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From Securities Regulation Daily, April 4, 2019

House FSC floats mandatory arbitration and other bills

By Mark S. Nelson, J.D.

The House FSC proposed bills that would ban mandatory arbitration provisions and that would legislatively reverse the Supreme Court’s Dodd-Frank Act whistleblower opinion.

The House Financial Services Committee held a hearing at which it proposed a package of bills aimed at banning mandatory arbitration clauses in securities offerings and brokerage agreements, while also proposing to reverse a Supreme Court decision on whistleblowers. Other bills proposed at the hearing would clarify the law of insider trading and direct the SEC to finish its Dodd-Frank Act rulemakings on executive compensation.

Mandatory arbitration. The Investor Choice Act of 2019, sponsored by Rep. Bill Foster (D-Ill), would ban the registration of a security under the Securities Act if the issuer’s bylaws or registration statement contain mandatory arbitration provisions regarding disputes between the company and its shareholders. The bill contains a similar ban regarding investment advisers.

Recently, the issue of mandatory arbitration emerged via a shareholder proposal, in response to which the SEC determined that the proposal, which sought arbitration of shareholder disputes, may be excluded from proxy materials because it could potentially violate state law. SEC Chairman Jay Clayton issued a statement in which he reiterated his prior comments on whether the SEC could approve such a proposal if presented with it in the form of a registration statement. Said Clayton: "… In response to these inquiries, I stated that, if the issue were to arise in an actual initial public offering of a domestic company, it would not be appropriate for resolution at the staff level but would rather be best addressed in a measured and deliberative manner by the Commission." The SEC’s Division of Corporation Finance later declined the shareholder’s request that it forward the no-action response to the Commission. The SEC’s no-action response prompted a lawsuit by the shareholder against the company.

The Investor Choice Act also would bar the use of mandatory arbitration agreements in agreements between brokerages, funding portals, and municipal securities dealers and their customers. Preexisting agreements would be voided.

Whistleblowers. One discussion draft put forward at the hearing would legislatively reverse the Supreme Court’s decision in Somers, in which the court held that the plain language of the Dodd-Frank Act’s whistleblower provision required a person to report to the SEC in order to take advantage of the available anti-retaliatory provisions. Prior to this decision, courts had split on the issue. The SEC also had offered its own interpretation of the relevant provision that favored whistleblowers by reading the SEC reporting requirement more flexibly than would the Supreme Court.

A bill to be introduced by Rep. Al Green (D-Texas) would amend Exchange Act Section 21F(a)(6) to add a special rule that, with respect to subsection (h) only, would define "whistleblower" to mean an individual (or a group of persons acting jointly) who takes any of the actions specified in subsection (h)(1)(A). Section 21F(h)(1)(A) bars an employer from retaliating against an employee if the employee provides information to the SEC, testifies or otherwise participates in an investigation, or who makes disclosures that are required or protected by the Sarbanes-Oxley Act.

Insider trading. A discussion draft titled the Insider Trading Prohibition Act would re-introduce a bill previously floated by Rep. Jim Himes (D-Conn) (see H.R. 1625 from the 114th Congress). The bill would explicitly make insider trading unlawful and define the standard and knowledge requirements for such liability. As compared to the earlier version, the discussion draft would expand the breach of fiduciary duty provision to include breach of a confidentiality agreement, breach of contract, or breach of any other personal or relationship of trust and confidence (the earlier version did not mention breach of a confidentiality agreement or breach of contract). The discussion draft also would add a sense of Congress that the bill does not intend to supersede Exchange Act Section 10(b), one of the SEC’s the main anti-fraud provisions, or Section 14(e), which prohibits untrue statements of material fact or omission regarding tender offers (the Supreme Court will hear oral argument on April 15 in Emulex, which poses questions about whether Section 14(e) requires negligence or scienter and whether it allows for an implied private law suit).

Several years ago, Congress sought (and failed) to amend the securities laws to clarify standards for insider trading after the Second Circuit’s Newman decision seemingly made it harder for regulators to bring insider trading cases (in addition to Rep. Himes’s bill, see H.R. 1173 and S. 702). In the years since, the Supreme Court reiterated the existence under Dirks of trading friends and family-based liability while in dicta partially reversed Newman ("To the extent the Second Circuit held that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends, …, we agree with the Ninth Circuit that this requirement is inconsistent with Dirks.") (citation omitted). The similar Martoma case resulted in a divided panel, but the majority later revised its opinion and some questions about insider trading liability remain unanswered.

Moreover, a related discussion draft, the 8–K Trading Gap Act of 2019, would bar executives from trading company stock during the four business day period between when an obligation to file a Form 8-K arises and the Form 8-K is filed with the SEC. The bill defines "covered period" as the period between when a company determines it possesses material, nonpublic information and the time when that information is either publicly disclosed or is no longer material.

Dodd-Frank rulemakings. Two bills would require the SEC to finish Dodd-Frank Act rulemakings. The first of them would require the SEC to complete its work on Exchange Act Section 10D. Section 10D requires the SEC to issue a rule directing exchanges to bar a company from listing its stock unless the company has disclosed its policy on incentive-based compensation paid to its executives with respect to financial information that must be reported under SEC regulations. The provision also states that a company policy must provide for the recovery of erroneously awarded compensation in the event of an accounting restatement resulting from material noncompliance with SEC financial reporting requirements. The SEC issued a proposed rule in 2015.

The second bill would direct the SEC to complete its Dodd-Frank Act rulemaking on pay versus performance disclosures. This provision requires the SEC to adopt rules under Exchange Act Section 14(i) for companies to disclose the relationship between executive compensation actually paid and the company’s performance. The SEC proposed such rules in 2015.

Both bills would require the SEC to act within 60 days of enactment. As punishment for the failure to act, the SEC’s chairman would have to appear before the House FSC and the Senate Banking Committee once each month until the specified rulemaking is completed.

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