Securities Law Archives - Page 20 of 26

Top Five Traps for the Unwary in Spin-Offs

A wave of corporate breakups has swept through the United States over the last few years as investors have taken notice of the fact that smaller companies focused on a single business tend to outperform their more diversified peers. A primary vehicle for these breakups has been the spin-off transaction, in which a publicly traded parent company distributes the shares of the spin-off company (spinco) to its own shareholders, creating a new, independent publicly traded entity. The New York Times, citing Dealogic, reported that there were 93 spin-off transactions worth $128 billion in 2011, and that 2012 kept pace with 85 spin-off transactions worth $109 billion. The rationale for a spin-off often is to unlock the value in a business or division that is trapped in a larger corporate bureaucracy. Conglomerates tend to spread capital across all of their divisions rather than focusing on the individual opportunities within each business that are the most promising. Holding company structures also can make decision-making more cumbersome and equity incentives less incentivizing for division management who feel as though their hard work is being diluted by the underperformance of other divisions or businesses.

Spin-offs, however, are complicated transactions that require a great deal of advance planning. In many cases, an announcement that a parent company is considering the spin-off of one of its businesses is actually the start of a “dual-track” process wherein the parent company considers and plans for a spin-off while also remaining open to potential bids from third parties to acquire the business. In even more complicated cases, a parent company agrees to sell a business to an acquirer in connection with a spin-off transaction.

The vast majority of spin-off transactions are designed to qualify under the rules of the Internal Revenue Code as “tax free” to the parent company and the shareholders who receive the spinco stock.

With this in mind, any company considering spinning off a division or business should keep in mind the following five potential traps.

1. Tax-Free Qualification – Legitimate Business Purpose

The spin-off must satisfy a legitimate business purpose in order to qualify under both the tax-free rules of the Internal Revenue Code and the Securities Act of 1933. The tax authorities require that the spin-off be motivated in whole or in substantial part by one or more legitimate corporate business purposes in order to ensure that the purpose of the transaction is not simply “tax avoidance.” The business purpose requirement is one of many requirements under the tax laws to qualify for a tax-free spin-off. Because the costs of triggering tax in a spin-off transaction often are very high, most parent companies obtain a legal opinion from outside counsel and obtain a ruling from the Internal Revenue Service as a condition to completing a spin-off transaction. As discussed in relation to trap number five below, a legitimate business purpose for the spin-off also is required under the securities laws in order for the distribution of the spinco stock to not be treated as a “sale” of securities by the parent company or the spinco requiring Securities Act of 1933 registration and the strict liability standard of care that comes with such a registration. See the article entitled, “Five Key Tax Considerations for Spin-Off Transactions” for a more in depth discussion of tax issues raised in spin-offs.

2. Separation of Assets and Liabilities

Before a business or a division can be spun off, both its assets and its liabilities must be separated. Large companies with long operating histories often find that the process of separating out the spinco business is not straightforward, because the legal entities that house the business might also house other businesses and divisions that share assets, services, products, employees, vendors and customers with the spinco business. The pre-spin separation transactions should avoid triggering contractual defaults and remedies under commercial agreements, financing agreements, intellectual property licensing agreements, collective bargaining agreements, employment contracts, benefit plans, etc. Often the spinco and the parent company or another legacy business must enter into complex sharing or licensing agreements or joint ventures relating to valuable intellectual property, such as trade names, trademarks or patents, as well as employee matters. See the article entitled “Trademark, Domain Name and Other IP Considerations for Spin-Offs” for a more in depth discussion of IP issues raised in spin-offs and see the article entitled, “Employee Benefit Issues in a Spin-Off” for a more in depth discussion of employee benefit issues raised in spin-offs.

The sharing of liabilities is often the most complicated endeavour because of the slew of legal obligations that are triggered. In allocating liabilities to the spinco, the parent company must evaluate the impact such allocation will have on the solvency of the parent and the spinco. Parent company directors can face personal liability under state corporate law for making an unlawful dividend because the company lacked sufficient capital to make such a dividend or for rendering the parent company insolvent by distributing out the spinco business, and the parent company itself can face claims of constructive fraudulent conveyance—i.e., the parent company received less than equivalent value, and either the parent or spinco was rendered insolvent (assets do not exceed liabilities), the parent and/or spinco was left with unreasonably small capital to run its respective business, or the parent or spinco was left with debts that exceed its respective ability to pay those debts as they become due. Parent company directors can rely on legal experts and financial advisors to assist them in satisfying their duty of care. A solvency opinion from a nationally recognized provider of such opinions is often a condition to the consummation of a spin-off transaction. Such an opinion may be helpful to the directors of the parent company and spinco for a variety of reasons: (i) it can help to show that the directors properly exercised their duty of care in determining to enter into the spin-off transaction; (ii) it can assist in rebutting a fraudulent conveyance claim; and (iii) it can assist in rebutting a claim that the company had insufficient capital to make such a dividend.

3. Transition Services

While one of the key rationales for spinning off a business or division is to allow the enterprise to operate independently, the reality in most cases is that, at least during the first year or so post-spin, a spinco must rely on its former parent company to provide many key administrative and operational services during the spinco’s transition period to a self-sufficient, independent public company. During the pre-spin planning period, companies should consider, among other things, which transition services will be required, how they will be provided, for how long and under what pricing terms. Typical transition services include legal, internal auditing, logistics, procurement, quality assurance, distribution and marketing. These arrangements often have durations that last between six and 24 months. Many parent companies agree to provide such transition services purely on a cost basis, while others will use a “cost plus” or “market” rate.

4. Spinco Management and Board of Directors

Again, while independence from the former parent company is a key benefit for most spincos, having corporate managers with institutional knowledge and history with the enterprise is an important factor in assisting the spinco to successfully transition to independence. Many spinco management teams include members who have served as executives at the former parent company. In many cases, these are managers who served as division leaders who reported to the parent company CEO or CFO and are now ready to step into executive roles on their own. It is also common for between one and three members of the parent company board to agree to take seats on the spinco board to provide the new public company board with a source of the company’s history and culture to ensure a smooth transition. However, because of the competing fiduciary duties that these directors will face if they hold seats on both the parent and spinco boards, it is important for the spinco board to also have a majority of truly independent directors. Spinco directors who are former executive officers of the parent also must be aware that the stock exchanges and influential shareholder services firms such as Institutional Shareholder Services will not view them as being truly independent from a corporate governance standpoint for some time after the completion of the spin-off. This will inhibit their ability to serve on key board committees of the spinco.

5. Preparation of the Disclosure

Under the U.S. Securities and Exchange Commission’s rules, a spin-off of the shares of a subsidiary to a parent company’s shareholders does not involve the sale of securities by either the parent company or the subsidiary as long as the following conditions are met: (i) the parent company does not provide consideration for the spun-off shares; (ii) the spin-off is pro rata to the parent company shareholders; (iii) the parent company provides adequate information about the spin-off and the subsidiary to its shareholders and to the trading markets; and (iv) the parent has a valid business purpose for the spin-off.

To meet the adequate public information requirement, parent companies are required to prepare and disseminate detailed “information statements” that effectively look like initial public offering registration statements for the spinco. These information statements are filed with the spinco’s Form 10 registration statement, which is required in order to register the spinco’s shares under the Securities Exchange Act of 1934 and to permit listing of such shares on a national securities exchange. The preparation of the spinco information statement can take up to three or four months and requires a great deal of effort and cooperation among the lawyers, the business leaders, the finance department, the human resources/employee benefits department and the auditors. In addition, under New York law, a spin-off of all or substantially all of a company’s assets may require a vote of such company’s shareholders, while under Delaware law, such a requirement is much less likely.

Article By:

Thomas P. Conaghan

Jeffrey Rothschild

McDermott Will & Emery

SEC Announces First Non-Prosecution Agreement Involving Foreign Corrupt Practices Act (FCPA) Violations

On April 22, 2013, the Securities and Exchange Commission (SEC) announced it had entered into a Non-Prosecution Agreement (NPA) with Ralph Lauren Corporation under which the company agreed to disgorge approximately $700,000 in connection with certain unlawful payments made by a foreign subsidiary to government officials in Argentina from 2005 to 2009. This is the first time the SEC has used a NPA for violations of the Foreign Corrupt Practices Act (FCPA).

According to the NPA, Ralph Lauren Corporation’s Argentine subsidiary paid “bribes,” i.e., payments in violation of the FCPA, to government and customs officials to improperly secure the importation of Ralph Lauren Corporation’s products in Argentina. The purpose of the unlawful payments, made through a “customs broker,” was to obtain entry of Ralph Lauren Corporation’s products into the country without certain paperwork and to avoid certain inspections by customs officials. The unlawful payments to Argentine officials totaled $593,000 during a four-year period.

The NPA further notes that the unlawful payments occurred during a period when Ralph Lauren Corporation lacked meaningful anti-corruption compliance and control mechanisms over its Argentine subsidiary. The company discovered the misconduct in 2010 as a result of measures it adopted to improve its worldwide internal controls and compliance efforts, including implementation of a FCPA compliance training program in Argentina. The NPA notes that the SEC determined not to charge Ralph Lauren Corporation with violations of the (FCPA) in light of several factors including: (1) the company’s prompt reporting of the violations on its own initiative, (2) the completeness of the information it provided, and (3) the company’s extensive, thorough, and real-time cooperation with the SEC’s investigation. According to the SEC, Ralph Lauren Corporation’s cooperation saved the Commission “substantial time and resources.”

In parallel criminal proceedings, the Justice Department also entered into a Non-Prosecution Agreement with Ralph Lauren Corporation under which the company will pay an $882,000 penalty.^[1]

NPAs are part of the Enforcement Division’s Cooperation Initiative announced in 2010. Prior to 2010, the SEC did not have the ability to enter into NPAs or Deferred Prosecution Agreements (DPAs). The purpose of the Cooperation Initiative was to give the Commission the flexibility to incentivize and reward cooperation while at the same time ensuring that cooperators are held accountable for their misconduct. Since 2010 and prior to this instance, the Commission has entered into three NPAs^[2] and two DPAs^[3] It is likely that the SEC will continue to use DPAs and NPAs particularly in connection with FCPA matters given the factual complexity of the cases and the difficulty in discovering violations, which almost always occur outside the U.S.

The Ralph Lauren NPA provides useful guidance as to what the SEC will consider in assessing corporate cooperation by detailing the significant actions that Ralph Lauren Cooperation took in connection with the parallel investigations. According to the NPA, Ralph Lauren Corporation:

reported preliminary findings of its internal investigation to the staff within two weeks of discovering the illegal payments and gifts:
voluntarily and expeditiously produced documents;
provided English language translations of documents to the staff;
summarized witness interviews that the company’s investigators conducted overseas; and
made overseas witnesses available for staff interviews in the U.S.

The NPA also notes that Ralph Lauren Corporation entered into tolling agreements during the staff’s investigation. The statute of limitations with respect to the 2005 conduct, the earliest conduct charged, would have likely run in 2010, just as the company reported the violations to the SEC.

The Ralph Lauren NPA provides several other takeaways. First, the Ralph Lauren Corporation agreed to enter into the NPA “without admitting or denying liability.” While the NPA also contains the standard provision prohibiting the Ralph Lauren Corporation from “denying, directly or indirectly, the factual basis of any aspect of the” NPA, the inclusion of the “without admitting or denying language” seems to run counter to the policy announced by the Enforcement Division in January 2012 to eliminate the use of “neither admit nor deny” language from settlement documents involving parallel (i) criminal convictions or (ii) NPAs or DPAs^[4] This may suggest that the “without admitting or denying liability” language remains negotiable.

Second, under the agreement, the Company must seek the staff’s prior approval of the contents of any press release concerning the NPA. Third, while the SEC emphasizes the Ralph Lauren Corporation’s enhanced compliance program and successful implementation of the enhancements, it also highlights that the Ralph Lauren Corporation has ceased retail operations in Argentina and is in the process of winding down all operations there. It is possible Ralph Lauren Corporation’s decision to close operations in Argentina was a significant factor in the SEC’s decision to use a NPA in this circumstance. Fourth, notably, the NPA does not require the Ralph Lauren Corporation to retain an independent consultant to review its policies and procedures and to prepare a report to the staff regarding any findings. The financial burden of independent consultant “reviews” is often significant. The staff’s willingness to forego such an undertaking demonstrates the value of taking quick and full remedial action during an investigation.

Fifth, the NPA also refers to “gifts” such as perfume, dresses and handbags valued at between $400 and $14,000, which were provided to three different government officials during the relevant time. This underscores the importance of having policies and procedures that extend beyond prohibiting monetary payments to government officials. Finally, the NPA requires that the Ralph Lauren Corporation “to pay disgorgement obtained or retained as a result of the violations discovered during the investigation.” In its press release, the SEC notes that Ralph Lauren Corporation will “disgorge” $700,000 in illicit profits and interest. The disgorgement, however, appears to be the total amount of unlawful payments plus interest made rather than any profit earned as a result of the unlawful payments. Disgorgement is frequently difficult to calculate, especially in FCPA cases. It appears that rather than tracing the unlawful payments to profits, the SEC was satisfied to use the amount of unlawful payments as a proxy for disgorgement. Moreover, the low monetary value of the unlawful payments may have also contributed to the SEC’s decision to enter into a NPA in this instance.

_{[1] The agreement with the Justice Department stands as yet another example of DOJ’s position that senior management be intricately involved in anti-corruption compliance efforts. More specifically, the agreement requires that Ralph Lauren’s “directors and senior management provide strong, explicit, and visible support and commitment to its corporate policy against violations of the anti-corruption laws and its compliance code.” Further, the agreement requires that the company “assign responsibility to one or more senior corporate executives of the Company for the implementation and oversight of the Company’s anti-corruption compliance code, policies and procedures.”}

_{[2] In December 2010, the SEC entered into a NPA with Carters Inc. in connection with a financial fraud perpetrated by a former Executive Vice President of Carters. The NPA focused on the isolated nature of the misconduct, Carters’ prompt self-reporting, extensive cooperation and remedial actions. In December 2011, the SEC entered into DPAs with Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae) in connection with certain misleading statements claiming that the companies had minimal holdings of higher-risk mortgage loans including subprime loans. The NPA focused on Freddie Mac’s and Fannie’s Mae’s cooperation in connection with the SEC’s litigation against former senior executives.}

_{[3] In May 2011, the SEC entered into a DPA with Tenaris S.A. in connection with FCPA violations. The DPA required Tenaris to disgorge approximately $5.4 million. The DPA focused on Tenaris’ early self-reporting, extensive cooperation and remedial actions. InJuly 2012, the SEC entered into a DPA with Amish Helping Fund in connection with certain misrepresentations and omissions in offering documents. Again, the DPA focused on Amish Helping Fund’s immediate and complete cooperation, its willingness to offer investors a right of rescission and its remedial efforts.}

_{[4] The Amish Helping Fund DPA entered into on July 18, 2012, does not contain the “without admitting or denying” or “neither admitting nor denying” language.}

Article By:

Mary P. Hansen

Drinker Biddle & Reath LLP

Investment Regulation Update – April 2013

The Investment Regulation Update is a periodic publication providing key regulatory and compliance information relevant to broker-dealers, investment advisers, private funds, registered investment companies and their independent boards, commodity trading advisers, commodity pool operators, futures commission merchants, major swap participants, structured product sponsors and financial institutions.

This Update includes the following topics:

SEC Adopts Rules to Help Protect Investors from Identity Theft
Increased Attention to Broker-Dealer Registration in the Private Fund World
SEC Issues Guidance Update on Social Media Filings By Investment Companies
AIFMD — Effect on U.S. Fund Managers
SEC Announces 2013 Examination Priorities
Reminder — Upcoming Form PF Filing Deadline
Reminder — Upcoming Dodd-Frank Protocol Adherence Deadline
Are you a Lobbyist?
Recent Events

SEC Adopts Rules to Help Protect Investors from Identity Theft

On April 10, 2013, SEC Chairman Mary Jo White’s official first day on the job, the SEC, jointly with the CFTC, adopted rules and guidelines requiring broker-dealers, mutual funds, investment advisers and certain other regulated entities that meet the definition of “financial institution” or “creditor” under the Fair Credit Reporting Act (FCRA) to adopt and implement written identity theft prevention programs designed to detect, prevent and mitigate identify theft in connection with certain accounts. Rather than prescribing specific policies and procedures, the rules require entities to determine which red flags are relevant to their business and the covered accounts that they manage to allow the entities to respond and adapt to new forms of identity theft and the attendant risks as they arise. The rules also include guidelines to assist entities subject to the rules in the formulation and maintenance of the required programs, including guidelines on identifying and detecting red flags and methods for administering the program. The rules also establish special requirements for any credit and debit card issuers subject to the SEC or CFTC’s enforcement authority to assess the validity of notifications of changes of address under certain circumstances. Chairman White stated, “These rules are a common-sense response to the growing threat of identity theft to all Americans who invest, save or borrow money.” The final rules will become effective 30 days after date of publication in the Federal Register and the compliance date will be six months thereafter.

Increased Attention to Broker-Dealer Registration in the Private Fund World

The role of unregistered persons in the sale of interests in privately placed investment funds is an area of great interest for the SEC and the subject of recent enforcement actions. On March 8, 2013, the SEC filed and settled charges against a private fund manager, Ranieri Partners, LLC, one of the manager’s senior executives and an external marketing consultant regarding the consultant’s failure to register as a broker-dealer. The Ranieri Partners enforcement actions are especially interesting for two reasons: (i) there were no allegations of fraud and (ii) the private fund manager and former senior executive, in addition to the consultant, were charged.

On April 5, 2013, David Blass, the Chief Counsel to the SEC’s Division of Trading and Markets, addressed a subcommittee of the American Bar Association. His remarks have been posted on the SEC website. Mr. Blass referenced a speech by the former Director of the Division of Investment Management, who expressed concern that some participants in the private fund industry may be inappropriately claiming to rely on exemptions or interpretive guidance to avoid broker-dealer registration.

In addition, Mr. Blass noted Securities Exchange Act Rule 3a4-1’s safe harbor for certain associated persons of an issuer generally is not or cannot be used by private fund advisers. He suggested that private fund managers should consider how they raise capital and whether they are soliciting securities transactions, but he did acknowledge that a key factor in determining whether someone must register as a broker-dealer is the presence of transaction-based compensation. The Chief Counsel also raised the question of whether receiving transaction-based fees in connection with the sale of portfolio companies’ required broker-dealer registration. He suggested that private fund managers may receive fees additional to advisory fees that could require broker-dealer registration, e.g., fees for investment banking activity.

On a related note, in two recent “no-action” letters, the SEC has established fairly clear rules regarding how Internet funding network sponsors may operate without being required to register as broker-dealers. On March 26 and 28, 2013, the SEC’s Division of Trading and Markets addressed this narrow, fact-specific issue in response to requests from FundersClub Inc. and AngelList LLC seeking assurances that their online investment matchmaking activities would not result in enforcement action by the SEC. The April 10, 2013 GT Alert—SEC Clarifies Position on Unregistered Broker-Dealer Sponsors of Internet Funding Networks is availablehere.

SEC Issues Guidance Update on Social Media Filings by Investment Companies

On March 15, 2013, the SEC published guidance from the Division of Investment Management (IM Guidance) to clarify the obligations of mutual funds and other investment companies to seek review of materials posted on their social media sites. This report stems from the SEC’s awareness of many mutual funds and other investment companies unnecessarily including real-time electronic materials posted on their social media sites (interactive content) with their Financial Industry Regulatory Authority filings (FINRA). In determining whether a communication needs to be filed, the content, context, and presentation of the communication and the underlying substantive information transmitted to the social media user and consideration of any other facts and circumstances are all taken into account, such as whether the communication is merely a response to a request or inquiry from the social media user or is forwarding previously-filed content. The IM Guidance offers examples of interactive content that should or should not be filed with FINRA. The IM Guidance is the first in a series of updates to offer the SEC’s views on emerging legal issues and to provide transparency and enhance compliance with federal securities laws and regulations. You may find a link to the SEC Press Release and IM Guidance here.

On a related note, on April 2, 2013, the SEC released a report of an investigation regarding whether the use of social media to disclose nonpublic material information violates Regulation FD. The SEC has indicated that, in light of evolving communication technologies and habits, the use of social media to announce corporate developments may be acceptable; however, public companies must exercise caution and undertake careful preparation if they wish to disseminate information through non-traditional means. The April 5, 2013 GT Alert—Social Media May Satisfy Regulation FD But Not Without Risk and Preparation by Ira Rosner is available here.

AIFMD – Effect on U.S. Fund Managers

New European Union legislation that regulates alternative asset managers who manage or market funds within the EU comes into force on July 22, 2013. The Alternative Investment Fund Managers Directive (AIFMD) will have a significant impact on U.S. fund managers if they actively fundraise in Europe after July 21, 2013 (or if they manage EU-domiciled fund vehicles). Historically, U.S. private equity firms raising capital in Europe have relied on private placement regimes that essentially allowed marketing to institutions and high net worth investors. Beginning July 22, 2013, U.S. fund managers may continue to rely on private placement regimes in those EU jurisdictions that continue to operate them; however, they will now be under an obligation to meet certain reporting requirements and rules set out in the AIFMD relating to:

transparency and disclosure, and
rules in relation to the acquisition of EU portfolio companies.

The transparency and disclosure rules require, for the most part, the disclosure of information typically found in a PPM; however, additional items are likely to be required such as the disclosure of preferential terms to particular investors and level of professional indemnity cover. The rules also require reports to be made to the regulator in each jurisdiction in which the fund has been marketed. The reports will need to include audited financials, a description of the fund’s activities, details of remuneration and carried interest paid, and details of changes to material disclosures. Acquisitions of EU portfolio companies also lead to reporting obligations on purchase – an annual report – and a rule against “asset stripping” for 24 months after the acquisition of control. Firms with less than €500 million in assets under management are exempt from the reporting requirements and reverse solicitation is potentially an option, as the directive does not prevent an EU institution from contacting the U.S. fund manager, but in practice it may be difficult to apply systematically. Fund managers may choose to register in the EU on a voluntary basis from late 2015. This will allow marketing across all EU member states on the basis of a single registration. However, registration will come with a significant compliance burden. If you plan to market in the EU after July 23, 2013, ensure that you review your marketing materials, evaluate your likely reporting obligations and consider how the portfolio company acquisition rules are likely to impact your transactions.

SEC Announces 2013 Examination Priorities

On February 21, 2013 the SEC’s National Examination Program (NEP) published its examination priorities for 2013. The examination priorities address issues market-wide, as well as issues relating to particular business models and organizations. Market-wide priorities include fraud detection and prevention, corporate governance and enterprise risk management, conflicts of interest, and technology controls. Priorities in specific program areas include: (i) for investment advisers and investment companies, presence exams for newly registered private fund advisers, and payments by advisers and funds to entities that distribute mutual funds; (ii) for broker-dealers, sales practices and fraud, and compliance with the new market access rule; (iii)for market oversight, risk-based examinations of securities exchanges and FINRA, and order-type assessment; and (iv) for clearing and settlement, transfer agent exams, timely turnaround of items and transfers, accurate recordkeeping, and safeguarding of assets, and; (iv) for clearing agencies, designated as systemically important, conduct annual examinations as required by the Dodd-Frank Act. The priority list is not exhaustive. Importantly, priorities may be adjusted throughout the year and the NEP will conduct additional examinations focused on risks, issues, and policy matters that are not addressed by the release.

Reminder—Upcoming Form PF Filing Deadline

SEC registered investment advisers who manage at least $150 million in private fund assets with a December 31^st fiscal year end should be well underway in preparing their submissions for the approaching April 30, 2013 deadline. Filings must be made through the Private Fund Reporting Depository (PFRD) filing system managed by the Financial Industry Regulatory Authority (FINRA). As a reminder, advisers to three types of funds must file on Form PF: hedge funds, liquidity funds and private equity funds. Hedge funds are generally defined as a private fund that has the ability to pay a performance fee to its adviser, borrow in excess of a certain amount or sell assets short. Liquidity funds are defined as a private fund seeking to generate income by investing in short-term securities while maintaining a stable net asset value for investors. Private equity funds are defined in the negative as not a hedge fund, liquidity fund, real estate fund, securitized asset fund or venture capital fund and does not generally provide investors with redemption rights. When classifying its funds, advisers should carefully read the fund’s offering documents and definitions on Form PF and should seek assistance of counsel. Particularly, we have seen the broad definition of hedge fund cause a fund considered a private equity fund by industry-standards to be a hedge fund for purposes of Form PF, thus subjecting the fund to more expansive reporting requirements. As is the case with filing Form ADV through IARD, the $150 Form PF filing fee is paid through the same IARD Daily Account and must be funded in advance of the filing. FINRA recently updated their PFRD System FAQs. The SEC has also posted new Form PF FAQs, which should be referred to for upcoming filings.

Reminder — Upcoming Dodd-Frank Protocol Adherence Deadline

All entities, including private funds, engaged in swap transactions must adhere to the ISDA Dodd-Frank Protocol no later than May 1, 2013 in order to engage in new swap transactions on or after May 1. Adherence to the Dodd-Frank Protocol will result in an entity’s ISDA swap documentation being amended to incorporate the business conduct rules that are applicable to swap dealers under Dodd-Frank. Adherence to the Protocol involves filling out a questionnaire to ascertain an entity’s status under Dodd-Frank (e.g., pension plan, hedge fund and corporate end-user). Further information on adherence to the Protocol can be obtained at ISDA’s website by clicking here.

Are you a lobbyist?

Over the last decade, many state and municipal governments have enacted new laws regarding how businesses may interact with government officials. These laws often establish new rules expanding the activities that are deemed to be “lobbying,” who is required to be registered as a lobbyist and what information must be publicly disclosed. Approximately half of the states, and countless municipalities, now define lobbying to include attempts to influence government decisions regarding procurement contracts – including contracts for investment advisors and placement agents – and impose steep penalties for companies that fail to register and disclose their “lobbying” activities and expenditures. Although some lobbying laws include exceptions for communications that occur as part of a competitive bidding process, the rules are inconsistent and not always clear. For example, although New York City’s lobbying law long included procurement lobbying, in 2010 the City’s Corporation Counsel and the City Clerk issued letters warning businesses that “activities by placement agents and other persons who attempt to influence determinations of the boards of trustees by the City’s . . . pension funds” are likely to be considered lobbying activity that requires registration and disclosure. Similarly, California’s lobbying law was expanded in 2011 to expressly include persons acting as “placement agents” in connection with investments made by California retirement systems, or otherwise seek to influence investment by local public retirement plans. Greenberg Traurig’s Investment Regulation Group, in conjunction with our Political Law Compliance team, is available to assist clients with questions regarding how to navigate increasingly complex lobby compliance laws and rules across the country and beyond. GT has a broad range of experience in advising to some of the world’s leading corporations, lobbying firms, public officials and others who seek to navigate lobbying and campaign finance laws.

Recent Events

On April 18, 2013, GT hosted the seminar, “The Far Reaching Impact of FATCA Across Borders and Across Industries” as both a webinar and live program in NY and Miami. The seminar explored the latest FATCA regulations and key intergovernmental agreements as well as their applications to a variety of industries. Click here to view the presentation.

On April 10, 2013, GT sponsored Artisan Business Group’s EB-5 Finance seminar at our NYC office. The program exposed participants to a unique alternative financing opportunity for projects that lend themselves to the EB-5 immigrant investor program and featured several GT speakers, including Steve Anapoell and Genna Garver, Co-Chair of the Investment Regulation Group, who provided a securities law update and considerations in the EB-5 area. Guest speakers included Jeff Carr from EPR, Phil Cohen from the EB-5 Resource Center, and Reid Thomas from NES Financial.

On April 2, 2013, GT co-hosted a Global Compliance seminar with Dun & Bradstreet on Foreign Corrupt Practices Act (FCPA) issues. The program included an overview of the FCPA, with a specific emphasis on the Department of Justice’s recently released Resource Guide to the FCPAand recent enforcement activities. A link to the Resource Guide can be found here.

Article By:

Arthur Don

Steven M. Felsenstein

Genna Garver

Greenberg Traurig, LLP

What You Need to Know About Foreign Account Tax Compliance Act’s (FATCA) Impact on Non-U.S. Retirement Plans

The National Law Review recently published an article regarding FATCA written by Kary Crassweller, Andrew C. Liazos, and Todd A. Solomon with McDermott Will & Emery:

On January 17, 2013, the Internal Revenue Service (IRS) published final regulations under the Foreign Account Tax Compliance Act (FATCA), which are effective immediately. Congress enacted FATCA in 2010 to make it more difficult for U.S. taxpayers to conceal assets held in offshore accounts. In order to discover information about offshore accounts, FATCA imposes significant reporting obligations on both non-U.S. foreign financial institutions (FFIs) and U.S. taxpayers holding foreign financial accounts. A non-U.S. retirement plan may be subject to FATCA reporting responsibilities as an FFI unless there is an available exemption. Failure to comply with applicable reporting requirements may trigger substantial withholding taxes and penalties. This On The Subject summarizes what employers need to know about FATCA for both plans and participants.

Plan-Level Requirements

Foreign Financial Institutions

An FFI must register with the IRS by October 25, 2013, and formally agree to implement procedures for identifying and disclosing information about financial accounts held by its U.S. customers. Unfortunately, a non-U.S. retirement plan is generally included in the broad definition of an FFI, which means it will be required to register and disclose information about its U.S. taxpayer participants if it is not exempt from FATCA. Complying with FFI reporting rules requires significant due diligence to identify account holders who are U.S. taxpayers. Failure by a non-exempt FFI to comply will subject it to a 30 percent withholding tax on certain U.S. source income and on the gross proceeds from the sale of certain assets that generate U.S. source income (such as debt and equity instruments).

Exemptions for Retirement Plans

The final regulations provide important exemptions from FATCA’s reporting and withholding requirements for some, but not all, non-U.S. retirement plans. In response to public comments, the final regulations revised certain exemption requirements under the proposed regulations to broaden the types of retirement plans that will be exempt from FATCA. Important exemptions include the following categories.

Broad Participation Retirement Plans. A non-U.S. retirement plan established to provide retirement, disability and/or death benefits for current or former employees and designated beneficiaries will be exempt from FATCA if these qualifications are met:

No single beneficiary has a right to more than 5 percent of the plan’s assets.
It is subject to government regulation and provides annual information reporting about its beneficiaries to the tax authorities in the country in which it is established or operates (its home country).
It satisfies at least one of the following requirements:
- It is exempt from tax on investment income in its home country because of its status as a retirement or pension plan.
- It receives at least 50 percent of its contributions (other than certain transfers) from sponsoring employers.
- Distributions or withdrawals (other than certain transfers or rollovers) are only allowed upon the occurrence of specified events related to retirement, disability or death, or penalties apply to distributions made prior to such specified events.
- Employee contributions (other than certain make-up contributions) are limited by reference to earned income or may not exceed $50,000 annually

Narrow Participation Retirement Plans. A non-U.S. retirement plan established to provide retirement, disability and/or death benefits for its current or former employees and designated beneficiaries will be exempt from FATCA if these qualifications are met:

The plan has fewer than 50 participants.
The plan is sponsored by one or more employers that are not investment entities or passive non-financial foreign entities.
The plan is subject to government regulation and provides annual information reporting about its beneficiaries to the relevant tax authorities in its home country.
Participants not resident in the plan’s home country are not entitled to more than 20 percent of the plan’s assets.
Employee and employer contributions to the plan (other than transfers from certain retirement savings accounts or other exempt retirement plans) are limited by reference to earned income and compensation, respectively.

Treaty-Qualified Retirement Plans. A non-U.S. retirement plan established in a country with which the United States has an income tax treaty in force will be exempt from FATCA reporting and withholding if it is entitled to benefits under such treaty on income derived from U.S. sources as a resident of that country that satisfies applicable benefit limitation requirements and is operated principally to administer or provide pension or retirement benefits. Tax treaties typically include specific definitions regarding when a person is treated as a resident of a country. Note that this exemption does not require a non-U.S. retirement plan to qualify for favored tax treatment either in the United States or in the country subject to the tax treaty with the United States.

401(a)-Type Plans. A pension plan that would meet the requirements of Section 401(a) of the Code if it were funded by a trust created or organized in the United States is exempt from FATCA reporting and withholding.

Investment Vehicles Designed Exclusively for Retirement Plans. Investment vehicles that exclusively invest funds of one or more types of retirement plans described above or of certain types of retirement savings accounts are exempt from FATCA reporting and withholding.

Even if exempt from FATCA reporting, a non-U.S. retirement plan is required to certify its status on an IRS Form W-8BEN (or suitable substitute) in order to avoid withholding and, in some cases, must also provide documentary evidence supporting the exemption. The IRS has not yet published revisions to W-8BEN that reflect the final regulations, so it remains to be seen what type of general documentary evidence will be required.

Intergovernmental Agreements

FATCA raises many compliance issues for a non-exempt FFI and can pose a catch-22 for an FFI, requiring it to either violate local law restrictions relating to the disclosure of account information or bear the risk of FATCA liability exposure. An intergovernmental approach to FATCA solves these compliance issues, significantly reduces FFI costs and simplifies tax administration. In order to implement FATCA’s information reporting requirements, the U.S. Treasury Department (Treasury) worked with several countries to develop model intergovernmental agreements (IGAs). Under one such model, an FFI reports information about financial accounts held by U.S. taxpayers directly to its government, and the foreign government then provides such information to the United States (a Model 1 IGA). In order to comply with any laws impeding a foreign government’s ability to report information directly to the United States, another model allows the signing country’s FFIs to report directly to the Treasury (a Model 2 IGA).

Each of the model IGAs includes an annex in which the signing countries may list categories of entities that will be exempt from FATCA reporting requirements. Annex II typically lists the retirement plans that will be exempt from FATCA’s withholding and reporting requirements irrespective of whether any of the other exemptions described above are available. For example, it was unclear under the FATCA proposed regulations whether certain pension plans established under UK law would have been exempt from FATCA; however, the IGA signed by the United Kingdom and the United States in September 2012 clarifies that most UK pension plans will be exempt from FATCA reporting requirements.

As of March 15, 2013, Denmark, Germany, Ireland, Italy, Mexico, Norway, Spain, Switzerland and the United Kingdom have initialed or signed IGAs with the United States. It is likely that other countries will adopt IGAs, as the Treasury is engaged with more than 50 countries and jurisdictions to implement the reporting and withholding provisions of FATCA. It is anticipated that IGAs will be entered into with the following countries in the coming months: Canada, Finland, France, Guernsey, Isle of Man, Japan, Jersey and the Netherlands.

Impact of Intergovernmental Agreements on U.S. Retirement Plans

The model IGAs are generally structured to be “reciprocal” in nature, meaning that the United States would agree to provide the same type of information about financial accounts held in the United States by the signing country’s taxpayers to the signing country. For example, the IGA with the United Kingdom requires the United States to report information about certain depository accounts and certain narrowly defined financial accounts held in the United States by residents of the United Kingdom. In addition, it commits the United States to adopt regulations to ultimately achieve an equivalent level of information being provided by the United States and the United Kingdom. Thus, under such reciprocal IGAs, it is not unlikely that a U.S. retirement plan eventually will be required to disclose information about non-U.S. taxpayer participants if the plan is not otherwise exempt from FATCA reporting. It remains to be seen what new reporting requirements may be imposed upon U.S. retirement plans.

Next Steps

Employers should evaluate whether their non-U.S. retirement plans qualify for a FATCA exemption under the final regulations. With respect to any non-exempt plans, employers should contact plan trustees regarding steps being taken to address potential FATCA coverage and monitor developments that may affect reporting obligations, including whether the home country appears likely to sign an IGA with the United States.

Individual-Level Requirements

In addition to the plan-level reporting for certain non-U.S. retirement plans, U.S. taxpayers participating in a non-U.S. retirement plan often have reporting obligations to the IRS under FATCA. In general, Section 6038D of the Internal Revenue Code requires U.S. citizens, resident aliens and certain nonresident aliens with U.S. source income to report beneficial ownership of “foreign financial assets” with an aggregate value of more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year (although higher thresholds apply to U.S. taxpayers who file joint tax returns or reside abroad). “Foreign financial assets” have been interpreted to include interests under a foreign pension or deferred compensation plan, and may also include foreign equity awards. Covered individuals are required to report these interests on IRS Form 8938 (as an attachment to the annual income tax return). Section 6038D reporting currently is effective and was required beginning in the 2012 tax filing season (i.e., by April 17, 2012, unless an extension was granted). Click here for a helpful set of Q&As published by the IRS addressing basic questions under IRS Form 8938. The FATCA final regulations do not change any reporting obligations that apply to individuals.

There is no exemption for a covered individual with an interest in a non-U.S. retirement plan from filing Form 8938 merely because the plan that is a foreign financial interest itself falls into one of the FATCA exemptions described above. In addition, the obligation of a covered individual to report under Form 8938 is separate from and in addition to reporting under the Report of Foreign Bank and Financial Accounts (FBAR). A U.S. individual may have FBAR filing obligations merely by having signature authority over foreign financial accounts with an aggregate value above $10,000. In contrast, Section 6038D and Form 8938 focus on equitable ownership of interests in certain foreign assets with different reporting thresholds depending upon the individual’s filing and residency status.

Covered individuals who fail to meet the Form 8938 reporting requirements are potentially subject to steep penalties. Section 6038D provides for to up to $50,000 in penalties. In addition, a 40 percent understatement penalty applies to any tax attributable to the non-disclosed assets. While there is currently no IRS correction program for failure to file a Form 8938 for 2012, covered individuals who have failed to meet such reporting requirements with respect to an interest in a plan that is a foreign financial asset may wish to consider amending their prior tax returns.

Next Steps

Employers should consider providing assistance to their employees who may be subject to Section 6038D reporting obligations. Assistance involves identifying foreign plans that may be subject to this reporting requirement and providing information on what values may be reported on Form 8938. Although it is the individual’s responsibility to meet any reporting requirements under FATCA, there are also related corporate governance risks for the multinational employer if executive and other employees are not properly reporting U.S. taxes on plan interests outside the United States. In this regard, it is important to keep in mind that the IRS has identified foreign funded retirement plans as a potential area of tax avoidance and is working on guidance with respect to the taxation of these plans.

Compliance with FATCA obligations is an important part of providing employee benefits outside of the United States for a multinational employer. Failure to take these obligations into account as part of compliance and risk management activities can result in adverse exposure to the company and its executive, particularly if there is a related significant underpayment of U.S. income tax.

Supreme Court Narrows ‘State Action’ Immunity From Antitrust Laws

Francis J. Serbaroli with Greenberg Traurig, LLP recently had an article, Supreme Court Narrows ‘State Action’ Immunity From Antitrust Laws, featured in The National Law Review:

The U.S. Supreme Court has referred to the federal antitrust laws as “a charter of freedom [having] a generality and adaptability comparable to that found to be desirable in constitutional provisions.” The antitrust laws are generally broadly worded, and they have been subject to various interpretations and reinterpretations over the past century. Certain types of anti-competitive activity, such as horizontal price fixing, have been deemed so obviously harmful to the marketplace as to be declared per se illegal. Others are judged by the so-called “rule of reason” analysis, in which courts weigh the effect on a defined market of the alleged anti-competitive activity.

Click the View Media link to read the full article.

Protect Your CEO’s Tweets and Posts from U.S. Securities Exchange Commission (SEC) Enforcement Action

Mark F. Foley with von Briesen & Roper, S.C. had an article, Protect Your CEO’s Tweets and Posts from U.S. Securities Exchange Commission (SEC) Enforcement Action, recently featured in The National Law Review:

The U.S. Securities Exchange Commission (SEC) Enforcement Division altered the jet stream of blogosphere commentary last December by, for the first time, recommending legal action against a CEO on account of a Facebook post. Immediately after the announcement, a blizzard of articles, tweets, and blogs buried the mediascape with opinions about the critical role of CEO social media use in the new economy, the wisdom or foolishness of allowing CEO’s to Tweet or post, and whether the SEC should be time warped back to the Stone Age it seems to prefer.

Sweeping away the accumulated hyperbole reveals two important takeaways from the SEC’s announcement, applicable to both public and private companies: i) the more things change, the more they remain the same, and ii) this latest “grave threat” to the modern world is not a crisis, but an opportunity. Social media can be a valid, legal, and effective way to communicate with investors, if it’s done right.

About Regulation FD

The SEC’s action responded to a July 2012 Facebook post by CEO Reed Hastings stating that members watched over 1 billion hours on Netflix in June. Netflix estimated that Hastings had reached 200,000 people through his Facebook, Twitter, and LinkedIn accounts. The SEC felt this was material information for investors and that by announcing it through social media, rather than more traditional outlets, Netflix had violated Regulation Fair Disclosure (Reg. FD).

The SEC adopted Reg. FD in 2000 to fix a perceived lack of fairness in the public securities markets. Before Reg. FD, public companies could share material information with analysts who participated in conference calls or meetings not open to smaller investors. Well-connected investors got trading advantages over the general public. Reg. FD prohibits public companies from providing material information to limited groups of investors without simultaneously making the information available to the entire marketplace.

Under Reg. FD, public disclosures must be made by “filing or furnishing a Form 8-K, or by another method or combination of methods that is reasonably designed to effect broad, non-exclusionary distribution of the information to the public.” The “other method” most often employed is a press release to an array of media outlets likely to disseminate the information broadly and quickly. Individuals and companies violating Reg. FD risk injunctions and monetary penalties.

Use of Social Media Growing, Creating Risks

Social media channels first became critical communication tools for companies after adoption of Reg. FD. A 2010 study of the 100 largest companies in the Fortune 500 found that 79% were using at least one of the four most popular social media platforms. See Burson-Marsteller Fortune Global 100 Social Media Study, Feb. 23, 2010, available at http://www.burson-marsteller.com/Innovation_and_insights/blogs_and_podcasts/BM_Blog/Lists/Posts/Post.aspx?ID=160

A 2012 Forbes article cited an IBM study saying 57% of surveyed CEO’s likely would be using social media by 2017. Mark Fidelman, IBM Study: If you Don’t Have a Social CEO, YourGoing to be Less Competitive, FORBES, May 22, 2012.

The SEC itself uses social media to disclose important information such as speeches, trading suspensions, litigation releases, and administrative proceedings.

While some CEOs see social media as “part of their job description,” others try to minimize risk by having employees write or review tweets before posting, and some CEOs have already tried social media and moved on. See Leslie Kwoh and Melissa Korn, 140 Characters of Risk: Some CEO’s Fear Twitter, WALL STREET JOURNAL, September 26, 2012.

Not everyone does, or should, use all forms of social media. The point of Twitter, for example, is to provide information contemporaneously with the occurrence of a thought or an event. This promptness is both the differentiating touchstone of the medium and its source of danger. Quick, unconsidered, unscripted communications by senior executives of public companies pose risks in the form of leaked intellectual property, disclosed business plans, angered customers, litigious investors, and frothy regulators. The SEC Netflix announcement demonstrates the potential for liability arising from disclosures of information requiring consideration through social media focused solely on promptness. A Facebook post subjected to prior review might have been a better choice.

Even where the SEC does not act, executives may be at risk. In May 2012, retailer Francesca’s Holdings Corporation fired its CFO, Gene Morphis after he tweeted: “Board meeting. Good numbers = Happy Board.” Mr. Morphis, who was also active on other social media outlets, had a history of postings about earnings calls, road shows, and other work related matters. Morphis lost his job even though the SEC took no action. Rachel Emma Silverman, Facebook and Twitter Postings Cost CFO His Job, WALL STREET JOURNAL, May 14, 2012.

Social Media Without Big Risk

The SEC has never issued guidance about the use of social media, but it has issued guidance that websites could be deemed sufficiently “public” to satisfy Reg. FD when: (1) it is a recognized channel of distribution, (2) posting on the web site disseminates the information in a manner making it available to the securities marketplace in general, and (3) there has been a reasonable waiting period for investors and the market to react to the posted information. Indeed, “for some companies in certain circumstances, posting … information on the company’s web site, in and of itself, may be a sufficient method of public disclosure,” SEC Release No. 34-58288 (Aug. 7, 2008) at 18, 25.

This is an example of how “the more things change, the more they stay the same” when it comes to the intersection of law and technology. The purpose of Reg. FD is to make sure that all investors have access to the same information roughly simultaneously. The specific communications method is not important so long as the principle of public disclosure to the general market, not subsets of investors, is served. Because 8-K filings and press releases were the most common ways to quickly and broadly disseminate information in the past, investors knew where to look for them and could monitor those information outlets. Now, when companies establish their websites as well-known places to find press releases, SEC filings, and supplemental information, they, too, have become acceptable means for Reg. FD disclosures.

The same analysis applies to social media, as well as any new communications technology that may exist in the future. The critical question is: has the company sufficiently alerted the market to its disclosure practices based on the regularity, prominence, accuracy, accessibility, and media coverage of its disclosure methods? If so, social media should be just as acceptable as any other communication tool.

One company seems to have found the right balance. Alan Meckler, CEO of WebMediaBrands Inc. drew the SEC’s attention after a pattern of regularly disclosing company information through social media back in December 2010. The SEC’s Division of Corporation Finance questioned whether Mr. Meckler’s Tweets “conveyed information in compliance with Regulation FD.”SEC letter dated December 9, 2010. Despite, the investigation, the SEC brought no enforcement action.

To use social media with minimum SEC risk, the company must educate investors so that they know such communications will always occur at a particular place and at least simultaneously with other outlets. This is done by a regular pattern of social media disclosure and links to other sources, such as SEC filings, showing the way. A company should not force investors to win a shell game, finding the nut of important information in Twitter this time, on Facebook the next time, and Instagram after that. Consistency, predictability, and transparency are key. Used this way, social media present an opportunity to communicate with investors in new ways, not a source of legal problems.

SEC Approves NYSE, NYSE MKT and NASDAQ Compensation Committee Listing Standards

The National Law Review recently published an article by Jeff C. Dodd and Scott L. Olson with Andrews Kurth LLP regarding, SEC regulations:

The Securities and Exchange Commission (SEC) recently approved amendments to the compensation committee listing standards of the New York Stock Exchange (NYSE),¹ the NYSE MKT² and the NASDAQ Stock Market (NASDAQ)³ that were initially proposed in September 2012 to comply with Rule 10C-1 of the Securities Exchange Act of 1934.⁴ In approving the listing standards, the SEC did not require any changes to the exchanges’ proposals, as amended.

The new listing standards will impact the authority and responsibilities of compensation committees with respect to their advisers and the independence analysis for compensation committee members. Although the SEC has approved the new compensation committee listing standards, issuers with listed equity securities subject to the new standards will have time to comply as follows.

NYSE- and NYSE MKT-listed issuers have until:

the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the enhanced compensation committee independence standards; and
July 1, 2013 to comply with the remaining standards (e.g., the authority to retain and fund advisers to the committee and the responsibility to consider specified independence factors before selecting or receiving advice from advisers).

NASDAQ-listed issuers have until:

July 1, 2013 to establish in the compensation committee charter, board resolutions or other board action the compensation committee’s new responsibilities and authority (i.e., the authority to retain and fund advisers to the committee and the responsibility to consider specified independence factors before selecting or receiving advice from advisers); and
the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the remaining standards (e.g., have a formal compensation committee of at least two independent directors, have a compensation committee charter and satisfy the enhanced compensation committee independence standards).

Current compensation committee listing standards will apply pending the transition to the new standards.

Click here to read about key aspects of the NYSE’s new compensation committee listing standards.

Click here to read about key aspects of the NYSE MKT’s new compensation committee listing standards.

Click here to read about key aspects of NASDAQ’s new compensation committee listing standards.

Click here to read about practical considerations for NYSE-, NYSE MKT- and NASDAQ-listed issuers to consider in response to the new compensation committee listing standards.

NYSE Compensation Committee Listing Standards

Committee charter requirements for compensation committee authority and responsibilities regarding its advisers. In addition to current NYSE charter requirements, compensation committee charters must specify the following:

the committee’s authority, in its sole discretion, to retain or obtain the advice of a compensation consultant, legal counsel or other adviser (collectively referred to throughout the discussion of the NYSE’s new listing standards as advisers);
the committee’s direct responsibility for the appointment, compensation and oversight of the work of any adviser retained by the committee;
the issuer’s responsibility to provide for appropriate funding (as determined by the committee) for the payment of reasonable compensation to any adviser retained by the committee; and
the committee’s responsibility to conduct an independence assessment before selecting or receiving advice from an adviser to the committee (as discussed in more detail below under “Assessment of adviser independence”).

The new authority and responsibilities regarding advisers do not:

require the compensation committee to implement or follow its advisers’ advice or recommendations; or
affect the ability or obligation of the compensation committee to exercise its own judgment in fulfilling its duties.

Assessment of adviser independence. As noted above and subject to limited exceptions discussed below, before selecting or receiving advice from an adviser (for compensation or non-compensation matters and regardless of who retained the adviser), the compensation committee must consider all factors relevant to that adviser’s independence from management, including:

the provision of other services to the issuer by the adviser’s employer;
the amount of fees received from the issuer by the adviser’s employer, as a percentage of the employer’s total revenue;
the policies and procedures of the adviser’s employer that are designed to prevent conflicts of interest;
any business or personal relationship between the adviser and a compensation committee member;
any issuer stock owned by the adviser (as the SEC noted in its adopting release for Rule 10C-1, it interprets this to include stock owned by the adviser’s immediate family members); and
any business or personal relationship between either the adviser or the adviser’s employer and an issuer’s executive officer (as the SEC noted in its adopting release for Rule 10C-1, this would include, for example, situations where an issuer’s CEO and the adviser have a familial relationship or where the CEO and the adviser or the adviser’s employer are business partners).

These factors are considerations for the compensation committee rather than bright-line standards. Although compensation committees must consider the specified factors, they are also responsible for identifying and considering all additional factors relevant to an adviser’s independence from management. After conducting the required independence assessment, compensation committees may select or receive advice from any adviser they prefer, even those that are not independent.⁵ In response to comments that compensation committees should be specifically required to also consider whether an adviser requires a contractual agreement to indemnify the adviser or limit the adviser’s liability, the NYSE noted that it is not apparent that the existence of such indemnification agreements or contractual limitations on liability is relevant to an independence analysis.⁶

Compensation committees must conduct the independence assessment for any adviser that the committee selects or receives advice from, other than:

in-house legal counsel; and
any adviser whose role is limited to:
- consulting on any broad-based plan that does not discriminate in scope, terms, or operation, in favor of executive officers or directors of the issuer, and that is available generally to all salaried employees; or
- providing information that either is not customized for a particular issuer or that is customized based on parameters that are not developed by the adviser and about which the adviser does not provide advice.

In response to comments, the NYSE made it clear that the independence assessment requirement applies to any outside legal counsel consulted by the compensation committee, including any regular outside counsel to the issuer consulted on matters such as SEC filing requirements or federal tax issues associated with equity compensation plans.

In response to a comment expressing concern about the possible need to conduct a new independence assessment before every compensation committee meeting for those advisers that regularly provide advice to the compensation committee, the NYSE indicated that the frequency of the assessment will be a facts and circumstances determination. Specifically, the NYSE noted that “[w]hile an annual assessment may be sufficient in some cases, in other circumstances a more frequent review may be warranted.” In approving the new standards, the SEC noted its expectation that the assessment would be conducted at least annually.

Compensation committee independence. Current listing standards require that a compensation committee be comprised solely of independent directors, and the board must affirmatively determine that a compensation committee member is independent under the general board independence standards set forth in Section 303A.02 of the Manual.

Under the new standards, in making an affirmative independence determination regarding a compensation committee member the board must also consider all factors specifically relevant to determining whether a director has a relationship to the issuer that is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member, including:

the source of compensation of the director, including any consulting, advisory or other compensatory fee paid by the issuer to the director; and
whether the director is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer.

These factors do not include any specific numerical or materiality tests, and are considerations for the board rather than bright-line standards. For example, the NYSE did not adopt an absolute prohibition on a board making an affirmative independence finding for a compensation committee member solely because the member or any of his or her affiliates are significant stockholders. Although the board must consider the specified factors, it must also identify and consider all additional factors that would be relevant to a compensation committee member’s independence from management. In response to comments, the NYSE confirmed that a single factor or relationship considered in the independence analysis may be sufficiently material to render a director non-independent.

When considering the source of a director’s compensation, the board should consider whether the director receives compensation from any person or entity that would impair his or her ability to make independent judgments about the issuer’s executive compensation. Likewise, when considering any affiliate relationship, the board should consider whether the relationship places the director under the direct or indirect control of the issuer or its senior management, or creates a direct relationship between the director and senior management, in each case of a nature that would impair the director’s ability to make independent judgments about the issuer’s executive compensation.

In response to comments that director fees should be an explicit factor to be considered in compensation committee independence determinations, the NYSE noted that it does not believe that it is likely that director fees would be a relevant consideration for the independence analysis. However, if “excessive” board compensation might affect a director’s independence, the NYSE noted that the listing standards would require the board to consider that factor in its independence determination, as the standards require the board to consider all relevant factors. The NYSE did not indicate what constitutes “excessive” board compensation.

If a compensation committee member ceases to be independent for reasons outside that member’s reasonable control, the member may, with prompt notice by the issuer to the NYSE, remain a compensation committee member until the earlier of (1) the next annual stockholder meeting or (2) one year from the event that caused the member to cease to be independent. This cure provision is limited to situations where the compensation committee continues to have a majority of independent directors.

Exemptions. The new compensation committee listing standards will not apply to the following issuers that are exempt from the NYSE’s current compensation committee listing standards:

controlled companies (i.e., issuers where more than 50% of the voting power for the election of directors is held by an individual, a group or another company);
limited partnerships (for example, master limited partnerships (MLPs));
companies in bankruptcy;
closed-end and open-end funds registered under the Investment Company Act of 1940 (1940 Act);
passive business organizations in the form of trusts (for example, royalty trusts);
derivatives and special purpose securities; and
issuers whose only listed equity security is preferred stock.

Smaller reporting companies (generally issuers with less than $75 million of public equity float) are exempt from the new enhanced compensation committee independence and consideration of adviser independence standards. As a result, their compensation committee charters will not have to reflect these matters. However, these issuers are subject to the other new standards. An issuer that ceases to qualify as a smaller reporting company will have:

six months from the date it ceases to be a smaller reporting company to comply with the consideration of adviser independence standard;
six months from the date it ceases to be a smaller reporting company to have one member of its compensation committee satisfy the enhanced compensation committee independence standard;
nine months from the date it ceases to be a smaller reporting company to have a majority of its compensation committee members satisfy the enhanced compensation committee independence standard; and
12 months from the date it ceases to be a smaller reporting company to have a compensation committee consisting entirely of members that satisfy the enhanced compensation committee independence standard.⁷

Foreign private issuers that elect to follow home country practice are exempt from the new compensation committee listing standards provided that they comply with the disclosure requirements of Section 303A.11 of the Manual.

Transition periods for newly-listed and other issuers. The current transition periods available to newly-listed issuers and certain other categories of issuers (e.g., issuers listing in connection with a carve-out or spin-off transaction) apply to the new compensation committee listing standards. For example, an issuer listing in connection with its initial public offering (IPO) must have one independent compensation committee member by the earlier of the IPO closing date or five business days from the listing date, a majority of independent members within 90 days of the listing date, and a fully independent committee within one year of the listing date.

Click here to read about practical considerations to consider in response to the new compensation committee listing standards.

NYSE MKT Compensation Committee Listing Standards

Compensation committee authority and responsibilities regarding its advisers. A compensation committee⁸ must have the following authority and responsibilities:

the authority, in its sole discretion, to retain or obtain the advice of a compensation consultant, legal counsel or other adviser (collectively referred to throughout the discussion of the NYSE MKT’s new listing standards as advisers);
the direct responsibility for the appointment, compensation and oversight of the work of any adviser retained by the committee;
the issuer must provide for appropriate funding (as determined by the committee) for the payment of reasonable compensation to any adviser retained by the committee; and
the responsibility to conduct an independence assessment before selecting or receiving advice from an adviser to the committee (as discussed in more detail below under “Assessment of adviser independence”).

The new authority and responsibilities regarding advisers do not:

require the compensation committee to implement or follow its advisers’ advice or recommendations; or
affect the ability or obligation of the compensation committee to exercise its own judgment in fulfilling its duties.

the provision of other services to the issuer by the adviser’s employer;
the amount of fees received from the issuer by the adviser’s employer, as a percentage of the employer’s total revenue;
the policies and procedures of the adviser’s employer that are designed to prevent conflicts of interest;
any business or personal relationship between the adviser and a compensation committee member;
any issuer stock owned by the adviser (as the SEC noted in its adopting release for Rule 10C-1, it interprets this to include stock owned by the adviser’s immediate family members); and
any business or personal relationship between either the adviser or the adviser’s employer and an issuer’s executive officer (as the SEC noted in its adopting release for Rule 10C-1, this would include, for example, situations where an issuer’s CEO and the adviser have a familial relationship or where the CEO and the adviser or the adviser’s employer are business partners).

These factors are considerations for the compensation committee rather than bright-line standards. Although compensation committees must consider the specified factors, they are also responsible for identifying and considering all additional factors relevant to an adviser’s independence from management. After conducting the required independence assessment, compensation committees may select or receive advice from any adviser they prefer, even those that are not independent.⁹ In response to comments that compensation committees should be specifically required to also consider whether an adviser requires a contractual agreement to indemnify the adviser or limit the adviser’s liability, the NYSE MKT noted that it is not apparent that the existence of such indemnification agreements or contractual limitations on liability is relevant to an independence analysis.¹⁰

Compensation committees must conduct the independence assessment for any adviser that the committee selects or receives advice from, other than:

in-house legal counsel; and
any adviser whose role is limited to:
- consulting on any broad-based plan that does not discriminate in scope, terms, or operation, in favor of executive officers or directors of the issuer, and that is available generally to all salaried employees; or
- providing information that either is not customized for a particular issuer or that is customized based on parameters that are not developed by the adviser and about which the adviser does not provide advice.

In response to comments, the NYSE MKT made it clear that the independence assessment requirement applies to any outside legal counsel consulted by the compensation committee, including any regular outside counsel to the issuer consulted on matters such as SEC filing requirements or federal tax issues associated with equity compensation plans.

In response to a comment expressing concern about the possible need to conduct a new independence assessment before every compensation committee meeting for those advisers that regularly provide advice to the compensation committee, the NYSE MKT indicated that the frequency of the assessment will be a facts and circumstances determination. Specifically, the NYSE MKT noted that “[w]hile an annual assessment may be sufficient in some cases, in other circumstances a more frequent review may be warranted.” In approving the new standards, the SEC noted its expectation that the assessment would be conducted at least annually.

Compensation committee independence. Current listing standards require that executive officer compensation be determined, or recommended to the board for determination, either by a compensation committee comprised solely of independent directors or by a majority of the independent directors. Moreover, the board must affirmatively determine that a compensation committee member is independent under the general board independence standards set forth in Section 803A(2) of the Guide.

Under the new standards, the board must also affirmatively determine that all of the compensation committee members (or all of the independent directors if an issuer does not have a compensation committee) are independent for compensation committee purposes. To make this determination, the board must consider all factors specifically relevant to determining whether a director has a relationship to the issuer that is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member, including:

the source of compensation of the director, including any consulting, advisory or other compensatory fee paid by the issuer to the director; and
whether the director is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer.

These factors do not include any specific numerical or materiality tests, and are considerations for the board rather than bright-line standards. For example, the NYSE MKT did not adopt an absolute prohibition on a board making an affirmative independence finding for a compensation committee member solely because the member or any of his or her affiliates are significant stockholders. Although the board must consider the specified factors, it must also identify and consider all additional factors that would be relevant to a compensation committee member’s independence from management. In response to comments, the NYSE MKT confirmed that a single factor or relationship considered in the independence analysis may be sufficiently material to render a director non-independent.

In response to comments that director fees should be an explicit factor to be considered in compensation committee independence determinations, the NYSE MKT noted that it does not believe that it is likely that director fees would be a relevant consideration for the independence analysis. However, if “excessive” board compensation might affect a director’s independence, the NYSE MKT noted that the listing standards would require the board to consider that factor in its independence determination, as the standards require the board to consider all relevant factors. The NYSE MKT did not indicate what constitutes “excessive” board compensation.

If a compensation committee member ceases to be independent for reasons outside that member’s reasonable control, the member may, with prompt notice by the issuer to the NYSE MKT, remain a compensation committee member until the earlier of (1) the next annual stockholders meeting or (2) one year from the event that caused the member to cease to be independent. This cure provision is limited to situations where the compensation committee continues to have a majority of independent directors.

The NYSE MKT amended its listing standards so that only smaller reporting companies (generally issuers with less than $75 million of public equity float) may rely on the current exception that allows one non-independent director to serve on the compensation committee under exceptional and limited circumstances, even for a director who fails the enhanced compensation committee independence standards. Under the exception, one non-independent director may be appointed to the compensation committee if:

the committee consists of at least three members;
the non-independent director is not currently an executive officer, employee, or an immediate family member of an executive officer or employee;
the board, under exceptional and limited circumstances, determines that the individual’s membership is required by the best interests of the issuer and its stockholders; and
the non-independent director serves for no longer than two years.

A smaller reporting company relying on the exception must provide certain disclosures required by NYSE MKT listing standards in the proxy statement for the next annual meeting following the determination (or annual report on Form 10-K if a proxy statement is not required), and any disclosure required by Instruction 1 to Item 407(a) of Regulation S-K regarding reliance on the exception.

Exemptions. The new compensation committee listing standards will not apply to the following issuers that are exempt from the NYSE MKT’s current compensation committee listing standards:

controlled companies (i.e., issuers where more than 50% of the voting power is held by an individual, a group or another issuer);
limited partnerships (for example, MLPs);
companies in bankruptcy;
closed-end and open-end funds registered under the 1940 Act;
asset-backed issuers and other passive business organizations (for example, royalty trusts);
derivatives and special purpose securities; and
issuers whose only listed equity security is preferred stock.

Smaller reporting companies are exempt from the new enhanced compensation committee independence and consideration of adviser independence standards. However, these issuers are subject to the other new standards. An issuer that ceases to qualify as a smaller reporting company will have:

six months from the date it ceases to be a smaller reporting company to comply with the consideration of adviser independence standard;
six months from the date it ceases to be a smaller reporting company to have one member of its compensation committee satisfy the enhanced compensation committee independence standard;
nine months from the date it ceases to be a smaller reporting company to have a majority of its compensation committee members satisfy the enhanced compensation committee independence standard; and
12 months from the date it ceases to be a smaller reporting company to have a compensation committee consisting entirely of members that satisfy the enhanced compensation committee independence standard.¹¹

Foreign private issuers may seek an exemption on the basis that they follow home country practice if they comply with the requirements of Section 110 of the Guide.

Transition periods for newly-listed issuers. The current transition periods available to newly-listed issuers apply to the new compensation committee listing standards. Thus, an issuer listing in connection with its IPO must have one independent compensation committee member at the time of listing, a majority of independent members within 90 days of listing, and a fully independent compensation committee within one year of listing.

Click here to read about practical considerations to consider in response to the new compensation committee listing standards.

NASDAQ Compensation Committee Listing Rules

Compensation committee authority and responsibilities regarding its advisers. A compensation committee must have the following authority and responsibilities:

the authority, in its sole discretion, to retain or obtain the advice of a compensation consultant, legal counsel or other adviser (collectively referred to throughout the discussion of NASDAQ’s new listing standards as advisers);
the direct responsibility for the appointment, compensation and oversight of the work of any adviser retained by the committee;
the issuer must provide for appropriate funding (as determined by the committee) for the payment of reasonable compensation to any adviser retained by the committee; and
the responsibility to conduct an independence assessment before selecting or receiving advice from an adviser to the committee (as discussed in more detail below under “Assessment of adviser independence”).

For those issuers without a standing compensation committee, until the requirement to have a standing compensation committee is effective (as discussed in more detail below under “Compensation committee composition and independence”) these requirements will apply to the independent directors who determine, or recommend to the board to determine, the compensation of executive officers.

Issuers will need to consider under the corporate law of the state of their incorporation whether to grant by July 1, 2013 the authority and responsibilities discussed above through a charter, board resolution or other board action.

The new authority and responsibilities regarding advisers do not:

require the compensation committee to implement or follow its advisers’ advice or recommendations; or
affect the ability or obligation of the compensation committee to exercise its own judgment in fulfilling its duties.

the provision of other services to the issuer by the adviser’s employer;
the amount of fees received from the issuer by the adviser’s employer, as a percentage of the employer’s total revenue;
the policies and procedures of the adviser’s employer that are designed to prevent conflicts of interest;
any business or personal relationship between the adviser and a compensation committee member;
any issuer stock owned by the adviser (as the SEC noted in its adopting release for Rule 10C-1, it interprets this to include stock owned by the adviser’s immediate family members); and
any business or personal relationship between either the adviser or the adviser’s employer and an issuer’s executive officer (as the SEC noted in its adopting release for Rule 10C-1, this would include, for example, situations where an issuer’s CEO and the adviser have a familial relationship or where the CEO and the adviser or the adviser’s employer are business partners).

These factors are considerations for the compensation committee rather than bright-line standards. After considering the six independence factors, compensation committees may select or receive advice from any adviser they prefer, even those that are not independent.¹²

Compensation committees must conduct the independence assessment for any adviser (including outside legal counsel) that the committee selects or receives advice from, other than:

in-house legal counsel; and
any adviser whose role is limited to:
- consulting on any broad-based plan that does not discriminate in scope, terms, or operation, in favor of executive officers or directors of the issuer, and that is available generally to all salaried employees; or
- providing information that either is not customized for a particular issuer or that is customized based on parameters that are not developed by the adviser and about which the adviser does not provide advice.

In approving the new listing rules, the SEC noted its expectation that the independence assessment would be conducted at least annually.

Compensation committee composition and independence. NASDAQ’s current listing rules require that an issuer’s executive officer compensation must be determined, or recommended to the board for determination, either by:

a compensation committee comprised solely of independent directors; or
independent directors constituting a majority of the board’s independent directors in a vote in which only independent directors participate.

NASDAQ eliminated the second alternative and by the relevant 2014 compliance date issuers, including smaller reporting companies (generally issuers with less than $75 million of public equity float), must have a standing compensation committee comprised of at least two members. Each compensation committee member must be an independent director (as defined in current Listing Rule 5605(a)(2)), and boards are required to make an affirmative determination that no independent director has a relationship that, in the board’s opinion, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.

In addition to satisfying the requirement that each compensation committee member be an independent director, the new rules provide that:

each member is prohibited from accepting directly or indirectly any consulting, advisory or other compensatory fee from the issuer or any of its subsidiaries; and
the board must consider whether a compensation committee member is affiliated with the issuer, a subsidiary of the issuer or an affiliate of a subsidiary of the issuer to determine whether any affiliation would impair the member’s judgment as a member of the compensation committee.

These independence factors do not include any specific numerical or materiality tests. In approving the listing rules, the SEC confirmed that, despite any explicit statement by NASDAQ on the matter, a single factor could disqualify a director from being independent under the enhanced compensation committee independence rules.

Although director fees are not an explicit factor to be considered in compensation committee independence determinations, NASDAQ noted that as boards must make an affirmative independence determination that each independent director has no relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director the board could, if appropriate, consider director fees in that context.¹³

The enhanced independence rules adopt the same bright-line prohibition against compensatory fees applicable to audit committees. The prohibition does not include a “look-back” period and, therefore, would apply only during a director’s service on the compensation committee. “Compensatory fees” do not include:

fees received for board or board committee service; or
the receipt of fixed amounts of compensation under a retirement plan, including deferred compensation, for prior service with the issuer (provided that the compensation is not contingent in any way on continued service).

Unlike the prohibition regarding compensatory fees, the rules do not impose a bright-line prohibition on affiliation, but rather impose a requirement to consider such affiliations when making a compensation committee independence determination. Although a board may conclude differently based on the specific facts and circumstances, NASDAQ does not believe ownership of issuer stock by itself, or possession of a controlling interest through ownership of issuer stock by itself, precludes a board from finding that it is appropriate for a director (for example, as a representative of a significant stockholder) to serve on the compensation committee. The board will not be required to apply a “look-back” period and, therefore, need consider affiliation only with respect to relationships that occur during a director’s service on the compensation committee.

Issuers, including smaller reporting companies, may rely on the current exception that allows one non-independent director to serve on the compensation committee under exceptional and limited circumstances, even for a director who fails the new enhanced compensation committee independence rules. Under this exception, one non-independent director may be appointed to the compensation committee if:

the committee consists of at least three members;
the non-independent director is not currently an executive officer, employee, or a family member of an executive officer;
the board, under exceptional and limited circumstances, determines that the individual’s membership is required by the best interests of the issuer and its stockholders;
the non-independent director serves for no longer than two years; and
the issuer provides certain disclosures required by the listing rules either on its website or in the proxy statement for the next annual meeting following the determination (or annual report if a proxy statement is not required), and the disclosures required by Instruction 1 to Item 407(a) of Regulation S-K regarding reliance on the exception.

If an issuer, including a smaller reporting company, fails to comply with the compensation committee composition requirements due to one vacancy, or one compensation committee member ceases to be independent for reasons beyond that member’s reasonable control, the issuer must regain compliance by the earlier of (1) its next annual stockholder meeting or (2) one year from the event that caused the non-compliance. If the annual stockholder meeting occurs within 180 days after the event causing the non-compliance, the issuer would instead have 180 days from the event to regain compliance. An issuer relying on the cure period must provide notice to NASDAQ immediately upon learning of the event or circumstances that caused the non-compliance.

Committee charter requirements. Issuers must certify that they have adopted a formal written compensation committee charter and that the compensation committee will review and reassess the adequacy of the charter on an annual basis.¹⁴ The charter must specify:

the scope of the committee’s responsibilities and how it carries out those responsibilities, including structure, processes and membership requirements;
the committee’s responsibility for determining, or recommending to the board for determination, the compensation of the issuer’s executive officers;
that the CEO may not be present during voting or deliberations by the committee on his or her compensation; and
the specific committee authority and responsibilities discussed above under “Compensation committee authority and responsibilities regarding its advisers.”

Smaller reporting companies must adopt either a formal written compensation committee charter or a board resolution that specifies only the matters in the first three bullets above. These issuers are not required to specify the compensation committee authority and responsibilities set forth in the fourth bullet above or to certify that they will review and reassess the adequacy of the charter or board resolution on an annual basis.

Exemptions. The new listing rules do not apply to the following issuers that are exempt from NASDAQ’s current compensation-related listing rules:

asset-backed issuers and other passive issuers;
cooperatives;
limited partnerships (for example, MLPs);
management investment companies registered under the 1940 Act; and
controlled companies (i.e., issuers where more than 50% of the voting power for the election of directors is held by an individual, a group or another company).

Smaller reporting companies are exempt from the new compensation committee listing rules, except as follows:

they must have (and certify that they have and will continue to have) a formal compensation committee comprised of at least two independent members based on the current independent director definition in Listing Rule 5605(a)(2), but not the enhanced compensation committee independence standards; and
they must certify that they have adopted a formal written compensation committee charter or board resolution as discussed above under “Committee charter requirements.”

An issuer that ceases to qualify as a smaller reporting company will have six months from the date it ceases to be a smaller reporting company to:

comply with the committee authority and responsibilities standards; and
certify to NASDAQ that it (1) has adopted a formal written compensation committee charter, including all of the matters specified above under “Committee charter requirements,” and (2) has, or will within the required phase-in schedule,¹⁵ comply with the enhanced compensation committee independence standards.

Foreign private issuers that follow their home country practice are exempt from the new listing rules provided that they comply with the disclosure requirements in current Listing Rule 5615(a)(3). In addition, foreign private issuers that follow their home country practice in lieu of having an independent compensation committee as required by NASDAQ listing rules must disclose in their annual reports filed with the SEC the reasons why they do not have an independent compensation committee.

Certification. Issuers must certify to NASDAQ within 30 days after the final implementation deadline applicable to them, on a form to be provided by NASDAQ, that they have complied with the new compensation committee listing rules. Although smaller reporting companies, foreign private issuers and controlled companies are exempt from some or all of the compensation committee listing standards, based on a sample certification form provided by NASDAQ in one of its rule filings these issuers would need to complete and file the required certification form.¹⁶

Transition periods for IPO issuers. Although issuers listing in connection with their IPO are subject to the new rules, they can phase-in compliance with the compensation committee composition requirements in accordance with current phase-in schedules. Thus, these issuers must have one independent compensation committee member at listing, a majority of independent members within 90 days of listing and a fully independent committee within one year of listing.

Practical Considerations

NYSE-, NYSE MKT- and NASDAQ-listed issuers and their boards and compensation committees that are subject to the listing standards should consider the following matters. In addition to the following, issuers should not forget to conduct a review of “conflicts of interest” with compensation consultants who had any role in determining or recommending the amount or form of executive and director compensation (subject to certain exceptions). A new SEC rule requires any such conflicts of interest to be disclosed in proxy statements for meetings involving the election of directors held on or after January 1, 2013.¹⁷ As part of this process, issuers should update their director and officer questionnaire to solicit information about the existence of business or personal relationships with compensation consultants and the consultants’ employers and establish policies and procedures for collecting and analyzing information about compensation consultants to determine whether a conflict of interest exists.

By July 1, 2013:

Grant required compensation committee authority and responsibilities regarding advisers.
- NASDAQ- and NYSE MKT-listed issuers should consider under the corporate law of the state of their incorporation whether to grant the new authority and responsibilities to the compensation committee (or, in lieu of such a committee, the independent directors who determine or recommend executive compensation) through a committee charter amendment, board resolution or other board action. Although the authority and responsibilities must be granted by July 1, 2013, NASDAQ-listed issuers are not required to include these matters in their compensation committee charter until 2014 (as discussed below). NYSE MKT-listed issuers are not required to have a compensation committee charter, but must determine how best to grant the required authority and responsibilities by July 1, 2013. Although not required until 2014, NASDAQ-listed issuers with existing compensation committee charters may determine it is best to amend their charters by July 1, 2013 to grant the required authority and responsibilities instead of relying on a board resolution or other board action.
- NYSE-listed issuers should review their compensation committee charters and amend as necessary to grant the new authority and responsibilities.
Conduct adviser independence assessment.
- Discuss the new listing standards with each existing and potential adviser to the compensation committee, even those advisers retained by management or the issuer, to determine whether an independence assessment is required.
- As specifically noted by the SEC in its adopting release for Rule 10C-1, establish policies and procedures for collecting and analyzing information about advisers before the compensation committee can select or receive advice from those advisers. Steps issuers could take include (1) collecting information internally on the services provided by advisers, including identifying the individual advisers that perform services for the issuer and such advisers’ employers, and the fees paid for such services, (2) having the advisers complete a questionnaire or requesting specific representations and covenants in the adviser engagement letter to solicit the information necessary for the compensation committee to consider the enumerated factors set forth in the listing standards and any other factors deemed relevant to the compensation committee, and (3) updating the director and officer questionnaire to determine the existence of any business or personal relationship with any adviser to the compensation committee or such adviser’s employer. Ensure that any policies and procedures developed are consistent with the compensation committee charter and other issuer procedures, and that they provide that the required independence assessment is conducted prior to selecting or receiving advice from new advisers and at least annually for existing advisers.
- For existing advisers to the compensation committee where an independence assessment is required, assess their independence and then schedule the next assessment for that adviser at least annually thereafter. As part of this exercise, boards of NYSE- and NYSE MKT-listed issuers should identify and consider any factors in addition to the six specified factors that would be relevant to an adviser’s independence from management. The listing standards are clear that advisers are not required to be independent if the independence assessment is conducted before selecting or receiving advice from an adviser. However, compensation committees may want to consider whether to adopt a policy that guides their actions if an adviser is not independent.

By the earlier of the first annual meeting after January 15, 2014, or October 31, 2014:

Evaluate compliance with enhanced compensation committee independence standards.
- Update the director and officer questionnaire to address the enhanced compensation committee independence standards.
- Evaluate the independence of compensation committee members to ensure they satisfy the enhanced compensation committee independence standards. Except for NASDAQ’s absolute prohibition on compensatory fees from the issuer or its subsidiaries, the enhanced independence standards do not impose a prohibition on committee membership if the enumerated independence factors are not satisfied. However, as stockholders and proxy advisory firms may be concerned if any factor is not satisfied boards should carefully consider how they will respond if a member does not satisfy the enumerated independence factors. Issuers may choose to conduct such an evaluation in 2013, and develop contingency plans in the event one or more of the existing compensation committee members would not be deemed independent under the enhanced independence standards (for example, in the case of a NASDAQ-listed issuer if a member receives any compensatory fees from the issuer or its subsidiaries). In such case, issuers should consider updating their 2013 director and officer questionnaire to include, for compensation committee members, questions that solicit the information that will enable the board to conduct an evaluation under the enhanced independence standards.
Establish a compensation committee. For NASDAQ-listed issuers without a formal compensation committee, establish a committee in accordance with the new listing rules.
Adopt a compensation committee charter. For NASDAQ-listed issuers, adopt a compensation committee charter that complies with the new charter standards or ensure that the existing compensation committee charter complies with the new charter standards.

Provide compliance certification. NASDAQ-listed issuers must certify to NASDAQ within 30 days after the final implementation deadline applicable to them, on a form to be provided by NASDAQ, that they have complied with the new compensation committee listing rules.

_{1. New York Stock Exchange LLC, Notice of Filing of Amendment No. 3, and Order Granting Accelerated Approval for Proposed Rule Change, as Modified by Amendment Nos. 1 and 3, to Amend the Listing Rules for Compensation Committees to Comply with Securities Exchange Act Rule 10C-1 and Make Other Related Changes, Release No. 34-68639 (Jan. 11, 2013), 78 Fed. Reg. 4570 (Jan. 22, 2013), available at http://www.gpo.gov/fdsys/pkg/FR-2013-01-22/pdf/2013-01106.pdf. The amendments impact Sections 303A.00, 303A.02(a) and 303A.05 of the NYSE Listed Company Manual (Manual). The text of the amended listing standards is included in Exhibit 5 to this NYSE rule filing.}

_{2. NYSE MKT LLC, Notice of Filing of Amendment No. 3, and Order Granting Accelerated Approval for Proposed Rule Change, as Modified by Amendment Nos. 1 and 3, to Amend the Listing Rules for Compensation Committees to Comply with Securities Exchange Act Rule 10C-1 and Make Other Related Changes, Release No. 34-68637 (Jan. 11, 2013), 78 Fed. Reg. 4537 (Jan. 22, 2013), available at http://www.gpo.gov/fdsys/pkg/FR-2013-01-22/pdf/2013-01104.pdf. The amendments impact Sections 110, 801(h), 803A and 805 of the NYSE MKT Company Guide (Guide). The text of the amended listing standards is included in Exhibit 5 to this NYSE MKT rule filing.}

_{3. The NASDAQ Stock Market LLC, Notice of Filing of Amendment Nos. 1 and 2, and Order Granting Accelerated Approval of Proposed Rule Change as Modified by Amendment Nos. 1 and 2 to Amend the Listing Rules for Compensation Committees to Comply with Rule 10C-1 under the Act and Make Other Related Changes, Release No. 34-68640 (Jan. 11, 2013), 78 Fed. Reg. 4554 (Jan. 22, 2013), available at http://www.gpo.gov/fdsys/pkg/FR-2013-01-22/pdf/2013-01107.pdf. The amendments impact compensation committee- and corporate governance-related Listing Rules 5605(d) and 5615, and add new Listing Rule 5605A. The amendments also include conforming amendments to audit and nominations committee-related Listing Rules 5605(c) and 5605(e)(3) and corrections of typographical errors in other listing rules. The text of the amended listing rules is included in Exhibit 5 to this NASDAQ rule filing.}

_{4. Please see our client alert dated October 22, 2012 for a discussion of the listing standard amendments as originally proposed, NYSE, NYSE MKT and NASDAQ Propose Amendments to Compensation Committee Listing Standards.}

_{5. Issuers should remember that pursuant to new Item 407(e)(3)(iv) of Regulation S-K their proxy statements for meetings involving the election of directors held on or after January 1, 2013 must include disclosure of any “conflict of interest” involving compensation consultants (but not other advisers such as lawyers) who had any role in determining or recommending the amount or form of executive and director compensation (subject to certain exceptions). “Conflict of interest” is not defined, but to determine whether a conflict of interest exists, issuers should use the factors set out in Exchange Act Rule 10C-1(b)(4) relating to adviser independence, which are the same six factors identified in the new NYSE standards.}

_{6. See Letter from Janet McGinness, Exec. Vice Pres., Corp. Sec’y & Gen. Counsel, NYSE Markets, to Elizabeth M. Murphy, Sec’y, SEC (Jan. 10, 2013), availableat http://www.sec.gov/comments/sr-nyse-2012-49/nyse201249-8.pdf.}

_{7. These issuers would also need to update their compensation committee charters to reflect these matters.}

_{8. For the remainder of the discussion of the NYSE MKT’s new listing standards, references to compensation committee are meant to refer to an issuer’s independent directors as a group where the issuer does not have a compensation committee, but instead relies on its independent directors to determine, or recommend to the board for determination, executive officer compensation.}

_{9. Issuers should remember that pursuant to new Item 407(e)(3)(iv) of Regulation S-K their proxy statements for meetings involving the election of directors held on or after January 1, 2013 must include disclosure of any “conflict of interest” involving compensation consultants (but not other advisers such as lawyers) who had any role in determining or recommending the amount or form of executive and director compensation (subject to certain exceptions). “Conflict of interest” is not defined, but to determine whether a conflict of interest exists, issuers should use the factors set out in Exchange Act Rule 10C-1(b)(4) relating to adviser independence, which are the same six factors identified in the new NYSE MKT standards.}

_{10. See Letter from Janet McGinness, Exec. Vice Pres., Corp. Sec’y & Gen. Counsel, NYSE Markets, to Elizabeth M. Murphy, Sec’y, SEC (Jan. 10, 2013), availableat http://sec.gov/comments/sr-nyse-2012-49/nyse201249-8.pdf. Although no comments were submitted on the NYSE MKT’s proposed listing standards, comments were submitted on the NYSE’s and NYSE Arca’s proposed listing standards. In response to these comments, NYSE Euronext (the parent company of NYSE, NYSE MKT and NYSE Arca) issued one response letter that addressed the comments on behalf of all NYSE exchanges, including NYSE MKT, as the comments raised are in substance applicable to all three proposals.}

_{11. Any such issuer that does not have a compensation committee must comply with this transition requirement with respect to all of its independent directors as a group.}

_{12. Issuers should remember that pursuant to new Item 407(e)(3)(iv) of Regulation S-K their proxy statements for meetings involving the election of directors held on or after January 1, 2013 must include disclosure of any “conflict of interest” involving compensation consultants (but not other advisers such as lawyers) who had any role in determining or recommending the amount or form of executive and director compensation (subject to certain exceptions). “Conflict of interest” is not defined, but to determine whether a conflict of interest exists, issuers should use the factors set out in Exchange Act Rule 10C-1(b)(4) relating to adviser independence, which are the same six factors identified in the new NASDAQ rules.}

_{13. See Letter from Erika J. Moore, Assoc. Gen. Counsel., NASDAQ Stock Market LLC, to Elizabeth M. Murphy, Sec’y, SEC (Dec. 12, 2012), available at http://www.sec.gov/comments/sr-NASDAQ-2012-109/NASDAQ2012109-9.pdf.}

_{14. NASDAQ also proposed, and the SEC approved, amendments to NASDAQ’s audit committee listing rules that require listed issuers to proactively certify that the audit committee “will review and reassess” the adequacy of the audit committee charter on an annual basis. Current listing rules require the certification to provide that the audit committee “has reviewed and reassessed” the adequacy of the audit committee’s charter on an annual basis. NASDAQ noted that this change is consistent with its current interpretation of the audit committee charter requirements and will harmonize the audit committee charter requirements with the new compensation committee charter requirements.}

_{15. A smaller reporting company that loses that status must comply with the enhanced compensation committee independence requirements as follows: (1) one member in compliance within six months from the date smaller reporting company status is lost, (2) a majority in compliance within nine months from the date smaller reporting company status is lost and (3) all members in compliance within one year from the date smaller reporting company status is lost.}

_{16. See Exhibit 3 to this NASDAQ rule filing for the form of compensation committee certification NASDAQ intends to use.}

_{17. For more information on this SEC disclosure requirement, please see our client alert dated July 9, 2012, SEC Adopts Rules Implementing Dodd-Frank Requirements for Compensation Committees and Compensation Advisers.}

Key Financial Industry Regulatory Authority (FINRA) Regulatory Focus of 2013: Retail Sales of Complex Products, According to Annual Letter [VIDEO]

The National Law Review recently published an article, Key Financial Industry Regulatory Authority (FINRA) Regulatory Focus of 2013: Retail Sales of Complex Products, According to Annual Letter [VIDEO], written by Mark T. Carberry with Neal, Gerber & Eisenberg LLP:

In January, the Financial Industry Regulatory Authority (FINRA) published its annual letter identifying its regulatory and examination priorities for 2013, a document intended to “represent [FINRA’s] current assessment of the key investor protection and market integrity issues on which [FINRA] will focus in the coming year.”

Although numerous such issues were identified by FINRA in its letter, including issues relating to the sale of private placement securities, anti-money laundering compliance, insider trading, margin lending practices, and algorithmic trading, a substantial focus for 2013 relates to suitability concerns and the sale of complex products to retail investors.

Economic Environment Sharpens FINRA’s Concern

FINRA specified in its letter a number of current general economic factors giving rise to concerns about retail investors purchasing complex products:

FINRA believes the “slow growth, low-interest rate environment…” has challenged retail customers to seek returns outside their stated risk tolerance;
“[A]n unprecedented compression of credit risk premiums and yields…;”
The fact that retail investors are, therefore, increasingly transferring funds from equity to debt markets;
Retail investor “appetite for yield…” has increased prices on investment-grade and high-yield debt issues, limiting substantially upside growth while exacerbating risk of loss.

In light of the above factors, FINRA expressed its particular concern “about sales practice abuses, yield-chasing behaviors and the potential impact of any market correction, external stress event or market dislocation on market prices.”

3 Complex Products Earn Particular FINRA Scrutiny

While FINRA’s assessment again identifies numerous complex products in previous annual reviews, including non-traded REITs and leveraged and inverse ETFs, FINRA singled-out the following three “recently surfaced…” products as potentially unsuitable for retail investors in the current economic environment, given their underlying market, credit and liquidity risk factors:

Business Development Companies (BDCs): BDCs, typically closed-end investment companies, are highlighted due to, among other things, their investment in the corporate debt and equity of private companies;
Leveraged Loan Products: These adjustable-rate loans are extended by financial institutions to companies with low credit quality;
Commercial Mortgage-Backed Securities: FINRA is concerned retail investors are not being advised by their registered representatives of the “considerable risks given today’s low-interest-rate, low-yield environment.”

FINRA’s Recommended Supervisory Points of Emphasis

Supervisory policies and procedures regarding the sale of complex products to retail investors will be subject to particular scrutiny in 2013. FINRA’s Regulatory Notice 12-03 (“Complex Products-Heightened Supervision of Complex Products”), offers substantial guidance regarding heightened supervisory procedures that may be appropriate. In brief, some of these supervisory procedures may include:

Suitability: Is there a process to ensure the mandatory suitability analyses have been undertaken, particularly in light of FINRA’s revised suitability rule (FINRA Rule 2111)?
Post-Approval Review: Is there a supervisory process in place to reassess – post-sale – the performance and risk profile of existing complex products? Does this process also capture any complaints received from customers relating to a particular complex product?
Training: Registered representatives who recommend complex products must have a thorough understanding of all features and risks of a given product to enable them to articulate such features and risks to retail clients. Have sufficient resources been allocated to such training, and is there a process in place to ensure this training was utilized and effective?
Financial Sophistication of Clients: FINRA recommends that firms adopt the approach mandated for options trading accounts – that financial advisors must have a reasonable basis to believe that a retail client is sufficiently knowledgeable in financial matters, that he or she is capable of evaluating the risks of a recommended transaction and that the client can bear the associated financial risks.
Discussions with the Client: In recommending a complex product, a registered representative should thoroughly discuss all features of the product, how the product is expected to perform under different market conditions, the risks of the product and potential returns and the costs of the product. Fundamentally this should be undertaken in a manner most likely to facilitate the client’s understanding of the product.

In sum, as advised in its letter, FINRA is “particularly concerned about firms’ and registered representatives’ full understanding of complex or high-yield products, potential failures to adequately explain the risk-versus-return profile of certain products, as well as a disconnect between customer expectations and risk tolerances.”

For these reasons, supervisory procedures regarding sales of complex products to retail investors in large part must be designed – and enforced – with the intent to give financial advisors the ability to provide credible, substantive responses to the regulatory inquiry, “How did you educate yourself regarding the particular features and risk factors of this product?” and “How did you effectively communicate that information to your (suitable) client?”

Securities and Exchange Commission’s (SEC) Rule 10b5-1 Trading Plans Under Scrutiny

The National Law Review recently published an article, Securities and Exchange Commission’s (SEC) Rule 10b5-1 Trading Plans Under Scrutiny, written by the Financial, Corporate Governance and M&A Litigation Group of Barnes & Thornburg LLP:

For more than a decade, corporate officers and directors of publicly traded companies have relied on trading plans, known as Rule 10b5-1 trading plans, in order to trade stock in their companies without running afoul of laws prohibiting corporate “insiders” from trading on material information not known to the general public. Historically, effective 10b5-1 plans have provided corporate insiders with an affirmative defense to allegations of unlawful insider trading.

Such plans typically involve a prior agreement between a corporate executive or board member and his or her broker. Under such agreements, the insider would provide standing trading instructions to the broker, requiring the broker to trade at a set stock price or a set time, for example. The broker would then effect the trade at the required price or time, regardless of the information held by the insider.

Recently, notwithstanding the Securities and Exchange Commission’s (SEC) longtime knowledge of potential abuses, such 10b5-1 plans have been under fire. In a Nov. 27, 2012, article in the Wall Street Journal titled “Executives’ Good Luck in Trading Own Stock,” the authors aired several complaints about such plans, including that “[c]ompanies and executives don’t have to file these trading plans with any federal agency. That means the plans aren’t readily available for regulators, investors or anyone else to examine. Moreover, once executives file such trading plans, they remain free to cancel or change them—and don’t have to disclose that they have done so. Finally, even when executives have such a preset plan, they are free to trade their companies’ stock at other times, outside of it.” The article went on to chronicle several purported abuses by officers and directors of such plans.

The current regulatory environment has simultaneously raised suspicions about plans and trades that are innocent, and potentially provided shelter for others that may be less so. In fact, in a Feb. 5, 2013, article in the Wall Street Journal entitled “SEC Expands Probe on Executive Trades,” the author noted that “[t]he Securities and Exchange Commission, expanding a high-profile investigation, is gathering data on a broad number of trades by corporate executives in shares of their own companies, according to people familiar with the probe.”

It would appear, from news like this, that the SEC is concerned that corporate insiders are adopting or amending 10b5-1 plans when in possession of non-public information that might affect market participants’ decision to trade in the company’s stock. Such changes could nullify the use of a 10b5-1 plan as a defense.

Seemingly in reaction to the perceived manipulation of 10b5-1 plans, the Council of Institutional Investors (CII) submitted a letter to the SEC on Dec. 28, 2012, requesting that the SEC implement rulemaking to impose new requirements with respect to Rule 10b5-1 trading plans. The CII letter calls for company boards of directors to become explicitly responsible for monitoring 10b5-1 plans, which undoubtedly will subject boards to increased scrutiny by the SEC. In addition, the CII letter proposes stricter regulatory rules including:

Adoption of 10b5-1 plans may occur only during a company open trading window
Prohibition of an insider having multiple, overlapping 10b5-1 plans
Mandatory delay of at least three months between 10b5-1 plan adoption and the first trade under the plan
Prohibition on frequent modifications/cancellations of 10b5-1 plan

The CII also advocates pre-announced disclosure of 10b5-1 plans and immediate disclosure of plan amendments and plan transactions. Under the CII’s suggested new rules, a corporate board also would be required to adopt policies covering 10b5-1 plan practices, monitor plan transactions, and ensure that such corporate policies discuss plan use in a variety of contexts. A similar set of suggestions can be found in Wayne State University professor Peter J. Henning’s Dec. 10, 2012, article, “The Fine Line Between Legal, and Illegal, Insider Trading,” found online at: http://dealbook.nytimes.com/2012/12/10/the-fine-line-between-legal-and-illegal-insider-trading/.

Given the uncertainty in the market concerning the current use of Rule 10b5-1 plans and the future of such plans, companies or individuals who may be subject to Rule 10b5-1 plans and/or future regulations in this area should consult with counsel before adopting or amending such plans.

Private Equity Beware: Securities Exchange Commission (SEC) Official Predicts Increased Scrutiny, Enforcement Action in 2013

The National Law Review recently published an article, Private Equity Beware: Securities Exchange Commission (SEC) Official Predicts Increased Scrutiny, Enforcement Action in 2013, written by Mark T. Carberry with Neal, Gerber & Eisenberg LLP:

In late January, the SEC published remarks from a high-ranking SEC official that included projections that the private equity industry would see more scrutiny and enforcement in 2013. “It’s not unreasonable to think that the number of [enforcement] cases involving private equity will increase,” said Bruce Karpati, Chief of the SEC Enforcement Division’s Asset Management Unit.* In his comments, Karpati rooted his prediction in private equity’s “significant growth spurt” preceding the financial crisis, the substantial increase in assets under management, and the fact that only recently have many private equity managers become registered investment advisers.

VALUATION & CONFLICTS OF INTEREST IN CROSSHAIRS

The misconduct that the SEC is most likely to target falls under two broad categories: valuation and conflicts of interest, according to Karpati.

As to valuation, Karpati described one form of manager misconduct that occurs when assets are “written up” during a fund raising period, only to be immediately written down after the fund raising period closes.

Karpati further identified the following common conflicts of interest that require control and disclosure:

Conflicts between the profitability of the private equity management firm and the best interests of investors, particularly where the firm is publicly traded;
Conflicts that arise when expenses are shifted from the management firm to the funds;
Conflicts that arise in charging additional fees to the portfolio companies where allowable fees are poorly defined in the partnership agreement;
Conflicts relating to the challenges of managing different clients, different investors and different products “under the same umbrella …,” with the potential that “preferred clients” will be favored at the expense of others;
Conflicts generated by a manager’s other business interests, including the possibility of diverting investment opportunities.

COOS/CFOS ‘CRITICAL’ IN MEETING FIDUCIARY DUTIES

Karpati deemed the roles of chief operating officer and chief financial officer “critical” in ensuring a firm satisfies its fiduciary duties to clients. This is true due to the unique, broad perspective they enjoy in running the business of the manager.

Karpati specified a number of “best practices” that private equity firms should consider:

Compliance risk explicitly should be integrated in overall, enterprise risk management;
COOs, CFOs and compliance personnel should proactively identify and resolve practices giving rise to conflicts of interest;
Firms should implement a set of compliance procedures appropriate for the particular business model in place;
COOs and CFOs should act as investor advocates, and be sufficiently empowered in the firm by, for example, securing membership on important, decision-making firm committees.

Karpati concluded his remarks by encouraging collaboration with legal and compliance resources whenever potential conflict of interest issues are identified.

Note: The Asset Management Unit is one of five specialized units within the SEC’s Division of Enforcement, each designed to address specific areas of the financial markets. The other units are the Market Abuse Unit, the Structured and New Products Unit, the Foreign Corrupt Practices Act Unit, and the Municipal Securities and Public Pension Unit.

1. Tax-Free Qualification – Legitimate Business Purpose

2. Separation of Assets and Liabilities

3. Transition Services

4. Spinco Management and Board of Directors

5. Preparation of the Disclosure

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