Thursday, July 30, 2015

Human Trafficking Bill Would Add to Supply Chain Duties

By Mark S. Nelson, J.D.

A bill introduced by Rep. Carolyn Maloney (D-NY) would create new socially-themed disclosure obligations under the federal securities laws for many companies. The Business Supply Chain Transparency on Trafficking and Slavery Act of 2015 calls on firms to disclose if their supply chains involve labor that may be the product of human rights abuses. The bill would add to the SEC’s growing specialized disclosure regime first mandated by the Dodd-Frank Act.

“This legislation simply requires businesses to publicly disclose what actions they have voluntarily undertaken to remove labor abuses from their supply chains,” said Rep. Maloney. “It is a good first step we can take to improve reporting and transparency so that we can enforce existing laws against labor abuses and allow consumers to make more informed decisions.”

The bill would amend the Exchange Act to require businesses with more than $100 million in global gross receipts to report annually to the SEC about their policies to prevent slavery and human trafficking from entering into their supply chains. According to the bill’s authors, it will enhance consumer choice, increase companies’ accountability for supply chain practices, and foster competition to adopt better practices for handling human rights issues.

A summary of the bill also noted that disclosures would have to be “prominently posted” on both the SEC’s and companies’ websites. The posting of these types of disclosures on company websites is already subject to an ongoing legal challenge over whether similar requirements for conflict minerals supply chains violate the First Amendment.

“Some companies may participate knowingly in human trafficking to pad the bottom line; others are willfully ignorant of where and how their inexpensive products are made; and still others simply do not know,” said co-sponsor Rep. Chris Smith (R-NJ). The representative, who also authored related legislation, said companies cannot ignore serious problems with their supply chains.

The latest version of the House bill was partially inspired by a recent State Department report urging businesses to do more regarding human rights. Senator Richard Blumenthal (D-Conn) said he will introduce a related bill.

Representative Maloney initially offered her bill in 2011 (H.R. 2759). That version would have added Exchange Act Section 13(r) to provide for companies’ disclosures about human trafficking. If enacted, the human trafficking provision will occupy a different part of Section 13 because subsection (r) is currently occupied by a provision for disclosures about firms’ business ties to Iran.

Wednesday, July 29, 2015

New Hampshire Adopts Uniform Securities Act

By Jay Fishman, J.D.

New Hampshire’s Governor, Maggie Hassan, signed Senate Bill 266, comprising a new uniform securities act. The bill was spurred by the Governor’s Live Free and Start Initiative and has had bipartisan legislative support. The new Act, modeled after the Model Uniform Securities Act of 2002, takes effect January 1, 2016.

Governor Hassan said that “One of Live Free and Start’s top priorities, the Uniform Securities Act modernizes our securities regulations with a focus on investor protection and reducing hurdles for businesses trying to raise the capital that they need. This important bipartisan measure will support the growth of innovative businesses, while also fairly balancing the state’s interest in regulating securities transactions, creating a synchronized and modern law that reflects current thinking and the way business and entrepreneurs work.”

Act highlights. The Act’s main articles are summarized below:

Exemptions. Securities exemptions cover government securities, foreign government securities, international and national banking securities, common carrier and public utility securities, exchange listed securities under Section 18(b)(1) of the Securities Act of 1933, nonprofit organization securities, equipment trust certificates, and common trust fund interests.

Transactional exemptions cover isolated nonissuer transactions, nonissuer transactions through a registered broker-dealer, bona fide pledgee transactions, nonissuer transactions involving a federal covered investment adviser, transactions exchanging securities for cash, underwriter transactions, nonissuer sales of notes or bonds, institutional investor sales, 25-purchaser sales, employee benefit plan transactions, existing securityholder transactions, offers when registered under this Act and not exempt from the Securities Act of 1933; offerings when registration has been filed, but not effective under this Act and exempt from the Securities Act of 1933; control transactions (such as mergers), rescission offers, out-of-state offers or sales; dividends, distributions and judicially approved reorganizations; nonissuer transactions involving specified foreign issuer's securities traded on designated security exchanges; and additional exemptions and waivers.

Federal covered securities. Issuers making an offering of federal covered securities under Section 18(b)(2) of the Securities Act of 1933—investment company securities—must submit SEC-filed records both before and after the initial offer, together with an initial or renewal notice fee. Issuers making a federal covered securities offering under Section 18(b)(4)(D)—a Rule 506 offering—must file a notice consisting of a copy of Form D, including the Appendix, a consent to service of process, and a $500 fee.

Securities registration. Securities may be registered in New Hampshire by coordination or qualification.

Industry persons. The Act covers the regulation of broker-dealers, agents, investment advisers, investment adviser representatives and federal covered investment advisers. Specific topics include licensing, post-licensing such as financial statement and recordkeeping requirements, along with succession, termination, withdrawal and denial/suspension/revocation.

Fraud. It is unlawful for any person, in connection with the offer, sale or purchase of any security (directly or indirectly) to: (1) employ a device, scheme or artifice to defraud; (2) make an untrue statement or omission of material facts; or (3) engage in an act, practice or course of business that operates, or would operate, as a fraud or deceit against another person. Specific topics include prohibited conduct in providing investment advice, evidentiary burden, filing of sales and advertising literature, misleading filings, misrepresentations concerning registration or exemption, qualified immunity, criminal penalties, civil liability and rescission offers.

Administration. The Act provides that: (1) the administrator may administer the Act in accordance with methods specific to the state; (2) the administrator may make it unlawful for the administrator or a designee to use any non-public records or information for personal benefit; (3) nothing in the Act should be construed to either create or derogate any privilege existing at common law, by statute, rule or otherwise; (4) the administrator may develop and implement investor education initiatives to inform the public about investing in securities; and (5) set up a Securities Investor Education and Training Fund to provide for investor education initiatives. More specific topics include investigations and subpoenas; civil enforcement, administrative enforcement, rules, forms, orders, interpretative orders and hearings; administrative files and opinions; public records, confidentiality, uniformity and cooperation with other agencies; judicial review, jurisdiction; service of process, severability, application of chapter to existing proceeding and existing rights and duties; and denial, suspension, condition or limitation of exemptions.

Tuesday, July 28, 2015

Latest Turn in Duka Administrative Proceeding: New Presiding Judge

By Jacquelyn Lumb

Administrative law judge (ALJ) James E. Grimes has been named to replace Cameron Elliott as the presiding judge in the SEC’s proceeding against Barbara Duka, a former managing director at Standard & Poor’s Ratings Services whom the SEC alleges perpetrated a scheme which led to false and misleading statements about S&P’s post-financial crisis methodology for rating certain mortgage-backed securities. Chief ALJ Brenda P. Murray made the change pursuant to delegated authority (In the Matter of Barbara Duka, July 24, 2015, Murray, B.).

Constitutional challenge. The SEC instituted the proceeding against Duka on January 21, 2015. Before the proceeding was commenced, Duka, on January 16, filed a complaint in the U.S. District Court for the Southern District of New York against the SEC in which she sought declaratory and injunctive relief from being compelled to submit to an allegedly unconstitutional SEC administrative proceeding.

In her complaint, Duka contended that SEC administrative law judges who are responsible for adjudicating the administrative proceedings enjoy at least two layers of tenure protection, which insulate them from Presidential oversight, rendering the proceedings unconstitutional on their face because they violate Article II of the U.S. Constitution. The court concluded that Duka was not entitled to preliminarily enjoin the SEC proceedings because she was unlikely to succeed on the merits of her constitutional claim.

Latest ruling. Elliott was designated as the ALJ to preside over the Duka proceedings on January 22, 2015, and set a hearing date for September 16. In his latest ruling, on July 8, he denied Duka’s motion for adjournment of the hearing.

The Release is No. AP-2969.

Monday, July 27, 2015

Appeals Court Hits ‘Like’ on Dismissal of Facebook IPO Suits

By Anne Sherry, J.D.

Derivative actions alleging that Facebook directors breached their fiduciary duties in connection with the company’s IPO were properly dismissed for failure to plead contemporaneous share ownership, the Second Circuit held. None of the putative plaintiffs satisfied the Federal Rule of Civil Procedure 23.1 requirement by alleging that they were shareholders at the time of the director defendants’ alleged wrongdoing (In re Facebook, Inc. Initial Public Offering Derivative Litigation, July 24, 2015, Jacobs, D.).

Dismissals. The various lawsuits, which the Judicial Panel on Multidistrict Litigation consolidated in the Southern District of New York, alleged that Facebook’s directors breached their duties to shareholders because the IPO registration statement did not include a sufficient description of the effect of increasing mobile usage on the company’s projected growth. When Facebook moved to dismiss the actions, the district court held that it had discretion to decide threshold grounds for dismissal without first adjudicating whether it had subject matter jurisdiction, a “possible arduous inquiry.” The complaints challenged disclosures made before the IPO, so plaintiffs who acquired Facebook in the IPO could not meet the Rule 23.1 threshold.

Lack of standing. The Second Circuit approved of the decision to decide the threshold questions first. Although the Supreme Court has stated that a court should not assume “hypothetical jurisdiction” to adjudicate the merits of a case, neither must a court make a difficult determination as to subject matter jurisdiction when another clear threshold defect would warrant dismissal. The district court’s dismissal based on a lack of standing to proceed in a derivative capacity—rather than on a deficiency as to the merits of the allegations—did not sidestep the Article III requirements.

Contemporaneous ownership. Furthermore, the district court concluded correctly that none of the plaintiffs satisfied Rule 23.1. Complaints that simply recited the language of the rule by alleging that they continuously held ownership interests in Facebook at the time of the alleged misconduct did not go far enough; the court is not bound to accept conclusory allegations as factual conclusions. Nor did the plaintiffs’ purchase of SharesPost units, which effected an agreement to purchase Facebook stock on the secondary market, make them eligible owners of stock. Finally, one of the plaintiffs unsuccessfully argued that her ownership of Facebook stock from and after the IPO was contemporaneous because the alleged omissions were part of a “continuing wrong.” A derivative plaintiff must have owned stock throughout the course of activities constituting the primary basis of the complaint; here, the challenged disclosures were made prior to the IPO.

The case is No. 14-1445.

Friday, July 24, 2015

Commissioners Urge SEC to Address Impermissible Retroactive Collateral Bars

By John Filar Atwood

Saying that they feel vindicated by the recent decision by the U.S. Court of Appeals for the District of Columbia Circuit in Koch v. SEC, Commissioners Daniel Gallagher and Michael Piwowar have called on the Commission to address retroactive collateral bars that have been entered since the enactment of the Dodd-Frank Act. Gallagher and Piwowar have dissented from every vote to impose retroactive collateral bars since they joined the Commission.

Court decision. In its recent ruling, the court held that the SEC cannot apply a Dodd-Frank Act provision to bar an individual from associating with municipal advisers and nationally recognized statistical rating organizations based on pre-Dodd-Frank conduct. In the court’s view, the application of that provision in that manner is impermissibly retroactive.

Case history. As noted in previous coverage in Securities Regulation Daily, an administrative law judge found that Donald Koch, an investment adviser, marked the close for three small bank stocks between September and December 2009 in order to give the appearance that his clients’ accounts were retaining their value. The SEC affirmed the order and issued five remedial orders, one of which barred Koch from associating with “any investment adviser, broker, dealer, municipal securities dealer, municipal adviser, transfer agent, or nationally recognized statistical rating organization.”

On appeal, the D.C. Circuit agreed that Koch marked the close, and was unpersuaded by his argument that he could not be liable under the Exchange Act and Investment Advisers Act in the absence of a finding of market impact. However, the court concurred with the argument that the SEC impermissibly applied the Dodd-Frank Act retroactively.

Gallagher and Piwowar issued a statement applauding the Circuit Court’s decision, claiming that it vindicates their opposition to such bars. In addition to voting against the imposition of retroactive collateral bars, the Commissioners have publicly criticized the legal analysis with respect to the imposition of the bars. The Commissioners also noted that former Commissioners Kathleen Casey and Troy Parades were also outspoken on the topic of the retroactive application of the securities laws.

SEC should take action. In their statement, Gallagher and Piwowar said that the SEC should promptly take action to address all impermissibly retroactive collateral bars that have been misapplied since the Dodd-Frank Act was implemented.

Thursday, July 23, 2015

FSOC Fights Document Production in MetLife SIFI-Designation Case

By Amy Leisinger, J.D.

In MetLife, Inc.’s ongoing action challenging its designation as a systemically important financial institution (SIFI), the Financial Stability Oversight Council (FSOC) has moved the D.C. federal district court to deny MetLife’s motion to compel disclosure of withheld and redacted materials. According to FSOC, disclosure of documents provided by state insurance regulators is precluded by the confidentiality protections of Dodd-Frank Act coupled with state law privileges (MetLife, Inc. v. Financial Stability Oversight Council, July 20, 2015).

Background. MetLife was designated a SIFI in December 2014, based on FSOC’s determination that material financial distress at the company could threaten financial stability. MetLife asked the court to overturn the designation, arguing (with the support of the Chamber of Commerce) that FSOC relied on weak economic assumptions to back its findings and that MetLife was not given a chance to rebut the Council’s reasoning because key data used to label MetLife as a nonbank SIFI was not made available.

On May 8, 2015, FSOC provided MetLife with an administrative record of more than 80,000 pages of information, noting that “certain documents or portions of documents have been redacted or withheld.” The excluded documents were ones provided to FSOC by state insurance regulators who had informed the council that the documents were sensitive and confidential and should not be disclosed to MetLife. Following a protective order entered by the court on June 12, 2015, FSOC produced the majority of the redacted and withheld documents with the permission of the state regulators, but the regulators requested that the council continue to withhold in full or redact in part a set of documents due to the particularly sensitive, privileged nature of the material. MetLife continues to move for production of all of the documents.

Deny motion to compel. FSOC moved to deny MetLife’s motion to compel, stating that it is required to withhold the documents pursuant to its obligations under Dodd-Frank Act Section 112, which provides that FSOC must “maintain the confidentiality of any data, information, and reports submitted.” In addition, according to FSOC, the state regulators that submitted the materials have informed FSOC that the materials are protected by state law privileges that preclude their disclosure, and the Dodd-Frank Act provides that submission of materials to FSOC does not constitute a waiver of any privilege under state law to which the information is subject. As such, FSOC argues, information protected by state law privilege transmitted to the council retains its privileged nature. This is particularly important given the possibility that disclosure of materials could have a chilling effect on candid participation in confidential regulatory discussions, FSOC claimed.

The existing record in this case is sufficient, and, if necessary, an in camera review would confirm that maintaining confidentiality of the withheld and redacted information would not cause undue prejudice, FSOC concludes.

The case is No. 15-cv-00245 (RMC).

Wednesday, July 22, 2015

SIFMA Raises ‘Deep Concerns’ Over DOL Retirement Fiduciary Rule

By Anne Sherry, J.D.

The Department of Labor is the wrong regulator to impose a fiduciary standard on retirement advisors, according to SIFMA. The industry group, which favors a best-interests-of-the-customer standard, submitted eight comment letters on the DOL’s proposal to redefine fiduciary under ERISA, arguing that the proposal is unworkable and that SEC and FINRA should remain in the lead on the issue.

Background. The DOL issued its proposal in April at the President’s urging to reduce conflicts of interest and hidden fees that the White House said cost retirement accounts $17 billion annually. The proposal brings within the definition of “fiduciary” any individual receiving compensation for providing advice that is individualized or specifically directed to a particular plan sponsor, plan participant, or IRA owner for consideration in making a retirement investment decision. The DOL also issued proposed exemptions along with the proposed rule, notably a “best interest contract exemption” that would allow fiduciary advisers and their firms to collect fees that would typically be unavailable to them, as long as they acknowledged their fiduciary status.

Comment letters. SIFMA’s comment letters address the fiduciary rule and the best interest contract exemption, as well as four prohibited transaction class exemptions (principal transactions in debt securities, PTCE 86-128, PTCE 84-24, and PTCE 75-1, Part V) and the rule’s other exemptions. The eight letters, which include one from the SIFMA Asset Management Group, draw support from a NERA study responding to the DOL’s regulatory impact analysis and a Deloitte report addressing the operational impact of the rule proposal.

Fiduciary rule. The group maintains that the expanded definition of fiduciary would leave investors without investment guidance in several areas. Investors would no longer be able to discuss the types of services that an advisor may provide should they choose to work together, and providers would no longer be able to pitch their services to small business owners, as these would be seen as fiduciary conversations. The rule would also restrict conversations about rollovers when investors change jobs.

Exemptions. In its executive summary on the comment letters, SIFMA said that “it should be clear from the outset that virtually all of the exemption amendments, as well as the new exemptions, are not administrable, as required under ERISA.” The best interest contract exemption is unworkable, SIFMA writes, because it both obstructs broker-dealers and imposes disclosure requirements that would overwhelm customers, impede transactions, and create losses for certain retirement accounts forced to sell asset that DOL deems “unworthy.”

Regulatory and operational impacts. SIFMA cites two studies to undermine the DOL’s regulatory impact analysis and demonstrate the operational impacts of the proposal. A study by NERA Economic Consulting finds that commission-based accounts do not underperform fee-based accounts and that most retirement holders would lose access to financial advice under the rule. The DOL also underestimated the cost of complying with its proposal, SIFMA wrote, by relying on data that SIFMA submitted to the SEC two years ago under assumptions specific to a contemplated SEC fiduciary rule. Finally, a Deloitte report commissioned by SIFMA finds that several requirements of the proposal would be unfeasible or impossible for firms to operationalize within their existing frameworks. The total startup costs for large and medium broker-dealers would be $4.7 billion, and ongoing costs would exceed $1.1 billion—nearly double the DOL’s estimates.

Tuesday, July 21, 2015

SEC Staff Updates Guidance Under the Volcker Rule

By Jacquelyn Lumb

The SEC’s Divisions of Trading and Markets, Investment Management, and Corporation Finance have updated their responses to frequently asked questions about the Volcker Rule to address the seeding period treatment for registered investment companies (RICs) and foreign public funds (FPFs). Section 13 of the Bank Holding Company Act, known as the Volcker Rule, was added by the Dodd-Frank Act and generally prohibits banking entities from engaging in proprietary trading or from acquiring or owning an interest in a hedge fund or a private equity fund, subject to certain exemptions.

RICs and FPFs. RICs and FPFs are not covered funds under the rule implementing Section 13, but a banking entity may own a significant portion of the shares of an RIC or an FPF during a period in which it tests the fund’s investment strategy, establishes a track record of the fund’s performance for marketing purposes, and attempts to distribute the fund’s shares, known as the seeding period.

Seeding period. The staff said that it would not advise its fellow regulatory agencies to treat an RIC or an FPF as a banking entity solely on the basis that either one is established with a limited seeding period, absent evidence that either was being used to evade Section 13 of the Bank Holding Company Act and the implementing rules. The agencies recognize that the seeding period may take time. Three years is the maximum period of time expressly permitted for seeding a covered fund under the implementing rules.

The staff said the seeding period generally would be measured from the date on which the investment adviser or similar entity begins making investments in accordance with the fund’s written investment strategy. Accordingly, the staff would not advise the banking agencies to treat an RIC or an FPF as a banking entity solely on the basis of the level of ownership of the RIC or the FPF during a seeding period, or to expect an application to be submitted to the Federal Reserve Board to determine the length of the seeding period.

In a footnote to the guidance, the staff notes that the final rule requires a vehicle that is a covered fund (as opposed to an RIC or an FPC) during its seeding period, and that is formed and operated under a written plan to become an RIC, to apply to the Federal Reserve Board for an extension of the one-year seeding period granted to covered funds.

Exclusions. The implementing rule also excludes from the definition of a covered fund an issuer that has elected to be regulated as a business development company under the Investment Company Act and has not withdrawn that election, or that is formed and operated under a written plan to become a business development company and complies with the Investment Company Act requirements. Consistent with the parallel treatment of RICs, FPFs, and SEC-regulated BDCs, the staff would not advise the regulatory agencies to treat an SEC-regulated BDC as a banking entity solely on the basis of the level of ownership of the BDC by a banking entity during the seeding period.

Monday, July 20, 2015

Senator Warren Asks Regulators for Data on Rollback of Swaps Pushout

By Lene Powell, J.D.

Senator Elizabeth Warren (D-Mass) and Rep. Elijah Cummings (D-Md) have requested information from four financial regulators about risks resulting from the partial repeal last December of the Dodd-Frank “swaps pushout” provision, which limited the kinds of derivatives that may be traded by financial institutions that receive federal assistance like deposit insurance or access to the Federal Reserve Board's discount window. The partial repeal expanded the types of derivatives activities that covered depository institutions may engage in. Warren and Cummings, who is the ranking member of the House Oversight and Government Reform Committee, are concerned that Congress lacks information about increased risks to taxpayers arising from the repeal.

"Without this understanding, the country risks moving blindly toward the same financial meltdown that plunged the economy into recession seven years ago," the legislators wrote in letters to the Federal Reserve, Office of the Comptroller of the Currency, FDIC, and CFTC.

The lawmakers said they had previously sought information from Bank of America, JPMorgan Chase, Citibank, and Goldman Sachs, but the banks provided only incomplete information.

Swaps pushout revision. As originally enacted, Section 716 of the Dodd-Frank Act prevented federally insured financial institutions from conducting certain swaps trading, including trading of commodity, equity, and credit derivatives. The prohibition required covered financial institutions to “push out” these types of swaps trades into separately capitalized affiliates. At the time, former Senate Agriculture Committee Chair Blanche Lincoln, the author of the pushout provision, said the aim was to require banks that may be bailed out by taxpayers to stop the riskiest derivatives dealing, which contributed to the 2008 financial crisis and was not central to the business of banking.

In December 2014, as part of the 2015 spending bill (HR 83), the swaps pushout was revised to allow financial institutions with federal deposit insurance to trade commodity and equity derivatives for hedging and other risk mitigation purposes. As a result, the only swaps that covered depository institutions must spin out to separately capitalized entities are structured finance swaps. However, even these swaps do not need to be pushed out if they are undertaken for hedging or risk management purposes or are expressly allowed by prudential regulators to take place in a covered depository institution.

Request for information. Warren and Cummings said the potential impact of the rollback of the swaps pushout was enormous, given the huge amount of swaps transactions ($117 trillion in notional value) and the key role of swaps in exacerbating the financial crisis. Therefore, in January 2015 they requested information from the largest banks affected by the swaps pushout. Among other details, they asked for data on the total value of swaps contracts each institution holds for “hedging” and “risk management” purposes, as well as the total value of swaps transactions each bank would have pushed out under the original Section 716.

The legislators said the banks provided fairly conclusory answers in response, in many instances lacking quantification, though some banks did provide partial data. Several banks said the information was proprietary and they would not provide it due to competitive concerns.

Clearly unhappy with the banks, Warren and Cummings turned to the banking regulators and the CFTC. "We believe that if these banks want continued access to federally insured deposit funds, they must be more transparent about the risks they are taking with that money. If they want to keep secret the risks they are taking, these banks should forfeit access to taxpayer-backed FDIC insurance,” they wrote.

In addition to asking the regulators for the same data they had requested from the banks, Warren and Cummings requested additional information including agency risk assessments and definitions of key terms. They also asked that the regulators evaluate the potential impact of Section 716 on the implementation of Sections 23A and 23B of the Federal Reserve Act, concerning transactions between banks and their affiliates, as well as a forthcoming rule to establish margin requirements for uncleared swaps transactions. The legislators gave a deadline of August 6, 2015 for the response.

Friday, July 17, 2015

IAC Examines Fund Fee and Expense Disclosure Issues

By Amy Leisinger, J.D.

At yesterday’s meeting of the SEC’s Investor Advisory Committee (IAC), an investment management panel discussed issues surrounding the disclosure of fees and risks in fund products and potential deficiencies in the information provided to, and understood by, retail investors. The committee said it is committed to finding ways to get the right information to investors and to make sure the data and descriptions provided are both understandable and useful. Investors deserve better disclosure, according to the IAC.

Members of the committee suggested that the SEC should fundamentally rethink disclosure, both in terms of the actual information provided and the means by which it is presented. This may be especially important given the results of a financial literacy study detailed by Lori Schock, director of the Commission’s Office of Investor Education and Advocacy. She noted that investors appreciate simplified, organized information in prospectuses, particularly in the form of graphs, charts, and bullet-point lists. The problem is, she said, a large number of investors are not reading statutory prospectuses, let alone summary prospectuses. It is unclear how much information about complex subjects like fees and expenses can be truly understood, Schock explained.

Susan Nash of the Division of Investment Management talked about the existing disclosure regime and what may be done to enhance it. Performance information is extremely important to investors and is typically well-documented, she said, but discussions of fees and expenses are often unclear, and testing has shown that the use of percentages as opposed to dollar amounts can be difficult to understand. Fee tables provide a great deal of information and facilitate comparisons among share classes and multiple funds, she explained, but it is not always clear whether investors comprehend what they are reading.

According to Nash, the division has undertaken a number of initiatives to enhance both the creation and use of disclosures, particularly in the form of the recent reporting modernization rule proposal and its suggestion of new monthly portfolio reporting and the filing of certain risk metrics with the SEC. This information will be useful for not only for Commission risk monitoring but also for investors as they receive information from industry participants and analysts, Nash stated. To assist in the disclosure process, according to Nash, the division will continue to publish guidance updates like those recently issued regarding enhanced mutual fund disclosure and risk management.

Investor advocate Mercer Bullard echoed the support for the provision of clear and concise information to retail investors and the confusion that can result from fee and expense discussions in prospectuses. He also stressed the importance of specific enhancements to disclosures involving conflicts of interest. Most of the time, the interests of a financial advisor align with the interest of the investor in terms of benefiting from fund growth, he noted. However, according to Bullard, investors need information on the incentives an advisor may have to act in opposition to their goals and objections to make a truly informed decision.

Thursday, July 16, 2015

NASAA Critical of FINRA Proposal on Disclosures Required of Brokers Bringing Customers to New Firms

By Matthew Garza, J.D.

NASAA has expressed disappointment with a re-proposed FINRA rule that softened disclosure requirements for brokers that transfer retail customer accounts to a new firm. Responding to a second request for comments, NASAA President William Beatty said that the watered-down proposal was inconsistent with FINRA’s recent emphasis on conflicts of interest and putting customers’ interests first.

The proposed rule would require a FINRA-registered firm that recruits a broker and induces retail customers to transfer assets to the recruiting firm to send a communication highlighting the implications of the asset transfer, as well as suggest questions the customer should ask.

First proposal. The initial proposal on the content of the communication called for disclosure of compensation that the representative received or would receive in connection with the transfer to a new firm and whether the compensation was asset-based or production-based. That proposal was withdrawn after commenters complained about operational aspects of the proposal and its effect on competition.

Beatty said NASAA’s initial comment about the rulemaking, submitted in March 2013 in response to FINRA Regulatory Notice 13-02, supported requiring written disclosures about enhanced compensation programs, particularly where the compensation was based on the representative’s future sales performance. NASAA asked for timely, detailed disclosure to customers of actual dollar figures paid to representatives that move accounts to new firms and discouraged “vague references to percentage payouts and generalized language.”

Re-proposal. The re-proposed version of the rule called for an “educational communication” highlighting the implications of the asset transfer. FINRA said the intent of the communication was to prompt the customer to ask about: (1) whether financial incentives received by the transferring representative created a conflict of interest; (2) if assets that may not be directly transferrable to the recruiting firm could incur fees upon liquidation and transfer or inactivity fees if left with the current firm; (3) potential costs, such as differences in the pricing structure and fees imposed by the recruiting firm; and (4) differences in products and services between the current firm and the recruiting firm.

NASAA criticisms. Failing to require more specific dollar-figure disclosures shifts the burden to the retail customer to determine if conflicts of interest are created when a broker transitions to a new firm, said Beatty. Use of the term “educational communication” was also objectionable to NASAA because it fails to apprise the customer of the importance of the document.

NASAA encouraged FINRA to revise the proposal by: (1) requiring “specific, substantive” disclosure of financial incentives; (2) referring to the communication as a disclosure document; (3) requiring more detailed disclosure of the potential implications of a transfer; and (4) requiring delivery of the disclosures in advance of any attempt to solicit the transfer.

Wednesday, July 15, 2015

SEC Hosts National Compliance Outreach Program for Broker-Dealers

By Jacquelyn Lumb

Chair Mary Jo White welcomed attendees to the SEC’s annual compliance outreach program for broker-dealers during which the staff shared its initiatives and priorities with the industry. White said that transparency with the industry is a priority of the Commission’s national exam program, which is why the Office of Compliance Inspections and Examinations, for the last three years, has released its planned areas of focus for the upcoming fiscal year based on practices that may pose risks to investors or issues of concern that have been identified during examinations.

Risk alerts. White added that the staff also publishes risk alerts, in part to help compliance professionals evaluate their controls and procedures in these areas. A recent alert announced this year’s plan to focus on the retirement industry and last year an alert announced that the staff would focus on cybersecurity. Cybersecurity was the topic of the outreach program’s first panel, which reviewed general examination findings, industry practices, and controls designed to mitigate cybersecurity risk.

Enforcement. White said the SEC’s enforcement program is another way to emphasize the importance of strong compliance programs. The SEC’s orders highlight areas where a compliance program operated effectively to identify misconduct, but also areas where those programs failed. In appropriate circumstances, the SEC will require that firms engage independent consultants to ensure that compliance policies are created to prevent a recurrence of the identified misconduct.

White emphasized that it is not the SEC’s intent to use its enforcement program to target compliance professionals—it will only take actions when there is significant misconduct or failures. The SEC will not bring cases based on second guessing compliance officers’ good faith judgments, according to White, but only where their actions cross a clear line.

Current priorities. White advised that the examination program’s current priorities include fee structures; suitability; order routing conflicts, recidivist representatives; microcap activity; excessive trading; and transfer agent activity, in addition to the retirement industry.

The compliance outreach program also included panel discussions on anti-money laundering risks and vulnerabilities, firm and branch supervision and sales practices, and the staff shared its insight from both the SEC’s and FINRA’s examination programs. White said that OCIE is currently developing its priorities for the 2016 fiscal year and they will be published upon completion. She said the staff welcomes input on risk areas and vulnerabilities that should be included among its examination priorities.

Regulator’s panel. During discussion about the SEC’s and FINRA’s examination program, the regulators mentioned the PCAOB’s inspections of audits of broker-dealers, and particularly its findings related to auditor independence. Compliance personnel should bear in mind any activities that may impair the auditor’s independence. The PCAOB also has identified deficiencies with respect to some of the audits of broker-dealers. The regulators recommended the PCAOB’s website as a resource for useful information for the industry.

Michael Ruffino, executive vice president, and head of member regulation-sales practice at FINRA closed with a list of items that identify a compliance-driven firm. First, he highlighted not only tone at the top, but also in the middle and at the bottom. Second is the recognition that good compliance is good business. Third, compliance should be a partner with the business side, not an adversary. Fourth, he said the customer comes first from a fiduciary and suitability standpoint. A firm should always ask if a product or service is in the best interest of the customers. Finally, he said ethical behavior is the only behavior, and firms should settle for nothing else.

Tuesday, July 14, 2015

House to Vote on Small Business Bills, Other Revisions

By Mark S. Nelson, J.D.

The full House is set to vote on a number of bills this week that would revise the securities laws to better accommodate small businesses. Five of the bills come from a package of thirteen bills approved in May by the House Financial Services Committee. These bills feature several adjustments to the Jumpstart Our Business Startups (JOBS) Act, and to other laws. The House will also consider several banking and mortgage-related bills.

Monday’s action. Up first is the Small Business Investment Company Capital Act of 2015 (H.R. 1023), sponsored by Rep. Steve Chabot (R-Ohio). Unlike some of the bills due for votes this week, this one came out of the House Small Business Committee and would amend the Small Business Investment Act of 1958 to raise the funding limit from $225 million to $350 million. This provision, which governs the leverage limit for multiple licenses under common control, was last increased in 2009.

According to an explanation of the bill (House Rep. No. 114–189), the change is needed to ensure that successful SBIC managers can seek investors who want higher returns in today’s historically low interest rate environment. The House Small Business Committee approved the bill by a voice vote in June, and the full House was scheduled to vote on it later yesterday. Another bill set for a vote today deals with advisers to SBICs.

JOBS Act tweaks and other bills. Today, the House is expected to consider five of the bills approved by the Financial Services Committee two months ago. Each of the bills will be considered under a suspension of the rules. The bills are:

  • Improving Access to Capital for Emerging Growth Companies Act (H.R. 2064)—The bill makes three significant changes to the JOBS Act. Like H.R. 37 (passed by the House in January), this bill shortens the time before a road show when an emerging growth company (EGC) must publicly file its once-confidentially submitted registration statement and any amendments to it from 21 to 15 days. The bill also provides for a grace period during which an EGC that lost its EGC status after it confidentially submitted (or publicly filed) a registration statement for SEC staff review may continue to be treated as an EGC. An amendment to the version of the bill to be considered adds Form F-1 to a provision that would ease the disclosure requirements for EGCs on Form S-1 regarding historical financial information mandated by Regulation S-X
  • SBIC Advisers Relief Act of 2015 (H.R. 432)—Clarifies the treatment of advisers for SBICs and venture capital funds under the Investment Advisers Act. 
  • Holding Company Registration Threshold Equalization Act of 2015 (H.R. 1334)—Makes conforming amendments to the Exchange Act for savings and loan holding companies. 
  • Small Company Simple Registration Act of 2015 (H.R. 1723)—Directs the SEC to revise its rules to allow smaller reporting companies to incorporate by reference on Form S-1 any documents the company files with the agency after the registration statement becomes effective. 
  • Swap Data Repository and Clearinghouse Indemnification Correction Act of 2015 (H.R. 1847)—Amends the Commodity Exchange Act (CEA) to clarify that the CFTC must get a written confidentiality agreement from certain entities before sharing swaps data. Related provisions would apply to security-based swaps governed by SEC rules. The version of the bill to be considered adds conforming amendments to the CEA and the Exchange Act. 
Two bills that were initially to be considered today were later removed from a list published by House Majority Leader Kevin McCarthy (R-Cal). The Encouraging Employee Ownership Act of 2015 (H.R. 1675) directs the SEC to amend its regulations to increase the disclosure thresholds for compensatory benefit plans. This bill drew some opposition and was reported by the Financial Services Committee by a vote of 45-15.

The other bill, the Streamlining Excessive and Costly Regulations Review Act (H.R. 2354), directs the SEC to determine if any significant regulations issued by it are outmoded or excessively burdensome. This bill also has its critics, resulting in a committee vote of 41-16.

Monday, July 13, 2015

Washington Proposes Regulation A Tier 2 Notice Filing

By Jay Fishman, J.D.

Washington is the first state to propose a notice filing for Regulation A Tier 2 offerings, following the SEC’s adoption of Regulation A amendments on June 19, 2015.

Initial offering. Issuers would send the Securities Division the following items before making an initial offer in Washington: (1) a complete Regulation A – Tier 2 Offering Notice Filing Form or other document identifying the filing; (2) a Form U-2, Uniform Consent to Service of Process (if not provided on the notice filing form); and (3) a fee of $100 for the first $100,000 of initial issue (or portion of in Washington) based on the offering price, plus one-fortieth of 1 percent for any excess over $100,000 for the first 12-month period. The initial filing is effective for 12 months.

Renewal offering. Issuers continuing the same offering for an additional 12-month period could renew the unsold portion of their notice filing by submitting the following items on or before the current notice filing’s expiration: (1) a Regulation A – Tier 2 Offering Notice Filing Form marked “renewal” and/or a cover letter (or other document) requesting renewal; and (2) a fee of $100 for each additional 12 months in which the same offering is continued. Issuers increasing the amount of securities subject to the renewal notice filing would pay a fee to cover the increased amount of securities being offered.

Amended offering. Issuers could increase the amount of securities offered in Washington by submitting before the securities sale covered by the below fee: (1) a Regulation A – Tier 2 Offering Notice Filing Form or other document describing the transaction; and (2) a fee of one-fortieth of 1 percent of the desired increase based on the offering price.

Friday, July 10, 2015

House FSC Hears Testimony on Stability Following Dodd-Frank

By Amy Leisinger, J.D.

In a hearing yesterday, the House Financial Services Committee discussed and heard testimony on whether, five years after the passage of the Dodd-Frank Act, the U.S. financial system is more stable than it was before the legislation. Despite mixed responses, the witnesses and committee members seemed to agree that the 2,000+ pages of the Act and its required regulatory changes did not, and possibly could not, address all pertinent issues.

Silvers testimony. According to testimony by AFL-CIO Director of Policy and Special Counsel Damon A. Silvers, the Dodd-Frank Act was a compromise, and, because it left a large number of questions to regulators, it has been vulnerable to the political forces. However, the Act gave regulators significant new powers and the discretion to use them, he said, and, while the U.S. financial system continues to suffer from structural problems, it is no longer as vulnerable to crisis as it once was. The Act includes measures to counter systemic risk and the issue of “too-big-to fail,” but their effectiveness depends on the willingness of financial regulators to properly implement it, according to Silvers. “Powers have not been used to anywhere near the extent they could to protect against another bailout of the banks by the public,” he explained.

The Dodd-Frank Act closed numerous loopholes in what was a “Swiss cheese system,” Silvers explained, which has resulted in greater resiliency and more transparency. However, the achievements face threats in the form of failed implementation and lack of preventing banks from becoming too big to fail. These issues need to be addressed to achieve increased stability, he concluded.

Calabria testimony. Mark A. Calabria, Ph.D., the director of Financial Regulation Studies at the Cato Institute, was unimpressed by Dodd-Frank’s efforts to increase stability. In his testimony, he noted that stating goals and purposes is not the same as achieving them. “[T]he alternative to Dodd-Frank was not “doing nothing,” Calabria said, and the urgency to address the crisis may have led to poor, even harmful, policy choices.

The financial crisis was driven largely by growth and failure in the property markets and their link to U.S. capital markets coupled with loose monetary policy and encouragement for high leverage, he explained. However, the main issue that drove the passage of the Dodd-Frank Act was the perception that certain large institutions enjoyed the backing of the federal government, according to Calabria, but the Act’s approach to ending TBTF without taxpayer or industry cost is basically optional. With errors of both “commission and omission,” Dodd-Frank has reduced financial stability, concentrating risks while leaving the primary causes of the financial crisis unaddressed, he opined.

Atkins testimony. Paul S. Atkins, CEO of Patomak Global Partners, LLC and former SEC Commissioner, took issue with the Act’s creation of the FSOC and the SIFI designation process, as well as the Volcker Rule and the impact on bond market liquidity and noted that costs associated with these changes are falling onto investors. He stated that the Volcker provisions of Dodd-Frank and the attendant regulations fail to address a key part of the financial crisis and, as implemented, may have serious consequences for investors, job creators, and the U.S. economy. He also faulted the Act for failing to address the “crazy quilt” of financial regulators and the need for coordination.

When asked by Committee Chairman Jeb Hensarling (R-Tex) about whether stability has actually decreased, Atkins suggested that forcing banks to back away from proprietary trading and restricting capital markets may actually have had a net negative effect. The focus of financial regulation should be on figuring who is being harmed and how it is happening, not on generalized assertions, he said.

Zywicki testimony. George Mason University Foundation Professor of Law Todd Zywicki concentrated his comments on the work of the Consumer Financial Protection Bureau (CFPB). The Dodd-Frank Act failed to make changes to increase consumer financial protection and, over time, has resulted in higher prices and reduced consumer choice, he said. Further, he continued, the CFPB continues to expand its power and promote its own interests, and curtailing consumer credit harms the average person. “[T]he overall impact of Dodd-Frank has been to slow our economic recovery, raise prices, reduce choice, and eliminate access to the financial mainstream for American families,” he opined.

Thursday, July 09, 2015

Sen. Warren Bill Sees Future in Glass-Steagall’s Past

By Mark S. Nelson, J.D.

Senator Elizabeth Warren (D-Mass) will introduce a bill that would restore some of the banking limits once enshrined in the Great Depression-era Glass-Steagall Act. She is joined in this effort by co-sponsors John McCain (R-Ariz), Angus S. King, Jr. (I-Me), and Maria Cantwell (D-Wash). The senators believe recent financial reforms did not go far enough to cut the risks posed by the biggest banks, so they are offering a bill that mirrors one they introduced in the 113th Congress to further curb banks’ riskiest activities, said a press release.

A modern Glass-Steagall framework. Banks would have a five-year period under Sen. Warren’s bill to transition into smaller versions of themselves, in which they must separate their deposit taking business from the riskier product offerings they created in the decades since the Glass-Steagall Act became law, was eroded by regulators, and then repealed. The bill also would impose penalties for violations of the banking laws targeted by Sen. Warren, noted a fact sheet.

"The biggest banks are collectively much larger than they were before the crisis, and they continue to engage in dangerous practices that could once again crash our economy,” said Sen. Warren. “The 21st Century Glass-Steagall Act will rebuild the wall between commercial and investment banking and make our financial system more stable and secure.” Senators McCain and Cantwell echoed these sentiments.

How the bill works. According to the bill’s safety and soundness provision, no federally insured depository institution may be an affiliate of, or be in common ownership or control with, or qualify as, an insurance company, securities entity, or swaps entity. Existing affiliate relationships that run afoul of the bill would have to end within five years of enactment, unless terminated early or granted a six month extension. Federal banking regulators could, after a hearing, order the early termination of these relationships when necessary in the public interest to prevent undue resource concentration or other anticompetitive or unsound banking practices.

Moreover, persons who are officers, directors, or employees of insurance companies, securities entities, or swaps entities, or another institution-affiliated party may not simultaneously hold these posts at an insured depository institution. An exception would exist if federal banking regulators determined that a person serving in these roles at both types of institutions would not unduly influence the depository institution’s investment policies or the advice that institution gives to its customers. Officers and directors required to terminate their roles at affiliated firms must do so as soon as practicable once Sen. Warren’s bill becomes law, but not later than 60 days after enactment.

“Securities entity” would mean any entity engaged in the issuance or distribution of securities, market making, broker-dealer activities, futures commission merchant activities, playing the role of investment adviser or taking part in investment company activities, or making hedge fund or private equity investments. But the term would not apply to a bank that is engaged in authorized trust and fiduciary activities.

The bill also would define “swaps entity” to include any swap dealer, major swap participant, security-based swap dealer, or major security-based swap participant, as described in the Commodity Exchange Act or the Exchange Act.

Senator Warren’s bill would update federal banking laws to clarify the activities permitted to national banks and federal savings associations. The bill further revises the Bank Holding Company Act to clarify the activities prohibited to bank holding companies. Under the holding company amendments, the executives of a bank holding company or its affiliate must attest in writing that their institutions are in compliance with activities ban.

Lastly, the bill would formally repeal specified Gramm-Leach-Bliley Act provisions and some provisions in the federal bankruptcy laws. The bill also would make numerous technical and conforming amendments to the banking laws.

Wednesday, July 08, 2015

NYSE Suspends All Trading for Three Hours Due to ‘Technical Issue’

By Lene Powell, J.D.

The New York Stock Exchange (NYSE and NYSE MKT) today suspended trading across all symbols for more than three hours, between 11:32 am and 3:10 pm ET. NYSE stated on Twitter that the suspension was due to an “internal technical issue” and was not the result of a cyber breach. The exchange said it chose to suspend trading to avoid problems arising from the technical issue and that trading of NYSE-listed securities continued unaffected on other market centers.

In a brief statement, Chair Mary Jo White echoed that NYSE and NYSE MKT stocks continued to trade normally through other trading venues during the disruption.

According to a NYSE statement, all orders at the time of suspension of trading were cancelled, including market-on-close, limit-on-close, and conditional orders. Good-til-cancelled orders remained active. Upon market re-opening, the Openbook feed for NYSE MKT Primary markets was not available for the rest of the day and customers were advised to use market data from the SIP feed. Closing auctions were expected to continue as normal.

It's All Relative: Tipping Family Members Is Sufficient to Establish Breach of Fiduciary Duty

By Rodney F. Tonkovic, J.D.

A Ninth Circuit panel has affirmed a conviction arising out of an insider-trading scheme between family members. In the wake of U.S v. Newman, Bassam Yacoub Salman argued that the evidence was insufficient to sustain his conviction. The panel found that the evidence was sufficient because it showed that an insider breached a fiduciary duty by disclosing information to Salman, who knew about the breach when he traded on it (U.S. v. Salman, June 9, 2015, Rakoff, J.).

Background. In 2003, Maher Kara, who worked for Citigroup’s healthcare investment banking group, became engaged to Salman's sister. As time went on, Salman grew close to Kara's brother, Michael, who began to share with Salman inside information that he had learned from Maher. Salman traded through an intermediary and eventually amassed over $2 million from his trades.

On September 1, 2011, Salman was indicted for one count of conspiracy to commit securities fraud and four counts of securities fraud. At trial, the government presented evidence that Salman knew that Maher Kara was the source of the information that he traded on. Maher testified that he gave Michael inside information out of love and for the benefit of his brother, and the evidence demonstrated that Salman was aware of the brothers' close relationship.

Salman was found guilty on all counts. He timely appealed the district court's denial of his motion for a new trial, but, in the meantime, the Second Circuit decided U.S. v. Newman, which held that to establish that a tippee engaged in insider trading, the government must prove – in a criminal case, beyond a reasonable doubt – that the tippee had knowledge of the personal benefit to the tipper and that there is a quid pro quo relationship.

Friends and family. On appeal, Salman urged the Ninth Circuit to adopt the Newman standard, arguing that the evidence was insufficient to find that Maher Kara disclosed information to Michael Kara in exchange for a personal benefit, or, if he did, that Salman knew of any such benefit. Judge Rakoff, writing for the panel, disagreed, finding that the Supreme Court's holding in Dirks v. SEC (1983) governed here. In Dirks, the Court held, as relevant in this case, that a "personal benefit" constituting a breach of fiduciary duty includes the "gift of confidential information to a trading relative."

In this case, Maher Kara's disclosure of confidential information to his brother was exactly the sort of gift envisioned by Dirks. Plus, Michael Kara testified that he told Salman that Maher was the source of the confidential information. There was no question, then, that the evidence was sufficient to find that Maher disclosed information in breach of his fiduciary duty and that Salman knew this.

Salman maintained that Newman interpreted Dirks to require more than just a friendship or familial relationship between tipper and tippee, such as some tangible benefit. The panel rejected this interpretation, saying that it would depart from "the clear holding of Dirks" and, moreover, that Newman itself said that "personal benefit" is broadly defined. "Proof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading," Judge Rakoff said, and that was what occurred in this case.

The case is No. 14-10204.

Tuesday, July 07, 2015

Newman No Help to Gupta; No Quid Pro Quo Required for Tipper Liability

By Lene Powell, J.D.

Newman did not add a requirement for tippers to receive a “quid pro quo” from tippees, so Rajat Gupta lost his bid to have his two-year sentence for insider trading vacated. According to Judge Rakoff, Newman did not change the “personal benefit” standard as it applied to Gupta’s case, so it would not have been futile to raise the issue on appeal and Gupta did not establish that he was actually innocent. Moreover, even if an element of a pecuniary benefit from tippee to tipper was required, as Gupta argued, such a benefit was proved against Gupta at trial (U.S. v. Gupta, July 2, 2015, Rakoff, J.).

Background. In 2012, former Goldman Sachs board member Rajat K. Gupta was sentenced to two years in prison for giving material non-public information about Goldman to Raj Rajaratnam of The Galleon Group, in violation of the insider trading prohibition under Exchange Act Section l0(b). In March 2014, a Second Circuit panel upheld Gupta’s conviction and denied his request for a new trial, ruling that the district court properly admitted, limited, or excluded wiretap and character evidence. On April 20, 2015, the Supreme Court denied certiorari on Gupta’s petition.

No futility under previous law. Gupta brought a motion for post-conviction relief under 28 U.S.C. § 2255 to vacate the sentence and judgment against him, arguing that, in light of the Newman decision, the court’s instruction to the jury concerning the "personal benefit" element of an insider trading violation was wrong and that not enough evidence of such a benefit was proved at trial to sustain his conviction.

In a Section 2255 motion, the defendant must demonstrate either cause for failing to raise the issue and resulting prejudice, or actual innocence. One way a habeas petitioner can establish cause is by showing that that it would have been futile to raise or preserve the issue, due to prior case law that consistently rejected the particular claim. Here, however, Gupta’s argument was not futile. Although Newman may have narrowed the range of evidence that would support an inference of “benefit,” it did not purport to overrule any binding precedent. Also, belying the claim that it was futile, at trial Gupta objected to the description of the benefit element in the jury instructions, but then decided not to pursue the argument on appeal. Because the argument was not futile—then or now—it should have been raised on appeal.

No actual innocence. Gupta argued that if the Newman standard of benefit had applied at the time of his trial, the evidence against him would not have been sufficient. According to Gupta, Newman requires that the tipper (Gupta) receive a “quid pro quo” from the tippee (Rajaratnam) in the form of a “potential gain of a pecuniary or similarly valuable nature.”

This was a misreading of Newman, said the court. That case was concerned with the liability of a remote tippee, and turned on whether the tippee knew that the information was the result of a breach of fiduciary duty by the tipper. Information about personal benefit went to whether evidence could reasonably support an inference of knowledge on the part of a remote tippee. However, Gupta was the tipper, so what Rajaratnam knew was irrelevant to Gupta’s own liability. Both before and after Newman, a tipper is liable for securities fraud if he takes sensitive market information provided to him in a fiduciary capacity and exploits it for some personal benefit. That is how the jury was instructed in Gupta’s case.

“A tipper's intention to benefit the tippee is sufficient to satisfy the benefit requirement so far as the tipper is concerned, and no quid pro quo is required,” said the court.

Even if the personal benefit element did apply to tippers, the burden of proof was satisfied in Gupta’s case. Gupta and Rajaratnam had a “meaningfully close relationship” because they were close friends and Gupta was on a short list of people allowed to speak with Rajaratnam at the end of the trading day. Moreover, they were close business associates with a “considerable history” of exchanging financial favors. The tips, which conveyed non-public information about a $5 billion investment in Goldman as well as an unprecedented quarterly loss, were "objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature." Further, because Gupta was a Galleon investor, any tips on which Rajaratnam traded had the potential to increase the value of Gupta's shares.

Motion denied. Because Gupta did not show either futility or actual innocence, the court denied the motion for post-conviction relief.

The case is No. 11 Cr. 907 (JSR).

Monday, July 06, 2015

‘Turnaround Queen’ Tilton Seeks Reversal of Fortune in Second Circuit

By Mark S. Nelson, J.D.

Self-proclaimed “Turnaround Queen” Lynn Tilton will take the path already trod by Laurie A. Bebo in the Seventh Circuit by taking her case disputing the constitutionality of the SEC’s administrative enforcement regime to the Second Circuit. Tilton, who opted to appeal the denial of a preliminary injunction by District Judge Ronnie Abrams earlier this week, will likely raise subject matter jurisdiction issues akin to those argued by Bebo’s lawyers in the federal appeals court in Chicago last month (Tilton v. SEC, July 1, 2015).

What the challengers want. Many observers of the nine cases against the SEC now percolating in district and appeals courts within three circuits (Second, Seventh, and Eleventh) pine for a major substantive opinion on the Article II appointments clause issues: Do the SEC’s administrative law judges (ALJs) enjoy too many layers of good cause removal? Should the Commission appoint its own ALJs?

Those looking for answers to these questions, including all of the SEC enforcement targets who have sued the agency, want federal courts to decide between two lines of cases. In one scenario, exemplified by the Supreme Court’s Freytag opinion, those contesting the SEC’s ALJs analogize them to the Tax Court’s special trial judges, who the Freytag court held were inferior officers (but whose appointments did not violate Article II). By contrast, the SEC defends its ALJs by analogizing them to the Federal Deposit Insurance Corporation’s “employee” ALJs who remain outside of Article II under the D.C. Circuit’s Landry opinion.

Leaping the jurisdictional hurdle. But prior to answering the big constitutional questions, the district courts have to decide (or be told by the appeals courts) if they can even hear the suits brought by those who dispute the SEC’s enforcement authority. This question likely depends on how courts apply the Supreme Court’s Thunder Basin, Free Enterprise, Elgin and McNary opinions.

Thunder Basin would allow pre-enforcement challenges to agency action if no meaningful route for judicial review exists, the suit is wholly collateral to the statutorily-prescribed review process, and the claims are beyond the agency’s expertise. In Tilton’s case, Judge Abrams ruled that the Exchange Act adequately provides for judicial review of an adverse order.

But Judge Abrams rejected a broader view of “meaningful” posed by Judge Richard M. Berman in Duka (also a case challenging the SEC’s ALJs, but ultimately denying the requested injunctive relief) in favor of a narrower view announced by Judge Lewis A. Kaplan in Chau (both Duka and Chau were decided by judges in the Southern District of New York). “Such an exception to the enforceability of statutory review schemes could swallow the schemes themselves; indeed, any arguably plausible claim in district court that an administrative proceeding should be enjoined as unconstitutional could confer jurisdiction and thus thwart Congress' intent to the contrary,” said Judge Abrams regarding a portion of the court’s reasoning in Duka.

Judge Abrams also noted that Tilton has judicial review options that were not available to those who challenged the PCAOB in Free Enterprise, or to the immigrants in McNary. In both cases, the persons suing the government agencies would have had to take adverse actions in order to spur agency enforcement actions against them that could in turn confer federal court jurisdiction.

As for the wholly collateral prong, Tilton tried to couch her claims as facial claims, rather than as-applied ones. But Judge Abrams said that while Tilton raised “a close question,” her claims are “intertwined” with the administrative proceeding because she raised the constitutional issues as an affirmative defense, she is within the statutory review framework, and she may yet get her desired result if the ALJ or the Commission rules in her favor. Judge Abrams said Tilton could still get a meaningful review if she loses the administrative case, even if constitutional issues are beyond the SEC’s ken.

What’s next. In the coming months, the public’s interest in the many suits trying to upend the SEC’s administrative regime will likely shift from what the federal trial courts can do for the challengers in the short term to whether the federal appeals courts might issue decisions that create a split of authority, one of the factors the Supreme Court can mull when asked to hear a case. For now, if a circuit split develops over the SEC’s ALJs, it will occur among the Second, Seventh, and Eleventh Circuits.

In the Bebo case, oral argument before a Seventh Circuit panel in June drew questions about how meaningful the statutory review process is under the securities laws, and whether the federal courts should stay out of the case on grounds analogous to Younger abstention. The Chicago-based appeals court has yet to issue its ruling in Bebo’s case, despite her lawyer’s request for an expedited decision. The SEC’s administrative proceeding against Bebo continued while she appealed the district court’s opinion.

In addition to the Bebo and Tilton appeals, the SEC has appealed its loss in the Hill case. The SEC recently asked the district judge who partially granted Charles L. Hill, Jr.’s request for a preliminary injunction to stop the SEC’s administrative proceeding against him to stay that order while the agency simultaneously appeals to the Eleventh Circuit.

The case is No. 15-cv-2472.