February 2009


From the editors of CCH Federal Securities Law Reporter, CCH Blue Sky Law Reporter and the securities publications of Aspen Publishers, this update describes important developments covered in these publications, as well as timely topics of interest generally to federal and state securities practitioners. This update includes a new feature, “Market Crisis Resources,” a compilation of links to vital information on the current market crisis. Also included is a “Hot Topic of the Month,” with research tips and references to CCH and Aspen source material on point. Finally, this update includes a preview of IPO Vital Signs, an advanced IPO research analysis tool, for IPO professionals and pre-IPO companies.

To view past issues of the Securities Update, please visit http://business.cch.com/updates/securities

If you have questions or comments concerning the information provided below, please contact me at rodney.tonkovic@wolterskluwer.com.

 

CCH Federal Securities Law Reporter

SEC Updates Oil and Gas Company Reporting Requirements
The SEC unanimously approved revisions to modernize its oil and gas company reporting requirements to help investors evaluate the value of their investments in these companies. The new disclosure requirements approved by the Commission include provisions that permit the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes. The new requirements also will allow companies to disclose their probable and possible reserves to investors. Currently, the Commission’s rules limit disclosure to only proved reserves. The new disclosure requirements also require companies to report the independence and qualifications of a reserves preparer or auditor; file reports when a third party is relied upon to prepare reserves estimates or conducts a reserves audit; and report oil and gas reserves using an average price based upon the prior 12-month period rather than year-end prices. Release No. 33-8995 at ¶88,423 (ip access user).

SEC Issues Report and Recommendations on Mark-to-Market Accounting
The SEC has issued a report to Congress advising that SFAS No. 157, Fair Value Measurements, should not be suspended, but that improvements should be made to the application of fair value. The 211-page report, which was mandated by the Emergency Economic Stabilization Act, outlines eight key recommendations by the staff of the Division of Corporation Finance and the Office of the Chief Accountant. The staff explained that SFAS No. 157 does not require mark-to-market or fair value accounting. Various accounting standards require fair value accounting of which mark-to-market accounting is a subset. SFAS No. 157 establishes a common definition of the term fair value for financial reporting and provides for expanded disclosures when preexisting standards require or permit the use of fair value. The staff concluded that a return to practices that existed prior to the issuance of SFAS No. 157 would be a return to reliance on conflicting guidance and would reduce comparability and the consistency of fair value measurements. The staff also found that SFAS No. 157 did not result in an increase in the use of fair value and that the application of the common definition of fair value did not have a significant impact on financial statements when it was adopted. SEC Report to Congress on Mark-to-Market Accounting at ¶88,422 (ip access user).

SEC Action Allows Central Counterparty for Credit Default Swaps
The SEC approved temporary exemptions allowing LCH Clearnet Ltd. to operate as a central counterparty for credit default swaps. The Commission acted to reduce counterparty risk and promote efficiency in the credit default swap market. The use of credit default swaps was a key part of the recent turmoil in the financial markets. The temporary exemptions will facilitate central counterparties such as LCH Clearnet and certain of their participants to implement centralized clearing quickly, while providing the Commission time to review their operations and evaluate whether registrations or permanent exemptions should be granted in the future. Release Nos. 34-59164 and 34-59165 at ¶88,420 (ip access user) and ¶88,421 (ip access user).

Uniform Standards Act Did Not Require Dismissal of Entire Action
A 3d Circuit panel vacated the dismissal of a class action brought against an investment adviser. The shareholders of mutual funds managed by the adviser claimed that the adviser had charged excessive fees and alleged violations of state and federal law. The district court found that the state law claims were preempted by the Securities Litigation Uniform Standards Act and held that SLUSA required the dismissal of the entire action with prejudice, including the claims that were not preempted. The court read the language of the statute to indicate that it was intended to regulate entire lawsuits.

As a matter of first impression, the panel held that the inclusion of SLUSA-preempted state-law claims in a complaint that also alleges non-preempted claims does not require dismissal of the entire action. The panel concluded that "neither the statutory language, the legislative history, nor the relevant case law supports the complete dismissal of such an action." The panel reasoned that dismissing the preempted claims, but allowing those outside of the SLUSA's scope to proceed was consistent with the statute's goal of preventing abusive securities litigation. The dismissal was accordingly vacated and the case remanded for further proceedings. In re Lord Abbett Mutual Funds Fee Litigation is reported at ¶95,046 (ip access user).

Skilling Conviction Affirmed, Sentence Will Be Modified
A 5th Circuit panel affirmed the conviction of former Enron executive Jeffrey Skilling on all counts. The appellate court concluded, however, that the trial judge incorrectly applied the federal sentencing guidelines and vacated the sentence. As a result, Mr. Skilling will receive a reduced sentence, but the re-calculated sentence will still call for several years in prison.

Initially, the court rejected Mr. Skilling's substantive challenge that he had been convicted under an improper legal theory. He was properly convicted of "honest services" fraud because he acted on his own and not at the direction of any superior, concluded the court. The panel also rejected several other claims by Mr. Skilling, including jury bias, improper jury instructions and prosecutorial misconduct.

With regard to sentencing, the court found that the trial judge improperly enhanced the sentence under the guidelines for "substantially jeopardizing the safety and soundness of a financial institution." The trial judge applied the financial institution enhancement because of the harm suffered by Enron's retirement plans. The appeals court rejected this interpretation, stating that "[u]nder the government's position, any large corporation would become a financial institution just by virtue of providing its employees with a tax-sanctioned retirement account." U.S. v. Skilling (5thCir) is reported at ¶95,037 (ip access user).

Audit Firms Not Liable in Ahold Fraud
The 4th Circuit rejected fraud claims against Deloitte & Touche and its Dutch affiliate. Ahold's fraudulent conduct, which was not at issue in this case, involved improper revenue recognition from a joint venture and from promotional allowances. Applying the Tellabs standard, the court held that the inference that the Deloitte defendants lacked the necessary scienter more compelling than any competing inference that they knowingly or recklessly perpetrated a fraud on Ahold's investors.

The court found that Ahold actively deceived their auditors, and that "the stronger and more plausible inference is that the Deloittes were, like the plaintiffs, victims of Ahold's fraud rather than its enablers." While the court observed that the firms might have done more to detect and prevent the fraud, it was not actionable misconduct by the firms given that their client actively conspired with others in order to deprive the accountant of accurate information about the client's finances. Public Employees' Retirement Assoc. of Colorado v. Deloitte & Touche (4thCir) is reported at ¶95,030 (ip access user).

Action in State Court Subject to CAFA Removal
Securities class actions covered by the Class Action Fairness Act of 2005 were removable to federal court, concluded a 7th Circuit panel. The case, which arose from a real estate investment trust merger, conflicts with a July 2008 9th Circuit case on the interplay between the non-removal provisions and CAFA.

In an earlier decision, the 9th Circuit held that the class action was not removable because the CAFA did not supersede the specific bar against removal contained in Securities Act Section 22(a). The court explained that Section 22(a) bars the removal of cases brought in state court asserting only claims arising under the Securities Act. The 9th Circuit panel found that the specific bar to removal in Section 22(a) was not trumped by the CAFA's more general grant of removal. The 7th Circuit, however, rejected this interpretation, finding that CAFA prevailed.

Initially, the 7th Circuit panel rejected the plaintiff's claim that he was a "buyer" of securities after he converted his existing holdings into cash. Judge Easterbrook wrote for the panel that "the `fundamental change doctrine' that turns a sale into a purchase is word play designed to overcome the actual text of the securities law." He added that the 9th Circuit in Luther "failed to recognize" the proper relationship between the statutes and that the court in Luther "did not appear to understand" the impact of CAFA. The appellate panel remanded the case to the federal district court to determine if any exemption from CAFA was available. "The best approach is to have the district court hold a hearing at which the parties can elaborate on their positions, for the characterization of an ambiguous claim is closer to a question of fact than to one of law," explained the court. Katz v. Gerardi (7thCir) is reported at ¶95,029 (ip access user).

Market Crisis Resources

This section provides links to vital information on the current market crisis. We offer a compendium of newsletter articles, white papers, primary source documents (e.g., regulations, releases, guidance, etc.), and other information to help track and understand the recent market upheavals and ensuing regulatory response.

  • See the new CCH Financial Crisis News Center for news and links to vital information on the current financial crisis, including a repository of primary source material and analytical content.
  • For current coverage of legislative and regulatory developments concerning the market crisis, please see Jim Hamilton's World of Securities Regulation blog at http://jimhamiltonblog.blogspot.com
  • See SEC Today for daily coverage of SEC news and policymaking, including a cover story detailing an issue or event of interest to the securities industry (see e.g., 1-27-09 (ip access user))
  • Federal Securities Law Reporter
  • Other reporters
  • White Papers
    • Financial Regulation Reform: What to Expect in the 111th Congress, by James Hamilton, (Nov. 2008) (ip access user)
    • The Other Bailout: How the Fed is Financing the Financiers, and Related SEC Disclosure, by Mark S. Nelson (Nov. 2008) (ip access user)
    • The Economic Bailout: An Analysis of the Emergency Economic Stabilization Act, by Katalina M. Bianco and John M. Pachkowski (Oct. 2008) (ip access user)
    • Market Crisis Focus on Short Selling: SEC Adopts Rules to Curb Abusive Practices, by James Hamilton (Sept. 2008) (ip access user)
    • Congress Overhauls Regulatory Regime for Fannie Mae and Freddie Mac, by James Hamilton (Aug. 2008) (ip access user)
    • The Subprime Lending Crisis: Causes and Effects of the Mortgage Meltdown, by Katalina M. Bianco (April 2008) (ip access user)
  • Newsletters
    • Hedge Funds and Private Equity: Risk Management and Regulatory Update (February 2009) (ip access user))
    • International Securities and Financial Reporting Update (1-22-09) (ip access user)
    • Mutual Funds Guide (1-26-09) (ip access user)
    • Subprime, Mortgage and Securitization Law News Updates (daily) (e.g., “House Passes Stimulus Bill” (1-30-09) (ip access user))
    • Subprime, Mortgage and Securitization Law Update (monthly) (January 2009) (ip access user)
    • The Investment Lawyer (January 2009) (ip access user)

CCH Blue Sky Law Reporter

Connecticut, Illinois, Maryland, Missouri and Vermont Adopt Electronic Form D Filing Procedures

Connecticut. Electronic Form D filing procedures in Connecticut apply to securities offerings made in reliance on Rules 504, 505 or 506 of federal Regulation D, as well in reliance on Section 4(6) of the Securities Act of 1933. These procedures cover the transition period of September 15, 2008 through March 15, 2009 during which the SEC allows issuers to paper-file old (or "Temporary") Form D, or paper or electronically file new Form D. The other requirements for Temporary Form D are not required when paper-filing new Form D. Beginning March 16, 2009, issuers will only be permitted to file new Form D and must file it electronically. Issuers filing either Form D version in Connecticut during the transition period for a Rule 506 offering must include $150 and submit the filing to the Securities Division within 15 days after the securities are first sold in the State. Issuers paper-filing Temporary Form D must sign the Form and include: (1) the Form D Appendix; (2) Form U-2, Uniform Consent to Service of Process; (3) Form D amendments for material changes; and (4) a Sales Agent/Broker-Dealer Questionnaire (or Equivalent). Issuers paper-filing new Form D must sign the Form and include Form D amendments for material changes. Issuers electronically filing new Form D may type their signature. The other requirements for Temporary Form D and paper-filing new Form D are not required when electronically filing new Form D. ¶14,621 (ip access user).

Illinois. Illinois' electronic Form D filing procedures apply to Rules 504, 505 and 506 of federal Regulation D. Between September 15, 2008 and March 15, 2009, the Illinois Securities Department will accept either a copy of the electronic version of new Form D or the SEC-filed existing ("Temporary") Form D. Beginning March 16, 2009, the Department will accept only a copy of the SEC-filed electronic version of Form D. ¶23,231 (ip access user).

Maryland. Between September 15, 2008 and March 15, 2009, issuers making securities offerings under either Rule 505 or 506 of federal Regulation D must file the version(s) of Form D accepted by the SEC at the time of filing, along with a manually executed Form U-2, Uniform Consent to Service of Process, when the version of Form D filed in connection with the offering does not contain a consent to service of process, and any other information required by the Maryland rules on Rule 505 and 506, including the applicable fee. ¶30,651 (ip access user).


Missouri. Issuers intending to make a Rule 506 securities offering in Missouri during the electronic Form D transition period --September 15, 2008 to March 15, 2009 --must paper-file directly with the Missouri Securities Division: (1) One manually signed copy of the SEC-filed Form D (including the appendix); (2) a Form U-2, Uniform Consent to Service of Process; and (3) $100. The notice must include a cover letter specifying the date the first sale of securities took place in Missouri. The notice must be filed within 15 calendar days after the first sale of securities in Missouri. ¶35,598 (ip access user).

Vermont. Vermont's 506 offering rule was adopted to accommodate electronic Form D that issuers have the option of filing electronically through March 15, 2009 but will be required to file electronically with EDGAR starting March 16, 2009. NOTE: The notice filing requirements do not apply to 506 offerings sold between July 1, 2006 and December 31, 2008 UNLESS additional sales of a 506 offering take place on or after January 1, 2009. Any 506 offerings sold on or after January 1, 2009 are subject to all of the 506 notice filing requirements. Issuers whose offer or sale of federal covered securities under Section 18(b)(4)(D) of the Securities Act of 1933 does not fall within one of the securities or transactional exemptions of the Vermont Uniform Securities Act (2002) must file with the Securities Division or its designee during the six-month transition period from September 15, 2008 to March 15, 2009, an initial notice consisting of either a Temporary Form D (that remains effective through March 15, 2009), or a copy of the paper or electronic copy of SEC-filed Form D. Either version of Form D must be manually signed by a duly authorized person of the issuer, or include a photocopy of a manually or electronically signed copy, along with a $600 fee. Issuers filing Temporary Form D must include a consent to service of process. The notice must be filed within 15 days after the first sale of securities in Vermont. Issuers must file a copy of Form D (that may be submitted electronically if permitted by the Commissioner) and a $600 fee on or after March 16, 2009. ¶58,405 (ip access user).

Michigan Adopts Uniform Securities Act of 2002
Michigan adopted Act 551, which can be cited as the “Michigan Uniform Securities Act (2002).” This Act replaces the existing Michigan Securities Act, and is effective October 1, 2009. Although differences occur, this new Act adopts a large part of the Uniform Securities Act of 2002 (USA 2002) verbatim. The enacted version of House Bill 5008, Act 551, can be found on the Michigan website at http://www.legislature.mi.gov.

Martin Act Preempted State Law Claims Involving Auction Rate Securities
A federal district court (S.D.N.Y.) has held that the New York Blue Sky Law (Martin Act) preempted state law claims alleging fraudulent and deceptive practices in the sale of auction rate securities. The plaintiff investors had asserted, inter alia, state law claims against a broker-dealer and its parent for breach of fiduciary duty, breach of the implied covenant of good faith and fair dealing, negligence, and violations of New York's consumer protection law. Relying on precedent from the New York state and federal courts, Judge McKenna ruled that no implied private right of action exists under the Martin Act because private claims that do not require pleading or proof of intent would interfere with the exclusive power of the Attorney General to prosecute state law securities claims sounding in fraud. Moreover, plaintiffs are not permitted through artful pleading to assert claims based on factual circumstances that would support Martin Act claims. Accordingly, the plaintiffs' state law claims were dismissed.

The court rejected the plaintiffs' argument that the above-referenced precedent had been overturned by the recent decision in Caboara v. Babylon Cove Development, LLC (see ¶74,726 (ip access user)), in which the Appellate Division of the Supreme Court held that the Martin Act did not preempt claims for breach of contract and common law fraud in a suit involving real estate securities. The court found the plaintiffs' reliance on Caboara unavailing because the decision appeared to overlook a long-standing distinction between the treatment of common law fraud claims, which the Martin Act does not preempt, and the treatment of other state law claims based on deceptive practices, which it does. In any event, the court reasoned, the holding in Caboara need not be extended beyond its facts because the plaintiffs in the instant case had advanced neither common law fraud nor breach of contract claims. Kassover v. UBS AG is reported at ¶74,746 (ip access user).

Aspen Federal Securities Publications

The Regulation of Corporate Disclosure, Third Edition, by J. Robert Brown, Jr.
The latest release, 2009-2 Supplement (ip access user), is now live on the IRN Corporate Governance Integrated Library. This complete and up-to-date handbook on the issue of corporate disclosure covers the impact of the federal securities laws on both informal communications and the process of communicating with shareholders. This recent update examines lower court use of the Supreme Court’s interpretation of the “strong inference” language in the PSLRA, with some surprising results; examines the SEC’s most recent pronouncements on the use of corporate Web sites to disseminate material information to the market place; examines the SEC’s latest pronouncements concerning potential liability under the antifraud provisions for the use of hyperlinks; updates the SEC’s interpretations of Regulation FD; discusses In re Thompson, a recent administrative proceeding brought against a director for the failure to disclose a business relationship with the company’s auditor; discusses a recent SEC enforcement proceeding, SEC v. Kohavi, brought against outside directors in connection with the backdating of stock options; adds an expanded discussion of a company’s obligations to have directors on the audit committee with financial expertise and the resulting disclosure obligations; reviews changes to the stock exchange rules on corporate governance; adds a new section that reviews corporate obligations to disclose related party transactions; revises the chapter on dissemination of material information with particular attention to the use of the Internet to disseminate the information; and updates the discussion of fraud on the market.

EDGAR Filer Handbook, by Charles H. Rider
The latest release, the 2009-1 Supplement (ip access user), will be live on the IRN Corporate Governance Integrated Library in early February. The production EDGAR system has been updated to Release 9.13.d.1, issued on October 27, 2008, and the previous Release 9.13.e.2, issued on September 29, 2008. This Supplement to the EDGAR Filer Handbook is current with the latest version of the EDGAR system. It also includes several important changes to the EDGAR system, which were implemented to support the amended rules and forms adopted by the Commission. Substantial parts of the EDGAR Filer Handbook have been significantly updated to reflect all changes in the EDGAR system and EDGARLink. With implementation of the new Form D on the SEC OnlineForms Management web site, all of the information and procedures in Section 6 pertaining to Forms 3, 4 and 5 and in Section 7 regarding Forms TA-1, TA-2 and TA-W are consolidated into a new Section 6 that focuses on all online filing. The new Section 6 also incorporates Form D. Additional EDGAR online forms will be included in Section 6 as they are implemented by the SEC in the future. In addition, all material concerning “filer-constructed” filings is combined into a new Section 7 devoted to this topic. We believe that this updated arrangement will make it easier and faster to zoom in on the particular information you need.

Hot Topic of the Month

This month's hot topic is credit default swaps. Credit default swaps are derivative contracts between two counterparties. Under these agreements, the buyer makes periodic payments to the seller, and will be paid by the seller if the underlying financial instrument goes into default. These instruments trade in a largely unregulated environment worth several trillion dollars. The use of credit default swaps was a key part of the recent turmoil in the financial markets.

In an effort to address concerns related to the market in credit default swaps that came to light in the recent financial crisis, the SEC recently issued an order granting a temporary exemption to exchanges and broker-dealers that engage in transactions involving credit default swaps. The credit default swaps market was operating without any meaningful regulation, transparency or central counterparties, according to the order. The establishment of central counterparties will help to control the risks that are inherent in the CDS market.

In a companion release, the SEC approved temporary exemptions from the requirement to register as a clearing agency under Exchange Act Section 17A allowing LCH Clearnet Ltd. to operate as a central counterparty for credit default swaps. The temporary exemptions are intended to allow central counterparties and their participants to implement centralized clearing quickly, while providing the Commission time to review their operations and evaluate whether registrations or permanent exemptions should be granted in the future. The conditions to the exemptions are designed to provide that key investor protections and important elements of Commission oversight apply, while taking into account that applying all the particulars of the securities laws could have the unintended consequence of deterring the prompt establishment and use of a central counterparty.

We publish related information in a wide range of resources (e.g., Federal Securities Law Reporter, SEC Today, Insights – Amy L. Goodman, Securities Regulation – Loss, Seligman & Paredes, etc.), and document types (laws, regulations, releases, newsletter articles, treatise discussion). For example:

Federal Securities Law Reporter

  • Exchange Act Section 12(a), at ¶23,001 (ip access user)
  • Exchange Act Section 17A(b)(1), at ¶26,202 (ip access user)
  • Release Nos. 33-8999, at ¶88,426 (ip access user); 34-59165 at ¶88,421 (ip access user). 34-59164, at ¶88,420 (ip access user)
  • Report letter (1-21-09) (ip access user); (12-31-08) (ip access user)
  • CCH Explanations (e.g., ¶26,204.010 (ip access user))

SEC Today

  • SEC Grants Temporary Exemption to Exchanges and Broker-Dealers Effecting Credit Default Swaps Transactions (12-31-08) (ip access user)
  • SEC Approves Exemptions to Allow Central Counterparty for Credit Default Swaps (12-23-08) (ip access user)
  • Congress Heeds SEC's Call for Regulation of Credit Derivatives (10-20-08) (ip access user)

Securities Regulation – Loss, Seligman & Paredes (e.g., Chapter 7.E.2 (ip access user))
Jim Hamilton’s World of Securities Regulation (http://jimhamiltonblog.blogspot.com/ e.g., 1-17-09 and 12-9-08)

IPO Vital Signs

IPO Vital Signs, an advanced IPO research analysis tool, assists IPO professionals and pre-IPO companies satisfy their most challenging research needs and answers hundreds of mission critical questions for all the players in the IPO process. IPO Vital Signs’ tabular data analyses focus on issues surrounding client advisement, deal negotiation, and prospectus disclosure.

IPO Week in Review, a weekly e-newsletter to keep professionals up to date with recent filing and going public activity, is an important element of the IPO Vital Signs system or is available by separate subscription. Coverage includes a monthly feature article on recent trends in going public in the U.S.

To see how an IPO Vital Sign works click on the Vital Sign title below:

#1003 - The IPO Queue

An interactive table that lists companies currently in registration at the SEC.

Review current IPO registrants by...

  • Prospective Issuer Name
  • Filing Date
  • SIC or NAICS Code
  • Business Description – Prospectus Summary First Paragraph
  • Proposed Offer Amount – if price range disclosed in initial registration
  • Revenue income
  • Net Worth
  • Team Members: Lead Manager(s), Co-Manager(s), Issuer’s Law Firm, Underwriters’ Law Firm, Auditor, Transfer Agent

Tip! Click on the column headings to re-sort the table in ascending order, pause and click again to sort in descending order.

Review prospective issuers’ business descriptions by

1. placing a check mark in the check boxes provided in column four for those prospective issuers you wish to review, and

2. clicking the [COMPARE] button located in the fifth column heading.