedge funds, which would have been collected by the FDIC. The assessments must collect $19 billion to pay for the legislation.Tonight, conferees struck Title XVI from the Act and replaced it with provisions that would raise the assessment for the FDIC deposit insurance fund on banks with over $10 billion in assets and end TARP and use the unused TARP funds. Chairman Frank said that, after discussions with FDIC Chair Shelia Bair, that the increased assessment would be weighted towards financial institutions with higher leverage that pose a higher risk to financial stability. There were no revisions to any other Titles of the ActWith that the conference voted to report out the amended Act and adjourned.
6/29/2010 06:35:00 PM
Conference Committee Struck Compromise on Uniform Duty of Care for Brokers and Advisers
The current regulatory regime treats brokers and advisers differently and subjects them to different standards of care even though the services they provide investors are very similar and investors view their roles as essentially the same. This regime was established during the New Deal and, although amended many times since, remains rooted in the last century. An ultimate goal of financial regulatory reform has been to allow the SEC to align duties for financial intermediaries across financial products. A corollary of this goal is that standards of care for all brokers when providing investment advice about securities to retail investors should be raised to the fiduciary standard to align the legal framework with investment advisers.The House bill would have imposed a uniform federal fiduciary duty on brokers and advisers, while the Senate bill directed the SEC to conduct a study on the matter. The House-Senate conference committee struck a compromise, vetted by Senator Tim Johnson, a senior member of the Banking Committee, under which the SEC will conduct a study under what Senator Johnson called strict parameters and the SEC is also authorized to impose a uniform federal fiduciary standard on brokers and investment advisers. (Sec. 913 of the Dodd-Frank Act)The legislation requires the SEC to conduct a study to evaluate the effectiveness and efficacy of the existing standards of care for brokers and investment advisers and whether there are regulatory gaps in the protection of retail customers with regard to the standards. (Sec. 913(b) of the Dodd-Frank Act.The SEC must consider if retail customers understand that there are different standards of care applied to brokers and advisers in the provision of personalized investment advice and whether retail customers are confused about the quality of the personalized investment advice they receive. The Act defines retail customers as natural persons who receive personalized investment advice about securities from a broker or investment adviser and uses them advice primarily for personal, family or household purposes. (Sec. 913(a) of the Dodd-Frank Act).The SEC study must also examine the regulatory and enforcement resources available to enforce the standards of care for brokers and advisers when providing personalized investment advice about securities to retail customers, including the frequency and effectiveness of examinations. The substantive differences in the regulation of brokers and investment advisers when advising and recommending securities to retail customers must also be examined, and any specific instances when the oversight of brokers provided greater protection to retail investors than the oversight of advisers, and the converse. The existing state regulatory standards for protecting retail securities customers must also be studied.The study must examine the potential impact on retail customers and their access to a range of services and products of imposing the investment adviser standard of care on brokers, as well as the impact of eliminating the broker and dealer exclusion from the definition of investment adviser in the Advisers Act, including on retail customers and state and federal resources. The varying level of services provided by brokers and investment advisers must be reviewed, as well as the varying scope and terms of retail customer relationships of brokers, dealers, investment advisers, persons associated with brokers or dealers, and persons associated with investment advisers with such retail customers.Finally, the SEC must examine the potential impact upon retail customers that could result from potential changes in the regulatory requirements or legal standards of care affecting brokers, and investment advisers relating to their obligations to retail customers regarding the provision of investment advice, including any potential impact on protection from fraud, access to personalized investment advice, and recommendations about securities to retail customers or the availability of such advice and recommendations.Within six months of enactment, the SEC must submit a report on the study to Congress describing its findings and conclusions and recommendations. The report must set forth the considerations, analysis, and public and industry input that the Commission considered, as required by the statute, and include an analysis of regulatory gaps in the protection of retail investors relating to the standard of care of brokers and advisers.The legislation goes on to authorize the SEC to impose a uniform federal fiduciary standard of care on brokers and investment advisers. (Sec. 913(g) of the Dodd-Frank Act. The receipt of compensation based on commission or other standard compensation for the sale of securities will not, in and of itself, be considered a violation of such standard applied to a broker or dealer. Moreover, there will be no continuing duty of care or loyalty owed by the broker to the retail customer after the providing of personalized investment advice about securities.The Commission may require a broker selling only proprietary or a limited range of products to provide notice to each retail customer and obtain the consent or acknowledgment of the customer. But the sale of only proprietary or other limited range of products will not, in and of itself, be considered a violation of the standard of care.The Commission must facilitate the provision of simple and clear disclosures to investors regarding the terms of their relationships with brokers and investment advisers, including any material conflicts of interest and, where appropriate, promulgate rules prohibiting or restricting sales practices, conflicts of interest, and compensation schemes for brokers and investment advisers that are contrary to the public interest and the protection of investors.The Dodd-Frank Act is not writing on a blank slate. As the worlds of brokers and investment advisers increasingly converged, the SEC has been attempting to calibrate the regulation of these securities professionals in a flexible and innovative manner consistent with investor protection. More practically, the SEC and Congress are trying to accommodate a regulatory regime erected in the 1930s with the realities of 2010.Currently, the fiduciary duty imposed by the Investment Advisers Act requires advisers to act solely with the client’s investment goals and interests in mind, free from any conflicts of interest that would tempt them to make recommendations that would also benefit them. Unlike investment advisers, brokers are not categorically bound by statute, regulation, or precedent to a per se rule imposing fiduciary obligations toward clients. Instead, the existence of fiduciary duties within a broker-client relationship has historically been significantly more contingent, turning ultimately on the factual nature of the relationship as interpreted by courts. Because of the distinct regulatory structures placed on investment advisers and broker-dealers, the dividing line between them has always been an elusive one, albeit an important one. Congress excluded brokers from the Advisers Act so long as the advice they give clients is solely incidental to their business as a broker and they do not receive any special compensation for rendering such advice.As investor confusion over the roles of brokers and advisers deepened, the SEC commissioned the Rand Center for Corporate Ethics, Law and Governance to prepare a report on investor and industry perspectives on investment advisers and broker-dealers. The report, entitled Investor and Industry Perspectives on Investment Advisers and Broker-Dealers, was released in December 2007 (hereinafter the ``Rand Report’’). It is becoming seminal and certainly informs the debate.The Rand Report’s essential conclusion is that the regulatory environment for brokers and investment advisers is eroding along with the distinctions between the two types of financial professionals on which it is based, which after all date back to the early 20th century. More broadly, the Report found that the current regulatory regime treats brokers and advisers differently when, in practice, their role is essentially the same, especially from the viewpoint of the investor. This regime was erected during the New Deal and, while amended many times over the years, is still organically rooted in the last century.The Report found that the bright line between brokers and investment advisers that may have existed in the 1930s has become increasingly blurred. Indeed, whether a financial services professional is a broker or an investment adviser is indistinguishable to most investors. Many investors think that brokers and advisers offer the same products and services. Moreover, most investors do not know the differences between a broker and an investment adviser, and the certainly are not generally aware that the regulatory standards may be different.One reason cited in the Report for the blurring of the line between brokers and investment advisers is that much of the marketing by brokers focuses on the ongoing relationship between the broker and the investor as brokers have adopted such titles as financial advisor and financial manager.
Federal Tax Bar Loses Giant
We note with great regret the passing of Martin D. Ginsburg, eminent authority on the federal tax code and spouse of US Supreme Court Justice Ruth Bader Ginsburg. Mr. Ginsburg was a professor at Georgetown University Law Center and of counsel to the law firm of Fried, Frank, Harris, Shriver and Jacobson; or as Mr. Ginsburg, always humble, once stated: “I am a school teacher and my wife is a public servant.” Mr. Ginsburg is co-author with Jack Levin on the seminal M&A tax treatise- Mergers, Acquisitions, and Buyouts, a Transactional Analysis of the Governing Tax, Legal and Accounting consequences. Susan Chazin, Associate Publisher of Mr. Ginsburg’s M&A treatise noted: “Marty Ginsburg was always thought- provoking, humorous and above all, a gentleman. He was a respected author who will be greatly missed.”
6/28/2010 03:44:00 PM
PCAOB's Dual Insulation from President's Authority Violates Constitutional Separation of Powers Doctrine
The PCAOB’s double layer of insulation from presidential removal of its members is an unconstitutional violation of the Separation of Powers doctrine, ruled the US Supreme Court. Board members are appointed by the SEC, which is constitutional the Court said, but their two separate layers of for cause tenure protection, SEC and PCAOB, restrict the President in his ability to remove a principal officer, who is in turn restricted in his ability to remove an inferior officer, even though that inferior officer determines the policy and enforces the laws of the United States. Congress cannot deprive the President of adequate control over a Board that is the regulator of first resort and the primary law enforcement authority for a vital financial sector of the economy. But the Court also ruled that the Board’s unconstitutional tenure provisions are severable from the remainder of the Sarbanes-Oxley Act. (Free Enterprise Fund v. PCAOB, Dkt. No 08-861).Concluding that the removal restrictions are invalid leaves the Board removable by the SEC at will, noted the Court, and leaves the President separated from Board members by only a single level of good-cause tenure. The Commission is then fully responsible for the Board’s actions, which are no less subject than the Commission’s own functions to Presidential oversight. Thus, the Court said that the Sarbanes-Oxley Act remains fully operative with these tenure restrictions excised.Since the Board members were validly appointed by the full Commission, the Court refused to broadly enjoin the Board’s continued operations. The audit firm challenging the Board’s constitutionality was entitled to declaratory relief sufficient to ensure that the reporting requirements and auditing standards to which they are subject will be enforced only by a constitutional agency accountable to the Executive.The central issue in the case is that the PCAOB’s second layer of tenure protection matters when the President finds it necessary to have a subordinate officer removed, and a statute prevents him from doing so. The Court ruled that the Board members’ multilevel protection from removal is contrary to Article II’s vesting of the executive power in the President. The President cannot “take Care that the Laws be faithfully executed” if he cannot oversee the faithfulness of the officers who execute them, reasoned the Court.Regarding the PCAOB, the President cannot remove a Board member who enjoys more than one level of good-cause protection, even if the President determines that the officer is neglecting his or her duties or discharging them improperly. That judgment is instead committed to SEC Commissioners who may or may not agree with the President’s determination, and whom the President cannot remove simply because they disagree with him. In the Court’s view, this situation contravenes the President’s constitutional obligation to ensure the faithful execution of the laws.While the Court has allowed limited restrictions on the President’s removal power, the Court could not allow two levels of protected tenure to separate the President from an officer exercising executive power. The Sarbanes-Oxley Act not only protects Board members from removal except for good cause, but withdraws from the President any decision on whether that good cause exists. That decision is vested instead in other tenured officers, the SEC Commissioners, none of whom is subject to the President’s direct control. The result is a Board that is not accountable to the President, and a President who is not responsible for the Board.The added layer of tenure protection makes a difference, said the Court, because without it, the SEC could remove a Board member at any time, and therefore would be fully responsible for what the Board does. The President could then hold the Commission to account for its supervision of the Board, to the same extent that he may hold the Commission to account for everything else it does. The Commissioners are not responsible for the Board’s actions. They are only responsible for their own determination of whether the Act’s rigorous good-cause standard is met. And even if the President disagrees with their determination, he is powerless to intervene unless that determination is so unreasonable as to constitute inefficiency, neglect of duty, or malfeasance in office.In the Court’s view, this novel structure does not merely add to the Board’s independence, but transforms it. Neither the President, nor anyone directly responsible to him, nor even an officer whose conduct he may review only for good cause, has full control over the Board. The President is stripped of the power and the ability to execute the laws because his ability to hold his subordinates accountable for their conduct is impaired.The Board’s second layer of tenure protection compromises the President’s ability to remove a Board member the Commission wants to retain. Without a second layer of protection, the SEC has no excuse for retaining an officer who is not faithfully executing the law. With the second layer in place, the Commission can shield its decision from Presidential review by finding that good cause is absent, a finding that, given the SEC’s own protected tenure, the President cannot easily overturn. No one has explained to the Court why the Board’s task, unlike so many others, requires more than one layer of insulation from the President.The current PCAOB-SEC arrangement is contrary to Article II’s vesting of the executive power in the President. Without the ability to oversee the Board, or to attribute the Board’s failings to those whom he can oversee, the President is no longer the judge of the Board’s conduct. He is not the one who decides whether Board members are abusing their offices or neglecting their duties. He can neither ensure that the laws are faithfully executed, nor be held responsible for a Board member’s breach of faith. This violates the basic principle that the President cannot delegate ultimate responsibility or the active obligation to supervise that goes with it, because Article II makes a single President responsible for the actions of the Executive Branch.Without a clear and effective chain of command, said the Court, the public cannot determine on whom the blame or the punishment of a pernicious measure ought really to fall. By granting the Board executive power without the Executive’s oversight, Sarbanes-Oxley subverts the President’s ability to ensure that the laws are faithfully executed and the public’s ability to pass judgment on his efforts. The Act’s restrictions are incompatible with the Constitution’s separation of powers.
Franken Amendment on Random Assignment of Credit Ratings May Yet Be Implemented
The legislation that passed the Senate on May 20, 2010 contained a provision, Sec. 939D, authored by Senator Al Franken that conducted a frontal attack on the conflict of interest problem by adding new Exchange Act Sec. 15E(w) to create an SRO overseen by the SEC that would assign credit rating agencies to provide initial ratings for asset-backed securities and structured financial products on a rotating basis. There was no comparable provision in the legislation the House passed on December 11, 2009. The House-Senate conference committee that produced the Dodd-Frank Act reached a compromise that directs the SEC to conduct a study on the feasibility of assigning a rating agency to issue ratings on structured products and, if no better method is found, implement the Sec. 15E(w) as authored by Senator Franken. (Sec. 939F of the Dodd-Frank Act).The SEC study must determine the extent to which the creation of such a system would be viewed as the creation of moral hazard by the Federal Government, and examine any constitutional or other issues concerning the establishment of such a system. The study must also look at the range of metrics that could be used to determine the accuracy of credit ratings; and alternative means for compensating nation rating organizations that would create incentives for accurate credit ratings. The study must assess potential mechanisms for determining fees for the raters and appropriate methods for paying the fees. (Sec. 939F(b) of the Dodd-Frank Act).Within two years of enactment, the SEC must report to Congress on the findings of the study. (Sec. 939F(c) of the Dodd-Frank Act). After submission of the report, the SEC must establish a system for the assignment of nationally recognized statistical rating organizations to determine the initial credit ratings of structured finance products in a manner that prevents the issuer, sponsor, or underwriter of the product from selecting the rating agency that will determine the initial credit ratings and monitor such credit ratings. In issuing rules, the Commission must give thorough consideration to the Franken-authored Exchange Act. Sec. 15W(e) and must implement the system set forth in Sec. 15W(e) unless the Commission decides that an alternative system would better serve the public interest and protect investors. (Sec. 939F(d) of the Dodd-Frank Act).The Franken Amendment further attacks the conflict of interest problem by creating a board overseen by the SEC that will assign credit rating agencies to provide initial ratings on a rotating basis. The SEC will create a credit rating agency board, a self-regulatory organization, tasked with developing a system in which the board assigns a rating agency to provide a product’s initial rating. Requiring an initial credit rating by an agency not of the issuer’s choosing will put a check on the accuracy of ratings, in the Senator’s view. The amendment does not prohibit an issuer from then seeking a second or third or fourth rating from an agency of their choosing. The amendment leaves flexibility to the Board to determine the assignment process. Thus, the new board gets to design the assignment process it sees fit, which can be random or based on a formula, just as long as the issuer doesn’t get to choose its rating agency. Cong. Record, May 10, 2010, S3465.
Dodd-Frank Act Creates Financial Crisis Assessment Regime to Comply with PAYGO
In order to comply with the Statutory Pay-As-You-Go Act, the Dodd-Frank Act establishes a financial crisis assessment regime, in Title XVI, with an attendant fund housed in Treasury. The Financial Stability Oversight Council must impose special assessments on a range of financial companies and hedge funds, which will be collected by the FDIC. The assessments must collect, in the aggregate, the lesser of $19 billion and the product of one and one-third and the amount necessary to fully offset the net deficit effects of the Dodd-Frank Act up and through September 30, 2020, with the amount to be determined by OMB.The assessments will be imposed on financial companies with $50 billion of more of consolidated assets and hedge funds with $10 billion or more of assets under management. In consultation with the SEC, the Council will define hedge funds for purposes of the financial crisis assessment regime.In making the special assessments, the Council must establish a risk matrix that takes into account, among other things, the need to satisfy the fund’s statutory amounts, the extent of the company’s leverage, the extent and nature of the company’s off-balance sheet exposures and transactions and relationships with financial companies. The risk matrix must also account for the company’s importance as a source of credit for households, businesses, and state and local governments and as a source of liquidity for the financial system, as well as the company’s importance as a source of credit for low-income, minority, or underserved communities and the impact the failure of such company would have on the availability of credit in some communities.In order to achieve equitable treatment in assessments, in establishing the special assessment system, the Council must consider differences among financial companies based on complexity of operations or organization, interconnectedness, size, direct or indirect activities, and any other risk-related factors appropriate to ensure that the assessments charged take into account the risk posed to the financial system by particular classes of financial companies.The Council may require companies to make available information to be used in determining the financial company’s assessments and verifying the accuracy of the information and for overall determination of the proper risk-based assessments. In order to mitigate the burden on financial firms, the Council must, to the fullest extent possible, accept reports that the financial company has already provided to state and federal regulators and SROs, as well as externally audited financial statements and other publicly reported information. Federal regulators can make on-site inspections of a financial company’s books and records to carry out the purposes of the information gathering.There is established in the Treasury a separate fund, the Financial Crisis Special Assessment Fund to be funded by assessments deposited from FDIC collections, which are to be considered fund assets and only fund assets, which may not be consolidated with any other funds within the Treasury. Fund assets can only be invested in US obligations issued directly to the fund and they must have suitable maturities and pay suitable interest rates. The fund cannot be used in connection with the liquidation of any failed firm under Title II of the Dodd-Frank Act, which is an orderly liquidation regime in which the firm goes out of business. Similarly, the fund cannot be used in connection with any financial stabilization action taken under the authority of the Dodd-Frank Act.
6/27/2010 04:58:00 PM
House-Senate Conference Reports Out Historic and Sweeping Overhaul of US Financial Regulation
A House-Senate conference committee has reported out the Dodd-Frank Wall Street Reform and Consumer Protection Act providing for a sweeping overhaul of the regulation of US financial services and markets. The overhaul of the US financial regulatory system is based on the themes of regulating systemic risk, enhancing transparency and disclosure, a shareholder advisory vote on executive compensation, expanding consumer and investor protection, and preventing regulatory arbitrage. The legislation provides for the regulation of hedge funds, and OTC derivatives, as well as a new resolution authority to unwind failing financial firms. The legislation ends taxpayer bailouts of financial institutions and securities firms by creating a way to liquidate failed firms without taxpayer money.The measure shines the light of disclosure on dark markets by regulating the derivatives markets and the shadow banking system of hedge funds and other private vehicles that grew up around it. The legislation provides for major corporate governance reforms, such as shareholder advisory votes on executive compensation and golden parachutes. The legislation also envisions a completely reformed securitization process with risk retention (skin in the game) playing an important role in the financial markets. A new independent regulator would be created with authority to make sure that consumer protection regulations are written and enforcedThe legislation would provide for joint SEC-CFTC regulation of derivatives, strengthen the SEC’s powers to better protect investors, and efficiently and effectively regulate the securities markets The Act would also reform the credit rating agency process by, among other things, mandating new rules for internal controls, independence, transparency and penalties for poor performance in order to restore investor confidence in these ratings. The legislation also establishes a systemic risk regulator based on the council of systemic risk regulators model employed in the European Union.Systemic Risk RegulatorThe financial crisis demonstrated that large, interconnected financial firms that pose a systemic risk to the entire financial system need to be under a consistent and conservative regulatory regime. These standards cannot simply address the soundness of individual institutions, but must also ensure the stability of the system itself.Any financial institution that is big enough, interconnected enough, or risky enough that its distress necessitates government intervention is an institution that necessitates oversight by a federal agency responsible for managing the overall risk to the financial system. In a world where financial innovation is pervasive and where market conditions constantly change, regulators must be authorized to take a holistic view of the playing field, identifying gaps, pointing to unsustainable trends, and raising questions about new kinds of interactions.Thus, the legislation would enact an early warning system by creating a regulator to police all systemically important firms and markets as a broad consensus develops on the need for Congress to create a systemic risk regulator. This regulator would be authorized to take proactive steps to prevent or minimize systemic risk. The legislation seeks to guarantee holistic regulation of the financial system as a whole, not just its individual components.The legislation would create an independent agency with a board of regulators to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the financial system. The new Financial Stability Oversight Council, chaired by the Treasury Secretary and comprised of key regulators such as the Fed, SEC and CFTC, would monitor emerging risks to U.S. financial stability, recommend heightened prudential standards for large, interconnected financial companies, and require nonbank financial companies such as hedge funds to be supervised by the Federal Reserve if their failure would pose a risk to U.S. financial stability.Office of Financial ResearchThe legislation establishes an executive agency to collect and standardize data on financial firms and their activities to aid and support the work of the federal financial regulators. The Office of Financial Research, headed by a Director appointed by the President for a six-year term, would provide the Council and financial regulators with the data and analytic tools needed to prevent and contain future financial crises by developing tools for measuring and monitoring systemic risk. The logic behind the Office is that it makes no sense to pass legislation creating a systemic risk regulator when there are no standardized tools for measuring systemic risk. The Office is patterned on an executive agency envisioned by the National Institute of Finance Act of 2010, S 3005, sponsored by Senator Jack Reed, Chair of the Securities Subcommittee.The Office would not only develop the metrics and tools financial regulators need to monitor systemic risk, it would also help policymakers by conducting studies and providing advice on the impact of government policies on systemic risk. Thus, the Office would be required to provide independent periodic reports to Congress on the state of the financial system. This will ensure that Congress is kept apprised of the overall picture of the financial markets. The legislation provides for the Office to house a data center that would collect, validate and maintain key data to perform its mission.Regulation of DerivativesThe financial crisis revealed that massive risks in derivatives markets went undetected by both regulators and market participants. In 2000, the Commodity Futures Modernization Act (CFMA) explicitly exempted OTC derivatives, to a large extent, from regulation by the CFTC. Similarly, the CFMA limited the SEC's authority to regulate certain types of OTC derivatives. As a result, the market for OTC derivatives has largely gone unregulated.According to the Obama Administration, the downside of this lax regulatory regime became disastrously clear during the recent financial crisis when many institutions and investors had substantial positions in credit default swaps tied to asset backed securities. Excessive risk taking by AIG and certain monoline insurance companies that provided protection against declines in the value of such asset backed securities, as well as poor counterparty credit risk management by many banks, saddled the financial system with an enormous unrecognized level of risk. The sheer volume of these contracts overwhelmed some firms that had promised to provide payment on the credit default swaps and left institutions with losses that they believed they had been protected against. Lacking authority to regulate the OTC derivatives market, regulators were unable to identify or mitigate the enormous systemic threat that had developed. Financial Regulatory Reform: A New Foundation, June 2009While OTC derivatives are supposed to protect businesses from risks, they became a way for companies to make enormous bets with no regulatory oversight and therefore exacerbated risks. Because the derivatives market was considered too big and too interconnected to fail, taxpayers had to foot the bill for bad bets that linked thousands of traders and created a web in which one default threatened to produce a chain of corporate and economic failures worldwide. These interconnected trades, coupled with the lack of transparency about who held what, made unwinding the “too big to fail” institutions more costly to taxpayers.During last year’s financial crisis, concerns about the ability of companies to make good on these derivatives contracts, and the lack of transparency about what risks existed, caused credit markets to freeze. Investors were afraid to trade as Bear Stearns, AIG, and Lehman Brothers failed because any new transaction could expose them to more riskIn an effort to address the systemic risk to the financial markets posed by derivatives, the Senate legislation would mandate, for the first time, the federal regulation of derivatives under a dual SEC-CFTC regime that emphasize transparency. The CFTC would regulate swaps and the SEC would regulate security-based swaps.The legislation includes mandatory clearing and trading requirements and real-time reporting of derivatives trades. Commercial end users using derivatives to hedge risk are exempted from mandatory swap clearing.Corporate GovernanceThe Obama Administration and the G-20 have determined that corporate governance failures, including compensation that encouraged short-term risk taking, were significant causes of the financial crisis. Bonuses that rewarded short term profits over the long term health and security of the firm, and other incentive-based compensation for executives to take big risks with excess leverage, threatened the stability of their companies and the economy as a whole. Thus, the legislation gives shareholders a say on pay and proxy access, ensures the independence of compensation committees, and requires companies to set clawback policies to take back executive compensation based on inaccurate financial statements as important steps in reining in excessive executive pay and helping shift management’s focus from short-term profits to long-term growth and stability.Say on PayThe legislation would enhance corporate governance and mandate increased transparency of executive compensation. Shareholders would be given the right to a non-binding vote on executive compensation. The advisory vote on executive compensation is designed to give shareholders a powerful opportunity to hold accountable executives of the companies they own, and a chance to disapprove where they see the kind of misguided incentive schemes that threatened individual companies and, in turn, the broader economy..The shareholder advisory vote on executive pay will not overrule a decision by the company or the board, or create or imply any change to, or addition to, the fiduciary duties of the directors, or restrict the ability of shareholders to make inclusion in proxy materials related to executive compensation.Dual RolesIt is widely acknowledged that a sound corporate governance practice is to bifurcate the roles of board chairman and CEO. Thus, the SEC is directed to adopt rules requiring a company to disclose in the annual proxy sent to investors the reasons why it has chosen the same person to serve as chairman of the board of directors and chief executive officer or why it has chosen different individuals to serve as board chair and chief executive officer. Section 973Compensation CommitteesIn a major corporate governance improvement, the legislation mandates independent board compensation committees. The SEC must adopt rules for exchange listing requiring that compensation committees include only independent directors and have authority to hire compensation consultants. This provision is designed to strengthen their independence from the executives they are rewarding or punishing.HedgingThe SEC is also directed to adopt rules requiring a company to disclose whether any employee or director is permitted to purchase financial instruments, including derivatives such as equity swaps, that are designed to hedge or offset any decrease in the market value of equity securities granted to the employee or director by the company as part of the compensation of the employee or directors or held directly or indirectly by the employee or director.Executive Compensation DisclosureThe SEC is required to amend Item 402 of Regulation S-K to mandate disclosure of the median of the annual total compensation of all employees, except the CEO; the annual total compensation of the CEO; and the ratio of the two. The annual total compensation of an employee must be determined by reference to Item 402 of Regulation S-K. This disclosure is required in annual reports and proxy statements, among other filings.Voting by BrokersIn addition, exchange rules must prohibit members that are not beneficial owners of a security from granting a proxy to vote the security in connection with a shareholder vote for the election of directors, executive compensation, or any other significant matter as the SEC may determine by rule, unless the beneficial owner of the security has instructed the member to vote the proxy in accordance with the voting instructions of the beneficial own.Hedge Fund and Private Equity Fund AdvisersThe legislation would require SEC registration of hedge fund advisers and disclosure of information to the Commission under a confidentiality regime. The SEC must require hedge fund advisers to disclose the amount of assets under management, their use of leverage and counterparty credit risk exposure, as well as their trading and investment positions, their valuation methodologies, and any side arrangements or side letters that treat fund investors more favorably than other investors.The legislation brings hedge fund advisers under SEC regulation by eliminating the exemption in section 203(b)(3) of the Investment Advisers Act for advisers with fewer than 15 clients. Under current law, a hedge fund is counted as a single client, allowing hedge fund advisers to escape the obligation to register with the SEC. The legislation exempts foreign private advisers, as well as containing a limited intrastate exemption, and an exemption for small business investment companies licensed by the Small Business Administration.There is an exemption for venture capital fund advisers.Family offices provide investment advice in the course of managing the investments and financial affairs of one or more generations of a single family. Since the enactment of the Investment Advisers Act, the SEC has issued orders to family offices declaring that those family offices are not investment advisers within the intent of the Act and thus not subject to registration. The legislation essentially codifies the SEC position by excluding family offices from the definition of investment adviser under Section 202(a)(11) of the Advisers Act.The legislation raises the asset threshold above which investment advisers must register with the SEC from the $25,000,000 set in 1996 by the National Securities Markets Improvement Act to $100,000,000.Accredited InvestorsAccredited investor status, defined in SEC regulations, is required to invest in hedge funds and other private securities offerings. Accredited investors are presumed to be sophisticated, and not in need of the investor protections afforded by the registration and disclosure requirements of the federal securities laws. For individuals, the accredited investor thresholds are dollar amounts for annual income ($200,000 or $300,000 for an individual and spouse) and net worth of $1 million, including the value of a person‘s primary residence). These amounts have not been adjusted since 1982. Thus, legislation irects the SEC to adjust the net worth needed to attain accredited investor status to $1,000,000, excluding the value of the person’s primary residence. Within the period of four years after enactment, however, the net worth standard must be $1,000,000, excluding the value of the primary residence.The legislation also directs the SEC, four years after enactment, and once every 4 years thereafter, to review the definition of accredited investor to determine whether the requirements of the definition should be adjusted or modified for the protection of investors, in the public interest, and in light of the economy. Upon completion of the review, the SEC may adjust the term accredited investor.Clearing and SettlementIn order to mitigate systemic risk in the financial system and promote financial stability, the legislationSEC Collateral BarsCurrently, a securities professional barred from being an investment adviser for serious misconduct could still participate in the industry as a broker-dealer. Noting that improved sanctions would better enable the SEC to enforce the federal securities laws, the Obama Administration sought authority for the SEC to impose collateral bars against regulated persons across all aspects of the industry rather than in a specific segment of the industry. The interrelationship among the securities activities under the SEC’s jurisdiction, the similar grounds for exclusion from each, and the SEC’s overarching responsibility to regulate these activities support the imposition of collateral bars.Thus, the legislation authorizes the SEC to impose collateral bars against regulated persons. The Commission would have the authority to bar a regulated person who violates the securities laws in one part of the industry, such as a broker-dealer who misappropriates customer funds, from access to customer funds in another part of the securities industry, for example, an investment adviser. By expressly empowering the SEC to impose broad prophylactic relief in one action in the first instance, this provision would enable the SEC to more effectively protect investors and the markets while more efficiently using SEC resources.SEC Fair FundThe Fair Fund provisions of the Sarbanes-Oxley Act take the civil penalties levied by the SEC as a result of an enforcement action and direct them to a disgorgement fund for harmed investors. The legislation would increase the money available to compensate defrauded investors by revising the Fair Fund provisions to permit the SEC to use penalties to recompense victims of the fraud even if the SEC does not obtain an order requiring the defendant to disgorge ill-gotten gains. Currently, in some cases, a defendant may engage in a securities law violation that harms investors, but the SEC cannot obtain disgorgement from the defendant because the defendant did not personally benefit from the violation.PCAOBThe Madoff fraud revealed that the Public Company Accounting Oversight Board lacked the powers it needed to examine the auditors of broker-dealers. Thus, the legislation brings broker-dealers under the PCAOB oversight regime. The PCAOB is given authority over audits of registered brokers and dealers that is generally comparable to its existing authority over audits of issuers. This authority permits the Board to write standards for, inspect, investigate, and bring disciplinary actions arising out of, any audit of a registered broker or dealer. It enables the PCAOB to use its inspection and disciplinary processes to identify auditors that lack expertise or fail to exercise care in broker and dealer audits, identify and address deficiencies in their practices, and, where appropriate, suspend or bar them from conducting such audits.Financial Literacy and Underserved InvestorsThe three vital components of financial literacy are education, consumer protection, and economic empowerment, and the legislation includes essential provisions in all three of these areas for consumers and investors. See remarks of Sen. Daniel Akaka, Cong. Record, Apr 30, 2010, p. S2996. With regard to education, the legislation requires a the SEC to conduct a financial literacy study and develop an investor financial literacystrategy intended to bring about positive behavioral change among investors. Section 916. In addition, an Office of Financial Literacy is created within the new Consumer Financial Protection Bureau and is tasked with implementing initiatives to educate and empower consumers. Section 1013. A strategy to improve the financial literacy among consumers, that includes measurable goals and benchmarks, must be developed.With regard to the second key component of financial literacy, consumer protection, the Act strengthens the ability of the SEC to better represent the interests of retail investors by creating an Investor Advocate within the SEC. Section 911. The Investor Advocate is tasked with assisting retail investors to resolve significant problems with the SEC or the self-regulatory organizations. The Investor Advocate’s mission includes identifying areaswhere investors would benefit from changes in Commission or SRO policiesand problems that investors have with financial service providers and investmentproducts. The Investor Advocate will recommend policy changes to the Commission and Congress in the interests of investors.The legislation also authorizes the SEC to effectively require disclosures to retail investors prior to the sale of financial products and services. Section 918. This provision will ensure that investors have the relevant and useful information they need when making decisions that determine their future financial condition. The information to be disclosed by SEC rule must be in summary format and contain concise information about investment objectives, strategies, costs, and risks, as well as any compensation or financial incentive received by the financial intermediary in connection with the purchase of the retail investment product.The measure authorizes the SEC to gather information from and communicate with investors and engage in such temporary programs as the Commission determines are in the public interest for the purpose of evaluating any rule or program of the SEC. Section 912. In the past, the SEC has carried out consumer testing programs, but there have been questions of the legality of this practice. This legislation gives clear authority to the SEC for these activities.The legislation modifies the Electronic Fund Transfer Act to establish remittanceconsumer protections. It would require simple disclosures about the costs of sending remittances to be provided to the consumer prior to and after the transaction. A complaint and error resolution process for remittance transactions would also be established. Section 1076.On the third component, economic empowerment, the legislation intends to increaseaccess to mainstream financial institutions for the unbanked and the underbanked. The legislation authorizes programs intended to assist low- and moderate-income individuals establish bank or credit union accounts and encourage greater use of mainstream financial services. Title XII would also encourage the development of small, affordable loans as an alternative to more costly payday loans.Credit Rating AgenciesCredit rating agencies market themselves as providers of independent research and in-depth credit analysis. But in the financial crisis, instead of helping people better understand risk, they failed to warn people about risks hidden throughout layers of complex securitized structures.Flawed methodology, weak oversight by regulators, conflicts of interest, and a total lack of transparency contributed to a system in which AAA ratings were awarded to complex, unsafe asset-backed securities and other derivatives, adding to the housing bubble and magnifying the financial shock caused when the bubble burst. When investors no longer trusted these ratings during the credit crunch, they pulled back from lending money to municipalities and other borrowers.The legislation establishes an independent office within the SEC dedicated to improving the quality of regulation of credit rating agencies. The Office of Credit Ratings, headed by a direct report to the SEC Chair, will promote accuracy in credit ratings and keep conflicts of interest from unduly influencing ratings.The Office of Credit Ratings must also conduct annual examinations of each credit rating agency, including a review of its policies, procedures, and rating methodologies and whether it follows these policies, the management of conflicts of interest, the implementation of ethics policies; the internal supervisory controls of the agency, the governance of the agency; the activities of its compliance officer; the processing of complaints, and the policies of the agency governing the post-employment activities of former staff.Reform of SecuritizationIn many ways, the financial crisis was at root a crisis of securitization. While traditional securitization was a successful tool for bundling loans into asset-backed securities, in the last decade it morphed into the short-term financing of complex illiquid securities whose value had to be determined by theoretical models. The inherent fragility of this new securitization model was masked by the actions of market intermediaries, particularly credit rating agencies. Predatory mortgages and securitization of those mortgages on Wall Street built a house-of-cards economy. The predatory subprime mortgages were done at the retail level, but the securitization and selling of those packages occurred on WallStreet. Remarks of Senator Jeff Merkley, Cong. Record May 6, 2010, S3319.The collapse of structured securitization revealed the ugly reality that, far from managing and dispersing risk, it had increased leverage and concentrated risk in the hands of specific financial institutions. The Obama Administration proposed the reform securitization by changing the incentive structure of market participants; increasing transparency to allow for better due diligence; strengthening credit rating agency performance; and reducing the incentives for over-reliance on credit ratings. Provisions of the draft legislation would implement these goals.One of the most significant problems in the securitization markets was the lack of sufficient incentives for lenders and securitizers to consider the performance of the underlying loans after asset-backed securities were issued. Lenders and securitizers had weak incentives to conduct due diligence regarding the quality of the underlying assets being securitized. This problem was exacerbated as the structure of those securities became more complex and opaque. Inadequate disclosure regimes also exacerbated the gap in incentives between lenders, securitizers and investors.There is a growing consensus that we have ``crossed the Rubicon’’ into originate and distribute securitization and there is no turning back to originate and hold. Indeed, restarting private-label securitization markets, especially in the United States, is criticalto limiting the fallout from the credit crisis and to the withdrawal of central bank andgovernment interventions. However, no one wants policies that would take markets back to their high octane levels of 2005–07. Thus, the legislation aims to put securitization on a solid and sustainable footing.The legislation reforms the process of securitization by, primarily, requiring companies that sell products like mortgage-backed securities to retain a portion of the risk to ensure that they will not sell toxic securities to investors, because they have to keep some of it for themselves. The legislation would require companies that sell products like mortgage-backed securities to keep some ``skin in the game’’ by retaining at least five percent of the credit risk so that, if the investment doesn’t pan out, the company that made, packaged and sold the investment would lose out right along with the people they sold it In addition, the legislation would require issuers to disclose more information about the assets underlying asset-backed securities and to analyze the quality of the underlying assets.Specifically, the legislation directs regulations to require any securitizer to retain a material portion of the credit risk of any asset that the securitizer, through the issuance of an asset-backed security, transfers, sells, or conveys to a third party. When securitizers retain a material amount of risk, they have skin in the game, thereby aligning their economic interests with those of investors in asset-backed securities. Securitizers who retain risk have a strong incentive to monitor the quality of the assets they purchase from originators, package into securities, and sell.Resolution AuthorityAccording to Treasury, the lack of a federal regulatory regime and resolution authority for large systemic financial institutions contributed to the financial crisis and, unless addressed with legislation, will constrain a federal response to future crises. As demonstrated by AIG, severe distress at large global non-depository financial institutions can pose systemic risks to the financial markets just as distress at banks can.Title II establishes an orderly liquidation authority to unwind large complex systemically important financial firms whose failure could put the entire financial system in jeopardy. According to Senator Mark Warner, a co-author of Title II, said that the title embodies three key principles: 1) it ends too big to fail; 2) the regime would be rarely used with bankruptcy remaining the preferred method; and 3) taxpayers are not burdened Senator Dodd said that the liquidation authority will wind down failing financial firms, force shareholders to be wiped out and culpable management to be fired, force creditors to bear loss and claw back any payment to creditors above liquidation value. The regime is designed to keep out non-financial commercial firms with a definition of financial company in which 85 percent of the revenues come from financial activities. This definition was intentionally designed to exclude commercial firms. The FDIC must run each receivership separately with separate accounting. House-Senate Conference Committee Meeting, June 17, 2010.Thus, the legislation establishes an orderly liquidation authority to give the U.S. government a viable alternative to the undesirable choice it faced during the financial crisis between bankruptcy of a large, complex financial company that would disrupt markets and damage the economy, and bailout of such financial company that would expose taxpayers to losses and undermine market discipline. The new orderly liquidation authority would allow the FDIC to safely unwind a failing nonbank financial firms or bank holding companies, an option that was not available during the financial crisis. The process includes several steps intended to make the use of this authority very rare. There is a strong presumption that the Bankruptcy Code will continue to apply to most failing financial companies..Once a failing financial company is placed under this authority, liquidation is the only option; since the failing financial company may not be kept open or rehabilitated. The financial company‘s business operations and assets will be sold off or liquidated, the culpable management of the company will be discharged, shareholders will have their investments wiped out, and unsecured creditors and counterparties will bear losses.The Dodd-Shelby Amendment, in conjunction with the Boxer Amendment, ends the idea that any firm can be too big to fail. Pursuant to the Dodd-Shelby Amendment, the legislation creates an orderly liquidation mechanism for the FDIC to unwind failing systemically significant financial companies. This mechanism represents a fundamental change in federal law that will protect taxpayers from the economic fallout of the collapse of a large interconnected systemically significant financial firm. Senator Chris Dodd, Cong Record, May 5, 2010, S3131.Shareholders and unsecured creditors will still bear losses and management at the failed firm will be removed. In fact, the Dodd-Shelby Amendment empowers regulators to bar culpable management and directors of failed firms form working in the financial sector. According to Senator Dodd, it makes sense that if someone has been involved in the mismanagement of a company and caused such disruption in the economy they should be banned from engaging in further economic activities. Senator Chris Dodd, Cong Record, May 5, 2010, S3131.Subject to due process protections, regulators can ban from the financial industry senior executives and directors at failed financial firms upon determining that they violated a law or regulation, a cease and desist order, or an agreement with a federal financial regulator; or breached their fiduciary duty; or engaged in an unsafe or unsound practices. In addition, the executive must have benefitted from the violation or breach, which must also involve personal dishonesty or a willful or continuing disregard for the firm’s safety or soundness. The length of the industry ban is in the regulator’s discretion, but must be at least two years.The Dodd-Shelby Amendment also requires post-resolution reviews to determine if regulators did all they were supposed to do to prevent the failure of a systemically significant institution. According to Senator Shelby, this post-resolution review is essential to hold regulators accountable for their actions or inactions as the case may be. Cong. Record, May 5, 2010, S3140.The Boxer Amendment puts to rest any doubt that the legislation ends federal bailouts of financial firms. The amendment means that no financial company is going to be kept alive with taxpayer money. Remarks of Senator Boxer, Cong. Record, May 4, 2010, S3063.Payment, Clearance and SettlementTitle VIII requires tough and heightened regulation of systemically important financial market utilities. There is presently no safety valve if they cannot perform their functions. The title would reduce systemic risk and complement existing SEC and CFTC regulation. It is a safeguard for financial market utilities that run into extraordinary liquidity problems. Plus, financial market utilities should not be carved out of systemic risk oversight. Financial market utilities provide critical services to the financial system, such as the clearing and settlement of US government securities, municipal securities, and derivatives.According to Senator Shelby, the legislation provides for enormous new duties for central clearinghouses. Derivatives legislation will mandate the clearing of many OTC derivatives for the first time. In this regard, he said that it is not possible to have an effective derivatives title without an effective payment, clearance and settlement title. Risk oversight role for Fed and discount window access for clearinghouses in a liquidity crunch will be important to ensure the stability of the financial system,Fixed Index AnnuitiesThe Harkin Amendment was inserted into the legislation that would treat fixed index annuities as insurance products to be regulated by state insurance officials, thereby essentially nullifying SEC Rule 151A. The amendment was offered by Senator Tom Harkin. Senator Jack Reed opposed the Harkin Amendment, stating that the SEC would be a more effective regulator of these hybrid instruments.A fixed index annuity is a hybrid financial product that combines some of the benefits of fixed annuities with the added earning potential of a security. Like traditional fixed annuities, fixed index annuities are subject to state insurance laws, under which insurance companies must guarantee the same 87.5 percent of purchase payments. Unlike traditional fixed annuities, however, the purchaser’s rate of return is not based upon a guaranteed interest rate.Rule 151A defines indexed annuities as not being exempt annuity contracts under Section 3(a)(8) of the Securities Act. Relying on a series of US Supreme Court rulings, the SEC reasoned that, given the unpredictability of the securities markets, index annuities contain substantial risk that must be addressed by the disclosure regime established by the Securities Act. Last year, a panel of the US Court of Appeals for the District of Columbia ruled that the rulemaking process was flawed by the fact that the SEC’s consideration of the effect of Rule 151A on efficiency, competition, and capital formation, as required by Securities Act Section 2(b), was arbitrary and capricious. American Equity Investment Life Insurance Co. v. SEC, No. 09-1021, CA DofC Circuit.The Harkin Amendment mirrors bi-partisan legislation introduced earlier in the Senate that would nullify the Commission’s adoption of Rule 151A before it has a chance to take effect. The Harkin provision provides that Rule 151A will have no force or effect. The draft legislation expresses a congressional sense that the SEC’s adoption of Rule 151A interferes with state insurance regulation, harms the insurance industry, reduces competition, and creates unnecessary and excessive regulatory burdens. The measure also embodies a congressional finding that indexed insurance and annuity products offered by insurance companies are subject to a wide array of state laws and regulations, including non-forfeiture requirements that provide for minimum guaranteed values, thereby protecting consumers against market swings.SEC FundingThe base conference bill provided for SEC self funding. A growing consensus developed in the House-Senate conference that the SEC should be under the congressional appropriations process. The final deal on SEC funding is based on the Shelby Amendment, which the House accepted. According to Senator Shelby, the provision would significantly increase the appropriated funds for the SEC. The provision would also enable the SEC to submit its budget request directly to Congress without obtaining prior White House approval. It would also allow the SEC to set up a $100 million reserve fund to use as needed for large scale improvements and during a crisis. The expenditures from the reserve fund would have to be reported to Congress. Senator Jack Reed praised the reserve fund as allowing the SEC to improve its technology and capital improvements at a time when the firms they regulate spend as much as ten times what the SEC spends on technology. House-Senate conference committee, June 24, 2010.
Supreme Court Restricts Extraterritorial Application of US Federal Securities Laws
In what is perhaps the first foreign-cubed case to ever reach the US Supreme Court, the Court ruled that Rule 10b-5 does not provides a cause of action to foreign plaintiffs suing foreign and American defendants for misconduct in connection with securities traded on foreign exchanges. The antifraud rule reaches the use of a manipulative or deceptive device only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States. When a statute gives no clear indication of an extraterritorial application, it has none. Since there is no affirmative indication in the Exchange Act that §10(b) applies extraterritorially, the Court concluded that it does not. The Court adopted a transactional test of whether the purchase or sale is made in the United States, or involves a security listed on a domestic exchange. (Morrison v. National Australia Bank, Ltd, Dkt. 08-1191).In the Court’s view, the fact that many difficult to apply judge-made tests on the extraterritorial aspects of the federal securities laws have developed over the years demonstrates the wisdom of the presumption against extraterritorial application of Rule 10b-5. Rather than guess anew in each case, the Court said that it would apply the presumption in all cases, preserving a stable background against which Congress can legislate with predictable effects.While this entire area of law is replete with judge-made rules because the implied private cause of action under §10(b) and Rule 10b–5 is a thing of the Court’s own creation, Justice Scalia emphasized that when it comes to the scope of the conduct prohibited by §10(b), the text of the statute controls the decision. On its face, §10(b) contains nothing to suggest it applies abroad.Under the Court’s transactional test, the Exchange Act does not reach conduct in the US affecting exchanges or transactions abroad. The probability of incompatibility with the applicable laws of other countries is so obvious that if Congress intended such foreign application it would have addressed the subject of conflicts with foreign laws and procedures.Like the United States, foreign countries regulate their domestic securities exchanges and securities transactions occurring within their territorial jurisdiction. And the regulation of other countries often differs from ours as to what constitutes fraud, what disclosures must be made, what damages are recoverable, what discovery is available in litigation, what individual actions may be joined in a single suit, what attorney’s fees are recoverable, and many other matters.The Court cited amicus briefs from other nations complaining of the interference with foreign securities regulation that the extraterritorial application of Rule 10b-5 would produce and urging the Court to adopt a clear test that will avoid that consequence. In separate amicus briefs, the UK and France cited international comity in urging the Court not to allow the application of Rule 10b-5 to upset the delicate balance that foreign nations have struck in regulating securities fraud and thereby offend the sovereign interests of foreign nations.The UK argued that the proper recognition of the sovereignty of other nations, the development of sophisticated regulation of the issuance and trading of securities withinnumerous nations, the globalization of capital markets, and international comity all combine to support a finding that the US federal courts lack jurisdiction to consider foreign-cubed cases. The UK and France also argued that they have sophisticated financial regulatory systems and substantive and procedural rules for remedying securities fraud and their approach to securities regulation and litigation differs in important respects from that of the U.S. Moreover, these differences represent legitimate policy choices and sovereign interests that ought to be respected by the United States.
Leahy Antifraud Amendment Approved by Senate Conferees
By unanimous consent, Senate conferees approved the bi-partisan Leahy Amendment, which is an antifraud amendment that Senator Leahy had offered on the Senate floor (SA 3794). The amendment was not voted on before the Senate passed the bill. As of last night, the House had not acted on the Leahy Amendment.The Leahy Amendment would add new Section 1079A to the bill to amend the US criminal code to increase the statute of limitations for securities fraud violations from five to six years, which aligns it with the current statute of limitations in tax fraud cases. The amendment would also direct the US Sentencing Commission to review and amend the federal sentencing guidelines and policy statements for offenses related to securities fraud and financial institution fraud to reflect the intent of Congress that penalties for the offenses appropriately account for the potential and actual harm to the public and the financial markets from the offenses.
Senate Conferees Agree on Shareholder Advisory Vote on Golden Parachutes
Senate conferees, on June 22, 2010, acceded to the House and agreed to require a shareholder advisory vote on golden parachutes. The bill the House passed had included golden parachutes in the say on pay provision, but the Senate-passed bill did not. Both House and Senate bills add a new section to the Exchange Act proxy provisions mandating a separate shareholder advisory vote to approve the compensation of the executives as disclosed pursuant to the SEC executive compensation disclosure rules for named executive officers. The shareholder vote is not binding on either the company or its board of directors.
Senate Conferees Approve Harkin Amendment on Fixed Income Annuities
By an 8-4 vote, Senate conferees approved an amendment to the financial reform legislation that would treat fixed index annuities as insurance products to be regulated by state insurance officials, thereby essentially nullifying SEC Rule 151A. The amendment was offered by Senator Tom Harkin. Senator Jack Reed opposed the Harkin Amendment, stating that the SEC would be a more effective regulator of these hybrid instruments.A fixed index annuity is a hybrid financial product that combines some of the benefits of fixed annuities with the added earning potential of a security. Like traditional fixed annuities, fixed index annuities are subject to state insurance laws, under which insurance companies must guarantee the same 87.5 percent of purchase payments. Unlike traditional fixed annuities, however, the purchaser’s rate of return is not based upon a guaranteed interest rate.Rule 151A defines indexed annuities as not being exempt annuity contracts under Section 3(a)(8) of the Securities Act. Relying on a series of US Supreme Court rulings, the SEC reasoned that, given the unpredictability of the securities markets, index annuities contain substantial risk that must be addressed by the disclosure regime established by the Securities Act. Last year, a panel of the US Court of Appeals for the District of Columbia ruled that the rulemaking process was flawed by the fact that the SEC’s consideration of the effect of Rule 151A on efficiency, competition, and capital formation, as required by Securities Act Section 2(b), was arbitrary and capricious. American Equity Investment Life Insurance Co. v. SEC, No. 09-1021, CA DofC Circuit.The Harkin Amendment mirrors bi-partisan legislation introduced earlier in the Senate that would nullify the Commission’s adoption of Rule 151A before it has a chance to take effect. The Fixed Indexed Annuities and Insurance Products Classification Act, S. 1389, provides that Rule 151A will have no force or effect. There is a companion bill in the House, HR 2733. The draft legislation expresses a congressional sense that the SEC’s adoption of Rule 151A interferes with state insurance regulation, harms the insurance industry, reduces competition, and creates unnecessary and excessive regulatory burdens.The measure also embodies a congressional finding that indexed insurance and annuity products offered by insurance companies are subject to a wide array of state laws and regulations, including non-forfeiture requirements that provide for minimum guaranteed values, thereby protecting consumers against market swings.
6/23/2010 09:46:00 AM
Specter Amendment Having Last Hurrah
An amendment offered by Rep. Maxine Waters in the House-Senate conference on the financial reform legislation mirrors an amendment offered to the Senate bill by Senator Arlen Spector (D-PA) that would overturn two US Supreme Court opinions and provide a private right of action for aiding and abetting securities fraud. The Waters and Specter amendments essentially mirror the Liability for Aiding and Abetting Securities Violations Act, S. 1551, introduced by Sen. Spector in 2009. The amendments would legislatively overrule what Senator Specter has called ``two errant decisions of the Supreme Court’’, namely the 1994 Central Bank of Denver v. First Interstate Bank ruling and the 2008 ruling in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc. The immunity from suit that Central Bank confers on secondary actors, said the senator, has removed much-needed incentives for them to avoid complicity in and even help prevent securities fraud; and all too often left the victims of fraud uncompensated for their losses.House conferees voted to adopt the Waters Amendment. The Senate rejected the idea of creating a private Rule 10b-5 cause of action against secondary actors in a securities fraud. But the Senate countered with the offer of a mandated GAO study on the costs and benefits of creating a private right of action against aiders and abettors of securities fraud.The Specter Amendment would take the limited, but important, step of amending the Exchange Act to authorize a private right of action under §10(b), the antifraud provision, and other, less commonly invoked, provisions of the Act, against a secondary actor who provides substantial assistance to a person who violates the securities antifraud rule. Any suit brought under the proposed Specter Amendment would be subject to the heightened pleading standards, discovery-stay procedures, and other defendant-protective features of the Private Securities Litigation Reform Act of 1995.Until the Central Bank ruling, noted the senator, every circuit of the Federal Court of Appeals had concluded that §10(b)'s private right of action allowed recovery not only against the person who directly undertook a fraudulent act, the primary violator, but also anyone who aided and abetted the actor. A five-Justice majority in Central Bank narrowed §10(b)'s scope by holding that its private right of action extended only to primary violators.When Congress debated the legislation that became the Private Securities Litigation Reform Act of 1995, then-SEC Chair Arthur Levitt and others urged Congress to overturn Central Bank, said Sen. Specter, but Congress declined to do so. Cong. Record, July 30, 2009, S8564.The PSLRA authorized only the SEC to bring aiding and abetting enforcement litigation. But in the senator’s view, SEC enforcement actions have proved to be no substitute for suits by private plaintiffs. The SEC's litigating resources are too limited for the SEC to bring suit except in a small number of cases, he averred, and even when the SEC does bring suit it cannot recover damages for the victims of fraud.n Stoneridge, the Court ruled that secondary non-speaking actors said to have participated with a company in a securities fraud scheme were not liable in a private action under Rule 10b-5 since the acts of suppliers said to have participated in the fraud were too remote to satisfy the antifraud rule’s reliance requirement.Since the company was free to do as it chose in preparing its books, conferring with its auditor, and issuing its financial statements, reasoned the Court, the investors cannot be said to have relied upon any of the deceptive acts of the suppliers said to have assisted the fraud.Senator Specter said that the Stoneridge opinion made matters still worse for defrauded investors.While Central Bank had at least held open the possibility that secondary actors who themselves undertake fraudulent activities could be held liable as primary violators, he said, Stoneridge largely foreclosed that possibility.In Stoneridge, a divided Court held that §10(b)'s private right of action did not reach two vendors of a cable company that entered into sham transactions with the company knowing that it would publicly report the transactions in order to inflate its stock price. The Court conceded that the suppliers engaged in fraudulent conduct prescribed by §10(b), but held that they were not liable in a private action because only the issuer, not they, communicated the transaction to the public.
6/22/2010 10:24:00 AM
House and Senate conferees have completed a great deal of agreement on the corporate governance provisions of the financial reform legislation, There will be a requirement for a non-binding shareholder advisory vote on executive compensation in the final legislation. But the Senate rejected a shareholder advisory vote for golden parachutes, as was in the House version.However, the Senate did agree to a House provision requiring institutional investment managers to annually disclose how they voted on any shareholder advisory vote on executive compensation unless the vote is otherwise required to be reported publicly by SEC regulations. As of this writing, the conferees had not settled on a final proxy access provisions. Both House and Senate bills authorize the SEC to adopt proxy access rules, but the Senate proposes to add 5 percent ownership and two-year holding period requirements.The legislation will mandate that each member of the board of directors compensation committee be an independent board member. But the legislation specifically exempts registered mutual funds, controlled companies, companies in bankruptcy, limited partnerships and foreign private issuers that provide annual disclosures to shareholders of the reason that they do not have an independent compensation committee.The compensation committee may, in its sole discretion, retain and obtain the advice of a compensation consultant meeting SEC independence standards. The compensation committee will be directly responsible for the consultant’s appointment, compensation and oversight. This oversight cannot be construed to require the compensation committee to implement or follow the consultant’s advice, and cannot otherwise affect the committee’s ability or obligation to exercise its own judgment.The conference struck out a provision requiring the SEC to adopt rules providing that in an uncontested election a director receiving a majority of the votes cast must be deemed to be elected.It is widely acknowledged that a sound corporate governance practice is to bifurcate the roles of board chairman and CEO. Thus, the legislation would direct the SEC to adopt rules requiring a company to disclose in the annual proxy sent to investors the reasons why it has chosen the same person to serve as chairman of the board of directors and chief executive officer or why it has chosen different individuals to serve as board chair and chief executive officer.The legislation directs the SEC to require companies to disclose in their annual proxy statement a clear description of any compensation required to be disclosed under the SEC executive compensation forms and information that shows the relationship between executive compensation and the company’s financial performance, taking into account the change in the value of the shares, dividends and distributions.In addition, the legislation requires the SEC to amend Item 402 of Regulation S-K to mandate disclosure of the median of the annual total compensation of all employees, except the CEO; the annual total compensation of the CEO; and the ratio of the two. The annual total compensation of an employee must be determined by reference to Item 402 of Regulation S-K. This disclosure is required in annual reports and proxy statements, among other filings. The legislation requires public companies to set policies to claw back incentive-based executive compensation if it was based on inaccurate financial statements that don't comply with accounting standards.The SEC is also directed to adopt rules requiring a company to disclose whether any employee or director is permitted to purchase financial instruments, including derivatives such as equity swaps, that are designed to hedge or offset any decrease in the market value of equity securities granted to the employee or director by the company as part of the compensation of the employee or directors or held directly or indirectly by the employee or director.
6/21/2010 05:01:00 PM
SEC Ombudsman and Whistleblower Protection Office Added to Financial Reform Conference Bill
Two new provisions were put into the financial reform conference bill this past week. They were both proposed by the House and accepted by the Senate.SEC Ombudsman: There would be created within the SEC an overall ombudsman. This was proposed by Rep. Scott Garrett, who explained that the ombudsman would ensure that SEC-regulated persons can ask questions without fear of an enforcement action. (House-Senate conference committee meeting, June 16, 2010). Chairman Frank supported it, but said that this provision would have to be harmonized with the Senate provision creating an office of Investor Advocate in the SEC. Indeed, the Senate accepted the proposal, contingent on placing the SEC Ombudsman within the new Office of Investor Advocate. While the legislative language will very likely incorporate much of H 7420, the fact that the Ombudsman will be placed within and harmonized with the Office of Investor Advocate created by Sec 914 of the Senate bill (and base conference bill), as per the Senate’s condition on agreeing with the proposal, the final legislative language will probably be different from H 7420.Office of Whistleblower Protection: The Senate agreed to an amendment proposed by Rep. Ed Royce and Rep. Spencer Bachus, Ranking Member on the Financial Services Committee, that would create an office at the SEC to handle whistleblower provisions in the base conference bill. The Royce-Bachus amendment will improve the stature of whistleblower complaints within the SEC by establishing a separate office within the Commission to better protect whistleblowers and ensure their concerns are being acted upon by the SEC. According to Rep. Bachus, this amendment will ensure that the SEC will have a high ranking official and office to coordinate and pursue the huge volume of whistleblower tips that very well could prevent future frauds like Madoff and Allen Stanford. Complaints from within industry or by investors are the cheapest, most effective way to identify fraudsters, Rep. Bachus said. (House-Senate conference committee meeting, June 16, 2010).
6/19/2010 12:40:00 PM
Senate Conferees May Accept End of Rating Agencies Expert Exemption
At the core of the Securities Act is the idea that a company should provide investors with basic information about the securities it is issuing. It requires issuers to publicly disclose significant information about themselves and terms of the securities. Those who make material misstatements of fact or omissions in a registration statement can be held accountable under Securities Act Section 11. This provision now covers many experts in the financial world, such as accountants, lawyers, investment bankers, directors, officers, and executives of the issuers. However, credit rating agencies are exempt from Section 11 liability by SEC rule.The Senate conferees to the House-Senate conference on the financial reform legislation may agreed to a House provision that would level the playing field by stating that Rule 436(g) will have no force, thereby effectively removing the “expert” exemption for credit ratings included in a registration statement. (Senator Dodd seems to have orally accepted it, but Banking Committee website says rejected). If true, rating agencies will now have greater liability under the securities laws if a rating is included in a registration statement. Rating agencies would be liable for omitting information from a registration statement, putting them on the same level as other experts like accountants, auditors, and lawyers. The provision is intended to make credit rating agencies more accountable for their work by making them liable for misstatements or omissions of fact from a statement.
6/18/2010 11:43:00 AM
Senate Proposes Minimum Ownership Thresholds and Holding Period for Proxy Access
In the House-Senate conference, the Senate has proposed changes in the proxy access provision in the financial reform legislation that would provide for a five percent ownership threshold and two-year holding period for access to management's proxy card to nominate directors. The proposal was authored by Senator Dodd. The current proxy access provision in the legislation authorizes the SEC to implement proxy access, but provides no ownership thresholds or holding periods.By an 8-4 vote, Senate conferees defeated a proposal by Senator Schumer that would have stricken the Dodd proposal. While he can support a holding period requirement, Senator Schumer believes that 5 percent stock ownership is too high a threshold. He explained that proxy access is a check on a company's management. It is an independent check by company shareholders who can exercise a proxy access right. While he can support a threshold, 5 percent is too high. He noted that the SEC has issued proposed proxy access rules that strike a thoughtful balance ensuring that substantial shareholders have proxy access.
6/17/2010 11:27:00 AM
A Senate counteroffer in the House-Senate conference reconciling the two versions of financial reform legislation would amend the Securities Act to address the effects of a 1995 Supreme Court ruling in the Gustafson case that has left investors in private securities offerings without protection from material misstatements or omissions in the security’s prospectus. This was the Levin Amendment in the Senate , SA 3969.In Gustafson v. Alloyd Co., 513 US 561 (1995), the Supreme Court ruled that Section 12(2) of the Securities Act does not extend to a private sale contract, since a contract, and its recitations, that are not held out to the public are not a "prospectus" as the term is used in the 1933 Act.According to Senator Levin, the Gustafson ruling interpreted the securities laws as depriving purchasers in private offerings of the same protections against material misstatements or omissions that apply to public offerings. The amendment would restore Congressional intent and close that loophole. Cong. Record, May 11, 2010, S3530. The amendment would bring investors in private securities offerings under within the scope of Section 12(2) of the Securities Act by amending the definition of prospectus in the 1933 Act.
Senate Agrees to a Number of House Proposals on Financial Reform
At the House-Senate conference commitee yesterday on financial reform legislation, theSenate agreed with the House proposals below and these provisions are now part of the conference billAdd the House provision requiring the SEC to study the need for enhanced examination and enforcement resources for investment advisers. (House § 7107)Amend the Senate whistleblower provision so that the confidentiality provision is more narrow, covering just information that could reasonably be expected to reveal the identity of the whistleblower, not all information provided to the SEC by the whistleblower (Senate § 922)Amend the Senate provision on production of documents by foreign auditing firms to broaden and clarify the type of work that triggers the obligation to produce work papers, and to ensure that foreign firms appoint an agent not only for service of process, but also for SEC document requests. (Senate § 929JAmend the Senate provisions to make clear that recklessness satisfies the intent standard for aiding and abetting liability in SEC enforcement actions under the Securities Act of 1933 and the Investment Company Act. (Senate § 929M).Add the House provision clarifying that recklessness satisfies the intent standard for aiding and abetting liability in SEC enforcement actions under the Securities Exchange Act of 1934. (House § 7215)Amend the Senate provisions to make clear that recklessness satisfies the intent standard for aiding and abetting liability in SEC enforcement actions seeking penalties under the Investment Advisers Act. (Senate § 929N,Add the House provision, as drafted in the Reed amendment, authorizing the SEC to seek civil penalties in cease and desist proceedings against any person, not only registrants. (House § 7211, p. 1317; Reed § 922(b))Add the House provision, as drafted in the Reed amendment, extending the SEC’s enforcement jurisdiction to cover significant steps in furtherance of a violation, even if the securities transactions occur outside the U.S., and to cover foreign conduct that has a foreseeable substantial effect with the U.S. (House § 7216, p. 1332; Reed § 922(d))Add the House provision, as drafted in the Reed amendment, clarifying that control person liability under the Section 20(a) of the Securities Exchange Act applies in SEC enforcement actions, not only in private actions. (House § 7220, p. 7220; Reed § 922(e))Add the House provision, as drafted in the Reed amendment, expanding recordkeeping and examination requirements for custodians who hold property of clients of investment companies or investment advisers. (House § 7106, p. 1287; Reed 993(a))Add the House provision, as drafted in the Reed amendment, giving the SEC authority to adopt rules that would require more timely reporting when a person acquires more than 5% ownership interest in an issuer. (House § 7105, p. 1285; Reed § 995(a))Add the House provision, as drafted in the Reed amendment, extending the fingerprinting requirement to personnel of national securities exchanges and national securities associations. (House § 7403, p. 1350; Reed 995(e))Add the House provision that invalidates any contractual provision requiring persons to waive compliance with any self-regulatory organization rules. (House § 7404)Add the House provision requiring the SEC to complete investigations and examinations within certain time frames, subject to exceptions for complex cases. (House § 7209)Add the House provision increasing the assessments on SIPC members from $150 annually to .02% of the member’s gross revenues derived from the securities business. (House § 7501)Add the House provision increasing penalties for fraud under SIPA from $50,000 to $250,000. (House § 7507)Add the House provision establishing civil and criminal penalties against any person who misrepresents membership in SIPC or who falsely claims that an account is protected under SIPA. (House § 7508)Add the House provision enhancing notice to missing security holders. (House § 7421Add the House provision requiring the SEC to hire a consultant to study the SEC’s operations and the possible need for comprehensive reform of the agency. (House § 7304,)Add the House provision requiring GAO to study issues surrounding employees who leave the SEC and become employed in the securities industry. (House § 7414,)Strike the Senate provision deferring by 180 days the effective date of the PCAOB’s right to assess fees on broker-dealers, to reflect the PCAOB’s calendar fiscal year. (Senate § 982,)Add a provision requiring agency heads, including the Chair of the SEC, to address deficiencies identified in any Inspector General report, or certify to both Houses of Congress that no action is necessary. (House § 3303)
6/17/2010 08:53:00 AM
SEC Self Funding Still Under Debate
After the House agreed to the Senate provision providing that the SEC could become self-funding, Senate conferees had doubts about SEC self-fuding being outside the congressional approproiation process. Senator Richard Shelby proposed an amendment that would give appropriators a role in the process. The amendment was not voted on since Senator Dodd wanted to hear from Senator Schumer on the amendment. Senator Schumer has been a proponent of SEC self-funding.In an earlier statement, Senator Shelby said that the legislation contains a surprising self-funding provision that will give the SEC complete control over the size and allocation of its budget. Let me repeat that, said the Senator, the Democrats are going to give the SEC virtual budget autonomy from Congressional oversight after the SEC dropped the ball in the Madoff and Stanford frauds.
6/17/2010 06:45:00 AM
Senate Conferees Agree to Section 404(b) Exemption for Smaller Companies
After a spirited debate, Senate conferees in the House-Senate conference committee on financial reform legislation agreed by a 7-5 vote to a House provision exempting small issuers (less than $75 million in market capitalization) from the requirements of Sarbanes-Oxley Section 404(b) (House § 7606).Section 404(a) of Sarbanes-Oxley requires that annual reports filed with the SEC must be accompanied by a statement that company management is responsible for creating and maintaining adequate internal controls and a further statement assessing the effectiveness of those controls. Section 404(b) requires the company's outside auditor to report on and attest to management's assessment of the company's internal controls.Senator Dodd spoke against the provision because Section 404(b) protects investors in small and large companies and reduces the opportunity for accounting fraud. The provision could permanently exempt half of the public companies from Section 404(b), noted Sen. Dodd, and these companies are more likely to engage in financial restatements.
House-Senate Conferees Reach Compromise on Franken Amendment
The House-Senate conference on the financial reform legislation has reached a compromise on the Franken Amendment mandating a new SRO within the SEC to randomly assign initial credit ratings for structured products. Under the compromise, the Franken Amendment, codified as Section 939D of the Senate bill , would take effect after an SEC study and report to Congress. The compromise provides that the SEC must implement the Franken Amendment after completion of the study unless the SEC determines that an alternative method would be better for investor protection. According to Senator Dodd, the SEC would have to proceed with the Franken provisions unless it is impossible to implement them and the study reveals a better way to implement this type of reform of the conflict of interest inherent in issuer-pays credit rating agency system. While he generally supports the Franken Amendment, Senator Dodd has consistently had concerns about how these provisions would be practically implemented.Authored by Senator Al Franken, the Amendment would create a Credit Rating Agency Board, a self-regulatory organization, tasked with developing a system in which the Board randomly assigns a credit rating agency to provide a structured product’s initial rating. Requiring an initial credit rating by an agency not of the issuer’s choosing, but randomly selected by the Board, will put a check on the accuracy of ratings and end forum shopping, in the Senator’s view. The provision does not prohibit an issuer from then seeking a second or third or fourth rating from an agency of their choosing. The provision leaves flexibility to the Board to determine the assignment process. Thus, the new Board gets to design the assignment process it sees fit, which can be random or based on a formula, just as long as the issuer doesn’t get to choose its initial rating agency. This should eliminate the current incentive for a rating agency to give an inflated rating in the hope of getting repeat business. Cong. Record, May 10, 2010, S3465.
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