Eyes On Wall Street : Executive Compensation Lawyers & Attorneys : Labaton Sucharow Law Firm : Class Action Litigation, Shareholder Rights

Investors hoping for strict enforcement of the new Volcker Rule guarding against risky proprietary investing by big banks shouldn't hold their breath.

The Volcker Rule, part of the Dodd Frank reforms inspired by the financial crisis, restricts U .S. banks from making certain kinds of speculative investments that do not benefit their customers. The rule's provisions are scheduled to be implemented on July 21, 2012.

However, Wall Street interests are fighting to weaken the proposed rule through intense lobbying efforts, vastly outgunning investors and their advocates.

A new Duke University study by Professor Kimberly D. Krawiec,based on agency records, determined that 94 percent of meetings between regulators and private interests regarding the Volcker Rule were arranged by financial institutions and their law firms -- while only six percent of such meetings involved public interest groups and unions. The intensity of industry lobbying should make investors everywhere feel nervous about the final product of the rulemaking process.

Contributed by Jodian Davis

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Today the EU unveiled the most sweeping reforms to date of the troubled credit rating industry. The proposed rules, which will require the approval of the European Parliament and EU member states, represent some significant progress in ongoing efforts to improve ratings. 

The reform proposal includes “mandatory rotation provisions” which would force issuers of financial products in Europe to rotate the credit rating agencies they use at least every three years. In addition, the proposal also contains a “cooling off” provision which would compel issuers to wait four years before hiring the same agency. The purpose of these provisions is to increase competition and reduce conflicts of interest. 

While US regulators have been reluctant to intervene in rating methodologies, the reform proposals would give ESMA, the European market regulator, the power to develop technical standards and approve specific rating methods. New rating methodologies, or adjustments to existing models, would have to be open to consultation and submitted to ESMA for approval.

Crucially, the proposed rules include a method for private enforcement, in that they would allow investors to sue credit rating agencies for compensation if they break EU regulations "intentionally or with gross negligence.”

Regulators apparently have dropped one of the most controversial proposed rules, which would have permitted ESMA to ban agencies from rating sovereign debt issued by countries in the process of being bailed out—an edict that would have further undermined the confidence of investors in sovereign debt.

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Regulators in the United States and abroad have embarked on an effort to crack down on market abuses involving computerized high-frequency trading. High-frequency trading was found responsible for the “flash crash” of May 6, 2010, and regulators suspect that it is contributing to the recent volatility observed in the markets.

High-frequency trading has become very popular, especially among large trading firms, since regulatory reforms encouraged exchanges to shift from floor-based trading to electronics several years ago. This practice now accounts for two-thirds of all trading volume on U.S. exchanges.

Critics warn that high-frequency traders fundamentally undermine the fairness of the financial system, because they make large profits at the expense of retail investors who have no access to such high-frequency trading technology. Long-term investors such as pension funds also complain that some traders may be using high-frequency trading technology to detect large buy or sell orders, and, by trading a fraction of a second ahead of large trades, take advantage of price moves. This concern is driving some large investors to move to venues away from public exchange, called dark-pools.

Domestic and overseas regulators are weighing several ideas for cracking down on manipulation by high-frequency traders. In the U.S., the Securities Exchange Commission approved a “large trader” rule in July that requires high-frequency traders to offer additional information about their activities. Some regulators have called for compulsory registration of high-frequency firms and pre-trade testing of their algorithms. The SEC has also proposed a powerful monitoring system called a consolidated audit trail that would gather data on trades in real time from all U.S. exchanges.

Institutional and retail investors concerned about market volatility should keep a close eye on regulators’ attempt to keep one step ahead in this technological arms race.

Contributed by Yoko Goto

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A new move by the legislature threatens to increase risk in already dangerously volatile markets.

Section 404(b) of the Sarbanes-Oxley Act sets out detailed internal control reporting requirements intended to better educate investors about the reliability of reported financial results. These protections were weakened by the Dodd-Frank Wall Street Reform and Consumer Protection Act, which created an exemption to this rule for companies with less than $75 million in market capitalization.

A newly introduced bill, “The Startup Expansion and Investment Act” would further erode this check on the reliability of financial filings.  

Under the proposed Act, new companies with market capitalizations of up to $1 billion would be allowed to opt out of the requirement under Section 404(b) for the first 10 years after going public – so long as they disclose this opt-out in their annual reports.

In an SEC study released last April, the Commission concluded that, while extending exemptions might result in some decrease in compliance costs for companies, such savings could not “justify the loss of investor protections and benefits to issuers.” 

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On August 4, 2011, the New York Stock Exchange LLC (“NYSE”) and NYSE Amex proposed more stringent rules governing reverse merger companies – companies that became public without having to meet the strict rules covering IPOs. The proposed rules contain a series of “seasoning” requirements that would effectively delay exchange listings for reverse merger companies.

Under the proposed standards that the NYSE submitted to the SEC, reverse merger companies would have to trade for at least a year in the U.S. over-the-counter market, or on another U.S. exchange or a regulated foreign exchange before obtaining an NYSE listing. They would also be required to maintain a minimum $4 stock price for a “sustained” period, and would have to file audited financial statements and an annual report with the SEC. In addition, the NYSE would have the discretion to impose tougher requirements on a particular reverse merger company if the exchange deems warranted.

The NYSE’s move followed an SEC warning to investors about the risks associated with reverse merger companies. 

Contributed by Yoko Goto

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On June 9, the U.S. Securities and Exchange Commission issued a bulletin warning investors about companies that enter U.S. markets through so-called “reverse mergers”—and explaining how they can be detected.

In a reverse merger, a private company merges with an existing public shell company to become listed on a U.S. exchange and gain access to capital markets—a process that avoids the regulatory scrutiny given to IPOs.

The bulletin points out that the lack of transparency in reverse merger companies poses grave risks to investors.  However, it can be very difficult to determine whether a public company has undergone this process.

To assist investors, the SEC identifies risk factor disclosures in SEC filings that may serve as red flags signaling a reverse merger.  For example, the SEC urges that investors look out for words or phrases such as “lack of public company experience,” “lack of history of compliance with U.S. securities laws and accounting rules,” “inability to comply with federal securities laws” or “inability to attract the attention of major brokerage firms.”   

The risks involved in reverse mergers are more than theoretical.  The SEC and U.S. exchanges have recently cracked down on many companies that became public through this process.  Trading in more than a dozen such companies has been suspended due to a lack of current, accurate information about these firms and their finances.  In addition, several reverse merger companies have recently seen their securities registrations revoked because of failures to make required periodic filings.

Submitted by Yoko Goto

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In the wake of the mortgage meltdown of 2007-2008, regulators have sought to substantially stiffen lending requirements for lower-income homeowners. This regulatory activity, spurred by the suggestion that overly generous lending to consumers with little ability to pay played a key role in the credit crisis, may make have the unintended consequence of discouraging some well-qualified minority applicants from entering the housing market.

 This potential downside to overly-stringent new rules has resulted in an unusual alliance.

Mortgage lenders and some non-profit organizations, including the N.A.A.C.P. and La Raza, are cooperating in an effort to protect working class and minority communities from stricter regulations on mortgage packaging that may ultimately discourage some applicants from minority groups from obtaining home loans. Among their targets: a proposal that would exempt mortgage packagers from bearing part of the risk in the loans they package if loan recipients provided a 20 percent down payment. 

Submitted by Melanie Boyce

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Maybe not, at least according to a new white paper released by the Council of Institutional Investors. 

The furor relates to the SEC’s proposal that Generally Accepted Accounting Principles (“GAAP”) issued by the U.S. Financial Accounting Standards Board be replaced with International Financial Reporting Standards (“IFRS”) issued by the International Accounting Standards Board—a process called convergence. 

In a paper titled “Criteria for an Independent Accounting Standard Setter,” Professor Donna L. Street of the University of Dayton expresses concern that the international standards suffer from   “significant pressures from governmental officials and bodies, particularly those representing the European Union.” In addition, she notes that the IASB has historically subsisted on voluntary contributions—raising serious questions about the its independence. The white paper further points out that only five of the present 20 seats on the IFRS Foundation are held by individuals from the investor community.

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For years, questions have been raised about whether purely advisory “say on pay” initiatives have any teeth. Those doubts are being put to rest in this proxy season, as new say on pay measures are subjecting executive compensation packages to an unprecedented level of scrutiny. This activity will only increase with the roll-out of sweeping new requirements for shareholder votes on executive compensation set out in Section 951 of the Dodd Frank legislation. 

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