January 2007

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.

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

CCH Federal Securities Law Reporter

December was a remarkably busy month for the Federal Securities Law Reporter. The SEC issued several proposed and final rulemaking releases on significant and controversial matters:

Executive Compensation
The SEC adopted interim final rules to conform the reporting of executive compensation to the amounts that are disclosed in companies' financial statements under FAS 123R. The SEC concluded that by adopting the amendments as interim final rules, it could avoid the presentation of different executive compensation under the amendments adopted in July 2006 from that in later years. The amendments revise the summary compensation table and the director compensation table with respect to stock awards and option awards to require disclosure of the compensation cost of the award over the service period, as described in FAS 123R. ¶87,734.

Internal Controls
The SEC extended the compliance dates for companies that are not accelerated filers with regard to rules that require companies to include reports and certifications regarding their internal controls over financial reporting. Under the extension, a non-accelerated filer is not required to provide management's report on internal control over financial reporting until it files an annual report for its first fiscal year ending on or after December 15, 2007. If the Commission has not issued additional guidance for management in time to be of sufficient assistance in connection with annual reports filed for fiscal years ending on or after December 15, 2007, the agency will consider whether it should further postpone this date. ¶87,721. The Commission also proposed guidance for management under Sarbanes-Oxley Act Section 404. The measure is a joint proposal of the Division of Corporation Finance and the Office of the Chief Accountant. In addition to outlining a top-down, risk-based evaluation process for internal control over financial reporting, the staff has proposed amendments to Exchange Act Rules 13a-15 and 15d-15 to make clear that a company that evaluates its internal controls in accordance with the proposed guidance will satisfy the annual evaluation required by those rules. ¶87,727. Finally, the Public Company Accounting Oversight Board proposed its revised Auditing Standard No. 2. ¶87,737.

Short Sales
The Commission proposed amendments to Regulation M's Rule 105 and Exchange Act Rule 10-1, with conforming amendments to Regulation SHO. The revisions to Rule 105 address continuing violations of the rule in connection with public offerings. The proposed amendments to Rule 10a-1 would remove short sale price tests altogether based on evidence that they are not necessary to prevent market manipulation. ¶87,717, 87,718.

Gramm-Leach-Bliley Act Rules
The SEC proposed for public comment revised rules to implement the bank broker provisions of the Exchange Act as contemplated by the Gramm-Leach-Bliley Act. The proposal is a joint release of the SEC and the Federal Reserve Board. In a companion SEC-only release, the exemption from the definition of dealer was reproposed for consideration of conduit securities lending activities, among other revisions. The SEC also voted to further extend its order exempting banks from the definition of broker until July 2, 2007. ¶87,724, 87,725, 87,726.

Investment Company Provisions
The SEC proposed new rules designed to provide additional investor protections that would affect pooled investment vehicles, including hedge funds. A proposed rule would prohibit advisers to pooled investment vehicles from making false or misleading statements or otherwise defrauding investors or prospective investors in those pooled investment vehicles. Two other proposed rules would revise the definition of "accredited investor" as it relates to natural persons. ¶87,736. In addition, the commissioners had approved the staff's recommendation that the SEC reopen the comment period on the investment company governance rules that were the subject of a court challenge by the Chamber of Commerce. ¶87,723. The agency requested comments on proposed amendments that impose two independent director conditions on investment companies in light of papers issued by agency economists. The papers focused on conflicts of interest that advisers have with regard to mutual funds they advise, and the statistical properties of mutual fund returns and potential relationships between those returns and fund governance.

Transfer Agents
The SEC amended rules and forms to require transfer agent registration, annual reporting, and withdrawal from registration be filed with the SEC electronically. The forms will be filed on the Commission's EDGAR database in XML format and will be accessible to the SEC staff and the public for search and retrieval. The amendments are intended to improve the Commission's ability to utilize the information reported on the forms in performing its oversight function of transfer agent operations and to publicly disseminate the information on the forms. ¶87,715.

Litigation
In what may be a case of first impression, a federal judge (SD Tex) has assessed fees and costs under Section 11(e) of the Securities Act against the plaintiff's law firm. The case involved an outside director who was also a senior official at a financial services company. It was alleged that the director was liable under Section 11 for signing Enron's false registration statement filed with the SEC and that the financial services company was also liable as a controlling person of the director. The court found that the fact that the financial services company employed the director was not enough to establish the power to control his role as an independent director. An award of fees and costs under Section 11(e) is conditioned on a finding that the action was without merit, that it was frivolous or brought in bad faith. The court went on to award fees and costs to the financial services company related to the summary judgment stage of the litigation because it appeared that the summary judgment briefing should not have been necessary and the continuance of the claim at that point was without merit. The court also reasoned that an award of fees and costs under Section 11(e) should be borne by counsel because non-attorney clients more likely than not would not have the ability to determine at what point, based on what evidence, an action becomes legally frivolous, while its counsel should. The court said that, if mere approval of a corporate officer's request to serve as an outside director on another company's board would be held to be control person liability, the effect would be to chill the willingness of qualified individuals to serve on boards of public companies as independent directors. This result would be a detriment to business, and the court could not countenance it. In re Enron Corp. Securities, Derivative, & ERISA Litigation is reported at ¶94,132.

CCH Blue Sky Law Reporter

Illinois Sets Forth New Branch Office Definition and Form BR for Dealers
The new definition of a "branch office" determined by agreement of the North American Securities Administrators Association, Inc., the New York Stock Exchange and the National Association of Securities Dealers, as well as Form BR, Uniform Branch Office Registration Form, were adopted by the Illinois Securities Department. Applicants for dealer registration must file Form BR with the Central Registration Depository (CRD), providing the address of each branch office located in Illinois, and paying a $20 fee for each branch office. Dealers must annually renew their branch office registrations by December 31, by submitting Form BR through the CRD, providing the address for each branch office in Illinois, and paying a $20 renewal fee for each branch office. Dealers must file an amended or initial Form BR with the CRD within 10 business days after either opening any branch office in Illinois not previously reported or closing any branch office in Illinois. ¶22,632, 22,679.

Louisiana Adopts Investment Adviser Representative Exam Requirements
Rules setting forth examination requirements for investment adviser representatives were adopted by the Louisiana Office of Financial Institutions. Investment adviser firms are required to send the Commissioner proof of each investment adviser representative having passed either the Uniform Investment Adviser Law Examination (Series 65) or the General Securities Representative Examination (Series 7) and the Uniform Combined State Law Examination (Series 66). ¶28,537.

CD-Plus-Bonus Package Did Not Constitute a Security
Setting aside an administrative desist and refrain order, the California Court of Appeal held that a CD-plus-bonus package did not constitute a security under California law. The respondents had used advertisements for high-rate certificates of deposit in order to lure customers to hear a sales pitch for annuities. Although perceiving the arrangement to be simply a "bait and switch" scheme to sell annuities, the appellate court concluded that the bonus package did not meet the definition of an investment contract, and hence a security, under either the risk capital or the Howey tests. Reiswig v. Department of Corporations for the State of California is reported at ¶74,602.

"Sale of Business" Doctrine Precluded Fraud Claims
The Hawaii Intermediate Court of Appeals held in Fong v. Oh that the anti-fraud provisions of the Hawaii Uniform Securities Act do not apply when a party sells all, as opposed to only a portion, of the stock of a corporation. The appellant purchasers contended that the appellee's failure to disclose that a portion of the corporation's income was derived from illegal cigarette sales constituted an omission of a material fact under Haw. Rev. Stat. §485-25. Although acknowledging the contrary opinion of the United States Supreme Court with regard to the "sale of business" doctrine, the appellate court relied on the Hawaii Supreme Court's precedent and ruled that the transaction at issue did not involve a security. The case is reported at ¶74,603.

Defective Return of Citation Did Not Support a Default Judgment
The Court of Appeals of Texas held that a default judgment was improper where the return of citation did not show that the person served had the capacity or authority to accept service of process on behalf of the Texas Securities Commissioner (Commissioner). The plaintiff had attempted to serve the defendant, a broker-dealer registered with the State of Texas, by delivering the process to the office of the Commissioner as the corporation's statutory agent. The appellate court held, however, that the return of citation was fatally defective because it was impossible to determine from the face of the record who the named recipient was or whether she was an agent authorized to accept service on behalf of either the Commissioner or the defendant. Harvestons Securities, Inc. v. Narnia Investments, Ltd. is reported at ¶74,604.

SROs Not Entitled to Immunity for Private Commercial Conduct
The United States Court of Appeals for the Eleventh Circuit held that the appellant self-regulatory organizations (SROs) were not entitled to absolute immunity from suit when they engaged in private commercial conduct. An investor claimed that the National Association of Securities Dealers, Inc. and its subsidiary, the NASDAQ Stock Market, Inc., violated the Florida Blue Sky Law by engaging in allegedly fraudulent marketing activity in order to profit from a resulting increase in trading volume. The appellate court concluded that, although the SROs enjoyed immunity with regard to any regulatory actions mandated by the Securities Exchange Act, their for-profit advertising activities remained unprotected because they were not quasi-governmental in nature. Weissman v. National Association of Securities Dealers, Inc. is reported at ¶74,605.

Pennsylvania Court Affirms Finding of the Willful Issuance of Unregistered Securities
The Commonwealth Court of Pennsylvania in Stas v. Pennsylvania Securities Commission affirmed an administrative finding that the petitioner willfully and fraudulently issued unregistered securities. The petitioner, a former securities agent, induced four Pennsylvania residents to enter into a series of private investment agreements by promising to pay them “tax free” interest at rates of up to twenty percent per year. On appeal, the petitioner contended that the Pennsylvania Securities Commission could not require her to offer restitution to the investors because her conduct did not constitute the issuance of a security, but merely involved the memorialization of a personal loan. The appellate court concluded, however, that the agreements met the Howey test for an investment contract, and hence a security, because the investors depended solely upon the petitioner's efforts to purchase stock necessary to generate the expected profits. The case is reported at ¶74,606.

New Smart Chart Added: The State-by-State Treatment of Hedge Funds
This new Smart Chart contains all the provisions in the Blue Sky Law Reporter on hedge funds.

New Smart Chart Added: Decisions Involving Arbitration
This new Smart Chart tracks state and federal court decisions that involve the arbitration of claims arising under state Blue Sky Laws.

Aspen Federal Securities Publications

Financial Reporting Handbook, by Michael Young
The latest release, Release 13, published in December and will be live on the IRN Corporate Governance Library shortly. This reference provides quick access to critical aspects of financial reporting. In addition to covering the Sarbanes-Oxley Act, SEC rules and regulations, standards of the Independence Standards Board and the AICPA and requirements of the New York Stock Exchange, NASDAQ, and the American Stock Exchange, the Financial Reporting Handbook tackles important underlying themes such as the centrality of the audit committee, the individual responsibility of executives, and the integrity of the outside auditor.

Securities Regulation, by The Late Louis Loss, Joel Seligman, and Troy Paredes
The 2007 Cumulative Supplement, which published in early December, updates the cornerstone Securities Regulation treatise. Part of the Securities Integrated Library on IRN, this supplement volume fully incorporates the large number of legislative, regulatory, and case law changes in the past year, including the SEC’s 2006 overhaul of executive compensation disclosure requirements; the SEC’s 2005 public offering reforms; the Supreme Court’s decision in Dura Pharmaceuticals v. Broudo concerning loss causation, and subsequent cases citing Dura; the regulatory framework implementing § 404 of Sarbanes-Oxley; the PCAOB’s rules promoting the ethics and independence of accounting firms; the SEC’s amendments to its accelerated filer deadlines for large accelerated filers; the SEC’s amendments to the penny stock rules; the Supreme Court’s opinion in Merrill Lynch, Pierce, Fenner & Smith v. Dabit concerning SLUSA preemption of state law class actions in “holding” cases; and the SEC’s approval of the application of the Nasdaq to become a national securities exchange.

Capital Markets Handbook, Edited by John C. Burch, Jr. and Bruce S. Foerster
The 2007 Supplement published in December and is part of the International Business Integrated Library on IRN. This supplement includes new information relating to the SEC’s Securities Offering Reform; amendments to the Analyst Rules (NASD Rule 2711 and NYSE Rule 472); proposals to amend Regulation M; prospectus delivery and the new free writing prospectus; changes in underwriting documents; domestic stock and options markets update; credit ratings agencies update; and an expanded glossary and additions to the significant dates section.