SEC Staff Provides New Guidance Regarding the Rule 15a-6 Registration Exemption for Foreign Broker-Dealers

[Editor’s Note:  This post is a Latham & Watkins Client Advisory.  The Network has further coverage in another post.]

On March 21, 2013, the Staff of the Division of Trading and Markets of the US Securities and Exchange Commission published guidance in the form of Frequently Asked Questions on Rule 15a-6 under the Securities Exchange Act of 1934.

The FAQs resulted from the efforts of a Task Force assembled by the Trading and Markets Subcommittee of the American Bar Association to discuss and seek clarification from the Staff with respect to certain recurring issues regarding Rule 15a-6.  This clarification was requested in the form of published FAQs to provide greater transparency to the industry and to resolve certain inconsistencies created by, among other things, Staff turnover and general confusion by the industry and other regulators as to the proper application of the Rule’s rather complex provisions to a marketplace that has become markedly more global and technologically advanced in the nearly 25 years since the Rule’s adoption.

In the FAQs, the Staff affirms the general applicability of certain previously issued interpretive guidance and addresses certain aspects of the operation of Rule 15a-6, primarily with respect to issues concerning solicitation, the dissemination of research reports, recordkeeping requirements and chaperoning arrangements between foreign broker-dealers and SEC-registered broker-dealers. Although necessarily limited in scope, the FAQs provide much welcome guidance at a time when cross-border transactions have become an integral part of the securities markets.

Background

Rule 15a-6 permits foreign broker-dealers to conduct certain limited activities in the United States and with US persons without having to register as a broker or dealer under the Exchange Act. Under Rule 15a-6, foreign broker-dealers may (i) effect “unsolicited” transactions with any person; (ii) solicit and effect securities transactions with SEC-registered broker-dealers, US banks acting in compliance with certain exceptions from the definitions of “broker” and “dealer”, certain supranational organizations, foreign persons temporarily present in the United States, US citizens resident abroad and foreign branches and agencies of US persons; and (iii) subject to a number of conditions, provide research to and effect resulting securities transactions with certain types of large institutional investors.  Rule 15a-6 also provides that a foreign broker-dealer may engage in a broader scope of activities, including soliciting and entering into transactions with specified categories of institutional investors, with the assistance or intermediation of an SEC registered broker-dealer (the establishment of such an arrangement is typically referred to as a “chaperoning arrangement” and the SEC-registered broker-dealer is often referred to as the “chaperoning broker-dealer”).

To read the rest of this Client Advisory, please click here and search the Advisory number “1495.”

From the Bench: Second Circuit denies class certification in lawsuit against J.P. Morgan

In Levitt v. J.P. Morgan Sec., Inc., 10-4596-CV, 2013 WL 1007678 (2d Cir. Mar. 15, 2013), the Second Circuit reversed a district court’s grant of class certification to a group of plaintiffs who alleged that Bear Sterns (subsequently bought by J.P. Morgan) had violated its duty to disclose when it did not notify investors of a fraudulent scheme by Sterling Foster, a now-defunct brokerage firm.

The case concerned allegations of fraud arising from a September 1996 IPO of ML Direct, a television marketing firm.  Sterling Foster orchestrated the IPO as the introducing broker, with Bear Sterns (subsequently acquired by J.P. Morgan) acting as the clearing broker.  In general, the clearing broker in a transaction owes no duty of disclosure to the customers of the introducing broker.  However, the plaintiffs sought to overcome this hurdle by establishing that Bear Sterns actively participated in the fraudulent scheme.

The district court agreed with the plaintiffs that Bear Sterns’s participation was extensive enough to trigger a duty to disclose.  However, the Second Circuit held that the plaintiffs had failed to allege “sufficiently direct involvement” by Bear Sterns.

The Second Circuit noted that providing “normal clearing services” do not give rise to a duty to disclose, even when the broker providing those services is aware of the introducing broker’s fraudulent intentions.  Rather, to trigger a disclosure duty, the clearing broker would have to actively depart from its normal passive clearing functions and affirmatively exert “direct control” over the introducing broker and the fraudulent trades.  The court found that Bear Sterns, by merely “allowing” such trades to proceed, had not assumed such a level of control.

The plaintiffs’ counsel characterized the ruling as “a sad day for investor protection,” stating that the court had “has for the first time held that a clearing firm has no duty to disclose that it is knowingly participating in market manipulation by its introducing broker.”

The court, however, carefully declined to address the legal implications of “market manipulation itself” on the duty to disclose, confining itself to its factual conclusion that Bear Sterns did not directly engage in such manipulation.  Underscoring the narrowness of the Second Circuit’s ruling, the New York district court refused to apply Levitt to a case where a defendant had made misleading statements, holding that the making of misleading statements constituted direct involvement.  The same district court has also recently observed that the question of market manipulation remains open.

SEC Reminds Private Funds of Broker-Dealer Registration Requirements

[Editor’s Note:  The following is an Arnold & Porter LLP Client Advisory, written by Robert E. Holton, Lily J. Lu, D. Grant Vingoe, and Lauren R. Bittman.]

SEC official reminds private funds, including contacts private equity funds, that certain fund-raising and marketing activities and fees for “investment banking activities” require broker-dealer registration.

On April 5, 2013, David Blass, Chief Counsel of the Division of Trading and Markets of the Securities and Exchange Commission (SEC), spoke before the Trading and Markets Subcommittee of the American Bar Association on broker-dealer registration issues that arise in the private funds context. In his remarks, Mr. Blass warned that acting as an unregistered broker-dealer is a violation of the Securities Exchange Act of 1934, as amended (the Exchange Act), and can have serious consequences, including sanctions by the SEC and rescission rights, even when no other wrong-doing is found. Mr. Blass also noted that the SEC staff has increased its attention to the issue of broker-dealer registration, and he reminded the audience that compliance by private fund advisers with the requirements of the Investment Advisers Act of 1940, as amended, is not enough. In light of the significant consequences of acting as an unregistered broker-dealer and the SEC staff’s increased attention to this issue and the private fund space in general, private fund advisers should review their fund-raising and marketing activities, policies and procedures and contracts and arrangements with portfolio companies and solicitors to ensure compliance.

Click here to read the entire Arnold & Porter Advisory.

Regulators focus on High-Frequency Trading and Wash Trades

High-frequency trading firms, who may be distorting financial market prices by conducting transactions with themselves, are drawing scrutiny from U.S. regulators.  Investigations of so-called wash trades by the Securities Exchange Commission (“SEC”), Commodity Futures Trading Commission (“CFTC”), and Financial Industry Regulatory Authority (“FINRA”) represent another episode in the struggle to understand and properly regulate high-frequency trading activity.

Wash trades are a form of self-dealing that occurs when one party places bid and ask requests for the same security.  This causes an appearance of increased activity in the security that can prompt other participants to enter the market.  The lured-in traders drive activity that affects the price of the security.  More importantly, the surge in volume creates profitable opportunities for high-frequency firms, who often act as market makers.

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Are All MOEs Created Equal?

[Editor’s Note:  The following post is a Kirkland & Ellis M&A Update, authored by Daniel E.WolfSarkis JebejianJoshua M. Zachariah, and David B. Feirstein.]

With valuations stabilizing and the M&A market heating up, a rebirth of stock-for-stock deals, after a long period of dominance for all-cash transactions, may bein the offing.

If this happens, we expect to see renewed use of the term “merger of equals” (MOE) to describe some of these all-equity combinations.  As a starting point, it may be helpful to define what an MOE is and, equally important, what it isn’t.  The term itself lacks legal significance or definition, with no requirements to qualify as an MOE and no specific rules and doctrines applicable as a result of the label.  Rather, the designation is mostly about market perception (and attempts to shape that perception), with the intent of presenting the deal as a combination of two relatively equal enterprises rather than a takeover of one by the other.  That said, MOEs generally share certain common characteristics.  First, a significant percentage of the equity of the surviving company will be received by each party’s shareholders.  Second, a low or no premium to the pre-announcement priceis paid to shareholders of the parties. Finally, there is some meaningful sharing or participation by both parties in “social” aspects of the surviving company.

While each of the aspects of an MOE deal will fall along a continuum of “equality” for the shareholders of each party, there are a handful of key issues that require special attention in an MOE transaction.  

Click here to read the entire Kirkland & Ellis LLP publication, discussing Social Issues, Change of Control, Shareholder Vote/Fiduciary Issues, Consideration, and Agreements.

Social Entrepreneurship Panel: A Recap

On April 3, 2013, the Berkeley Center for Law, Business and the Economy (BCLBE) hosted a Social Entrepreneurship: Legal, Financial and Public Policy Dimensions panel moderated by Professor Eric Talley.  Panelists included legal experts R. Todd Johnson (Partner, Jones Days), Jonathan Storper (Partner, Hanson Bridgett), Kyle Westaway (Founder of Westaway Law) and Jordan Breslow (General Counsel at New Island Capital) as well as Vince Siciliano (CEO and President of the New Resources Bank).

Talley began by asking for a definition of social entrepreneurship.  Johnson offered “any organization that makes money and does social good” and Siciliano added “maximizing distribution [for a given product] while being profitable” as social enterprises attempt to maximize social impact for a given product or service.  Breslow, who works for an impact investment advisor, talked about how one of the downsides of a nonprofit, as compared to a social enterprise, is that “in giving money away [investors] lose control.”

Measuring profits is straightforward but measuring social impact is not always so easy.  However, as Johnson notes, “we need to get past the head-scratching period of asking ‘how do we measure impact’ that comes from looking at social entrepreneurship as a sector. It’s not a sector. It’s a way of doing business.”  Social impact can be applied to any business sector — health care, education, technology, etc. For some sectors, the impact equation is simple. For example, d.light solar sells solar light and power products so it is “relatively easy to calculate how much kerosene and therefore CO2 is avoided by its products.”  It is harder for other sectors, such as services, or where impact is based upon human transformation or long-term goals. “Sometimes the outcome should be obvious, but is simply hard (or expensive to capture) such as greening of supply chains.”  Westaway agreed noting that he “applauds the idea of standardization but it is hard to do.”

Talley asked the panelist to assess whether these types of enterprises are more risky than others, that perhaps, do not consider their social impact. Siciliano suggested that some social enterprises may be considered risky by traditional investors because they are not well understood.  “As a commercial bank, one of the New Resource Bank’s competitive advantages” he explained “is its sector expertise.” He offers that it is not about the risk of the underlying business model as much as that traditional commercial banks assess high risk to these enterprises because of their limited exposure to some of the new sectors these enterprises are operating in. “We don’t view these companies as risky because we better understand their markets and stage of growth.” Specific industry examples include organic products, alternative energy, energy efficiency retrofits, green real estate, and nonprofits.

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Using the Web to Match Private Companies and Potential Investors: SEC No Action Letters Open a Door, but Questions Remain

[Editor’s Note:  The following post is a Goodwin Proctor Alert, which relays regulatory and legislative developments.]

In a no action letter dated March 26, 2013 (the “FC Letter”), the staff of the U.S. Securities and Exchange Commission (the “SEC”) indicated that they would not recommend action against the operators of the FundersClub website (“FundersClub”) for failing to register as a broker/dealer under the U.S. Securities Exchange Act of 1934 (the “Exchange Act). Two days later, a similar letter (the “AL Letter”) was issued to the operators of the AngelList website (“AngelList”)

The Letters may remove one of the most significant obstacles to the development of a broad-scale, online business in which accredited investors are able to select and invest in private companies. However, the Letters are based upon a number of representations made by FundersClub and AngelList that may be difficult to defend or apply in practice. They also leave unaddressed a number of related legal issues. Thus, the Letters may represent only the beginning of a process in which entrepreneurs, investment managers, private companies, the Staff, the SEC and others explore and develop the rules and practices under which such a business may be operated.

This Client Alert briefly describes certain key issues and conclusions associated with the Letters and highlights some of the issues and risks that remain.

Click here to read the entire article.

[The Alert concludes that t]he Letters may be a key milestone in the development of a broad-based marketplace in which Web-based efficiencies are applied to matching (i) private companies seeking capital with (ii) accredited investors willing to provide it. Nevertheless, important open issues remain. In particular, the representations made by FundersClub and AngelList in obtaining the Letters may prove difficult to defend or apply in practice. Moreover, key questions (e.g., regarding general solicitation and the procedures by which investors may be verified as “accredited”) await further guidance from the SEC. Finally, other parties such as state regulators and various self-regulatory organizations have not yet weighed-in and may have a material impact.

Upcoming Events from the Berkeley Center for Law, Business and the Economy

Smart Course Planning: What to Take in Business Law and Why

Today, April 8th at 12:45 in Boalt Hall, Room 100, join BCLBE for an information session about next semester’s business law courses at Berkeley Law. Executive Director of BCLBE, Ken Taymor, along with several other Boalt faculty will preview Fall 2013 classes and highlight new course offerings. This is an opportunity for students to learn how the various business course offerings can help prepare them for professional practice. Miranda-Lin Bailey (Boalt ’04) from Aera Energy also will participate in the discussion and share her perspective on what coursework to pursue before graduation and why.

Registration is available here.

Corporate v. Litigation Practices, Presented by Paul Hastings

On Thursday, April 11th at 12:45 in Boalt Hall, Room 110, attorneys from Paul Hastings will present the differences between litigation and transactional work. Moderator Samantha Eldredge will discuss with the panel of Paul Hastings attorneys the differences in work, style, and necessary skills. The event is cosponsored by the Career Development Office and BCLBE.

To RSVP, please contact Sarah Cunniff. For questions, email Phyliss Martinez or Sarah Cunniff.

The First Five Years of China’s Antimonopoly Law

On Monday, April 15th at 12:45 in Boalt Hall, Room 110, Nathan Bush, a Partner in the Beijing and Singapore office of O’Melveny & Myers, will present on the first five years of Chinese antitrust enforcement under the Antimonopoly law and the future of Chinese competition policy under the new Xi Jinping government. The law is China’s first comprehensive competition statute. Since it took effect on August 1, 2008, China has emerged as a significant antitrust jurisdiction as its competition authorities have blocked or imposed conditions on worldwide mergers, fined foreign cartels, and even challenged the commercial practices of some state-owned enterprises.

CLE credit is available. Registration is available here.

Week in Review: The Administration on Wall Street

The Obama Administration has continued its aggressive prosecution of suspect players in the financial meltdown that shaped most of the President’s first term.

Four mortgage insurers, including an AIG subsidiary, have agreed to a $15 million settlement over allegations of improper ‘kickbacks’ paid to lenders for more than a decade.  The Consumer Financial Protection Bureau made the announcement today.  Its director, Richard Cordray, charged, “We believe these mortgage insurance companies funneled millions of dollars to mortgage lenders for well over a decade.”  For more, see the NYTimesand WSJ.

Also today, the U.S. Department of Justice filed a fraud suit against Golden First Mortgage Corp, alleging the company and its CEO “repeatedly lied” to the government.  The complaint claims that Golden First rushed paperwork through internally, although the company certified (to HUD and the FHA) that proper due diligence had been conducted.  According to the government, Golden First used three employees to process 100-200 loans per month—predictably leading to “extraordinarily high” default rates as high as 60% in 2007.  For more, see Thomson Reuters.

On a related note, district court Judge Victor Marrero (S.D.N.Y.) indicated that he may not accept a “neither admit nor deny” provision in SAC Capital Advisor’s insider trading settlement.  At a hearing last week, he made a point unlikely to encounter much resistance:  “There is something counterintuitive and incongruous in a party agreeing to settle a case for $600 million that might cost $1 million to defend and litigate if it truly did nothing wrong.”  Judge Marrero is not the first to question these clauses – commonly demanded by corporate litigants – but his remarks demonstrate a growing judicial skepticism with the practice.  For more, see BusinessweekReuters, and The New Yorker.