Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

Steve Quinlivan and Jill Radloff will speak at a seminar sponsored by Minnesota CLE titled “New Wall Street Reform Act.”  Steve is chair of the seminar.  The date of the event is September 28, 2010.  Course information can be found here.

Section 413 of the Dodd-Frank Act directs the SEC to adjust the net worth standard in the definition of accredited investor used in Regulation D.  Regulation D is often used, including by small businesses, to raise capital.  It provides an exemption from having to comply with the registration requirements of the Securities Act, which can be costly and time consuming.

Prior to the adoption of the Dodd-Frank Act,  a person was an accredited investor if a person had a net worth, or a joint net worth of a person and any spouse, of not less than $1,000,000.  Section 413 modifies this standard by excluding the value of the person’s primary residence from the net worth calculation.  The $1,000,000 standard excluding the value of a person’s primary residence was immediately applicable upon adoption of the Act.

While Regulation D provides an exemption from having to comply with the registration requirements under federal securities laws, companies raising capital must also comply with securities laws of the state in which an investor resides.  Those state laws are often referred to as “blue-sky” laws.  As a result of Dodd-Frank, some states are having to modify their blue sky laws.  For instance, Oregon has proposed an amendment to its administrative rules to align its definition with Dodd-Frank.  The Oregon rules apparently repeat the text of the definition of accredited investor in its entirety, thus necessitating an amendment.

The Minnesota statute is structured differently from Oregon, however.  Minn. Stat.  § 80A.41(1) defines an accredited investor “as the term is defined in Rule 501(a) of Regulation D adopted pursuant to the Securities Act of 1933.”  The related blue sky rule uses the same approach.

The Dodd-Frank Act effectively amended the definition of “accredited investor” upon enactment.  As a result, it likely is not necessary for Minnesota to amend its statute and rules like Oregon.  We believe those conducting exempt offerings in Minnesota should interpret the statute accordingly.

Jill covered some of the basic points of the SEC’s prior proposal on proxy access here.  My recollection is  the proposal received a record number of comments from the public.  To some, the proposal was highly controversial, and to others the proposal just did not work well.  The only thing we can predict with accuracy is the final rules will contain some significant deviations from the proposal and not everyone who voiced an opinion is going to be happy with any final rule.

 My comment letter to the SEC is here.  Some of the points I raised in my comment letter were:

 The Rules Should be Revised to Specify What Steps a Registrant Can Take to Oppose a Shareholder Nominee

 The proposed amendment to Item 7 of Schedule 14A will require the registrant to include a 500 word statement of the nominating shareholder in support of the nominating shareholder pursuant to Rule 14a-18(l).  However, the Rules do not provide any clarity as to what the registrant may state in opposition to this statement, other than the registrant’s board recommendation included on a proxy card as set forth in Rule 14a-4.  While footnote 217 to the proposing release states the process will be similar to the practice under Rule 14a-8, the extent that the registrant may lawfully oppose the shareholder nominee is not clearly set forth in the rules.  In this regard I note that Rule 14a-8(m) specifically permits the registrant to oppose a shareholder proposal, and that guidance is missing from the proposed rules. The Commission should adopt proposed rules similar to Rule 14a-8(m).

 Likewise, the rules permit nominating shareholders wide latitude to make statements in support of its nominee outside of the proxy statement under Rule 14a-2(8).  The Commission should clarify the ability for the registrant to permissibly make solicitations in opposition to the shareholder nominee outside of the proxy statement.

The Rules Should be Revised so that They Will Not Deter Settlements with Activist Investors

 Rule 14a-18(d) as written will likely have the effect of deterring settlements between the registrant and activist investors.  Activist investors often negotiate with registrants for representation on the board of directors.  Ideally, one way for a registrant to satisfy an activist investor would be to agree not to oppose the eligibility of an activist’s nominee pursuant to the proposed rules and let the shareholders decide whether to elect the activist.  However, if the registrant were to agree to such an arrangement, an activist investor could not represent there is no agreement with the registrant regarding the nominee as required by Rule 14a-18(d).  In addition, a registrant may be reluctant to otherwise settle with an activist if another shareholder nominee can be included in the proxy statement by another shareholder.  As a result, Rule 14a-18(d) should be revised to (i) permit a registrant to agree not to contest the eligibility of a shareholder nominee and (ii) if the registrant has settled a threatened election contest by placing a shareholder’s designee on the board of directors, further shareholder nominees would not be permitted under the proposed rules for a specified period of time.

 The Rules Should be Revised to Specify the Appropriate Course of Action When Multiple Nominations Are Received on the Same Day

 It is possible that a registrant could receive multiple nominations from different shareholders or groups on the same day.  In such event, how does the registrant determine who is the “first nominating shareholder or shareholder group from which the registrant receives timely notice” under proposed Rule 14a-11(d)? Does the rule hinge on receipt of the notice “sent” to the registrant pursuant to the fist paragraph of Rule 14a-18, the “simultaneous” notice to the registrant referred to in Rule 14n-1, dissemination of the notice pursuant to Rule 14n-3, or constructive receipt by filing of the notice on the EDGAR system? If it is in the order in which the Schedule 14N is received on the EDGAR system that should be made clear.

 The Rules Should be Revised to Provide Guidance on a Registrant’s Course of Action When the Registrant Believes One Nomination is Not Eligible and Another Nomination is Received

 A registrant may receive a nomination which the registrant believes does not meet the criteria for inclusion under Rule 14a-11, and the registrant may then follow the procedures under Rule 14a-11(f).  A registrant may then receive a proposal from a second nominating shareholder that it believes is eligible for inclusion under Rule 14a-11.  However, at this point the registrant may not know whether the Commission will agree with its decision to exclude the first proposal, yet the registrant is required to advise the second nominating shareholder within 14 days of whether its proposal will be excluded as required by Rule 14a-11(f)(3).  The rules should provide for guidance in this area.  Is the registrant supposed to notify the second nominating shareholder that the nomination is not eligible pursuant to the procedures under Rule 14a-11(f) and wait until eligibility for the first nomination is finally determined?  Or the rules could be revised to allow the registrant to defer notifying the second nominating shareholder as to exclusion of its proposal until such time as the SEC has taken action on the first nomination.

Michael Barr, Treasury Assistant Secretary for Financial Institutions, outlined the path forward for implementing the Dodd-Frank Act on August 10, 2010.

 Mr. Barr noted the agencies involved in implementing financial reform are in the process of establishing timelines for moving forward on the scores of studies, regulations, and other regulatory actions required by the Dodd-Frank Act.  In some critical areas, the agencies are already drafting proposed rules for public comment.  

 Mr. Barr stated the Financial Stability Oversight Council will meet for the first time in September and will establish an integrated road map for the first stages of reform and put that in the public domain.

 He discussed that Treasury is going to move quickly to begin shaping reforms of the derivatives market. In this process, Treasury will work with the Fed, the SEC and the CFTC to develop specific quantitative targets and timelines for moving the standardized part of the over-the-counter derivatives business onto central clearing houses. 

 The full text of Mr. Barr’s remarks are here.

Section 971 of the Dodd-Frank Act provides that the SEC may prescribe rules that permit shareholders to include nominees for election as directors in proxy statements and prescribe certain procedures the issuer must follow.  This provision will eliminate debate that has occurred in the past as to whether the SEC has power to adopt proxy access rules.  While the SEC is not required to adopt proxy access rules, it is widely expected that it will do so.

Given the expectation that the SEC will adopt proxy access rules, it is useful to review the SEC’s prior rule making efforts since those proposed rules may serve as a starting point for rules to be issued by the SEC in the future.  In July 2009, the SEC issued proposed rules pursuant to Release No. 33-9052 titled “Proxy Disclosure and Solicitation Enhancements.” After extensive comments were received on the prior proposal, the SEC reopened the comment period, as noted in Release No. 33-9086 titled “Facilitating Shareholder Director Nominations.”

Under the prior proposal, certain shareholders would have been able to include their nominees to the board of directors in the company’s proxy materials unless the shareholders were otherwise prohibited — either by applicable state law or a company’s charter/bylaws — from nominating a candidate for election as a director.

The prior proposal applied to all Exchange Act reporting companies, including investment companies, other than companies which only have a class of debt securities registered under the Exchange Act.

Shareholders would have been eligible, under the prior proposal, to have their nominee included in the proxy materials if:

  • They owned at least 1 percent of the voting securities of a “large accelerated filer” (a company with a worldwide market value of $700 million or more) or of a registered investment company with net assets of $700 million or more.
  • They owned at least 3 percent of the voting securities of an “accelerated filer” (a company with a worldwide market value of $75 million or more but less than $700 million), or of a registered investment company with net assets of $75 million or more but less than $700 million.
  • They owned at least 5 percent of the voting securities of a non-accelerated filer (a company with a worldwide market value of less than $75 million) or of a registered investment company with net assets of less than $75 million.

The prior proposal limited the number of directors a shareholder may nominate and have elected to the board.  No more than one shareholder nominee, or a number of nominees that represents up to 25 percent of the company’s board of directors, whichever is greater, could be nominated or hold board seats at any one time.  For example, if the board was comprised of three members, one shareholder nominee could be included in the proxy materials. If the board was comprised of eight members, up to two shareholder nominees could be included in the proxy materials.

Other facets of the prior proposal included:

  • Groups of shareholders would have been able to aggregate holdings to meet applicable thresholds.
  • Shareholders would have been required to have held their shares for at least one year.
  • Shareholders would have been required to sign a statement declaring their intent to continue to own their shares through the annual meeting at which directors are elected.
  • Shareholders would have been required to certify that they were not holding their stock for the purpose of changing control of the company, or to gain more than minority representation on the board of directors.

Of course, we have no way of predicting whether the SEC will use the prior proposal as a starting point, but we think it is useful for those interested in the subject to refresh their recollection on the mechanics involved.

The FDIC Board of Directors today approved the creation of a new Office of Complex Financial Institutions (CFI) and Division of Depositor and Consumer Protection (DCP) to help carry out its responsibilities under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The CFI will perform continuous review and oversight of bank holding companies with more than $100 billion in assets as well as non-bank financial companies designated as systemically important by the new Financial Stability Oversight Council. CFI will also be responsible for carrying out the FDIC’s new authority under the Act to implement orderly liquidations of bank holding companies and non-bank financial companies that fail. The FDIC believes the absence of such authority exacerbated the recent financial crisis, when such firms as AIG, Lehman Brothers, and Bear Stearns became insolvent.

 See the FDIC’s full press release here.

 Separately the Wall Street Journal reported (subscription required) that federal regulators expressed concern that certain provisions of the Dodd-Frank Act could do more harm than good.

The Dodd-Frank Act expands the areas in which brokers are prohibited from voting unless they have received specific client instructions.  Section 957 of the Act amends the Securities Exchange Act of 1934 to prohibit brokers from voting uninstructed shares on issues related to executive compensation (including the new “say on pay” votes), director elections and certain other matters as determined by the Securities and Exchange Commission (SEC).  The Act requires all national securities exchanges to adopt rules to implement these provisions. 

 Section 957 of the Act is meant to codify and expand the scope of NYSE Rule 452.  Under the current version of Rule 452, brokers are prohibited from voting uninstructed shares in “non-routine” matters, such as approval of equity plans and the election of directors.  The NYSE has already announced that it will file an amendment to NYSE Rule 452 with the SEC.  The new Rule 452 will apply to shareholder meetings occurring after July 21, 2010 and will cover all types of executive compensation plans, including “say on pay” votes.

 For public companies, the Dodd-Frank Act changes the calculus of proxy voting.  In matters related to executive compensation, board selection and other matters to be determined by the SEC, companies will no longer be able to count the votes of uninstructed shares. 

 Close examination of corporate charter documents (Articles or Certificates of Incorporation and By-laws) and state law will be required to determine whether broker non-votes, which may now constitute a substantial part of the “participants” at a shareholder meeting, will count for quorum purposes.  In addition, the effect of non-votes will have to be considered in determining whether a particular measure has garnered enough affirmative votes to pass.

The author wishes to thank Evan Berquist, who contributed to this post.

 

Section 954 of the Dodd_Frank Act requires national securities exchanges (meaning for instance, the NYSE, Amex and Nasdaq) to adopt rules as directed by the SEC, which rules will require issuers to develop and implement a policy providing:

  •  for disclosure of an issuer’s policy on incentive compensation that is based on financial information required to be reported under securities laws; and

 

  • that, if an accounting restatement is prepared, the issuer will recover any excess incentive-based compensation from any current or former executive officer who received such incentive-based compensation in the three preceding years.

 

These policies are typically referred to as “clawback” policies.

 Here are some recent examples of clawback policies from public filings:

  • Nike (8-K filed July 20, 2010)

 

  • Flextronics (Exhibit 10.06 to 10-Q filed on August 5, 2010)

 

  •  Ford (Exhibit 10.2 to 10-Q filed May 7, 2010)

 

  • HCA (Exhibit 10.1 to 8-K filed April 6, 2010) (note here the policy is embedded in an incentive plan)

Will these policies work under Dodd-Frank?  We do not know, because the rules are not yet written.  But they are food for thought.

 What is apparent however is there is no standard form for a clawback policy.  We encourage compensation committees and boards  to deliberate carefully when the time comes.

 We did not prepare any of these policies and do not vouch for them.  They were selected at random after a brief search.

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires certain investment advisers to “private funds” to maintain certain records and file reports with the SEC for the purpose of providing the SEC and the Financial Stability Oversight Council with an opportunity to identify potential systemic risk in the system and to address those risks before they result in a major market disruption  A private fund is defined as an entity that would fall within the definition of an “investment company” under the Investment Company Act but for reliance on one of two exemptions from that definition.  An “investment company” is broadly defined to include those entities which hold themselves out as being  primarily engaged in investing in securities. The first exemption from the definition of an “investment company” referred to in Dodd-Frank is available when an issuer has less than 100 beneficial owners of its securities.  The second exemption applies when all of the issuers owners are “qualified purchasers,” meaning certain entities that have significant invested amounts.  Many  private equity funds and hedge funds may fall within the definition of a private fund and be subject to these provisions of the Dodd-Frank Act.

Advisers to Private Funds Registered With the SEC

Section 404 of the Dodd-Frank Act, which amends Section 204 of the Investment Advisers Act of 1940, sets forth the general rules for advisers to private funds that are registered with the SEC.  It provides the SEC may require any investment adviser to a private fund registered with the SEC:

  • to maintain such records of, and file with the SEC such reports regarding, private funds advised by the investment adviser, as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk by the Financial Stability Oversight Council; and
  • to provide or make available to the Council those reports or records or the information contained therein.

Under the Dodd-Frank Act the records of private funds that are advised by investment advisers subject to Section 404 are deemed to be the records of the investment adviser.  Presumably, this will have the effect of subjecting new types of information on private funds to existing record keeping requirements applicable to investment advisers.  

In addition, Section 404 of the Dodd-Frank Act requires investment advisers to maintain certain records and information relating to clients, subject to inspection by the SEC.  These records and information include, for each private fund advised by the investment adviser, a description of:

  • the amount of assets under management and the use of leverage, including off-balance-sheet leverage;
  • counterparty credit risk exposure;
  • trading and investment positions;
  • valuation policies and practices of the fund;
  • types of assets held;
  • side arrangements or side letters, whereby certain investors in a fund obtain more favorable rights or entitlements  than other investors;
  • trading practices; and
  • such other information as the SEC, in consultation with the Financial Stability Oversight Council, determines is necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk, which may include the establishment of different reporting requirements for different classes of fund advisers, based on the type or size of private fund being advised.

A number of issues relating to these new record-keeping requirements have not yet been resolved, and will be the subject of forthcoming rules to be developed by the SEC.  For example, the SEC will promulgate rules relating to how long records must be retained by investment advisers, how often investment advisers will be subject to regular record inspections, and the conditions pursuant to which the SEC may conduct non-scheduled record inspections “as necessary and appropriate in the public interest and for the protection of investors, or for the assessment of systemic risk.”  Forthcoming rules will also specify the form and content of new reports that investment advisers will be required to file relating to their work with private funds.

Confidentiality of Information Relating to Private Funds

The Dodd-Frank Act requires the SEC to share information it collects on private funds with the Financial Stability Oversight Council, and allows for information sharing with other departments and agencies.  One concern relating to the additional record keeping, reporting, and inspection provisions applicable to advisers to private funds is that compliance with these new rules and the sharing of information among regulators will lead to the disclosure of highly confidential and proprietary information that has traditionally been closely guarded by private funds.  The Dodd-Frank Act attempts to address this concern by providing that the Financial Stability Oversight Council and any other department or agency that receives information relating to private funds must maintain the same level of confidentiality with respect to that information as was maintained by the SEC.

The SEC has the authority to maintain a high level of confidentiality with respect to sensitive information, and is exempt from the public disclosure requirements contained in the Freedom of Information Act (Title 5, Section 552 of the United States Code).  The Dodd-Frank Act identifies a subclass of “proprietary information” collected by the SEC for special treatment.  Proprietary information included in reports to the SEC is subject to the same limitations on disclosure as are provided in Section 210(b) of the Investment Advisers Act, which  amongst other things, prohibits the disclosure of such information to anyone not a member, officer, or employee of the SEC without the approval of the SEC. Proprietary information is defined to include sensitive, nonpublic information regarding:

  • the investment or trading strategies of the investment adviser;
  • analytical or research methodologies;
  • trading data;
  • computer hardware or software containing intellectual property; and
  • any additional information that the SEC determines to be proprietary.

Exempt Advisers to Private Funds

Investment advisers with assets under management of less than $150,000,000 that solely act as advisers to private funds are exempt from registration as investment advisers under the Dodd-Frank Act.  These exempt advisers to private funds are not subject to the record keeping requirements described above.  Exempt advisers will still be subject to some level of record keeping requirements and to some form of reporting, but the specifics of these obligations are left to the discretion of the SEC. The Dodd-Frank Act requires the SEC, when promulgating rules applicable to exempt advisers,  to take into account the size, governance, and investment strategy of such funds to determine whether they pose systemic risk, and to match the administrative burden of the new rules with the level of systemic risk posed by such funds.

HP’s Chief Executive Officer, Mark Hurd, resigned after an investigation disclosed that Hurd had a “close personal relationship” with an H-P contractor hired by the Office of the CEO and that “Mark never disclosed that.”  According to HP’s General Counsel, “there were instances of compensation and reimbursement for services that were never performed,  and there were “inaccurate expense reports submitted by Mark or on his behalf” that were intended to conceal the relationship.  See the Wall Street Journal account of the conference call where this was announced.

Now the San Francisco Chronicle is reporting  that Mr. Hurd will be receiving $50 million in severance payments.  Seems a little unbelievable for a guy that filed false expense reports.   Maybe it is because the HP board did not have the back bone to fire Mr. Hurd for cause or his relevant agreements did not permit it.

Its unclear to me where the $50 million number came from, but HP’s 8-K  states in “connection with Mr. Hurd’s resignation from HP, HP and Mr. Hurd entered into a Separation Agreement and Release (the “Separation Agreement”) that provides Mr. Hurd, in exchange for signing a general release of claims in favor of HP, with (i) a severance payment of $12,224,693 under the HP Severance Plan for Executive Officers; (ii) an extension until September 7, 2010 of the expiration date of his outstanding options to purchase up to 775,000 shares of HP common stock that were vested as of the date of his resignation; (iii) pro-rata vesting and settlement, at the same time and on the same terms as other HP employees, of 330,177 performance-based restricted stock units granted to Mr. Hurd in January 17, 2008 based on actual HP performance during the three-year performance period ending on October 31, 2010; and (iv) settlement on December 11, 2010 of 15,853 time-based restricted stock units granted to Mr. Hurd on December 11, 2009 at a price equal to the lesser of (a) the closing price of HP’s common stock on August 6, 2010 or (b) the per share closing trading price of HP common stock on December 11, 2010.  The value of both the pro-rata performance-based restricted stock units and the time-based restricted stock units to which Mr. Hurd is entitled is capped such that Mr. Hurd will not receive greater value in respect of those awards on their dates of settlement than what he would be entitled to assuming the closing price of HP’s common stock on their respective settlement dates is the same as the closing price on August 6, 2010.”

So it’s not a surprise that Congress decided to reform executive compensation through Dodd-Frank.