Financial Market Crisis Developments

SEC SPEAKS

Schapiro Outlines SEC Priorities

In a recent speech before the Council of Institutional Investors Spring Meeting, SEC Chairman Mary Schapiro reiterated the SEC's commitment to the protection of investors. Chairman Schapiro went on to say that although the SEC's "lifeblood—disclosure—is generally working well," there are some gaps, such as hedge funds and credit default swaps, for which more disclosure is needed. In addition to considering requesting legislation to enable the SEC to regulate in these areas, the SEC is also considering:

  • Increased leadership, compensation and risk disclosures. In June, the Commission will consider:
    • whether to enhance disclosure around director nominee experience, qualifications and skills;
    • whether boards should disclose to shareholders their reasons for choosing their particular leadership structure;
    • whether current compensation disclosures accomplish the objective of providing shareholders with the most relevant information;
    • whether greater disclosure is needed about how a company—and the company's board in particular—manages risks both generally and in setting compensation. Here Chairman Schapiro noted that she does not anticipate seeking to "mandate any particular form of oversight" because "this [is] really beyond the Commission's traditional disclosure role" and "would suggest that there is a one-size-fits-all approach to risk management;" and
    • whether additional disclosures are needed about a company's overall compensation approach, beyond decisions only with respect to the highest paid officers, as well as compensation conflicts of interests.
  • Providing proxy access. In May the Commission will consider a proposal providing shareholders a "meaningful opportunity to nominate directors." In formulating this proposal, the Commission will consider its 2003 and 2007 proposals on this issue as well as recently proposed changes to the Delaware General Corporation Law.
  • Expanding credit agency disclosures. The Commission's "early thoughts" on reforms to the credit rating process include requiring more disclosure from credit rating agencies, such as the assumptions underlying their methodologies, fees received from issuers and factors that could change ratings.

SEC DEVELOPMENTS

SEC Holds Roundtable to Examine Oversight of Credit Rating Agencies

At a recent SEC roundtable, SEC commissioners and staff members, as well as credit rating agency executives and academics, discussed the role of credit ratings in the financial crisis. The panelists also talked about the SEC's recent rules and rule proposals that address issues of competition, conflicts of interest and accountability with respect to credit rating agencies. Some highlights of the discussion are set forth below:

  • Issuer Pays Model. The panelists acknowledged the value of the broad dissemination of ratings but several expressed the view that the current credit rating system, which features a handful of prominent agencies which are paid by issuers seeking ratings, should be reexamined. While some panelists suggested that the current "issuer pays" model contains an inherent conflict of interest, other panelists asserted that the government should not favor one type of business model over another, and pointed out that all types of compensation models can pose conflicts of interests.
  • The Future of Credit Ratings. Most panelists agreed that although market participants have lost some confidence in the current credit rating system, credit ratings are still needed and useful. These panelists suggested that a shift to less reliance on credit ratings and more independent investor analysis would be beneficial. Changes to the current credit rating system that increase transparency and reduce conflicts of interest are expected to improve rating reliability.
  • Alternative Models. A few panelists outlined alternative models intended to eliminate or mitigate conflicts of interest in the credit rating industry. One suggestion was to have established credit rating agencies share fees with newly formed investor-owned credit rating agencies. Another suggestion was to create a pool of available ratings dollars via ear-marked fees on new bond issuances.

SEC Proposes Short Sale Restrictions

The SEC recently issued proposals that would revive restrictions on short sales in equity securities. The proposed restrictions on short sales are contained in five proposed rules that adopt two alternative approaches.

Meredith Cross Named Director of the Division of Corporation Finance

Meredith Cross has been named Director of the Division of Corporation Finance. Ms. Cross, who was most recently a securities lawyer in private practice, previously served as Deputy Director of the Division of Corporation Finance and in other staff positions within the Division of Corporation Finance.

SEC Issues Smaller Reporting Company IPO Guidance

The Division of Corporation Finance has posted a compilation of the staff's frequent comments on smaller company IPO registration statements. While the guidance relates specifically to smaller reporting companies, it serves as a helpful checklist of staff hot-button items to consider when preparing any registration statement.

In particular, the staff reminds companies that:

  • The prospectus summary should be a balanced summary of both the positive and negative aspects of the company's business and offering.
  • Risk factors should be only one or two short paragraphs, should limit each risk subheading to one risk and should avoid mitigating language such as clauses that begin with "while," "although" or "however." The staff also finds it unhelpful to state in risk factors that there is or can be no assurance of a particular outcome.
  • MD&A can be improved by the inclusion of a "balanced executive-level discussion of the matters management is most concerned with in evaluating the company's financial condition and operating results." This executive summary could include a discussion of industry-wide factors; how the company earns revenues and generates cash; and a discussion of lines of business, location of operations and principal products or services as well as short-term opportunities, challenges and risks.
  • The staff often questions a company's form eligibility when it files a Form S-3 to register securities on behalf of selling security holders that were affiliated with the company.
  • If a company's registration statement appears incomplete or out of date when filed, the staff will defer their review of the registration statement until the company files an amendment which completes the registration statement and/or makes it current.
  • Companies should carefully review their registration statements to resolve any inconsistencies in disclosure from section to section.
  • The staff often asks the company to provide written support for promotional statements or statistics provided in their filings. In some instances, the consent of the source of the promotional information is needed.
  • The staff often comments on photographs, charts or maps used in prospectuses. If a company intends to include such materials in its prospectuses but not its EDGAR filings, the company must submit those materials for staff review prior to using them.

FASB DEVELOPMENTS

FASB Issues Fair Value Guidance, Modifies Temporary Impairment Standards

The FASB recently issued two staff positions related to fair value measurements and a third staff position that deals with other-than-temporary impairments. The issuance of the guidance should allow financial institutions the ability to use more judgment in valuing their financial assets, particularly those with inactive markets, and may "ease" the impact of current valuation requirements.

NASDAQ DEVELOPMENTS

Nasdaq Rules Reorganized

The Nasdaq has reorganized its rules relating to the qualification, listing and delisting of companies listed or applying to list on Nasdaq. These rules, which previously made up part of the Nasdaq Rules 4000 Series, have been placed in a new 5000 series in what Nasdaq calls a "clearer and more intuitive structure." According to Nasdaq, it did not make any substantive changes to its rules as part of this reorganization but it did eliminate redundancies and make the rules more plain English.

The general organization of the new 5000 series is as follows:

5000 series: General definitions (including some new definitions such as "company," "issuer" and "shareholder");
5100 Series: A description of the Nasdaq's discretionary authority;
5200 series: Qualitative requirements (other than corporate governance requirements) which all companies seeking to list or already listed on the Nasdaq must meet;
5300 series: Quantitative initial and continued listing standards for securities listed on the Nasdaq Global Select Market;
5400 series: Quantitative initial and continued listing standards for securities listed on the Nasdaq Global Market;
5500 series: Quantitative initial and continued listing standards for securities listed on the Nasdaq Capital Market;
5600 series: Corporate governance standards applicable to all Nasdaq listed companies, including written interpretations of the Nasdaq corporate governance rules previously found in Rule 4550;
5700 series: The requirements for listing other securities; and
5800 series: The requirements and processes relating to a company that fails to meet a listing standard.

Nasdaq Extends Suspension of Bid & Ask Price and Lengthens Compliance Period Related to Market Capitalization Requirements

Nasdaq has extended its previous suspension of its bid price and market value requirements until July 19, 2009. Without this suspension, a security listed on Nasdaq would be considered deficient if it failed to achieve at least a $1 closing bid price and a specified minimum market value of publicly held shares, for a period of 30 consecutive business days. Once deficient, a company is allowed an additional period to regain compliance and undergoes a hearing process prior to delisting.

NYSE DEVELOPMENTS

NYSE Suspends $1 Price Criteria and Extends Suspension of Continued Listing Market Capitalization Requirement

The NYSE has suspended, until June 30, 2009, its $1 price criteria for capital and common stock. Without this suspension, a company would be considered below NYSE compliance standards if the average closing price of its security (as reported on the consolidated tape) was less than $1.00 over a consecutive thirty-trading-day period.

The NYSE has also modified its continued listing criteria through June 30, 2009 to require a listed company to have an average market capitalization of at least $15 million over any thirty-day period (previously, the NYSE required an average thirty-day market capitalization of at least $25 million).

OTHER DEVELOPMENTS & DAVIS POLK MEMOranda

Fifth Circuit Affirms Reporting Covenant does not Require Filing of Exchange Act Reports by SEC Deadlines

In the last few years, there have been a number of situations where issuers have failed to file reports with the SEC on a timely basis and bondholders alleged that such failure violated Section 314(a) of the Trust Indenture Act ("TIA") which is incorporated into all public debt indentures. In the first case that was litigated on this issue, Bank of New York v. Bearingpoint, Inc., a New York state court held in 2006 that Section 314(a) of the TIA required timely filing of SEC reports. Since then, a number of courts have disagreed and held that the TIA does not impose an independent obligation to make timely filings of SEC reports.

The U.S. Court of Appeals for the Fifth Circuit recently became the latest court to disagree with the BearingPoint decision when it filed an opinion in Affiliated Computer Services Inc. v. Wilmington Trust Company. Relying heavily on the opinion filed by the Eighth Circuit last December in a similar case, United Health Group Inc. v. Wilmington Trust Co., the Fifth Circuit stated that Section 314(a) of the TIA merely requires an issuer to provide copies of Exchange Act reports to the indenture trustee when they are actually filed with the SEC, rather than when they are due to be filed with the SEC.

Update on "Carried Interest" Legislation: New Levin Bill

President Obama's budget proposal, released on February 26, 2009, contained the following line item: "Tax carried interest as ordinary income." On April 3, Representative Levin (D-Mich.) re-introduced legislation to treat income derived from a sponsor's "carried interest" or "incentive allocation" in an investment partnership as ordinary income and to subject that income to self-employment tax. In comments released with the bill, Representative Levin rejected various arguments that have been raised against changes to the taxation of "carried interest" allocations, including the argument that fund managers are similar to entrepreneurs who receive founders' stock in their companies.

Delaware Supreme Court Reverses Lyondell; Supports Board Discretion in Sale Process

The Delaware Supreme Court recently reversed the Chancery Court in Lyondell v. Ryan, ruling that the Lyondell directors did not breach their fiduciary duties of loyalty in connection with the $13 billion acquisition of the company by Basell AF in 2007. In its reversal, the Supreme Court held that the directors did not fail to act in good faith in fulfilling their duties under Revlon and granted summary judgment in favor of the directors.

EPA Proposes Mandatory Greenhouse Gas Emissions Reporting Rule

The Environmental Protection Agency ("EPA") has been very busy recently. In addition to the much-reported proposed rule announced last week by the EPA finding that carbon dioxide and other greenhouse gasses endanger public health and welfare and therefore are subject to regulation under the Clean Air Act, the EPA has also proposed the first comprehensive national greenhouse gas ("GHG") emissions reporting system. This system would require approximately 13,000 facilities (representing 85% to 90% of the GHGs emitted in the United States) to report their emissions of GHGs, including carbon dioxide, methane, nitrous oxide, hydrofluorocarbons and certain other gases. The proposed rule would impose new requirements on a number of industrial sectors, including coal, petroleum and natural gas suppliers, manufacturers of vehicles and engines, and cement, iron and steel producers, as well as other facilities that emit 25,000 metric tons or more of carbon dioxide equivalent per year. The proposal is not expected to affect most commercial or residential building owners or agricultural operations.

Operations subject to the proposed rule generally would be required to begin collecting GHG emissions data in calendar year 2010 and reporting such data in early 2011, while vehicle and engine manufacturers would begin reporting for model year 2011. As estimated by the EPA, the private sector costs of the proposed rule are not that significant (approximately $160 million for the first year and $127 million per year thereafter), but the information is expected to be used in connection with setting future limitations on GHG emissions, through the Clean Air Act as a result of EPA's recent proposed endangerment finding or through new legislation, either of which could result in very significant costs to all affected industries.