10b5-1 Trading Plans Continue to Draw Attention

As we previously discussed, executives’ trading under Rule 10b5-1 plans has been the focus of SEC scrutiny.  The Wall Street Journal continues to publish articles casting 10b5-1 trading plans in a harsh light, and the SEC is continuing its aggressive pursuit of those illegal insider trading.  Recently, the Council of Institutional Investors wrote to the SEC to reiterate the requests made in its December 28, 2012 letter asking the SEC to consider various changes to Rule 10b5-1 or the issuance of interpretive guidance “to address the variety and number of abuses that have been identified” with respect to 10b5-1 trading plans. 

The SEC has a lot on its plate at the moment and the SEC may not address the perceived abuses or misuses of 10b5-1 trading plans any time soon.  Nonetheless, public company boards should consider reviewing their policies regarding 10b5-1 trading plans to be sure the policies are up to date and adequately address the needs of the company’s officers and directors as well as investors’ concerns.  For more on what to consider when reviewing your 10b5-1 trading plans, please see our December 2012/January 2013 issue of Up to Date.

SEC Adopts New Rules Addressing Identity Theft

Not long after being sworn in as the new Chairman of the Securities and Exchange Commission, Mary Jo White presided over her first open SEC meeting on April 10, 2013.  At that meeting, the SEC adopted rules requiring certain businesses regulated by the SEC to adopt and implement programs to detect and respond to indicators of possible identity theft.  The rules were adopted jointly by the SEC and the Commodity Futures Trading Commission (CFTC), but they aren’t exactly new.

In 2003, Congress amended the Fair Credit Reporting Act (FCRA) to require certain federal agencies to issue joint rules and guidelines on detecting, preventing and mitigating identity theft.  At that time, the FCRA did not require the SEC or the CFTC  to adopt such rules.  However, the FCRA gave the Federal Trade Commission (FTC) the authority to adopt and enforce identity theft rules related to entities regulated by the SEC and CFTC.  The Dodd-Frank Act amended the FCRA and effectively transferred rulemaking responsibility and enforcement authority with respect to identify theft rules to the SEC and CFTC with respect to those entities that are subject to each agency’s enforcement authority.  

The SEC indicates in its press release that the proposed SEC/CFTC rules relating to identify theft were largely identical to the rules that the FTC and the other federal agencies adopted under the FCRA (see our Up to Date article regarding proposed rules).  The SEC’s rules apply only to SEC-regulated entities that meet the definition of “financial institution” or “creditor” in the FCRA, such as broker-dealers, mutual funds and investment advisers.  The rules generally require these entities to adopt an identity theft prevention program designed to (i) identify relevant types of identity theft red flags, (ii) detect the occurrence of those red flags, (iii) respond appropriately to those red flags, and periodically update the identity theft program.  The rules go into effect 30 days after publication in the Federal Register and compliance is required six months after the effective date.

Take Care When Using Finders

With good reason, many securities lawyers, myself included, cringe when they hear that a business client has engaged a “consultant” or “finder” to help raise capital rather than a registered broker.  Under Section 15(a) of the Securities Exchange Act of 1934, as amended, with some limited exceptions, it is unlawful for any person to effect any transactions in, or induce or attempt to induce the purchase or sale of, any securities unless the person is registered as a broker or dealer under the Exchange Act or associated with a registered broker or dealer.  What activities will require a person to register?  Even the SEC admits in its guidance on registering as a broker or dealer that it is not always easy tell.  However, one clear indicator that a person is probably acting as a broker or dealer is the person’s receipt of transaction-based compensation, such as a percentage of invested capital.    

The SEC recently announced that it had charged William M. Stephens with soliciting investments for two related investment funds while not registered as a broker under the Exchange Act.  As described in the Cease-and-Desist Order, with respect to investors introduced by Mr. Stephens, Mr. Stephens was to be paid one percent of amounts investors committed to invest.  In addition, Mr. Stephens provided various investment materials to prospective investors, such as private placement memoranda and subscription documents.   

Why should a company raising capital care if a consultant or finder is acting as an unregistered broker?  The involvement of an unregistered broker could give investors a right of rescission, that is, the right to require the company to buy back the securities the investor purchased at the original purchase price.  Obviously, the consequences of having to repurchase a large number of securities could be catastrophic as they were for Neogenix Oncology, Inc.  As detailed in a surprisingly frank series of letters  from Neogenix’s management to shareholders and Neogenix’s SEC filings, Neogenix’s use of unregistered finders to secure investments gave rise to up to $31 million of potential rescission liabilities.  These potential liabilities, and their impact on Neogenix’s ability to raise additional capital, ultimately contributed to  Neogenix’s decision to file for bankruptcy.

Upcoming SEC Roundtables

Recently, the SEC announced two roundtables – the Credit Ratings Roundtable  and the Fixed Income Roundtable.  

The Credit Ratings Roundtable will be held on May 14, 2013 in response to the SEC Staff report on Assigned Credit Ratings.  The SEC staff issued the credit ratings report in response to Section 939F of the Dodd-Frank Act.  Section 939F requires the SEC to study various issues relating to credit rating process and report its findings to Congress.  The credit rating process report focuses on conflicts of interest in the credit rating process for structured finance products, the feasibility of alternative credit rating systems, metrics that could be used to judge the accuracy of credit ratings for structured finance products and alternative compensation structures that would provide incentives for accurate credit ratings. 

The Fixed Income Roundtable will be held on April 16, 2013 and focus on the corporate bond market and the municipal securities market.  The municipal securities market was the subject the SEC’s July 2012 Report on the Municipal Securities Market.    The 2012 report makes a host of recommendations regarding the municipal securities market, including recommendations to improve price transparency, strengthen brokers’ existing obligations to provide investors with the best execution and fair pricing, and enhance disclosure, as well as increases in the SEC authority to regulate the municipal securities markets. 

Both roundtables will be held at the SEC’s headquarters in Washington, D.C., open to the public and webcast live.

I’ve Got Too Much Disclosure on My Hands

Throughout the years, much has been written about disclosure overload driven by securities and accounting rules, including reports by auditors and scholarly research.  From time to time, even Securities and Exchange Commissioners have been known to discuss the perils of disclosure overload.  One such Commissioner is Troy A. Paredes.

In his comments before the annual SEC Speaks in 2013 conference held on February 22, 2013, SEC Commissioner Paredes once again discussed his concerns about overloading the investing public with too much information.  In summarizing his concerns about over-disclosure, Commissioner Paredes offered the following suggestion:  “In fashioning the disclosure regime at the core of the federal securities laws, we must account for the fact that too much disclosure, particularly when it is too complex, can be counterproductive.  . . .  It would be better for investors to be provided with shorter, more manageable SEC filings, for example, rather than the lengthy documents they receive today.”  If you listen carefully, I think you may be able to hear a collective cheer of approval from corporate America. 

For those that are interested, Commissioner Paredes made similar remarks in October 2011 while presenting the A.A. Sommer, Jr. Lecture on Corporate, Securities and Financial Law at Fordham University School of Law.

SEC Intensifies Scrutiny on Stock Sales by Insiders and 10b5-1 Plans

On February 5, 2013, the Wall Street Journal published the third in a series of articles discussing trading by public company executives in their companies’ securities, including trading pursuant to Rule 10b5-1 trading plans.  A 10b5-1 trading plan is a plan for buying or selling securities meeting the requirements of Securities Exchange Act Rule 10b5-1(c).  A properly adopted and implemented Rule 10b5-1 trading plan provides an affirmative defense against accusations of insider trading and allows the purchases and sales of securities even when the person who adopted the plan is aware of material nonpublic information. 

This latest Wall Street Journal article, “SEC Expands Probe on Executive Trades,” reports that the Securities and Exchange Commission has expanded its investigation into trading by corporate executives beyond the seven companies named in the first article in the series.  This latest article also refers to “shortcomings of the regulations” and “loopholes in the rules . . . known as a 10b5-1 plans.”  Whether or not you agree with the characterization of 10b5-1 plans as “loopholes” (I don’t), the Wall Street Journal’s recent reporting makes clear that trading by executives pursuant to 10b5-1 trading plans is likely to be subject to intense scrutiny in the coming months.  If you have not done so recently, now may be a very good time to review your company’s policies with respect to 10b5-1 trading plans and other insider trading policies to be sure they are adequate for today’s environment.  For some tips on what you may wish to consider in such a review, please see our December 2012/January 2013 Up to Date newsletter.

Chief of SEC’s Asset Management Unit Provides Compliance Tips for Private Equity Funds

On January 23, 2013, Bruce Karpati, Chief of the Asset Management Unit (“AMU”) of the Enforcement Division of the Securities and Exchange Commission, addressed the Private Equity International Conference held in New York.  The transcript of his presentation discusses potential compliance issues in the private equity industry on which the AMU may focus.  This presentation also serves as a useful guide for legal compliance professionals and executives serving the private equity industry highlighting certain areas on which they should focus.

In his comments, Mr. Karpati discussed the organization of the AMU and how the AMU has gained an expertise in the private equity industry.  Mr. Karpati explained that it is “not unreasonable to think that the number of cases involving private equity will increase” and he described a number of recent enforcement actions which highlight certain issues that may arise  at private equity firms.  Mr. Karpati stated that the AMU has found that some of the main industry stressors are fundraising and capital overhang.  In addition, Mr. Karpati indicated that many of the potential compliance issues in the private equity industry arise from conflicts of interest, such as the conflict between the profitability of the management company and the interests of investors, the shifting of expenses from one fund to another fund, and charging of additional fees to portfolio companies, especially where the permitted fees may be poorly defined by the fund’s limited partnership agreement.  In discussing conflicts of interests, Mr. Karpati stated that “Although conflicts of interest are a natural part of the private equity business, it is up to each manager to identify, control, and appropriately disclose material conflicts so that investors are informed and not harmed or disadvantaged.”     Finally, Mr. Karpati explained that private equity COOs and CFOs are critical in making sure that investors’ interests are paramount to the interests of the management company and its principals and discussed various ways that COOs and CFOs could reduce the risk of inquiry by the Division of Enforcement and ensure that their private equity firm and its principals are meeting their fiduciary responsibilities.

SEC Issues FAQ’s on Disclosure of Activities Relating to Iran

In August 2012, the Iran Threat Reduction and Syria Human Rights Act of 2012 became law.  Among other things, Section 219 of the Act added Section 13(r) to the Securities Exchange Act of 1934.  Section 13(r) requires companies that file periodic reports under Section 13(a) of the Exchange Act to disclose in their quarterly and annual reports certain information related to activities that they or any of their affiliates knowingly engaged in involving Iran.  Generally, the activities for which disclosure is required are defined by various laws and executive orders that already exist and govern activities relating to Iran.  Importantly, Section 219 does not require the SEC to promulgate any rules.  Thus, reporting companies will have to comply with the disclosure requirements with respect to periodic reports required to be filed after February 6, 2013.    

To provide reporting companies assistance in interpreting and complying with new Section 13(r), on December 4, 2012, the SEC released seven new FAQs discussing the additional disclosure requirements.  Among other things, the FAQs affirm that activities covered by Section 13(r) that occurred during the fiscal year covered by an annual report must be reported in such annual report even if the activities occurred prior to August 10, 2012, the date the Act became law.  In addition, the SEC confirmed that reporting companies should look to the definition of “affiliate” in Exchange Act 12b-2 when interpreting Section 13(r).

SEC Provides Further Relief in the Wake of Hurricane Sandy

On November 14, 2012, the Securities and Exchange Commission announced  the issuance of an order providing regulatory relief to publicly traded companies, investment companies, accountants, transfer agents and others affected by Hurricane Sandy.  To address compliance issues caused by the hurricane and its aftermath, the order conditionally exempts affected persons from the requirements of the federal securities laws with respect to:  (i) Exchange Act filing requirements for the period from October 29, 2012 to November 20, 2012 (and imposes a new deadline of November 21, 2012 for missed filings); (ii) proxy and information statement delivery requirements for companies attempting to deliver materials to affected areas; (iii) Investment Company Act requirements for the transmittal to shareholders in affected areas of annual and semi-annual reports during the period of  October 29, 2012 to November 20, 2012; (iv) transfer agent compliance with certain Exchange Act requirements for the period from October 29, 2012 to December 1, 2012; and (v) auditor independence requirements as they relate to reconstruction of previously existing accounting records of clients. 

The Commission has also directed the SEC staff generally to take the position that filings subject to and filed in compliance with the regulatory relief granted by the order be considered timely for the purposes of eligibility to use Form S-3 (and well-known seasoned issuer status, which is based in part on Form S-3 eligibility), and to consider companies making such filings to be current in their Exchange Act reporting requirements for purposes of Form S-3 and Form S-8 eligibility and availability of current public information under the Securities Act Rule 144.  The Commission has also directed the staff to take similar positions with respect to various investment company and investment adviser filing requirements.

SEC and DOJ Issue Joint Guidance on FCPA Interpretation

On November 14, 2012, the Enforcement Division of the United States Securities and Exchange Commission and the Criminal Division of the United States Department of Justice announced the issuance of A Resource Guide to the U.S. Foreign Corrupt Practices Act.  The 130 page guide addresses various topics that will be of interest to any company with activities outside the United States, including who and what is covered by the FCPA’s anti-bribery provisions; the definition of  a “foreign official”; what constitute proper and improper gifts, travel and entertainment expenses; facilitating payments and a host of other topics as well.  The SEC, in its press release, said that “the guide takes a multi-faceted approach toward setting forth the statute’s requirements and providing insights into SEC and DOJ enforcement practices.” 

As previously noted by my colleagues Shawn M. Wright and James R. Billings-Kang in an article appearing in The National Law Journal, the DOJ and the SEC continue to be very active in enforcing the FCPA and as previously discussed in this blog, companies with operations outside the United States should consider their SEC disclosure obligations relating to the FCPA.  As such, the guide is sure to be a great resource to both companies with international operations and the legal community advising them with respect to the FCPA.  For additional resources relating to the FCPA, please visit our website.