This posting, the May 2012 Davis Polk Dodd-Frank Progress Report, is the fourteenth in a series of Davis Polk presentations that illustrate graphically the progress of the rulemaking work that has been done and is yet to occur under the Dodd-Frank Act. The Progress Report has been prepared using data from the Davis Polk Regulatory Tracker™, an online subscription service offered by Davis Polk to help market participants understand the Dodd-Frank Act and follow regulatory developments on a real-time basis.

In this report:

• As of May 1, 2012, a total of 221 Dodd-Frank rulemaking requirement deadlines have passed. This is 55.5% of the 398 total rulemaking requirements, and 78.9% of the 280 rulemaking requirements with specified deadlines.
• Of these 221 passed deadlines, 148 (67%) have been missed and 73 (33%) have been met with finalized rules. Regulators have not yet released proposals for 21 of the 148 missed rules.
• Of the 398 total rulemaking requirements, 108 (27.1%) have been met with finalized rules and rules have been proposed that would meet 146 (36.7%) more. Rules have not yet been proposed to meet 144 (36.2%) rulemaking requirements.
• This month, in a major Title VII rulemaking development, the CFTC and SEC approved final rules further defining the terms “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant” and “eligible contract participant.” In addition, the FDIC and Treasury released a final rule that will govern the maximum obligation the FDIC may incur in liquidating a covered financial company.

Thank you for permitting me to testify before you today on cost-benefit analysis conducted by the Securities Exchange Commission (SEC). I am speaking today on behalf of the Committee on Capital Markets Regulation (Committee), of which I am the Executive Director for Research. The Committee has, since its 2006 Interim Report, [1] strongly supported improved cost-benefit analysis by both the SEC and other agencies. Today, the need for improved cost-benefit analysis is particularly evident in the agencies’ respective rulemakings under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). We are deeply concerned that the inadequate cost-benefit analysis in the vast majority of rulemakings under Dodd-Frank could expose these rules to judicial challenge, prevent important rules from taking effect, and contribute to uncertainty in our markets over their fate.

The broad scope of new regulation under Dodd-Frank, issued by agencies including the SEC, Commodity Futures Trading Commission (CFTC) and others, will result in fundamental changes across the financial industry. Sound cost-benefit analysis must be a part of this process, to ensure that in each case, the proposed rule is optimal among all reasonable alternatives. In light of the ruling last July by the U.S. Court of Appeals for the D.C. Circuit in Business Roundtable v. Securities and Exchange Commission, [2] and a current lawsuit seeking to strike down the CFTC’s recently promulgated position limits rule, [3] we believe many of the rules under Dodd-Frank could be subject to successful challenge in court. It would be an unfortunate outcome if, after the Dodd-Frank rulemaking process has run its course for several years, important rules are invalidated because of inadequate analysis. Even if such rules are not eventually invalidated, prolonged uncertainty around their fate threatens to hamper economic activity.

…continue reading: The Need for Improved Cost-Benefit Analysis of Dodd-Frank Rulemaking

On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (“JOBS Act” or the “Act”) into law. While the Act and recent commentary have focused primarily on common equity issuances by “Emerging Growth Companies” (or “EGCs”), the JOBS Act also impacts companies that have issued only debt securities in registered transactions, typically pursuant to an “A/B” exchange for privately offered high-yield debt securities. Many of these companies subsequently become “voluntary filers” of SEC Exchange Act reports to comply with on-going debt covenants.

The attached chart summarizes how certain JOBS Act provisions apply to these debt-only issuers. As indicated in the chart, they may benefit from a number of JOBS Act provisions with regard to their Securities Act registration statements and Exchange Act reports, including:

• potentially indefinite EGC status, assuming the $1 billion revenue, $1 billion debt issuance every three years, and certain other thresholds are never crossed;
• the option to submit to the SEC confidential drafts of Securities Act registration statements for any offering prior to the issuer’s first sale of its common equity securities pursuant to an effective Securities Act registration statement;
• the option to comply with new accounting standards applicable to public companies on the schedule that is applicable to private issuers; and
• the option to provide scaled back executive compensation disclosure.

In addition, after the SEC adopts implementing rules, companies that issue debt securities privately will be permitted to engage in general solicitation and general advertising in connection with offerings made in reliance on Rule 506 of Regulation D and Rule 144A under the Securities Act, just as they will be able to do with respect to equity offerings.

…continue reading: JOBS Act Applies to Debt-Only Issuers

Corporations subject to criminal and civil regulatory investigations have long grappled with the highly charged decision over whether to provide the government with privileged communications and attorney work product or whether to maintain those materials as privileged despite a governmental inquiry. On the one hand, a corporation may hope to avoid criminal prosecution or civil regulatory action, as well as potential downstream effects of such actions on insurance rights and indemnification, by forthright disclosure of “relevant facts” to the government, including information that may be protected by attorney-client privilege or the attorney work product doctrine. See Principles of Federal Prosecution of Business Organizations, reprinted in United States Attorneys’ Manual, tit. 9 ch. 9-28.710, 9-28.720(a). On the other hand, in disclosing privileged materials and work product to the government, the corporation risks having waived the privilege over those very same materials as to third parties, including civil litigants seeking to recover monetary damages from the corporation.

…continue reading: Court Rejects Selective Waiver Doctrine for Privileged Materials

The Commission has authorized that a Study be sent to Congress expressing the views of the Staff on the cross-border scope of the private right of action under Section 10(b) of the Securities Exchange Act of 1934. However, my conscience compels me to write separately to record my views on the Study. I write to convey my strong disappointment that the Study fails to satisfactorily answer the Congressional request, contains no specific recommendations, and does not portray a complete picture of the immense and irreparable investor harm that has resulted, and will continue to result, due to Morrison v. National Australia Bank, Ltd.

In the United States we have a strong belief that, whether rich or poor, we are all entitled to our day in court. Sadly, for many American investors this is no longer true.

If American investors are defrauded by a company that they have invested in – and that company is listed on a foreign exchange – investors may be unable to have their day in court and seek redress against this company for its lies and misrepresentations. Thus, investors have been stripped of a traditional American right.

This was not always the case. For decades, federal courts applied the same standard to determine whether U.S. federal securities law applied to frauds that took place, in whole or in part, outside of the United States. Under that standard, Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and other antifraud provisions applied “when there was ‘significant U.S. fraudulent conduct that directly caused the plaintiffs losses’ (the conduct test) or when there were ‘significant effects’ on the U.S. securities markets (the effects test).”

…continue reading: Defrauded Investors Deserve Their Day in Court

On April 4, 2012, President Obama signed the Stop Trading on Congressional Knowledge Act (the “STOCK Act”), and the House Committee on Ethics issued the first set of guidance under the STOCK Act (see memorandum). Among other things, the STOCK Act confirms that Congressional Members and staff, and federal executive and judicial branch officials, owe a duty with respect to material, nonpublic information derived from the person’s position with the federal government under the insider trading provisions in Section 10(b) of the ’34 Act and related SEC Rule 10b-5. In other words, information held by such federal officials qualifies as inside information upon which an insider trading case can be based if it is shared. Although much has been said as to when a federal official can be liable as a “tipper” in an insider trading case, the following focuses on the “tippee” liability that can accrue to the company with which the official shares such information.

A company’s tippee liability is derivative of the tipper’s liability; that is, a tippee will not be found liable unless the tipper is found to be liable. For a tipper to be liable, he or she must (1) disclose material, nonpublic information to the tippee in breach of his or her fiduciary duty and (2) receive a personal benefit as a result of the disclosure. While the interpretation by the courts of “personal benefit” has not been consistent, it is important to note that a number of courts have broadly interpreted this requirement, for example finding the passing of information to maintain goodwill with the tippee sufficient to meet the test. If the elements of tipper liability are satisfied, tippees can be held liable if the tippee (1) acts on the information, and (2) knows, or reasonably should know, that the tipper’s disclosure is in breach of his or her fiduciary duty.

…continue reading: Unique Issues Facing Companies Under the STOCK Act

On April 5, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”), which as we’ve previously noted represents a very significant loosening of restrictions around the IPO process and post-IPO reporting obligations. While most of the commentary on this legislation has thus far focused on its impact on capital markets matters, there are implications for private company mergers and acquisitions as well.

Late-stage private companies contemplating an M&A or IPO exit often undertake so-called “dual-track” processes in which they simultaneously file an IPO registration statement with the SEC and hold discussions with prospective acquirors.  The IPO side of the process effectively becomes a stalking horse for M&A discussions and tends to force the hand of prospective acquirors that might otherwise not move as quickly as the target would like.  The publicly filed registration statement both attracts attention and provides prospective acquirors with a sort of first-stage diligence that theoretically helps encourage bids.

Under the JOBS Act, emerging growth companies or “EGCs” will now have the ability to file their registration statements confidentially, so long as the confidential filings are ultimately released at least 21 days before the road show.  Whether confidential filings will become the norm remains to be seen; there are a number of reasons why an IPO candidate might want to continue to use the traditional public filing process, including the publicity, customer and employee-related benefits of having a highly visible registration statement.  For many companies, however, these benefits will be outweighed by the competitive advantages of keeping early filings confidential.  The optionality that confidential filings create may be hard to resist: A confidential filer can now pull its deal without the stigma associated with withdrawing a publicly filed registration statement.

…continue reading: The JOBS Act: Implications for Private Company Acquisitions and M&A Professionals

Recently, the Financial Stability Oversight Council (“Council”) unanimously approved a final rule (the “Final Rule”) and related interpretive guidance (the “Final Guidance”) under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), [1] regarding the designation of systemically important nonbank financial companies (often referred to as nonbank “SIFIs”). The Final Rule and Final Guidance describe how the Council will apply the statutory designation standards and the procedures it intends to employ in exercising this authority. Designated companies are required to comply with enhanced prudential standards and are subject to consolidated supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Federal Reserve’s recent proposal regarding these enhanced standards suggests that this will be a comprehensive and rigorous regulatory regime. [2]

The Final Rule and Final Guidance, which are substantially similar to the Council’s October 2011 proposed rule and guidance (the “October 2011 Proposal”), [3] do not provide significant new insight as to which companies will ultimately be designated. Nonetheless, it is an important initial procedural step to enable the actual designation process to begin. Secretary of the Treasury Geithner, who chairs the Council, has indicated that the first of these designations will be made this year.

…continue reading: Final Rule on Designation of Systemically Important Companies

It is an honor for me to participate in the Public Company Oversight Board’s public meeting to discuss proposals to enhance auditor independence, objectivity and professional skepticism, including the potential of imposing rules setting a maximum term limit for audit relationships. Sadly, many people in official Washington seem prepared to jettison the interests of investors without reason as would occur in the proposed JOBS legislation, which as currently written would unnecessarily savage important barriers against fraud and manipulation of markets. We should never be afraid to experiment with opportunities for reducing unnecessary regulatory costs, particularly for smaller companies. At the same time, we shouldn’t let anyone’s financial agenda be a pretext for allowing the unscrupulous a free rein to abuse savers and investors. In its current form this legislation has too many elements that are simply fantasies, such as that a company with $1 billion in revenue is a “small business”, when that is 10-20X too high a threshold.

When Jim Doty and I were at the SEC, the Commission created an entire set of registration statements and ’34 Act filings (eg, Form 10-KSB) geared for small companies to lower their costs in raising capital or being public companies. Companies could elect the simpler forms if they wished, although they might pay a market penalty for providing less information. We allowed things like requiring two years of audited financials rather than 3 years, and three years rather than five years of selected financial data. We simplified disclosure requirements for smaller firms with less than $25mm in revenue (about $41mm in today’s dollars), but nobody got a free pass for fraud and there was still transparency for investors in current results.

…continue reading: Proposals for Auditor Independence and Audit Firm Rotation

This column looks at four circumstances having special impact on the governance of executive pay today and then focuses on one of them, proxy advisers (with particular attention to the largest one, Institutional Shareholder Services (ISS)). It concludes with suggestions as to steps that might be taken to better regulate proxy advisers.

Four Influential Factors

Increasing Complexity of the Executive Pay Discussion. Discussions of executive pay in proxy statements are often extremely complex and lengthy (frequently 30 to 40 pages of narrative and tables). Many companies are putting into the Compensation Discussion and Analysis (CD&A) their own tables (most especially their own competing version of the Summary Compensation Table) in order to express their own views on the correct way to explain and justify executive pay at the issuer. It has become a challenge to understand any one company’s executive pay arrangements and an even greater challenge to understand how that company’s executive pay arrangements relate to those at competitor companies.

Institutional Shareholders. Institutional shareholders represent an overwhelming proportion of the vote at publicly traded companies. (They own approximately 75 percent of the market value of exchange- traded companies.) These institutional shareholders owe a fiduciary duty to the persons who own their shares or are beneficiaries of the trust funds managed by them. This duty includes understanding how the companies in which they have invested are managed, including management of executive pay. The explosion of data noted in the preceding paragraph has meant a challenge to these institutional shareholders in trying to understand the executive pay practices at thousands of companies that they (collectively) are investing in.

…continue reading: Say on Pay: Who Is Watching the Watchmen?