Published by RR Donnelley
Editorial Content by LegalWorks
Blake A. Bell, Editor in Chief
In This Issue:
SEC I: SEC Proposes Changes to the Regulations Regarding Credit Ratings Agencies
U.S. Securities and Exchange Commission, SEC Publishes Proposals To Increase Investor Protections by Reducing Reliance on Credit Ratings, News Release 2008-127 (July 1, 2008).
U.S. Securities and Exchange Commission, Archived Webcast of SEC Chairman's Statement on Proposal (July 1, 2008) (Windows Media Player).
U.S. Securities and Exchange Commission, Proposed Rule: References to Ratings of Nationally Recognized Statistical Rating Organizations, Release No. 34-58070 (July 1, 2008).
U.S. Securities and Exchange Commission, Proposed Rule: Securities Ratings, Release Nos. 33-8940 and 34-58071 (July 1, 2008).
U.S. Securities and Exchange Commission, Proposed Rule: References to Ratings of Nationally Recognized Statistical Rating Organizations, Release Nos. IC-28327 and IA-2751 (July 1, 2008).
U.S. Securities and Exchange Commission, SEC Proposes Comprehensive Reforms to Bring Increased Transparency to Credit Rating Process, News Release 2008-110 (June 11, 2008).
U.S. Securities and Exchange Commission, Proposed Rule for Nationally Recognized Statistical Rating Organizations, Release No. 34-57967 (June 16, 2008).
In open meetings held on June 11 and June 25, the SEC voted unanimously to propose three sets of comprehensive reforms to the regulations regarding the nation's credit ratings agencies. Among other things, the proposals are intended to bring increased transparency to the credit ratings process and curb practices that contributed to the current credit crisis gripping the nation's markets.
Following the dismal performance of credit ratings agencies and, some say, the many conflicts of interest that infected the process, the Commission became concerned that its inclusion of requirements related to ratings in its rules and forms, in effect, placed an "official seal of approval" on ratings that might have adversely affected the quality of due diligence and investment analysis performed by the nation's investors. Accordingly, the Commission decided to remove or revise many such references in its rules, hoping to "reduce undue reliance on credit ratings" and hoping for "improvements in the analysis that underlies investment decisions".
The Commission's proposed rulemaking continues implementation of regulatory authority that the Commission received from Congress to register and oversee nationally-recognized statistical rating organizations. Under this authority, which became effective last September, the Commission has been conducting examinations and assembling data on ratings agencies from a variety of sources. The proposals announced on June 11 were intended primarily to regulate what the Commission perceived as conflicts of interest at the ratings agencies as well as the need to revise disclosure requirements, internal policies and the business practices of the credit rating agencies.
The proposals consist of hundreds of pages of text. In the broadest sense, the proposals are summarized as follows:
In the first part of its proposal, the Commission proposes to:
- Prohibit a credit rating agency from issuing a rating on a structured product unless information on assets underlying the product was available.
- Prohibit credit rating agencies from structuring the same products that they rate.
- Require credit rating agencies to make all of their ratings and subsequent rating actions publicly available. This data would be required to be provided in a way that will facilitate comparisons of each credit rating agency's performance. This would provide a powerful check against providing ratings that are persistently overly optimistic, and further strengthen competition in the ratings industry.
- Attack the practice of buying favorable ratings by prohibiting anyone who participates in determining a credit rating from negotiating the fee that the issuer pays for it.
- Prohibit gifts from those who receive ratings to those who rate them, in any amount over $25.
- Require credit rating agencies to publish performance statistics for 1, 3, and 10 years within each rating category in a way that facilitates comparison with competitors in the industry.
- Require disclosure by the rating agencies of the way they rely on the due diligence of others to verify the assets underlying a structured product.
- Require disclosure of how frequently credit ratings are reviewed; whether different models are used for ratings surveillance than for initial ratings; and whether changes made to models are applied retroactively to existing ratings.
- Require credit rating agencies to make an annual report of the number of ratings actions they took in each ratings class and maintain an XBRL database of all rating actions on the rating agency's Web site. This would permit easy analysis of both initial ratings and ratings change data.
- Require the public disclosure of the information a credit rating agency uses to determine a rating on a structured product, including information on the underlying assets. That would permit broad market scrutiny, as well as competitive analysis by other rating agencies that are not paid by the issuer to rate the product.
- Require documentation of the rationale for any significant out-of-model adjustments.
The second part of the Commission's proposal would require credit rating agencies to differentiate the ratings they issue on structured products from those they issue on bonds, either through the use of different symbols, such as attaching an identifier to the rating, or by issuing a report disclosing the differences between ratings of structured products and other securities.
Finally, the third part of the Commission's proposal would ensure that the role the SEC has assigned to ratings in its rules is consistent with the objective of having investors make an independent judgment of risks and of making it clear to investors the limits and purposes of credit ratings for structured products.
SEC II: SEC Proposes Changes to the Regulations Regarding Foreign Broker Activities in the U.S.
U.S. Securities and Exchange Commission, SEC Proposes Amendments to Improve Regulation of Foreign Broker Activities in U.S., News Release 2008-124 (June 27, 2008).
U.S. Securities and Exchange Commission, Archived Webcast of SEC Chairman's Statement Regarding the Proposal (June 25, 2008) (Windows Media Player).
U.S. Securities and Exchange Commission, Proposed Rule: Exemption of Certain Foreign Brokers or Dealers, Release No. 34-58047 (June 27, 2008).
On June 27, the SEC published for comment proposed rule changes intended to increase the range of services that foreign broker-dealers may offer in the United States. Additionally, the proposal would "maintain" a regulatory structure applicable in this context.
The Commission long has been criticized for a regulatory regime regarding foreign brokers that required any contact by a foreign broker-dealer with a U.S. institution must be "chaperoned" by a person registered with a U.S. broker-dealer. Even the Commission admitted that "this chaperoning requirement has proven unwieldy as investors face significant inconvenience caused by differences in time zones and limitations on when investors can be contacted . . . Further difficulties for U.S. investors arise because U.S. registered personnel have to be available for communications with foreign broker-dealers".
In broad terms, the Commission's proposal will expand and streamline the conditions under which foreign broker-dealers could operate without triggering the registration, reporting and other requirements of the Exchange Act and related rules that apply to unregistered broker-dealers. Foreign brokers would, of course, remain subject to the antifraud provisions of the federal securities laws".
SEC III: U.S. Senate Confirms Three SEC Commissioner Nominees
U.S. Securities and Exchange Commission, Statement from Chairman Cox Regarding Senate Confirmation of SEC Commissioner Nominees, News Release 2008-125 (June 27, 2008).
On June 27, the U.S. Senate confirmed three presidential nominees to seats as Commissioners on the Securities and Exchange Commission. The Senate confirmed law professor Troy Paredes to fill an upcoming Republican vacancy on the five-member Commission. Luis Aguilar and Elisse Walter were confirmed for seats designated for Democrats that have been vacant for months. By law, no more than three members of the Commission at any time may be members of the same political party.
Elisse Walter previously served as Senior Executive Vice President of the Financial Industry Regulatory Authority Inc. Luis Aguilar previously served as a securities attorney in Atlanta. Troy Paredes previously served as a professor at Washington University Law School in St. Louis.
Senate Confirmation now gives the Commission its full slate of members after months of criticism that the Commission was operating below capacity at a critical time in the life of the nation's financial markets.
SEC IV: SEC Files Civil Fraud Proceeding and Justice Department Obtains Indictments Against Ex-Managers of Bear Stearns Hedge Funds
U.S. Securities and Exchange Commission, SEC Charges Two Former Bear Stearns Hedge Fund Managers with Fraud, News Release 2008-115 (June 19, 2008).
U.S. Securities and Exchange Commission, SEC v. Ralph R. Cioffi and Matthew M. Tannin, Litigation Release No. 20625 (June 19, 2008).
Securities and Exchange Commission v. Ralph R. Cioffi and Matthew M. Tannin, Case No. 08-2457, Block, J., Pohorelsky, M.J., Complaint (E.D.N.Y., Complaint Filed June 19, 2008).
United States of America v. Ralph Cioffi and Matthew Tannin, Case No. CR-08-415, Indictment (E.D.N.Y., Indictment Filed June 18, 2008).
On June 19, the Securities and Exchange Commission charged two former Bear Stearns Asset Management hedge fund managers with "fraudulently misleading investors about the financial state of the firm's two largest hedge funds and their exposure to subprime mortgage-backed securities before the collapse of the funds in June 2007". The U.S. Attorney's Office for the Eastern District of New York and the FBI conducted a separate, parallel investigation of the pair that led to their indictment the previous day on conspiracy and fraud charges.
Some have described the two former hedge fund managers as the new poster-children of the subprime crisis. Others have alleged that the collapse of the two funds touched off the subprime crisis, the reverberations of which continue to be felt in the world's markets.
The Commission's civil fraud allegations contained in its complaint tell a troubling story. According to the Commission:
[T]he Bear Stearns High-Grade Structured Credit Strategies Fund and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund collapsed after taking highly leveraged positions in structured securities based largely on subprime mortgage-backed securities. Cioffi acted as senior portfolio manager and Tannin acted as portfolio manager and chief operating officer for the funds, and they misrepresented the funds' deteriorating condition and the level of investor redemption requests in order to bring in new money and keep existing investors and institutional counterparties from withdrawing money. For example, Cioffi misrepresented the funds' April 2007 monthly performance by releasing insufficiently qualified estimates — based only on a subset of the funds' portfolios — that projected essentially flat returns. Final returns released several weeks later revealed actual April losses of 5.09 percent for the High-Grade Structured Credit Strategies Fund and 18.97 percent for the High-Grade Structured Credit Strategies Enhanced Leverage Fund.
The SEC's complaint alleges that Cioffi and Tannin also misrepresented their funds' investment in subprime mortgage-backed securities. Monthly written performance summaries highlighted direct subprime exposure as typically about 6 to 8 percent of each fund's portfolio. However, after the funds had collapsed, the BSAM sales force was ultimately told that total subprime exposure — direct and indirect — was approximately 60 percent.
The SEC further alleges that Cioffi and Tannin continually exaggerated their own investments in the funds while using their personal stake as a selling point to investors. Tannin repeatedly told investors, directly and through the Bear Stearns sales force, that he was adding to his own stake in the funds in order to take advantage of the buying "opportunity" presented by the funds' losses. Tannin never actually added to his investment. He mocked as "silly" at least one investor who sought to redeem instead of following Tannin's supposed example. Meanwhile, Cioffi redeemed $2 million, which was more than one-third of his personal investment in the funds at the end of March 2007. Cioffi transferred it to another BSAM fund that he described as "short sub prime," which he knew was profitable at the time.
The indictment contains nine counts. It alleges, among other things, that although Cioffi began transferring one-third of his $6 million personal investment out of the funds on March 23, he and Tannin continued to mislead investors regarding the state of the funds into June.
SEC V: Division of Corporation Finance Issues Guidance on Section 3(a)(10) Exemption from '33 Act Registration Requirements U.S. Securities and Exchange Commission Division of Corporation Finance, Staff Legal Bulletin No. 3A (CF) (June 18, 2008).
On June 18, staff of the SEC's Division of Corporation Finance issued Staff Legal Bulletin No. 3A(CF) providing guidance on guidance on the Section 3(a)(10) exemption from the registration requirements under the Securities Act of 1933 and also on the Securities Act resale status of securities that are received in certain transactions exempt from registration under Section 3(a)(1).
Although the exemption is available without any action by the Division or the Commission, issuers increasingly have sought "no-action" letters from the Commission to address circumstances that render them unsure of the availability of the exemption. Consequently, the Division of Corporation Finance decided to address in its bulletin many of the issues that commonly arise in connection with such "no-action" requests.
The bulletin addresses the timing of no-action requests and the timing of security holders' votes. It also addresses the requirements underlying the exemption including: (i) the requirement that the securities must be issued in exchange for securities, claims or property interests; (ii) the requirement that a court or authorized governmental entity must approve the Exchange's terms and conditions; and (iii) the requirement that, before approval, the court or authorized governmental entity must hold a hearing on the fairness of the exchange that must be open to everyone to whom the securities would be issued in the proposed exchange.
FASB I: FASB Issues Exposure Draft on Accounting for Hedging Activities
Financial Accounting Standards Board, FASB Issues Exposure Draft on Accounting for Hedging Activities, News Release (June 6, 2008).
Financial Accounting Standards Board, Exposure Draft: Proposed Statement of Financial Accounting Standards - Accounting for Hedging Activities, an Amendment of FASB Statement No. 133 (June 6, 2008).
On June 6, the Financial Accounting Standards Board issued an Exposure Draft of a proposed amendment to FASB Statement No. 133 dealing with accounting for hedging activities. With the Exposure Draft, FASB seeks feedback regarding a proposal to simplify hedge accounting by eliminating multiple methods of hedge accounting currently being used for the same transaction. The proposal also would require an entity to designate all risks as the hedged risk (with certain exceptions) in the hedged item or transaction. The intent is to reflect better the economics of such items and transactions in the financial statements.
PRACTICAL GUIDANCE: Courtesy of RealCorporateLawyer.com
RealCorporateLawyer.com provides its readers with free access to a very large collection of law firm memoranda providing practical guidance on current hot topics. Readers are encouraged to visit the frequently-updated "Emerging Legal Issues" area of the home page for such current memoranda, as well as the Expert Analysis: SEC Reform Portal section containing hundreds of other such memoranda. Recent additions include:
Also, don’t forget that RR Donnelley offers a selection of reference publications of interest to corporate counsel.
COMINGS AND GOINGS: Who's Doing and Saying What and Where?
On July 1, the Commission announced that Dan Gallagher has been named Deputy Director in the Division of Trading and Markets. He has served as Counsel to the SEC Chairman since 2007. See U.S. Securities and Exchange Commission, Dan Gallagher Named Deputy Director in Division of Trading and Markets, News Release 2008-129 (July 1, 2008). Also on July 1, the Commission announced that its Chief Information Officer, R. Corey Booth completed his SEC service on June 30 and will join the Boston Consulting Group in New York as a leader of its financial services practice. See U.S. Securities and Exchange Commission, SEC Chief Information Officer Corey Booth Completes SEC Service, News Release 2008-126 (July 1, 2008). On June 27, the U.S. Senate confirmed three SEC Commissioner Nominees: Elisse Walter, Sr. E.V.P. of FINRA; Luis Aguilar, Atlanta securities attorney; and Prof. Tory Paredes of Washington University Law School. See U.S. Securities and Exchange Commission, Statement from Chairman Cox Regarding Senate Confirmation of SEC Commissioner Nominees, News Release 2008-125 (June 27, 2008). The Commission named Donald M. Hoerl as Regional Director of the SEC's Denver Regional Office on June 18. He had served in that office as Associate Regional Director for Enforcement since 1997. See U.S. Securities and Exchange Commission, Donald M. Hoerl Named Acting Regional Director of SEC's Denver Regional Office, News Release 2008-113 (June 18, 2008). SEC Chairman Christopher Cox announced on June 4 that Steven B. Harris, a former long-time Senate Banking Committee official, has been appointed to the PCAOB. See U.S. Securities and Exchange Commission, Steven B. Harris Appointed to Public Company Accounting Oversight Board, News Release 2008-107 (June 4, 2008). On June 3, SEC Chairman Cox announced that six former SEC Chairmen would join him for a roundtable discussion at SEC headquarters: Richard Breeden (1989-93); Bradford Cook (1973); William Donaldson (2003-05); Roderick Hills (1975-77); Harvey Pitt (2001-03); and David Ruder (1987-89). See U.S. Securities and Exchange Commission, Chairman Cox to Convene SEC Chairmen Roundtable, News Release 2008-106 (June 3, 2008). The same day, SEC Chairman Cox and Linda Chatman Thomsen, Director of the Commission's Division of Enforcement, announced that George Curtis and Scott Friestad have been appointed as the new Deputy Directors in the Enforcement Division. See U.S. Securities and Exchange Commission, Chairman Cox, Director Thomsen Announce New Deputies in SEC's Enforcement Division, News Release 2008-104 (June 3, 2008). Only the day before, the Commission announced the retirement of Walter G. Ricciardi as Deputy Director of the Division of Enforcement. See U.S. Securities and Exchange Commission, SEC Announces Walter Ricciardi To Retire as Deputy Director of Enforcement Division, News Release 2008-103 (June 2, 2008).
On June 25, SEC Chairman Christopher Cox delivered four statements during the Commission's open meeting: (1) Statement on Proposal to Increase Investor Protection by Reducing Reliance on Credit Ratings; (2) Statement at Open Meeting on Equity-Indexed Annuities; (3) Statement at Open Meeting on Amendments to Rule 15a-6; (4) Statement at Open Meeting on Streamlining the Review of SRO Rulemaking. Chairman Cox spoke at Stanford Law School Directors' College on June 23 regarding "Making Disclosure More Useful for Public Company Directors,". He also spoke on June 12 before the CFA Institute Conference on Next Generation Asset Management regarding "Disclosure from the User's Perspective,". Chairman Cox delivered a "Statement at Open Meeting on Rules for Credit Rating Agencies" at the Commission's June 11 open meeting. At the same meeting, Commissioner Paul S. Atkins delivered "Statement at Open Meeting to Consider Proposed Rules under the Rating Agency Act,". Chairman Cox also delivered the "Opening Address to International Roundtable on Interactive Data" on June 10, 2008.
Commission Staffers were busy on the speaking circuit during June as well. On June 25, several Commission Staffers delivered statements during the Commission's open meeting, including: (1) Andrew J. Donohue, Director, Division of Investment Management delivered "Opening Remarks before the Commission Open Meeting,"; (2) Steven Hearne, Special Counsel, Division of Corporation Finance, delivered "Division Statement before the Commission Open Meeting"; and (3) Erik R. Sirri, Director, Division of Trading and Markets, delivered three sets of remarks - "Opening Remarks before the Commission Open Meeting," and a second set of "Opening Remarks before the Commission Open Meeting" and a third set of "Opening Remarks before the Commission Open Meeting". The Commission's Director of the Office of International Affairs, Ethiopis Tafara, spoke on June 19 regarding "Investors' Choice in the Regulation of Global Capital Markets?". Erik R. Sirri delivered yet another opening statement at the Commission's June 11 open meeting. See Opening Remarks before the Commission Open Meeting. John W. White, Director of the Commission's Division of Corporation Finance, spoke on June 5 regarding "IFRS and U.S. Companies: A Look Ahead". On June 4, Andrew J. Donohue, Director of the SEC's Division of Investment Management delivered the "Keynote Address Before SIFMA's Institutional Brokerage Conference". The same day, Linda Chatman Thomsen, Director of the SEC's Division of Enforcement, spoke at the Compliance Week Conference regarding "It's Always Something". Finally, on June 2, Andrew J. Donohue delivered "Remarks Before the NAVA Compliance and Regulatory Affairs Conference".
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©2008 RR Donnelley
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