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Governance & Securities Law Focus A QUARTERLY NEWSLETTER FOR CORPORATES AND FINANCIAL INSTITUTIONS
Europe Edition October 2011
In this newsletter, we provide a snapshot of the principal European and US governance and securities law developments
of interest to European corporates and financial institutions during the third quarter of 2011.
ABU DHABI | BEIJING | BRUSSELS | DÜSSELDORF | FRANKFURT | HONG KONG | LONDON | MILAN | MUNICH | NEW YORK
PALO ALTO | PARIS | ROME | SAN FRANCISCO | SÃO PAULO | SHANGHAI | SINGAPORE | TOKYO | TORONTO | WASHINGTON, DC
In This Issue ·······················································
EU DEVELOPMENTS 1 Draft Legislation Curbing Audit Firms ESMA Consultation Paper on AIFMID Implementation ESMA Report on Amended Prospectus Directive
GERMAN DEVELOPMENTS 2 BaFin Consultation under Securities Trading Act Reform of Capital Markets Model Case Proceedings Act
ITALIAN DEVELOPMENTS 3 Disclosure for Cash-Settled Derivatives
UK DEVELOPMENTS 3 ABI Report on Board Effectiveness ABI Principles of Remuneration Narrative Reporting and Executive Remuneration Revised Takeover Code Becomes Effective Amended Takeover Panel’s Practice Statements Call for Evidence for the Kay Review of UK Equity Markets DTRs: FSA Quarterly Consultation No 30 FRC’s Effective Company Stewardship Consultation Review of FRC’s Turnbull Guidance Prospectus Regulations 2011 FRC reaffirms Importance of True and Fair View Bribery Act 2010 Update FSA fines Willis Limited Civil Recovery Order against Macmillan Publishers FSA Consultation on New Financial Crime Guide Consultation on Anti-Bribery Guidance
US DEVELOPMENTS 9 SEC Developments Congressional Developments PCAOB Developments Corporate Governance Trends: Shearman & Sterling’s 9th
Annual Surveys of Selected Corporate Governance Practices Trends from the 2011 Proxy Season: ISS Reports Noteworthy US Securities Law Litigation Recent SEC/DOJ Enforcement Matters
ASIAN DEVELOPMENTS 21 Chinese Listing for Overseas Companies Use of VIE Structure in China
DEVELOPMENTS SPECIFIC TO FINANCIAL INSTITUTIONS 23 EU Developments German Developments UK Developments US Developments
EU DEVELOPMENTS
Draft Legislation Curbing Audit Firms
The European Commission, according to draft legislation
seen by Reuters on 27 September 2011, is proposing to ban
audit firms from providing consulting services to
companies they audit, or even banning them from
consulting altogether, thereby potentially forcing them to
split off their consulting businesses. The draft legislation
might also include a requirement for mandatory auditor
rotation every nine years and for “joint audits”, forcing the
big four audit firms to share auditing work with smaller
rivals. EU Internal Market Commissioner Michel Barnier
announced that the draft legislation will be published in
November.
ESMA Consultation Paper on AIFMID Implementation
On 13 July 2011, the European Securities and Markets
Association (“ESMA”) published a consultation paper
which included proposed guidelines for the European
Commission’s Level 2 implementation of the Alternative
Investment Fund Managers Directive (the “AIFMD”)
which entered into force on 21 July 2011.
The consultation paper covers the following key issues:
the threshold conditions that determine whether
managers are subject to the AIFMD, especially where
assets under management fluctuate above and below
the stated thresholds, and procedures for opting into
the AIFMD. ESMA has taken the view that for an
alternative investment fund the calculation of the
value of assets under management should include
assets acquired through leverage and should be
calculated on the basis of net asset value, with a
modification for cross-holdings;
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minimum capital requirements to cover risks of
professional liability – these requirements would be
more robust compared to similar requirements in
other sectors and could include an option of obtaining
insurance which meets certain criteria;
the operating requirements of alternative investment
fund managers, e.g., governance, conduct of business,
conflicts of interest management, delegation and
capital;
the appointment of depositaries and their
safekeeping, cash management and oversight
functions; and
annual reporting, investor disclosure, the contents of
the obligation to register with national regulators and
the establishment of information gathering
mechanisms.
The consultation does not include draft advice on the
criteria for the private placement regime for funds and
managers outside the EU.
ESMA is expected to deliver its final guidelines to the
European Commission by 16 November 2011 with the
European Commission expected to finalise and publish a
directive or regulation incorporating such guidelines in
the summer of 2012.
The consultation paper is available at:
http://www.esma.europa.eu/data/document/2011_209.p
df.
ESMA has undertaken a separate consultation on funds
and managers outside the EU and third country delegates.
The advice focuses on the use of co-operation
arrangements between the supervisory authorities of
Member States and third countries and is available at:
http://www.esma.europa.eu/popup2.php?id=7702.
ESMA Report on Amended Prospectus Directive
In our July 2011 Newsletter, we reported on the ESMA
consultation on the amended Prospectus Directive. On 4
October 2011, ESMA provided the European Commission
with its technical advice on possible delegated acts
concerning the Prospectus Directive as amended by
Directive 2010/73/EU. The report is available at:
http://www.esma.europa.eu/popup2.php?id=7983.
GERMAN DEVELOPMENTS
BaFin Consultation under Securities Trading Act
Under the Securities Trading Act, employees of
investment service firms in investment advisory, sales or
compliance functions may carry out such functions only if
they fulfil certain requirements of expertise and integrity.
The German Federal Financial Services Supervisory
Authority (“BaFin”) is now consulting on the draft bill of
an ordinance on the notification regarding employees that
specifies the details of such qualifications. It further
describes the requirements to prove such expertise and
the necessary notifications to BaFin. Following the
contemplated effectiveness of the ordinance on 1
November 2012, investment services firms must also
submit to BaFin any complaints received from private
customers related to the activities of such employees.
Reform of Capital Markets Model Case Proceedings Act
The Capital Markets Model Case Proceedings Act
(“KapMuG”), a procedural code with the aim of
coordinating civil proceedings regarding parallel claims of
investors in capital markets litigation, similar to a class
action, came into force in 2005, initially for a limited
period of time. The KapMuG allows for the
commencement of a model case proceeding, with the
ruling of the model case being binding on all the relevant
parties. On 21 July 2011, the Ministry of Justice published
a draft bill which broadens the scope of the KapMuG to
cover investment intermediaries and advisers. Moreover,
the draft bill modifies the prerequisites for the
commencement and the expansion of the model case and
certain cost provisions. The new rules will simplify the
settlement of the model case. Systematically, the KapMuG
will remain an independent code and will not be
integrated into the German Code of Civil Procedure (ZPO).
The Act will come into force no later than 1 November
2012 without any further time limitation.
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ITALIAN DEVELOPMENTS
Disclosure for Cash-Settled Derivatives
On 9 September 2011, the Italian securities regulator,
CONSOB, introduced new rules on disclosure
requirements applicable to cash-settled derivatives having
shares of an Italian listed company as underlying.
CONSOB’s regulatory amendments, consistent with the
solutions implemented at the EU level and at the national
level by the UK and French securities regulators, address
the concerns raised in recent years over the use of non-
reportable cash-settled equity derivatives as a source of
information asymmetry or as a tool to acquire influence or
creeping control over listed issuers.
Prior to the implementation of the new rules under the
Italian Securities Act, positions held through cash-settled
derivatives fell outside the scope of the Italian reporting
regime applicable to non-insiders.
Under the new reporting rules, ad hoc disclosure will be
required in the event that the “aggregate long position”
held in a listed company exceeds 10 percent, 20 percent,
30 percent or 50 percent. The aggregate long position
means the sum of any shares actually held, potential
holdings, i.e., physically-settled derivatives, and “other
long positions” held by the same person or its affiliates.
The term “other long positions” is defined to include any
instrument or contract that is positively linked to the
performance of the underlying shares, irrespective of any
trading platform (i.e., regulated markets or OTC), other
than physically-settled derivatives, before netting any
short positions. However, an “aggregate long position”
that exceeds the above mentioned thresholds is reportable
only if it comprises aggregate “other long positions”
exceeding 2 percent of the share capital of the issuer.
The new disclosure regime is in addition to the existing
reporting requirements for actual physical shares and
potential holdings.
The new disclosure rules follow the amendments to the
Italian takeover rules in April 2011 which provide, among
other things, that OTC derivatives granting a long position
over listed shares, including cash-settled derivatives, must
now be taken into account for purposes of calculating the
statutory thresholds which trigger the obligation to launch
a mandatory offer.
The new reporting rules provide for certain exemptions to
the disclosure regime. A cash-settled derivative is
disregarded for purposes of calculating the aggregate long
position if: (i) it is held by authorised brokers and
investment companies in order to hedge a client’s position
(so-called client serving exemption); (ii) it is held by
authorised market makers acting in their capacity as such,
both on regulated markets and OTC, provided that the
market maker does not intervene in the management of
the relevant issuer or exert any influence on the purchase
of such positions as well as on the price making thereof
and the aggregate long position does not exceed the 30
percent reporting threshold; or (iii) it relates to the
performance of equity indices or similar instruments,
provided that the number of shares forming part of such
indices or underlying such instrument do not exceed 1
percent of the share capital of the issuer or 20 percent of
the aggregate value of the shares covered by such index or
instrument.
The new disclosure requirements applicable to cash-
settled derivatives will enter into effect on 21 October
2011. For purposes of monitoring the existing long
positions in the Italian market, the new rules prescribe
that all the aggregate long position held as of that date
must be reported to the market, unless already otherwise
disclosed.
UK DEVELOPMENTS
ABI Report on Board Effectiveness
On 29 September 2011, the Association of British Insurers
(“ABI”), one of the most prominent investor protection
bodies in the UK, published its Report on Board
Effectiveness which contains recommendations for
improving board effectiveness in three key areas:
diversity; succession planning; and board evaluation. Its
recommendations are based on a detailed review of the
narrative content of the annual reports for FTSE 350
companies, excluding investment trusts.
In the area of boardroom diversity, the report
recommends a more extended discussion in annual
reports about the steps being taken and the issues faced in
achieving diversity, widening the search for non-executive
directors and setting measurable objectives with respect to
the promotion of gender and other diversity, particularly
at senior management level. In the area of succession
planning, the report recommends extending succession
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planning to all senior management, not just board level
executives, with improved disclosure of the steps that are
being taken. With respect to board evaluation, the report
recommends more open reporting on the outcomes of the
evaluation process and, in order to avoid conflicts of
interest where external evaluations are used, not to use
firms involved in the company’s board recruitment or
remuneration consultancy. For FTSE 350 companies,
external evaluations are now required every three years by
the UK Corporate Governance Code.
The report is available at:
http://www.ivis.co.uk/PDF/ABI_1684_v6_CS4.pdf.
ABI Principles of Remuneration
On 29 September 2011, the ABI also published a revised
edition of its executive remuneration guidelines, now
issued as the “ABI Principles of Remuneration”. These do
not involve any radical departure from the previous
version of the guidelines that were issued in 2009. They
do, however, contain an increased focus on the
responsibility of remuneration committees to ensure that
levels of pay are appropriate. Remuneration committees
are required to take into account pay and conditions
elsewhere in the group when setting executive
remuneration and may have a role to play in determining
remuneration below board level, especially where the
remuneration levels and associated risks are material to
the group’s overall performance. They specifically advise
against using “median” pay as a benchmark because of its
ratchetting effect and state that shareholders expect to see
claw back and “malus” provisions included in the design of
executive remuneration.
The guidelines are available at: Guidelines >> Executive
Remuneration.
Narrative Reporting and Executive Remuneration
On 19 September 2011, the Department for Business,
Industry and Skills published a consultation on the future
of narrative reporting (the “NRC”) and a discussion paper
on executive remuneration (the “DPER”), two documents
aimed at improving the corporate governance framework
in the UK.
The NRC proposes to simplify the reporting requirements
for companies and the disclosure obligations regarding
performance and pay. The DPER discusses promoting a
clearer and stronger link between executive remuneration
and company performance.
The consultation period for both documents ends on 25
November 2011. They follow on from the call for evidence
entitled “A long-term focus for corporate Britain”
launched in October 2010, which addressed corporate
governance and “economic short-termism” in the UK.
The NRC seeks comments as to whether:
remuneration reporting requirements should be
changed to include a requirement to provide
information on the link between the performance of
companies and top executives earnings. In this
context, the NRC suggests requiring a graph plotting
remuneration of the CEO over the past five years
against an appropriate measure of company
performance and stating the total expenditure on
executive remuneration as a proportion of profit; and
the ratio between the CEO’s pay and median earnings
in a company should be published.
In order to clarify key issues for potential investors in a
more readily-accessible format than current annual
reports of large companies, the NRC suggests splitting a
company’s annual report into two documents, namely:
a “Strategic Report”, which would provide
shareholders with key information about the financial
performance of the company and a concise
description of the company's strategy, risks and
business model; and
an “Annual Directors’ Statement”, which would
provide the detailed information that underpins the
Strategic Report. It is proposed that the content of the
Annual Directors’ Statement be more closely
prescribed to facilitate greater comparability between
companies and over periods of time. The proposed
changes will mostly affect quoted companies.
The DPER seeks comments on:
whether the current advisory shareholder vote on
executive remuneration should become binding in
order to encourage shareholders to take a more active
role in governance;
whether companies should include shareholder
representatives on nomination committees;
how to modify remuneration committees to better
reflect the make-up of the company, for example by
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including shareholder, employee and independent
representation;
whether there should be an employee vote on
remuneration proposals;
increased transparency over the use of remuneration
consultants;
options for aligning remuneration incentives and
sustainable, long-term performance, for example by
requiring a five-year rather than three-year vesting
schedule and deferral period; and
whether all UK listed companies should put in place
claw-back mechanisms for incentive rewards.
The scope of these consultations goes beyond
transparency measures and into the realm of corporate
governance reform as evidenced by the international
comparisons made in the documents, in particular to the
Reform Act (as defined below) in the US. Combined, they
seek to make corporate governance information more
accessible, widen the scope of disclosures and make them
more meaningful to shareholders, change the presentation
format and improve the interaction between directors and
shareholders.
While the proposals are at the discussion stage only and
the DPER notes particular difficulties regarding the
interaction of its proposals with employment law, this
second round of consultation shows a determination on
the part of the Department for Business, Industry and
Skills to reform this area of law.
The NRC is available at:
http://www.bis.gov.uk/assets/biscore/business-
law/docs/f/11-945-future-of-narrative-reporting-
consulting-new-framework.pdf.
The DPER is available at:
http://www.bis.gov.uk/assets/biscore/business-
law/docs/e/11-1287-executive-remuneration-discussion-
paper.pdf.
The call for evidence is available at:
http://www.bis.gov.uk/assets/biscore/business-
law/docs/l/10-1225-long-term-focus-corporate-
britain.pdf.
Revised Takeover Code Becomes Effective
On 19 September 2011, the detailed amendments to the
UK Takeover Code that were first published in draft form
on 21 March 2011 and then republished on 21 July 2011 in
a slightly revised, but not materially different, final form,
became effective.
These amendments, which have resulted in the
publication of a new (10th) edition of the Code, among
other things:
require the naming of potential offerors when a
possible offer has to be announced, except where the
announcement is made after another offeror has
announced a firm intention to make an offer;
require the offeror, except where a firm offer is
subsequently announced by another offeror, within a
fixed period of 28 days, to announce either a firm and
effectively binding intention to make an offer or an
intention not to make an offer, in which case the
offeror will, for the next six months and subject to
certain exceptions, be prohibited from making
another offer for the target. With the consent of the
Panel, the 28-day period is extendable. This period is
commonly referred to as the “PUSU period”, i.e., a
“put up or shut up” period;
prohibit targets from agreeing “offer-related” deal
protection terms, including inducement fees, with
offerors, except for (i) inducement fees agreed with
competing “white knight” offerors at the time of their
commitment to make a firm offer, as long as these
fees do not exceed in the aggregate 1 percent of the
value of the target, and (ii) deal protection terms
agreed by targets that have announced a formal sale
process, subject to the same 1 percent limit; and
require greater disclosure of offer-related fees and
expenses, financial information in relation to the
offeror and its financing, even in the case of an all
stock bid, and of the offeror’s intentions with regards
to the target and its employees following the offer.
The revised Code is available at:
http://www.thetakeoverpanel.org.uk/wp-
content/uploads/2008/11/RS201101.pdf.
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Our related client publication that discussed the changes
to the Code as originally proposed is available at:
http://www.shearman.com/files/Publication/c27b722f-
257f-43f2-a07b-
e505edbcf8a3/Presentation/PublicationAttachment/f0d8
bfac-f672-4943-9d14-ebaacb89bb84/EC-042011-UK-
Takeover-Panel-publishes-draft-rule-changes-to-the-
Takeover-Code.pdf.
Transitional arrangements operate with respect to the
application of the revised Code to offer periods that had
already started before 19 September. Details of these
arrangements are available at:
http://www.thetakeoverpanel.org.uk/wp-
content/uploads/2008/11/transitionalarrangements.pdf .
The Panel has stated that it will carry out a review of how
the revisions to the Code are working, on or after 19
September 2012, depending on the level of bid activity
following these revisions taking effect.
Amended Takeover Panel’s Practice Statements
On 19 September 2011, the Takeover Panel published a
statement outlining changes made to its Practice
Statements, which have been updated to reflect the new
edition of the Takeover Code discussed above. Although
Practice Statements do not form part of the Code, they are
published by the Panel’s Executive to offer guidance as to
how the Panel will normally interpret and apply certain
provisions of the Code. The statement outlined the
following significant changes:
Practice Statement 6
A “strategic review” announcement by a target which
refers to an offer as one option will start an offer
period and therefore, under the new rules, will trigger
the requirement for any potential offeror with whom
the company is in talks to be identified and a PUSU
deadline (as mentioned above) to be specified, and
updating announcements will be required where an
offer is no longer being considered as part of the
strategic review or where it does later becomes an
option being considered.
Practice Statement 20
The Panel will treat a bidder as being in breach of the
rule that a potential offeror must not attempt to
prevent a target from making an announcement,
where the offeror attempts to specify the
circumstances in which the target may not publicly
identify the offeror, e.g., by stipulating that its
approach will be automatically withdrawn if: the
target does not engage with the offeror within a
specified period of time; a possible offer
announcement is triggered; or the target receives an
approach from a third party, and
where it is proposed that a possible offer
announcement does not name an offeror, since its
approach has been unequivocally rejected, the Panel
should be consulted.
Practice Statement 23
This statement now deals with the limited
circumstances in which inducement fees will be
permitted, i.e., as discussed above, in cases of
competing offers and as part of a formal sale process.
The Panel’s statement is available at:
http://www.thetakeoverpanel.org.uk/wp-
content/uploads/2010/12/2011-25.pdf.
Call for Evidence for the Kay Review of UK Equity Markets
On 15 September 2011, Professor John Kay called for
evidence in relation to his independent review of the UK
equity markets and their impact on the long-term
competitive performance of UK quoted companies. This
marked the beginning of the review that was announced
by the UK Government in June 2011 and was discussed in
our July 2011 Newsletter.
The evidence will inform the issues and questions to be
asked in Professor Kay’s examination, including how
companies review investment in intangible assets such as
corporate reputation, whether government policies aimed
at facilitating long-term investment by companies have
been effective, and whether rules on disclosures of major
shareholdings are excessive or inadequate.
An interim report describing preliminary findings and
possible recommendations is expected in February 2012,
and a final report will be published in July 2012.
DTRs: FSA Quarterly Consultation No 30
In a quarterly consultation published on 7 September 2011
the FSA included, among a number of proposed
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amendments to its Handbook (or “rule book”), an
amendment to the Disclosure and Transparency Rule
(“DTR”) that requires issuers to take all reasonable care to
ensure that any information they notify to the market is
not misleading, false or deceptive. The amendment would
exclude from this requirement the information about
major shareholdings that DTR 5 requires shareholders to
notify to issuers and then issuers to disclose to the market.
The amendment will make it clear that the issuer is not
responsible for double-checking the shareholding
information provided to it by shareholders. Responses to
the Consultation should be received by 6 November 2011.
The Quarterly Consultation is available at:
http://www.fsa.gov.uk/pages/Library/Policy/CP/2011/11
_18.shtml.
FRC’s Effective Company Stewardship Consultation
On 1 September 2011, the Financial Reporting Council
(“FRC”) published feedback that it received in response to
its Effective Company Stewardship discussion paper
published in January 2011 regarding improvements to
corporate reporting and the audit process, which we
discussed in our April 2011 Newsletter.
In its feedback, the FRC identifies as a common issue that
the audit does not meet user or public expectations and
that there is a need for greater transparency in terms of
judgements made by management and auditors in the
preparation and auditing of financial statements. The FRC
believes that the information required to give greater
transparency should be provided through a report by the
audit committee, in contrast to the European Commission
and the US Public Company Auditing Oversight Board
who tend to support the provision of this information, for
example, through an expanded audit report. Although
asking for greater transparency, the FRC explains that its
proposals need not necessarily result in still longer annual
reports since it will be possible to either discard some
information that is currently provided or publish it in a
different way, such as through the company’s website.
In addition to committing to work with the UK
Government on the implementation of its proposals for
narrative reporting discussed above, the FRC intends to
take action in the following areas:
Strategy Risk and Going Concern. The FRC
believes that companies should focus primarily on
strategic risks as opposed to operational risks or risks
that arise without any action by the company. The
FRC wants such risks to be disclosed with an
explanation as to how the company will address them,
and any obstacles they may encounter. The FRC
intends to update its so-called Turnbull guidance to
directors on internal control to reflect improvements
in practice and to clarify the board’s responsibility for
determining the nature and extent of significant risks
it is willing to take. The FRC will also consider
whether the UK Corporate Governance Code should
be amended to reflect the lessons from its enquiry, led
by Lord Sharman, into issues for companies and
auditors in addressing going concern and liquidity
risks.
Role of the Audit Committee. The FRC proposes
that audit committees should have a greater role and
that annual reports should include, in full, the
committee’s report to the board, setting out the
approach they have taken to discharge their
responsibilities. The audit committee’s remit should
include consideration of the entire annual report, and
of whether the information provided in the report as a
whole, is fair and balanced.
Audit and the Role of Auditors. The FRC believes
that the contribution by auditors should be more
transparent, and the FRC proposes to review auditing
standards governing the reporting by auditors to audit
committees and the auditing standards on audit
reports.
Refreshing the Audit. The FRC intends to consult
on proposals to require companies to put their audits
out to tender at least once every ten years, or explain
why they have not done so, and to publish an
explanation in their annual report as to how they
came to the decision of whether or not to put the audit
out to tender.
The FRC's Paper “Effective Company Stewardship – Next
Steps” is available at:
http://www.frc.org.uk/images/uploaded/documents/ECS
%20Feedback%20Paper%20Final1.pdf.
Review of FRC’s Turnbull Guidance
Earlier this year the FRC held a series of meetings with
companies, investors and advisers to discuss how boards
have approached their responsibilities in terms of risk
management. On 1 September, the FRC published a
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report summarising the key points which emerged from
these meetings. One of these is that the FRC intends to
carry out a limited review of its existing guidance to
directors with respect to their responsibilities for internal
control, to take account to the UK Corporate Governance
Code’s re-articulation of the role of the board.
The summary may be found at:
http://www.frc.org.uk/images/uploaded/documents/Boa
rds%20and%20Risk%20final1.pdf.
Prospectus Regulations 2011
On 31 July 2011, and as previously announced by the UK
Government, two key amendments were made to the
Financial Services and Markets Act 2000 with respect to
prospectus exemptions, by way of early implementation of
the amendments to the EU Prospectus Directive agreed
last year. The changes are:
the number of persons, other than qualified investors,
to whom an offer of transferable securities may be
made or directed at before it ceases to be exempt from
the requirement for a prospectus is increased from
100 to 150, and
the limit for the total consideration of an offer in the
EU in respect of which a prospectus is not required is
increased from €2.5 million to €5 million.
FRC reaffirms Importance of True and Fair View
On 21 July 2011, the Accounting Standards Board and the
Auditing Practices Board of the FRC published a paper
which reconfirmed their view that the true and fair view
requirement remains of fundamental importance in both
UK GAAP and IFRS and has not changed as a result of the
introduction of IFRS in the UK, where it is mandatory for
the consolidated accounts of UK listed issuers.
The paper goes on to explain that, in those very rare cases
when following a particular accounting policy would not
result in a true and fair view, directors and auditors are
legally required to adopt a more appropriate policy, even if
this involves a departure from the relevant accounting
standard.
The paper is available at:
http://www.frc.org.uk/images/uploaded/documents/Pap
er%20True%20and%20Fair.pdf.
Bribery Act 2010 Update
Despite only being in force since 1 July 2011, the first
individual has already been charged under the Bribery Act
2010. A clerk from Redbridge Magistrates Court is
accused of requesting and receiving a bribe intending to
perform his function as a court clerk improperly, under
section 2(1) of the Bribery Act.
A commentary on the Bribery Act written by our partners
Stephen Fishbein, Philip Urofsky and Richard Kelly,
which has been published in The Review of Securities &
Commodities Regulation, is available at:
http://www.shearman.com/files/Publication/6b9afc1d-
c183-411d-9f18-
6d9c2a2a0b41/Presentation/PublicationAttachment/a96
d8900-33aa-4031-a4f0-7952516eca0c/LT-081711-The-
UK-Bribery-Act-2010-Fishbein-Urofsky-Kelly.pdf.
FSA fines Willis Limited
On 21 July 2011, the Financial Services Authority (“FSA”)
published its Final Notice to Willis Limited (“Willis”), a
leading insurance broker. Willis was found to have failings
in its anti-bribery systems and controls in relation to
payments made to overseas third parties. It was fined
nearly £7 million for breaches of the FSA’s Principles for
Business and the FSA Handbook. This is the biggest fine
imposed by the FSA to date in this area, but it would have
been nearly £10 million if it were not for a number of
mitigating circumstances, including the fact that Willis
settled at an early stage of the investigation.
The FSA determined that between 14 January 2005 and 31
December 2009, Willis failed to take reasonable care to
establish and maintain effective systems and controls to
counter the risks of bribery and corruption associated with
making payments to overseas third parties. These third
parties had helped Willis win and retain business from
overseas clients, and it was found that Willis had a weak
control environment in relation to the making of such
payments. As a result, there was an unacceptable risk that
the payments made by Willis could be used for corrupt
purposes, including the payment of bribes. A number of
payments made by Willis during the course of the FSA’s
investigation were identified as suspicious and were
reported to the Serious Organised Crime Agency in the
UK.
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While Willis had amended its policies and guidance
following a letter circulated by the FSA in November 2007
to all wholesale insurance broker firms, including Willis,
and the publication of the Final Notice to Aon Limited by
the FSA in January 2009, the FSA determined that Willis
had failed to implement these policies properly. The Final
Notice also criticises the limited information given to
senior management on financial crime issues.
The FSA’s Final Notice is available at:
http://www.fsa.gov.uk/pubs/final/willis_ltd.pdf.
Civil Recovery Order against Macmillan Publishers
On 22 July 2011, the High Court granted a civil recovery
order against Macmillan Publishers Ltd (“Macmillan”) in
the sum of £11.2 million. The order was imposed following
an agreement between the Serious Fraud Office (“SFO”)
and the company, and recovers sums received by
Macmillan through illegal payments which it had made to
secure business contracts in Africa. Separately, Macmillan
has also been debarred from participating in World Bank
funded tender business for a period of at least three years,
and a compliance monitor will be in place for a 12-month
period, who will report to both the SFO and the World
Bank.
Macmillan has also agreed to undertake an independent
investigation into publicly tendered contracts which it had
won elsewhere in Africa between 2002 and 2009. The
SFO stated that “It was impossible to be sure that the
awards of tenders to the Company…were not accompanied
by a corrupt relationship.” Therefore, Macmillan may have
received revenue which had been derived from unlawful
conduct.
Macmillan was able to enter into a civil settlement with
the SFO. This reflected a number of factors, including the
fact that it approached the SFO with a view to co-
operation and its agreement to undertake an internal
investigation. The civil recovery order imposed by the
High Court is in recognition of sums Macmillan received
which were generated through its unlawful conduct.
Although the Macmillan action is only the fifth time that
the SFO has entered into such a civil settlement with a
company, it is the third such settlement this year alone.
The SFO press release is available at:
http://www.sfo.gov.uk/press-room/latest-press-
releases/press-releases-2011/action-on-macmillan-
publishers-limited.aspx.
FSA Consultation on New Financial Crime Guide
In June 2011, the FSA launched a consultation on a
financial crime guide it intends to publish. The
consultation paper includes the draft text for the new
regulatory guide, which will outline steps that firms can
take to reduce their financial crime risk. It is intended to
provide good and poor practice indications for firms on
anti-bribery systems and controls. Comments on the
consultation paper were due by 21 September 2011, and
the finalised guide is expected to be published later this
year.
The guide will contain guidance on a variety of topics,
including financial crime systems and controls, anti-
money laundering, bribery and corruption, fraud and data
security. It will also indicate steps that firms can take to
reduce their financial crime risk.
The FSA guide will be the latest in a line of guidance which
has been published on anti-bribery and corruption. The
guide is not intended to be binding; instead it will indicate
what firms can do to comply with their legal and
regulatory obligations. The FSA specifically notes that the
draft guide has been written with reference to the Ministry
of Justice guidance on adequate procedures under the
Bribery Act, which is also non-binding and non-
prescriptive.
The FSA consultation paper is available at:
http://www.fsa.gov.uk/pages/Library/Policy/CP/2011/11
_12.shtml.
Consultation on Anti-Bribery Guidance
On 1 July 2011, Transparency International UK launched a
consultation on its draft anti-bribery due diligence
guidance for transactions. Responses to the consultation
were due by 15 September 2011, and the final guidance is
due to be published shortly.
The consultation draft is available at:
http://www.transparency.org.uk/publications.
US DEVELOPMENTS
SEC Developments
In our 2010 Newsletters, we reported on the Dodd-Frank
Wall Street Reform and Consumer Protection Act of 2010
(the “Reform Act”) that was signed into law on 21 July
10
2010. The Reform Act requires rulemaking by the SEC to
implement certain of its provisions:
SEC Adopts Changes to Eligibility Requirements for Use of Forms S-3 and F-3
In our April 2011 Newsletter, we reported that the SEC
had proposed changes to the eligibility requirements for
the use of the short-form registration statements on
Forms S-3 and F-3 by removing references to credit
ratings and replacing them with alternative standards of
credit-worthiness, as required by Section 939A of the
Reform Act. On 26 July 2011, the SEC voted unanimously
to approve the final version of these rules.
Forms S-3 and F-3 permit eligible issuers to
incorporate by reference information from the issuer’s
reports filed under the US Securities Exchange Act of
1934, as amended (the “Exchange Act”), to satisfy
many of the offering disclosure requirements of the
US Securities Act of 1933, as amended (the “Securities
Act”).
Issuers that are eligible to use Forms S-3 and F-3 may
also register securities in a shelf registration under
Rule 415 of the Securities Act, which enables them,
once the shelf registration statement is effective, to
conduct offers on a delayed or continuous basis
without further action required by the SEC.
Companies may use short-form registration on Forms S-3
or F-3 if they satisfy the form’s registrant requirements
and at least one of several alternative transaction
requirements. One of the transaction requirements
currently allows the use of short-form registration for a
primary offering of non-convertible securities, such as
debt or preferred stock, if the offered securities have
received an investment grade rating by at least one
nationally recognised statistical rating organisation. The
final rules eliminate references to credit ratings in the
context of this transaction requirement and replace them
with eligibility criteria that focus on issuers that are widely
followed in the market.
The final rules establish the following four alternative tests
to determine issuer eligibility:
The issuer has issued, as of a date within 60 days
prior to the filing of the registration statement, at least
US$1 billion in non-convertible securities other than
common equity, in primary offerings for cash, not
exchange, registered under the Securities Act, over the
prior three years;
The issuer has outstanding, as of a date within 60
days prior to the filing of the registration statement, at
least US$ 750 million of non-convertible securities
other than common equity, issued in primary
offerings for cash, not exchange, registered under the
Securities Act;
The issuer is a wholly-owned subsidiary of a well-
known seasoned issuer (“WKSI”) as defined under the
Securities Act; or
The issuer is a majority-owned operating partnership
of a real estate investment trust (“REIT”) that
qualifies as a WKSI.
The calculation of the numerical thresholds for the tests
based on prior securities issuances is derived from the
definition of WKSI and applied in the same way.
Therefore, in determining the US$1 billion and US$750
million thresholds, only registered offerings for cash are
taken into account – registered exchange offers and
private placements are disregarded.
The final rules expand the eligibility criteria from those
originally proposed by the SEC, reflecting the SEC’s desire
not to alter the pool of issuers that are eligible for the use
of short-form registration. As a result, the SEC expects
that about all issuers that could currently rely on the
existing test would be able to qualify for the revised forms.
In addition, issuers may continue to rely on the other
transaction requirements of Forms S-3 and F-3 that
remain unchanged and may therefore continue, for
example, to use those forms if they have a public float held
by non-affiliates of US$75 million or more.
In order to ease transition, the final rules include a
temporary grandfather provision that allows an issuer to
use Form S-3 or Form F-3 for a period of three years from
the effective date of the amendments if it has a
“reasonable belief” that it would have been eligible to use
those forms under the old regulation. Despite these
provisions, the concern remains that some investment
grade debt issuers will be excluded from the use of short-
form registration once the grandfathering period expires.
This may particularly be the case for investment grade
foreign private issuers that do not have the required public
equity float and are infrequent issuers in the US debt
market. In this context, the staff of the SEC has recently
indicated that it may consider requests for relief from any
11
issuers who would otherwise lose their status as a result of
the rule changes.
The final rules make related amendments to safe harbors
for certain communications during the offering process,
registration statements on Forms S-4 and F-4 for
securities issued in connection with business
combinations and exchange offers and Schedule 14A of the
Exchange Act.
The final rules became effective on 2 September 2011 and
are available at: http://www.sec.gov/rules/final/2011/33-
9245.pdf.
SEC Adopts Large Trader Reporting Requirements
On 26 July 2011, the SEC adopted final rules establishing
large trader reporting requirements. New Rule 13h-1 and
Form 13H, adopted under Section 13(h) of the Exchange
Act, will assist the SEC to identify market participants that
conduct a substantial amount of trading activity, as
measured by volume or market value, in the US securities
markets, collect information on their trading and analyse
their trading activity.
Rule 13h-1 will require a large trader to identify itself to,
and register with, the SEC and make certain disclosures
on Form 13H. The initial Form 13H must be filed
“promptly” and it is the SEC’s view that a filing within 10
days after the large trader reaches the required trading
activity level is appropriate. Upon receipt of Form 13H, the
SEC will assign to each large trader a unique identification
number, which the large trader must provide to its
registered broker-dealer.
A “large trader” is defined as a person who directly or
indirectly, including through other persons controlled
by such person, exercises investment discretion over
one or more accounts and effects transactions for the
purchase or sale of any NMS security, i.e., US-listed
stocks and options, for or on behalf of such accounts,
by or through one or more registered broker-dealers,
in an aggregate amount equal to or greater than either
2 million shares or shares with a fair market value of
US$20 million during any calendar day, or 20 million
shares or shares with a fair market value of US$200
million during any calendar month.
In addition to data already required to be collected under
current rules, the registered broker-dealers of large
traders are required to maintain records of certain
additional elements in connection with transactions
effected through accounts of such large traders, namely
the large trader identification number and the time
transactions in the account are executed. Any such
information must be reported to the SEC upon request.
In addition, certain registered broker-dealers subject to
the new rule are required to perform limited monitoring of
their customers’ accounts for activity that may trigger the
large trader identification requirements of Rule 13h-1.
Rule 13h-1 also requires foreign entities that are large
traders to register with the SEC and file reports on Form
13H. Conversely, the recordkeeping and reporting
requirements of the rule apply only to US-registered
broker-dealers. With respect to securities transactions
effected by foreign large traders through foreign
intermediaries, the SEC indicated that (i) a US-registered
broker-dealer is allowed to treat the foreign intermediaries
for which it executes transactions as its clients and is not
required to collect information about the foreign
intermediaries’ customers, and (ii) a foreign large trader
must report the foreign intermediaries with which it
maintains accounts.
The final rules became effective on 3 October 2011. Large
traders must comply with the identification requirements
of the rule by 1 December 2011. Broker-dealers must
comply with the requirements to maintain records, report
transaction data when requested, and monitor large trader
activity by 30 April 2012.
The final rules are available at:
http://www.sec.gov/rules/final/2011/34-64976.pdf.
Our related client publication is available at:
http://www.shearman.com/files/Publication/2a6a0d64-
4571-4f29-beff-
7ec3a73c970b/Presentation/PublicationAttachment/f99c
10c0-cdf5-4700-a759-3e32c2558c55/FIA-100711-
Preparing-for-Large-Trader-Reporting.pdf.
SEC’s Proxy Access Rules Vacated
In our October 2010 Newsletter, we reported that the SEC
had adopted final rules to implement “proxy access”, the
regulatory regime that granted certain shareholders the
right to include a limited number of director nominees
directly in the proxy statements of public companies.
Subsequently, in our January 2011 Newsletter, we
reported that the US Chamber of Commerce and the
Business Roundtable had brought a legal challenge against
the proxy access rules in the US Court of Appeals for the
12
District of Columbia Circuit and that as a result, the SEC
had stayed the effectiveness of the rules pending the
outcome of the legal review.
On 22 July 2011, the US Court of Appeals for the District
of Columbia Circuit vacated the proxy access rule
contained in Rule 14a-11, holding that the SEC had acted
arbitrarily and capriciously for having failed to adequately
assess the economic effects of its new rule. In particular,
the court stated that the SEC, among others,
inconsistently and opportunistically framed the costs and
benefits of the rule; failed adequately to quantify certain
costs or to explain why those costs could not be quantified;
neglected to support its predictive judgements; and failed
to respond to substantial problems raised by commenters.
Such problems included the potential costs to companies
of special interest shareholders, such as unions or pension
funds, who seek access to promote their narrow goals at
the expense of maximising shareholder value for other
shareholders or the applicability of the rule to investment
companies.
In a statement issued on 6 September 2011, the SEC
confirmed that it is not seeking a rehearing of the decision
nor seek US Supreme Court review. While it further stated
that it remained committed to a meaningful opportunity
for shareholders to exercise their right to nominate
directors, it would carefully consider and learn from the
court’s objections to determine the best path forward.
The court ruling does not affect the amendments to the
SEC’s current regime set forth in Rule 14a-8 that were
adopted at the same time as the proxy access rules. Those
amendments allow shareholders to propose and adopt
bylaw amendments seeking to establish a proxy access
procedure at their individual companies. The SEC had
voluntarily stayed the effectiveness of these amendments
at the same time it stayed the effectiveness of the proxy
access rule. The amendments to Rule 14a-8 became
effective on 20 September 2011 upon publication in the
Federal Register.
Our related client publication is available at:
http://www.shearman.com/files/Publication/d9991c14-
9f5e-4e42-94f3-
59d0d88afe24/Presentation/PublicationAttachment/78f5
0442-caeb-42d3-9982-06ca38df7eb8/MA-091211-
Project-Alert-Proxy-Rules-2.pdf.
SEC’s Whistleblower Programme Becomes Effective
On 12 August 2011, the SEC’s new whistleblower
programme officially became effective. On the same day,
the SEC launched a new webpage for people to report a
violation of the federal securities laws and apply for a
financial reward. The SEC’s new webpage at
www.sec.gov/whistleblower includes information on
eligibility requirements, directions on how to submit a tip
or complaint, instructions on how to apply for an award,
and answers to frequently asked questions.
We had reported on the SEC’s proposed rules in our
January 2011 Newsletter and on the rules adopting the
final whistleblower programme in our June 2011
Newsletter.
Petition for Disclosure of Corporate Spending on Political Activities
On 3 August 2011, the Committee on Disclosure of
Corporate Political Spending, a group consisting of ten
corporate and securities law experts, submitted a petition
to the SEC for rulemaking under Section 14 of the
Exchange Act, asking for the development of rules to
require public companies to disclose to shareholders the
use of corporate resources for political activities.
According to the petition, shareholders in public
companies have increasingly expressed strong interest in
receiving information about corporate spending on
politics, as evidenced by the significant number of related
shareholder proposals. During the 2011 proxy season,
more proposals relating to political spending were
included in proxy statements than any other type of
proposal. In addition, since 2004, large public companies
have increasingly agreed voluntarily to adopt policies
requiring disclosure of the company’s spending on
politics, responding to increased shareholder demand for
that kind of information and showing that such disclosure
is both feasible and practicable.
The Committee argues that providing shareholders with
information about corporate political spending is
necessary for corporate accountability and oversight
mechanisms to work and for markets and the procedures
of corporate democracy to ensure that such spending is in
shareholders’ interest. The petition also cites the recent
decision of the US Supreme Court in Citizens United v.
FEC, where the Court relied upon “shareholder objections
raised through the procedures of corporate democracy” as
a means through which investors could monitor the use of
13
corporate resources on political activities, arguing that this
control mechanism is premised on the fact that
shareholders are provided with the necessary information.
In light of the Citizens United decision’s removal of
restrictions on the scope of corporate resources that could
be spent on political activities, the authors of the petition
expect that corporate political spending will likely become
even more important to public investors in the future.
A copy of the petition is available at:
http://www.sec.gov/rules/petitions/2011/petn4-637.pdf.
SEC to Hold Roundtable on Conflict Minerals
On 29 September 2011, the SEC announced that it will
host a public roundtable on 18 October to discuss the
agency’s required rulemaking under Section 1502 of the
Reform Act, which relates to reporting requirements
regarding conflict minerals originating in the Democratic
Republic of the Congo and adjoining countries. The panel
discussion will focus on key regulatory issues such as
appropriate reporting approaches for the final rule,
challenges in tracking conflict minerals through the supply
chain, and workable due diligence and other requirements
related to the rulemaking.
SEC and NYSE Promulgations on “Reverse Mergers”
NYSE. In our July 2011 Newsletter, we reported on
certain SEC and NASDAQ promulgations on “reverse
mergers”. After NASDAQ recently proposed additional
listing rules that would impose certain seasoning
requirements before companies resulting from a reverse
merger companies could seek a listing, on 22 July 2011,
the NYSE filed with the SEC proposed rules to adopt
comparable additional listing requirements.
As a reminder, in a “reverse merger” transaction, an
existing public shell company, which is a public
reporting company with few or no operations,
acquires a private operating company, US or non-US
– usually one that is seeking access to funding in the
US capital markets. The shareholders of the private
company typically exchange their shares for a large
majority of the public company shares, gaining a
controlling interest, and the private company’s
management takes over the board of the public
company. A reverse merger is often perceived to be a
quicker and cheaper method of “going public” than an
initial public offering. While the public company must
report the reverse merger to the SEC on Form 8-K,
there are no registration requirements under the
Securities Act.
While the NASDAQ and the NYSE rules are very similar, a
number of differences exist. Under the proposed NYSE
rules, a reverse merger company would not be eligible for
listing unless the combined entity had, immediately
preceding the filing of the initial listing application:
Traded for a period of at least one year in the US over-
the-counter market, on another national securities
exchange, or on a regulated foreign exchange
following the reverse merger. This seasoning period is
designed, among others, to provide greater assurance
that the company’s operations and financial reporting
are reliable and to provide time for regulatory and
market scrutiny of the company;
Filed with the SEC information about the reverse
merger transaction through which it was formed. A
US issuer would be required to file a Form 8-K which
includes Form 10-equivalent information and all
required audited financial statements and a foreign
private issuer would be required to file a Form 20-F
including comparable information;
Maintained on both an absolute and an average basis
for a sustained period and through the listing a
minimum stock price of at least a US$ 4. The rules do
not define “sustained period”; and
Timely filed with the SEC all required reports since
the consummation of the reverse merger, including at
least one annual report on Form 10-K or 20-F,
containing audited financial statements for a full fiscal
year since the reverse merger.
Comments on the proposed rules were due by 12
September 2011 and the SEC is scheduled to decide on the
rule proposal by 8 November 2011. The proposed rules are
available at:
http://www.sec.gov/rules/sro/nyse/2011/34-65034.pdf.
SEC. On 14 September 2011, the SEC issued a new form of
guidance entitled “CF Disclosure Guidance: Topic No. 1 –
Staff Observations in the Review of Forms 8-K filed to
Report Reverse Mergers and Similar Transactions”. The
guidance contains a summary of common comments
made in the review of Forms 8-K filed to report reverse
merger transactions and provides helpful hints on how to
prepare appropriate disclosure in these circumstances.
14
The staff of the SEC is frequently referring companies to
the disclosure items of Form 8-K that require a discussion
of the completion of acquisitions or dispositions of assets
(Item 2.01) and changes of control (Item 5.01) and
reminds them that if the company is a shell company,
Form 10 disclosure is required, including information
about the business, director and executive officers,
executive remuneration, related-party transactions, risk
factors and MD&A. In addition, item 9.01 of Form 8-K
requires the inclusion of historical financial statements of
the business being acquired and pro forma financial
information.
The SEC guidance is available at:
http://www.sec.gov/divisions/corpfin/guidance/cfguidan
ce-topic1.htm.
SEC Staff Issues No-Action Relief from Registration and Disclosure for Grants of Restricted Stock Units
On 13 September 2011, the social media company Twitter,
Inc. obtained a no-action letter from the staff of the SEC’s
Division of Corporation Finance. The letter exempts the
company from registering restricted stock units (“RSUs”)
it awards to employees and other service providers under
Section 12(g) of the Exchange Act, regardless of the
number of grantees.
Section 12(g) of the Exchange Act and Rule 12(g)(1)
thereunder generally require an issuer that (i) has a
class of securities held of record by 500 or more
persons and (ii) has more than US$10 million in
assets, to register those securities under the Exchange
Act and thereby becoming obligated to file periodic
Exchange Act reports.
Notable features of the Twitter RSUs include: the shares
subject to the RSUs are not issued until the occurrence of
certain specified events; they are granted without any
consideration payable by the employees; they may not be
sold, are generally not transferable and there is no trading
market for them; and they do not provide the employee
with any voting, dividend or other ownership rights until
the underlying shares are delivered.
The SEC no-action relief will cease to apply once (i)
Twitter otherwise becomes subject to Exchange Act
registration or reporting requirements with respect to any
class of securities or (ii) the date that Twitter undergoes a
“change in control”, as defined in the RSUs.
Our related client publication is available at:
http://www.shearman.com/files/Publication/b21fc844-
7615-4eca-9fad-
a4ca1aa96fcc/Presentation/PublicationAttachment/5359
0298-2a63-4c95-acfd-af863d0e6823/ECEB-092711-SEC-
Permits-Twitter-to-Make-RSU-Grants-Without-
Registration-and-Disclosure.pdf.
SEC Issues Interpretive Advice on Status of Sovereign Wealth Fund as Accredited Investor and QIB
On 14 July 2011, the SEC’s Division of Corporation
Finance issued interpretive advice as to the status of a
sovereign wealth investment fund as an “accredited
investor” under Regulation D and a “qualified institutional
buyer” under Rule 144A. Based on the facts presented, the
Division was of the view that the fund (i) although not
organised as an entity specifically listed in Rule 501(a)(3)
of Regulation D, may be treated as an “accredited
investor” if it satisfies the other requirements of that
definition and (ii) although not organised as an entity
specifically listed in Rule 144A(a)(1)(i)(H), may be treated
as a “qualified institutional buyer” if it satisfies the other
requirements of this definition.
The interpretive advice is available at:
http://www.sec.gov/divisions/corpfin/cf-
noaction/2011/alaskapermanentfund-071411-501a.htm.
SEC Staff Issues Credit Rating Agencies Examination Report
On 30 September 2011, the staff of the SEC issued a report
summarising its observations and concerns arising from
the examinations of ten credit rating agencies registered
with the SEC as nationally recognised statistical rating
organisations and subject to SEC oversight. The report,
which was mandated by the Reform Act, identified
concerns at each of the credit rating agencies, including
failures to follow ratings methodologies and procedures,
to make timely and accurate disclosures, to establish
effective internal control structures for the rating process
and to adequately manage conflicts of interest.
The report is available at:
http://www.sec.gov/news/studies/2011/2011_nrsro_secti
on15e_examinations_summary_report.pdf.
Updated Compliance and Disclosure Interpretations
On 8 July 2011, the SEC’s Division of Corporation Finance
updated its ‘‘Compliance and Disclosure Interpretations’’
addressing four main areas of disclosure: certain
15
compensation-related disclosures, disclosures regarding
departing directors, disclosures related to shareholder
advisory votes on the frequency of say-on-pay votes and
notifications of late filings. In addition, the Division of
Corporation Finance also issued a statement on WKSI
waivers.
The comprehensive set of Compliance and Disclosure
Interpretations as updated is available at:
http://www.sec.gov/divisions/corpfin/cfguidance.shtml.
Updated Financial Reporting Manual
On 1 July 2011, the SEC’s Division of Corporation Finance
updated its Financial Reporting Manual for issues related
to, among others, subsidiary guarantor financial
statements, reporting requirements of the International
Centre for Financial Regulation (“ICFR”) for newly public
companies and reporting requirements in a reverse
recapitalisation. In addition, on 1 September 2011, certain
style revisions were made to the manual.
The comprehensive updated Financial Reporting Manual
is available at:
http://www.sec.gov/divisions/corpfin/cffinancialreportin
gmanual.pdf.
SEC Updates EDGAR Filer Manual
On 1 August 2011, the SEC adopted revisions to the
Electronic Data Gathering, Analysis, and Retrieval System
(“EDGAR”) Filer Manual to reflect updates to the EDGAR
system that become functional on the same date. The SEC
Release adopting the revisions is available at:
http://www.sec.gov/rules/final/2011/33-9246.pdf.
Congressional Developments
The SEC Modernisation Act
On 2 August 2011, the chairman of the US House
Financial Services Committee Spencer Bachus announced
plans for a bill called the “SEC Modernisation Act” that
would lead to a comprehensive restructuring of the SEC.
Under the proposed, rather controversial, legislation,
various segments of the SEC would be consolidated, the
management structure of the SEC would be changed and
limitations would be imposed on the uses of certain funds
received by the SEC. In particular, the draft proposals
include the following reforms:
Consolidation of duplicative offices;
Among others, the independent Office of
Compliance, Inspections and Examinations
would be abolished with its examiners being
folded into various other divisions and the
independent Office of Investor Advocate would
be demoted and integrated into another office.
Implementation of managerial and ethics reforms;
Among others, the SEC chairman would be
required to submit in writing no later than 31
January of every calendar year the agency’s
agenda for that year to US Congress.
Establishment of a new ombudsman to receive
complaints from the businesses the SEC regulates;
and
Limitation of the permitted uses of the US$ 100
million reserve fund authorised by the Reform Act.
Chairman Bachus stated that his proposal was in part
inspired by the report on the organisation and operations
of the SEC, presented by the Boston Consulting Group
(“BCG”) to US Congress in March 2011, on which we
reported in our April 2011 Newsletter.
In this context, on 9 September 2011, the SEC’s staff of the
Office of the Chief Operating Officer published its first
progress report on the implementation of BCG’s
recommendations. Under the Reform Act, the SEC is
required to issue progress reports to US Congress every six
months for a period of two years after the issuance of the
independent consultant report. According to its first
report, the SEC has now developed the necessary
programme management and oversight infrastructure to
address the next step, namely conducting a thorough
analysis of each recommendation and designing
appropriate approaches for those recommendations
selected for implementation. The report further states that
over the next six months, significant work will be done
within each workstream to analyse BCG’s
recommendations and recommend what, if any, actions
should be taken.
On 15 September 2011, SEC Chairman Mary Schapiro
testified before the US House of Representatives
Committee on Financial Services on the report issued by
BCG, the progress made by the SEC in implementing
BCG’s recommendation, the SEC Modernisation Act and a
second bill, called the “SEC Regulatory Accountability Act,
which would establish a significant number of additional
16
standards for cost-benefit analyses for SEC rules and
orders.
The SEC’s “Report on the Implementation of SEC
Organisational Reform Recommendation” is available at:
http://www.sec.gov/news/studies/2011/secorgreformrep
ort-df967.pdf.
The Startup Expansion and Investment Act – SOX 404
Republican Benjamin Quayle recently introduced a House
bill, the Startup Expansion and Investment Act, that
would make internal control reporting and assessment
requirements of Section 404 of the Sarbanes-Oxley Act of
2002 (“SOX 404”) optional for certain “smaller”
companies. The bill would add to SOX 404 an exemption
allowing an issuer to elect not to provide the
management’s assessment described in subsection (a)(2)
and the auditor’s attestation on internal control described
in subsection (b) if the issuer has a total market
capitalisation for the relevant reporting period of less then
US$1 billion and is either not subject to the Exchange Act
annual reporting requirement under Exchange Act
Sections 13(a) or 15(d), or has been subject to the
requirement for less than 10 years.
PCAOB Developments
PCAOB Concept Release on Auditor Independence and Mandatory Audit Firm Rotation
On 16 August 2011, the Public Company Accounting
Oversight Board (“PCAOB”) issued a concept release to
solicit public comment on ways that auditor
independence, objectivity and professional skepticism
could be enhanced.
Stressing the importance of auditor independence,
the PCAOB is concerned that there is a fundamental
conflict of interest in the relationship of the audit firm
with its client due to the audit client paying the fees of
the auditor. Through the concept release and the
comment process, the PCAOB intends to open a
discussion of the appropriate avenues to assure that
auditors approach the audit with the required
independence, objectivity and professional
skepticism.
The PCAOB’s main focus is on mandatory audit firm
rotation and it is soliciting comments on the advantages
and disadvantages of such an approach. Mandatory audit
firm rotation would limit the number of consecutive years
for which a registered public accounting firm could serve
as the auditor of a public company. According to the
PCAOB, by ending a firm’s ability to turn each new
engagement into a long-term income stream, mandatory
audit rotation could fundamentally change the audit firm’s
relationship with its audit client and might, as a result,
significantly enhance the auditor’s ability to serve as an
independent gatekeeper.
The concept release notes that proponents of rotation
believe that setting a term limit on the audit
relationship could free the auditor, to a significant
degree, from the effects of client pressure and offer an
opportunity for a fresh look at the company’s financial
reporting.
In contrast, opponents express concerns about the
costs of changing auditors and the need to divert
management resources to educate a new audit firm
and believe that audit quality may suffer in the early
years of an engagement and that auditor rotation
could exacerbate that issue.
The PCAOB is seeking comments on a number of specific
questions, including the appropriate length of the allowed
term and whether it should consider a rotation
requirement only for audit tenures of more than 10 years;
whether a rotation requirement should apply to all audits
or only to those of the largest issuer clients; and how it
could mitigate transition issues. The PCAOB is also
seeking comment on whether there are other measures
that could meaningful enhance auditor independence,
objectivity and professional skepticism.
Comments are due on 14 December 2011. The PCAOB will
hold a roundtable on the topic in March 2012.
The concept release is available at:
http://pcaobus.org/Rules/Rulemaking/Docket037/Relea
se_2011-006.pdf.
Corporate Governance Trends: Shearman & Sterling’s 9th Annual Surveys of Selected Corporate Governance Practices
In September 2011, we published our 9th Annual Surveys
of Selected Corporate Governance Practices of the 100
largest US public companies for 2011. For non-US
companies, whether listed in the US or not, the practices
and trends of the largest US companies provide instructive
information in an increasingly convergent global
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corporate governance environment. And today in a
continuing period of global economic challenge, the
pressure for change in corporate governance practices has
intensified.
This year, our General Governance Practices and Director
& Executive Compensation surveys provide an in-depth
analysis of practices and trends shedding light on how
companies are addressing important governance issues.
Our surveys include findings and observations related to
board structure, majority voting, risk management, anti-
takeover defenses, shareholder and management proxy
statement proposals, say-on-pay, claw back policies and
executive and director stock ownership guidelines.
With the passage of the landmark Reform Act in 2010, the
focus in the US over the past year has been on creating the
rules and regulations called for by the Reform Act. As our
survey shows, even though shareholders were not quite as
active during the 2011 proxy season as they were in 2010,
companies and their boards continue to face significant
investor scrutiny. In the executive compensation area, it
was a year of transition. For example, the adoption of
mandatory say-on-pay required many public companies to
rethink their compensation programmes and processes, as
well as how they present this information to shareholders
such as the relationship of compensation to risk.
Our corporate governance web site is available at:
http://corpgov.shearman.com for more information about
our surveys, our annual corporate governance symposium
to be held on 18 October 2011 in New York and our
corporate governance practice.
Trends from the 2011 Proxy Season: ISS Reports
US Proxy Season
On 1 August 2011, the Institutional Shareholder Services
Inc. or ISS, an influential proxy advisory firm, published
its Preliminary 2011 US Postseason Report. According to
ISS, the key takeaways from the 2011 US proxy season are
the following:
Advisory Votes on Compensation
“Say-on-Pay” Votes. During the first year of
advisory votes on executive compensation under the
Reform Act, investors overwhelmingly endorsed
companies’ pay programmes, providing 91.2 percent
support on average.
Shareholders voted down management “say-on-
pay” proposals at only 37 Russell 3000
companies, or just 1.6 percent of the total that
reported vote results. Most of the failed votes
apparently were driven by pay-for-performance
concerns. Factors contributing to investor
dissent were large negative share returns, tax
gross-ups, discretionary bonuses, inappropriate
peer benchmarking, excessive pay, and failure to
address significant opposition to compensation
committee members in the past.
Frequency of Votes. Investors overwhelmingly
supported an annual frequency for future pay votes.
As of 30 June, annual votes had garnered
majority (or plurality) support at 1,792
companies in the Russell 3000 index, as
compared to triennial votes, which won the
greatest support at 412 companies, and biennial
votes, which received the most support at just 16
firms.
Golden Parachute Votes. The Reform Act also
requires companies to hold separate shareholder
votes on “golden parachute” arrangements when they
seek approval for mergers, sales, and other
transactions. Given that the SEC rules on this
mandate did not take effect until 25 April, few
companies held parachute votes this season.
As of 21 July, six Russell 3000 companies had
conducted golden parachute votes, and five
received more than 89 percent support.
Impact of “Say-on-Pay” and Look Ahead.
“Say-on-pay” votes, while increasing investors’
workloads, spurred greater engagement by companies
and prompted some firms to make late changes to
their pay practices to win support.
In a recent speech, SEC Commissioner Luis
Aguilar observed that advisory votes appear to
be facilitating an increase in communication
between issuers and shareholders, and have
resulted in positive changes to many companies’
executive pay practices.
Looking ahead to 2012, many investors will be
looking to see how companies respond to failed
votes and significant dissent, with issuers that
received greater then 30 percent opposition this
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year likely receiving greater attention in 2012.
Shareholders will be looking to see if these
companies make meaningful changes to address
the linkage between pay and performance and
other compensation concerns.
Governance Proposals
General. The overall volume of governance
proposals was down this season, mainly due to the
absence of “say-on-pay” proposals, which became
unnecessary after the passage of the Reform Act.
Board Declassification. Among governance
proposals, the biggest story this year was the greater
support for shareholder proposals seeking board
declassification, which is further evidence of the
waning acceptance of classified boards at large
companies. On average, these resolutions received
73.5 percent support.
Explanations for the surge in support are the
fact that activists primarily targeted large-cap
companies, which generally have greater
institutional share ownership and the focus by
institutional investors on this issue due to a
number of recent Delaware court decisions
upholding poison pills at companies with
classified boards.
Majority Voting and Independent Chair. The
2011 proxy season also showed renewed interest in
majority voting after US Congress removed a majority
voting listing requirement from the Reform Act, with
proposals receiving 59.7 percent approval on average.
Independent chair proposal also fared better this year.
Takeover Defense Limits. There was less
shareholder support for takeover defense limits with
fewer shareholder proposals to repeal supermajority
rules. Explanations for the smaller volume of
proposals are on the one had the fact that companies
were able to omit a number of proposals and on the
other hand that there was an increase in management
proposals on this issue.
Looking Ahead. It appears likely that investors will
again file large numbers of board declassification and
majority voting proposals, while shifting their focus
on mid-cap companies. One key question for 2012 is
how shareholders will respond to the US appeals
court ruling that struck down the SEC’s controversial
proxy access rule.
Other Proposals
Environmental and Social Issues. Investor
support for shareholder resolutions on environmental
and social issues continued to rise. This year, there
was a 20.6 percent average approval rate for these
proposals, the first time the support level reached the
20 percent mark. Five proposals received a majority
of votes cast, a new record.
Director Nominations. The arrival of “say-on-
pay” contributed to a significant decline in
shareholder opposition to directors. As of 30 June,
just 43 directors at Russell 3000 firms had failed to
win majority support, down from 87 in the same
period in 2010.
Poor meeting attendance, the failure to put a
poison pill to a shareholder vote, and the failure
to implement majority-supported shareholder
proposals were among the reasons that
contributed to majority dissent against board
members this year.
The full ISS Preliminary 2011 US Postseason Report is
available at:
http://www.issgovernance.com/docs/2011USSeasonPrevi
ew.
European Proxy Season
In addition, on 12 September 2011, ISS published its
European Voting Results Report, aimed at capturing
voting patterns at shareholder meetings in Europe. The
report places its emphasis upon European wide trends
over the last four years, with a focus on the areas of
disclosure, turnout and dissent and covers shareholder
meetings that took place in 17 key European markets. The
key conclusions of ISS’s report are the following:
Disclosure of Voting Results
Voting result disclosure continued to improve in more
markets than it regressed; however, given that full
disclosure is now legally required in most markets
surveyed, ISS found it disappointing to record that
only five markets have all companies disclosing their
results in full.
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Improvement in this area is considered a key stepping
stone in encouraging shareholders to participate at
meetings as it helps them to understand the
implications of their voting stance at individual
meetings, as well as gauging overall market sentiment
on different proposals.
Voter Turnout
Europe-wide turnout has increased over the previous
four years with 2011 exhibiting the highest turnout
recorded. This is partly due to the implementation of
the EU Shareholder Rights Directive and the removal
of barriers to voting, as well as the increasing interest
in best practice codes that seek to encourage and
enhance the benefits of more active engagement
through such participation.
The UK saw its highest ever year-on-year increase in
2011 most likely following the implementation of the
UK Stewardship Code.
In addition, the troubled European countries Greece,
Ireland and Portugal all saw a significant increase in
the level of turnout for 2011.
Shareholder Dissent
Although the overall level of dissent remained static
over the past four years, trends in the type of proposal
can be identified over the same period. Dissent on the
discharge of directors, director nominations and M&A
activity has declined over the last four years, whereas
dissent on capital authorities has increased.
Remuneration-related proposals and the approval of
share plans remained the most contentious items
recording the highest dissent on average, although
2011 saw a decline in both. This is possibly in light of
improved company performance and a movement
towards best practice.
The number of proposals rejected has slightly
increased this year, with capital authorities and share
plans being the most rejected items.
The number of companies with shareholder proposals
on their ballots has slowly increased over the past four
years, with an uptick in the number of companies
with accepted proposals in 2011.
The full ISS European Voting Results Report is available
at:
http://www.issgovernance.com/docs/2011EuropeanVotin
gResultsReport.
Noteworthy US Securities Law Litigation
US Federal District Courts analyse Rule 10b-5
liability of corporate insiders applying US
Supreme Court “ultimate authority” standard
established in Janus: In re Merck Securities
Litigation and Hawaii Ironworkers Annuity
Trust Fund v. Cole. In our July 2011 Newsletter, we
reported on the decision in Janus Capital Group v. First
Derivative Traders, where the US Supreme Court held
that “the maker of a statement” for purposes of pleading
and proving securities fraud under Section 10(b) and Rule
10b-5 is the person or entity with “ultimate authority” over
the statement, including its content and whether and how
to communicate it. Following this decision, two federal
district courts have recently analysed Janus’s application
to corporate insiders.
In In re Merck Securities Litigation, the plaintiffs alleged
that a corporate officer was liable under Section 10(b)
because he signed SEC filings that included material
misstatements and he made material misstatements in
news reports. The officer argued that, even though the
plaintiffs identified alleged misstatements attributed to
him, he should not be held liable because the corporation
had “ultimate authority” over the alleged misstatements
and not him. The court rejected this argument and stated
that, “[t]aken to its logical conclusion, the officer’s position
would absolve corporate officers of primary liability for all
Rule 10b-5 claims, because ultimately, the statements are
within the control of the corporation which employs
them.” The court distinguished Janus by stating that the
defendant in that case acted on behalf of a “separate and
independent entity,” and not on behalf of the corporation
that made the alleged misstatements. Because the
corporate officer in Merck made alleged misstatements
pursuant to his authority to act as an agent of the
corporation, the court ruled that he had “ultimate
authority” over the statements and could be held liable
under Section 10(b).
In Hawaii Ironworkers v. Cole, the plaintiffs alleged that
four officers were liable under Section 10(b) because they
provided false accounting information that was
incorporated into the company’s SEC filings. The
defendants argued that, even if they provided false
20
accounting information that was incorporated into public
statements, they could not be held liable because they did
not have ultimate authority over the public statements.
The court agreed and stated that “it is not enough to have
drafted the statement; only the person or entity with
ultimate authority can be found to have made the
statement.” The court explained that Janus’s holding is
not limited to “legally separate entities” that contribute to
or participate in making a misstatement. It also applies to
corporate insiders who draft misstatements, but do not
have ultimate authority over the statements. The court
distinguished Merck by stating that the alleged
misstatements in that case were attributed directly to the
corporate officer who signed the SEC forms and who was
quoted in articles or reports, whereas in this case, the
misstatements were not publicly attributed to any of the
defendants. As a result, the court held that under Janus,
the defendants were not the maker of the statements and
could not be held primarily liable.
US Court of Appeals clarifies standard for
Securities Act liability for alleged misstatements
of opinion: Fait v. Regions Financial Corp. In
August 2011, the US Court of Appeals for the Second
Circuit affirmed the district court’s dismissal of a
securities class action under Sections 11 and 12 of the
Securities Act because the alleged misstatements were
matters of opinion and the plaintiffs had not plausibly
alleged that the opinions were objectively false and
disbelieved by the defendant at the time they were made.
The plaintiffs alleged in the complaint that, despite
adverse trends in the mortgage and housing markets in
2008, the defendants failed to write down goodwill and to
sufficiently increase loan loss reserves. As a consequence
of these failures, the defendants allegedly included
materially false and misleading statements about goodwill
and loan loss reserves in the registration statement for an
offering. The defendants moved to dismiss the complaint
on the ground that the challenged statements were
matters of opinion that the defendants believed at the time
they were made. The district court granted the defendants’
motion to dismiss and the Second Circuit affirmed. The
court explained that goodwill and loan loss reserves
depended on management’s judgement and were not
matters of objective fact. As a result, in order to give rise to
liability under the Securities Act, the plaintiffs had to
allege not only that the opinions were false, but also that
the defendants did not believe the opinions when they
were made. Because the plaintiffs did not plausibly allege
that, the court ruled that they failed to state a claim under
the Securities Act.
This case highlights the different pleading requirements
for alleged misstatements of fact and opinion under
Securities Act. If the alleged misstatement is factual, then
a plaintiff is required to plausibly allege that the statement
is objectively false. If, however, the alleged misstatement
is a matter of opinion, then the plaintiffs must plausibly
allege both that the opinion is objectively false and that
the statement, when made, did not reflect the defendant’s
true opinion.
New York federal court applies US Supreme
Court’s tolling doctrine to statute of repose: In re
Morgan Stanley Mortgage Pass-Through
Litigation. In September 2011, a federal court in New
York ruled that the statute of repose that governs claims
under the Securities Act can be tolled under the American
Pipe doctrine. As background, the Securities Act has a one
year statute of limitations and a three year statute of
repose. The statute of limitations begins to run when a
plaintiff discovers, or a reasonably diligent plaintiff would
have discovered, facts constituting a violation of the
securities laws. The statute of repose, on the other hand,
begins to run when the securities are offered to the public
and is designed to provide certainty by extinguishing the
securities claim after a three-year period. Under the US
Supreme Court’s opinion in American Pipe, the
commencement of a class action suspends the applicable
statute of limitations as to all members of the purported
class. The defendants asserted that, unlike a statute of
limitations, a statute of repose is meant to be absolute and
cannot be tolled. The court, however, disagreed and ruled
that the American Pipe tolling doctrine equally applied to
a statute of repose. The court explained that, under
American Pipe, members of the purported class are
treated as parties to the class action and therefore the
limitation and repose periods do not run against them
while the class action suit is pending. Because the statute
of repose was tolled during the pendency of the original
complaint, the court ruled the new claims that were added
in the amended complaint were timely filed.
This case is at odds with two other recent rulings from
federal district courts in New York, which ruled that
American Pipe did not toll the statute of repose. This issue
is currently on appeal in the Second Circuit and could
have a significant impact on securities class action
procedure. If the Second Circuit rules that statutes of
21
repose cannot be tolled, then members of the purported
class who are not named plaintiffs will potentially look for
strategies to preserve their interests before the repose
period expires, such as filing placeholder lawsuits or
motions to intervene.
Recent SEC/DOJ Enforcement Matters
US Department of Justice enters into plea
agreement with Bridgestone Corporation for
FCPA violations. In September 2011 Bridgestone
Corporation, a company with headquarters in Tokyo,
agreed to plead guilty and pay a US$28 million criminal
fine for, among other things, conspiring to make corrupt
payments to government officials in various Latin
American countries in violation of the Foreign Corrupt
Practices Act (“FCPA”). The US Department of Justice
(“DOJ”) alleged that Bridgestone, a manufacturer of
marine hoses that are used to transfer oil between tankers
and storage facilities, violated the FCPA by authorising
and approving corrupt payments to foreign government
officials employed at state-owned entities. The DOJ also
alleged that, when Bridgestone secured a sale, it paid the
local sales agent a “commission” consisting of not only the
local sale agent’s actual commission, but also the corrupt
payments that the agent then passed to the employees of
the state-owned customer.
Under the plea agreement, the DOJ agreed to recommend
a substantially reduced fine because of Bridgestone’s
cooperation with the investigation, including conducting a
worldwide internal investigation, voluntarily making
employees available for interviews, and collecting,
analysing and providing to the DOJ evidence and
information. In addition, Bridgestone has committed to
continuing to enhance its compliance programme and
internal controls.
This case shows the DOJ’s continued aggressive
enforcement of FCPA violations around the world.
SEC settles FCPA charges against Diageo plc. In
July 2011, Diageo plc, a producer of premium alcoholic
beverages, settled charges filed by the SEC, which alleged
that it violated the FCPA by making improper payments to
government officials in India, Thailand, and South Korea.
The SEC alleged that Diageo paid more than US$2.7
million in illicit payments to government officials through
its subsidiaries to obtain lucrative sales and tax benefits
relating to its Johnnie Walker and Windsor Scotch
whiskeys. The SEC stated that Diageo and its subsidiaries
concealed these improper payments in their books and
records by recording them as legitimate expenses for
third-party vendors, or categorising them in vague terms.
Without admitting or denying the findings, Diageo agreed
to cease and desist from further violations and to pay over
US$13 million in disgorgement and prejudgement interest
and a financial penalty of US$3 million. Diageo also
agreed to cooperate with the SEC’s investigation and
implement certain remedial measures, including the
termination of employees involved in the misconduct and
significant enhancements to its FCPA compliance
programme.
ASIAN DEVELOPMENTS
Chinese Listing for Overseas Companies
In our October 2010 Newsletter, we reported on the
launch of the International Board of the Shanghai Stock
Exchange, which is still highly anticipated, both within
and outside China. The International Board would allow
qualified foreign companies to list their shares in China
and have them traded in Renminbi. The draft listing rules,
including guidelines for listing, trading, settlement and
disclosure, have been substantially completed, although
the launch date remains uncertain. While the Chinese
Government has not yet formally announced a timetable
for the launch of the International Board, it is expected to
launch in 2012, with many high profile foreign companies
lobbying to be among the first group of companies
approved for listing.
The following is a summary of certain key provisions of
the draft listing rules:
Qualification Requirements. Foreign companies
seeking a listing on the International Board must
meet the following requirements:
Having maintained an overseas listing for at
least the previous three years;
Having a market capitalisation of at least
RMB30 billion (approximately US$4.7 billion)
at the time of the application for listing;
Having an aggregate net profit of at least RMB3
billion (approximately US$470 million) in the
three financial years preceding the application
for listing; and
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Having an aggregate net profit of at least RMB1
billion (approximately US$157 million) in the
twelve months preceding the application for
listing.
Public Shareholding. Foreign companies with a
total market value of RMB400 million (approximately
US$63 million) or less must have a minimum of 25
percent of the total share capital issued through a
public offering. Foreign companies with a total
market value of more than that amount must have a
minimum of 10 percent of the total share capital
issued through a public offering.
All shares listed on stock exchanges overseas
and on the International Board will be counted
to determine whether the minimum public
shareholding requirement has been satisfied;
however, shares listed on the International
Board must account for at least 5 percent of the
total listed shares. Foreign companies with large
market capitalisation may be granted some
flexibility regarding this requirement.
Accounting Method. Currently, the draft listing
rules require foreign companies listed on the
International Board to engage a PRC-accredited
accounting firm to audit their financial statements in
accordance with PRC GAAP. However, since the
European Union agreed in 2008 to recognise PRC
GAAP as equivalent to IFRS and has granted China
equivalent status regarding audit oversight in early
2011, China may consider reciprocal treatment and
permit foreign companies incorporated in the EU to
list on the International Board with financial
statements and audit reports issued by EU-accredited
accounting firms in accordance with IFRS.
Use of VIE Structure in China
In September 2011, multiple media sources reported that
the China Securities Regulatory Commission (the “CSRC”)
had prepared and submitted in August 2011 a report to the
State Council to propose the implementation of more
stringent and comprehensive regulation and control over
the use of the variable interest entity structure (the “VIE
structure”).
The main feature of the VIE structure is that control
over, and the economic benefits from, operating
assets in China are obtained through contractual
arrangements rather than direct ownership. This
structure has been widely used in foreign investment
and financing transactions in China as a way of
allowing foreign investors to obtain control of
domestic PRC entities in industries where foreign
ownership is restricted or prohibited. Leading PRC
law firms have also taken the position that
acquisitions of equity or assets of domestic companies
by foreign investors and overseas listings of domestic
companies through offshore special purpose vehicles
using the VIE structure are not required to undergo
certain review and approval procedures of the
Ministry of Commerce (“MOFCOM”) and the CSRC,
which are otherwise generally required under the
Regulations on the Mergers and Acquisitions of
Domestic Enterprises by Foreign Investors (“Circular
No. 10”).
In the report, the CSRC is said to have criticised the VIE
structure as being abused by market players to circumvent
China’s foreign investment restrictions, the review and
approval procedures under Circular No. 10 and other
regulations, citing recent high profile US listings of leading
Chinese internet companies as examples. Policy-related
suggestions made in the report include that any overseas
listing using the VIE structure should be subject to the
review and approval of MOFCOM and the CSRC, and PRC
lawyers and auditors should not be allowed to issue
unqualified opinions on the VIE structure in overseas
listing transactions. The report, however, also
recommended that companies already listed overseas
using a VIE structure should be allowed to keep their
current listings, and the PRC Government should reform
domestic listing rules to encourage companies to seek
domestic PRC listings. The CSRC has not confirmed the
content or the existence of this report, and some
commentators have dismissed the report as being an
internal preliminary policy paper that was never meant for
wider circulation outside of the CSRC.
Even before the media coverage of the CSRC report, the
VIE structure had recently been at the centre of a dispute
involving the leading online B2B marketplace Alibaba’s
spin-off of its payment solution provider Alipay as a
separate domestic PRC entity for what it claimed were
PRC regulatory reasons. Also, in August 2011, MOFCOM
promulgated rules to implement a security review system
for transactions involving foreign investors acquiring or
obtaining “de facto control” of domestic PRC entities of
23
national security concerns, which unequivocally subject
the VIE structure used in those transactions to MOFCOM
review and approval procedures. If the policy
recommendations included in the CSRC report are
adopted, it could significantly impair the ability of Chinese
companies in restricted industries to seek foreign
financing and overseas listings, as MOFCOM and CSRC
review and approval procedures would likely present
significant hurdles, both in terms of the substantive
requirements for such approvals and the potential delays
they could cause.
Nevertheless, the current prevailing view is that any new
regulation is unlikely to be adopted within the next six to
nine months, particularly in light of the expected
leadership change within the PRC central government in
2012. However, this additional uncertainty regarding
potential future regulatory actions could cause companies
that have adopted a VIE structure and are contemplating
an overseas listing to accelerate their listing plans in order
to complete their listings before new regulations, if any,
take effect. It may also cause private equity and other
investors to think twice before making new investments
into businesses that are organised using VIE structures.
DEVELOPMENTS SPECIFIC TO FINANCIAL INSTITUTIONS
EU Developments
Remuneration - EBA Consultation Papers on Bank Remuneration Data Collection
On 28 July 2011, the European Banking Authority (“EBA”)
published two consultation papers on the collection of
bank remuneration data. The requirements for disclosure
are set out in the current capital requirements regime
consisting of two directives (together “CRD III”), although
the European Commission has published its proposals for
amendments to CRD III (“CRD IV”) as noted below.
In accordance with CRD III, the EBA is proposing
that information about the number of individuals in a
credit institution whose salary is in excess of €1
million will be made public at an aggregate level on a
Member State basis. This requirement to collect
aggregate quantitative information on remuneration
would apply to significant institutions constituting 60
percent of the market share of the Member State.
National regulators have the discretion to determine
which firms are significant institutions. Should the
FSA choose to align its determination of significant
firms with its current tier one classification of firms
under the existing UK remuneration regime the
information requirements in the UK would not be
significantly altered.
The EBA’s proposal for CRD IV imposes an obligation
on financial institutions to publicly disclose the
number of individuals with a remuneration of €1
million or more, broken into pay bands of €500,000.
This requirement is limited to individuals in certain
defined management categories. The proposals for
CRD IV are still in draft form.
The consultation papers are available at:
http://www.eba.europa.eu/cebs/media/Publications/Con
sultation%20Papers/2011/CP46/CP46-Draft-Guidelines-
on-the-remuneration-benchmark-exercise.pdf.
http://www.eba.europa.eu/cebs/media/Publications/Con
sultation%20Papers/2011/CP47/CP47-Draft-Guideline-
on-data-collection-for-high-earners.pdf.
EU Implementation of Basel III
On 20 July 2011, the European Commission published its
proposals for amending the EU capital requirements
regime in response to the Basel III reforms. The proposals
are intended to replace CRD III with a new directive, CRD
IV, and a detailed regulation which would be directly
applicable across Member States and include the
following:
Authorities would be empowered to impose sanctions
that are effective, proportionate and dissuasive and
such sanctions could apply to individuals. The penalty
for certain breaches would be set at 10 percent of total
annual turnover or income, for an individual, or twice
the amount of the benefit derived from the breach,
where the benefit can be determined. The proposals
do not cover criminal sanctions.
The amount of regulatory capital that firms would be
required to hold in accordance with Basel III would be
increased and, for the first time, minimum liquidity
standards in the form of a liquidity coverage ratio
would be introduced. The details for the ratio will be
determined after a review period scheduled for 2015.
Certain firms would be subject to a leverage ratio,
monitored by competent authorities. Initially,
24
supervisory authorities would have the power to
impose a leverage ratio on individual banks. From
2015, institutions would be required to publish their
leverage ratios. The implications of compulsory
leverage ratios for all institutions will be the subject of
ongoing monitoring and review, with the possibility of
implementation in 2018.
Two further capital buffers would be introduced, a
capital conservation buffer that would be identical for
all banks in the EU, and a countercyclical capital
buffer that would be determined at Member State
level.
Corporate governance provisions would be enhanced
with the stated objective of requiring firms to have
more independent risk management functions and for
credit institutions to have more diverse management
boards, particularly with regards to female
representation.
The European Commission, concerned with over-
reliance on external credit rating agencies, has also
included several incentives for firms to use internal
rather than external credit ratings, even for the
purposes of calculating regulatory capital
requirements.
Other amendments to the current regime are
designed to encourage banks to centrally clear over-
the-counter derivatives.
The proposals are available at:
http://ec.europa.eu/internal_market/bank/regcapital/in
dex_en.htm#crd4.
Basel Consultation Paper on G-SIBs
On 19 July 2011 the Basel Committee on Banking
Supervision (the “Basel Committee”) published a
consultation paper setting out an assessment methodology
for identifying global systemically important banks (“G-
SIBs”). Seeking to address concerns that global systemic
risk may not easily be identified by current national or
regional regulatory policies, the Basel Committee sets out
a methodology for identifying G-SIBs and imposes
additional capital requirements on them to enhance their
loss absorbency.
Putative G-SIBs would be identified by measuring the
impact of their failure on the global financial system, using
the following five indicative characteristics: size,
interconnectedness, lack of substitutability, global, i.e.,
cross-jurisdictional, activity and complexity. G-SIBs, once
identified, would be required to have a further Common
Equity Tier 1 capital requirement ranging from 1 percent
to 2.5 percent to ensure enhanced loss absorbency. The
increased loss absorbency requirements would be
introduced in parallel with the Basel III capital
conservation and countercyclical buffers, becoming fully
effective on 1 January 2019.
Responses to the paper included suggestions that the
indicators be more risk sensitive, less relative and that the
assessment and calculation for further capital
requirements for G-SIBs be more transparent such that G-
SIBs will be in an informed position to reduce their global
systemic risk profiles.
The consultation paper is available at:
http://www.bis.org/publ/bcbs201.pdf.
FSB Paper on Recovery and Resolution Plans
On 19 July 2011 the FSB and the Basel Committee
launched a public consultation on their proposals for
recovery and resolution plans (“RRPs”) for systemically
important financial institutions (“SIFIs”). The
consultation coincides with the proposals put forward for
identifying G-SIBs discussed above.
The four key objectives are:
to strengthen national resolution regimes by giving
regulatory authorities a broader range of powers and
tools, including statutory bail-ins. The UK has already
set out proposals for the Prudential Regulatory
Authority to have a more proactive role in supervision
and the recent Vickers Report as noted below
discusses bail-ins. A bail-in power enables a
regulatory authority to write down unsecured or
uninsured claims, or convert them into equity,
thereby financing the “internal” recapitalisation and
recovery of a firm;
to increase cross-border cooperation arrangements,
which would give regulatory authorities resolution
powers with regard to all financial institutions
operating in their jurisdictions, including the local
branch operations of foreign institutions;
for RRPs to be informed by ex ante resolution
assessments. Having a RRP in place would be
mandatory for global SIFIs; and
25
to identify and make plans to overcome barriers to
resolution.
Responses to the consultation have noted that there is no
clear timeline for the implementation of the proposals.
The UK has stated its intention to implement its own RRP
regime by 30 June 2012.
The consultation paper is available at:
http://www.financialstabilityboard.org/publications/r_11
0719.pdf.
Basel Committee Responses to FAQ on Liquidity and the Definition of Capital
The Basel Committee has published its responses to
frequently asked questions concerning liquidity and the
definition of capital with respect to the proposed Basel III
regulatory framework. The Basel Committee has agreed to
periodically review further frequently asked questions and
publish answers along with such technical elaborations
and interpretative guidance as it deems necessary. With
respect to questions concerning liquidity, the responses
include worked examples.
The responses are available at:
http://www.bis.org/publ/bcbs198.pdf.
http://www.bis.org/publ/bcbs199.pdf.
German Developments
BaFin Consultation on Interest Rate Risk incurred in the Banking Book
Under the German Banking Act, BaFin may take
supervisory measures if the equity capital of a credit
institution drops by 20 percent or more due to a sudden
and unexpected change of the interest rate. Upon the
occurrence of future stress scenarios that are set forth in
the draft circular, banks are to assume an overnight
parallel shift of the interest rate curve of 200 basis points
in both directions. However, exceeding the 20 percent
threshold set out above will not automatically trigger
supervisory measures. BaFin assures that the capital
resources will be valued on an integrated basis, taking into
account the overall capital ratio described under the
Solvency Ordinance, which specifies the Basel II capital
requirements. The Circular will replace BaFin Circular
7/2007.
BaFin Consultation on further Implementation of the amended Banking Directive and the amended Capital Adequacy Directive
BaFin has issued a consultation on a draft ordinance that
will implement the provisions of Directive 2010/76/EU
(CRD III), which include:
an increase of the equity capital requirements in the
trading books of credit institutions that use their own
market risk models; banks that are not using their
own risk models will only be required to extend the
underlying equity capital for positions in shares;
higher equity capital requirements for re-
securitisations, dependent on the assignable risk
weight; and
additional disclosure requirements.
Restructuring Fund Ordinance Comes into Force
The Restructuring Fund Ordinance, which specifies the
calculation of the bank levy, came into force on 26 July
2011. The final ordinance introduces a levy-free allowance
of €300m, increased contribution rates for relevant
liability positions and derivatives as well as a higher
“reasonable burden” threshold that caps contributions at
20 percent of a bank’s annual net profit, with the objective
to significantly increase the expected income from the
bank levy.
UK Developments
Final FSA Guidance on Remuneration Code
In August 2011 the FSA published its final guidance on the
Remuneration Code. The new guidance includes:
guidance on retention periods – the FSA considers
that the rules that require the deferral of
remuneration in shares or other instruments as part
of variable remuneration will normally be satisfied if
there is a six-month deferral period;
guidance on guaranteed variable remuneration –
under the new guidance, prior notification should be
given and individual guidance sought regarding
whether the award is appropriate if the award is to
certain employees with variable remuneration that
constitutes more than 33 percent of their total
remuneration or if the total remuneration is more
than £500,000. The FSA should be notified of all
26
remuneration packages for certain managers and
risk-takers;
frequently asked questions and detailed responses on
the Remuneration Code; and
templates for the Remuneration Policy Statement
self-assessment, and code staff lists, for firms in tiers
two, three and four.
The FSA also contains two sample “Dear CEO” letters to
be sent to tier one firms and firms in tiers two, three and
four, respectively. These letters set forth how the FSA
intends to assess firms’ implementation of the
Remuneration Code for the coming year and the letter to
tier one firms includes a template for their Remuneration
Policy Statement.
The Remuneration Code implements CRD III, which
aligned remuneration principles across the EU. It is not
yet clear what amendments, if any, to the Remuneration
Code will be necessary as a result of CRD IV, which is
currently undergoing public consultation. For example,
the European Commission has proposed a restriction on
the payment of variable remuneration by credit
institutions and investment firms whose capital falls below
certain buffer levels.
The FSA is also providing guidance for buy-outs of
existing awards of deferred variable remuneration
packages provided by previous employers. Current FSA
rules permit such buy-outs if the buy-out occurs in the
context of hiring new staff and is limited to the first year of
service. The FSA guidance stipulates that prospective
employers take reasonable steps to obtain evidence of the
existing award from the previous employer to ensure they
comply with the Remuneration Code.
The guidance is available at:
http://www.fsa.gov.uk/Pages/About/What/International
/remuneration/fg11_11/index.shtml.
FSA Consultation Paper on Recovery and Resolution Plans
The Financial Services Act 2010 requires the FSA to make
rules regarding Recovery and Resolution Plans or RRPs.
On 9 August 2011 the FSA published a consultation paper
which sets forth its expectations of how firms should be
planning for stress situations, which would require a firm
to take certain actions to recover or, if necessary, wind
down in an orderly manner.
The key proposals are that the recovery plans contain:
material and credible options to cope with a range of
scenarios, including both distinctive and market-wide
stress situations, capital shortfalls, liquidity pressures
and profitability issues, with an aim to return the firm
to a stable and sustainable position;
options the firm would not otherwise consider such as
disposals of entire businesses, parts of businesses or
group entities; unplanned equity capital raisings; and
elimination of dividends and variable remuneration;
and
governance procedures, including triggers and
procedures to ensure timely implementation of
recovery options across identified stress situations.
The resolution plan should aim to:
identify significant barriers to resolution;
minimise the impact on financial stability and on UK
depositors and customers;
allow action to be taken and executed under time
pressure (the so-called “resolution weekend”); and
identify the functions that need to be continued
because of their critical nature to the UK economy or
financial system, the functions that would need to be
proactively wound up to avoid financial instability
and the non-critical functions that would be allowed
to fail.
In case of an insolvency, the relevant insolvency
practitioner would be provided with a CASS Resolution
Pack that would detail investment business client money
and custody assets in order to promote a faster return of
such assets to clients.
The Prudential Regulation Authority will supervise RRPs
and the FSA has stated that such supervision will occur
through the establishment of a proactive intervention
framework. The deadline for consultation is 9 November
2011. It is expected that firms will have RRPs in place by
30 June 2012.
The consultation paper is available at:
http://www.fsa.gov.uk/pages/Library/Communication/P
R/2011/070.shtml.
Vickers Report
On 12 September 2011 the Independent Commission on
Banking (the “Commission”), chaired by Sir John Vickers,
27
released its much awaited final report on the reform of the
UK banking sector (the “Vickers Report”). The Vickers
Report expands on the Commission’s April 2011 interim
report and contains a summary of responses to the
Commission’s consultation.
The Commission’s recommendations include:
ring-fencing banks’ retail and commercial operations.
Only ring-fenced banks, which must be legally and
operationally separate from related investment banks,
will be permitted to carry out certain activities such as
accepting deposits and lending to individuals. Ring-
fencing is intended to protect vulnerable clients from
the risks associated with wholesale and investment
banking;
large ring-fenced banks would be required to
maintain a ratio of equity to risk-weighted assets
(“RWAs”) of at least 10 percent;
UK headquartered global systemically important
banks and large ring-fenced banks would be required
to maintain capital of core equity and bail-in debt of
at least 17 percent of RWAs, with lower requirements
for smaller banks;
all UK headquartered banks would be required to
maintain a Tier 1 leverage ratio of at least 3 percent
(up to 4.06 percent for large ring-fenced banks);
banks’ unsecured debt with a term of 12 months or
more would be subject to a “primary bail-in power”
i.e., a power to write down such debt. All other
unsecured liabilities or liabilities secured only by a
floating charge would be subject to a “secondary bail-
in power” if the primary bail-in power is insufficient;
the priority of creditors in the event of an insolvency
would be changed as bank deposits that are insured
by the Financial Services Compensation Scheme
would be accorded preferential status (above floating
charge holders) and would therefore be better
protected; and
measures to increase competition among UK banks
would be introduced. The Commission is keen to
increase competition in the banking sector, not only
by ensuring a substantial divestiture of the Lloyds
banking group, but also by making it easier to switch
current accounts and increasing transparency for
comparison purposes. Although the Commission
decided not to make a market investigation reference
with respect to the banking sector, it considers that it
might be necessary to do so in the next few years.
The Commission estimates that the costs to UK banks of
implementing its recommendations will be in the range £4
billion to £7 billion. The Commission has noted that the
interaction of the proposals with VAT and pensions law
may necessitate amendments to these areas of the law.
The Commission proposes that its recommendations
should be implemented by the end of 2019, to coincide
with the timeframe agreed for the implementation of the
Basel III reforms. The UK Government has indicated its
intention of providing a legislative response to the Vickers
Report within the current Parliament.
The Vickers Report is available at:
http://bankingcommission.s3.amazonaws.com/wp-
content/uploads/2010/07/ICB-Final-Report.pdf.
Our related client publication is available at:
http://www.shearman.com/files/Publication/3a925aac-
7521-4c0f-8fa5-
b23a8d332062/Presentation/PublicationAttachment/104
3fa6e-d6b8-45bd-9cc7-a9801c2b94d5/FIA-100511-The-
Vickers-Report.pdf.
US Developments
The Leaked Staff Drafts: New Volcker Rule – Related Concerns for Non-US Banks
A leaked draft staff memorandum outlining proposed
regulations to implement the so-called “Volcker Rule”
gave early insight into the thinking of the Federal financial
regulatory agencies. The rule is intended to separate
commercial banks from proprietary trading and private
investment fund activities. The Federal Deposit Insurance
Corporation at a meeting on 11 October 2011 issued the
proposed regulations, totaling 288 pages, in single-space
typescript. The Federal Reserve, the SEC, and the
Comptroller of the Currency, also approved the proposal
in substantially the same form. It appears that the
Commodity Futures Trading Commission will issue its
own corresponding proposed rule covering those financial
institutions subject to its jurisdiction, notwithstanding the
statutory requirement that all of the agencies’
implementing rulemaking proposals be coordinated, to
prevent potential regulatory arbitrage. .
For foreign banks, the draft was troublesome as it in many
respects drew no distinction between US and non-US
28
operations of foreign banks. If adopted in its current form,
foreign banks would need to comply with a complicated
set of rules to avoid being considered to be engaging in a
prohibited activity in the United States. In addition, key
issues for foreign banks include the scope of an exemption
from the trading prohibition for activity occurring outside
the US and recordkeeping requirements.
Our client publication, which provides an overview of
several key issues that should concern non-US banks is
available at:
http://www.shearman.com/files/Publication/ed91e3c0-
b6b5-47c7-945d-
21bf37830e44/Presentation/PublicationAttachment/73ff
0ae7-e07c-4d65-8000-6885436cf51b/FIA-101011-The-
Leaked-Staff-Drafts-New-Volcker-Rule-Related-
Concerns-for-Non-US-Banks.pdf.
FDIC Rule Permits Compensation Recoupment from Executives of Failed Financial Firms
On 7 July 2011 the Federal Deposit Insurance Corporation
(the “FDIC”) adopted a final rule under Section 210(s) of
the Reform Act permitting the US Government to recoup
or “claw back” two years of compensation paid to certain
current and former executives or directors who are
“substantially responsible” for the failure of their financial
firms.
Covered Financial Companies. The new rules
apply to any “covered financial company”, which is
defined as a financial company, other than an insured
depository institution, that satisfies the criteria for
FDIC receivership under Section 203(b) of the
Reform Act. Section 203(b) of the Reform Act
requires, among other things, a determination that
the failure of the financial company would have
serious adverse effects on financial stability in the
United States. “Financial company” means any
company that is (i) incorporated or organised under
any provision of US federal or state law; and (ii) a
bank holding company, non-bank financial company
supervised by the Federal Reserve System or a
company the Federal Reserve has determined is
predominately engaged in activities that are financial
in nature.
Recoupable Compensation. The new rules permit
the FDIC to recoup compensation paid to the
executive or director during the two years preceding
the date upon which the FDIC is appointed receiver
for a failing financial company. If the executive or
director has committed fraud, however, the two-year
time limit will not apply. Compensation is broadly
defined under the rules. Virtually all types of
remuneration, including cash, equity and other non-
cash benefits, such as perquisites and post-
employment benefits, are subject to recoupment. The
FDIC will determine the size of the claw back after
evaluating the executive’s overall role in the firm’s
failure.
Applicability of the Claw Back. In determining
whether to recoup an executive’s compensation, the
FDIC will consider how the executive or director
performed his duties and also the results of that
performance. If the FDIC determines that a current or
former executive or director is “substantially
responsible for the failed condition” of the company,
then the agency may recover the executive’s
compensation from the preceding two years. An
executive or director is “substantially responsible” if
he failed, individually or in conjunction with others,
to carry out his duties with the skill and care an
ordinarily prudent person in a like position would
exercise under similar circumstances, and, as a result,
materially contributed to the failure of the company.
The rule uses an ordinary negligence standard,
requiring only that the executive reasonably should
have known his actions would harm the company.
Presumption of Responsibility. The rules list
certain executives and directors who will be
presumptively responsible for the financial condition
of the company. Responsibility is imparted onto the
executive or director who (i) serves as the company’s
chairman of the board of directors, chief executive
officer, president, chief financial officer or other
officer in a similar strategic or policymaking role; (ii)
is removed from his position in management,
pursuant to other requirements of the Reform Act, as
a result of his contribution to the company’s poor
financial performance; or (iii) is judged by a court to
have breached his duty of loyalty to the company.
Executives will have an opportunity to rebut the
presumption of responsibility. Moreover, those
executives or directors who join a company
specifically for the purpose of improving its financial
condition are exempted from the presumptions if they
29
were employed for this purpose within two years
preceding the FDIC’s appointment as receiver.
Enforcement. The FDIC anticipates that it will
seek recoupment of compensation through the
court system.
The final rules went into effect on 15 August 2011. Our
client publication is available at:
http://www.shearman.com/files/Publication/6d5fa88d
-159e-42d5-b4fa-
aa94e7528ee5/Presentation/PublicationAttachment/71
7c6fc7-38be-4e4d-a376-50b1ad70f5c9/ECEB-072711-
FDIC-Rule-Permits-Compensation-Recoupment-from-
Executives-of-Failed-Financ.pdf.
Increased Enforcement of Money-Laundering and Bribery Legislation by the US Government
In light of the recent political climate and the
magnitude of proceeds from corruption flowing
through the global financial system, various arms of the
US Government have issued warnings to financial
institutions of increased scrutiny of payments to foreign
officials:
The US Treasury Department’s Financial Crimes
Enforcement Network (“FinCEN”) issued
reminders to financial institutions to take
reasonable steps to guard against the flow of funds
that might represent proceeds from bribery,
corruption, misappropriated state assets or other
illegal payments from, or intended for, Tunisia,
Egypt and Libya. FinCEN’s guidance urges
financial institutions to assess the impact of recent
events in the Middle East on patterns of financial
activity when assessing the risks of particular
customers and transactions.
The DOJ also announced two new enforcement
initiatives that will impact financial institutions.
The Kleptocracy Asset Recovery Initiative is
designed to target the proceeds from foreign
corruption laundered into or through the
United States.
Secondly, the DOJ has created a new unit
within the Criminal Division’s Asset
Forfeiture and Money Laundering Section
devoted to investigating complex,
international financial crime, emphasizing
financial institutions and their employees.
US regulators are also increasingly enforcing the
Bank Secrecy Act that requires US financial
institutions to conduct enhanced due diligence on
foreign private banking accounts held by, or on
behalf of, current or former “senior foreign political
figures”.
These initiatives serve as a reminder of the US
Government’s determination to enforce its money
laundering, corruption and sanctions laws and
emphasize the need for financial institutions to have
effective anti-money laundering programmes in place,
containing appropriate risk-based policies and
procedures and due diligence processes to identify
clients. While these initiatives are directed at US
financial institutions, it should be noted that the DOJ
has in the past brought cases against foreign financial
institutions for concealing that certain wire transfers
originated from sanctioned countries.
This newsletter is intended only as a general discussion of these issues. It should not be regarded as legal advice. We would be pleased to provide additional details or advice about specific situations if desired.
If you wish to receive more information on the topics covered in this publication, you may contact your usual Shearman & Sterling representative or any of the following:
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