Insights from Winston & Strawn

Following the SEC’s announcement earlier in January of its examination priorities for 2016, SEC Chair Mary Jo White last week discussed the SEC’s rulemaking agenda for 2016, during a keynote address delivered on Tuesday, January 26 at the Securities Regulation Institute in Coronado, California. The Wall Street Journal and BloombergBusiness both reported on her remarks.

The Wall Street Journal noted Chair White’s statement that the SEC may act to bolster company disclosure requirements regarding the diversity of their directors. While existing rules require companies to disclose to shareholders whether diversity is considered in the selection of management-backed candidates for director positions, the SEC will apparently consider whether to require greater specificity regarding the racial and gender composition of the board.

Another priority mentioned by Chair White is the completion of a set of proposed rules regarding executive compensation. These rules would broaden the circumstances in which companies would be required to claw back certain top officials’ incentive compensation to include instances in which the companies’ financial results are later restated.

BloombergBusiness focused on Chair White’s comments regarding valuations of private companies, some of which have been highlighted recently by significant decreases suffered in their stock prices shortly after their initial public offerings. While not necessarily connected to an upcoming rulemaking, Chair White expressed a renewed desire to protect investors in unlisted shares from excessive hype, and to ensure these investors are receiving sufficient and accurate information at the time of their investments.

The SEC is currently operating with just three of its five commissioner positions filled, following the expiration of former Commissioner Luis Aguilar’s five-year term in 2015, and the recent resignation of former Commissioner Daniel Gallagher.

Feature: Shareholder Activism

While 2015 was on pace to be a record-setting year for shareholder activism, pundits and prognosticators have already declared 2016 the year of decline for activist hedge funds. Late last year, analysts from Moody’s Investors Services released a report, summarized in an article by CFO, in which it noted that while the total number of activist cases was likely to reach a record high in 2015, a variety of factors will conspire to restrain shareholder activism at North American nonfinancial corporations in 2016. The Moody’s analysts cited a crowded field of activists competing for a declining number of attractive targets and the potential for market volatility to disrupt activists’ ability to launch new campaigns as support for their prediction. Recent  commentary in Bloomberg points to declining returns in 76 activist funds, measured by data from Hedge Fund Research, as further evidence that “the heyday [of activist hedge funds] appears to be over.” And University of California, Berkeley, law professor Steven Davidoff Solomon, writing for DealBook, views the recent stock market downturn as a harbinger of trouble for activist hedge funds. Solomon compares the impact of the current market climate on activist hedge funds with the 2008 financial crisis, noting that the destructive effect of the down market on these funds’ returns may lead not only to a reduction in activist attacks but also the potential collapse of some of the funds.

While those forecasting the decline of shareholder activism focus on nonfinancial corporations, others see the potential for an increase of shareholder activism in the financial sector. The New York Times article notes that the regulatory climate, along with potential conflicts of interest, has discouraged hedge fund activists from targeting financial institutions in the past.  However, some recent examples in the financial sector indicate increased interest by certain hedge funds to extend their activism and could signal the spread of activism to some of the largest financial institutions that are plagued by underwhelming returns.

In a recent blog post for the CLS Blue Sky Blog, Columbia University law professor John C. Coffee, Jr. finds that one recent example of hedge fund activism in the financial sector provides evidence that no company, even a systemically important financial institution, is “too big to target.” Coffee examines the available evidence on hedge fund activism and its effect on the performance of targeted companies’ stocks to consider the long-term effects of activism. Coffee also considers potential policy measures to address what he terms the “wolf pack,” which refers to a group of activist hedge funds that coalesce in an effort to prevail in proxy fights so as to benefit from trading gains before knowledge of their ownership position in the target becomes public. Coffee notes that empirical evidence on the effects of activism is inconclusive, with some studies indicating long-term gains for targets failing to test results against control groups for a more accurate assessment. Coffee concludes that, while the Securities and Exchange Commission (“SEC”) appears unwilling to bring enforcement for informed trading during the window before a Schedule 13D is filed in the wake the Newman case, the SEC could take other policy measures, such as shortening the Schedule 13D filing window or revising the definition of “group” under Section 13(d)(3) of the Securities Exchange Act to include the “wolf pack,” thereby discouraging its formation in the first place.

Although Coffee notes that the evidence of hedge fund activism’s impact on targets’ gains is inconclusive, the topic remains hotly debated.  The Harvard Law School Forum on Corporate Governance and Financial Regulation recently published a response by economics and finance professors Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch to a study by Martin Cremers, Erasmo Giambona, Simone M. Sepe, and Ye Wang (the “CGSW Study”), which CGSW Study challenges conclusions drawn by Bebchuk and his colleagues that a target’s long-term stock returns are not negatively impacted by activist interventions. Cremers and his colleagues questioned the methodology of the original Bebchuk study and demonstrated through their own research that similar companies that were not subject to activist interventions performed better in the long term than those targeted by activist hedge funds. In their response, Bebchuk and his colleagues dismissed the CGSW study on the grounds that it used a flawed methodology and produced claims and conclusions that were inconsistent with its own results, as well as the “large body of evidence on stock returns accompanying activist interventions.” Cremers and his colleagues responded to the Bebchuk critique in a blog post on the Harvard Law School Forum.

Finance professors Hadiye Aslan and Praveen Kumar approached the question of the effects of hedge fund activism from another angle by considering its effect not on the target company itself but on industry competitors. In a recent blog post on the CLS Blue Sky Blog, Aslan and Kumar discussed the results of their study of the spillover effects of activist interventions on industry competitors during an approximately 15-year period. Aslan and Kumar found that hedge fund activism had a “significant negative effect on rivals’ product market performance.” While Aslan and Kumar conclude that activist investors do appear to improve the market position of target firms, the industry-wide effect of hedge fund activism is potentially troubling, possibly leading to detrimental effects on innovation as a result of industry consolidation and adverse effects on the average investor who may hold stock in a target’s competitor.

Jason D. Schloetzer, professor of accounting at Georgetown University, shifts the conversation away from the effects of hedge fund activism to the tactics activists employ when targeting companies in a recent article published by The Conference Board and included on the Harvard Law School Forum on Corporate Governance and Financial Regulation. Schloetzer examines several recent attempts by activist hedge funds to replace board members at target companies and the use of “golden leashes,” or compensation offers made privately by activist funds to their nominee directors, to advance these efforts. Schloetzer also discusses the use of advance notification bylaws by target companies to circumvent the ability of activist funds to use golden leashes by requiring their disclosure and prohibiting the election of board members who agree to these special compensation arrangements. Schloetzer explains that the use of golden leashes and advance notification bylaws to block them are highly controversial. Critics of special compensation arrangements claim that these third-party payments compromise board independence and cohesion and serve as additional evidence of activists’ focus on short-term gain at the expense of long-term performance. Critics of advance notification bylaws to counteract special compensation arrangements claim these bylaws reflect a “material failure of corporate governance” on the part of the target company because they restrict shareholders’ ability to vote for qualified board candidates. View the blog post here.

FINRA – Regulatory Matters at a Glance

Please click here to view a summary of the regulatory notices, rule filings, guidance and the like published by the Financial Industry Regulatory Authority (“FINRA”) during the previous month.

Banking Agency Developments


OCC Releases Dodd-Frank Stress Test Scenarios for 2016

On January 28th, the Office of the Comptroller of the Currency (“OCC”) released economic and financial market scenarios that will be used in the upcoming stress tests for covered institutions with more than $10 billion in assets. The supervisory scenarios include baseline, adverse, and severely adverse scenarios, as described in the OCC’s final rules that implement stress test requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. OCC Press Release.

OCC Names Senior National Bank Examiner

On January 27th, the OCC announced that it has designated Brad Linskens as Senior National Bank Examiner, a title that recognizes examiners who have distinguished themselves through high-quality performance and service as field examiners, subject matter experts, and advisers on highly complex and technical bank supervision issues. OCC Press Release.

Federal Reserve

Federal Reserve Extends Comment Period for Proposal on Capital Banks’ Buffer Rule

On January 29th, Reuters reported that the Federal Reserve has extended the comment period for its proposal on how much capital banks should hold as a buffer against a major credit meltdown. Comments, which were initially due by February 19th, are now due on March 21st. The Countercyclical Capital Buffer (“CCyB”), which would raise the capital requirements for large banks when they face increased risks of losses, would then be available to help banks absorb shocks that are associated with declining credit conditions. Reuters.

Federal Reserve Releases Supervisory Scenarios for 2016 CCAR and Dodd-Frank Stress Test Exercises

On January 28th, the Federal Reserve Board released the supervisory scenarios for the 2016 Comprehensive Capital Analysis and Review (“CCAR”) and Dodd-Frank Act stress test exercises. It also issued instructions to firms participating in CCAR, which this year will include 33 bank holding companies with $50 billion or more in total consolidated assets. Federal Reserve Press Release.

Federal Reserve Issues FOMC Statement

On January 27th, the Federal Reserve issued a statement on the fact that information received since the Federal Open Market Committee (“FOMC”) met in December suggests that labor market conditions improved further even as economic growth slowed in late 2015. The FOMC also reaffirmed its “Statement on Longer-Run Goals and Monetary Policy Strategy,” with a revision to clarify that it views its inflation objective as symmetric, and with an updated reference to participants’ estimates of the longer-run normal unemployment rate in the most recent Summary of Economic Projections.

Treasury Department Developments


CFPB Releases Monthly Complaint Snapshot

On January 28th, the Consumer Finance Protection Bureau (“CFPB”) released its latest monthly consumer complaint snapshot, which highlights consumer complaints about financial services including as debt settlement, check cashing, money orders, and credit repair. The report shows that consumer complaints about these sorts of financial services normally revolve around issues of fraud or problems with reliable customer service. This month’s snapshot further highlights trends seen in complaints coming from New York State and the New York metro area. CFPB Press Release.

Securities and Exchange Commission

SEC Announces Agenda for Equity Market Structure Advisory Committee Meeting

The SEC published the agenda for the upcoming Equity Market Structure Advisory Committee meeting, which will be held on February 2, 2016. The meeting will focus on the events of August 24, 2015, as well as other issues impacting customers in the current equity market structure, and will include presentations by SEC staff, Q&A sessions, and committee discussion sessions on these topics. SEC Press Release.

SEC Updates XBRL Guidance

The SEC’s Division of Economic and Risk Analysis published updated interpretations and FAQs related to the SEC’s interactive data disclosure rules on January 26th. SEC XBRL FAQs.

Ceresney Highlights Enforcement’s Efforts to Combat Financial Reporting Misconduct Proactively

In a keynote address to the Directors Forum 2016 on January 25th, SEC Division of Enforcement Director Andrew Ceresney discussed the Division’s work in the area of issuer reporting and disclosure, emphasizing the importance of aggressively pursuing financial reporting deficiencies. Ceresney highlighted the Division’s focus on audit committee members and external auditors, as well as the SEC’s enhanced efforts to detect financial reporting misconduct through the use of the Corporate Issuer Risk Assessment program, which allows the Division to detect anomalous patterns in financial statements and enables the Division to become more proactive in its enforcement efforts. Ceresney Remarks.

Commodity Futures Trading Commission

CFTC Signs MOU with German Authorities to Enhance Supervision of Cross-Border Clearing Organizations

On January 27th, the U.S. Commodity Futures Trading Commission (“CFTC”) announced that CFTC Chairman Timothy Massad signed a Memorandum of Understanding (“MOU”) with the Bundesanstalt für Finanzdienstleistungsaufsicht (“BaFin”) and Deutsche Bundesbank (“Bundesbank”) regarding cooperation and the exchange of information in the supervision and oversight of clearing organizations that operate on a cross-border basis in the U.S. and in Germany. CFTC Press Release.

Federal Rules Effective Dates

Click here to view table.

Exchanges and Self-Regulatory Organizations

Financial Industry Regulatory Authority

SEC Approves FINRA’s Crowdfunding Portal Rules

On January 22nd, the SEC issued an order granting accelerated approval to the Financial Industry Regulatory Authority’s (“FINRA”) proposal to adopt new funding portal rules to facilitate the registration of SEC-registered funding portals as FINRA members as required under Regulation Crowdfunding and to establish notification requirements for FINRA broker-dealers that participate in crowdfunding transactions or enter into control relationships with funding portals. The SEC also provided notice of the filing of an amendment to FINRA’s proposed rules that clarifies the applicability of FINRA Rule 8210 to key persons controlling funding portals and makes other technical changes to the language of the rules. SEC Release No. 34-76970.

International Swaps and Derivatives Association

ISDA Reviews Trading Activity Data for Interest Rate Derivatives and Credit Default Swaps

On January 28th, the International Swaps and Derivatives Association (“ISDA”) published its SwapsInfo Fourth Quarter 2015 Review, which examines the impact of regulatory changes on electronic and bilateral trading activity in interest rate derivatives and credit default swaps. ISDA SwapsInfo Fourth Quarter 2015 Review.

New York Stock Exchange

NYSE Arca Gains Approval of Proposed Price Collar Thresholds for Trading Halt Auctions

On January 28th, the SEC approved a rule change proposed by NYSE Arca, Inc. (“NYSE Arca”) that would amend its existing rules to establish price collar thresholds for Trading Halt Auctions to ensure that a re-opening trade will not deviate significantly from prior prices. The rule would set price collar thresholds for Trading Halt Auctions at 10 percent for securities with a consolidated last sale price of $25.00 or less, five percent for securities with a consolidated last sale price between $25.00 and $50.00, and three percent for securities with a consolidated last sale price greater than $50.00. SEC Release No. 34-76994.

SEC Approves NYSE Exchanges’ Proposals to Delete Rules  Governing Reporting Requirements for Off-Exchange Transactions

On January 28th, the SEC approved the New York Stock Exchange, LLC’s (“NYSE”) and NYSE MKT LLC’s (“NYSE MKT”) separately filed proposals to eliminate their respective rules that establish regulatory requirements for members effecting off-Exchange transactions in Exchange listed securities that are not reported to the Consolidated Tape.

NYSE Arca Amends Proposed Generic Listing Standards for Managed Fund Shares

On January 26th, the SEC announced that NYSE Arca has filed a second amendment to its proposed rule change that would adopt generic listing standards for Managed Fund Shares. The SEC indicated that NYSE Arca withdrew the first amendment it filed with respect to the proposed rule change and the newly-filed amendment supersedes NYSE Arca’s original proposal in its entirety. Comments should be submitted within 15 days of publication in the Federal Register, which is expected the week of February 1. SEC Release No. 34-76974.

SEC Institutes Disapproval Proceedings Regarding NYSE’s Tick Size Pilot Proposal

On January 25th, the SEC instituted proceedings to determine whether to disapprove NYSE’s proposal to establish rules to comply with the quoting and trading requirements of the Plan to Implement a Tick Size Pilot Program under Rule 608 of Regulation NMS. Comments should be submitted within 21 days of publication in the Federal Register. Rebuttals are due within 35 days. SEC Release No. 34-76971. According to a report in Reuters, NYSE’s version of the rules to implement the Tick Size Pilot places more restrictions on dark pools than those proposed by other exchanges, prompting the SEC to consider whether NYSE’s proposal unfairly limits some trading firms from using exceptions for conducting trades off exchange.

Judicial Developments

Complaint Alleging Securities Violations Fails to Adequately Allege That Ernst & Young Hua Ming Was Aware of Fraud (not precedential)

Zech Capital LLC, which contended that Ernst & Young Hua Ming’s (“EYHM”) securities violations were committed in connection with EYHM’s audit of SinoTech Energy Limited, appealed dismissal of its complaint for failure to adequately allege intent or knowledge of wrongdoing (“scienter”). On January 27th, the Second Circuit affirmed dismissal, finding that the circumstantial evidence alleged in the complaint does not admit a strong inference that EYHM was complicit in SinoTech’s fraud or that it recklessly conducted its audit so as to admit an inference that it knew or must have been aware of the fraud. Zech.

Panel Grants a New Trial to Executives Convicted of Securities Fraud

Under the defendants’ tenure as CEO and CFO of medical device company ArthroCare and, allegedly with their knowledge, ArthroCare practiced a fraudulent scheme called “channel stuffing” with a related entity as coconspirator in an effort to smooth out uneven earnings. The defendants were subsequently found guilty by a jury of securities fraud violations and other charges. On January 25th, the Fifth Circuit vacated the convictions and remanded for a new trial, holding that the trial court erred in excluding certain evidence that determined that two other ArthroCare executives hid the fraud from the defendants. Gluk.

U.S. Supreme Court Rules for Pharmaceutical Company over Employee Stock Lawsuit

On January 25th, the U.S. Supreme Court reversed a Ninth Circuit ruling in favor of plaintiffs, current and former employees of pharmaceutical company Amgen, who contended that they lost money by investing in Amgen’s stock ownership plan. Plaintiffs had argued that the value of their retirement plans was reduced when Amgen stock declined. It was later revealed that Amgen had marketed two anemia drugs for off-label uses that were unsafe. The Court remanded for a determination of whether plaintiffs may amend the case in order to adequately plead a claim for breach of the duty of prudence. Amgen.

Industry News

New York’s Financial Regulator Extends Comment Period for AML Plan

On January 28th, Reuters reported that the New York Department of Financial Services (“NYDFS”) has extended the comment period for a proposal requiring banks to strengthen measures to prevent money laundering and the financing of terrorist groups. The NYDFS extended the deadline from February 1st to March 31st in an effort to get more input from the public. Reuters.

Securities Regulators Are Returning $21.5 Million Settlement to Hedge Fund Shut After Raid

On January 26th, DealBook reported that securities regulators will be returning $21.5 million in settlement money that hedge fund Level Global Investors paid to resolve an insider trading investigation. A federal judge has ordered the hedge fund’s 2013 settlement vacated after the SEC said that it would not oppose the request by lawyers for the now-shuttered hedge fund. DealBook.

World Economic Forum Creates New Task Force to Study Global Financial System

On January 26th, Reuters reported that the World Economic Forum (“WEF”) has created a new task force with Bank of England Governor Mark Carney and his equivalent at the Reserve Bank of India, Raghuram Rajan, to study how rapid changes in technology affect financial stability and growth. The WEF said that the task force will focus on the inclusion of emerging market economies in the global financial system, technology-enabled innovation, and the economic cost benefit of post-crisis regulatory reforms. Reuters.

Delaware Court Rejects Proposed Settlement of Shareholder Class Action

Delaware’s Court of Chancery has rejected the proposed “disclosure” settlement of a shareholder class action. On January 26th, reported on the court’s determination that such settlements would provide no benefit to investors to disclose additional information in proxy materials. A professor at Fordham Law School called this decision “a nail in the coffin” of disclosure settlements.

Securities Class Action Filings Were Up in 2015

On January 26th, Law 360 referenced a report which found that there were 11% more federal securities class actions filed in 2015 than in 2014 – plaintiffs filed 189 securities class action lawsuits in 2015, up from 170 in 2014 and 166 in 2013. The report, prepared by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse, also found that U.S. exchange-listed companies were more likely to be hit with a shareholder class action in 2015 than they were at any time since the late 1990s. Law 360.

There Are Signs of Strain in the U.S. Bond Market

On January 24th, Bloomberg Business reported on the cracks that are being exposed in the U.S. bond market as a result of the lack of liquidity. Data compiled by Barclays Plc has shown that investors are paying almost twice the average premium to own the most-recently auctioned 10-year notes, known as “on-the-run” securities, instead of “off-the-run” ones issued just a few months earlier. Part of it can be explained by the chaos in financial markets, while selling by emerging-market central banks has also widened the gap in prices. Beyond those issues are deeper concerns about the structure of the U.S. bond market as well as whether post-crisis rules intended to prevent another financial catastrophe have ultimately left it broken. The signs of strain have even caught the attention of the Treasury Department, which this month called on market participants to provide suggestions for fixes. Bloomberg Business.

SEC Is Criticized for Lax Enforcement of Climate Risk Disclosure Requirements

Following criticism from advocates of sustainability in business, the SEC is reportedly encouraging its staff to be more vigilant in reviewing climate change disclosures from energy companies. On January 23rd, The New York Times reported on an alliance of 62 institutional investors that has been calling for the SEC to step up its enforcement of such climate-related disclosures. The investors noted in a letter to the SEC that they are concerned that oil and gas companies “are not disclosing sufficient information about several converging factors that, together, will profoundly affect the economics of the industry.” Among the factors that these companies are expected to address in their regular securities filings are legislation and regulation related to climate change, international treaties on the issue, and the physical impacts of climate change, like flood or drought. The New York Times.