The bounty program was authorized in a little-noticed provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, passed by Congress and signed into law by President Obama in July. Unlike much of the Dodd-Frank Act, this provision affects all companies subject to federal securities laws, not just companies in the financial services industry.

Section 922 of the Dodd-Frank Act added a new section 21F to the Securities Exchange Act of 1934 which provides that the SEC must pay rewards to whistleblowers who provide original information about violations of the federal securities laws that leads to successful enforcement actions resulting in more than $1 million in penalties. Awards, ranging between 10 and 30 percent of collected penalties, are to be paid from an Investor Protection Fund for which almost $452 million has already been budgeted. The Dodd-Frank Act also prohibits retaliation against informants in the SEC program and provides for redress in the federal courts. On November 3,  the SEC approved a 181-page Notice describing, and seeking public comment until December 17 on,  the agency’s proposed rules for implementing the whistleblower program authorized by the legislation.  See www.sec.gov/news/press/2010/2010-213.htm.  Under the Dodd-Frank Act, the SEC has until April 17, 2011, to adopt final rules.

Implications

All publicly-held companies now face new risks that their employees will bypass their companies’ own internal compliance programs and go directly to the SEC in hope of winning huge Dodd-Frank awards (or, in some cases, seeking protection under Dodd-Frank’s anti-retaliation provisions from discharge for their own work-related problems). The result could well diminish the effectiveness of the internal programs and leave companies facing the burden of defending against claims – many of which may be spurious – taken to the SEC that become the basis of investigations by the agency. The risks are exacerbated by the fact that members of the plaintiffs’ bar already have launched aggressive marketing campaigns seeking to represent whistleblowers in their efforts to win awards from the SEC. See, for example, www.secsnitch.com. “The reality is that we’ve now set up a competing mechanism with an incentive structure that no honest and diligent board can compete with. Congress is potentially gutting the ability of every honest director in America to do his or her job,” Stanford Law Professor and former SEC Commissioner Joseph Grundfest told attendees at an American Bar Association meeting in August. “The SEC has long advocated for corporate compliance programs, but this whistleblower-bounty program would essentially eviscerate them,” U.S. Chamber of Commerce spokesman David Hirschmann commented after the SEC issued its proposed rules.

What should you do now?

The SEC’s rulemaking process provides an opportunity for publicly-held companies, their trade associations and others to try to convince the SEC to adopt rules that will minimize the negative corporate governance implications of the new whistleblower program. We urge you to consider submitting comments to the SEC before the December 17 deadline. A large volume of thoughtful comments raising concerns could well have a positive impact on the SEC.     

In the meantime, we believe companies would be well-advised to expect the worst and to begin an assessment of their internal compliance programs in light of current best practices, as well as the evolution of those best practices likely to result in the near future from the Dodd-Frank provision. The internal “ethics hot line” processes for seeking and responding to employee concerns that have appeared to be sufficient in the past may no longer be adequate. Serious consideration should be given to enhancements that will encourage employees in more meaningful ways to use internal options for reporting their concerns about compliance with securities laws, as well as other laws applicable to their employers’ operations. Given the significance of the issues raised by the government’s new Dodd-Frank whistleblower program, senior management, as well as boards of directors, should be involved as reassessments are conducted.

We can help.

Troutman Sanders has assembled a team of lawyers, from a variety of disciplines and with extensive experience advising corporate clients in the establishment and administration of compliance programs, to provide assistance in responding to the new challenges presented by the Dodd-Frank whistleblower provision. In the near term, if you are interested in filing comments on the SEC’s proposed rules, we can assist you in preparing them. For the longer term, we can bring our experience and unique outside perspective to bear in working with you on an assessment of your current compliance activities and of changes to them that might now be advisable. 

CONTACT

Kevin C. Fitzgerald
202.274.2955

Terry Bridges
404.885.3163

Aurora Cassirer
212.704.6249

Brinkley Dickerson
404.885.3822

Richard Gerakitis
404.885.3328

Jeffrey Jakubiak
202.274.2892

Bryan Lavine
404.885.3170

Jacob A. Lutz
804.697.1490

DeWitt R. Rogers
404.885.3412

John S. West
804.697.1269

• Panalpina World Transport (Holding) Ltd.;
• SNEPCO;
• Transocean Inc;
• Tidewater Marine International Inc;
• Pride International Inc. and Pride Forasol S.A.A;
• Global SantaFe Corp.; and,
• Noble Corporation

These separate cases arose from transactions in which DOJ alleged that the companies engaged in bribing numerous foreign officials in an effort to circumvent local rules and regulations relating to the import of goods and materials in foreign jurisdictions.  The companies agreed to pay a total of $156,565,000 in criminal penalties.  Also, the SEC announced its settlements with these companies, which involve civil disgorgement, interest and penalties totaling approximately $80 million. The matters stem from an investigation that focused on allegations of foreign bribery in the oil field services industry.

Additional details on each investigation, including the Criminal Information filings, Plea Agreements, Deferred Prosecution Agreements, and other court documents are located at:  http://www.justice.gov/opa/opa_documents.htm. 

More importantly for U.S. businesses engaged in international transactions or with foreign subsidiaries, each of the Deferred Prosecution Agreements included an attachment entitled “Corporate Compliance Program.”  Each company had to agree to continue to conduct, in a manner consistent with all obligations under the Agreements, appropriate reviews of its existing controls, policies and procedures.  The Corporate Compliance Program attachment would appear to set forth DOJ’s current FCPA “best practices” guidelines and can provide valuable guidance for any company in assessing their current FCPA policies and procedures.

In the Corporate Compliance Program attachment DOJ indicates that, at a minimum, companies should include the following elements as part of it controls and procedures:

• Promulgation of clearly articulated and visible policies against violations of the FCPA.
• Strong, explicit and visible senior corporate support of such policies.
• Implementation of compliance standards and procedures designed to reduce the prospect of FCPA violations, including polices governing:
  • Gifts;
  • Hospitality, entertainment, and expenses;
  • Customer travel;
  • Political contributions;
  • Charitable donations and sponsorships;
  • Facilitation payments;
  • Solicitation and extortion.
• The assignment of responsibility for the implementation and oversight of such policies, standards and procedures to “one or more senior corporate executives.”
• Annual review and appropriate updates to the program.
• Ensure a system of financial and accounting procedures to maintain accurate books and records.
• Effective internal communication and reporting mechanisms, as well as instituting appropriate disciplinary procedures.

In addition, to the extent that agents and business partners are involved, DOJ expects companies to “institute appropriate due diligence and compliance requirements pertaining to the retention and oversight of all agents and business partners.” These include “properly documented risk-based due diligence pertaining to the hiring and appropriate and regular oversight of agents and business partners,” and informing agents and business partners of the company’s commitment to abide by the prohibitions against foreign bribery, and of the company’s ethics and compliance standards.

For further information regarding the FCPA or other anticorruption matters please contact any of the Troutman Sanders LLP attorneys listed on this advisory.

On October 6, 2010, the FDIC proposed 12 C.F.R. section 380 (the “Proposed Rule”) which addresses four different provisions of the OLA: (1) treatment of claims of similarly situated creditors; (2) continuation of certain personal services agreements; (3) provability of certain contingent claims; and (4) liquidation of insurance companies and their subsidiaries.  On October 19, 2010, the FDIC published notice of the Proposed Rule containing the text of the Proposed Rule and supplementary information (Supplementary Information”) and seeking public comment (“Request for Comment”) concerning the Proposed Rule and OLA generally for purposes of future rulemaking.  The comment period on the Proposed Rule ends on November 18, 2010 while the comment period on the more general questions posed by the FDIC ends on January 17, 2011.

Treatment of Similarly Situated Creditors’ Claims

Section 210(b)(4) of the Act permits the FDIC to pay certain creditors of a receivership more than other similarly situated creditors if necessary to (1) maximize the value of the assets; (2) initiate and continue operations essential to implementation of the receivership and any bridge financial company to which assets may be transferred for future sale or disposition by the receiver; (3) maximize the present value of return from the sale or other disposition of the assets, or (4) minimize the amount of any loss on sale or other disposition.  Section 380.2 of the Proposed Rule would define certain categories of creditors who never satisfy these requirements.  These include (1) holders of “long-term senior debt”; (2) holders of subordinated debt; (3) shareholders and other equity holders; and (4) other holders of general or senior unsecured claims (unless the Board of Directors of the FDIC specifically determines that additional payment or credits are necessary and meet the requirements of the Act).  The Proposed Rule defines “long-term senior debt” as “senior debt issued by a covered financial company to bondholders or other creditors that has a term of more than 360 days.” The term excludes partially funded, revolving or other open lines of credit that are necessary to continuing operations essential to the receivership or any bridge financial company and contracts to extend credit enforced by the receiver under the Act.
 
The Supplementary Information states that extraordinary payments made under such authority are subject to clawback by the FDIC in the event the proceeds from the sale of the assets of the covered financial company are insufficient to repay any monies drawn by the FDIC from the United States Treasury during the liquidation, thereby assuring creditors of the covered financial company will be assessed before the financial industry as a whole will be under provisions of the Act.  Importantly, the Supplementary Information also provides that such payments must be considered in light of the Act’s required report to Congress, not later than 60 days after appointment of the FDIC as receiver for a covered financial company specifying the identity of any claimant treated in a manner different from other similarly situated claimants, the amount of any payments and the reason for such action.  It suggests that this information will allow other creditors to file a claim asserting challenges to such payment.

Personal Service Agreements

Section 380.3 defines “personal service agreement” as a written agreement between an employee and a covered financial company, covered subsidiary or a bridge financial company setting forth the terms of employment, including a collective bargaining agreement.  Before repudiation of such an agreement, the FDIC as receiver may utilize the services of employees who have a personal service agreement and any payments would be treated as an administrative expense of the receiver.  Any party that acquires a covered financial company or any operational unit, subsidiary or assets thereof from the FDIC as receiver or from any bridge financial company will not be bound by a personal service agreement unless the acquiring party expressly assumes the personal service agreement. The provision for payment of employees would not apply to senior management participating in major policy making functions of the covered financial company. The Proposed Rule defines the term “senior executive” as a person who has authority to participate (other than in the capacity as a director) in major policymaking functions including certain high ranking officers enumerated therein unless the person is excluded by resolution of the board of directors, bylaws, operating agreement or partnership agreement of the company from participation (other than as a director) in major policy making functions of such company.  The acceptance of services subject to a personal service agreement by the FDIC or any bridge financial company would not limit or impair the ability of the receiver to later disaffirm such agreement nor to recover compensation from any senior executive or director of a failed financial company.

Contingent Claims

The Act has provisions concerning allowance of contingent claims.  For clarification, section 380.4 of the Proposed Rule provides that claims based on contingent obligations of the covered financial company consisting of a guarantee, letter of credit, loan commitment, or similar credit obligation, may be provable against the FDIC if such contingent obligation becomes due and payable upon the occurrence of a specified future event (other than the mere passage of time) which event (1) is not under the control of either the covered financial company or the party to whom the obligation is owed and (2) has not occurred as of the date of the appointment of the FDIC as receiver.  If the receiver repudiates a guarantee, letter of credit, loan commitment, or similar credit obligation that is contingent as of the date of the receiver’s appointment, the actual direct compensatory damages for repudiation would be no less than the estimated value of the claim as of the date that the FDIC was appointed receiver of the covered financial company based upon the likelihood that such contingent claim would become fixed and the probable magnitude of such claim. There is no standard set for determining the likelihood that a contingent claim will become fixed or the probable magnitude of the claim.

Liquidation of Covered Financial Companies that are Insurance Company Subsidiaries; Lien Limitation

Proposed Rule section 380.5 provides that the FDIC shall distribute the value realized from the liquidation, transfer, sale or other disposition of the direct or indirect subsidiaries of an insurance company, that are not themselves insurance companies, solely in accordance with the order of priority in section 210(b)(1) of the Act.  Although the Proposed Rule does not so state, it appears to be predicated on the assumption that not only is the subsidiary not an insurance company but also that the subsidiary is a covered financial company subject to section 210(b)(1).  The Supplementary Information indicates that the purpose of section 380.5 of the Proposed Rule is to clarify that such value will be available to the policyholders of the parent insurance company to the extent required by the applicable State laws and regulations.  However, under Section 210(b)(1) obligations to shareholders have the lowest priority.  Therefore, the language of section 380.5 of the Proposed Rule appears to be inconsistent with the purpose stated in the Supplementary Information.

Section 380.6 limits liens by the FDIC on assets of covered financial companies that are insurance companies or covered subsidiaries of insurance companies.

The foregoing is only a summary of certain of the many significant issues affecting financial institutions.  If you have any questions about the foregoing or about other financial institution issues, please direct them to your regular contact at Troutman Sanders LLP or to any of the persons listed in the sidebar to this release.

CONTACT

Hollace T. Cohen
Deputy Practice Group Leader (Bankruptcy)
212.704.6067

Jake Lutz
Practice Group Leader
(Financial Institutions)
804.697.1490

Section 922 of the Dodd-Frank Act establishes a new whistleblower program (the Program) for individuals that provide information to the Securities and Exchange Commission (the SEC) about securities law violations.  If a whistleblower provides original information(1) to the SEC and this information leads to a successful SEC enforcement proceeding, the Program may award to the individual providing the information between 10 percent and 30 percent of any sanction imposed over $1 million.  The Program also protects whistleblowers against retaliation by an employer because of providing information to the SEC under the Program, participating in any investigation or enforcement activity initiated by the SEC based upon the information provided, or making public disclosures that are otherwise provided by federal securities laws. 

Although the SEC must issue final regulations by April 17, 2011 to fully implement certain aspects of the Program, the whistleblower protections against retaliation, the accompanying private right of action and eligibility for whistleblower awards began immediately upon enactment of the Dodd-Frank Act.  As compared to the whistleblower provisions of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley), the Program provides greater remedies and longer filing periods than Sarbanes-Oxley, without requiring (as Sarbanes-Oxley does) that the whistleblower exhaust available administrative remedies with the Department of Labor before filing an action in federal district court to enforce the Program’s anti-retaliation protections.

Section 922 of the Dodd-Frank Act also amends the whistleblower provisions of Sarbanes-Oxley to extend the time in which whistleblowers must file claims with the Department of Labor to 180 days, and to begin this time at the later of the date on which the violation occurs or the date on which the whistleblower became aware of the securities law violation.  Also as a result of the Dodd-Frank Act, whistleblowers claiming protection under Sarbanes-Oxley are now entitled to a jury trial and companies cannot avoid litigation of Sarbanes-Oxley retaliation claims through arbitration agreements or settlement and release agreements to be signed by the whistleblower that waive anti-retaliation rights provided by Sarbanes-Oxley.

Employees of companies that provide consumer financial products or services will receive additional whistleblower protections, commencing when the Consumer Financial Protection Bureau (CFPB) receives its authority over federal consumer financial laws on July 21, 2011.  Section 1057 of the Dodd-Frank Act protects these employees from retaliation because of providing information to the CFPB or other government agency about violations of the Dodd-Frank Act’s consumer protection provisions or other law or regulation enforced by the CFPB, testifying in a proceeding or filing an action under any federal consumer financial law, or refusing to participate in an activity the employee reasonably believes violates any law subject to the CFPB’s jurisdiction.  Similar to the revised Sarbanes-Oxley provisions, companies generally cannot avoid litigation of Section 1057 retaliation claims by using pre-dispute arbitration agreements or settlement and release agreements signed by the whistleblower that waive anti-retaliation rights provided by Section 1057.

In light of these significant increases in whistleblower protections and reporting incentives, publicly-traded companies and companies that provide consumer financial products and services should: (1) ensure that proper reporting mechanisms and anti-retaliation policies are implemented, (2) consider strategies to encourage internal reporting of concerns regarding compliance with securities and consumer financial protection laws, (3) review and revise management and board of directors training programs to include information on recognizing corporate whistleblower complaints, and (4) implement policies for processing and responding to any such complaints received by company management or the board.

The foregoing is only a summary of certain of the many significant issues affecting financial institutions.  If you have any questions about the foregoing or about other financial institution issues, please direct them to your regular contact at Troutman Sanders LLP or to any of the persons listed in the sidebar to this release.

In June 2010 the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corporation (together, the Regulatory Agencies) issued guidance on sound incentive compensation policies for banking organizations.  This guidance states that compensation arrangements at banking organizations should provide employees incentives that appropriately balance risk and reward (so as to not encourage imprudent risk-taking), be compatible with effective controls and risk-management, and be supported by strong corporate governance, including active and effective oversight of incentive compensation arrangements by the board of directors(1). The Regulatory Agencies expect banking organizations to take prompt action to address the principles set forth in its guidance.  They may take enforcement action against any banking organization with relevant arrangements that are not compliant with the guidance.

Banking organizations that are publicly traded (or their publicly-traded holding companies, as applicable) also must increase executive compensation disclosures in proxy statements and annual reports once the disclosure requirements contained in the Dodd-Frank Wall Street Reform and Customer Protection Act (the Dodd-Frank Act) are effective.  In late 2010, the Securities and Exchange Commission (the SEC) plans to propose rules giving shareholders an advisory vote on executive compensation and so-called golden parachutes.  In mid-2011, the SEC plans to propose rules requiring disclosure of the relationship between the executive compensation actually paid and the company’s financial performance, and the ratio of CEO compensation to median employee compensation.

Organizations that focus on corporate governance continue to issue updates to their proxy voting policies, which become more and more influential and must be considered when evaluating compensation practices.  Public companies will need to adopt policies that will recapture certain incentive compensation paid to employees.  Banking organizations will need to evaluate their relationships with compensation consultants for potential independence and conflict issues.  Even pension funding relief, as enacted under the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act, will be affected by the amount of compensation paid to employees.

Another potential area of regulatory focus is compliance with Internal Revenue Code (Code) Section 409A, which governs all types of nonqualified deferred compensation.  By December 31, 2008, banking organizations should have reviewed and amended, if needed, all nonqualified deferred compensation arrangements (including all deferred compensation plans, employment agreements, severance and change in control agreements, equity compensation plans and similar types of arrangements) to ensure either compliance with Code Section 409A or an exemption from Code Section 409A.  For those who missed the deadline, the IRS has established a correction program for arrangements that do not satisfy the document requirements of Code Section 409A.  One of the most favorable provisions of the correction program is the ability to correct document failures by December 31, 2010 and avoid the unfavorable tax consequences that typically apply upon noncompliance with Code Section 409A.

In light of these developments, we recommend that banking organizations review their executive compensation agreements and incentive compensation plans and policies as well as their corporate governance and SEC compliance procedures during the 4th quarter of 2010.  Such a review will prepare the banking organization for upcoming regulatory examinations, will identify compensation issues for action by the bank or the bank’s board of directors, and will better position the bank or bank holding company to respond to the shareholder vote on executive compensation requirement, the executive compensation disclosure requirements, and any other requirements contained in the Dodd-Frank Act.  Moreover, this is one last chance to correct Code Section 409A problems at relatively little cost.

We will continue to monitor how the Regulatory Agencies incorporate reviews of  executive and incentive compensation into bank regulatory examinations, and how the SEC implements the Dodd-Frank Act’s executive compensation disclosure requirements.  We will provide our friends and clients with future updates regarding these important and timely issues.

The foregoing is only a summary of certain of the many significant issues affecting financial institutions.  If you have any questions about the foregoing or about other financial institution issues, please direct them to your regular contact at Troutman Sanders LLP or to any of the persons listed in the sidebar to this release.

Under the SBLF the United States Treasury (the Treasury) will make capital investments by purchasing securities in participating community banks, most likely in the form of senior preferred stock.  The SBLF limits investment by the Treasury to 5 percent of risk-weighted assets for participating banks with total assets of $1 billion or less, and to 3 percent of risk-weighted assets for participating banks with more than $1 billion but less than $10 billion of total assets.  Community banks with a 4 or 5 CAMELS rating (or have had such a rating in the past 90 days) may not participate in the SBLF.  Although the dividend rate of SBLF securities would initially be set at 5 percent, the participating community bank could decrease the dividend rate by increasing its small business lending; as a general example, to decrease the dividend rate to 1%, small business lending must increase by 10% or more.  However, four and a half years after issuance, the dividend rate on SBLF securities will increase to 7 percent regardless of the level of small business lending.

The Treasury will review applications to participate in the SBLF and will consult with each applicant’s federal and state regulators, as applicable, before deciding whether to award SBLF funds. The SBLF does not limit the Treasury’s discretion to deny an application for SBLF funds.  The SBLF also authorizes the Treasury and federal banking regulators to consider making an SBLF investment in an otherwise eligible community bank conditioned on private matching investments.  In circumstances where private matching investment is required, then Treasury may only invest up to 3% of risk-weighted assets of the community bank.  When applying to participate in the SBLF a community bank must submit a plan describing how its business strategy allows it to address the needs of small businesses in its market area. This small business lending plan will be considered confidential supervisory information and will not be publicly available. Under the SBLF, “small business lending” is broadly defined to generally include all loans of less than $10 million to small businesses other than acquisition, development and construction loans.     

The SBLF instructs the Treasury to issue regulations to permit eligible community banks to refinance preferred stock issued to the Treasury pursuant to the TARP program.  Although such participation in the SBLF would not provide additional capital, a community bank refinancing in this manner could reduce the cost of capital issued to the Treasury and possibly eliminate TARP executive compensation restrictions.

The SBLF is not part of TARP and does not currently contain TARP-like executive compensation restrictions; however, the SBLF authorizes the Treasury to issue additional regulations regarding participation in the program in order to “manage risks associated with the administration of the [SBLF].”  This provision gives the Treasury authority, if it desires, to implement regulations for SBLF participants similar to those imposed upon TARP participants.  The SBLF also instructs the federal banking agencies to issue regulations regarding minimum underwriting standards for loans made by participating community banks.

The foregoing is only a summary of one of the many significant issues affecting financial institutions.  If you have any questions about the foregoing or about other financial institution issues, please direct them to your regular contact at Troutman Sanders LLP or to any of the persons listed in the sidebar to this release.

CONTACT

Jake Lutz
Practice Group Leader
804.697.1490

Tom Powell
404.885.3294

Jerome Walker
212.704.6286

CONTRIBUTOR

Seth Winter
804.697.2329

To download the complete executive summary, please click here.

Troutman Sanders Energy Practice Group has long been a leader in the industry and has a wealth of experience in regulatory changes. Please call us if you need any assistance regarding these developments.

Please join us for a webinar to discuss the new financial regulations and how they may affect your business.

ABOUT THIS EVENT
This program covers portions of the Act of interest to a wide range of banks and other financial companies, including Regulatory Restructuring and Reforms, Orderly Liquidation Authority, Mortgage Lending Reforms and Consumer Financial Protection, Corporate Governance and Executive Compensation Reforms, and Derivatives and Related Securities Matters.                                              

AGENDA/PRESENTERS

Welcome (Jake Lutz)

Banking and Financial Companies (Jake Lutz, Jerome Walker, Tom Powell and Hollace Cohen)

Click here for Hollace Cohen’s presentation slides.
Click here for Jake Lutz’s presentation slides.
Click here for Tom Powell’s presentation slides.

• Regulatory Restructuring
• FDIC Orderly Liquidation Authority
• Capital Requirements
• Deposit Insurance Reform

Mortgage Lending Reform (Fred Palmore)
Click here for presentation slides.

• Residential loan origination standards
• Mortgage servicing and escrow accounts
• Real estate appraisal requirements
• Regulatory authority of Bureau of Consumer Financial Protection and Federal Reserve

Consumer Protection (William Hurd, Ashley Taylor and Fred Palmore)

• Creation and Authority of Bureau of Consumer Financial Protection
• Relationship of the Dodd-Frank Act’s consumer financial protections to state consumer financial protection law
• Act’s new preemption provisions will make national bank preemption of state consumer laws more difficult giving State Attorneys General greater authority to enforce state consumer protection laws against national banks.
• Act confers authority to State Attorneys General and to State Regulators to enforce the Act and its regulations against state chartered entities and national banks.  

Corporate Governance and Executive Compensation (Dave Meyers and Susan Ancarrow)
Click here for presentation slides.

• Corporate Governance reforms: proxy access, broker discretionary voting, and proxy disclosures regarding governance structure and employee and director hedging
• Executive Compensation reforms: say-on-pay, golden parachutes, compensation committee independence, clawback policies and proxy disclosures
• Implementation timelines
• SEC management improvements

Over-the-Counter Derivatives (John Leonti)
Click here for presentation slides.

• Review of Title VII and how it intends to increase the transparency and reduce the perceived systematic risk of the over-the-counter derivatives market with the introduction of central clearing, exchange trading and data repositories
• Overview of the CFTC’s and the SEC’s regulation of swaps and security-based swaps, as well as market participants

Q&A and Closing Remarks (Jake Lutz)

CLE Approval Pending. To apply for CLE credit, contact events@troutmansanders.com.

Regulation D is a safe harbor from the registration requirements under the federal Securities Act of 1933.  And since 1996, federal law has made it clear that private placements under Rule 506 of Regulation D are also exempt from regulation under state blue sky laws.  By complying with the relatively simple requirements of Rule 506, an issuer may sell securities to up to 35 non-accredited investors and an unlimited number of accredited investors.  Corporations, limited partnerships and other entities, as well as trusts and natural persons, may qualify as accredited investors.  Before the change effected by the financial reform bill, the definition of “accredited investor” applicable to a natural person required that he or she:

• has, at the time of purchase, net worth, either alone or jointly with his or her spouse, of more than $1,000,000, or

• had, in each of the two most recent years, income of more than $200,000 alone or more than $300,000 jointly with his or her spouse, and a reasonable expectation of reaching the same income level in the current year.

The accredited investor test is considered by the SEC as a way to determine if a person is likely to have the ability to bear the economic risk from an investment in a private investment vehicle.  The definition of a natural person “accredited investor” had been unchanged since its adoption by the Securities and Exchange Commission in 1982.  Since then, rising home values and higher salary levels caused a significant increase in the number of individuals qualifying as accredited investors.

Three provisions of the financial reform bill, set forth in section 413, have significant consequences for the accredited investor test for natural persons:

• The SEC is directed to adjust the standard for determining the net worth of a natural person by excluding the value of the person’s primary residence.
• The SEC may review the accredited investor definition as it applies to natural persons to determine if any adjustments are appropriate “for the protection of investors, in the public interest, and in light of the economy.”  No adjustment to the net worth test would be made, however, for four years, other than the exclusion of primary residence value. 

• The SEC is directed to review the entire accredited investor definition, as it applies to natural persons, not earlier than four years after enactment and at least once every four years thereafter.  In these reviews, the SEC would apply the same criteria, namely, to consider whether changes are appropriate “for the protection of investors, in the public interest, and in light of the economy.”

Because section 413 directs the SEC to revise the natural person accredited investor definition, we expect that the SEC will act quickly to comply with the statue. The exclusion of the value of a primary residence from the net worth test will reduce the number of natural persons eligible to invest in private placements as accredited investors. It is unclear at this time what the SEC’s intention will be in any review of the accredited investor definition.

*   *   *

In addition to the change in the accredited investor test, the financial reform bill, in section 926, requires the SEC to issue rules for the disqualification of Rule 506 offerings by companies involving individuals who are subject to “bad boy” orders barring them from certain financial or securities activities or who have been “convicted of any felony or misdemeanor in connection with the purchase or sale of any security or involving the making of any false filing with the [SEC].”  These new rules are required to be issued within one year of enactment of the bill and are to be substantially similar to the disqualification provisions under Rule 262 of Regulation A.  It is unclear what level of involvement by these “bad actors” will disqualify an offering; clarification of this question will await the final SEC rules.

*   *   *

We will provide updates on significant future developments in these areas.

CONTACT:

Timothy I. Kahler
212.704.6169

Thomas M. Rose
757.687.7715

According to the Panel, $1.4 trillion in commercial real estate loans will mature between 2010 and 2014. Due to market decreases in commercial property values borrowers currently owe more than their property is worth on nearly half of these commercial real estate loans. The Panel noted that the impact of this decrease in value is particularly troubling with respect to small and midsize banks, which are expected to bear an estimated $200 to $300 billion in losses.

The Panel recognized that proactive steps in regulatory enforcement, accounting practices, capital enhancement and removal of risky assets from bank balance sheets should be coordinated to lessen the potential impact that the commercial real estate crisis might have on local communities, small businesses and individuals.  The Panel noted that one potential means to address this issue is to speed the availability of TARP funds to these small and mid-size financial institutions or to legislatively make other sources of funds available to such entities. Whether such action would be approved by Congress, however, is unclear. The text of the report is at http://cop.senate.gov/reports/library/report-021110-cop.cfm.

Troutman Sanders partner Mark Elliott provided testimony at the Atlanta Field Hearings on Commercial Real Estate on January 27, 2010, and our firm regularly represents commercial lenders and financial institutions involving TARP and commercial real estate issues.

CONTACT

John C. Lynch
Financial Services Litigation Team Leader
757.687.7765

David N. Anthony
Financial Services Litigation Team Leader
804.697.5410

Jake Lutz
Financial Institutions Group Leader
804.697.1490