SEC and CFTC Updates - December 2013 Publication


Bad Actor Offering Disqualification and Disclosure


On July 10, 2013, the Securities and Exchange Commission (the “SEC”) adopted bad actor disqualification provisions for Rule 506 of Regulation D under the Securities Act of 1933, to implement Section 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The disqualification and related disclosure provisions appear as paragraphs (d) and (e) of Rule 506 of Regulation D.


The effective date of the rule amendments was September 23, 2013. Disqualifying events that occurred before September 23, 2013, may still rely on Rule 506, but will have to comply with certain disclosure provisions of Rule 506(e). Matters that existed before the effective date of the rule and would otherwise be disqualifying are, however, required to be disclosed in writing to investors.


In determining whether disclosure is required, the rule looks to the timing of the triggering event (e.g., a criminal conviction or court or regulatory order) and not the timing of the underlying conduct. A triggering event that occurs after effectiveness of the rule amendments will result in disqualification, even if the underlying conduct occurred before effectiveness. The SEC expects that issuers will give reasonable prominence to the disclosure to ensure that information about pre-existing bad actor events is appropriately presented in the total mix of information available to investors.


While the questions that need to be asked of relevant covered persons as a result of the Rule 506 amendments are relatively straightforward, the potential complexity in complying with the new rules will be to methodically identify all twenty-eight categories of potential covered persons in a comprehensive and ongoing manner for funds that are typically involved in continuous offerings. Identifying covered persons, which may include certain fund investors, to question may involve some interpretation, and the additional steps to take (beyond such questioning) with respect to compensated solicitors merits some consideration. Orical has developed a handy worksheet and questionnaire to assist firms in conducting this analysis, which is available here:


Master Rule 506(d) Covered Person Worksheet

Rule 506(d) Covered Person Questionnaire and Certification


If you have any questions regarding the bad actor provisions, please contact an attorney at Orical.


The full release from the SEC can be found via the following link.


SEC, CFTC, Treasury, FDIC and Federal Reserve Governors Adopt Volcker Rule


SEC, CFTC, Treasury, FDIC and Federal Reserve Governors recently issued final rules developed jointly to implement section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Volcker Rule”).


The final rules prohibit banking entities from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on these instruments, for their own account. The final rules also impose limits on banking entities’ investments in, and other relationships with, hedge funds or private equity funds.


Like the Dodd-Frank Act, the final rules provide exemptions for certain activities, including market making, underwriting, hedging, trading in government obligations, insurance company activities, and organizing and offering hedge funds or private equity funds. The final rules also clarify that certain activities are not prohibited, including acting as agent, broker, or custodian.


Banking entities with significant trading operations will be required to establish a detailed compliance program and their CEOs will be required to attest that the program is reasonably designed to achieve compliance with the final rule. Independent testing and analysis of an institution’s compliance program will also be required. The final rules reduce the burden on smaller, less-complex institutions by limiting their compliance and reporting requirements. Additionally, a banking entity that does not engage in covered trading activities will not need to establish a compliance program.


The final rules become effective April 1, 2014; however, the Federal Reserve Board has extended the conformance period until July 21, 2015. Beginning June 30, 2014, banking entities with $50 billion or more in consolidated trading assets and liabilities will be required to report quantitative measurements. Banking entities with at least $25 billion, but less than $50 billion, in consolidated trading assets and liabilities will become subject to this requirement on April 30, 2016. Those with at least $10 billion, but less than $25 billion, in consolidated trading assets and liabilities will become subject to the requirement on Dec. 31, 2016. The agencies will review the data collected prior to Sept. 30, 2015, and revise the collection requirement as appropriate.


The full adopting release of the Volcker Rule issued by the SEC can be found via the following link.


Short Sales and Risk Alerts


The SEC recently issued a National Exam Program Risk Alert indicating that many funds are engaging in short sales in violation of Rule 105 of Regulation M of the Exchange Act. The Risk Alert identifies by name over 40 firms that have settled SEC actions over the last several years. Since publication of the Risk Alert, senior SEC officials have publicly identified Rule 105 compliance as a consistent weakness identified during exams. Mary Jo White recently said: “Similarly, we recently issued a risk alert on Rule 105 of Regulation M--a rule that generally bans firms from improperly participating in public offers soon after short selling those same stocks. It is a very important rule but, as our exams discovered, a rule often not observed….” Rule 105 makes it unlawful for a person to purchase securities in a firm commitment equity offering from an underwriter or broker-dealer participating in the offering if that person sold short the security that is the subject of the offering during the Rule 105 restricted period, absent an available exception. Rule 105 does not require intent on the part of the short seller to engage in a prohibited transaction. The Rule 105 restricted period is typically the period beginning five days before the pricing of the offered securities and ending with such pricing.


The National Exam Program Risk Alert can be found via the following link.



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