June 25, 2022

Volume XII, Number 176


June 24, 2022

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June 23, 2022

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Cadwalader Cabinet: Past Time for Pens Down

SEC Proposes to Expand Beneficial Ownership Reporting

The SEC proposed amendments to rules governing beneficial ownership reporting under SEA Sections 13(d) ("Reports by Persons Acquiring More Than Five per Centum of Certain Classes of Securities") and 13(g) ("Statement of Equity Security Ownership").

The proposed amendments would (i) accelerate filing deadlines for Schedules 13D and 13G beneficial ownership reports, (ii) expand the application of Regulations 13D and 13G to certain derivative securities, (iii) clarify the circumstances in which two or more persons have formed a "group" that would be subject to the beneficial ownership reporting obligations, (iv) exempt certain persons from being subject to regulation as a "group" and (v) require the filing of Schedules 13D and 13G to be done through a "structured, machine-readable data language."

The SEC stated that the proposed rules "would improve transparency and provide more timely information for shareholders and the market."

Proposed Amendments

The SEC proposed amendments include, among other things:

  • New Schedule 13D and 13G Filing Deadlines:

    • Amend Rule 13d-1(a) requiring the filing of Schedule 13D within five days after the acquisition date.

    • Amend Rules 13d-1(b) and (d) requiring Qualified Institutional Investors ("QIIs") and Initial Exempt Investors to file the initial Schedule 13G within five business days after the end of the month in which beneficial ownership exceeds 5% of a covered class.

    • Amend the filing deadline to five days under Rule 13d-1(c) after the date when the person is obligated to file an initial Schedule 13G.

    • Amend Rule 13d-2(c) to require that QIIs file an amendment to their Schedule 13G within five days after the date on which their beneficial ownership exceeds 10% of a covered class, rather than the current requirement of 10 days after the end of the month.

  • Regulation of Certain Derivative Securities:

    • Amend Rule 13d-3 to incorporate a new proposed rule 13d-3(e)(1) to provide that a holder of cash-settled derivative securities, other than security-based swaps, will be deemed a beneficial owner of equity securities in a covered class referenced by the derivative security if such person holds the derivative security with the purpose of influencing the issuer's control of the given class of equity securities.

  • Clarification of Group Formation and Related Exemptions:

    • The proposals seems to expand the definition of group very substantially by providing that if one person discloses to another person that the firm will make a Schedule 13D filing and those does so, those two persons are deemed to have formed a group, even in the absence of an agreement to act in concert. A limited exception is provided in the case of transactions between an investor and a financial institution entering into an agreement as to a derivative security.

  • Structured Data Requirements for Schedules 13D and 13G:

    • Require that all disclosures except for exhibits to the Schedules be filed using XML-based language. Disclosures that fall under this requirement include "quantitative disclosures, textual narratives, and identification checkboxes."

Comments on the proposed amendments will remain open for 60 days following publication of the proposing release on the SEC's website on April 11, 2022, or for 30 days following publication of the proposing release in the Federal Register - whichever is later.

Commissioner Statements

SEC Chair Gary Gensler supported the proposal, saying that it would "reduce information asymmetries and promote transparency, thereby lowering risk and illiquidity." He noted the "rapidity of current markets and technologies" as a reason for updating those old rules.

SEC Commissioner Hester M. Peirce dissented. She stated that the proposal does not adequately contend with market realities today or "the balance embodied in Section 13(d) of the Exchange Act." She questioned the justification of technological advancements as a reason to shorten the timeframe by noting that the initial reasons for Congress's enactment of Section 13(d) was for the purposes of balancing the need for shareholders to know of changes in control against the benefit of allowing the party seeking to engage in changes of control to keep that information private. She also stated that the SEC "paints the [investor] as a victim" and that disparities in information "make markets function." She argued the importance of encouraging investors to seek out information to find undervalued companies, noting that information asymmetries are a feature of U.S. capital markets. Further, she contended that there is not sufficient justification for expanding the definition of beneficial ownership to cover certain cash-settled derivative transactions, given that such securities "convey" neither "ownership" nor "voting rights."

Commentary by Steven Lofchie

SEC Chair Gensler is overwhelming market participants with a flood of major rule proposals. There is simply no way that market participants are able to assess so many major proposals in such a short time period.

This particular proposal raises numerous regulatory, operational and even statutory questions.  For example, the very expanded definition of "group" effectively expands the scope of Section 13(d) under the Securities Exchange Act well beyond any ordinary understanding of the statute.  

FINRA's 2022 Report on Exam and Risk Monitoring Program Adds Five Topic Areas

In its annual Examination and Risk Monitoring Program Report, FINRA covered twenty-one different topics related to a firm's core compliance responsibilities. FINRA added five new topics since last year's report. The new topic areas include:

  • Firm Short Positions and Fails-to-Receive in Municipal Securities;

  • Trusted Contact Persons;

  • Funding Portals and Crowdfunding Offerings;

  • Disclosure of Routing Information; and

  • Portfolio Margin and Intraday Trading.

For covered topics, the Report (i) identifies the relevant rules, key considerations for member firms' compliance programs, and noteworthy findings from recent examinations, and (ii) outlines effective practices that FINRA observed during its oversight while providing resources that the member firms may find helpful when reviewing their procedures and fulfilling their compliance obligations. Some of the areas of focus highlighted in the Report were:

  • "FINRA's initial findings from Reg BI and Form CRS reviews;

  • firms' compliance with certain regulatory obligations related to:

    • the Consolidated Audit Trail,

    • best execution and

    • Rule 606 of Regulation NMS;

  • problems with some mobile apps' communications with customers and firms' supervision of activity on those apps, particularly controls around account openings;

  • firms' compliance with their regulatory obligations with securities activities involving Special Purpose Acquisition Companies;

  • the increasing number and sophistication of cybersecurity threats faced by firms and their customers; and

  • firms' communications and disclosures made to customers regarding complex products."

FINRA stated that the Report is intended to be an up-to-date, evolving resource or library of information for firms.

SEC Proposes Amendments to Whistleblower Rules

The SEC proposed two amendments to the rules governing the agency's whistleblower program.

The first proposed amendment would revise SEA Rule 21F-3(b)(3) (regarding potential recovery under other whistleblower award programs in related actions) to allow the awarding of claims in related actions that otherwise would be covered by an alternative whistleblower program. The second proposed amendment would revise SEA Rule 21F-6 ("Criteria for Determining Amount of Award") by affirming the Commission's authority to consider the dollar amount of a potential award for the purpose of increasing an award but not lowering an award.

SEC Chair Gensler supported the amendments, stating that "[w]histleblowers provide a critical public service and duty to our nation, taking personal and professional risks in doing so. Since the program's inception, enforcement matters brought using information from whistleblowers have resulted in more than $1.3 billion that has been (or is scheduled to be) returned to harmed investors."

SEC Commissioner Hester M. Peirce opposed the amendments, stating that "[a]bandoning recently adopted rules simply because they have been challenged in court both thwarts our rule-making process and risks the perception that our duly adopted rules are provisional, subject to further revision if one really, really objects."

OFAC Issues Final Rule to Remove Burundi Sanctions

OFAC issued a final rule removing the Burundi Sanctions Regulations from the Code of Federal Regulations. The rule will take effect upon its publication in the Federal Register on February 11, 2022.

As previously covered, this action follows from the termination of Executive Order 13712 ("Blocking Property of Certain Persons Contributing to the Situation in Burundi") on November 18, 2021. That termination resulted in (i) the removal of all individuals on OFAC's Specially Designated National and Blocked Persons List solely due to the Burundi Sanctions Regulations, and (ii) the unblocking of all property and interests blocked solely pursuant to the Burundi Sanctions Regulations.

CAT Offers "Roadmap" for CAIS Reporting Obligations for Small Firms

The Consolidated Audit Trail ("CAT") provided a roadmap to assist "Small Industry Members" in meeting their Customer and Account Information System ("CAIS") reporting obligations. All Industry Members (Large and Small) must report Customer and Account information to CAT CAIS for all Active Accounts by July 11, 2022.

To comply, a broker-dealer must:

  • report equities, options and/or multi-leg transaction events containing the field firmDesignatedID to the CAT transaction system;

  • submit a CAT CAIS Registration Form;

  • grant CAT CAIS Test Environment Entitlement to personnel within the firm;

  • report CAT CAIS data through a CAT Reporting Agent or through self-reporting;

  • establish a CAT CAIS Reporting Relationship with a CAT Reporting Agent; and

  • certify for full CAIS production no later than June 20, 2022.

District Court Finds Portfolio Manager Liable for Misstatements on Risk Management Practices

The United States District Court for the Western District of Wisconsin granted partial summary judgment, on the SEC's request, against a portfolio manager who allegedly lied to investors as to the manager's risk management practices.

The Court found that (i) the former mutual fund portfolio manager falsely told investors that he used a modeling software daily to evaluate financial risks, and (ii) the portfolio manager's claims were material because risk management was a determinative factor for potential investors.

The Court held that the portfolio manager's conduct violated Securities Act Sections 17(a)(2) ("Recordkeeping Requirements Relating to Stabilizing Activities") and 17(a)(3) ("Records to Be Made by Certain Exchange Members, Brokers and Dealers"), as well as Advisers Act Rule 206(4)-8 ("Pooled Investment Vehicles").

Primary Sources

  1. SEC Proposed Rule: Modernization of Beneficial Ownership Reporting

  2. SEC Fact Sheet: Modernization of Beneficial Ownership Reporting

  3. SEC Press Release: SEC Proposes Rule Amendments to Modernize Beneficial Ownership Reporting

  4. SEC Chair Gary Gensler's Statement of Support

  5. SEC Commissioner Hester M. Peirce's Statement of Dissent

  6. FINRA News Release: FINRA Publishes 2022 Report on Exam and Risk Monitoring Program

  7. FINRA 2022 Report on Its Examination and Risk Monitoring Program

  8. SEC Press Release: SEC Proposed Changes to Two Whistleblower Program Rules

  9. SEC Proposed Rule: The Commission's Whistleblower Program Rules

  10. SEC Fact Sheet: Proposed Changes to Whistleblower Program Rules

  11. SEC Chair Gary Gensler's Statement of Support

  12. SEC Commissioner Hester M. Peirce's Statement of Dissent

  13. Treasury: Removal of the Burundi Sanctions Regulations; Counter Narcotics Designations

  14. FINRA Small Firm Roadmap to July 11, 2022: CAT Customer and Account Information System (CAIS)

  15. SEC Litigation Release: SEC Obtains Partial Summary Judgment against Portfolio Manager for Misrepresenting Risk Management in Mutual Fund

  16. SEC Opinion and Order: Edward S. Walczak (Case 3:20-cv-00076-wmc)

© Copyright 2022 Cadwalader, Wickersham & Taft LLPNational Law Review, Volume XII, Number 42

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