Securities Compliance Sentinel - Analysis of Cutting Edge Securities Industry Issues

The SEC’s Office of Compliance Inspections and Examinations announced that it will increase their examinations of newly registered private fund advisers starting this summer. 

These examinations are being done in conjunction with those hedge fund and private equity advisers previously registered with the Commission as a result of the Dodd-Frank Act.  The SEC Staff made it abundantly clear that these newly registered advisers will be examined, pursuant to a set of risk factors and not by the traditional OCIE exam cycle.  The OCIE Staff will also look at the level of risk and determine the number of times new registrants will be examined in the future.  For this determination, the SEC Staff will look at past regulatory or legal violations; aberrational performance; the size of the fund determines the risk; the advisors complexity; problems internally; when the last exam occurred; and significant changes and assets for business.  Nonetheless, the SEC Staff cautioned that they will look at both quality and quantity factors, and that these risk factors are very similar to those already in place for previous registrants. 

In short, OCIE intends to utilize risk based assessment examinations in the future.

OCIE is intending to review newly registered hedge and private equity fund advisers by focusing in on certain priorities.

In particular, OCIE will review due diligence practices; fraud indicators; unknown service providers; problem custody arrangements; insider trading and front running issues; and preferential treatment to determine if there are conflicts of interest.  OCIE also intends to take a global approach and not look at any one particular issue.  OCIE's focus will, most certainly, focus in on complex entities with high frequency trading.  Such a review will include an SEC staff examination of fund governance; compliance, audit and management functions; protection of assets; and the transmission of performance data and advertising. 

These principals will guide the OCIE staff in conducting examinations along with the new OCIE examination manual. 

Congressman Bachus (R-Ala.) introduced a bill that would shift the oversight of registered investment advisers from the SEC to a self-regulatory organization that would report to the SEC.  This development represents the crystallization of one of the fears emanating out of Dodd-Frank, which mandated that the SEC study how to tighten oversight over RIAs.

Advisers fear that an SRO will be more expensive than the SEC and would lack the experience to address the fiduciary duty standard that governs RIAs.  Conversely, FINRA has long lobbied for it to become the SRO for RIAs, noting its long-standing oversight of broker-dealers.  FINRA's track-record with broker-dealers suggests that it is well-positioned to become the SRO for RIAs.  From the public's perspective, something has to be done because, under the current system, RIAs are examined less than once every 11 years, a point on which Bachus has focused.  The SEC has at least tacitly endorsed the role of an SRO over RIAs because of the SEC' budget limitations to do the job itself.

The timing of this bill does not endear it to short term success.  In an election year, many may not want to rock the boat to push this bill along.  In other words, the bill just may not have the political juice to become reality.  Nevertheless, at some point there will surely be an SRO for RIAs, either FINRA, a better funded SEC, or, less likely, a brand new agency.  Time will tell, but we are probably looking at another year of this debate before there is an SRO for RIAs.

There was plenty of debate when the SEC adopted its new whistle blower bounty program.  Many commentators thought that the program would result in an onslaught of whistle blowers directly reporting to the SEC instead of first contacting the subject corporation.  The Quarterly Fraud Index reported, however, that the opposite may actually be taking place.  The new program appears to have caused many corporations to improve their internal reporting mechanisms.  If this effort continues, the fear of a mad rush to the SEC may have been irrational.

Among other things, the study found that the concern over the implementation of the program caused many companies to revamp their internal reporting policies and procedures.  By re-focusing on these internal reporting programs, the corporate world has also seen an increase of internal fraud reporting, as opposed to an influx of reports to the SEC.  Another positive result out of the whistle blower program is organizations implementing predetermined investigative templates and procedures, which will allow companies to act much quicker within the 90-day window in which a whistle blower can secure his standing with the SEC.   Along these lines, many companies have predetermined arrangements with third-party providers, such as law firms and auditors, to avoid any time lag once they receive a report of fraud.

If these corporate reforms continue, I believe that companies will be able to steer fraud reporting to an internal platform and not be as exposed to the SEC whistle blower program as originally feared.  The SEC whistle blower program has to be lauded to the extent that it was the impetus of corporate reform, but further study is needed to determine if the reporting ends with an internal report or continues to actual reporting to the SEC.  Only then can we say that the SEC's whistler blower program resulted in wide-spread corporate reform

The SEC issued an alert intending that firms detect and prevent unauthorized trading in brokerage and advisory accounts. 

This release related to certain risks the SEC’s Office of Compliance Inspections and Examinations found in its investigations and examinations.  OCIE had reports of unauthorized trades and rogue trading by traders, portfolio managers, brokers and others.  The SEC warned firms that they must take action to ensure that such trading does not occur in the future.

Accordingly, firms must be cognizant that the SEC is looking at these issues, and will bring actions if need be.

Recently, the SEC announced that it would take steps to bar felons and bad actors from any Regulation D offering. 

This rule was mandated by the Dodd-Frank Act, and the SEC issued the proposal last May 2011.  This new rule may be in place before the end of this year, but there is no certainty on timing at this point.  This new rule is part of an overall effort by the SEC to attempt to remove bad actors from early stage offerings since these offerings usually involve raising capital for small companies.

In late February, a judge from the United States District Court for the Southern District of New York approved a settlement where a former executive and analyst cooperated with the SEC in a widespread insider trading investigation. 

The SEC agreed that, given the cooperation, there was no need to impose a small penalty.  As such, these employees, who provided substantive information on expert networking firms to the SEC, were, therefore, rewarded.

It appears that the SEC is following through on its promise to allow for cooperation to be a benchmark in avoiding certain penalties.

Much has happened in nearly one since since the Dodd-Frank Act became effective, and much more remains.  According to the recent thoughts of one commentator, Kyle Colona of Compliance EX, Dodd-Frank may be doomed to fail as it faces it first year of existence.

Colona noted five factors working against the full implementation of the law: (1) the CFTC and SEC are far behind schedule; (2) the regulatory authority under the Act is shared by too many entities; (3) recent comments from the Federal Reserve Bank suggest that the Volcker Rule may not become law because of its impossibility to implement; (4) the financial services industry has unleashed a full-scale effort to defeat the full implementation of the Act; and (5) certain banks are trying to influence the public that implementation of the Volcker Rule would be bad.

I think that there is now a sixth factor that may work against the full implementation of the Dodd-Frank Act; namely, a presidential election this fall.  With the politicalclimate becoming more and more focused on the election, it is only natural that there would be less attention devoted to a law that the financial services industry is committed to pealing back or doing away with altogether.  If the President loses the election, there are some who believe that Dodd-Frank may be in trouble.  Even if the President prevails, it is unlikely that there will be full implementation because attention will surely be focused elsewhere.

Although it is unlikely that there may ever be full implementation of the Act, we need to still anticipate that many provisions of the Act will come to pass.  For example, at some point, the SEC will finally commit to the adoption of the uniform fiduciary duty rule and there will be a decision on who will serve as the SRO for investment advisors.  Dodd-Frank is not dead; it just may limp along for the next year.

Last week, I wrote about the Crowdfunding portion of the JOBS (Jumpstart Our Business Startups) Act, which was.  This week, I will try to review the rest of the Act in a series of posts.  Today: an overview and Title V (Private Company Flexibility and Growth).  Tomorrow, I’ll cover Titles II and IV, which give Regulations A and D makeovers, making Reg D more appealing to private issuers and making Reg A appealing for the first time, kinda like those teen movies where the nerdy girl takes off her glasses and lets down her hair and BAM she’s drop-dead gorgeous.  Only with securities law.  After that, I’ll finish with Title I, which gives “Emerging Growth Companies” a break on some of the ’34 Act’s reporting requirements.

The JOBS Act, despite its clever title, is not actually about jobs.  It’s a bill about capital markets.  I acknowledge that more efficient capital markets lead to more effective use of capital and eventually to more employment.  But that’s a bit too indirect to be able to say with a straight face that the Act is designed to boost payrolls; when I tip the UArts student serving me at Starbucks, I don’t get to call myself a patron of the arts. 

So, that being said, the question about the JOBS Act isn’t whether it will create new jobs. The question is whether it will improve capital markets by removing needlessly cumbersome regulations and lead to the optimal allocation of capital, or whether it will cry havoc and unleash the dogs of warrantless deregulation upon the unwitting masses of potential fraud victims.  (I’m pretty sure these are the only two options, judging by the rhetoric of the bill’s supporters and detractors.)

As a sub-goal, the JOBS Act is designed to address the decline in IPOs over the past decade, which many blame on Sarbanes-Oxley’s (SOX) more onerous auditing and reporting requirements.  (Then again, the US had more IPOs than any other country, so maybe it’s a problem with IPOs generally, not American regulations on them.)  More American-based IPOs means, in theory, more SEC-required disclosures.  More disclosures means more information available for the market, which will mean more optimal pricing.  And that’s a good thing.

Unfortunately, I don’t see how the JOBS act will increase the number of IPOs.  If anything, I think this Act will be a death knell for smaller IPOs, and Title V (Private Company Flexibility and Growth) will be to blame. 

First off, a bill purporting to promote initial public offerings probably shouldn’t have a provision entitled “Private Company Flexibility and Growth”.  Title V increases the number of record holders a company may have before it must go public from 500 to 2000.  Before, only 35 of those 500 could be “non-accredited investors”, but now 500 of the 2000 can be non-accredited. (An accredited investor is basically someone with so much money that the SEC assumes they know what they are doing, so they don’t need as much protection in the form of disclosures.)  On top of all that: employees who receive stock under a stock plan won't count towards the total.  That would include former employees who left with their stock.  The takeaway: private companies will be able to stay private longer.

One of the reasons why Facebook is going public is because they are pressed up against that 500 person limit.  On top of that, there are enough current Facebook shareholders - employees and investors - who want to cash out (Mark Zuckerberg said as much in his letter to potential shareholders), but they have a pretty illiquid and limited market.  By increasing the threshold to 2000, both of these issues are ameliorated: another 1,500 potential investors not just pushes the go-public threshold back, it also adds a lot of liquidity in the form of a deeper pool of investors.  And that 1,500 figure is probably a lot higher, given that individuals who received shares purusant to employee stock plans won't count towards the threshold.  That small provision, alone, might have been enough to keep Facebook private.

At this point, a quick tangential aside about private v. public is in order.  Going public means more regulations, stricter audits, more potential for lawsuits, and giving up some company secrets.  It’s not a terribly appealing process for a company, and it can cost quite a bit of cash.  Old corporate finance theory taught that companies go public to gain access to the capital needed to grow.  But that’s bunk.  A successful private company will have no trouble financing its expansion using debt.  Let’s consider Facebook again: would you give them a loan?  I know I would.  And so would pretty much any bank out there.  Facebook doesn’t need more investors in order for it to grow.  Moreover, there are tax benefits to taking on debt instead of issuing equity: a company can deduct interest payments from its income.  On top of that, higher leverage means greater return on equity, and fewer shareholders means fewer people you need to split the profits with. Many companies only go public because they simply get too big (in terms of shareholders) to stay private.  The JOBS Act makes it a lot easier to hold out longer now. 

Like the rest of the JOBS Act, Title V is less about creating jobs and more about making it cheaper and easier for companies to raise money.  Cheaper and easier might sound good, but it doesn’t come free.  Cheaper and easier means less disclosure and less public information, and that leads to misallocated capital.  So while cheaper and easier means more deserving companies will be able to raise funds, it also means that more awful companies and fraudsters will be able to raise funds, too. 

The House passed the JOBS (Jumpstart Our Business Startups) Act today, a package bill aimed to make it easier for small businesses and start ups to raise capital.  This is obviously a momentous occasion, right?

Not quite.  As it turns out, the House has already passed most (4 out of 6) of the provisions of this bill in separate bills, including the Crowdfunding Act that I've been crowing about since October.  All those bills sailed through the House with ease only to disappear in the Bermuda Triangle that is the Senate.

The JOBS Act will loosen some of the Securities Act regulations, meaning it would be easier for small and mid-cap companies to "ramp up" capital formation on their way to a full and proper IPO.  All neat stuff worthy of serious debate and consideration, and maybe even a vote if we're lucky.   

The House passed the JOBS act 390-23 (apparently there are 23 Representatives who HATE JOBS).  The White House fully supports it.  So what's the hold up?

That "cooling saucer" we call the Senate, that's what.  At this point, legislative milk is turning into ice cream.  Senate Leader Harry Reid has no apparent interest in passing this bill, and he risks a political debacle if he doesn't get his act together (see: the previous paragraph).  I'm not saying that there aren't any legitimate concerns about the impact this act would have on securities market and the potential for fraud - there are.  And certainly the SEC is too preoccupied with Dodd-Frank implementation to swiftly promulgate regulations to gap fill the would-be statute.  And don't get me wrong: this is obviously a bit of political grandstanding by the GOP (any time someone passes a bill they already passes, you can be assured politics, not policy, is the driver). 

But, C'MON already. This week alone, I've worked with some partners here at Fox as they've found devilishly clever ways to help startup clients find (and negotiate with) VC and angel investors.  My experience helping these hardworking and bright entrepreneurs fight to find investment has certainly made me more sympathetic to their struggle.

Post Blog Post Note:  Then again, maybe not.  The Economist this week also ran an two interesting pieces on why our small business fetish may be holding us back, and how programs designed to help small businesses may retard their incentives for growth.  Check them out here and here.

The SEC published a small entity compliance guide for investment advisers relating to the new Form PF.  These new reporting requirements affect SEC registered investment advisers with at least $150 million dollars in assets under management.  Some of these new guidelines will also apply to CFTC commodity pool operators and commodity trading advisers.

The SEC registered advisers will be divided into 2 groups, small advisors and large advisers.  The definitional requirements for large advisers are specific and may require certain calculations, however.  Clearly, large advisers have assets under control of anywhere between a billion dollars and more.  For the purposes of the Form PF, all other advisers would be considered small private advisers.

Generally, an investment adviser is a small business pursuant to the Investment Advisers Act and the Regulatory Flexibility Act if it has assets under management of less than $25 million dollars.  As such, these advisers will, generally, have no reporting requirements on a Form PF.  However, for those advisers, who are not defined as a small business, there may be certain reporting requirements.  For example, advisers with over $150 million dollars in private fund assets under management, but are not large advisors must file a Form PF once a year within 120 days at the end of the fiscal year.  Large private advisers must file a Form PF within 60 days.  Moreover, the requirements for advisers with over $150 million dollars, but who are not large advisers, are less than those of large private fund advisers.  Essentially, the more money you have under management, the more information you must provide.

In short, advisers should consult with securities counsel to ensure accurate reporting in the future.

The SEC approved a number of rule changes promulgated by the MSRB to facilitate risk-based examinations for participants in the municipal securities industry.  These municipal securities industry participants are, generally, FINRA members. 

In particular, the new rules, G-9 and G-16, relate to record preservation and periodic examinations, respectively.  It is believed that these new rules will allow FINRA to focus on the municipal securities industry participants who pose the greatest risk to the market.  FINRA will now be allowed to examine these participants every four years as well as require that certain records be maintained for four years rather than three. 

The new periodic examinations were immediately effective while the changes to record keeping are effective June 16, 2012.

Although the SEC’s rulemaking deferral regarding the uniform fiduciary standard has gained much press, the SEC's other rulemaking initiatives pursuant to the Dodd-Frank Act march on, and will have a significant effect on broker dealers and investment advisors in the upcoming year.

In particular, the SEC has scheduled a joint SEC-CFTC report to Congress on stable value contracts, and the adoption of rules pertaining to trade reporting, data elements and real time public reporting for security-based swaps.  Further, the SEC and CFTC will define key terms for swap products and intermediaries as well as security-based swap clearing agencies.  The SEC will also look to register and regulate security swap based data repositories and for mandatory clearing of security-based swaps.  Additionally, the SEC will look at the end user exceptions for the mandatory clearing of security-based swaps. 

The SEC will also consider a permanent rule to register municipal advisors this year.  However, certain controversial rules relating to conflict materials rule finalization and resource extraction disclosures as well as corporate governance rules relating to executive compensation claw backs, performance disclosure pay, compensation ratio and hedging policies have been pushed forward to the first part of this year.  Moreover, the SEC still has not set up certain offices that the Dodd-Frank Act required including, but not limited to, the credit ratings and municipal securities oversight function offices.  Currently, the SEC believes these functions are being performed by its Division of Trading and Market's Staff. 

In sum, the SEC’s Dodd-Frank Act rule making is still ongoing and will continue as it moves forward.

The SEC's delay in adopting an uniform fiduciary duty will only be prolonged but yet another analysis that the SEC will commission.  Chairman Schapiro recently announced plans to issue a public request for information regarding "retail financial advice and the regulatory alternatives".  With respect to the adoption of the uniform fiduciary duty standard, the SEC suggested that it was still in the information gathering stage of rule-making.  Interpretation; the SEC is no closer to adopting a uniform fiduciary duty standard.  Although the SEC has not ruled rule-making for 2012, it is not likely.

The SEC has advised the House Financial Services CapitalMarkets subcommittee that it has three economists working on the initiative.  Among other things, the economists have reviewed available market information for the retail financial advice market, including the differences between broker-dealers and registered investments advisers.  Notwithstanding the work of the economists to date, the SEC noted that the rule-making associated with the uniform fiduciary duty will require an analysis of information that may not be publicly available such that it will be particularly important for the SEC to solicit the public to provide information and/or empirical data.

Of the information that the SEC will seek in its public request for information, broker-dealers should expect that some of the data sought will cover a cost-benefit analysis of whether the adoption of a uniform standard will outweigh the cost of doing so.  Although delayed, the SEC is, it appears, trying to have a full and complete analysis to ultimately justify a uniform fiduciary duty.  In light of the manner in which many courts and arbitration panels treat broker-dealers, this whole exercise could be seen as making something "official" that has already been in place for many years.  The question that remains is whether the cost to make the standard an "official" one is worth it considering the prevailing view of many that it may already exist.

Among other criticism lodged against the SEC was its inability to conduct routine examinations of investments advisors beyond a small sampling in any given year.  Dodd-Frank required an analysis of whether investments advisors should have their own self-regulatory organization to conduct some examinations because the SEC lacked the resources to comprehensively examine them.  Three options are being considered; (1) provide additional funding to the SEC; (2) give the responsibility to FINRA; or (3) create a new SRO.

A recent study by the Boston Consulting Group has found that it would cost investment advisors twice as much money to pay an SRO than it would to properly fund the SEC.  In a related study, BCG found that the overwhelming majority of investment advisors surveyed preferred to have continued SEC oversight than have FINRA act as their SRO regardless if it cost more to properly fund the SEC.  Investment advisors even preferred the creation of a new SRO over giving oversight responsibility to FINRA.

The key take away from this study is economics.  In this age where the public is clamoring for more oversight, the least expensive avenue to pursue that oversight is to have the SEC funded in a manner that would allow it to conduct more meaningful examinations across a greater sector of investment advisors.  Plus, this course avoids the unnecessary overlap, bureaucracy and increased costs if FINRA's jurisdiction is expanded to include investment advisors.  Where money talks, investment advisors should expect that the SEC will maintain oversight over you.  But do not expect the status quo; you should expect increased funding and a dramatic increase in examinations over a greater segment of investment advisors.  In the end, the devil you know is better than the devil you do not know.

The SEC adopted a rule requiring hedge fund and private equity fund advisors to report systemic risk data.  The new Form PF was jointly developed by the SEC and the CFTC in consultation with members of the Financial Stability Oversight Council, to satisfy Dodd Frank Act Sections 404 and 406. 

In particular, for hedge, private equity, and liquidity funds, the information required on the Form PF is tiered so that detailed information will be required from larger private advisors as opposed to smaller ones.  The minimum reporting requirement will be for those funds with $150 million dollars of assets under management, and smaller private fund advisors will not be required to file the form at all.  Further, there will be additional information required of those advisors managing at least $1.5 billion dollars.  According to the SEC, this requirement will only effect approximately 230 advisors in the United States.  Many of these advisors will have 60 days from the end of the quarter to prepare this information while smaller advisors will have 120 days to file such information.  For the largest advisors, filings must begin by June 15, 2012, while all others must file after December 15, 2012.

Of course, there is no certainty that this information will be effectively used to assess risk, or that there will be any benefit from these filings.

Responding to numerous complaints, especially, regarding companies operating from the People’s Republic of China, the SEC has determined that it will tighten the listing requirements for companies involved in reverse mergers.  In particular, these new regulations will effect those companies listed on the Nasdaq, New York Stock Exchange, and the NYSE Amex. 

As many know, a reverse merger occurs when a shell company is acquired by a private company, and the two entities merge.  The SEC has estimated that since 2007, more than 600 of these “back door registrations” have occurred. 

The SEC had determined that obtaining reliable information from these types of entities, has not been easy.  In fact, the SEC was forced to suspend trading in many of these reverse merger companies since there was outdated or inaccurate financial information.  It is believed that, with these heightened requirements and the necessity to file the information prior to these companies becoming listed, the SEC will provide greater protections to investors. 

Now, with the new listing rules, these companies will have to endure a one year trading period in the over the counter market, or other U.S. or foreign regulated exchange after the reverse merger.  These companies will also have to provide additional financial and other records to the SEC prior to listing.  Further, the company will be required to keep a minimum share price for a period of time of at least 60 trading days before its application and listing are approved.  However, certain companies will be exempt from the new rules where the reverse merger companies are listing as part of a firm commitment underwriting, public offering or whose mergers occurred previously and where the company has already filed annual reports with audited financial information.

In sum, the SEC is cracking down on these reverse merger companies because it believes the companies are fraught with fraud.  Those wishing to conduct these types of transactions should be advised accordingly.

The SEC released two new rules yesterday: one on mine safety (I wonder how many securities lawyers have ever set foot in a mine) and the other changing the net worth standard for accredited investors.  Both new rules come to us courtesy of Dodd-Frank. 

Because mine safety disclosure isn't really my forte, I'll focus on accredited investors.  Under the new rule, set to become effective in February, individuals will no longer be able to include the value of their primary residency as an asset in the calculation of net wealth for accredited investor status.  So pay heed, all you issuers hoping to avoid registration purusant to Reg D of the '33 Act!  That guy who spends everything trying to make his house the best on the block?  Instead of being an "accredited investor", he might be just "that guy with the really gaudy house."  On the flipside, the rule no longer treats your mortgage as a liability either (with a few exceptions), so the net impact of the change will be diluted in many instances.

And there are, of course, other ways an individual can qualify as an accredited investor (earning over $200,000 a year, for example), so this shouldn't hurt Reg D offerings much, but it's definitely something to watch out for. 

It’s December, so its time for the usual blizzard of End-of-the-Year lists, reviews, recaps and predictions.  Since I was already digging through a heap of these on corporate law, I figured I would save you the trouble of doing the same.  So here it is, your corporate governance Review and Preview Review, highlighting the major regulatory themes of 2011 and expectations for 2012.

2011 Review

Say-on-Pay (SOP): This was the inaugural year for Section 951 of the Dodd-Frank Act, which requires public companies to hold advisory shareholder votes on named-executive compensation practices.  Already, it’s had a major impact on the relationship between pay and performance, leading many compensation committees to reduce the amount of non-performance-based pay, increase shareholder alignment and increase disclosure in the Compensation Discussion and Analysis required in proxy statements. 

In 2011, over 40 companies received negative say-on-pay advisory votes.  That sounds bad, until you realize that this is less than 2% of companies holding a SOP vote.  That said, 10 of these 44 companies have be subsequently struck with shareholder derivative suits, leading some to believe that negative votes lead to lawsuits.    Personally, I wonder if this is more correlation than causation, but it’s a trend to watch out for regardless.  Still, the average SOP vote received 92.1% approval. 

According to ISS, the major contributory factor to a negative vote was pay-for-performance concerns.  Basically, a combination of higher pay but lower performance compared to peer firms caused shareholders to express their displeasure.   

Anti-Anti-Takeover: “Among governance proposals, the biggest story of this year was the greater support for shareholder proposals that seek board declassification. These resolutions averaged 73.5% support, up more than 12% from 2010, and won majority support at 22 out of 23 large-cap firms.”  Moreover, shareholders and proxy advisors both fought to remove poison pills – according to a Conference Board survey, now only 20% of companies have a shareholders rights plan in place. 

2012 Preview

Say-On-Pay: Laurel Hill’s Francis Byrd wants compensation committees to “prepare with a similar level of intensity as last year” noting that institutional investors revise their voting guidelines annually.  He's right, they do, and have: the Glass Lewis Proxy Season Preview warns “absent evidence that a board is actively engaging shareholders on [say-on-pay votes] and responding accordingly, we will recommend holding compensation committee members accountable.”  The ISS 2012 Policy Update goes into gross detail on how exactly it will determine whether an executive is getting paid too much.  Tax gross seem to be in the crosshairs of many governance advocates this year.

Clawbacks: §954 of Dodd-Frank will lead to a clawback requirement for companies listed on the national securities exchanges.  Listed companies need to develop and implement a policy providing for the clawback of a named-executive officer’s incentive-based compensation awarded during a 3-year period preceding an accounting restatement.  954 overlaps somewhat with SOX 304, but unlike SOX it does not require misconduct and only claws back the “extra” compensation erroneously awarded, rather than everything. 

Clawbacks will be one of the hardest of Dodd-Frank’s governance provisions to implement, and it intends on tackling it sometime during the first half of 2012.  Some companies have already begun to update their previous clawback policies in expectation for this change, but many compensation committees still need to address this issue in the coming year. 

Anti-Management Entrenchment: Activist Shareholders and hedge funds will continue the fight to remove poison pills and declassify boards. 

Proxy Access: SEC revisions to Rule 14a-8 came into effect in September, and a few activist investors have already filed proposals.  Expect more of these in 2012.  Both Glass Lewis and ISS say they will review these proposals on a case by case basis. 

Environmental and Social Issues: We can expect continued fallout from the Supreme Court’s Citizen United decision.  Already, a collection of big names in the academic world – the folks who wrote everyone’s Sec Reg book, basically –  has petitioned the SEC for a rulemaking to require corporations to disclose spending on political activity.  Laurel Hill notes that public pension funds and labor-related pension funds are looking to make more proposals this year.  Glass Lewis will vote in favor of proposals requiring more disclosure. ISS is changing its policy from case-by-case to generally being in favor of these proposals. 

The Dodd-Frank Act required that security based swap dealers or major security based swap participants to register with the SEC.  These swap based entities are required to register with the SEC while all others are under the jurisdiction of the CFTC. 

The SEC proposed rules requiring these entities to register electronically with the SEC on a Form SBSE, similar to the Form BD for broker-dealer registration.  CFTC swap entities register using the shorter Form SBSE-A.  Additionally, the SEC will require that these forms be updated promptly if there are any inaccuracies.  There will also be something new according to one SEC Commissioner.  The rules may require a knowledgeable senior officer to provide a certification as to the firm’s financial, operational and compliance capabilities.  This person will also have to disclose how the firm arrived at those conclusions.  Further, non-U.S. swap entities will have to identify a U.S. Agent, and submit an opinion of counsel that the SEC will be able to access its books and records, as well as a requirement to submit to an on-site inspection. 

The swap dealer registration proposal will be open for a 60 day comment period, and all are encouraged to consider commenting.

My colleague, Josh Horn, has written an amazing article that should be on every compliance officer’s desk.  It details methods for investigating and responding to ponzi schemes. 

In this day and age, we are met with another Ponzi scheme occurring or being uncovered almost every day.  Josh’s article is an exceptional primer since it details the steps for a proper investigation, as well as, disseminating the investigation results to the appropriate authorities.  Further, Josh lays out an approach to avoid litigation, and, if litigation does strike, responding to it.  This article appeared in the September – October 2011 Special Edition for the National Society of Compliance Professionals, in its publication, N.S.C.P. Currents, and may be viewed at www.foxrothschild.com/newspub/newspubArticle. aspx?id=4294970030.

I hope everyone considers it.

The House Financial Services Committee tweaked H.R. 2930 in markup last week, gaining Democratic support in the process.  The "Entrepreneur Access to Capital Act", aka the Crowdfunding Act, was passed on to the full House by a voice vote.  This suggests at least a modicum of bipartisan support, a rare sight in the 112th Congress. 

The amended bill allows issuers to generally solicit up to $1 million (or $2 million if they provide investors accredited financial statements) from small investors without triggering registration requirements.  That's less than the $5 million in Rep. McHenry's original bill, but still a lot more than the $0 companies can currently raise through general solicitation.  The amended version also requires providing the SEC some extremely basic information: the issuer's name, address, website and what it plans on doing with the money it raises.  These amendments seem to have appeased Democratic lawmakers who were concerned about the possibility of shysters preying on the naiveté of small retail investors. 

The bill goes down the floor of the House for a vote later this week.  Unless political intransigence rears its ugly head, the bill should sail through the House with nothing but self-congratulatory speeches on bipartisanship slowing it down.  And then, with any luck, we will see a Senate version start making its way through that august hall's byzantine cooridors sometime in the near future. 

The SEC recently joined the FDIC, the OCC and the Federal Reserve in advancing the Volcker Rule for public comment.  The Volcker Rule is shaping up to be one of Dodd-Frank’s most contentious and confusing new regulations.

Volcker Rule proponents hope that it will, like the late-great Glass-Steagal Act before it, rein in risk-relishing bankers by prohibiting short-term proprietary trading of securities.  Opponents fear it will be overly broad, capturing market-making activities and needlessly raising the cost of capital.  Both want big changes, clouding any predictions on what the final version will look like. 

So, basically, Wall Street has a few months to respond to a 298-page rule proposal jointly issued by four Federal regulators that asks nearly 400 questions which could cost millions of dollars.  Hence the impression some folks get that the only thing certain about the Volcker Rule is the uncertainty surrounding it.  Some analysts seem terrified of this zombie regulation – once dead, now crawling out of the grave with a sickly hunger for brains profits.         

Then again, this resurrected rule might not be so scary.  Stock prices of the major US financial institutions that will fall under its purview remained steady despite the announcement.  The Volcker Rule really is just the watered-down second coming of the law from 1933 until 1999.  The uncertainty of the law is really only found around its margins – trying to determine exactly where market-making ends and proprietary trading begins.  In other words, the devil – that scary boogieman, uncertainty – remains in the details. 

Sure, it seems like everyone is unhappy with the proposal, which took over a year to draft but only minutes to attract detractors.  It has either too many exemptions or too few, depending on who you ask.  But I’ve found that when two groups that never seem to agree on anything suddenly agree on something, you should take that something and do the exact opposite.  A rule that upsets everyone for different reasons tends to be one that is moderate, sensible and likely to have a real and lasting impact.   

In the mean time, we will follow the developments closely.  Histrionics about how awful/amazing the finalized rule will look aside, it will be one of the more arcane of Dodd-Frank's new regulations.  Anyone falling under its penumbra would do well to tread cautiously and with counsel.

Reuters recently reported that the SEC and FINRA were asking trading firms specific details regarding their trading strategies and/or their secret computer codes. 

This new effort by the SEC and FINRA is part of a joint investigation into suspicious market activity as well as to examine compliance with securities regulations.  The specific requests relating to computer code, obviously, have irked many in the industry since the requests have to do with targeting stock trading firms and hedge funds.  These inquiries relate to trading information and computer coding information that may have been shared or “borrowed” with others, and used for illegal activity.  Clearly, the SEC and FINRA are focusing on this information to better understand the trading markets, but, of course, if they find anything of an illegal nature, it may result in enforcement examinations.

FINRA executives, recently, told a SIFMA conference that FINRA did not make these requests “lightly.”  However, this worries many since the information is privileged and proprietary, and may find its hands into competitors.  Although, the SEC and FINRA both have policies in place to protect such information, once the information is out, companies may find themselves in a predicament.  Counsel should certainly handle these particular issues.

In an interesting speech, SEC Chairman Mary Shapiro stated that she believes securities violations are often the result of peer pressure and not individual greed. 

Chairman Shapiro was referring to the recent guilty verdicts in the Galleon insider trading matter, as well as numerous other insider trading convictions.  Chairman Shapiro seemed to suggest that individuals are engaging in insider trading to “return a favor,” or enhance their reputations in their businesses.  Further, she claims that the penultimate approach to performance is a motivating factor for many, and the old adage that “everybody was doing it” is a driving force.

Although Chairman Shapiro seems to sincerely believe her words, this may be an overly simplistic approach to insider trading.  Many individuals, who have been convicted, earned large sums of money, and it is unlikely that they were solely motivated to increase their reputational standing or that they were returning favors to friends.  At the very least -- or to be as generous as possible to Chairman Shapiro -- peer pressure may play some part, but the overwhelming evidence seems to suggest that the pursuit of money plays a much larger role in insider trading.

In January 2001, the Securities and Exchange Commission (“SEC”) recommended the implementation of a uniform fiduciary duty standard for broker-dealers and registered investment advisors. Significant debate has followed regarding the potential parameters and scope of such a duty. Recently, the Securities Industry and Financial Markets Association (“SIFMA”), a lobbying group for large broker-dealers, proposed a framework for a uniform fiduciary duty.

Although SIFMA reiterated its support for such a standard, it also recommended against applying the fiduciary duty found in the Investment Adviser Act of 1940 to broker-dealers, stating that it would adversely impact “choice, product access and affordability of customer services”. Among other things, SIFMA proposed a new fiduciary duty for broker-dealers to accommodate broker-dealer conduct that would otherwise be in violation of the 40 Act.

In doing so, SIFMA recommended that, in its rulemaking, the SEC “provide the necessary rule-based guidance regarding when the fiduciary duty begins and ends and what disclosures and consents, if any, are necessary to satisfy the duty where a broker-dealer gives “advice involving principal trading, structured products, hybrid accounts, complex investment strategies, concentrated positions, and receipt of commissions and differential loads for different products.” To implement this standard, SIFMA proposed that it be articulated in the initial customer agreement. SIFMA also recommended that the fiduciary duty apply on an account-by-account basis.

By implementing a new fiduciary duty standard unique to broker-dealers, SIFMA believes that the SEC will properly take into account the distinctions in the law between registered investment advisers and broker-dealers while taking customer service into account. It remains to be seen if SEC heeds this call to action, or if the SEC simply rubbers stamps the 40 Act fiduciary duty standard to broker dealers.