June 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. 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

New Investor Asset Custody Rules Proposed
The SEC approved the issuance of proposed new rules to strengthen the investment adviser custody requirements in response to recent major investment scams. The proposal would add a requirement that all registered advisers with custody of client assets must undergo a “surprise" examination by an independent public accountant. Investment advisers whose client assets are not held by a firm independent of the adviser would be required to obtain a written report from an accountant registered with the Public Company Accounting Oversight Board about the adviser’s controls. The proposed surprise examination conducted by an independent public accountant would verify that client assets exist. The accountants would be required to notify the SEC within a day if they discover any material discrepancies. The current rules do not require a surprise exam if the custodian sends statements directly to the clients. Release No. IA-2876 will be published at ¶88,623.

Authority Delegated to SEC General Counsel to Designate Officers
The SEC has amended its rules to delegate authority to the General Counsel to designate officers in authorized investigations conducted by the Office of General Counsel. The delegation will allow the General Counsel to designate additional officers for an authorized investigation or to rescind designations as the investigation proceeds. The new authority is intended to spare the Commissioners and their staffs from having to review matters in which the Commission has already issued an order and that implicate no policy issues. Release No. 34-59829 at ¶88,611 (ip access user).

Panel Reverses Scienter Finding, Shortens Class Period
A panel of the 3rd Circuit Court of Appeals affirmed in part a district court's judgment in a putative class action brought by shareholders in communications company. The shareholders alleged that the company made false or misleading statements about earnings growth potential and price competition during the class period. The district court granted the company's motion to dismiss the complaint for failure to meet the pleading requirements of the Private Securities Litigation Reform Act.

The panel found that the company's forward-looking statements regarding future financial results were protected by the Private Securities Litigation Reform Act's safe harbor provisions. Statements that the company was "on track" were a reaffirmation of an earlier projection and thus protected. The statements were also accompanied by "extensive and specific" cautionary language including warnings concerning intense competition and uncertainties related to marketing strategies. The panel also found that the shareholders failed to plead that the company acted with the actual knowledge that the statements were false or misleading. The panel then found that allegations that the company's officers acted with conscious or reckless disregard for the truth when discussing pricing and competition were sufficient to raise a strong inference of at least recklessness. Taken together, the circumstantial evidence gave rise to a strong inference that the company's chief financial officer either knew that his statements were false at the time they were made or was reckless in disregarding the obvious risk of misleading the public. The panel, however, only found an inference of scienter for statements made in March 2005, since earlier statements lacked at least some of the inculpating circumstances surrounding the March statements.

The panel reversed the district court's judgment dismissing the claims relating to the March pricing statements, affirmed it for the claims relating to the remaining statements, and remanded for further proceedings. The panel also held that since the complaint failed to adequately plead fraud for any statements made before March 2005, the class period could begin to run no earlier than that date. Institutional Investors Group v. Avaya, Inc. (3rdCir) is reported at ¶95,217 (ip access user).

Indenture Did Not Require Timely SEC Filing
A 5th Circuit panel affirmed a district court declaratory judgment finding an indenture obligor not to be in default because it had no obligation to file timely annual reports with the SEC. An indenture provided that an issuer of notes would file with the trustee copies of annual reports within fifteen days after they were filed with the SEC, but due to an internal investigation of its stock option practices, the issuer announced that it would not timely file a Form 10-K. Holders of the notes then sent the issuer notices of default asserting that the failure to timely file constituted a default. After completing its investigation, the issuer filed its reports with the SEC and delivered copies to the trustee. The issuer had asked the court to declare that it was not in default, while the trustee claimed that the issuer had breached the indenture by failing to timely file with the SEC.

In a matter of first impression, the panel noted that the dispute turned on the interpretation of Section 314(a) of the Trust Indenture Act, which "requires an issuer of bonds to file with the trustee copies of the annual reports which it is "required to file" with the SEC." The district court found that Section 314(a) required that the issuer timely provide copies of reports to the trustee after they were filed with the SEC but did not require that anything be filed. The panel, after examining SEC rules and cases from other circuits, held that "[s]ection 314(a) of the TIA does not impose an independent obligation timely to file reports with the SEC. Rather, Section 314(a) requires [the issuer] to provide copies of reports that are actually filed with the SEC." The panel then found that the language of the indenture itself did not impose an obligation timely to file reports with the SEC. Affiliated Computer Services, Inc. v. Wilmington Trust Co. (5thCir) is reported at ¶95,209 (ip access user).

"Suspect" Timing Not Scienter
According to a 5th Circuit panel, statements and alleged omissions made by a company CEO prior to and during an issuer tender offer were not fraudulent. The CEO stated shortly before commencement of the offer that the company did not anticipate a dividend increase for nearly two years, but that the dividend policy remained under review. Eight days after the end of the tender offer period, the company provided materials to its board proposing a change in dividend policy, recommending a 350 percent increase of the annual dividend on common stock and a 400 percent increase in the stock repurchase program.

Although the appellate court recognized that the dividend increase recommendation timing was "suspect," the panel concluded that the investors failed to provide facts sufficient to support a "cogent and compelling" inference that the statements were made intentionally or recklessly to mislead. "In fact," stated the court, "it is not clear that Appellees ever issued a materially misleading statement or omission of fact concerning the dividend policy. The close proximity of the dividend increase to the end of the tender offer, though it provides some support for an inference of scienter, is not sufficient, without more, to establish a strong inference of the requisite intent." Flaherty & Crumrine Preferred Income Fund Inc. v. TXU Corp. (5thCir) is reported at ¶95,204 (ip access user).

CCH Blue Sky Law Reporter

Florida Exempts Single-Share Stock Certificate as a Gift
An exemption from registration is available for the offer or sale of a single-share stock certificate as a gift by a single-share stock certificate retailer, provided: (1) the shares of stock are purchased through a registered dealer; (2) the stock certificate is marketed, offered and sold as a decoration or novelty item; (3) the stock certificate is mounted, matted or framed; (4) each framed stock certificate represents one share of stock in the underlying company; (5) the stock certificate retailer does not offer the stock certificate for investment purposes; (6) the stock certificate retailer does not offer investment advice; (7) the stock certificate retailer does not directly or indirectly promote itself as a dealer; (8) the stock certificate retailer is not compensated solely for the single-share transaction; (9) the purchase and transfer of ownership of the certificate is completed within 60 days after the purchase; and (10) the offer and sale is not made in violation of the Florida securities laws or rules. ¶17,450H (ip access user).

Kansas Increases Fees for Investment Companies
The notice filing fee for offerings of investment company securities is increased to $750, from $500. The notice filing fee for offerings of unit investment trust securities is increased to $500, from $200. Investment companies whose name or whose portfolio or series name changes after filing the notice must file an additional Form NF and $100 for each portfolio or series affected by the name change, before the initial offer of a security under the new name is made in Kansas. The investment companies must indicate their former name or their former portfolio or series name on the new Form NF. ¶26,405M (ip access user).

New Mexico Proposes to Increase Sales Rep. and IA. Rep. Licensing Fees
The licensing fees for sales representatives and investment adviser representatives would be increased to $50, from $40, under rule changes proposed by the New Mexico Securities Division. ¶41,507 (ip access user).

North Carolina Adopts Administrative Hearing Procedures
Procedures for conducting investigations and holding administrative hearings were adopted by the North Carolina Department of the Secretary of State. The rules consist of the North Carolina Securities Division's issuing letters of inquiry and investigative subpoenas for testimony; conducting administrative hearings and contested case proceedings; negotiating settlements with a respondent or respondent's counsel; seeking temporary or summary orders before a notice of hearing or during a contested case proceeding; and issuing final orders. The "Administrator," "Deputy Securities Administrator," "Department," and "Division" are defined in a new rule while the existing rule defining these terms is repealed. The Securities Division is charged with enforcing these rules. ¶43,403 (ip access user), ¶43,500 (ip access user), ¶43,500A (ip access user), ¶43,501 (ip access user), ¶43,501A (ip access user), ¶43,501B (ip access user), ¶43,501C (ip access user), ¶43,501D (ip access user), ¶43,501E (ip access user), ¶43,501F (ip access user), ¶43,501G (ip access user).

Utah To Increase Mutual Fund and Rule 506 Fees
The mutual fund/unit investment trust notice fee will increase to $600, from $500, and the Rule 506 notice filing fee will increase to $100, from $60, for filings received by the Utah Securities Division on or after July 1, 2009. ¶57,517 (ip access user).

Virginia Proposes Securities Rule Changes
Rule revisions anticipated to become effective July 1, 2009 were proposed by the Virginia Division of Securities and Retail Franchising. One proposal would eliminate the Form U-2 filing requirement for Rule 505 and 506 offerings but mandate issuers to submit as their notice to the Division the same Form D filed with the SEC. Other proposals would adopt NASAA's Model Custody Rule 102(e)(1)-1 and the NASAA policy statement on corporate securities definitions, require additional information on investment adviser and federal covered investment adviser registration applications, amend the examination and termination requirements for agents and investment adviser representatives, and allow agents terminating employment with registered broker-dealers because of retirement or disability to continue to receive compensation after termination if certain conditions are met. ¶60,404 (ip access user), ¶60,411 (ip access user), ¶60,412 (ip access user), ¶60,414 (ip access user), ¶60,415C (ip access user), ¶60,415CC (ip access user), ¶60,416 (ip access user), ¶60,417 (ip access user), ¶60,435B (ip access user), ¶60,439 (ip access user), ¶60,450A (ip access user), ¶60,458A (ip access user), ¶60,458K (ip access user), ¶60,458O (ip access user), ¶60,458Q (ip access user), ¶60,458S (ip access user), ¶60,458U (ip access user).

Fraud Claim Could Not Rest on Omissions from Martin Act Disclosures
The New York Court of Appeals has held that the purchaser of a condominium could not bring a claim for common law fraud based solely on alleged material omissions from disclosures mandated by the New York Blue Sky Law (Martin Act). Reversing the decision below, the state high court emphasized that the Martin Act authorizes only the Attorney General to enforce its provisions and permits no private right of action. Although the plaintiff alleged that the defendants fraudulently represented that there were no material changes in the offering by not disclosing various construction and design defects, the court reasoned that the disclosures would not have been required but for the Martin Act and its implementing regulations. Accordingly, to accept the plaintiff's pleading as valid would impermissibly expand the statute's detailed disclosure requirements by transforming every claim concerning latent construction defects into a claim for common law fraud. Kerusa Co. v. W10Z/515 Real Estate LP is reported at ¶74,764 (ip access user).

Aspen Federal Securities Publications

Securities Regulation, by the late Louis Loss, Joel Seligman & Troy Paredes. The new Fourth Edition of Volumes IV and XI (Finding Devices) of the cornerstone Securities Regulation treatise will publish in early June. Part of the Securities Integrated Library on IRN, this Fourth Edition volume fully incorporates the large number of legislative, regulatory, and case law changes since Securities Regulation, Third Edition was published.

Hot Topic of the Month

This month's hot topic is controlling person liability. A director or officer may incur controlling person liability for fraud and other violations committed by another person. Under Exchange Act Section 20(a), any person who directly or indirectly controls someone who has violated the law is liable to the same extent as the violator. The controlling person is not liable, however, if he or she acted in good faith and did not induce the other person to commit the violation. Similarly, Securities Act Section 15 imposes controlling person liability upon a person who controls another person liable under Section 11 or 12. Controlling person claims are predicated on a primary violation of securities law; where there is no underlying primary security claim, secondary claims must be dismissed.

Controlling person status is a factual question, and a director of a corporation is not automatically liable as a controlling person. There must be some showing of actual participation in the company's operation or some influence before courts will impose the consequences of control. The courts are split on the necessary level of participation or influence to trigger control person liability. Some circuits have adopted the so-called "culpable participant" test, requiring some evidence that the alleged control person actually participated in the transaction in question. Under this test, liability may be established without regard to whether the controlling person was directly or indirectly involved in the fraud and may be premised on inaction, but only if it is apparent that the inaction intentionally furthered the fraud or prevented its discovery. Other courts have rejected the culpable participation requirement and have, instead, required the plaintiff to show that the defendant: (1) exercised general control over the operations of the company principally liable; and (2) possessed the power or ability to control the specific transaction or activity on which the primary violation was predicated, even if that power was not exercised.

We publish related information in a wide range of resources (e.g., Federal Securities Law Reporter, 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

Insights – Amy L. Goodman (e.g., “Company Liability after the Act Sarbanes-Oxley” (October 2004) (ip access user)
Securities Regulation – Loss, Seligman & Paredes (e.g., Chapter 11.D.1 (ip access user))
Corporate Finance and the Securities Laws – McLaughlin & Johnson (e.g., Chapter 5.01[D] (ip access user))
The Regulation of Corporate Disclosure – Brown (e.g., §10.05 (ip access user))
Jim Hamilton’s World of Securities Regulation (http://jimhamiltonblog.blogspot.com/ see e.g., 12-6-06)

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:

#807 - Going Concern Disclosure

An interactive table featuring going concern disclosures as they appear in the IPO prospectuses of all post 1/1/01 companies classified as going concerns

Use IPO Vital Sign #807 to...

  • Compare "going concern" IPO issuers in terms of revenue, lead manager and SIC code.
  • Determine if you or your client company's financial situation is conducive to doing an IPO.
  • Analyze the placement and content of going concern disclosures and draft those portions of the IPO prospectus.

Tip! To get a comparative reading of all going concern disclosures highlighted in this IPO Vital Sign, click the [All] button located in the Going Concern Disclosure column header. Click the compare button to open up the full disclosure window. To deselect all of the disclosures, click the [None] button, also located in the column header.