The following brief updates exemplify trends and areas of current focus of relevant regulatory authorities: 

Petition for Rehearing in Northstar v. Schwab Denied by Ninth Circuit

In Northstar Financial Advisors Inc., v. Schwab Investments, the United States Court of Appeals for the Ninth Circuit recently ruled that three novel state law claims were validly pled by a plaintiff seeking to represent a class of mutual fund shareholders.1 The state law claims alleged in this case were based on theories of breach of contract against the fund, breach of fiduciary duty against the trustees and adviser, and breach of the investment advisory agreement against the adviser. The district court judge had previously dismissed the plaintiff’s claims in a 2011 ruling. The Ninth Circuit’s decision became final on April 28, 2015, when the defendants’ motion for rehearing and for rehearing en banc was denied.

Supreme Court Widens SEC’s Reinterpretive Reach

As a general matter, when a federal agency, including the SEC, first issues a rule interpreting one of its regulations, it is generally not required to follow the notice-and-comment rulemaking procedures under the federal Administrative Procedure Act (“APA”). In a March 9, 2015 decision, Perez v. Mortgage Bankers Association, the Supreme Court rejected the argument that an agency must use the APA’s notice-and-comment procedures when it wishes to issue a new interpretation of a regulation that deviates significantly from one the agency has previously adopted. From time to time, the SEC issues interpretive guidance with respect to the rules it has promulgated. In view of the Mortgage Bankers decision, the SEC now has greater latitude in changing its prior interpretive guidance. 

SEC's Risk Alert Regarding Never-Before-Examined Investment Company Initiative

On April 20, 2015, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued a National Exam Program Risk Alert to provide further information concerning an initiative to conduct risk-based examinations of certain SEC-registered investment company complexes that have not previously been examined by OCIE. According to the Risk Alert, the initiative will focus on registered investment company complexes that were launched one or more years ago, with regard to two or more of the following “higher risk areas” associated with the operation of such complexes: Rule 38a-1 compliance programs, annual contract reviews, advertising and distribution, valuation and NAV calculations, and leverage and the use of derivatives.

SEC Issues First Formal Guidance on Forum Selection

In the face of criticism regarding the recent increase in the number of enforcement cases being brought as administrative proceedings, in early May 2015, the SEC’s Division of Enforcement (the “Division”) issued an explanation regarding its approach to forum selection in contested actions (the “Forum Selection Explanation”) that describes the factors that the Division will consider in making a recommendation to the SEC regarding whether an enforcement action should be brought as an administrative or a judicial proceeding. The factors identified are the availability of the desired claims, legal theories, and forms of relief in each forum; whether any charged party is a registered entity or an individual associated with a registered entity; the cost, resource, and time effectiveness of litigation in each forum; and the fair, consistent, and effective resolution of securities law issues and matters. The Division also noted that these four factors are a non-exhaustive list, and the Division may consider other factors. The Forum Selection Explanation also states that Administrative Law Judges “develop extensive knowledge and experience concerning the federal securities laws and complex or technical securities industry practices or products.” This suggests the Division believes it is beneficial to have matters that involve unsettled and complex legal issues under the federal securities laws, or an interpretation of the SEC’s rules, decided by Administrative Law Judges.

EU Regulators Impose Fines for Breaches of Short Sales Regulations

A number of EU regulators have started to impose fines on firms, including U.S. firms, for breach of the EU short selling regulations, which went into effect in November 2012. As a reminder, firms that execute short sales of EU-listed securities are subject to the following requirements:

  • Net short positions of 0.2% of an issuer’s outstanding shares and, thereafter, each 0.1% increment must be disclosed to the relevant competent authority. Net short positions of 0.5% and above are disclosed to the relevant competent authority, which discloses the position publicly.
  • The calculation of net short positions includes indirect holdings held through related financial instruments, including derivatives (including index derivatives), baskets, depository receipts, and ETFs.
  • Sovereign debt – short positions of 0.1% or 0.5% (depending upon the issuer) must be reported to the relevant competent authority.
  • There are prohibitions on “naked” short selling, with rules as to what amounts to an acceptable “locate” at the time of execution of the short sale.