SEC Announces Roundtable on Short Selling and Securities Lending

The SEC has announced that it will hold a roundtable on September 30, 2009 to solicit views of investors, issuers, financial services firms, self-regulatory organizations and the academic community on issues related to securities lending, pre-borrowing, and possible additional short sale disclosures. According to the SEC press release:

The roundtable panelists will consider, among other things, additional means to foster transparency, such as adding a short sale indicator to the tapes to which transactions are reported for exchange-listed securities, and requiring public disclosure of individual large short positions. Panelists will also consider whether it would be appropriate to impose a pre-borrow or enhanced "locate" requirement on short sellers, potentially on a pilot basis. Additionally, panelists will discuss issues related to securities lending such as compensation arrangements, disclosure practices, and methods of collateral and cash-reinvestment.

Typically, SEC roundtables are held at the agencies headquarters in Washington, DC, and are webcast via a link on the SEC's website, www.sec.gov. We will post more details about the September 30th roundtable when they are made available.

In conjunction with its announcement of the September 30 roundtable, the agency also announced that the SEC has made permanent Regulation SHO Rule 204T, an interim final temporary rule designed to prevent fails and "naked" short selling. Rule 204T was adopted as an interim final temporary rule in October of 2008, with an expiration date of July 31, 2009. In addition, the Commission stated that it is working with "several self-regulatory organizations (SRO) to make short sale volume and transaction data available through the SRO Web sites. This effort will result in a substantial increase over the amount of information presently required by another temporary rule, known as Temporary 10a-3T. That rule, which will expire on August 1, applies only to certain institutional money managers and does not require public disclosure."

The Commission continues to consider the comments on its April 2009 rule proposals on approaches to restricting short sales, the "short sale price test" and the "circuit breaker" approaches.

The full text of the SEC's announcement of the roundtable and actions on short selling regulation is available at: http://www.sec.gov/news/press/2009/2009-172.htm

The full text of the April 2009 proposed amendments to Reg SHO is available at: http://www.sec.gov/rules/proposed/2009/34-59748.pdf

Related articles:

• "SEC Proposes Short-Selling Restrictions," April 16, 2009
  
  
• "OCIE's Director Shares Focus of SEC Compliance Exams," October 23, 2008
  
  
• "SEC Extends Short-Selling Orders," October 2, 2008

SEC Approves Two More OTC Central Counterparties

Last week, the SEC issued exemptive orders that will add two European entities to the list of approved central counterparties for clearing credit default swaps. The orders issued on July 23 provide the necessary regulatory exemptions to allow ICE Clear Europe Limited and Eurex Clearing AG to join two other companies, ICE US Trust LLC and the Chicago Mercantile Exchange, Inc., approved in March, as central counterparties. Though the Commission's jurisdiction over the over the counter markets for credit default swaps is limited, or those CDS that are not swap agreements (“non-excluded CDS”), the Commission’s exemptive orders for these counterparty designations provides conditional exemptions from certain requirements of the Exchange Act, will provide the SEC with extensive oversight of the central counterparties, "and should enhance the quality of the credit default swap market and the Commission's ability to protect investors."

The Commission believes that using well-regulated CCPs to clear transactions in CDS would provide a number of benefits, by helping to promote efficiency and reduce risk in the CDS market and among its participants, requiring maintenance of records of CDS transactions that would aid the Commission’s efforts to prevent and detect fraud and other abusive market practices, addressing concerns about counterparty risk – through the novation process – by substituting the creditworthiness and liquidity of the CCP for the creditworthiness and liquidity of the counterparties to a CDS, contributing generally to the goal of market stability, and reducing CDS risks through multilateral netting of trades.

The SEC's announcment of the new central counterparties is available at: http://www.sec.gov/news/press/2009/2009-170.htm

The exemptive orders are availble at:

• Exemptive Order Release No. 34-60372
  
  
• Exemptive Order Release No. 34-60373

Related article:

• "SEC Permits CME to Operate as Central CDS Counterparty," April 9, 2009
  

Credit Rating Agency Reform Legislation Sent to Capitol Hill

Given the role the credit rating agencies, agencies the SEC calls "NRSROs," played in the recent housing and credit crises, strengthened regulation of the NRSROs was high on the list of reforms identified by the Obama Administration and regulators. The bill is intended to strengthen the SEC's oversight of the agencies, address conflicts of interest, increase transparency and disclosure, and reduce reliance by regulated entities on ratings from NRSROs. According to the Treasury's fact sheet on this legislation each of the areas is addressed as follows:

Conflicts of Interest

Bar Firms From Consulting With Any Company That They Also Rate: Credit ratings agencies will face similar restrictions to other professional service providers, like accountants, and will be prohibited from providing consulting services to companies that contract for ratings.

Strengthen Disclosure And Management Of Conflicts Of Interest: The legislation will prohibit or require the management and disclosure of conflicts arising from the way a rating agency is paid, its business relationships, affiliations or other conflicts.

Disclose Fees Paid By An Issuer Along With Each Rating Report: Each rating report will disclose the fees paid by the issuer for a particular rating, as well as the total amount of fees paid by the issuer to the rating agency in the previous two years.

Look-Back Requirement To Address The Conflicts From A "Revolving Door": If a rating agency employee is hired by an issuer and if the employee had worked on ratings for that issuer in the preceding year, the rating agency will be required to conduct a review of ratings for that issuer to determine if any conflicts of interest influenced the rating and adjust the rating as appropriate.

Designate A Compliance Officer: Each rating agency will be required to designate a compliance officer – reporting directly to the board or the senior officer of the firm – with direct responsibility over compliance with internal controls and processes. The compliance officer will not be allowed to engage in any rating activities, marketing, sales, or setting of compensation; and will be required to submit a report annually to the SEC.

Transparency & Disclosure

Require Disclosure Of Preliminary Ratings To Reduce "Ratings Shopping": Currently, an issuer may attempt to "shop" among rating agencies by soliciting `preliminary ratings' from multiple agencies and then only paying for and disclosing the highest rating it received for its product. We would shed light on this practice by requiring an issuer to disclose all of the preliminary ratings it had received from different credit rating agencies so that investors will see how much "shopping" happened and whether there were discrepancies with the final rating.

Require Different Symbols To Be Used To Distinguish The Risks Of Structured Products: One of the challenges in the current crisis was that investors did not fully realize that the risks posed by structured products such as asset-backed securities are fundamentally different from those posed by corporate bonds, even with similar credit ratings. Our proposal requires rating agencies to use different symbols for structured finance products as an indication of these disparate risks.

Require Qualitative And Quantitative Disclosure Of The Risks Measured In A Rating: Agencies will be required to provide a much fuller picture of the risks in any rated security through the addition of qualitative and quantitative disclosure of the risks and performance variance inherent in any given security. Ratings cannot be a substitute for investor due diligence. Therefore, to facilitate investor analysis, we will require that each rating also include a clear report containing assessments of data reliability, the probability of default, the estimated severity of loss in the event of default, and the sensitivity of a rating to changes in assumptions. This report will present information in a way that makes it simple to compare this data across different securities and institutions. This additional information will increase market discipline by providing clearer estimates of the risks posed by different investments.

Strengthen SEC Authority and Supervision

Establish A Dedicated Office For Supervision Of Rating Agencies: Our legislative proposal establishes a dedicated office within the SEC to strengthen supervision of rating agencies and to carry out the enhanced regulations required.

Mandatory Registration: Unlike the current voluntary system of registration, our proposal would make registration mandatory for all credit rating agencies. This will bring all ratings firms into a strengthened system of regulation.

SEC Examination Of Internal Controls And Processes: The SEC will require each rating agency to document its policies and procedures for the determination of ratings. The SEC will examine the internal controls, due diligence, and implementation of rating methodologies for all credit rating agencies to ensure compliance with their policies and public disclosures.

Reduce Reliance on Credit Rating Agencies

PWG Review of Regulatory Use of Ratings: Treasury will work with the SEC and the President's Working Group on Financial Markets to determine where references to ratings can be removed from regulations.

SEC Recently Requested Public Comment on Whether to Remove References to Ratings in Money Market Mutual Fund Regulation: As part of a comprehensive set of money market fund reform proposals, the SEC requested public comment on whether to eliminate references to ratings in the regulation governing money market mutual funds, as a way to reduce reliance on ratings. Treasury will work with the SEC to examine opportunities to reduce reliance and increase the resilience of the money market mutual fund industry.

Require GAO Study On Reducing Reliance: In addition to regulatory efforts to reduce reliance on credit ratings, this legislation would require the GAO to study and issue a report on the reliance on ratings in federal and state regulations.

Strongly Support SEC Actions on Credit Rating Agencies

Enable Additional Ratings On Structured Products: Because structured products are often complex and require detailed information to assess, it can be difficult for a rating agency to provide "unsolicited ratings" – ratings on products it was not paid to rate. These ratings, while in existence previously, were ineffective because investors understood that these unsolicited ratings did not benefit from the same information as the fully contracted ratings. The SEC has proposed a rule that would require issuers to provide the same data they provide to one credit rating agency as the basis of a rating to all other credit rating agencies. This will allow other credit rating agencies to provide additional, independent analysis to the market.

Require Disclosure Of Full Ratings History: The SEC has proposed to require NRSROs to disclose, on a delayed basis, ratings history information for 100% of all issuer-paid credit ratings.

Strengthen Regulation And Oversight Of Credit Rating Agencies: In response to the credit market turmoil, in February the SEC adopted several measures to increase the transparency of the rating agencies' methodologies, strengthen disclosure of ratings performance, prohibit certain practices that create conflicts of interest, and enhance recordkeeping and reporting obligations to assist the SEC in performing its regulatory and oversight functions. The SEC has allocated resources to establish a branch of examiners dedicated specifically to conducting examination oversight of rating agencies.

Although the text of the bill presented to Congress appears to be unavailable at the moment, the full text of Treasury's fact sheet on this legislation is available at: http://www.ustreas.gov/press/releases/tg223.htm

Related Articles:

• "SEC Publishes NRSRO Rule Releases," February 5, 2009
  
  
• "Rules Implementing the Credit Rating Agency Reform Act," December 8, 2008
  
  
• "April 15 Roundtable on Credit Rating Agencies," March 30, 2009
  

SEC's Indexed Annuity Rule Under Legal Cloud

A new SEC rule we posted about late last year requiring certain indexed annuities to register with the Commission was challenged recently by an insurance company, American Equity Investment Life Ins. Co., whose annuity products would fall under the new rule. The challenged rule, Securities Act Rule 151A, adopted late in December of 2008, defines "indexed annuities," and requires indexed annuities that satisfy the rule’s definition and are issued on or after January 12, 2011 to register under the Securities Act. As we reported in our December 29, 2008 post about the new rule:

Section 38(a)(8) of the Securities Act exempts annuity contracts and optional annuity contracts from regulation under the Securities Act. But, the Section 38(a)(8) exemption is not available to all contracts that are “annuity contracts” under state law (e.g., variable annuities). Whether or not indexed annuities fell within the scope of the exemption, however, had not been clarified until now. Under the new rule 151A, indexed annuities are not "annuity contracts" and are not exempt from the Securities Act if the amounts payable by the insurer under the contract are more likely than not to exceed the amounts guaranteed under the contract. The rule also provides a principles-based manner in which this determination is made.

The rule was challenged on the grounds that the SEC's interpretation of the term "annuity contract" was unreasonable, and also on the grounds that the Commission failed to assess sufficiently the effect of the rule on efficiency, competition, and capital formation under as required for SEC rulemaking by the Securities Act. The DC Circuit found that the SEC's interpretation of the term "annuity contract" was reasonable, but remanded the case to the SEC to address the deficiencies in its analysis of the effect of the rule on efficiency, competition, and capital formation. Should the Commission remedy the analysis sufficient to meet what the Court sees as the SEC's obligations under the Securities Act, it is likely that Rule 151A will survive this round of challenges.

The full text of the DC Circuit Court's opinion in American Equity Investment Life Ins. Co. v. SEC (D.C. Cir. 7/21/09) is available at: http://lawprofessors.typepad.com/files/d.c.opiniononindexannuities.pdf

Related Articles:

• "Indexed Annuities Under the SEC's Eye," December 29, 2009

UCLA Prof. Stout: Re-regulation of Derivatives

In a piece posted on Harvard Law School's Forum on Corporate Governance and Financial Regulation blog, Lynn A. Stout, Paul Hastings Professor of Corporate and Securities Law at UCLA Law School posits that the freeze up of the credit markets in late 2008 was both predictable and preventable, and may be averted in the future by carefully crafted re-regulation of the derivatives markets.

It was the deregulation of financial derivatives that brought the banking system to its knees. The leading cause of the credit crisis was widespread uncertainty over insurance giant AIG’s losses speculating in credit default swaps (CDS), a kind of derivative bet that particular issuers won’t default on their bond obligations. Because AIG was part of an enormous and poorly-understood web of CDS bets and counter-bets among the world’s largest banks, investment funds, and insurance companies, when AIG collapsed, many of these firms worried they too might soon be bankrupt.
. . .
This could have been avoided if we had not deregulated financial derivatives.

According to Professor Stout, derivatives are not new, "are not really 'products' and they are not really 'traded.'" Rather, they are simply documented bets on future outcomes, typically used to hedge against risks, but sometimes used for pure speculation. It is this speculative use that amplifies their risk, because it disconnects the transaction from the economic interest underlying the the transaction, encouraging more speculation and risk-taking, and creating "asset price bubbles, reduced returns, price manipulation schemes, and other economic ills."

Regulations designed to keep this kind of speculation in check were removed, beginning with the Financial Services Act of 1986 in the UK and accompanied by the Commodity Futures Modernization Act (CFMA) of 2000, to disastrous effect.

The CFMA not only declared financial derivatives exempt from CFTC or SEC oversight, it also declared all financial derivatives legally enforceable. The CFMA thus eliminated, in one fell swoop, a legal constraint on derivatives speculation that dated back not just decades, but centuries. It was this change in the law—not some flash of genius on Wall Street—that created today’s $600 trillion financial derivatives market.

Professor Stout argues that re-regulating the derivatives market would preserve the beneficial uses of derivatives, that is, allowing market participants to use them as economic hedges, while eliminating, or at lest curtailing their use for speculation. This re-regulation presumably would reduced the potential catastrophic risk posed by widespread speculative derivatives.

Unchecked derivatives speculation thus adds risk to the system by making it possible for individual speculators, like AIG (and Barings and LTCM and Enron and Bear Stearns) to lose very large amounts of money very unexpectedly.

. . .

Yet the data suggests that speculation, not hedging, drives over-the-counter financial derivatives markets. For example, we know the CDS market was dominated by speculation in 2008.

Professor Stout's proposed regulatory solution is a simple return to the rules of the past that refuse to enforce derivatives contracts with purely speculative motives.

The old common law rule against difference contracts was a simple, elegant legal sieve that separated useful hedging contracts from purely speculative wagers, protecting the first and declining to enforce the second. This no-cost, hands-off system of “regulation” (there is no cheaper form of government intervention than refusing to intervene at all, even to enforce a deal) did not stop speculators from using derivatives. But it did require speculators to be much more careful about their counterparties, and to develop private enforcement mechanisms like organized exchanges that kept speculation confined to an environment where traders were well-capitalized and knew who was trading what, with whom, when. This approach kept runaway speculation from adding intolerable risk to the financial system. And it didn’t cost a penny of taxpayer money.

The full text of Professor Stout's blog post is available at: http://blogs.law.harvard.edu/corpgov/2009/07/21/how-deregulating-derivatives-led-to-disaster/

Hedge Fund Legislation Delivered to Congress

The Administration and the Department of the Treasury took another step in their reform agenda for the nation's financial markets by delivering hedge fund regulation to Congress for consideration. As expected, the legislation proposes to require hedge fund advisers to register with the SEC, subject hedge funds to recordkeeping requirements, and impose new restrictions and requirements on hedge funds' dealings with investors, creditors, counterparties, and regulators.

In order to monitor the hedge fund industry for potential systematic risk, the proposed legislation would require hedge funds to provide detailed information on the amount of assets under management, borrowings, off-balance sheet exposures, counterparty credit risk exposures, trading and investment positions, and other important information. The legislation would also give the SEC the power to conduct examinations and share information with the Federal Reserve, and the Financial Services Oversight Council.

This latest legislation contains few unexpected proposals, and does not differ significantly from other hedge fund regulation efforts, such as the "Hedge Fund Adviser Registration Act" or the "Hedge Fund Transparency Act," previously proposed.

The full text of the "Private Fund Investment Advisers Registration Act of 2009" delivered to Congress on July 15 is available at: http://www.treas.gov/press/releases/reports/title%20iv%20reg%20advisers%20priv%20funds%207%2015%2009%20fnl.pdf

Related articles:

• "Aguilar Warns of Hedge Fund Risk," June 30, 2009
  
  
• "Connecticut Moves to Regulate Hedge Funds," June 2, 2009
  
  
• "Hedge Fund Adviser Registration Act," April 1, 2009
  
  
• "Legislative Spotlight Falls on Hedge Funds," February 4, 2009

"Pay to Play" Rule Proposals on SEC Agenda

The SEC has announced that at tomorrow's open meeting, it will consider re-proposing rules designed to address "pay to play" practices in the investment adviser industry. The Commission proposed similar rules in 1999 that sought to prohibit an investment adviser from providing advisory services for compensation to a government client for two years after the adviser or any of its partners, executive officers or solicitors make a contribution to certain elected officials or candidates; however the 1999 rule proposal was never adopted.

Although it is not clear if the proposed rules being considered on Wednesday will differ materially, or at all, from the 1999 version, according to the Commission's Sunshine Act notice:

The Commission will consider whether to propose a rule to address "pay to play" practices by investment advisers. The proposal is designed, among other things, to prohibit advisers from seeking to influence the award of advisory contracts by public entities through political contributions to or for those officials who are in a position to influence the awards.

Wednesday's open meeting is scheduled to be held at the SEC's headquarters at 100 F Street NE, in the Auditorium (Room L-002), and start at 2:00PM. The meeting is open to the public, and will be webcast via a link on the SEC's website, www.sec.gov.

The full text of the 1999 "Pay for Play" rule proposal, "Political Contributions by Certain Investment Advisers," is available at: http://frwebgate4.access.gpo.gov/cgi-bin/waisgate.cgi?WAISdocID=091286285148+0+3+0&WAISaction=retrieve

The Sunshine Act Notice for the July 22, 2009 open meeting is available at: http://sec.gov/news/openmeetings/2009/ssamtg072209.htm

Schapiro Updates Congress on Oversight Agenda

On July 14, 2009, SEC Chairman Mary L. Schapiro testified before the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises on the role the Commission is playing in addressing the financial crisis, and steps the agency is taking to improve investor protection and confidence. Chairman Schapiro wasted no time listing the initiatives and changes already commenced at the SEC since she took the helm:

[W]e have begun implementing many changes at the agency that will reinforce our focus on investor protection and market integrity. Indeed, there is an invigorating sense of urgency at the Commission to make sure we are rapidly implementing changes designed to protect investors and promote investor confidence.

We are:

• working to fill regulatory gaps exposed by the economic crisis;
• seeking to strengthen standards governing broker-dealers and investment advisers;
• enhancing disclosure provided to investors;
• streamlining enforcement procedures and focusing on cases that will have the greatest impact;
• revamping the system for handling the approximately one million tips and complaints we receive annually;
• improving our risk assessment capabilities;
• bolstering our internal training; and
• bringing on new leadership and new skill sets throughout the agency.

Reinvigorating the agency's enforcement efforts maintains an area of focus for the Commission. Schapiro told the committee that the controversial and troubled "Penalty Pilot Program" has been terminated as an unnecessary hurdle to effective enforcement. The program, instituted under Chairman Christopher Cox, required enforcement staff to have the assent of a majority of the Commissioners before beginning negotiations regarding penalties for violations of the securities laws. Chairman Schapiro also testified that the process of approval of formal orders for enforcement has been streamlined and accelerated. Also, the agency has implemented a more robust method for handling complaints and tips, and has engaged "the Center for Enterprise Modernization, a federally funded research and development center operated by The MITRE Corporation, to help us establish a centralized system to more effectively identify valuable leads for potential enforcement action as well as areas of high risk for compliance examinations."

Schapiro also outlined some of the steps the agency is taking to strengthen SEC examinations and oversight, including:

• enhancing training of examiners;
  
  
• recruiting professionals with expertise in securities trading, portfolio management, valuation, forensic accounting, information security, derivatives and synthetic products, and risk management;
  
  
• Improving systems of surveillance;
  
  
• risk-targeting of firms for examination; and
  
  
• developing systems to mine data from multiple sources (including examinations, investigations, filings and tips), link the data together, and combine it with data sources from outside the SEC to assist in determining which firms or practices raise red flags and require greater scrutiny.

Chairman Schapiro also said the Commission will continue to focus on improving transparency and investor protection by enhancing regulation of custody controls by investment advisers, implementing "investor-oriented enhancements to the municipal securities market within the constraints posed by the current limitations on the Commission's authority," curtailing so-called "pay-to-play" practices by investment advisers to public pension plans, and exploring the regulation of "dark pools." She also reported that the Commission would continue work on its existing rulemaking initiatives combating abusive short-selling, exploring alternatives to regulation of credit rating agencies, strengthening proxy access to shareholders, and improving money market fund regulation.

Schapiro used the opportunity not only to report on the Commission's activities and plans, but also to deliver a wishlist of legislative changes she feels would improve investor protections and strengthen investor confidence:

Finally, there are a number of other possible legislative changes that Commission staff have identified to help the Commission to better protect investors. These include:

• Authorizing a whistleblower program to incentivize insiders to provide information leading to the successful enforcement of the federal securities laws;
  
  
• Enhancing the Commission's ability to require ongoing disclosure in trading markets with respect to securities and beneficial ownership;
  
  
• Giving the PCAOB authority to inspect auditors of broker-dealers, as included in H.R. 1212 introduced by Chairman Kanjorski;
  
  
• Eliminating the statutory provision that prohibits broker-dealers from competing on price when selling mutual fund shares;
• Authorizing the SEC to verify client assets with mutual fund and adviser custodians;
  
  
• Establishing "aider and abettor" Commission causes of action in those areas of the law in which it does not currently exist (e.g., Securities Act and the Investment Company Act);
  
  
• Providing for nationwide service of process in civil actions filed in federal courts;
  
  
• Authorizing the release of certain grand jury information to Commission staff for use in matters within the Commission's jurisdiction; and

• Expanding the sanctions available to the Commission (e.g., through collateral bars and penalties for aiding and abetting under the Investment Advisers Act).

The full text of Chairman Mary Schapiro's July 14, 2009 congressional testimony is available at: http://www.sec.gov/news/testimony/2009/ts071409mls.htm

SEC Release Focuses on Compensation

In an effort to provide more informative disclosure to investors, the SEC has recently proposed a number of changes to rules governing the solicitation of proxies. In addition to the items outlined in our July 13, 2009 post, "SEC Publishes Proxy Disclosure and Solicitation Proposals," the release proposes a number of other changes focusing on compensation. For example, the proposal would change the summary compensation table for stock and option awards. Currently, the value reported in the table is the dollar amount of the award used for financial statement reporting purposes. The proposal would change the disclosure to require disclosure based on the aggregate grant date fair value. The release states that the change would "permit investors to better evaluate the amount of equity compensation awarded."

In addition, the proposed rules would require changes to the compensation discussion and analysis disclosure in order to provide more information about a company’s overall compensation policies. The new disclosure would require information about how compensation policies create incentives that could affect the company’s risk and risk management, based on a company’s particular circumstances. The rules "would require a company to discuss and analyze its broader compensation policies and overall actual compensation practices for employees generally, including non-executive officers, if risks arising from those compensation policies or practices may have a material effect on the company."

Under the proposal, the following situations could require additional disclosure about a company’s compensation policies:

• At a business unit of the company that carries a significant portion of the company’s risk profile;
  
  
• At a business unit with compensation structured significantly differently than other units within the company;
  
  
• At business units that are significantly more profitable than others within the company;
  
  
• At business units where the compensation expense is a significant percentage of the unit’s revenues; or
  
  
• That vary significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while the income and risk to the company from the task extend over a significantly longer period of time.

The proposal also contains examples of issues regarding compensation practices that may result in risks that could have a material effect on the company. Examples of such compensation practices are:

• The general design philosophy of the company’s compensation policies for employees whose behavior would be most affected by the incentives established by the policies, as such policies relate to or affect risk taking by those employees on behalf of the company, and the manner of its implementation;
  
  
• The company’s risk assessment or incentive considerations, if any, in structuring its compensation policies or in awarding and paying compensation;
  
  
• How the company’s compensation policies relate to the realization of risks resulting from the actions of employees in both the short term and the long term, such as through policies requiring claw backs or imposing holding periods;
  
  
• The company’s policies regarding adjustments to its compensation policies to address changes in its risk profile;
  
  
• Material adjustments the company has made to its compensation policies or practices as a result of changes in its risk profile; and
  
  
• The extent to which the company monitors its compensation policies to determine whether its risk management objectives are being met with respect to providing incentives to its employees.

Additionally, the proposed rules would require disclosure about fees paid to compensation consultants and their affiliates when they are involved in setting compensation for executives and directors while at the same time providing other services to a company. The disclosure would be required to include a description of additional services provided by the consultants.

The text of the proposal is available at: http://www.sec.gov/rules/proposed/2009/33-9052.pdf


Related articles:

• "SEC Publishes Proxy Disclosure and Solicitation Proposals," July 13, 2009
  
  
• "SEC Considers Slate of Proxy Rule Changes," July 2, 2009
  
  
• "July 1 SEC Open Meeting to Include "Say on Pay" Proposals," June 29, 2009

A CCO for the SEC

As part of Chairman Mary Schapiro's revitalization of the SEC, the organization has announced it will create a Chief Compliance Officer position whose job it will be to police the organization's compliance with its own rules and policies, including the rules governing the trading by SEC employees. To strengthen the controls around SEC employee trading, the Commission has proposed new rules expanding the organization's existing Rule 5 to:

• Require the pre-clearance of all trades.
  
  
• Prohibit all trading in the securities of a company under SEC investigation, regardless of whether the employee is aware of the investigation.
  
  
• Require all employees to authorize their brokers to provide duplicate trade confirmation statements to the agency.
  
  
• Prohibit the ownership of securities in publicly-traded exchanges and transfer agents, in addition to existing prohibitions against owning securities in other firms directly regulated by the Commission.
  
  
• Require employees to certify that they do not have any non-public information about the company whose securities they are trading.
  
  
• Require supervisors to conduct periodic reviews of employee securities transactions and compare any transactions to the employee’s work projects.

The Commission also plans to implement an updated computerized system of tracking and verifying employee trading.

The SEC's CCO position has not yet been filled, but the response to the job posting apparently was well received, and interviews already have begun. This set of compliance related actions was prompted by the recent report of the Inspector General criticizing the agency on many counts. Also, recent news reports about several SEC employees who allegedly traded improperly have driven the Commission to address employee trading controls. The Commission's statement indicates that two of the employees identified as having traded in apparent violation of the SEC's internal rules have not yet been disciplined pending criminal inquiry by the U.S. Attorney's Office.

The full text of the Commission's statement for the record to the House Subcommittee on Oversight and Investigations is available at: http://www.sec.gov/news/testimony/2009/ts071309sec.htm

Related articles:

• "GAO Releases Study on SEC Enforcement," May 13, 2009
  
  
• "Inspector General to Ask SEC Some Tough Questions," January 7, 2009

Consumer Protection Legislation Delivered To Congress

On June 30, the Administration delivered to Congress a bill that would create the Consumer Financial Protection Agency("CFPA"). According to a statement by the Department of the Treasury, the agency contemplated by the bill will be charged with:

• Looking out for American families when they take out loans or use other financial products or services – with a mission to promote access and Protect consumers from unscrupulous practices across the market.
  
  
• Implementing and enforcing the new credit card bill signed into law by President Obama and Congress and have authority to combat the worst abuses in mortgage markets.
  
  
• Promoting transparency, simplicity, fairness, accountability, and access – laying the cornerstone for the effort to fundamentally reform our system of financial regulation.

Under this legislation, the CFPA would look out for consumers, protecting them against unscrupulous practices and provide them increased access to efficient and innovative markets by:

• bringing together fragmented responsibility for consumer protection;
  
  
• Monitoring for risks, with a focus on risks to consumers;
  
  
• Weighing benefits and costs of new regulation on access to credit and burden on financial institutions;
  
  
• streamlining and consolidate regulatory requirements, acting as a single point of contact for consumer protection.

The CFPA would be structured to be independent and accountable, with a stable source of funding. The director of the agency would be appointed by the President and confirmed by the Senate, and the agency will be governed by a board, with one seat on the board reserved for a federal prudential regulator.

The full text of the proposed Consumer Financial Protection Agency Act of 2009 is available via the following links:

• Title X
• Title XI

SEC Publishes Proxy Disclosure and Solicitation Proposals

On July 10, the SEC published rule proposals regarding “Proxy Disclosure and Solicitation Enhancements” that the Commission voted to approve at its July 1 open meeting.  As we described in our July 2 News Feed post “SEC Considers Slate of Proxy Rules,” the proposals are designed to improve disclosures in proxy solicitations.  In addition to the proposals involving disclosure, the release also proposes rule changes to the proxy solicitation process.

The proposed rules would require new or amended disclosure about:

• The relationship between a company’s compensation policies and risk;
  
  
• Stock and options awards to company executives and directors;
  
  
• Qualifications of directors and nominees as well as disclosure about legal proceedings involving directors and executives;
  
  
• A company’s governance structure;
  
  
• The role of the board in risk management; and
  
  
• Potential conflicts of interest of compensation consultants.

Of particular interest to funds are the proposals that would require disclosure about qualifications of directors and board nominees, disclosure about legal proceedings, a company’s governance structure, and the role of the board in risk management.  Investment companies would be required to include expanded disclosure about director qualifications, past directorships, and legal proceedings in proxy and information statements regarding an election of directors.  In addition, the fund’s SAI would be required to include the new disclosure about director qualifications and past directorships.

Specifically, the proposal requires disclosure about each director’s (or nominee’s) particular "experience, qualifications, attributes, or skills that qualify that person to serve as a director of the company as of the time that a filing containing the disclosure is made to the Commission."  Similar disclosure would be required regarding a director’s or nominee’s service on a particular committee of the board.  Additionally, the proposal would require disclosure of any directorships held by a director or nominee at any time during the last five years at public companies (even if the director or nominee is no longer on that board).  Finally, disclosure about legal proceedings that are material to an evaluation of the ability or integrity of any director, director nominee, or executive officer would be required for directors, nominees or executive officers for a period of 10 years (rather than the currently required 5 years).

Like operating companies, the proposed rules also would require investment companies to disclose information about their management structure in both proxy statements and the fund’s SAI.  Investment companies would have to disclose whether the fund’s board chair is an interested person.  If so, the fund would also have to disclose whether the fund has a lead independent director and what role the lead independent director plays.  Investment companies would also have to describe the board’s role in risk management.

The full text of the proxy proposals is available at http://www.sec.gov/rules/proposed/2009/33-9052.pdf.

Related articles:

• "SEC Considers Slate of Proxy Rule Changes," July 2, 2009
  
  
• "July 1 SEC Open Meeting to Include "Say on Pay" Proposals," June 29, 2009

Investor Advisory Committee to Hold Public Meeting

The SEC announced yesterday that it would hold a meeting of the newly formed Investor Advisory Committee.  This meeting is to be held on July 27, 2009 in the Auditorium (Room L-002) at the SEC's Headquarters located at 100 F Street NW in Washington, DC, and will start at 10:00AM.  The meeting is open to the public, and will be webcast via a link on the SEC's website, www.sec.gov. 

As we mentioned in our June 5, 2009 post on the Investor Advisory Committee, the advisory council was formed by the Commission to give investors greater voice in the Commission's activities by:

• advising it on matters of concern to investors in the securities markets;
  
  
• providing the Commission with investors' perspectives on current, non-enforcement, regulatory issues; and
  
  
• serving as a source of information and recommendations to the Commission regarding the Commission's regulatory programs from the point of view of investors. 

The Investor Advisory Committee is comprised of Commissioner Luis A. Aguilar, who serves as the Commission's primary sponsor, and co-chaired by Richard (Mac) Hisey, President of AARP Financial Incorporated and AARP Funds, and Hye-Won Choi, Senior Vice President and Head of Corporate Governance for TIAA-CREF. Fred Joseph, President of the North American Securities Administrators Association and Securities Administrator for the State of Colorado, serves as an ex officio participant.

The SEC's announcement does not contain any details of the topics to be covered at this first open meeting of the Investor Advisory Committee, but the SEC does invite statements and/or comments to be submitted through the SEC's normal comment channels.

The Commission staff will post all statements and comments on the Advisory Committee’s Web site at:
http://www.sec.gov/spotlight/investoradvisorycommittee.htm.

The full text of the SEC's announcement of the July 27, 2009 Advisory Committee meeting is available at:  http://www.sec.gov/rules/other/2009/33-9049.pdf

Related article:

• "SEC Forms Investor Advisory Committee," June 5, 2009
  

SEC Publishes "Say on Pay" Rule Proposal for TARP Recipients

The SEC has published the full text of its proposal to amend proxy rules to include an advisory shareholder vote on executive compensation for companies participating in the Troubled Asset Relief Program (TARP).  These proposals, along with two other "say on pay" rule proposals, were considered at the Commission's July 1, 2009 open meeting.

These rules, if adopted, would require annual shareholder advisory votes on executive compensation for TARP recipients as required by the Emergency Economic Stabilization Act of 2008 (EESA). These votes would be required in all proxy solicitations made while a company has TARP assistance outstanding, and are designed to make it easier for TARP recipients to comply with the EESA.

Comments on this proposal are due 60 days after the publication of the rule release in the Federal Register.  Comments on this rule proposal may be read at:  http://www.sec.gov/comments/s7-12-09/s71209.shtml

The full text of the rule proposal is available at:  http://www.sec.gov/rules/proposed/2009/34-60218.pdf

Related articles:

• "SEC Considers Slate of Proxy Rule Changes," July 2, 2009
  
  
• "July 1 SEC Open Meeting to Include "Say on Pay" Proposals," June 29, 2009

Money Market Fund Proposals: New Duties for Directors

Directors overseeing money market mutual funds will want to pay close attention to the recent rule proposals on money market funds published last week by the SEC.  In addition to the existing responsibilities of directors of money market funds for oversight of fair valuation and portfolio quality, the release proposes rules that would require directors to determine whether the money market funds they oversee sell to "retail" or "institutional" investors.  This determination would be made necessary by other rules in the proposal requiring funds selling to institutional investors to have twice the liquidity of funds sold primarily to retail investors.

Our proposed amendments would require that a money market fund’s board determine, no less frequently than once each calendar year, whether the fund is an institutional money market fund for purposes of meeting the liquidity requirements. [citation omitted]  In particular, the fund’s board of directors would determine whether the money market fund is intended to be offered to institutional investors or has the characteristics of a fund that is intended to be offered to institutional investors, based on the: (i) nature of the record owners of fund shares; (ii) minimum amount required to be invested to establish an account; and (iii) historical cash flows, resulting or expected cash flows that would result, from purchases and redemptions. [citation omitted] The provision is designed to permit fund directors to evaluate the overall characteristics of the fund based on relevant factors. [citation omitted] 

Because, if adopted, a higher liquidity requirement for institutional funds might create incentives for money market funds to deem themselves "retail" funds in order to have greater strategic and competitive flexibility in their portfolios, the determination of whether a fund is a "retail" or "institutional" money market fund could be criticized or even subject to litigation.  The Commission's proposal to place the responsibility for this determination on money market fund directors is bound to be controversial given that the role of fund directors is one of oversight, and technical determinations are typically left to fund management with the board reviewing and approving management's procedures and the reasonableness of its considerations and conclusions. 

As noted in our recent letter to SEC Chairman, Mary L. Schapiro on potential money market reforms, the independent directors of mutual funds – and particularly the independent directors of money market funds – have a strong interest in the continuing debate over the possibilities for reforming the regulation of money market funds.  The Forum, as the voice of independent fund directors, intends to submit a comment letter to the SEC on its money market rule proposals, communicating fund directors' position on the proposals and providing feedback on the proper role of directors in the "institutional" versus "retail" money market fund determination. 

Related articles:

• "SEC Publishes Money Market Reform Proposals," July 6, 2009
  
  
• "SEC Proposes Money Market Reform Options," June 24, 2009
  
  
• "President's Plan Maintains and Strengthens SEC's and CFTC's Powers," June 18, 2009
  
  
• "Schapiro Affirms Role of Directors in Money Market Reform," June 9, 2009
  
  
• "Forum Comments on Potential Money Market Reforms," June 1, 2009
  
  
• "Chairman Schapiro's First Address to the Fund Industry," May 4, 2009
  
  
• "Donohue Outlines IM Regulatory Priorities," March 24, 2009

SEC Publishes Money Market Reform Proposals

On June 30, the SEC published the full text of money market reforms the Commission voted to propose for public comment at it's June 24, 2009 open meeting. As we described in our June 24 News Feed post, "SEC Proposes Money Market Reform Options," the proposals are intended to tighten restrictions on money funds and are aimed at increasing their stability and preventing the kind of sudden vulnerability they suffered last fall due to liquidity problems and market events. This release includes proposed regulatory amendments that, if adopted, would tighten the risk limiting parts of Rule 2a-7, including credit quality, maturity, and liquidity, increase the transparency of money market funds to both the Commission and investors, and lessen the effect when a particular fund breaks the buck and decides to liquidate. The release also requests industry comment on several concepts of potential future regulation of money market funds:

• Whether stable net asset value should be abandoned in favor of a floating rate;
  
  
• Whether funds should be permitted to make redemptions in kind to institutional shareholders;
  
  
• The appropriate role of credit rating agencies. The questions with respect to credit rating agencies would include the possibility that boards would designate certain credit rating agencies (which would be routinely reevaluated) that the fund could rely on to make purchased decisions and use to monitor securities after purchase. The designation would be based on the NRSROs performance, accuracy etc; and
  
  
• How the rules may better address the risks of investing in SIVs and other asset backed securities.

Comments on the rule proposals and the concepts on future regulatory changes are due by September 8, 2009.

The full text of the Commission's recent money market rule proposals is available at: http://www.sec.gov/rules/proposed/2009/ic-28807.pdf

Comments submitted on this proposal are available at: http://www.sec.gov/comments/s7-11-09/s71109.shtml

Related articles:

• "SEC Proposes Money Market Reform Options," June 24, 2009

• "President's Plan Maintains and Strengthens SEC's and CFTC's Powers," June 18, 2009
  
  
• "Schapiro Affirms Role of Directors in Money Market Reform," June 9, 2009
  

• "Forum Comments on Potential Money Market Reforms," June 1, 2009
  
  
• "Chairman Schapiro's First Address to the Fund Industry," May 4, 2009
  
  
• "Donohue Outlines IM Regulatory Priorities," March 24, 2009

SEC Considers Slate of Proxy Rule Changes

At an open meeting yesterday, the SEC considered several matters related to proxy solicitations, approving the proposing releases on several proxy matters, and adopting previously proposed rules dealing with broker discretionary voting. According to the Commission, these new rules, both proposed and final, are "intended to better inform and empower investors to improve corporate governance and help restore investor confidence."

Shareholder Approval of Executive Compensation of TARP Recipients

The SEC proposed rules requiring annual shareholder advisory votes on executive compensation for TARP recipients as required by the Emergency Economic Stabilization Act (EESA). These votes will be required in all proxy solicitations made while a company has TARP assistance outstanding. The rules are designed to make it easier for TARP recipients to comply with the EESA.

Proxy Disclosure and Solicitation Enhancements.

The SEC proposed rules designed to improve disclosure in proxy solicitations concerning:

• <Compensation issues. The proposed rules would require disclosure of the relationship between a company’s compensation policies and its risk profile. This disclosure would require a discussion of broad compensation policies and practices for all employees (not just named executive officers as is currently required) and how those policies and practices may materially affect the company.
  
  
• Director and director nominee qualifications. The proposal would require disclosure about the director’s/nominee’s qualifications, including experience, attributes, and skills for board service as a whole, as well as service on particular committees. Information about a director’s/nominee’s service on other public company boards during the last five years would also be disclosed. Additionally, the current five-year requirement for the disclosure of legal proceedings would be expanded to 10 years.
  
  
• Corporate governance/leadership structure. The proposed rules would require a company to disclose in its proxy materials its leadership structure, and why that structure is best for the company. Required disclosure would include why the Chair/CEO positions are or are not held by the same individual and whether the board has a lead independent director. Additionally, proxy statements would have to disclose the board’s role in risk management.
  
  
• Compensation consultants. The proposed rules would address possible conflicts of compensation consultants by requiring disclosure of information on fees and services provided by these consultants.
  
  
• <More timely disclosure of results. The new rules would require that results of shareholder votes would be required to be reported on Form 8-K within 4 days after the meeting where the vote took place.
  
  
• Finally, the rules would clarify proxy rules and facilitate shareholder communications in voting.

Order approving amendments to NYSE Rule 452 dealing with brokers discretionary voting.

The Commission voted (3 -2) to adopt rules proposed prohibiting brokers holding shares in street name from voting in uncontested elections of directors where no voting instructions were received from customers. The rule will not apply to companies registered under the 1940 Act. Additionally, the rule codifies 2 existing interpretations with respect to investment companies. The rule will preclude discretionary voting on material changes to an investment advisory contract. Additionally, the rule defines a material amendment to an investment advisory contract to include shareholder approval of a contract with a new investment adviser for which shareholder approval is required.

A video archive of the Commission's July 1 Open Meeting is available at: http://www.sec.gov/news/press/2009/2009-147.htm

The text of Chairman Mary Schapiro's opening statement at the July 1 meeting is available at: http://www.sec.gov/news/speech/2009/spch070109mls.htm

The proposing release for the first item, "Shareholder Approval of Executive Compensation of TARP Recipients," was published by the Commission on just after the July 1 open meeting. The full text of that release can be read at: http://www.sec.gov/rules/proposed/2009/34-60218.pdf

The proposing release for the "Proxy Disclosure and Solicitation Enhancements" item, and the final rule release for the broker discretionary voting item will be published by the Commission in upcoming weeks, and will be available on the Commission's website.

SEC Proposes Shareholder Access to Director Nominations

Earlier this month, the SEC published for comment the text of the proxy access rules the Commission proposed at its May 20, 2009 open meeting, "Facilitating Shareholder Director Nominations" (the Release). This proposal would require companies, in certain conditions, to include shareholder nominees for directors in their proxy materials, and is somewhat controversial, only garnering three votes in favor of proposing it out of the five member Commission.

The Release proposes a new rule, Rule 14a-11, that if adopted would require companies to include shareholder nominees for directors in company proxy materials under a set of prescribed circumstances. The Release also proposes to amend the existing Rule 14a-8(i)(8) to allow shareholders to propose amendments to the company's governing documents to put into effect the shareholder nomination of directors contemplated in the newly proposed Rule 14a-11.

The new rule would apply to all companies filing reports with the SEC under the Securities Exchange Act of 1934 (with a few exceptions) regardless of size, and notably including investment companies.

Tiered Eligibility

In order for shareholders to seek to nominate directors, the Release proposes a minimum ownership requirement tiered according to company size:

• 1 percent of the shares of a large accelerated filer (net assets of $700 million or more),
  
  
• 3 percent of the shares of an accelerated filer (net assets of $75 million or more, but less than $700 million), and
  
  
• 5 percent of the shares of a non-accelerated filer (net assets less than $75 million).

According to the Release, "the tiered beneficial ownership thresholds that [the Commission is] proposing represent an effort to balance the varying considerations and address the possibility that certain companies could be impacted disproportionately based on their size."

For investment companies, the tiered structure would be applied based on investment companies' net assets as of a specified measurement date:

Because registered investment companies are not classified as large accelerated filers, accelerated filers, and non-accelerated filers, we propose to base the tiers on the net assets of the companies.[citation omitted] In particular, we are proposing tiers for registered investment companies that are based on the worldwide market value levels used by reporting companies (other than registered investment companies) to determine filing status.[citation omitted]

Under the proposal, the amount of net assets of a registered investment company for these purposes would be the amount of net assets of the company as of the end of the company’s second fiscal quarter in the fiscal year immediately preceding the fiscal year of the meeting, as disclosed in the company’s Form N-CSR filed with the Commission, except that, for a series investment company the amount of net assets would be the company’s net assets as of June 30 of the calendar year immediately preceding the calendar year of the meeting, as disclosed in a Form 8-K filed in connection with the meeting where directors are to be elected. [citation omitted]

Though investment companies do not typically file a Form 8-K, the Commission believes it to be necessary because Form N-CSR, the fund's annual report, discloses assets by series, rather than in aggregate.

Holding Period and Aggregation of Ownership

In addition to the minimum ownership requirement, the proposed rule would require Each nominating shareholder to have held the requisite number of shares continuously for at least one year prior to the date it notifies the company of its intent to nominate a director, and must intend to hold the shares at least through the date of the annual or special meeting.

Under the proposal, shareholders who are otherwise unaffiliated would be permitted to aggregate their holdings to meet the minimum ownership threshold described above. The rule would impose no limit on the size of a nominating group, and would allow communications, filed with the SEC, for the purpose of forming a nominating group, provided they are limited in scope to the nomination of directors and do not request or solicit actual proxies. These nominating groups would still be required to report under Regulation 13D if they reach the point where they have beneficial ownership of in excess of 5% of the company's securities, however.

Limit on Number of Directors Nominated

Shareholders using the the proposed method of nominating directors could nominate the greater of:

1. one director (for a board of seven or fewer) or
   
   
2. up to 25 percent of the board (rounded down to the closest whole number under 25 percent).

Any additional shareholder-nominated directors may be elected through a conventional proxy contest for the same meeting.

Timing of Proposals

Shareholder nominations of directors would still be subject to the timing restrictions applicable to other proxy proposals under Rule 14a-8.

Filings and Required Disclosures

In order to use the proposed Rule 14a-11 nominating process, each nominating shareholder, including each shareholder comprising a nominating group, would be required to make a number of affirmative representations about their intentions, including:

• the shareholder intends to hold its shares through the date of the annual meeting, as well as its intent with respect to continued ownership following the meeting (although the proposed rule is silent as to whether and how the shareholder’s lending of its shares during this period would affect either of these statements);
  
  
• the shareholder’s nominees are in compliance with applicable objective stock exchange independence requirements;
  
  
• neither the nominee nor the nominating shareholder has an agreement with the company regarding the nomination;
  
  
• the shareholder is not attempting to effect a change of control (or to gain more than a minority of directors);
  
  
• the candidate’s nomination to or initial service on the board, if elected, would not violate controlling state or federal law or applicable listing standards;and
  
  
• the shareholder or shareholder nominating group is eligible to use Rule 14a-11 in terms of the minimum share ownership requirements.

Given the controversial nature of this wide ranging proposal, even amongst the SEC's commissioners, there will very likely be a great many comments submitted by an enormous diversity of constituencies. Because the fund industry is included in this proposal, it bears special attention from fund directors as well as management and industry service providers.

The full text of the proposing release is available at: http://sec.gov/rules/proposed/2009/33-9046fr.pdf