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Subject:                                Securities Regulation Daily Wrap Up - Jan 17


Wolters Kluwer

Securities Regulation Daily

January 17, 2017

Wolters Kluwer

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In the News


·        Foley & Lardner LLP

·        Goldberg Kohn

·        Locke Lord LLP

·        Morgan,Lewis & Bockius LLP

·        Neely & Callaghan

·        Ogletree,Deakins,Nash,Smoak & Stewart,P.C.

·        Schiff Hardin LLP


·        Adams Capital Management,Inc.

·        Aisling Capital LLC

·        Alta Communications,Inc.


TOP STORY—Moody’s settles claims against its pre-financial crisis conduct for $864 million

By Joseph Arshawsky,J.D.

The Department of Justice,21 states,and the District of Columbia,reached a nearly $864 million settlement agreement with Moody’s Investors Service Inc.,Moody’s Analytics Inc.,and their parent,Moody’s Corporation (collectively,Moody’s). The settlement resolved allegations arising from Moody’s role in providing credit ratings for residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDO),contributing to the worst financial crisis since the Great Depression.

During the years leading up to the financial crisis,Moody’s was a nationally recognized statistical ratings organization. For a fee,Moody’s issued alphanumeric credit ratings of structured finance instruments,including RMBS and CDOs. Moody’s also issued credit ratings of corporate bonds and other types of structured finance instruments,financial and non-financial entities,and governments,among other things.

The settlement agreement resolved pending state court lawsuits in Connecticut,Mississippi,and South Carolina,as well as potential claims by the Justice Department,18 states and the District of Columbia. The multi-faceted settlement included a statement of facts in which Moody’s acknowledged key aspects of its conduct,and a compliance agreement to prevent future violations of law.

Statement of Facts. The statement of facts addressed Moody’s representations to investors and the public generally about: 1) its objectivity and independence; 2) its management of conflicts of interest; 3) its compliance with its own stated RMBS and CDO rating methodologies and standards; and 4) the analytic integrity of certain rating methodologies.

The statement of facts addressed whether Moody’s credit ratings were compromised by what Moody’s itself acknowledged were the conflicts of interest inherent in the so-called "issuer pay" model,under which Moody’s and other credit rating agencies were selected by the same entity that put together and marketed the rated securities and therefore stood to benefit from higher credit ratings.

Among other things,Moody’s acknowledged:

·        Moody’s published and maintained online its "Code of Professional Conduct" for the stated purpose of promoting the "integrity,objectivity,and transparency of the credit ratings process," including managing conflicts of interest that it publicly acknowledged arose from the fact that RMBS and CDO issuers determined whether to retain Moody’s to rate these securities.

·        Moody’s passed these conflicts on to the managing directors of the business units,who were then asked to resolve the "dilemma" between maintaining ratings quality and the need to win business from the issuers that selected them.

·        Moody’s publicly stated that its ratings "primarily address the expected credit loss an investor might incur," which included its assessment of both the "probability of default" and the "loss given default" of rated securities.

·        Starting in 2001,Moody’s RMBS group began using an internal tool in rating RMBS that did not calculate the loss given default or expected loss for RMBS below Aaa and did not incorporate Moody’s own rating standards. Instead,the tool was designed to "replicate" ratings that had been assigned based on a previous model that calculated expected loss for each tranche and incorporated Moody’s rating level standards. In October 2007,a senior manager in Moody’s Asset Finance Group (AFG) noted the following about Moody’s RMBS ratings derived from the tool: "I think this is the biggest issue TODAY. [A Moody’s AFG Senior Vice President and research manager]’s initial pass shows that our ratings are 4 notches off."

·        Starting in 2004,Moody’s did not follow its published idealized expected loss standards in rating certain Aaa CDO securities. Instead,Moody’s began using a more lenient standard for rating these Aaa securities but did not issue a publication about this practice to the general market.

·        In 2005,Moody’s authorized the expanded use of this practice to all Aaa CDO securities and,in 2006,formally authorized the use of this practice,or of an even more lenient standard,to all Aaa structured finance securities. Throughout this period,although "[m]any arrangers and issuers were aware" that Moody’s was using a more lenient Aaa standard,Moody’s did not issue publications about these decisions to the general market.

The statement of facts further addressed other important aspects of Moody’s rating methodologies,including its "inconsistent use of present value discounts" in assigning CDO ratings and its selection of assumptions about the correlations between assets in CDOs.

Compliance commitments. Under the terms of the compliance commitments,Moody’s agreed to maintain a host of measures designed to ensure the integrity of its credit ratings. These include:

·        Separation of Moody’s commercial and credit rating functions by excluding analytical personnel from any commercial related discussions and excluding personnel responsible for commercial functions from determining credit ratings or developing rating methodologies;

·        Independent review and approval of changes to rating methodologies by maintaining separate groups to develop and review rating methodologies;

·        Changes to ensure that specified personnel are not compensated on the basis of the company’s financial performance;

·        Enhancing Moody’s oversight functions to monitor the content of press releases and the timeliness of methodology development;

·        Deploying new technological platforms and centralized systems for documentation of rating procedures; and

·        Certifications of compliance by the President/CEO of Moody’s with these commitments for at least five years

Penalties. In addition to the non-monetary measures,such as the compliance commitments,the settlement includes a $437.5 million federal civil penalty,which is the second largest payment of this type ever made to the federal government by a ratings agency. The remainder,over $426 million,will be distributed among the settlement member states in alignment with terms of the agreement,as compensation for the harm they suffered as a result of Moody’s conduct.

Companies: Moody’s Investors Service Inc.; Moody’s Analytics Inc.; Moody’s Corp.

MainStory: TopStory CreditRatingAgencies Enforcement FraudManipulation

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STRATEGIC PERPECTIVES—2016 in review: technology and trends

By Amy Leisinger,J.D.

Today,Securities Regulation Daily examines 2016 trends in financial technology and product development and an enhanced focus on the application of existing laws and regulations and the need for new approaches in light of these changes. In particular,Amy Leisinger notes the evolving discussions of cybersecurity concerns and blockchain technology and ongoing disclosure changes and administrative questions in 2016 in review: Cybersecurity and blockchain evolve,disclosure and agency authority continue to trend.

MainStory: CFTCNews CommodityFutures CorporateGovernance CyberPrivacyFeed ExchangesMarketRegulation FinancialIntermediaries InternationalNews PublicCompanyReportingDisclosure SECNewsSpeeches Swaps

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REGULATION TRACKER—Upcoming SEC and CFTC comment deadlines and effective dates

For Proposed Rules Comment Calendars and tables of Final Rule Effective Dates,please consult the Securities Regulation Daily SEC and CFTC Regulation Trackers. Recent activity includes the following:

Consolidated Audit Trail. On November 15,the SEC voted unanimously to approve a proposed national market system plan to create,implement,and maintain a consolidated audit trail that will allow regulators to track all activity throughout the U.S. markets in NMS securities. Chair Mary Jo White said that the central repository for trade and order data will improve regulators’ ability to conduct market research,reconstruct market events,and identify and investigate market misconduct. The SEC has yet to post the proposal release.

Universal proxy. On October 26,SEC Chair Mary Jo White and Commissioner Kara Stein voted to move forward with a proposal to require the use of a universal proxy card in all contested board elections that are subject to the Exchange Act,over the objection of Commissioner Michael Piwowar. The commissioners also unanimously approved a separate initiative to provide exemptions to help facilitate intrastate and regional securities offerings. Please see the SEC Regulation Tracker for details.

Investment company reporting modernization. The SEC on October 13 approved three sets of final rules and form amendments affecting investment companies’ reporting and operations. The Commission unanimously authorized changes to require mutual funds and other open-end management investment companies to adopt liquidity risk management programs,and voted 2-1 to adopt amendments related to swing pricing and modernization of reporting.

Capital requirements. The CFTC has unanimously approved proposed rules establishing minimum capital requirements for swap dealers (SDs) and major swap participants (MSPs). The rules,called for by the Dodd-Frank Act enacted in 2010,were long in coming. With margin requirements becoming finalized and implemented over the past few years,the Commission is now taking this opportunity to move the rulemaking process forward and bring further clarity to the swap community on these important issues. Please see the CFTC Regulation Tracker for details.

Position limits. The CFTC re-proposed regulations to implement limits on speculative positions in 25 core physical commodity futures contracts and their "economically equivalent" futures,options,and swaps. The reproposal includes amendments to definitions and provisions regarding exemptions,reporting requirements,and acceptable practices for exchange position limits. The CFTC also issued a final rule to amend part 150 of the Commission’s regulations regarding the policy for aggregation under the Commission’s position limits regime for futures and option contracts on nine agricultural commodities.

Revisions to Regulation Automated Trading (AT) proposal. The CFTC issued a Supplemental Proposal making significant changes to Regulation Automated Trading (AT),the proposed rules issued in late 2015. The Supplemental Proposal would substantially revise proposed risk control requirements,including broadening the scope from algorithmic trading to all electronic trading and changing the types of market participants required to maintain risk controls. Other proposed revisions include reduced reporting requirements,the addition of a volume-based test to a proposed registration requirement for proprietary traders,and a change in the way the CFTC would obtain algorithmic trading software or "source code" from trading firms.

Swap data access. The CFTC proposed rule amendments to make it easier for domestic and foreign regulators to access swap data repository (SDR) swap data.

Recordkeeping. The CFTC voted unanimously to propose amendments to recordkeeping requirements set forth in Regulation 1.31.

RegulatoryActivity: AccountingAuditing ClearanceSettlement CFTCNews CommodityFutures Derivatives DoddFrankAct Enforcement ExchangesMarketRegulation FormsFilings InternationalNews InvestmentCompanies IssuerRegistration PublicCompanyReportingDisclosure RiskManagement SECNewsSpeeches Swaps WhistleblowerNews

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SEC NEWS AND SPEECHES—White warns of potential threats to SEC’s historic independence

By Jacquelyn Lumb.

SEC Chair Mary Jo White,in remarks to the Economic Club of New York,looked ahead to the challenges facing the Commission after her departure,including threats to its independence. She characterized her tenure as the first post-crisis Commission since it followed the financial crisis and has been reshaped by the major legislation that was adopted in response. That legislation is still being debated,she said,and it faces a new round of Congressional activity. White said her bottom line is that in order to be a strong market regulator,the SEC must use all of its tools—not just disclosure and enforcement—and it must remain fiercely independent.

White is confident that the SEC in 2017 is better equipped to meet the challenges of the securities markets and to protect investors than it was from 2008 through 2010. She reviewed the reforms that have been adopted in response to the financial crisis and the 2010 flash crash. Some of the continuing debate about the SEC’s role is due to the many statutory mandates that have been imposed over the past six years,in her view,many of which involve very controversial issues. These statutory mandates have occupied a great deal of the SEC’s agenda,but White said the staff has also continued to address important "day jobs" such as reviewing issuer filings and overseeing exchange operations.

Guiding principles. White described three principles that are essential to remaining a strong capital markets regulator in the aftermath of the financial crisis. Investor protection must remain paramount; investors must be allowed to take informed risks and face the consequences; and the capital markets must be viewed in the context of the larger financial system.

Disclosure will continue to be a key component in the SEC’s post-crisis regulation,according to White,but disclosure alone cannot adequately protect investors. The SEC also must use its authority to regulate participants in the securities markets,including exchanges,broker-dealers,investment companies and advisers. She said the challenge is achieving the appropriate regulatory balance while ensuring that investors are protected,markets are orderly,and issuers can attract capital.

Issues for new chair and Commission. The appropriate regulatory path will continue to evolve,White noted. In reviewing some of the SEC’s post-crisis initiatives,she urged the next chair and Commission to prioritize the completion of fund liquidity and derivatives proposals and to continue the initiative to address instability in the equity markets posed by certain trading strategies.

White also encouraged the next chair to continue to update the financial responsibility rules for broker-dealers and the guidance for financial institutions,including bank holding companies. She emphasized the importance of the interrelationships between financial institutions and the markets,in which the Financial Stability Oversight Council plays a role,and said it is important for the Commission to continue to engage in the full array of forums relating to the capital markets,both domestic and international.

Fight for independence. Finally,on the issue of independence,White said it is at the core of the SEC’s mission. She acknowledged that during her tenure the Commission has made hard decisions that attracted criticism from both political parties. Recent trends have raised the question of whether the SEC’s independence can be preserved,she said,such as the increasingly specific statutory mandates,and lots of them. Some of these mandates direct the SEC on how it should act rather than allowing it to exercise its expert discretion. White said it is very eye-opening to contrast the broad directives of the 1975 Securities Act amendments with the highly detailed requirements in the Dodd-Frank and JOBS Acts.

White also pointed to legislative proposals to change the SEC’s rulemaking process and called on the next Commission to challenge those efforts. Trends like these create real consequences for the SEC and other independent regulators. She warned that if the SEC’s discretion is not meaningfully preserved,it would be to the detriment of investors and the markets. Even a bipartisan Congress is not as well equipped as the SEC is to address the wide range of technical issues that are inherent in the SEC’s daily regulatory actions,she advised. She called on Congress to defend the SEC’s independence and its right to exercise that independence in order to continue with its critical mission.

RegulatoryActivity: SECNewsSpeeches BrokerDealers Derivatives DoddFrankAct ExchangesMarketRegulation InvestmentCompanies JOBSAct

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ENFORCEMENT—10 advisory firms settle SEC ‘pay-to-play’ charges

By Anne Sherry,J.D.

The SEC settled charges with ten investment advisory firms alleged to have violated the pay-to-play rule. Each firm will pay between $35,000 and $100,000 as a penalty for accepting fees from city or state pension funds without waiting two years after their associates made campaign contributions. The settlements do not include admissions of wrongdoing.

Pershing Square. For example,a Massachusetts state pension plan invested in a Pershing Square fund beginning in 2011. In 2013,an associate of the Pershing Square advisory firm made a $500 campaign contribution to a candidate for an office with influence over selecting advisers to the pension plan. Pershing Square continued to advise the fund for compensation. The order imposes a $75,000 civil penalty.

FFL Partners. Similarly,FFL Partners advised a closed-end fund in which a Wisconsin state pension plan had committed to invest $50 million over time. In 2012,an FFL associate contributed $10,000 to a gubernatorial candidate. Again,FFL continued to advise the fund for compensation without observing the two-year timeout and agreed to pay a $75,000 penalty.

NGN Capital. NGN also advised a closed-end fund that had secured a $50 million investment,this time from four New York City pension plans. An NGN associate made mayoral campaign contributions totaling $1925,but the firm continued to advise the fund. NGN agreed to pay a $100,000 penalty.

Other settling parties. The seven other firms and their respective penalties are:

·        Adams Capital Management: $45,000

·        Aisling Capital: $70,456

·        Alta Communications: $35,000

·        Commonwealth Venture Management Corporation: $75,000

·        Cypress Advisors: $35,000

·        Lime Rock Management: $75,000

·        The Banc Funds Company: $75,000

In addition to the monetary penalties,the orders censure the respondent firms.

Companies: Adams Capital Management,Inc.; Aisling Capital LLC; Alta Communications,Inc.; Commonwealth Venture Management Corp.; Cypress Advisors,Inc.; FFL Partners,LLC; Lime Rock Management LP; NGN Capital LLC; Pershing Square Capital Management,L.P.; The Banc Funds Company,LLC

LitigationEnforcement: Enforcement InvestmentAdvisers PrivateEquityNews MassachusettsNews NewYorkNews WisconsinNews

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ENFORCEMENT—Blackrock pays $340,000 to settle SEC charges over improper separation agreements

By Brad Rosen J.D.

The Securities and Exchange Commission filed charges and simultaneously entered into a settlement with BlackRock,Inc. in connection with the firm’s improper use of separation agreements whereby departing employees were required to waive their rights to obtain awards under the SEC whistleblower program. BlackRock agreed to pay a $340,000 penalty,as well as embarking on certain undertakings. Additionally,the SEC acknowledged a number of remedial actions that BlackRock had already implemented (In the Matter of BlackRock,Inc.,Release No. 34-79804,January 17,2017).

According to the SEC’s order,as a matter of course,over 1,000 exiting BlackRock employees were required to sign separation agreements which contained violative language providing that they "waive any right to recovery of incentives for reporting of misconduct" in order to receive their monetary separation payments from the firm. This restraint constituted a violation of SEC Rule 21F-17 according to the Commission.

BlackRock added the problematic waiver provision in October 2011 after the SEC adopted its whistleblower program rules as part of the Dodd-Frank market reforms which were enacted in 2010. The firm continued using this language in separation agreements until March 2016. Notably,however,the Commission acknowledged that these agreements "did not…prohibit former employees from communicating directly with the Commission or any other governmental agency regarding potential violations of law."

Anthony S. Kelly,CoChief of the SEC Enforcement Division’s Asset Management Unit,stated "asset managers simply cannot place restrictions on the ability of whistleblowers to accept financial awards for providing valuable information to the SEC." He added,"BlackRock took direct aim at our whistleblower program by using separation agreements that removed the financial incentives for reporting problems to the SEC."

Notwithstanding,the order indicates that BlackRock had voluntarily revised its separation agreements and had removed the troublesome contract language prior to the time SEC staff first contacted the firm regarding this matter. It was also noted that BlackRock took other remedial actions,including the implementation of mandatory yearly training to summarize employee rights under the SEC’s whistleblower program,and had updated its policies and procedures to ensure that employees understood there rights and options under the whistleblower regime. BlackRock settled this matter without admitting nor denying the charges contained in the order.

The release is No. 34-79804.

LitigationEnforcement: DoddFrankAct Enforcement SECNewsSpeeches WhistleblowerNews

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ENFORCEMENT—Chilean-based chemical and mining company resolves FCPA violations for $30 million

By Rebecca Kahn,J.D.

The SEC announced that Chilean-based chemical and mining company Sociedad Quimica y Minera de Chile S.A. (SQM) violated the Foreign Corrupt Practices Act (FCPA) and agreed to pay more than $30 million to resolve parallel civil and criminal charges of failure to keep adequate books and records,and failure to oversee an executive discretionary account. SQM took remedial measures,self-reported and cooperated with Chilean and U.S. authorities in the investigation of the admitted violations (In the Matter of Sociedad Quimica y Minera de Chile,S.A.,Release No. 34-79795,January 13,2017).

SQM was charged with books and records and internal controls provisions of the FCPA because its books and records inadequately reflected the purpose of payments from the discretionary account (which account was intended to provide "travel,publicity and advisory services" for the CEO) and for failing to devise and maintain an effective system of internal accounting controls over the account.

In its order,the SEC considered the company’s deferred prosecution agreement (DPA) with the Department of Justice,wherein it admitted responsibility for violating the books and records and internal controls provisions of the FCPA.

SQM agreed to pay a $15 million penalty to settle the SEC charges and a $15.5 million penalty as part of the DPA. It further agreed to retain an independent compliance monitor for two years and self-report to the SEC and DOJ for one year after the monitor’s work is complete.

Improper payments. According to the SEC order,from at least 2008 to 2015,SQM made nearly $15 million in improper payments to Chilean political figures controlled by or closely tied to Chilean politicians. Most of the payments were made based on fake documentation submitted to SQM by individuals and entities posing as legitimate vendors.

Inadequate controls. SQM was charged with failure to conduct due diligence on third parties that received payment from the discretionary account and failed to keep "adequate internal accounting controls" to verify the legitimacy of the payments or to properly oversee the fund. SQM was also charged with falsely recording payments to foreign officials and failed to "devise and maintain an adequate system of internal controls" over the discretionary account.

Remedial efforts. SQM self-reported the violations and conducted an internal investigation in 2015,in response to inquiries from Chilean tax authorities and the media that it had taken improper tax deductions for payments to certain vendors. SQM fired the responsible executive,formed a corporate governance committee and strengthened its internal audit department. It also created a separate compliance and risk management department,and hired outside experts to review and improve payment process controls and approvals. It also reformulated its code of ethics and enhancing mandatory training related thereto.

The release is No. 34-79795.

Companies: Sociedad Quimica y Minera de Chile,SA

LitigationEnforcement: Enforcement InternationalNews SECNewsSpeeches

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EXCHANGES AND MARKET REGULATION—N.D. Ill.: Court okays removal to federal court of lawsuit by market makers against exchanges

By Joseph Arshawsky,J.D.

National Securities Exchanges’ removal to federal court of a lawsuit brought by market maker firms seeking to recover fees paid,was proper,a federal court in Illinois ruled. The court held that despite attempts to plead only state law claims,the lawsuit required interpretation of SEC-approved exchange rules,and therefore implicated federal question jurisdiction (Citadel Securities,LLC v. Chicago Board Options Exchange,Inc. ,January 12,2016,Gettleman,R.).

A number of market maker firms filed suit seeking to recover fees allegedly improperly charged to and paid by them to the National Securities Exchanges under certain "payment for order flow" (PFOF) or marketing fee programs. PFOF is an arrangement by which a broker receives payment from a market maker in exchange for sending order flow to them.

The exchanges imposed fees on market makers when a trade was made for a "customer," but not trades made for proprietary "house trades," where a firm traded on its own behalf. The firms filed a state court suit alleging that over a multi-year period the exchanges improperly charged PFOF fees on millions of orders not subject to those fees.

The complaint attempted to eliminate all references to any violation by the exchanges of their own rules,replacing them with allegations that the exchanges charged fees that were not part of the PFOF program. The exchanges removed the suit to federal court,and the member firms moved to remand. The court denied the remand motion.

The "arising under" test. The issue is whether the market makers’ claims "arise under" the Exchange Act. While the claims did not directly arise under the federal law because the federal law did not create the causes of action asserted,there is another possibility. Even when a claim "finds its origin" in state law,a federal court has jurisdiction of a state-law claim if it necessarily raises a stated federal issue,actually disputed and substantial,which a federal forum may entertain without disturbing any congressionally approved balance of federal and state power. This includes cases in which a state-law cause of action "is brought to enforce a duty created by the Exchange Act because the claim’s very success depends on giving effect to the federal requirement."

The Exchange Act. The market makers’ complaint,alleged that the exchanges violated their own rules,which are established and approved by the SEC as part of its regulatory function,and with which the exchanges are bound to comply under Section 78s(g)(1) of the Exchange Act. Thus the complaint raised federal questions,resolution of which were necessary.

To show that the exchanges were not entitled to the fees,the market makers must show that the exchanges violated their own rules. Absent a violation of those rules,the exchanges were entitled to assess and keep the fees. Thus,the claims necessarily implicated a federal issue.

"Actually disputed." The federal issue is "actually disputed." Indeed,it is the central point of the dispute. The market makers simply could not win without showing that the exchanges violated their own rules.

Substantial. The federal issue was also substantial. The exchanges are part of the National Market System which provides the foundation for investor confidence in U.S. capital markets. Thus,whether the exchanges complied with their own rules is sufficiently significant to the development of a uniform body of federal securities regulation to satisfy the requirement of importance to the federal system as a whole,according to the court. Lack of federal jurisdiction would threaten uniformity,subjecting the PFOF programs to differing state contract laws.

Federal-state balance. Finally,the states have no particular interest in resolving matters involving violations of rules approved by the SEC. Congress’ grant of exclusive jurisdiction to the federal court under the Exchange Act is a strong signal that the exercise of federal jurisdiction over state claims that necessarily raise such allegations will not upset the congressionally approved federal-state balance of power. Accordingly,federal jurisdiction supporting removal was proper.

The case is No. 1:16-cv-09747.

Attorneys: Ellen M. Wheeler (Foley & Lardner LLP) for Citadel Securities,LLC,Ronin Capital,LLC,Susquehanna Securities and Susquehanna Investment Group. Paul E. Dengel (Schiff Hardin LLP) for Chicago Board Options Exchange,Inc. Terrence Patrick Canade (Locke Lord LLP) for NASDAQ OMX PHLX LLC f/k/a Philadelphia Stock Exchange,Inc. and International Securities Exchange,LLC. David Joel Chizewer (Goldberg Kohn) for NYSE Arca,Inc. f/k/a Pacific Exchange,Inc. and NYSE MKT LLC f/k/a NYSE Amex LLC.

Companies: Citadel Securities,LLC; Ronin Capital,LLC; Susquehanna Securities; Susquehanna Investment Group; Chicago Board Options Exchange,Inc.; NYSE Arca,Inc. f/k/a Pacific Exchange,Inc.; NYSE MKT LLC f/k/a NYSE Amex LLC; International Securities Exchange,LLC

LitigationEnforcement: ExchangesMarketRegulation IllinoisNews

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FRAUD AND MANIPULATION—N.D. Tex.: Four brokers charged for selling unregistered oil and gas offerings

By Rebecca Kahn,J.D.

The SEC announced charges against four unregistered brokers who raised approximately $9.8 million from more than 200 investors in two unregistered oil-and-gas programs (SEC v. Charlet ,January 13,2017).

Filed in Dallas federal court,the SEC complaint alleges that from at least 2010 through 2012,the four brokers sold oil and gas interests on behalf of Texas-based Charles O. Couch and Couch Oil & Gas,Inc. (COG). The sales reps were engaged through XO Marketing Solutions,Inc. to market the unregistered securities offerings,and to locate and solicit investors,many of whom were not accredited. The representatives were not registered with the SEC or FINRA in any capacity,or licensed as brokers,at any point during the relevant period.

The sales reps allegedly sold interests to non-accredited investors without providing them with financial statements or other financial information. While much of the misleading information that was provided to COG investors about the programs was prepared by Couch,the sales reps were responsible for promoting the programs online,locating investors,distributing offering materials,and making recommendations concerning the securities offered for sale.

Couch testified that after learning of the SEC investigation and telling the sales reps to "wind up" their sales,they sold another $2.3 million in interests in one of the programs. The sales reps were compensated based on total sales,receiving more than $2 million between them.

The SEC alleged violations of Securities Act Sections 5(a) and (c) and Exchange Act Section 15(a),for the sale of unregistered securities.

Prior charges. The SEC previously charged Couch and Couch Oil with fraud and other violations arising from the same securities offerings. On May 9,2016,the court entered final judgments against Couch and Couch Oil that included permanent injunctions and ordered payment of over $7.3 million in monetary relief.

Principal agrees to settle. The complaint alleged that,as founder,owner,principal,and control person of XO Marketing,one broker was directly responsible for the offer and sale of all securities made by XO Marketing and the sales reps. He was not a registered representative nor was he associated with any broker,dealer,or investment adviser and did not hold any securities licenses. XO Marketing was likewise not registered or licensed. Without admitting or denying the allegations in the complaint,that broker has consented to permanent injunctions and to pay $323,509 disgorgement with prejudgment interest and a $25,000 civil penalty. The settlement is subject to court approval.

The SEC is seeking permanent injunctions,disgorgement with prejudgment interest,and civil penalties against the remaining sales reps.

The case is No. 3:17-cv-00139-D.

Attorneys: Janie L. Frank for the SEC.

Companies: Couch Oil & Gas,Inc.,XO Marketing Solutions,Inc.

LitigationEnforcement: Enforcement FraudManipulation SECNewsSpeeches TexasNews

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FRAUD AND MANIPULATION—U.S.: High Court will consider statute of repose,application of limitations period to disgorgement

By Rodney F. Tonkovic,J.D.

The Supreme Court will once again look at the effect of American Pipe tolling on statutes of repose. The court was set to address the issue in 2014,but withdrew certiorari after of a tentative settlement to that case. The court also granted certiorari for a petition asking that it resolve a circuit split on whether disgorgement claims are exempt from the five-year statute of limitations period found in 28 U.S.C. § 2462.

CalPERS. The petitioners in CalPERS v. Moody Investors Service,Inc. opted out of class actions against Bear Stearns and the underwriters of Lehman Brothers debt offerings,respectively,for allegedly fraudulent activity during the financial crisis. The Second Circuit dismissed their individual claims as time-barred by the statute of repose,following its IndyMac decision.

In IndyMac ,the Second Circuit noted that courts have repeatedly recognized that Section 13’s three-year limitations period is a statute of repose,an absolute period not subject to equitable tolling. The court reasoned that it did not matter whether American Pipe’s tolling rule was equitable or legal: if equitable,it would not toll a repose period; if legal,the Rules Enabling Act would bar its extension to the Section 13 limitations period. The Supreme Court granted cert the IndyMac in 2014,but withdrew it as improvidently granted,leaving intact the panel's ruling that American Pipe tolling rule does not apply to Section 13.

This petition is one of several asking the court to place equitable tolling back on its agenda. The petitions generally urge that the circuit split should be resolved in favor of tolling.

Here,CalPERS asks whether the filing of a putative class action serves,under the American Pipe rule,to satisfy the three-year statute of repose under the Securities Act. Courts of appeal for the Tenth,Seventh,and Federal Circuits have held that American Pipe applies to statutes of repose,while the Sixth and Eleventh Circuits joined the Second in refusing to apply tolling.

The petition argues that Congress could not have intended the flood of protective motions that would result if statutes of repose were not tolled during the pendency of a class certification action. The Second Circuit’s rule also dramatically increases the cost of litigation for potential opt-out plaintiffs,and may cause defendants to shoulder the costs of unnecessary litigation if a fee-shifting statute applies. The petitioners add that applying American Pipe tolling to Section 13 comports with the legislative purposes of the Securities Act.

The petition also asks whether American Pipe applies when a member of a timely filed putative class action files an individual suit before class certification is decided. In both American Pipe and IndyMac,it notes,the class member waited until class certification was denied before pursuing an individual action. But CalPERS filed its own action after the statute of repose had expired but before the district court ruled on class certification. "In such circumstances,tolling is not required because the class member’s action was timely commenced and maintained without interruption."

Kokesh. Next,Kokesh v. SEC asks that the court resolve a circuit split on whether disgorgement claims are exempt from the five-year statute of limitations period found in 28 U.S.C. § 2462. Kokesh,who was ordered to pay the SEC over $53 million in disgorgement and interest asserted that the order was based on alleged violations that occurred as far back as 1995 and was barred by Section 2462,which sets a five-year limitations period for suits "for the enforcement of any civil fine,penalty,or forfeiture." A Tenth Circuit panel disagreed,holding that the injunction was not a penalty and that the disgorgement order was neither a penalty nor forfeiture within the meaning of the statute. Disgorgement,the panel explained further,is remedial in nature and not a "forfeiture" under the statute.

In his petition,Kokesh argues that the circuits have split on whether disgorgement is synonymous with forfeiture. The Tenth Circuit joined the D.C. and First Circuits in holding that Section 2462 does not apply to disgorgement claims while the Eleventh Circuit,in SEC v. Graham ,sees "no meaningful difference in the definitions of disgorgement and forfeiture." It is uncertain,the petition says,whether the SEC can reach back to punish violations as far in the past as it chooses to look,and the Commission has exploited this uncertainty. The petition notes that that the Court expressly reserved the question of whether disgorgement is subject to Section 2462’s limitations period in Gabelli v. SEC and that the issue is ripe for resolution.

SEC brief. In its brief in Kokesh,the Commission sides with the Tenth Circuit,and sets out its position that disgorgement is not a "penalty" or "forfeiture" under Section 2462. Disgorgement,the Commission contends,is equitable and,being remedial in nature,differs from damages and penalties that are meant to punish. Similarly,disgorgement,which is intended to prevent unjust enrichment,is not a forfeiture,a term which has historically been used to refer to an in rem procedure to take property used in criminal activity.

The Commission's brief observes that the Tenth Circuit's decision is consistent with decisions in the First,Second,Ninth,and D.C. Circuits. The Eleventh Circuit's differing opinion on the matter in SEC v. Graham cannot be reconciled with the holdings in the other circuits,the brief says. Graham,the Commission posits,stands as a significant obstacle to national uniformity in the administration of the securities laws,and makes Kokesh an appropriate vehicle to resolve the question of Section 2462's applicability.

Read the docket. This case,and others pending before the Court,can be referenced in the latest version of the Supreme Court Docket. Cases are listed separately,along with a brief summary of the questions raised and the status of the appeal.

The petitions are Nos. 16-373 (CALPERS) and 16-529 (Kokesh).

LitigationEnforcement: Enforcement FraudManipulation InvestmentAdvisers SupremeCtNews

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WHISTLEBLOWER NEWS—6th Cir.: Court affirms dismissal of whistleblower suit where no facts were presented

By Gregory Kane,J.D.,M.B.A.

The Court affirmed the district court’s dismissal of a whistleblower retaliation suit filed by a former employee who claimed to have reported illegal activity to the FBI,and possibly the SEC,but provided no facts to support his claims (Verble v. Morgan Stanley Smith Barney,LLC ,January 13,2017,Moore,K.).

Background. Plaintiff was an employee of Morgan Stanley Smith Barney,LLC from November 2006 until he was fired in June 2013. Plaintiff alleged that he was fired as retaliation for helping the FBI with its investigation into Pilot Flying J,which was found to have engaged in fraud-related activities.

At no time did the plaintiff provide facts to the district court that were adequate to support his claims,even when challenged that he had not done so by defendant’s motion to dismiss. The district court dismissed plaintiff’s Sarbanes-Oxley retaliation claim,False Claims Act claim,Dodd-Frank retaliation claim and Tennessee state-law laim accordingly.

Appeal. The court affirmed the dismissal of plaintiff’s claims. It found no Sarbanes-Oxley claim was ever made. It found plaintiff never alleged facts that would support a False Claim Act claim. It affirmed the Dodd-Frank retaliation claim dismissal,however,on different grounds than the district court used to dismiss.

The question of whether the plaintiff would qualify as a whistleblower under the Dodd-Frank Act for having allegedly reported a violation to the FBI,but possibly not the SEC,has not been settled. Instead the court held that the complaint failed to allege sufficient facts as to the Dodd-Frank retaliation claim to state a plausible claim for relief and dismissal was upheld on that basis.

The case is No. 15-6397.

Attorneys: Richard Forlani Neely (Neely & Callaghan) for John S. Verble. Sarah E. Bouchard (Morgan,Lewis & Bockius LLP) and Keith D. Frazier (Ogletree,Deakins,Nash,Smoak & Stewart,P.C.) for Morgan Stanley Smith Barney LLC and Morgan Stanley & Co.,Inc.

Companies: Morgan Stanley Smith Barney LLC; Morgan Stanley & Co.,Inc.

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IPO TRACKER—2017 IPO market starts with $375 million deal

By John Filar Atwood.

Gores Holdings II pushed the 2017 IPO market off the starting block with a $375 million offering last week. The blank checks company is the first new issuer in U.S. markets since December 15th. The January 12th offering is far earlier than the first IPO of 2016,which was not completed until February 2nd. It also is a little earlier than the January 15th start to the 2015 IPO market,but three days later than the first deal of 2014.

New registrants. The week’s activity included one new registration,filed by Foundation Building Materials. The company,which is owned by private equity firm Lone Star Fund IX (U.S.) and affiliates,distributes wallboard,suspended ceiling systems and insulation in the U.S. and Canada. Foundation has entered into a tax receivable agreement with Lone Star under which it will pay to Lone Star 90 percent of the savings on certain federal,state,local,and non-U.S. income taxes. GMS Inc.,a Georgia-based company that is in the same business as Foundation,raised $147 million in its public market debut last May.

Withdrawals. Viventia Bio was the only registrant to withdraw last week. The Winnipeg-based company was acquired by Eleven Biotherapeutics and subsequently pulled its plans for an IPO. Viventia,which develops protein therapies to treat cancer,publicly registered in October 2015.

The information reported in IPO Tracker is gathered using IPO Vital Signs,a Wolters Kluwer Law & Business database that includes all SEC registered IPOs,including REITs and those non-U.S. IPO filers seeking to list in the U.S. markets. IPO Vital Signs does not track closed-end funds,best efforts or non-underwritten deals,or IPO offerings for amounts less than $5 million.

Companies: Gores Holdings II,Inc.; Foundation Building Materials,Inc.; Viventia Bio Inc.

IndustryNews: IPOs CorporateFinance FormsFilings SecuritiesOfferings

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In the News


Foley & Lardner LLP |Goldberg Kohn |Locke Lord LLP |Morgan,Lewis & Bockius LLP |Neely & Callaghan |Ogletree,Deakins,Nash,Smoak & Stewart,P.C. |Schiff Hardin LLP


Adams Capital Management,Inc. | Aisling Capital LLC | Alta Communications,Inc. | Chicago Board Options Exchange,Inc. | Citadel Securities,LLC | Commonwealth Venture Management Corp. | Couch Oil & Gas,Inc.,XO Marketing Solutions,Inc. | Cypress Advisors,Inc. | FFL Partners,LLC | Foundation Building Materials,Inc. | Gores Holdings II,Inc. | International Securities Exchange,LLC | Lime Rock Management LP | Moody’s Analytics Inc. | Moody’s Corp. | Moody’s Investors Service Inc. | Morgan Stanley & Co.,Inc. | Morgan Stanley Smith Barney LLC | NGN Capital LLC | NYSE Arca,Inc. f/k/a Pacific Exchange,Inc. | NYSE MKT LLC f/k/a NYSE Amex LLC | Pershing Square Capital Management,L.P. | Ronin Capital,LLC | Sociedad Quimica y Minera de Chile,SA | Susquehanna Investment Group | Susquehanna Securities | The Banc Funds Company,LLC | Viventia Bio Inc.

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