FEBRUARY 26, 2007
Highlights From “SEC Speaks” 2007
Following are the highlights of the “SEC Speaks” conference held in Washington, D.C. on
February 9-10, 2007.
I. Chairman’s Speech – Christopher Cox
Chairman Cox commenced his address by praising the SEC staff, and in particular the
Enforcement Division staff, for their work. He emphasized that while criticism may
sometimes be levied at the SEC and its staff, the job of law enforcement is to “stay the
course.” He observed that this country’s “free enterprise system depends upon the rule
of law that the SEC upholds.” Chairman Cox went on to discuss a variety of initiatives
upon which the SEC and its staff have focused in the past year. In particular, Chairman
Cox stated that this past year the SEC conducted “the most comprehensive overhaul
of the executive compensation rules in over a decade.” As noted by Chairman Cox,
the recent overhaul of the executive compensation rules will result this spring in
investors finding “in their proxy statements the most clear, understandable, and
comprehensive presentation of executive compensation that has ever been provided at
any time, in any country on earth.”
On the technology front, Chairman Cox observed that the use of XBRL (eXensible
Business Reporting Language) interactive technology has substantially improved the
To receive future copies of SEC
staff ’s ability to analyze the wealth of information filed with the SEC and to identify
Updates via email, please send your
name, company or firm name and
any associated issues on a more timely basis. The SEC has also allocated significant
email address to Melanie Mitzman at resources towards the development of new software designed to better manage its
email@example.com enforcement cases and to aid in the prompt disbursement of funds to investors. As
noted by Chairman Cox, the SEC’s new Phoenix system will help the SEC “more
accurately track, collect, and distribute the billions of dollars in penalties and
This SEC Client Update has been prepared by disgorgements that flow from [its] enforcement work.” Chairman Cox further
Sidley Austin LLP for informational purposes only indicated that the SEC aims to “meet the gold standard” for disaster preparedness and
and does not constitute legal advice. This
is devoting substantial resources to ensuring the SEC can continue its mission critical
information is not intended to create, and receipt of
it does not constitute, a lawyer-client relationship.
objectives in the event of a disaster.
Readers should not act upon this without seeking
Chairman Cox also praised the Chief Compliance Officer Outreach Program
advice from professional advisers.
(CCOutreach Program), which was instituted in 2006. The goal of this program is to
Attorney Advertising - For purposes of compliance with New
York State Bar rules, our headquarters are Sidley Austin
improve compliance by opening the lines of communication between chief
LLP, 787 Seventh Avenue, New York, NY 10019, 212.839.5300 compliance officers and SEC staff and to provide for the discussion of timely issues in
and One South Dearborn, Chicago, IL 60603, 312.853.7000.
Prior results do not guarantee a similar outcome. an effective way. He also spoke to the SEC’s continuing efforts to partner more closely
with other regulators, as well as with private sector entities, in should seek out the interpretative materials published on the
order to better leverage the SEC’s resources. As an example, he SEC’s website, including transition questions and answers and a
noted the “Senior Summit,” an investor education initiative revised set of telephone interpretations. Mr. Lynn noted
conducted in 2006 in coordination with the National particularly the staff ’s view that the new compensation
Association of Securities Dealers, Inc. (NASD), the American discussion and analysis (CD&A) may have to cover awards in
Association of Retired Persons and the North American respect of 2006 or other events after the end of the fiscal year.
Securities Administrators Association. Illustrations were changes in policies regarding perquisites or
option grant dates differing from those in force in 2006.
Chair man Cox highlighted some of the SEC’s major
accomplishments during the past year. In particular, he discussed Division Director John White emphasized the “principles-
the significant number of hedge fund cases brought by the SEC based” character of the new item, under which there may not
in connection with, among others, insider trading abuses, be a rule for every situation. He suggested review of five recent
inappropriate fund valuation schemes and failures to supervise. speeches he has given on the subject, which are also available
Chairman Cox mentioned cases brought against companies online. He discouraged the attitude of companies who
such as SG Cowen, Langley Partners and Spiegel in connection demand,“Where does it say that I have to disclose that?”
with illegal trading schemes using private investments in public
Mr. Lynn discussed some process matters concerning the new
equities (PIPEs). He further mentioned enforcement actions
rules. There will not be, he said, a special program for review of
against Jefferies & Co. for gifts and entertainment abuses that
proxy materials including the new compensation disclosures. At
were offered in exchange for directed brokerage.
least in the first year of the new rules, the staff will not select
In emphasizing the importance of the SEC’s role in protecting preliminary proxy materials because they omit compensation
the savings and investments that contribute to the economic disclosure. The staff recognizes that additional time may be
prosperity of the United States, Chairman Cox indicated that needed to prepare responses to the new disclosure requirements.
during the past year over one billion dollars has been distributed
Former Chairman David Ruder asked whether litigation risk
to injured investors. As noted by the Chairman,“[w]e can all
may be heightened by the new compensation disclosure rules
take comfort in knowing that every time the [SEC] succeeds in
because of their emphasis on judgment. Linda Thomsen, the
getting money back to injured investors, there’s a little more
Director of the Division of Enforcement, responded that her
justice, and a little more fairness, in the world.” To this end, he
staff consults with the Division of Corporation Finance and
noted that during the past year the SEC’s Enforcement staff has,
that she intends to approach the new regulations on a
among other things, filed 37 emergency actions to halt
principled basis intended to foster better conduct.
fraudulent conduct and has halted trading in 71 issuers where
the SEC found that there was inadequate public disclosure. The Restatements and delayed filings. Concerning restatements
full text of Chair man Cox’s speech is available at and delayed filings, Mr. Lynn said that the staff will generally not
http://www.sec.gov/news/speech/2007/spch020907cc.htm. comment whether use of effective registration statements on
Forms S-3 and S-8 may be used before the time form eligibility
II. Division of Corporation Finance
under the Securities Act of 1933 (Securities Act) is retested,
Executive compensation disclosure. The Division’s Chief which is generally when the Form 10-K is required to be filed.
Counsel, David Lynn, discussed the recent amendments to Item Before then, use of the prospectus is dependent on the company’s
402 of Regulation S-K, prescribing the rules for disclosure of judgment of the adequacy of its disclosure. When the Form 10-
executive compensation. He suggested that practitioners
K is filed, delayed or delinquent reports under the Securities to recommend adoption of Rule 12h-6 substantially as
Exchange Act of 1934 (Exchange Act) may impair the use of proposed. Mr. Dudek also noted the recent change in the New
abbreviated registration forms, absent a waiver from the staff. York Stock Exchange (NYSE) rules abolishing the requirement
for annual reports sent to shareholders, which will be a
Amendments to the “best price rule.” Mergers and
substantial benefit to foreign companies.
Acquisitions Chief Brian Breheny noted the effectiveness of
amendments to the “best price rule” in December 2006. The International Financial Reporting Standards. Deputy
amended rule provides a safe-harbor standard under which Chief Accountant Craig Olinger discussed International
compensation paid to target executives cannot be deemed part of Financial Reporting Standards (IFRS). The SEC staff has
the tender offer. Mr. Breheny also discussed recent no-action undertaken review of filings using IFRS and it consults with
correspondence. In McDonald’s Corporation (September 27, 2006), international regulators as a part of the effort. Mr. Olinger
the staff modified its views concerning a formula-priced tender identified a number of issues that have become the subject of
offer to allow the final pr ice to be fixed two days before frequent staff comment:
expiration. Alliance Semiconductor (September 22, 2006) permitted
• Representation of IFRS compliance “as published by the
a modified Dutch auction for shares without specific disclosure of
[International Accounting Standards Board (IASB)];”
the number of shares to be purchased. Finally,concerning options
backdating, Mr. Breheny said that the staff is aware of adverse tax • Items included or excluded from income statements;
consequences that may result from repricing tender offers due to • Use of home-country cash flow presentation standards
Section 409A of the Internal Revenue Code. The SEC is instead of IASB guidance;
consulting the Internal Revenue Service and hopes to publish
guidance soon. Companies who find themselves in this situation • Accounting for subsidiaries, particularly where basis of
should contact Mr. Breheny or his staff. control is unclear;
Termination of Exchange Act registration by foreign • Revenue recognition; and
issuers. International Corporate Finance Chief Paul Dudek • Asset impairment.
discussed the amended proposal to allow termination of
Mr. Olinger seemed to suggest that some issues may result from
Exchange Act registration by foreign companies. The revised
the principles basis of IFRS, necessitating the use of judgment.
version of proposed Rule 12h-6 is significantly more liberal
He said that the staff endeavors to “avoid a U.S. GAAP
than the original. Average daily trading volume in the United
imprint” on IFRS as a result of its reviews.
States not exceeding 5% of trading world-wide would be the
basic test for qualifying companies to terminate registration. Sarbanes-Oxley Section 404 compliance. Rulemaking
Strictures against selling activities in the United States would be Chief Elizabeth Murphy noted the SEC’s efforts to ease the
limited to registered offer ings. Immediate claims of the transition to compliance with internal control measures
Exchange Act exemption in Rule 12g3-2(b) will be permitted required by Section 404 of the Sarbanes-Oxley Act of 2002
both to companies using Rule 12h-6 and to companies that had (SOX) for smaller public companies, generally those with
terminated reporting under the old system. The proposing release market capitalizations under $75 million. In December 2006,
is available at http://www.sec.gov/rules/proposed/2006/34- the SEC acted to defer the requirement for management
55005.pdf, and the public comment period expired on February evaluation of internal controls by these companies until fiscal
12, 2007. We understand that the staff intends to move quickly years ending on or after December 15, 2007, and for the
requirement for the auditors’ evaluations until fiscal years Disclosure review operations. Assistant Director Pamela
ending on or after December 15, 2008. Following their IPOs, Long described the staff ’s disclosure review operations, where
companies will not be subject to SOX Section 404 until they most of the Division’s professionals work. Concer ning
have filed their first annual reports. comment letters on Form 10-K, she noted that these routinely
include a request for a response within ten business days. While
Small business initiatives. Small Business Policy Chief
the receipt of a response within this period is the strong
Gerald LaPor te said that the staff is consider ing the
preference, the staff will accede to requests for extensions of
recommendations of the SEC Advisory Committee on Smaller
time. Companies who disagree with comments included in the
Public Companies. Actions under consideration include
staff ’s letter are well advised to discuss the issue with the
limited access to Form S-3 for primary offerings by small
examiners of the filing, which may resolve the matter in short
business issuers. Concerning increased enforcement actions
order. Otherwise, appeal to the senior staff may be appropriate.
involving Securities Act Rule 504 offerings, Mr. LaPorte
When appealing to senior staff, a complete presentation should
referred to the SEC’s complaint in SEC v.Allixon, LR 19987
be made, including both factual and legal arguments and any
(February 1, 2007), where the attorney who opined to the
filing precedents. In cases where responses to the staff
validity of the exemption has been named as a defendant.
inadvertently include confidential information, the staff may be
Shareholder proposals. Deputy Director Martin Dunn willing to prevent the publication of the responses on the
discussed shareholder proposals. The Second Circuit decision internet. Requests for assistance in such a case must be prompt
in AFSCME v.AIG (September 5, 2006) disputed the staff ’s in that all of the correspondence may be published on the SEC’s
view that a proxy access proposal “relate to an election” and so website beginning 45 after the conclusion of the staff ’s review.
is per mitted to be excluded from proxy mater ials under
Senior Assistant Chief Accountant Donald Walker encouraged
Exchange Act Rule 14a-8(i)(8). As a result, the staff declined to
attorneys to take the lead in responding to comment letters,
express any view on a similar proposal in Hewlett-Packard
even on accounting issues. In his view, significant delays and
(January 22, 2006), a most unusual action. Reliant Electric,
other inefficiencies can follow from uncoordinated responses to
faced with a similar situation, is seeking a declaratory judgment
the staff. He emphasized that, if a company can show that the
in federal court that the proposal may be excluded. Mr. Dunn
subject of a staff inquiry is immaterial, there should be no
said that the issue is also presented in a pending request from
further comment on the issue.
UnitedHealth Group, but that state law arguments may prevent
the staff from reaching the issue under Rule 14a-8(i)(8). Special purpose acquisition companies. Associate Director
Neither Mr. Dunn nor any other member of the staff Paul Belvin discussed special purpose acquisition companies
mentioned rulemaking efforts in response to the Second (SPACs). The large numbers of SPAC offerings (and the
Circuit decision, which had appeared to be the preferred course acquisitions that follow their offerings) are reviewed by the
immediately after the court had ruled. Office of Emerging Growth Companies. Mr. Belvin noted the
recent participation of mainstream investment banks and law
Updates to Division’s home page. Corporation Finance
firms in SPAC offerings. SPACs, he said, had developed as a kind
Division Director John White noted that the Division’s home
of blank-check company designed to avoid subjection to the
page on the SEC’s website had been reorganized and updated.
penny stock rules, a result that can be achieved by establishing a
As part of the effort, revised interpretations of Regulation S-K
net asset value above the levels fixed by the rules. Most SPAC
Item 402 have just been posted. Mr. Lynn said that the same
offerings, however, observe Rule 419 strictures as technical
would be done for Rule 144 interpretations.
volunteers, including the rule’s conditions concerning escrow of offering. A different form of registration, usually Form S-1,
proceeds and allowing original subscribers to recover their must be used. Because delayed primary offerings may only be
investments at the time the SPAC acquires a third-party business. made on S-3, a recharacterized PIPEs deal on Form S-1 must
be commenced promptly and made on a continuous basis.
Mr. Belvin’s practical suggestions covered the process of the
Multiple S-1 registration statements may be required before the
staff ’s reviews of both the registration statement and the
whole investment is disposed of. Finally, because variable at-
acquisition. Subjects commonly raised by the staff include the
the-market pricing is available only to primary S-3 companies,
SPAC’s research and criteria for prospective acquisitions,
the offering must be made at a fixed price to the public.
conflicts of interest as they relate to all of management, any
private equity firm, and potential targets, and valuation methods Ms. McGee indicated that the staff tends to treat PIPEs
to be applied to any acquisition. Mr. Belvin stated that the staff involving the possible issuance of more than a third of the
finds that descr iptions of management’s exper ience are outstanding common stock as primary offerings. She said that
sometimes over exuberant and inappropriate. Timing can be other unspecified circumstances might persuade the staff to
both a disclosure matter and a practical problem. The staff agree that the transaction should be treated as a secondary
commonly requests clarification of management’s authority to offering. Offerings involving less than a third of outstanding
extend the period allowed for consummating a qualifying common equity might be recharacterized if the selling security
acquisition, which is typically eighteen months. He also noted holders are affiliates of the issuer or persons in the business of
that some companies have allowed themselves insufficient time selling security holders.
or flexibility to make such an acquisition. He noted experiences
Other matters that might be taken into account in the
where SPACs have not responded to staff comments until
characterization of the offering as primary or secondary may
almost the expiration of the allowed period. Mr. Belvin strongly
include: (i) the number of selling secur ity holders; (ii)
suggested that SPAC offerings should take the staff review
relationships and course of dealing between the company and
process into account when planning their schedules.
the shareholders; (iii) payment terms, including the form of
PIPEs offerings. Deputy Chief Counsel Carol McGee payment and its valuation; (iv) discounts and other concessions
discussed PIPEs offer ings, particularly those involving to selling security holders; (v) the company’s intentions in
convertible securities. McGee noted that the staff has had respect of repaying any debt incurred in the transaction; and (vi)
financings of this type under consideration for many years. She how recently similar transactions have been effected. Ms.
recommended consultation of the staff ’s Telephone McGee did not indicate what weight would be accorded to the
Interpretation Manual from July, 1997. Interpretation H.6 lays several factors. In the event a company has made recent PIPEs
out the basic controversy still in issue — whether the offering transactions with the same investors, the staff may refuse to
is a genuine secondary offering for the account of persons other make a registration statement effective less than 60 days from a
than the issuer or a primary offering for the account of the similar registration statement (if all securities have been sold) or
company. If the latter, and if the company is eligible to sell six months from the effectiveness of the most recent previous
securities for its own account on Form S-3, then, subject to registration statement. In the former case, the staff will demand
unqualified characterization of the selling security holders as a written representation that all securities were sold.
underwriters, there is no further dispute with the staff. III. Division of Market Regulation
If, however, the company is not S-3 eligible, then several severe Consolidated supervised entities. After introducing the
consequences follow if the transaction is deemed a primary plenary session panel, Dr. Eric Sirri, the Division Director,
discussed the significance of the move towards consolidated equity securities, listed options, security futures products,
supervised entity (CSE) regulation. He noted that SEC- unlisted derivatives, warrants, index warrants and related
registered broker-dealers that are large organizations in a instruments. Under the new portfolio margining methodology,
holding company structure generally have numerous affiliates margin is computed on actual net risk as opposed to on each
with operations both inside and outside of the United States individual position or strategy in a customer’s account. He
and, thus, these organizations are subject to regulation by observed that the new portfolio margining requirements should
multiple regulators in functionally different, and in some cases be significantly lower than under a position or strategy-based
– conflicting, ways. CSE regulation is intended to allow such methodology currently in place, and may therefore allow
firms to avoid inconsistent regulation. He observed that, to considerably more leverage in the market place. For more
date, five firms have elected to be regulated with the SEC as information on portfolio margining, see our January 8, 2007
CSEs: Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill client alert, available at http://www.sidley.com/db30/cgi-
Lynch and Morgan Stanley. For these five firms, the SEC b i n / p u b s / I nve s t m e n t _ M a n a g e m e n t _ 0 1 0 4 0 7 . p d f .
regulates not just the registered broker-dealer entities, but also Notwithstanding these already significant changes, Mr.
the entire organization. Among other things, the objective is to Macchiaroli noted that fir ms are pushing for even more
ensure that activities carried out in unregulated entities do not comprehensive changes to the margin requirements, including
impair the ability of the broker-dealers to carry out their reforms that would allow for “self-margining” based upon the
business in a compliant and effective manner, and does not firm’s own assessment of its margin needs.
impair the integrity of the marketplace. The trade-off is that
Credit rating agencies. Mr. Macchiaroli also discussed the
although CSEs must submit to regulation by the SEC with
SEC’s recent proposals on the regulation and oversight of credit
respect to affiliates that would not otherwise be subject to direct
rating agencies, which are intended to implement provisions of
SEC regulation, the regulated broker-dealer/affiliates get
the Credit Rating Agency Reform Act of 2006, enacted on
tangible benefits, such as the ability to utilize risk-based models
September 29, 2006. Mr. Macchiaroli noted that the regulatory
to calculate net capital charges instead of the for mulaic
authority afforded to the SEC primarily relates to books and
approach laid out in Exchange Act Rule 15c3-1.
records requirements and insider trading practices, as well as
Portfolio margining. Mike Macchiaroli, an Associate rulemaking authority with respect to conflicts of interest and
Director, discussed portfolio margining, which represents a coercive practices by the rating agencies. The SEC’s proposed
substantial overhaul of the self-regulatory organization (SRO) “Form NRSRO” would require the rating agencies to disclose
margin rules. Mr. Macchiaroli provided a brief background of all of their processes for producing a rating, as well as their
U.S. margining system, noting that while the Federal Reserve processes and procedures for managing issues such as insider
Board (FRB) has jurisdiction to set initial margin requirements, trading and conflicts of interest. Mr. Macchiaroli noted that the
the SROs have jurisdiction to set margin maintenance levels, comment period expires on March 12, 2007, and the legislation
which the SROs have done based on position or strategy-based calls for final rules to be adopted no later than June 26, 2007.
marg in requirements. The latter methodology applies The SEC proposing release is available at
prescribed margin percentage requirements to each security http://www.sec.gov/rules/proposed/2007/34-55231.pdf.
position and/or strategy, either long or short, held in a
Broker-dealer email retention issues. Mr. Macchiaroli also
customer’s account. He indicated that the SRO portfolio
discussed broker-dealer recordkeeping requirements insofar as
margining rules generally allow, on a pilot basis, SRO members
they apply to the retention of email communications (which
to elect to apply a portfolio margin methodology to margin
are treated as written communications for purposes of the The SEC is also proposing to eliminate the historical “price test”
rules). Among other things, firms have expressed continued restrictions on short sales. Mr. Brigagliano noted that the short
difficulty in identifying those email communications that relate sale “Pilot program” implemented as part of Regulation SHO
to their “business as such” and have urged the Division staff to enabled the SEC staff to examine the effects of a price test on
define the term or otherwise provide further guidance as to its securities trading. Based upon those studies, it was determined
intended meaning and scope. Mr. Macchiaroli indicated that that the price test did not enhance market quality. The SEC’s
the SEC staff is considering these requests. In addition, he proposing release with respect to the “price test” elimination
observed that records kept in other than paper or microfiche is available at http://www.sec.gov/rules/proposed/2006/34-
format must be retained in “write once read many” (WORM) 54891.pdf and our related client aler t is available at
for mat. Fir ms continue to express concer ns as to the h t t p : / / w w w. s i d l e y. c o m / d b 3 0 / c g i -
considerable additional expense the WORM requirement bin/pubs/MarketRegulationUpdate120606.pdf . The
imposes. As an alter native, fir ms are urging the SEC to comment period for the proposed price test elimination expired
recognize systems that protect the integrity of the records. The on February 12, 2007.
Division staff is also considering these ongoing requests and
Finally, the SEC is proposing to reformulate and tighten up the
expressions of concern.
provisions of Rule 105 of Regulation M, which addresses short
Short sale regulation. James Brigagliano, another Associate sales in the period immediately prior to the pricing of a public
Director, discussed three active rulemakings relating to short sale offering. Among other things, the proposals would reformulate
regulation. He noted that while they each address discrete the rule into an allocation rule – prohibiting investors from
activities, they have a common theme – i.e., more carefully receiving an allocation of the offering shares if they had effected
targeting regulations at harmful activity while eliminating short sales in the security during the rule’s restricted period.
unnecessary regulation. Mr. Brigagliano expects the SEC to take The SEC’s proposing release for the Rule 105 amendments is
action on each of the three proposals within the next few months. available at http://www.sec.gov/rules/proposed/2006/34-
54888.pdf and our related client aler t is available at
The SEC is proposing to tighten the “locate” and “close out”
h t t p : / / w w w. s i d l e y. c o m / d b 3 0 / c g i -
requirements of Regulation SHO. In particular, since
bin/pubs/MarketRegulationUpdate120606.pdf . The
Regulation SHO’s adoption in 2004, the SEC has observed
comment period on the Rule 105 proposals also expired on
that where there continue to be a high level of fails in a
February 12, 2007.
particular security, the fails appear to be primarily attributable
to several specific exceptions from the “close-out” requirements Over-voting of shares. Mr. Brigagliano discussed concerns
in Regulation SHO – including the “grandfather exception.” as to the over-voting of shares held by brokers in street name.
For this reason, the SEC has proposed to eliminate the By way of example, he noted that over-voting can happen in
grandfather exception and to tighten the options market maker connection with securities lending in transactions, where the
exception. The SEC proposing release for these amendments is vote follows the borrower but the owner of the shares is also
available at http://www.sec.gov/rules/proposed/2006/34- credited with owning the shares and hence with a vote. The
54154.pdf and our related client aler t is available at SEC staff is examining voting patter ns and consider ing
h t t p : / / w w w. s i d l e y. c o m / d b 3 0 / c g i - potential rulemaking in this area.
bin/pubs/SECUpdate71306.pdf. The comment period for
Regulation NMS. David Shillman, another Associate
these proposals closed on September 19, 2006.
Director, provided an update on Regulation NMS. He noted
that the next functional compliance date is the Trading Phase http://www.sec.gov/rules/sro/amex/2007/34-55213.pdf). She
Date, which was previously extended and is now scheduled to noted that securities that track prices of commodities and
commence on March 5, 2007. He observed that the “Pilot currencies are particularly interesting because they allow
Stocks Phase Date” and “All Stocks Phase Date” were also securities customers to track non-securities products; however,
extended and are now scheduled to commence on July 9, 2007 they also raise certain regulatory challenges as to surveillance and
and August 20, 2007, respectively. These extensions are further transparency. She indicated that the SEC staff has been working
discussed in the related SEC release, available at with the exchanges to expedite the listing and trading of these
http://www.sec.gov/rules/final/2007/34-55160.pdf. Mr. products. Ms. King made special mention of two new products
Shillman acknowledged that it has been a long process and that – one developed by the Chicago Mercantile Exchange (CME)
both the markets and the industry have devoted much effort to and one by the Chicago Board Options Exchange (CBOE).
Regulation NMS compliance. He is optimistic that there will be The CME product is an exchange-traded credit event contract
no further delays. He noted that the SEC staff has also published – in essence, a surrogate for credit default swaps. The CBOE
a set of frequently asked questions regarding Regulation NMS, product is a binary option that pays a certain amount based
which are available on the SEC web site at upon a particular credit-related event that is confirmed to have
http://www.sec.gov/divisions/marketreg/nmsfaq2.htm and occurred, based upon a debt security of an issuer. She noted that
http://www.sec.gov/divisions/marketreg/subpenny612faq.htm. because the terms of the CBOE’s credit default option are
directly linked to provisions in the referenced debt security, the
Regulatory consolidation. Mr. Shillman also discussed the
SEC believes the instrument clearly is a security. The SEC
NASD and NYSE’s regulatory consolidation initiative. For firms
published the CBOE’s proposals with respect to the listing and
that are members of both organizations, there have been ongoing
trading of credit default options on February 7, 2007 (available
complaints with respect to duplicative regulation and
examination, as well as inconsistent rules. He noted that the
current initiative is intended to address these concerns. Mr. Cross-border exchange combinations. Ms. King discussed
Shillman emphasized that the consolidation would be with the increasing interest in cross-border market combinations,
respect to regulation of member firms only – it would not noting the NYSE/Euronext merger as the most immediate and
consolidate regulation of the markets themselves. As such, he obvious example. The SEC must focus upon the regulatory
noted that the NYSE would still regulate its markets, including implications of such combinations. She observed that the
the imposition of listing standards. Mr. Shillman anticipates that pending NYSE/Euronext combination does not, under its
other conditions to the merger will be addressed by the NYSE current structure, have substantial US regulatory implications.
and NASD in the near term. He indicated that the consolidation Ms. King noted that the merger would combine, under a single
is intended to be completed during the second quarter of 2007. publicly traded holding company, the business of NYSE Group
and the five European exchanges operated by Euronext. She
New derivatives products. Elizabeth King, another Associate
emphasized, however, they would continue to act as separate
Director, discussed the increasing development of new and
subsidiaries under the new holding company, with their
innovative derivatives products, including ones that operate like
respective assets continuing to be held as they are currently held.
exchange-traded funds (ETFs) and track currencies and
In reviewing this combination, Ms. King indicated that the staff
commodities or other baskets. At the end of January 2007, the
has been focusing upon the NYSE’s ability to continue to meet
SEC published the American Stock Exchange’s (AMEX)
its obligations as an SRO and to provide the SEC with tools to
proposed standards for listing fixed-income ETFs (available at
effectively oversee the SROs. In that regard, she noted that the
corporate documents include provisions designed to preserve available at http://www.sec.gov/rules/proposed/2006/34-
the independence of the SROs, including ownership and voting 54946.pdf and our related client aler t is available at
by shareholders of the holding company. She noted that the http://www.sidley.com/db30/cgi-bin/pubs/FIUpdate107.pdf.
SEC has entered into a memorandum of understanding (MOU)
Point of sale disclosures. Caite McGuire, the Division’s
with Euronext’s regulators — the MOU was announced via a
Chief Counsel, discussed the staff ’s continuing efforts to
Januar y 25, 2007 SEC press release, available at
identify the types of disclosures broker-dealers should provide
their customers, as well as when and how those disclosures are
Proposed Regulation R. Robert Colby, the Division’s most effectively made. Ms. McGuire observed that, for many
Deputy Director, discussed proposed Regulation R – the SEC’s types of selling efforts, if disclosure is not provided at the time
third attempt at implementing bank broker rules. He noted of sale, the disclosure may lose its benefit and fail to “break
that the proposed regulation, which was issued jointly with the through.” In thinking about the nature and timing of
FRB, focuses on four main areas: (i) networking arrangements; disclosures, the staff is considering how disclosures can be
(ii) trust and fiduciary activities; (iii) money market fund provided most effectively – both in terms of the effectiveness of
sweeps; and (iv) custodial accounts. As to networking the communication to investors and the cost-effectiveness with
arrangements, Mr. Colby observed that the proposed rules which such disclosures can be made by the broker-dealers.
define certain terms relevant to determining the permissibility
Recordkeeping under Rules 15c3-1 and 15c3-3. Tom
of a referral fee paid to an unregistered bank employee for the
McGowan, an Assistant Director, noted that the Division is
referral of business to a broker-dealer. In addition, the proposal
reviewing a no-action letter regarding “recordkeeping issues
would include an exemption allowing the payment of a larger
under Rules 15c3-1 and 15c3-3” but provided no further
referral fee in connection with an unregistered bank employee’s
elaboration on the specifics.
referral of certain high net worth and institutional customers.
As to trust and fiduciary activities, the proposals would allow Bank sweep programs. Mr. McGowan also noted some
Rule 12b-1 fees to qualify as “relationship compensation,” concerns with respect to the operation of bank sweep programs.
which is in turn relevant to determining the permissibility of Traditionally, he noted, broker-dealers swept customer free credit
the compensation banks receive in connection with balances to money market mutual funds, but now the norm
transactions for trust and fiduciary accounts. The proposals seems to be to sweep to affiliated banks, albeit FDIC-insured, that
would impose cer tain limitations in connection with pay a much lower interest rate. The staff is concerned about
transactions for bank custodial accounts, including limitations adequate disclosure to, and affirmative approval/consent from,
with respect to the nature of compensation payable to the bank customers. Another issue is that broker-dealers take the position
and the banks’ ability to market and advertise secur ities that when cash is swept to a bank, the broker-dealer no longer
transaction activity for such accounts. Finally, the proposals has any Rule 15c3-3, or books and records, responsibility for the
would allow banks to sweep depository funds into money cash. By the same token, if the cash is swept to the bank on an
market funds that are not treated as “no-load” funds if the bank omnibus arrangement, the bank claims that it does not have
customer provides informed consent. He noted that the SEC responsibility to the broker-dealer’s customers because the bank
hopes to move very quickly towards the adoption of final rules. does not know the identity of the broker-dealer’s customers, nor
He also noted that, post-adoption, the SEC and FRB would does it have access to the broker-dealer’s records. The Division is
work together to provide joint interpretative guidance with apparently developing guidelines for recordkeeping in
respect to compliance. The Regulation R proposing release is connection with bank sweep programs.
IV. Commissioner’s Remarks – Paul S. Atkins to the invective. While he understands the advantages to the
regulators of obtaining a waiver, he perceives a number of
After a few opening jokes about his distaste for “rulemaking by
serious flaws with this investigatory “short cut.” He made
speech,” Commissioner Atkins turned to discussing how the
particular mention of requests or demands for waivers being
SEC is endeavoring to learn from its lessons during 2006. He
made by the SEC examiners of broker-dealers and investment
observed a recent positive trend at the SEC but emphasized
advisers, noting that in those cases the examiners are acting
that, to continue to improve, the SEC must continue to
without direct supervision of the SEC. Commissioner Atkins
“identify, analyze and learn from” its mistakes. He indicated
emphasized that he would personally take a very critical view
that the SEC’s mistakes often stem from faulty inter nal
of such requests and would seriously question their propriety.
processes or an “end justifies the means” approach to decision-
He also referenced the ABA’s proposed changes to the SEC’s
making. He then recounted a number of the SEC’s specific
“Seaboard” report (regarding what factors the SEC will
mistakes and lessons in 2006.
consider when evaluating whether to afford a par ty
Among other things, the SEC has learned that other branches of “cooperation credit”). He noted that while the Seaboard
the gover nment will not be shy in holding the SEC report does not specifically enumerate privilege waiver as a
accountable. As an example, he referenced the SEC’s proposed factor, a footnote tied to factor 11 alludes to its potential
rules relating to the independence of mutual fund boards of relevance. Commissioner Atkins believes that, in the six years
directors – noting that it “took two decisions from the Court of since Seaboard has been issued, the footnote has served as a
Appeals to make the [SEC] realize that the process for adopting “backdoor” through which cooperation credit has been given
that rule was deeply flawed and violated the Administrative for waivers. He emphasized that he personally refuses to
Procedures Act (APA).” The Court of Appeals also vacated the consider waiver as relevant to “cooperation credit” and
SEC rule requiring hedge fund advisers to register with the indicated that it may well be appropriate to eliminate the
SEC, finding that the rule was an awkward and inadequately footnote altogether. He also believes it is time for the SEC
justified departure from the SEC’s prior approach, as well as to review its processes sur rounding staff requests for
from the statute itself. In 2006, the SEC was also taken to task protected information. For example, he posited that the SEC
by the Financial Services Regulatory Relief Act and the Credit should be ensuring that all waiver requests – however subtle
Rating Agency Relief Act, both of which served as very public – should first be vetted at the highest levels. The full text of
rebukes by Congress for the SEC’s failure to provide clarity in C o m m i s s i o n e r A t k i n s ’ s p e e c h i s ava i l a bl e a t
those areas and to adopt rules. Commissioner Atkins assured http://www.sec.gov/news/speech/2007/spch020907psa.htm.
everyone that the SEC has “taken these rebukes to heart.”
V. Division of Investment Management
Among other things, Chairman Cox has called upon the SEC’s
Office of General Counsel to undertake a “top-to-bottom Mutual fund disclosure. The Director of the Division,
review” of the SEC’s process for assessing the economic Andrew Donohue, began the discussion with a brief overview
ramifications of its rulemakings. Commissioner Atkins is of SEC initiatives addressing cer tain key investment
hopeful that the SEC will learn from these lessons and will not management issues, in areas ranging from mutual fund
allow similar situations to arise in the future. disclosure to fund of funds. For example, Mr. Donohue
discussed deployment of XBRL in connection with
Commissioner Atkins also discussed the ongoing controversy
streamlining and improving mutual fund disclosure for
with respect to privilege waivers. He described a “culture of
investors. Mr. Donohue introduced Susan Nash, an Associate
waiver” and acknowledged that the SEC has been no stranger
Director of the Division of Investment Management, to address time taking into consideration any liability issues that may arise
this topic in detail. under the securities laws due to the abbreviated nature of short
form disclosure documents.
Ms.Nash stated that the Division will undertake a “comprehensive
reevaluation of mutual fund disclosure” in an effort to provide Exchange-traded funds and business development
investors with a user-friendly electronic disclosure document companies. Douglas J. Scheidt, Chief Counsel and an
rather than a physical prospectus that is lengthy, complex and Associate Director of the Division, led the discussion on recent
overwhelming in “legalese.” Ms. Nash cited a recent SEC developments in the area of ETFs. At the outset of this
roundtable discussion that addressed, among other things, the discussion, Mr. Scheidt noted that the popularity of ETFs is
improvement of the quality of mutual fund disclosure. The expected to increase and the staff will “get out of the way” to
roundtable panel members agreed that short-form disclosure advance the introduction of ETFs.
documents available on a real-time basis and presented in
Index-based ETFs and actively-managed ETFs. ETFs are indexed-
electronic format with searchable options under key areas such as
based investment vehicles that currently track the S&P 500,
risks, costs, performance and investment strategies would be most
NASDAQ, the Dow Jones Industrial Average, a foreign index
beneficial to investors and analysts. The full text of the transcript
or other indices. The contents of an indexed-based ETF’s
of the roundtable discussion is available at
portfolio are published at the beginning of each business day.
Redemptions and purchases from ETFs are priced at net asset
Ms. Nash explained that it is possible with interactive data to value (NAV), allowing for an arbitrage mechanism (i.e., if the
turn investment information into searchable “bits” and items investment adviser is not maintaining the price of ETF shares
of data and, in that regard, interactive data would operate in at NAV, arbitrage opportunities may arise for purchase of those
similar fashion to an internet search engine. As described on shares and subsequent redemptions at NAV). In order to
the staff ’s website,“[t]hink of every fact in an annual report, operate an ETF, investment advisers or sponsors of prospective
every number in a company’s financial statements, as having a indexed-based ETFs must first submit applications to the staff
unique barcode that tells standard software what the item seeking exemption from certain provisions of the Investment
represents and how it relates to other items in the report. Company Act of 1940 (Company Act). The filing process,
Interactive data ‘tags’ all of the key facts in these large particularly the comment and response stages, historically has
documents, so that software can instantaneously recognize proven to be arduous in terms of time and expense. Mr.
t h e m a n d s e r ve t h e m u p t o t h e i nve s t o r.” S e e Scheidt explained that the Division plans to propose an
http://www.sec.gov/spotlight/xbrl/interactivedata.htm#idata exemptive rule under the Company Act that would permit
_what. Information will also be “layered” so that investors indexed-based ETFs to enter the market without seeking
have the option of viewing more detailed information of exemptive relief. Mr. Scheidt additionally noted that the
summaries. Division will adopt approaches to streamline review by
“prioritizing” index-based ETF applications and expanding the
At the close of her discussion, Ms. Nash noted the following
relief granted in current ETF exemptive orders by providing an
“concrete” initiatives of the Division in the area of mutual fund
option for ETFs to introduce similarly-structured ETFs in the
disclosure: (i) to permit mutual funds to submit the front
future absent filing for exemptive relief on a second occasion.
portions of their prospectuses in a data-tagged for mat,
including on-going development of that format; and (ii) Mr. Scheidt also discussed an innovative ETF structure – the
creation of short form disclosure documents while at the same actively-managed ETF. Unlike indexed-based ETFs, the
investment adviser or manager of an actively-managed ETF list their securities on an exchange. The first alternative involves
makes the investment decisions on behalf of the fund without companies with a public float of less than $75 million and the
reference to a foreign or domestic index. Mr. Scheidt stated second alternative includes companies with a market capitalization
that the “main issue” for actively-managed ETFs is of less than either $150 million or $250 million. Mr.Scheidt noted
“transparency” of portfolio holdings. Unlike managers of that the Division prefers the latter alternative and will make a
index-based ETFs, portfolio managers of actively-managed recommendation to the SEC “soon.” The full text of the release is
ETFs may be hesitant to disclose portfolio holdings, in part available at http://www.sec.gov/rules/proposed/2006/ic-
because the portfolio of an actively-managed ETF is inherently 27539.pdf.
subject to unpredictable changes. Also, managers would face
Proposed “accredited natural persons” category and
the problem of signaling to the market their investment
proposed antifraud rule. Mr. Scheidt discussed the staff ’s
strategies, which in the opinion of most managers, harms the
recent proposal to define a new category of accredited investor
potential to maximize returns for their investors. Mr. Scheidt
– an “accredited natural person” solely in connection with the
stated that the Staff has received “several applications” for
offer and sale of securities issued by a “private investment
actively-managed ETFs seeking exemptive relief under the
vehicle,” excluding venture capital funds.” Under the proposed
Company Act, and the Division may make recommendations
approach, an “accredited natural person” would include any
to the SEC “in the near future.”
natural person who meets either the net worth or income tests
Business development companies. Mr. Scheidt then focused on specified in the Securities Act’s current definition of “accredited
recent regulatory developments in the area of business investor” and, in addition, who owns, individually or jointly with
development companies (BDCs). A BDC is precluded from that person’s spouse, at least $2.5 million in investments (as
making investments to the extent, at the time of investment, a adjusted for inflation every five years). A “private investment
substantial portion of its total assets are not invested in securities vehicle” for these purposes would include any issuer that would
of “eligible portfolio companies.” As defined under Section qualify as an “investment company,” as defined in Section 3(a) of
2(a)(46) of the Company Act, an “eligible portfolio company,” the Company Act, but for the exclusion therefrom provided in
among other things,“does not have any class of securities with Section 3(c)(1) thereunder (but not Section 3(c)(7)). All other
respect to which a member of a national securities exchange, provisions of Regulation D, and Sections 4(6) and 2(a)(15), and
broker, or dealer may extend or maintain credit to or for a Rule 215, under the Securities Act would continue to apply.
customer pursuant to rules or regulations adopted by the Mr. Scheidt noted that the SEC has received over two hundred
[FRB] under Section 7 of the [Exchange Act].” comments on the release relating to the proposed “accredited
natural person” category – primarily from individual investors
In 1998, the FRB promulgated an amendment that expanded
who disagree that the SEC should be able to determine what is,
the scope of the definition of margin security, resulting in more
in effect, a “suitable” investment. In addition, many of those
types of securities falling under that definition. In effect, this
comments inquire why the SEC is so focused on regulation of
amendment significantly reduced the number of companies
the hedge fund industry. In response, Susan Nash explained that
qualifying as “eligible portfolio companies” under the Company
hedge funds are “non-transparent” investment vehicles in
Act. In a 2006 release, the SEC revised and reproposed Rule 2a-
comparison to other types of companies and that hedge funds
46(b) to create a new definition of “eligible portfolio company.”
typically do not seek to obtain money from investors who
The staff proffered Rule 2a-46(b) in two alternatives, with each
would be excluded from the definition of “accredited investor”
alternative applying solely to domestic operating companies that
as a result of the proposed “accredited natural person” category.
A Sidley client alert discussing the proposals in respect of acquired fund must be accumulated and presented as an
the “accredited natural person” category and the antifraud additional expense in a fund of funds’ fee table. The staff
rule is available at http://www.sidley.com/db30/cg i- believes that the amendments will improve transparency of the
bin/pubs/InvManJan207.pdf. expenses of funds of funds. The full text of the adopting release
on Rules 12d1-1, 12d1-2 and 12d1-3, as well as the
Robert E. Plaze, an Associate Director of the Division, stated
amendments to certain registration forms is available online at
that the antifraud rule was proposed in “response to” the
Goldstein v. Securities and Exchange Commission decision (451 F.3d
873 (D.C. Cir. 2006)). As proposed, the antifraud rule would, in Redemption fees. Mr. Plaze briefly discussed amendments to
effect, grant the Commission authority to bring enforcement Rule 22c-2 under the Company Act, which were adopted in
actions under the Investment Advisers Act of 1940 (Advisers 2006 in response to the market timing “scandals” and abuses
Act) in the event the SEC believes that an investment adviser to associated with short-term trading of mutual fund shares. Rule
a pooled investment vehicle has disseminated false or misleading 22c-2 requires, in part, that most open-end investment
information to investors or prospective investors or otherwise companies enter into certain agreements (i.e., shareholder
has committed fraud with respect to any investor or prospective information agreements) with intermediaries that hold investor
investor. Mr. Plaze explained that in the Goldstein decision, the shares in omnibus accounts. Such intermediary agreements
court expressed the view that, for purposes of Section 206(1) must provide funds with access to infor mation about
and (2) (the “antifraud provisions”) of the Advisers Act, the client transactions in the omnibus accounts and thus is beneficial to
of an investment adviser managing a pool is the pool itself, not investors in that the transparency in such accounts would be
the investors in the pool. Mr. Plaze then cited Abrahamson v. increased. The amendments to Rule 22c-2 g ive funds
Flesc hner as author ity for the proposed antifraud r ule. additional time to revise agreements with intermediaries and
Abrahamson v. Fleschner, 568 F.2d 862 (2nd Cir. 1977). change systems to accommodate the transmission and receipt
of trading information. The rule, as amended, extends the
Importantly, Mr. Plaze noted that the Goldstein court’s decision
deadlines for mutual funds to: (i) enter into shareholder
had an adverse “impact on the enforcement program of the
information agreements with their intermediaries (extended to
staff ” in the face of increasing fraud in the marketplace (i.e.,
April 16, 2007); and (ii) be able to require and promptly receive
financial statement fraud, misrepresentations of NAV, incorrect
shareholder identity and transaction information pursuant to
manager biographies, etc.). In the enforcement session of the
such agreements (extended to October 16, 2007).
seminar, Peter Bresnan, a Deputy Director of the Division of
Enforcement, addressed Mr. Plaze’s concern in stating that the FASB Interpretation No. 48. Barry D. Miller, an Associate
Goldstein decision makes “Enforcement’s role more important.” Director of the Division, discussed Financial Accounting
Standards Board (FASB) Interpretation No. 48, which is
Fund of funds. Mr. Plaze discussed three new rules under the
effective for fiscal years beginning after December 15, 2006.
Company Act adopted by the SEC on June 20, 2006. Under
Mr. Miller explained that Interpretation No. 48 involves the
certain circumstances, Rules 12d1-1, 12d1-2 and 12d1-3 allow
accounting methodologies used to determine tax positions for
registered investment companies to invest in shares of other
investment companies. In 2006, the Investment Company
funds without seeking exemptive relief from the SEC. Mr.
Institute (ICI) requested the SEC to delay the implementation
Plaze also addressed recent amendments to certain registration
date of Interpretation No. 48 for the fund industry. The ICI
forms under the Company Act (Forms N-1A, N-2, N-3, N-4
noted that funds calculate NAV on a daily basis while operating
or N-6). These amendments require that the expenses of an
companies do not calculate daily NAVs. That disparity results husband gave her negative information about Cubist, she told
in allowing operating companies more time to assess their tax him that she intended to tip her brother, and did so despite her
positions relative to their financial statements and, as a result, husband’s protests. Her brother sold his stock as soon as he
operating companies are in a better position to comply with could after receiving Rocklage’s tip and, as a result, avoided
Interpretation No. 48. losses of $100,000. After the SEC brought its case against her,
Rocklage and others moved to dismiss on the grounds that, by
Mr. Miller referred to the SEC’s letter response to ICI for
later telling her husband that she intended to tell her brother
guidance on this issue. In that letter, the staff states that in
about the information, no deception had occurred. The First
“light of the unique issues and challenges that the application
Circuit held that the misappropriation theory applied, finding
of Interpretation 48 presents for funds (particularly with
that Rocklage’s acquisition of the mater ial nonpublic
respect to the calculation of NAV), we would not object if a
information was deceptive, since at the time her husband told
fund implements Interpretation No. 48 in its NAV calculations
her the news he did not know that she had a secret agreement
as late as its last NAV calculation in the first required financial
with her brother and intended to tip him.
statement reporting period for its fiscal year beginning after
December 15, 2006.” December 22, 2006 Letter to ICI re: SEC v.Talbot, 430 F. Supp. 2d 1029 (C.D. Cal. 2006). The SEC
Implementation of FASB Interpretation No. 48, available online at has appealed the final judgment dismissing the SEC’s case on
http://www.sec.gov/divisions/investment/letter_mutual_fund summary judgment. The SEC alleged that Talbot, a Fidelity
_fin_48.htm. board member, learned from Fidelity’s CEO that LendingTree,
VI. Judicial and Legislative Developments Inc. would be acquired. At the time, Fidelity was a major
LendingTree shareholder. The court held that the SEC failed
The conference panel included Brian Cartwright, SEC General to prove that Talbot, as a Fidelity board member, owed a duty of
Counsel, Andrew Vollmer, Deputy General Counsel, Jacob confidentiality to LendingTree when he obtained information
Stillman, Solicitor, Richard Humes,Associate General Counsel, about the merger, and as such, no violation of a duty occurred
Joan Loizeaux of the Office of the General Counsel, and when Talbot traded on the merger information.
commentators Richard Roberts of RR&G and former SEC
Commissioner Isaac Hunt. The panelists reviewed, among Primary liability. Simpson v. AOL Time Warner, Inc., 452
others, the following judicial decisions and pending cases: F.3d 1040 (9th Cir. 2006). The Ninth Circuit adopted a test
for distinguishing between a primary violator and an aider
Insider trading. SEC v. Rocklage, 470 F.3d 1 (1st Cir. 2006). and abettor for the purposes of charging under Rule 10b-
In this insider trading case the First Circuit affirmed a district 5(a), based on the SEC’s amicus curiae brief. 1 The court
court decision denying defendants’ motion to dismiss, in favor agreed with the SEC that “engaging in a transaction, the
of the SEC. The court held that defendant Patricia B. Rocklage principal purpose and effect of which is to create the false
engaged in illegal insider trading when she passed to her appearance of fact, constitutes a ‘deceptive act’” and held
brother material, nonpublic information that she had learned that “to be liable as a pr imar y violator of § 10(b) for
from her husband, the CEO of Cubist, Inc. Unbeknownst to participation in a ‘scheme to defraud,’ the defendant must
her husband, Rocklage had an agreement to tip her brother if have engaged in conduct that had the principal purpose and
she learned any negative information about Cubist. After her effect of creating a false appearance of fact in furtherance of
The SEC’s br iefs are available at http://www.sec.gov/litigation/br iefs/homestore_102104.pdf and
the scheme.” 2 The cour t, however, rejected the SEC’s No. 8721, Exchange Act Release No. 54143 (July 13, 2006).
suggestion that primary liability could be established by The SEC held Dolphin and Bradbury, Inc., a broker-dealer, and
mere involvement or participation in a transaction that had its CEO, Robert J. Bradbury, violated the antifraud provisions
“a deceptive purpose and effect.”3 of the federal securities laws when it offered and sold municipal
bonds with “offering documents that recklessly omitted to
Cooperation with criminal authorities. U.S. v. Stringer, 408
disclose mater ial fact that made infor mation provided
F. Supp. 2d 1083 (D. Ore. 2006). The SEC filed an amicus curiae
misleading.”4 The SEC ordered the respondents to cease and
brief in support of the government appealing the dismissal of a
desist from committing or causing any violation or future
criminal indictment and suppression of evidence where the
violation of the provisions they were found to have violated; to
evidence was obtained by the criminal authorities from the SEC
pay civil money penalties; and ordered the broker-dealer to
in its parallel investigation of the defendants. The district court
disgorge ill-gotten profits.
decision dismissed criminal securities charges against three
defendants for due process violations in the SEC’s civil Reporting violations. In the Matter of Gateway International
investigation. In the SEC’s investigation, the defendants Holdings, Inc. and Lawrence A. Consalvi, Exchange Act Release
provided testimony and documents, and were then indicted on No. 53907 (May 31, 2006). In 2003, Gateway International
criminal charges based on the information provided. The court Holdings, Inc. ceased filing periodic reports after it could not
found that, by the SEC’s failing to notify the defendants that it prepare its consolidated financial statements because two of its
was coordinating with the U.S. Attor ney’s Office, the subsidiar ies denied it access to their books and records.
investigations were not parallel investigations, but rather, the was Although Gateway began filing again in 2005, the SEC pursued
SEC conducting its investigation on behalf of the criminal Section 12(j) proceedings based on Gateway’s failure to file
authorities, allowing the criminal authorities to stay under the period statements due between May 2003 and December
defendants’ radar. The indictments were ultimately dismissed, 2004. The SEC held that “Gateway’s conduct with respect to
but the SEC’s interview statements and any evidence derived its reporting obligations was serious, egregious, recurrent, and
from the statements were suppressed. The decision does not evidenced a high degree of culpability.”5 The SEC ordered the
prevent information sharing between the SEC and criminal revocation of Gateway’s securities pursuant to Exchange Act
authorities, but does draw attention to how the SEC and Section 12(j) and ordered Gateway’s CEO, Lawrence A.
criminal authorities share information and the disclosure of such Consalvi, to cease and desist from causing any violations or
information sharing. The SEC’s amicus curiae brief is available future violations of Exchange Act Section 13(a) and Rules 13a-
at http://www.sec.gov/litigation/briefs/2006/stringerbrief.pdf. 1 and 13a-13 thereunder.
Violations of antifraud provisions. In the Matter of Dolphin Constitutionality of the PCAOB. Free Enterprise Fund and
and Bradbury, Inc. and Robert J. Bradbury, Securities Act Release Beckstead and Watts, LLP v. Public Company Accounting Oversight
452 F.3d at 1048.
Secur ities Act Release No. 8721, Exchange Act Release No. 54143, at 1, 2006 SEC LEXIS 1592 (July 13, 2006), available at
Exchange Act Release No. 53907, at 10, 2006 SEC LEXIS 1288 (May 31, 2006), available at http://www.sec.gov/litigation/opinions/2006/34-
Board, No. 06-00217 (D.D.C. Jan. 7, 2006). In a matter of great that a holder class action “is distinguishable from a typical Rule
interest to the SEC, the plaintiffs questioned the 10b-5 class action in only one respect: It is brought by holders
constitutionality of the Public Company Accounting Oversight instead of purchasers or sellers. For purposes of SLUSA pre-
Board (PCAOB), stating that: (i) “the Board exercises wide- emption, that distinction is irrelevant; the identity of the
ranging, core governmental powers immune from presidential plaintiffs does not determine whether the complaint alleges
oversight in contravention of the most fundamental elements fraud ‘in connection with the purchase or sale’ of securities.”7
of the Constitution’s separation of powers principles;” (ii) Thus, the court rejected the limitation of the purchaser-seller
“although the Board members exercise significant, core standing requirement of Blue Chips Stamps v. Manor Drug Stores,8
governmental powers, they are appointed by the SEC rather which bars private parties who neither purchased nor sold
than in the manner required by Article II of the Constitution. securities from bringing suit pursuant to Section 10(b) and
Their appointments, and the Board’s exercise of its delegated Rule 10b-5.
powers, are therefore contrary to the Appointments Clause of
Antitrust immunity. Credit Suisse First Boston Ltd. v. Billing,
the Constitution;” and (iii) “[t]he Board is also the recipient of
126 S. Ct. 2916 (2006). The Supreme Court granted certiorari
improperly and unconstitutionally delegated legislative power,
to decide whether alleged conduct by underwriters of IPOs
including, but not limited to, its broad power to enact law, its
violated antitrust laws. The district court had held that alleged
authority to set its own budget without any constraint or
tying and laddering agreements and other alleged violative
legislative cap, and its authority to fund that budget through the
conduct was immune from the antitrust laws. The Second
imposition of a tax on all public companies.”6 Oral argument
Circuit disagreed and reversed the district court’s decision and
on the plaintiffs’ motions for summary judgment was held on
held that immunity did not apply. The SEC joined the United
December 21, 2006 and a decision is pending.
States in a letter brief arguing that certiorari should be granted
SLUSA preemption of state-law claims. Merrill Lynch, and that the conduct, even if illegal, should be immune from
Pierce, Fenner & Smith, Inc. v. Dabit, 126 S. Ct. 1503 (2006). In a the antitrust laws because to find otherwise could interfere with
major decision, the Supreme Court reversed the Second the functioning of the capital markets. The brief is available at
Circuit’s decision and agreed with the SEC’s amicus curiae http://www.sec.gov/litigation/briefs/csfb032105.pdf.
brief that Securities Litigation Uniform Standards Act (SLUSA)
Challenges to SEC rules. The panel also discussed two major
preempts not only certain state-law securities fraud class actions
losses for the SEC: Chamber of Commerce v. SEC,9 and Goldstein v.
brought by purchasers or sellers, but also those state-law
SEC.10 As discussed at last year’s SEC Speaks, in September 2004,
securities fraud class actions brought by “holders,” or private
the U.S. Chamber of Commerce filed a petition for review to the
parties who neither purchased nor sold securities and were
U.S. Court of Appeals for the District of Columbia challenging
induced to hold securities they already owned. The court held
provisions of the SEC’s mutual fund governance rule adopted in
Free Enterprise Fund and Beckstead and Watts Complaint at 4.
126 S. Ct. at 1515.
421 U.S. 723 (1975).
443 F.3d 890 (D.C. Cir. 2006).
451 F.3d 873 (D.C. Cir. 2006).
July 2004, 11 requir ing investment companies to have an VII. Commissioner Remarks – Annette L. Nazareth
independent chair of the board of directors and a board composed
Commissioner Nazareth’s speech focused primarily on the
of at least 75% independent directors. On June 21, 2006, the
competitiveness of the U.S. financial markets in the years ahead.
court granted the Chamber’s petition and held, in a unanimous
She observed that some have expressed concern that the U.S.
decision, that the SEC violated the APA by failing adequately to
markets are at r isk of losing their competitive edge.
consider: (i) the costs mutual funds would incur in complying
Commissioner Nazareth mentioned the interim report from
with the conditions; and (ii) at least one reasonable proposed
the Committee on Capital Markets Regulation that addressed,
alternative to the independent chair condition. The court
among other things, the United States’ falling IPO market-
remanded the proceeding to the SEC to address the identified
share as evidence of diminished competitiveness. She also
deficiencies. In a June 29 meeting, the SEC responded in a 3 to 2
referenced a report that surveyed financial service leaders in the
vote reaffirming the rules at issue, relying on publicly available
United States and abroad and raised a number of
materials in considering costs to comply with the requirements of
recommendations for addressing competitive concerns,
the rule, rather than opening a new period for public comments
including clearer guidance with respect to SOX Section 404.
under the APA. On July 7, 2005, the Chamber of Commerce
She acknowledged that it is unpleasant to hear so many
filed a new petition with the Court of Appeals challenging the
concerns about U.S. market decline but emphasized that she
SEC’s June 29 vote. The Court of Appeals ultimately set the rule
remains optimistic as to both the debate and its outcome.
aside, finding that the SEC once again erred by determining that
publicly available information exempted it from the public Commissioner Nazareth stated that she believes the questions and
comment requirements under the APA. criticisms raised by others are a central part of the American
psyche and reflect constant reassessment and innovation.
In Goldstein, the SEC lost a challenge to its “hedge fund rule,”
Commissioner Nazareth believes the focus should be on ensuring
which required registration with the SEC of certain hedge
that the U.S. markets remain an attractive, cost-effective means of
funds under the Advisers Act. In determining which advisers
raising capital, while also maintaining a high level of market
had to register, the SEC’s reading of the Advisers Act required
integrity and investor protection. To that end, the Commissioner
hedge fund advisers to count individual investors in a fund to
stated that the U.S. regulatory system’s effectiveness and efficiency
determine whether the adviser was exempt from registration.
can be improved with some targeted modifications. The
The District of Columbia Circuit held that the SEC’s reading
Commissioner mentioned Section 404 management guidance
of the Advisers Act was unreasonable, and that the definition of
that was recently proposed as an example of how the SEC has
“client” as used in the Advisers Act is someone who received
started to address the unintended costs of regulation. She stated
direct and individualized service. In rejecting the rule, the
that the guidance issued is intended to liberate management by
court found that only the funds themselves, and not the
encouraging them to apply the guidance to their own situations
investors in the funds, receive direct and individualized service.
instead of following a prescribed mold.
The court’s reading of the Advisers Act requires that the
exemption turn on the number of funds maintained by a hedge Commissioner Nazareth mentioned the proposed regulatory
fund adviser, not the number of investors in a given fund. consolidation of the NYSE and the NASD and expressed her
belief that, among other things, the merger will help reduce
costs by streamlining duplicative regulation. The
Investment Company Act Release No. 26520, 2004 LEXIS 1582 (July 27, 2004), available at http://www.sec.gov/rules/final/ic-26520.htm.
Commissioner also stated that issues outside of the SEC’s data in financial statements, footnotes, MD&A and reports for
jurisdiction may have a profound effect on the U.S. financial easy retrieval and comparison by analysts, the SEC and investors.
markets, including restrictive immigration and visa laws
On the subject of auditor liability, Mr. Hewitt observed that the
hampering the U.S. markets’ ability to attract the most talented
size of damages claimed in civil lawsuits against accountants has
professionals. Given the number of financial market
increased to the point that one judgment could bankrupt a firm,
participants that operate in multiple jurisdictions, she indicated
leading to investor disruption and further consolidation in an
that obtaining more consistent global regulatory standards
already concentrated profession. He noted that five European
would aid in providing market efficiencies and competitiveness.
Union (EU) countries had adopted auditor liability caps, and
Commissioner Nazareth concluded by stating that we should discussed an EU report released on January 18, 2007, which asks
continue to assess and analyze our regulations, innovate for comment on four possible methods of dealing with auditor
change and maintain a broad perspective to ensure that our liability: (i) the introduction of a fixed monetary cap at the
rules do not become stagnate or become impediments to European level; (ii) a cap based on the market capitalization of
investment in the U.S. capital markets. The full text of the audited company; (iii) a cap based on a multiple of the audit
C o m m i s s i o n e r N a z a re t h ’s s p e e c h i s ava i l a bl e a t fees; and (iv) “proportionate liability,” which would have each
http://www.sec.gov/news/speech/2007/spch020907aln.htm. party (auditor and audited company) liable only for the portion
VIII. Cross-Division Accounting Session of loss that corresponds to the party’s degree of responsibility.
Conrad W. Hewitt, Chief Accountant, introduced the panel and Mr. Hewitt stated that EU action could lead to U.S.
listed the key initiatives of the Office of Chief Accountant: (i) Congressional initiatives to limit auditor liability. In response
accounting complexity; (ii) XBRL technology; (iii) auditor to a question by former SEC Chairman Harvey Pitt about
liability; (iv) international accounting convergence; (v) SOX whether a movement toward a principles-based accounting
Section 404 – the SEC’s proposed guidance to management and system might actually increase auditor liability, Mr. Hewitt
the PCAOB’s proposed Auditing Standard No. 5. mentioned that the SEC has discussed the issue with the “Big
6” accounting firms and is discussing with the PCAOB the
On accounting complexity, Mr. Hewitt advocated a return to the possibility of adding safe harbors to Auditing Standard No. 5.
“P” in GAAP – Generally Accepted Accounting Principles. He
noted that there is no “R” in GAAP for “Rules.” An excessively On international accounting convergence, Mr. Hewitt traced
rules-based accounting system has led to unnecessary complexity the progress since the “roadmap” laid out by his predecessor,
and costs to both issuers and investors. A principles-based Donald T. Nicolaisen, in his 2005 address, “A Secur ities
approach would lead to a focus more on the economic substance Regulator Looks at Convergence” (available at
of transactions rather than the form, and would be consistent http://www.sec.gov/news/speech/spch040605 dtn.htm). This
with the trend in the international accounting community. A roadmap established the goal of eliminating by 2009 or sooner
framework for this project is expected in the next two months. the requirement that SEC filings by foreign private issuers
contain a reconciliation with US GAAP.
Mr. Hewitt said that the 40 reporting companies participating in
the SEC’s voluntary XBRL pilot program have made over 100 Mr. Hewitt summar ized the SEC’s effor t to provide
filings, incurring minimal costs. XBRL, a key initiative of management with guidance to increase the efficiency of its
Chairman Cox, permits SEC filers to define, identify and tag assessment of internal control over financial reporting required
by SOX Section 404. The SEC’s proposal would encourage
management to adopt a top-down risk-based integrated http://www.pcaobus.org/Standards/Staff_Questions_an
approach and focus on what might result in a material error in d_Answers/2006/07-28_APA_1.pdf; and (iii) SEC
financial reporting. The comment per iod on the SEC’s Januar y 16, 2007 sample letter sent in response to
proposed Management’s Report on Internal Control Over inquiries related to filing restated financial statements for
Financial Reporting (Securities Act Release No. 8762, available errors in accounting for stock option grants, available at:
at http://www.sec.gov/rules/proposed/2006/33-8762.pdf) http://www.sec.gov/divisions/corpfin/guidance/oilgaslt
expires at the end of February. This SEC proposal was the r012007.htm.
subject of a comprehensive Sidley client alert available at
Joseph Ucuzogluia, Professional Accounting Fellow, provided
h t t p : / / w w w. s i d l e y. c o m / d b 3 0 / c g i -
additional guidance on the stock option granting issue and also
discussed the SEC’s letter to Zions Bankshares on using
Carol Stacey, the Chief Accountant of the Division of “market instruments” to establish fair value for employee stock
Cor poration Finance, discussed several issues, many of options under FASB Statement 123R (available at
which are discussed in more detail in “Current Accounting http://www.sec.gov/info/accountants/staffletters/zions012507
and Disclosure Issues in the Division of Cor poration .pdf). He noted that while market values are generally better
Finance” ( N ove m b e r 3 0 , 2 0 0 6 ) , a v a i l a b l e a t than financial models, the challenge presented is that unlike a
http://www.sec.gov/divisions/corpfin/cfacctdisclosureissues.pdf: normal transaction in which the seller wants to achieve the
highest sale price and the buyer the lowest sale price, in this case
• SAB 108 on quantifying misstatements – she noted that
both the buyer and the seller have an incentive to achieve the
this is only applicable to material errors, and that disclosure
lowest sale price. Therefore, it is important that there be a large
is required for each error.
number of bidders and that there be “perfect” information flow.
• Materiality – she stated that prior accounting literature He also noted that the current move to fair value accounting
needs an update and referred to a speech by Todd E. will increasingly call upon attorneys to provide accountants
H a rd i m a n o n D e c e m b e r 1 2 , 2 0 0 6 , ava i l a bl e a t with probability assessments.
In the Accounting workshop, Susan Koski-Grafer, of the
International Deputy Group, discussed the international efforts
• FASB Interpretation No. 48 — income tax uncertainties. and the International Organization of Securities Commissions
• Financial statement classifications - she noted issues in (IOSCO) initiatives. She also discussed the efforts on
classifications in statements of cash flows, income international convergence of auditing standards, in addition to
statements and balance sheets. accounting standards, and mentioned that the International
Auditing and Assurance Standards Board expects to release 27
• Stock option granting issues - she discussed the options exposure drafts in 2007.
g rant timing issues and referenced the following
guidance: (i) SEC September 19, 2006 guidance from In the Corporate Finance session, Craig Olinger commented
t h e S E C C h i e f A c c o u n t a n t , ava i l a bl e a t on the international convergence efforts. He also discussed
http://www.sec.gov/info/accountants/staffletters/fei_ai the results of the SEC‘s review of the first year of filings by
cpa091906.htm; (ii) PCAOB Audit Practice Alert No. 1 foreign pr ivate issuers under IFRS. A summary of SEC
entitled “Matters Relating to Timing and Accounting for c o m m e n t s o n t h e s e f i l i n g s i s ava i l a bl e a t :
O p t i o n s G r a n t s ” ( Ju l y 2 8 , 2 0 0 6 ) , ava i l a bl e a t http://www.sec.gov/news/speech/2006/spch121206jae.htm.
These fall into the following categories: (i) assertions of IFRS commitment towards eliminating the reconciliation
compliance as published by IASB; (ii) income statement requirement for foreign private issuers using the IFRS standard.
presentation; (iii) cash flow presentation; (iv) treatment of X. Division of Enforcement
subsidiaries/associates; (v) revenue recognition; (vi) asset
impair ments; and (vii) disclosure issues. Mr. Olinger The Enforcement panel included Linda Chatman Thomsen,
emphasized that the SEC is not a creator of IFRS and that it Director of the Division of Enforcement; Peter Bresnan and
is coordinating its review with the IASB and foreign Walter Ricciardi, co-Deputy Directors of Enforcement; Susan
regulators. Markel, Chief Accountant of Enforcement;Antonia Chion, an
Associate Director in Enforcement; Luis Mejia, Chief Litigation
IX. Commissioner’s Remarks – Kathleen L. Casey
Counsel; and David Bergers, Rose Romero and Daniel Hawke,
Commissioner Casey introduced herself as the newest member District Administrators of the Boston District Office, Fort Worth
of the SEC, having served on the Senate Banking Committee District Office and Philadelphia District Office, respectively. The
on Capital Hill prior to starting her position at the SEC seven panel discussed a variety of enforcement issues including
months ago. The Commissioner then expressed her confidence penalties and recently-litigated cases, and noted a number of
in the SEC’s mission to protect investor s and ensure different types of cases and new trends seen in the last year.
transparent, efficient and competitive markets. She commented
Linda Thomsen began the discussion by introducing the panel
that the SEC’s enforcement activities are to be fir m in
and noting some new cases, including the case filed last week
punishing fraud but also f air in imposing sanctions.
against El Paso Corporation for improper payments to Iraq under
Commissioner Casey suggested that, instead of an environment
the U.N.’s Oil for Food program,12 options backdating cases and
where the market fears enforcement actions, the SEC should
the recent Aragon Capital Management LLC13 action involving one
communicate expectations to allow the market to quickly cure
family’s illegal insider trading in Taro Pharmaceuticals Industries.
deficiencies. She also mentioned the need for improving SOX
Section 404, which requires issuers to publish internal financial Penalties. Walter Ricciardi addressed corporate penalties in light
reporting controls and procedures information in their annual of the “Statement of the Securities and Exchange Commission
reports. She lamented the costly and burdensome result the Concerning Financial Penalties” (Penalties Statement),14 and the
implementation of Section 404 has generated and looks role of cooperation and integrity in the investigatory process.
forward to receiving comments on the SEC’s proposals to adopt After outlining the Penalties Statement, Ricciardi noted that the
a more pr incipled, r isk-based and efficient approach. SEC is still seeking and obtaining large penalties against entities,
Commissioner Casey concluded by reiterating the SEC’s including those against: (i) Doral Financial Corporation15 - $25
million; (ii) RenaissanceRe Holdings Ltd.16 - $15 million;
SEC Press Release, SEC Files Settled Books and Records and Internal Controls Charges Against El Paso Corporation for Improper Payments to Iraq
Under the U.N. Oil for Food Program (Feb. 7, 2007), http://www.sec.gov/news/press/2007/2007-16.htm.
Complaint available at http://www.sec.gov/litigation/complaints/2007/comp19995.pdf.
SEC Press Release, Statement of the Securities and Exchange Commission Concerning Financial Penalties (Jan. 4, 2006), available at
Complaint available at http://www.sec.gov/litigation/complaints/2006/comp19837.pdf.
Complaint available at http://www.sec.gov/litigation/complaints/2007/comp19989.pdf.
(iii) Raytheon Company 17 - $12 million; and (iv) El Paso • Conrad Seghers - a federal jury in the Northern District of
Corporation18 - $2.25 million. Texas found Seghers liable for violating the antifraud
provisions of the federal securities laws for fraudulently
Litigation update. Luis Mejia briefly noted the Division’s
offering and selling securities in three Texas-based hedge
recent litigation achievements, including:
funds, Integral Equity, LP, Integral Hedging, LP, and
• Stephen Treadway - a federal court jury in the Southern Integral Arbitrage, LP, raising over $71.6 million from
Distr ict of New York found Treadway liable for approximately 30 investors.23
committing securities fraud, breaching his fiduciary duty,
• Bruce Snyder - a federal jury in the Southern District of
and other violations of the securities laws for defrauding
Texas (Houston Division), found that Snyder, the former
mutual fund investors by approving an undisclosed market
Chief Accounting Officer of Waste Management, Inc.
(WMI), violated the antifraud and books-and-records
• Henry Yuen - a Central Distr ict of California judge provisions of the federal securities laws and engaged in
ordered Yuen to pay over $22 million in disgorgement and illegal insider trading of WMI’s stock.24
civil money penalties.20
• James Franklin - a federal jury in the Southern District of
• Paul Johnson - a federal jury in the Southern District of California found Franklin and Samuel Wolanyk liable for
New York found that Johnson violated the antifraud violations of the antifraud provisions of the federal
provisions of the federal securities laws when he failed to securities laws for “pumping and dumping” the stock of
disclose that he had a financial interest in companies he publicly traded companies.25
discussed in research reports and media statements.21
Institutional insider trading. Peter Bresnan discussed the
• David Zwick - a federal jury in the Southern District of SEC’s continued interest in insider trading by hedge funds and
New York found that Zwick participated in a fraudulent institutions. Bresnan stated that there are essentially two main
kickback scheme in which Suncoast, a registered broker- categories of hedge fund cases: (i) where the hedge fund
dealer, received order flow and trades at favorable prices victimizes its investors; and (ii) where the hedge fund victimizes
from an employee of New York Life Insurance Company, the market. Examples of the first category are cases where the
Inc., in exchange for cash kickbacks and gifts.22 hedge fund stole or misused fund assets, concealed trading losses,
Complaint available at http://www.sec.gov/litigation/complaints/2006/comp19747.pdf.
Complaint available at http://www.sec.gov/litigation/complaints/2007/comp19991.pdf.
SEC Litigation Release No. 19888 (Oct. 26, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19888.htm.
SEC Litigation Release No. 19694 (May 10, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19694.htm.
SEC Litigation Release No. 19468 (Nov. 17, 2005), available at http://www.sec.gov/litigation/litreleases/lr19468.htm.
SEC Litigation Release No. 19785 (Aug. 1, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19785.htm.
SEC Litigation Release No. 19631 (Mar. 1, 2006), available at http://www.sec.gov/litigation/litreleases/lr19631.htm.
SEC Litigation Release No. 19557 (Feb. 7, 2006), available at http://www.sec.gov/litigation/litreleases/lr19557.htm.
SEC Litigation Release No. 19466 (Nov. 16, 2005), available at http://www.sec.gov/litigation/litreleases/lr19466.htm.
and sent false statements to clients. Cases that highlight Friedman, Billings35 case concerning alleged insider trading against
misappropriation include those brought against Viper Capital the interest of the firm’s own clients. Finally, Bresnan discussed
Management, LLC,26 and Spiro Germenis,27 both brought in increased numbers of reports from mutual funds that hedge funds
November 2006. Bresnan next turned to cases involving are front running orders, and noted the SEC’s insider trading
misrepresentations, such as Bayou28 and Wood River.29 The SEC is bounty program which provides 10% of any recovery to a person
also looking at cases where hedge funds receive preferential reporting an insider trading case.
treatment from other investment advisers, reminiscent of the
Stock option backdating. Toni Chion discussed investigations
Beacon Hill Asset Management LLC case.30 Bresnan further noted
into stock option backdating and repeatedly referred to the
cases that hurt the market, specifically mentioning the Obus31 and
Brocade36 and Comverse37 cases. She noted that the interest in stock
Aragon Capital Management LLC32 cases.
options should be viewed as part of a SEC-wide interest in
Bresnan then discussed the SEC’s interest in hedge fund trading improving transparency of corporate disclosure. Chion noted
in PIPE offerings, specifically pointing to the January 4, 2007 that, although the SEC has filed only three cases for options
action against Joseph J. Spiegel, which alleged that the former backdating, the Division is conducting more than 130 active
Spinner Global Technology Fund, Ltd. (SGTF) portfolio manager investigations in this area. Chion provided a glimpse into the
engaged in a trading scheme on SGTF’s behalf in violation of the SEC’s thought process on this issue with a list of factors that are
antifraud and registration provisions of the federal securities laws informing the staff ’s recommendations, including the duration of
in connection with three PIPE offerings.33 Bresnan said that the the conduct, the egregiousness of the conduct, the quality of the
SEC’s focus on hedge funds includes looking for violations of evidence of backdating (both direct and circumstantial), the level
Rule 105 of Regulation M, market timing and late trading. of scienter on the part of the individuals involved, and evidence of
Bresnan noted that the SEC will continue to look at institutional attempts at concealment, destruction of evidence and lying.
insider trading, such as the June 2006 Morgan Stanley34 matter Chion noted that the staff may also consider interest on the part
concerning the firm’s alleged failure to maintain and enforce of criminal authorities, participation of gatekeepers, non-option
policies and procedures related to insider trading, and the recent financial misconduct, as well as cooperation and remedial acts.
SEC Litigation Release No. 19905 (Nov. 8, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19905.htm.
SEC Litigation Release No. 19920 (Nov. 21, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19920.htm.
SEC Litigation Release No. 19692 (May 9, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19692.htm.
SEC Litigation Release No. 19428 (Oct. 13, 2005), available at http://www.sec.gov/litigation/litreleases/lr19428.htm.
SEC Litigation Release No. 18745A (June 16, 2004), available at http://www.sec.gov/litigation/litreleases/lr18745a.htm.
SEC Litigation Release No. 19667 (Apr. 25, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19667.htm.
SEC Litigation Release No. 19995 (Feb. 8, 2007), available at http://www.sec.gov/litigation/litreleases/2007/lr19995.htm.
SEC Litigation Release No. 19956 (Jan. 4, 2007), available at http://www.sec.gov/litigation/litreleases/2007/lr19956.htm.
Exchange Act Release No. 54047, 2006 SEC LEXIS 1465 (June 27, 2006), available at http://www.sec.gov/litigation/admin/2006/34-54047.pdf.
Exchange Act Release No. 55105, 2007 SEC LEXIS 84 (Jan. 12, 2007), available at http://www.sec.gov/litigation/admin/2007/34-55105.pdf.
SEC Litigation Release No. 19768 (July 20, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19768.htm.
SEC Litigation Release No. 19796 (Aug. 9, 2006), available at http://www.sec.gov/litigation/litreleases/2006/lr19796.htm.
Market timing and late trading. David Bergers discussed which Atkins articulated on the first day of the conference.
market timing and late trading cases. He noted that the SEC is Atkins derided what he views to be a “culture of waiver,” and
not yet finished bringing these cases, but that there are very few announced his desire to take a hard look at current SEC
left in the pipeline. Current market timing and late trading practices to ensure that the staff is in check with current
cases are focusing on third parties, such as brokers and hedge standards. Atkins noted that he had recently received a letter
funds involved in larger matters. By way of example, Bergers from the American Bar Association urging a revision to the
pointed to the March 2006 case against Bear, Stearns,38 the Seaboard 21(a) report to remove the footnote discussing waiver
August 2006 case against Prudential Equity Group, LLC,39 and of privilege. Atkins referred to the Seaboard footnote as a “back
the January 2007 Clarion Management matter.40 Bergers also door” that allows cooperation credit to be afforded for waiving
discussed recent conflict of interest cases, such as BISYS Fund privilege, and said that in his view, it was time for the SEC to
Services, Inc.41 and Jefferies & Co., Inc.42 review staff requests for protected information.
Additional topics. The panelists touched on other topics as XI. Office of Compliance and Inspection
well. They discussed the increase in cases against regulated Examinations
entities, including an apparent resurgence in micro cap fraud, Risked-based examination program. Lori Richards,
fraudulent schemes targeting senior citizens, and recent cases Director of the Office of Compliance Inspections and
involving invasions into individual investors’ online brokerage Examinations (OCIE), discussed the SEC’s continued focus on
accounts. Linda Thomsen and one of the panelists discussed the risk-based examinations for 2007. Ms. Richards provided the
issue of the SEC staff ’s requests for privileged documents from following statistical information with respect to the growth of
individuals and entities under investigation. Thomsen noted the industry by stating that there are: (i) over 10,400 registered
that the staff will work to protect from disclosure to third investment adviser s; (ii) over 900 mutual funds; (iii)
parties any privileged information received during SEC approximately 6,000 registered broker-dealers, including
investigations, and will also try to collect information using approximately 172,000 broker-dealer branch offices; (iv) 12
methods that will avoid a waiver, including presentations and SROs; (v) approximately 600 transfer agents; and (vi) 7
proffers. Thomsen stated that the Seaboard 21(a) report43 seeks organizations that perform clearing agency functions. She
to encourage cooperation and that, while a waiver of privilege noted that OCIE continues to focus on firms’ activities that
may be one of the ways a company can cooperate with the present elevated compliance risk, and, to that end, OCIE has
staff, waiver is not the pr imary focus of Seaboard. Most expanded its ability to identify high risk firms and high risk
interesting in this exchange was the fact that Thomsen’s issues that may be present within firms. She stated that OCIE’s
position apparently conflicts with Commissioner Atkins’ view, risk-based approach allows it to focus on issues within a firm for
Securities Act Release No. 8668, Exchange Act Release No. 53490, Investment Company Act Release No. 27262, 2006 SEC LEXIS 623 (Mar. 16,
2006), available at http://www.sec.gov/ litigation/admin/33-8668.pdf.
Exchange Act Release No. 54371, 2006 SEC LEXIS 1927 (Aug. 28, 2006), available at http://www.sec.gov/litigation/admin/2006/34-54371.pdf.
SEC Litigation Release No. 19972 (Jan. 19, 2007), available at http://www.sec.gov/ litigation/litreleases/2007/lr19972.htm.
Exchange Act Release No. 54635, 2006 SEC LEXIS 2370 (Oct. 20, 2006), available at http://www.sec.gov/litigation/admin/2006/34-54635.pdf.
Exchange Act Release No. 54861, 2006 SEC LEXIS 2813 (Dec. 1, 2006), available at http://www.sec.gov/litigation/admin/2006/34-54861.pdf.
Exchange Act Release No. 44969, 2001 SEC LEXIS 2210 (Oct. 23, 2001), available at http://www.sec.gov/litigation/investreport/34-44969.htm.
review and to identify the scope of an examination. She coordination, she stated that firms that are dually registered as
observed that in determining the scope of an examination, the investment advisers and broker-dealers are likely to see
SEC staff will conduct an analysis of a firm’s compliance examination teams with staff members having both areas of
program and, based on such analysis, the staff will identify and expertise. With respect to external coordination, she stated that
focus on areas of weakness dur ing its examination. She the SEC will work with co-regulators in the securities and
discussed the importance of firms engaging in an open and banking areas.
candid dialogue with the SEC staff because the more a firm
Broker-dealer examination program. The SEC staff
educates the SEC staff regarding its compliance program and
conducted approximately 741 broker-dealer examinations last
demonstrates that the firm has a robust internal control program
year, with approximately 86% resulting in deficiency letters,
effective in reducing risks, the faster staff will be able to move on
16% resulting in enforcement referrals and 17% resulting in
to other areas of the firm with weaker internal controls. Ms.
SRO refer rals. The top five broker-dealer deficiencies
Richards stated that OCIE expects to continue to conduct: (i)
identified during the last year were: (i) supervision; (ii) books
examinations of the largest broker-dealers, and broker-dealers
and records compliance; (iii) anti-money launder ing
considered “high r isk,” on a regular cycle; (ii) random
compliance; (iv) suitability and misrepresentation; and (v) net
examinations of lower risk broker-dealers; (iii) examinations of
capital computation errors.
high risk investment advisers on a regular cycle; and (iv) random
examinations of lower risk investment advisers. The staff identified the following areas of focus for the broker-
dealer examination program: (i) compliance and supervision
Ms. Richards stated that OCIE is trying to assist firms in
(review of a firm’s outsourcing of business functions and the
addressing compliance issues and OCIE has tried to become
growth of branch offices); (ii) risk management and internal
more transparent and proactive with firms. To that end, she
controls (focusing on, among other things, complex structured
discussed the CCOutreach Program, which is designed to
finance transactions and back office and compliance
enable the SEC and its staff to better communicate and
departments keeping pace with the sale and marketing of new
coordinate with mutual fund and investment adviser chief
products); (iii) business continuity programs; (iv) net capital and
compliance officers with respect to information on compliance
customer reserve computations; (v) sales practices and suitability
practices and issues that OCIE is finding dur ing its
(review of sales to seniors, Section 529 plans, fee-based accounts,
examinations. She stated that the SEC will continue to
collateralized mortgage obligations and real estate investment
conduct regional and national seminars with respect to this
tr usts); (vi) controls to prevent trading on non-public
program during 2007.
information (i.e., information barriers); (vii) best execution of
Ms. Richards also discussed OCIE’s new website and stated that fixed income products; (viii) institutional order handling; (ix)
the website should provide firms with a better understanding retail equity order routing; and (x) option retail orders.
of the examination program, including: (i) the examination
Investment adviser examination program. The SEC staff
process (e.g., document requests, onsite visits); (ii) the
examined approximately 1,346 investment advisory firms, with
“Examination Hotline” for firms with questions, complaints or
approximately 81% resulting in deficiency letters and 6%
concerns about an SEC examination; (iii) relevant speeches of
resulting in enforcement referrals. The top five investment
OCIE staff; and (iv) OCIE special studies and reports.
adviser deficiencies during the last year were identified as: (i)
Ms. Richards indicated that OCIE is working to coordinate its information disclosure, reporting and filings; (ii) compliance
efforts internally and externally. With respect to internal
rules; (iii) personal trading; (iv) performance advertising and indicated that clearing agencies should expect continued
marketing; and (v) information processing and protection. examinations of OFAC-related issues and leakage of
Investment company examination program. The SEC
staff conducted approximately 308 investment company Examination hotline. The SEC staff provided contact
examinations, with approximately 73% resulting in deficiency information for the examination hotline at 202-551-EXAM or
letters and 8% resulting in enforcement referrals. The panelists firstname.lastname@example.org.
identified the top five fund deficiencies during the last year as: XII. Ethics Panel
(i) information disclosure, reporting and filings; (ii) corporate
governance; (iii) compliance rules; (iv) personal trading; and (v) Sarbanes-Oxley reporting obligations for lawyers. Richard
information processing and protection. M. Humes, an SEC Associate General Counsel who oversees the
attorney discipline aspects of the Office of the General Counsel,
Transfer agent examination issues. The SEC staff ’s spoke about Part 205 to the SEC Rules of Conduct and its
examination of transfer agents identified the following issues: (i) implementation of SOX Section 307. Under Part 205, an
lost security-holders and lost or stolen certificates;(ii) safeguarding attorney has a duty to report up the ladder any evidence of
of customer information; and (iii) direct security purchases. “material violations” that are “reasonably likely” to occur. The
Additional areas of focus. It was noted that anti-money reporting options for an attorney include reporting to: (i) his/her
laundering is a high priority for the SEC and the SROs. The supervising attorney; (ii) the chief legal officer of the issuer
SEC staff, along with the SROs, conducted approximately 2,500 (CLO); or (iii) to a qualified legal compliance committee
examinations where anti-money laundering was a focus. It was (QLCC). Under each option, the initial reporting attorney is
noted that approximately 33% of all firms examined were cited discharged from the burden of determining whether a “material
for anti-money laundering deficiencies, including deficiencies in violation” has occurred and from taking remedial action. If the
customer identification programs and suspicious activity reporting attorney does not reasonably believe that the issuer has
monitoring. It was further noted that the SEC brought its first made an “appropriate response” within a reasonable time, he or
enforcement action against a broker-dealer with respect to anti- she must report this determination to the QLCC, or if there is no
money launder ing issues related to the fir m’s customer QLCC, to the audit committee, to another designated
identification prog ram. In addition, the SEC signed a independent board committee, or to the board of directors.
memorandum of understanding with FinCEN to share macro- Mr. Humes stressed that, under Part 205, there is no mandatory
level statistics and information related to significant deficiencies in requirement to “report out” and a reporting attorney who is
exams. The staff noted that firms face an enforcement risk for dissatisfied with the issuer’s response has no further responsibility
situations where: (i) the firm does not follow its anti-money to report the confidential information to the SEC (or, make a
laundering procedures; and/or (ii) the firm has a weak anti- “noisy withdrawal”). Attorneys are,however,permitted to “report
money laundering oversight program. out” to prevent perjury or rectify the consequences of criminal or
The panel noted the following additional areas of focus in the fraudulent acts. In the SEC rule proposal to Part 205, a
examination programs: (i) sales to military personnel; (ii) commenter suggested that an alternative to a “noisy withdrawal”
outsourcing (i.e., reviewing how firms monitor employees and was to require the issuer to file a form 8-K to inform the SEC of
confidential information when outsourcing activities in foreign an attorney’s withdrawal. To date, the SEC has not taken final
jurisdictions); and (iii) identity theft. The SEC staff also action on this comment. Mr. Humes believes that the current
rule appears to be working and that accumulating more evidence comments on a proposed new Rule 502 of the Federal Rules
before taking further action may be beneficial. of Evidence. In par ticular, Mr. Humes descr ibed the
controversial provision of Rule 502(c) as a selective disclosure
In the last few years, Mr. Humes has seen evidence of attorneys
exception that would provide for the turning in of privileged
using Part 205 as leverage to encourage corporate clients to
materials without causing waiver of the privilege. Such
make the appropriate disclosures. Current trends point to
exception would preempt inconsistent state laws. According to
corporations implementing rules that either track, or are more
Mr. Humes, the SEC’s April testimony noted that a number of
stringent than, Part 205 and cover not only in-house counsel but
efficiencies stemming from the ability to obtain work product
any and all employees aware of material violations. Mr. Humes
and attorney client materials have allowed the SEC to provide
also noted a substantial increase in the volume of whistleblowers
more prompt relief for defrauded investors. The SEC is
filing complaints with the Department of Labor. Thus far, the
currently preparing a response to the Advisory Committee’s
SEC has not brought enforcement action under Part 205.
request for anecdotal evidence of cost and time savings.
Attorney misconduct in appearing before the SEC. Mr.
Post-employment restrictions on SEC staff members. William
Humes also discussed Rule 102(e) of the SEC Rules of Practice
Lennox, the SEC’s Ethics Counsel, briefly discussed “revolving
relating to suspension and disbarment from appearing and
door” and post-employment restriction issues on former SEC
practicing before the SEC. Mr. Humes has seen a number of
personnel. Under 18 U.S.C. 208 and other rules of professional
referrals from the Division of Enforcement involving possible
responsibilities, an SEC employee may not work on a matter if
misconduct of attorneys appearing or practicing before the
he or she has a financial interest therein. Mr. Lennox also
SEC — e.g., attorneys accused of destroying documents,
described the restrictions on former SEC personnel working
perjury, and obstructing investigations. To assuage any concerns
on “particular matters involving specific parties” in cases where
that the Division of Enforcement would use Rule 102(e) as
the former SEC staff member was personally and substantially
leverage for attorneys to agree to settlements, a new unit in the
involved during his or her tenure with the SEC. For private
SEC’s Office of General Counsel is now taking on the referrals
law firm attorneys receiving offers to revolve through to the
and conducting informal Rule 102(e) investigations. The SEC
government side, Mr. Lennox warned that SEC employment
has not yet brought any actions, but Mr. Humes anticipates
offers may be threatened where candidates fail to inform their
heightened activity in the future.
clients, who are subject to SEC matters, of their pending
Proposed Rule 502(c) on selective waiver of attorney- employment with the SEC. Finally, Mr. Lennox invited former
client pr ivilege and work product. In January and SEC personnel to contact members of the SEC’s Ethics Office
February 2007, the Advisory Committee on Evidence Rules with questions on post-employment rules.
has been hearing public testimony and accepting written
Questions regarding the "SEC Speaks" conference and any of the topics discussed herein may be directed to any of the lawyers
identified below or to any of our other lawyers with whom you regularly discuss securities and corporate law matters:
Partners William D. Kerr Barry W. Rashkover Associates
Barbara J. Endres 312.853.2140 212.839.5850 Farrah J. Chu
202.736.8287 email@example.com firstname.lastname@example.org 212.839.5808
Lauren Blumenthal Kleiman Jose F. Sanchez
Paul V. Gerlach 212.839.5525 213.896.6103 Rebecca F. Ebert
202.736.8582 email@example.com firstname.lastname@example.org 212.839.5928
John A. MacKinnon Michael J. Schmidtberger
Dennis C. Hensley 212.839.5534 212.839.5458 Celia J. Mitchell
212.839.5731 email@example.com firstname.lastname@example.org 202.736.8293
Joseph McLaughlin Norman D. Slonaker
Michael Hyatte 212.839.5312 212.839.5356 Nadia Persaud
202.736.8012 email@example.com firstname.lastname@example.org 212.839.5930
George B. Parizek
David M. Katz 202.736.8227 John I. Sakhleh
212.839.7386 email@example.com 202.736.8988
BEIJING BRUSSELS CHICAGO DALLAS FRANKFURT GENEVA HONG KONG LONDON LOS ANGELES NEW YORK SAN FRANCISCO SHANGHAI SINGAPORE TOKYO WASHINGTON, D.C.
Sidley Austin LLP, a Delaware limited liability partnership, operates in affiliation with other
partnerships, including Sidley Austin LLP, an Illinois limited liability partnership, Sidley Austin
(UK) LLP, a Delaware limited liability partnership (through which the London office operates),
and Sidley Austin, a New York general partnership (through which the Hong Kong office
operates). The affiliated partnerships are referred to herein collectively as Sidley Austin, Sidley
or the firm.