On On December 17, 2013, the Securities and Exchange Commission (the "SEC") announced data relating to enforcement actions during the SEC's 2013 fiscal year that ended on September 30, 2013. During fiscal year 2013, the SEC filed 686 enforcement actions. The $3.4 billion in disgorgement and penalties resulting from those actions is 10 percent higher than in fiscal year 2012 and 22 percent higher than in fiscal year 2011, when the SEC filed the most actions in agency history. Fiscal year 2013 also saw a significant spike in whistleblower activity with 3,238 tips being received and whistleblower payouts exceeding $14 million.

A key change in SEC policy in 2013 that will significantly affect the course of enforcement actions in 2014 and beyond is the SEC's new admissions policy for settlements. The SEC changed its longstanding settlement policy and now requires admissions of misconduct in a discrete category of cases where heightened accountability and acceptance of responsibility by a defendant are appropriate and in the public interest. These admission requirements are particularly important as such admissions in most cases will constitute "bad actor" events under recent amendments to Regulation D and proposed amendments to Regulation A that would disqualify the offending party from participating in certain offerings of securities in reliance on Rule 506 of Regulation D or Regulation A.

In fiscal 2013, actions relating to insider trading, financial crisis enforcement and misconduct by gatekeepers (e.g., accountants and lawyers) continued to be prevalent. In addition, the SEC increased its enforcement efforts in areas relating to market structure and exchanges, municipal securities offerings and Rule 105 of Regulation M that prohibits covering short sale positions by buying shares in a public offering.

As we enter 2014, the SEC expects even greater enforcement activity. In fiscal year 2013, the SEC opened 908 investigations and obtained 574 formal orders of investigation, which represent increases of 13 percent and 20 percent as compared to fiscal year 2012, respectively. With so many investigations in the pipeline, the SEC has affirmed in public releases that "the Enforcement Division headed into the next fiscal year well positioned for significant achievements across its program." In addition to the enforcement focus areas noted above, the SEC recently has created the Microcap Task Force to address fraud in the microcap markets and target gatekeepers and the Financial Reporting and Audit (FRAud) Task Force to detect and prevent financial statement and other accounting frauds.

While the SEC has identified the foregoing enforcement topics as areas of key interest, and 2013 saw a number of high profile cases in these areas (e.g., SAC Capital and Mark Cuban), it should be noted that the SEC is not limiting the scope of its enforcement activities to these areas. SEC Chair White recently noted in statements at the Securities Enforcement Forum on October 9, 2013 that the SEC must pursue not only the high profile, high dollar amount violations, but also "violations such as control failures,… and even violations of prophylactic rules." Chair White stated that the SEC should strive to be everywhere. "Investors do not want someone who ignores minor violations, and waits for the big one that brings media attention. Instead, they want someone who understands that even the smallest infractions have victims, and that the smallest infractions are very often just the first step toward bigger ones down the road. They deserve an SEC that looks at its enforcement mission in exactly that way."

As the SEC looks to broaden its enforcement reach, it is important to note that the types of actions that the SEC brings will have to expand. SEC Commissioner Daniel M. Gallagher noted in his address at the November 7, 2013 FINRA Enforcement Conference that many of the settlement agreements approved by the SEC in 2013 were weak fraud cases that "would have made excellent failure-to-supervise cases … I would much rather see the staff bring high-quality failure-to-supervise cases than to try to shoehorn bad facts into a weak fraud theory. A failure-to-supervise theory often provides an elegant solution to factual and legal difficulties posed by a questionable fraud charge, particularly a non-scienter fraud charge based on some ethereal notion of 'collective negligence.' And bringing a failure-to-supervise case would also vindicate SEC regulations that serve an important role in regulating the securities markets."

It is clear that Commissioner Gallagher's remarks at the FINRA Enforcement Conference did not fall on deaf ears. On January 2, 2014, FINRA published its 2014 Regulatory and Examination Priorities in which FINRA identified compliance with suitability standards, conflicts of interest rules, new Rule 506 and Crowdfunding activities and recidivist brokers as key enforcement areas in 2014. Any market participant doing "bad actor" due diligence under the recent amendments to Rule 506 will tell you that one of the most common disclosure events for a broker dealer on FINRA's BrokerCheck website is a failure to supervise violation. Based on the recent public statements by Chair White and Commissioner Gallagher, we anticipate a similar increase in failure to supervise and other "indirect" liability cases from the SEC in 2014 and beyond.

Securities Law Tracker 

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Monitor Report: Key Changes and Challenges to SEC Rules

SEC Issues Report on Reg. S-K Mandated by JOBS Act

On December 20, 2013, the staff of SEC issued a report reviewing disclosure requirements under Regulation S-K, the first such comprehensive review of disclosure requirements since a 1996 task force. The review was mandated by Section 108 of the JOBS Act and consists of a thorough item-by-item review of the history, regulatory landscape and market practices under Regulation S-K and staff recommendations for possible future reform of the integrated disclosure system.

The report identifies the following economic principles that the staff believes should guide the reform process:

  • Improving the "informativeness" of disclosure to security holders, potential investors and market participants;
  • Administrative and compliance costs associated with a disclosure requirement;Whether historical objectives and policy considerations are still applicable or require updating to address disclosure gaps;
  • The reliability of sources of information, including those that are not the issuer, and the ability of investors to seek appropriate redress for inaccurate information;
  • Competitive costs of disclosure of proprietary information, particular with respect to the emerging growth companies;
  • Maintaining investor confidence and the reliability of public company information; and
  • The ability of the SEC to maintain an effective enforcement program.

In addition to these economic principles, the report states that the staff believes that any changes to the disclosure rules should address four key issues.

  • Any recommended revisions "should emphasize a principles-based approach as an overarching component of the disclosure framework, in order to address the tendency toward implementation of increasing layers of static requirements, while preserving the benefits of a rules-based system affording consistency, completeness and comparability of information across registrants."
  • Consider the appropriateness of current scaled disclosure requirements and whether further scaling would be appropriate for emerging growth companies.
  • Explore alternative methods of information delivery and presentation, both through EDGAR and other systems, including possible filing and disclosure systems based on the nature and frequency of the disclosures.
  • Consistent with the plain English requirements that already exist, identify ways to present information that is more user-friendly and navigable and discourage unnecessary repetition of immaterial information.

In addition to these general principles and theories relating to a comprehensive approach to disclosure reform, the report identifies the following specific areas of Regulation S-K in need of updating:

  1. Risk Factors. In addition to undertaking substantive review of risk factor disclosure, the report recommends consolidating various risk related disclosures such as risk factors, legal proceedings and quantitative and qualitative risk disclosures into a single requirement.
  2. Business, Property and Operations. When Items 101, 102 and 302 of Regulation S-K were first adopted, almost every company had a material physical presence. As our economy has evolved to a services-based, global economy, many companies no longer require physical locations to operate or can easily substitute physical locations without any material impact on their operations. The report recommends considering fundamental changes to the types of information about a company's business, operations and assets that more accurately would capture material information about modern companies.
  3. Corporate Governance. The report identifies the use of boilerplate as a concern in respect of corporate governance, although the counterpoint to this concern is that a certain level of uniformity is to be expected in respect of governance matters that are clearly best practices. The report also suggests that consideration should be given to assessing whether current governance disclosures are material to investors.
  4. Executive Compensation. Although the report acknowledges that executive compensation has been the subject of the most rule changes and interpretative guidance in recent years, it remains an area of lengthy and often technical disclosure relating to complex accounting rules and compensatory and benefit plans. The report suggests additional scaled disclosure may be appropriate and that certain disclosure may not be useful to investors.
  5. Offering Documents. The report notes that many offerings are conducted pursuant to electronic delivery and the use of a physical prospectus book is increasingly rare. Accordingly, the report suggests that consolidating and streamlining the presentation in offering prospectuses may be appropriate. In addition, the report notes that the requirements pertaining to underwriting arrangements and compensation need to be updated to reflect current market practices.
  6. Exhibit Requirements. Locating exhibits on EDGAR can be difficult as it requires navigating back-and-forth between different screens. In addition, the number of required exhibits has grown significantly since the last review of exhibits was conducted in 1980, and there is often inconsistency among different exhibit disclosure requirements (e.g., the exclusionary provisions applicable to merger agreements filed pursuant to Item 601(b)(2) are not applicable to material contracts filed pursuant to Item 601(b)(10)). The report suggests a comprehensive review of exhibits for ongoing relevancy and consistency.

The report concludes with the Staff's recommendation that the SEC take a comprehensive approach with respect to any possible reform of Regulation S-K in lieu of a targeted approach. The Staff believes a comprehensive approach, although a longer-term project involving significant staff resources, would result in more meaningful and consist changes and "achieve the dual goals of streamlining requirements for companies, including emerging growth companies, and focusing in useful and material information for investors." The Staff report remains publicly available and open for public comment. It is not known when or if the SEC will take any actions with respect to the report.

SEC Proposes New Regulation A+: An Overview – Does It Make the Grade?

On December 18, 2013 the Securities and Exchange Commission (the "SEC") proposed amendments to Regulation A ("Reg. A") pursuant to Title IV of the Jumpstart Our Business Startups Act of 2012 (JOBS Act). Reg. A was adopted in 1936 as a rule under the Securities Act of 1933, as amended (the "Securities Act"), in order to assist small businesses with accessing the capital markets under the SEC's recently enacted regulatory regime. Since then, Reg. A has been rarely used and is arguably defunct. In the new proposing release, the SEC noted that from 2009 through 2012, there were only 19 qualified Reg. A offerings for a total offering amount of approximately $73 million. During the same period, there were approximately 27,500 offerings of up to $5 million (i.e., at or below the statutory limit for Reg. A offerings), for a total offering amount of approximately $25 billion, which used a Regulation D ("Reg. D") exemption. Thus, in order to gain some utility from this rule, the JOBS Act mandated certain amendments to be promulgated by the SEC, which are summarized below.

Both new Reg. A, called "Reg. A+" by many, and old Reg. A, provide an exemption from the extensive public registration requirements for smaller issuances of securities by certain types of issuers. Elements of the old Reg. A that would remain the same for offerings under proposed Reg. A+ are that the securities issued may be sold publicly by means of a general solicitation, the securities issued will be freely tradable subject to certain restrictions, the civil liability provisions of Section 12(a)(2) of the Securities Act will apply to Reg A+ offerings and the issuer may engage in "testing the waters" activities similar to existing Rule 254 that permits Reg. A issuers to solicit interest prior to the filing of the offering statement with the SEC. Reg. A+ distinguishes between two types of offerings that may be conducted pursuant to its terms, Tier 1 and Tier 2. Tier 1 is substantially similar to old Reg. A, subject to few exceptions (such as allowing for electronic filings of the Form 1-A and "access equals delivery" with respect to the offering statement"). An issuer may elect to conduct an offering under either tier.

Below is a table summarizing the important provisions of the new rule.

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This client alert is intended only to provide a brief summary of the proposed Reg. A+ rules. The full proposing release provided by the SEC is available here.