NewsWire - Norton Rose Fulbright

CAPITAL MARKETS

NewsWire WINTER 2014

FEATURED ARTICLE

Other People’s Money: Why the Capital Markets Often Struggle With Construction Risk

Over the last several years, there has been a good deal of discussion about “project bonds,” loosely defined as bonds issued in the capital markets (as opposed to loans made in the traditional bank financing market or notes sold in the institutional private placement market) to finance the construction of a project. Projects may be either “greenfield” or “brownfield,” but in both cases, there is some construction or completion risk, meaning that during the period before the requisite construction work has been completed and the project is fully operational, there is some risk that the revenue stream from the project may not exist or be in sufficient to cover debt service. PAGE 1 TRANSACTION PROFILE

Lessons from the Trenches: Muni Bonds Paving the Roads Ahead

Earlier this year, Chadbourne represented the successful bidder in the public-private partnership for the I-69 Section 5 Project, which involved the financing, design, construction, operation and maintenance related to the upgrading of an existing four-lane median-divided highway to an interstate highway in Indiana, including four new interchanges, 12 new bridge structures, improvements to the existing interchanges and overpasses, and a new operations and maintenance management center. PAGE 4

IN THIS ISSUE 1

Other People’s Money: Why The Capital Markets Often Struggle With Construction Risk

4 Lessons from the Trenches: Muni Bonds Paving the Roads Ahead 8

Interview with Jill Wallach, BTG Pactual

11 Issuer’s Counsel Corner 11 Updates on Procedures for Submission of SEC Confidential Treatment Requests 12 Study Finds SEC Comment Letters Prompt Insider Sales 13 Regulation A+: Gallagher’s Re-Proposal for Venture Exchanges

INTERVIEW

13 Designated Offshore Securities Markets Under Regulation S: You’d be Surprised Who’s Not on the List

Jill Wallach, BTG Pactual

15 Underwriter’s Counsel Corner

Ms. Wallach is currently an associate partner and chief legal counsel of the international offices of BTG Pactual. She was selected by The Legal 500 as one of the top 100 in-house Corporate Counsel in Latin America in 2014 and in the United States in 2013. In her current role, she is responsible for legal and regulatory for the bank’s commodities, asset management, investment banking and private banking divisions. She serves as a director of various BTG Pactual global investment funds. PAGE 8

15 Trends in Anti-Corruption and AML Represetations and Warranties; Strict Liability for Issuers 16 Section 3(c)(7) Procedures: SolarCity Securitizations

18 Notes from the Bench 22 Regulatory Roundup 24 Upcoming Events

© 2014, Chadbourne & Parke LLP This material may constitute Attorney Advertising in some jurisdictions. Prior results do not guarantee a similar outcome.

CAPITAL MARKETS

NewsWire WINTER 2014

EDITOR MARC M. ROSSELL

+1 (212) 408-1057 [email protected]

To Our Readers We welcome our readers to our inaugural Capital Markets Newswire, the Winter 2014 edition. We are very excited about the content and format of the Newswire and hope you will share any comments about it with us. This Newswire includes a featured article on project bonds and the role of financial intermediaries in the offering process, highlighting one of the factors that makes bond offerings in the capital markets to finance construction a challenge. We are also pleased to feature an in-depth interview with the internal counsel at one of the leading Latin American investment banks, who has offered some valuable insights

into several issues that capital markets lawyers face in their routine dealings with cross-border transactions. We also have included a transaction profile of one of our recent capital markets offerings, highlighting some of the salient aspects of the deal and lessons learned from the experience. In addition, we feature several sections which deal with current trends and developments in the capital markets area as they affect the legal practice. The “Issuer’s Counsel Corner” and “Underwriter’s Counsel Corner” sections offer insights and practice points affecting those areas of the practice which impact issuers and underwriters, respectively. Our “Notes

from the Bench” section highlights recent judicial cases, administrative proceedings and other developments in the enforcement area which affect the capital markets practice. “Regulatory Round-Up” features recent legislative, regulatory and other developments that we thought were significant to take note of. Finally, our “Upcoming Events” section sets forth a few of the securities law related conferences, meetings and other events which capital markets practitioners might want to attend or be mindful of. We hope you enjoy this Newswire and look forward to hearing from you if you have any comments or ideas for future editions.

CONTRIBUTORS LUCIA BENABENTOS

ALEX M. HERMAN

BRITTNEY RENZULLI

MIKAELA C. CAVALLI

BETH R. KRAMER

MARC M. ROSSELL

STEPHANIE DIFAZIO

SETH M. KRUGLAK

LISA SCHAPIRA

PATRICK DORIME

SEY-HYO LEE

CLAUDE S. SERFILIPPI

NICOLAS FERRE

ALAN RAYLESBERG

CHRISTIAN URRUTIA

+1 (212) 408-5414 [email protected] +1 (212) 728-4479 [email protected] +1 (212) 728-4477 [email protected] +1 (212) 408-5455 [email protected] +1 (212) 408-5210 [email protected]

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CAPITAL MARKETS NEWSWIRE | WINTER 2014



FEATURED ARTICLE

Other People’s Money: Why the Capital Markets Often Struggle With Construction Risk By Marc M. Rossell

Over the last several years, there has been a good deal of discussion about “project bonds,” loosely defined as bonds issued in the capital markets (as opposed to loans made in the traditional bank financing market or notes sold in the institutional private placement market) to finance the construction of a project. Projects may be either “greenfield” or “brownfield,” but in both cases, there is some construction or completion risk, meaning that during the period before the requisite construction work has been completed and the project is fully operational, there is some risk that the revenue stream from the project may not exist or be insufficient to cover debt service. In most greenfield projects, the debtor is a special-purpose or single-asset entity, and completion of construction and the ability to commence commercial operation of the project is a condition to the receipt of revenue, such as from an off-taker, from government sources, from a lessee or other obligor, or from multiple users such as in the case of a toll road, airport, bridge or port facility. One Size Does Not Fit All Project financing structures come in all shapes and sizes and each structure is typically unique to the particular project, with its own risks and jurisdictional particularities, making it difficult to draw definitive conclusions beyond fairly broad generalizations. Concession arrangements and public works contracts vary from country to country and often from project to project in the same country. However, there is one thing that is almost universally agreed: it is more difficult for bond investors in the capital markets to accept construction risk than for lenders in the traditional bank financing or institutional private placement markets. If bank lenders and institutional investors can become comfortable with this risk profile, what makes it challenging for bondholders to accept construction risk?

Lenders Have Their Own Money at Stake Project development has historically been financed in the bank market where banks act as direct lenders to the project company using their own balance sheets. Since banks have their own money at stake, they go through an intensive risk analysis of the project with direct due diligence efforts. They often advise the sponsors on project structure and conduct their own due diligence with the sponsors as well as with all the third parties involved in the project, including contractors, independent engineers, traffic consultants, equipment suppliers, insurance consultants and, if appropriate, governmental authorities with regulatory oversight and conveyance authority for projects subject to concessions or public works contracts. Bank lenders have dedicated teams of project finance experts to analyze project

and industry-specific risks directly with project participants, generally over extended periods of time, and they come to a well-informed investment decision whether to extend financing for the project. Bank lenders and their counsel also draft and negotiate lending documentation directly with the sponsors and their counsel. Although the institutional investor market has not been as active as the bank market in project financing, institutional investors also undertake their own extensive due diligence review and, together with their counsel, negotiate the documentation directly with the sponsors and their counsel. Institutional private placement investors also have their own money at stake. Recent bank regulatory reforms and the capital and liquidity problems faced by European banks, who have been CHADBOURNE

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historically significant players in the project financing sector, generated an interest by market watchers in exploring whether the capital markets could be a viable source of construction financing for projects. Aside from the pesky financial issue of “negative carry” caused by the use of bond offering proceeds to finance construction costs over extended periods, there continue to be challenges when the bond market is confronted with construction risk. Other People’s Money Capital markets transactions in the international bond markets are executed in a much different way than bank credit facilities or institutional private placements and the role of the financial intermediary is much different. Underwriters of bonds (or so-called initial purchasers in Rule 144A offerings) do not have their own balance sheets at risk. In some sense, they are focused on attracting other people’s money. Underwriters are committed to purchase bonds only for a short period of time and only after they have assured themselves that the “book building” marketing efforts will sustain firm commitments from buyers of bonds. Certainly, they undertake significant due diligence. But this diligence effort is not predicated on their role as principal with their own money at stake. It is only to ensure that the disclosure document used to offer the bonds in the market is correct and complete so that they can protect themselves from securities law liability to the investors to whom the bonds are ultimately sold. Obviously, there are also franchise and reputational issues at stake and underwriters have a vested interest in the integrity of the deal and generally structure the deal to make it attractive to investors, but at the end of the day, bond underwriters have a very different risk profile than do bank lenders and institutional investors in a private placement. The disconnect in the project financing area is that the potential buyers of bonds, unlike bank lenders and private placement investors, do not have the opportunity to do their own extensive due diligence on

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the project or to negotiate the documentation, and are thus relying on the offering memorandum — the package of information supplied by the project sponsors and the underwriters — and relatively short meetings with project managers during the “roadshow presentation,” to make the case for why they should buy the bonds. Granted, there are likely to be ratings of the bonds issued by ratings agencies, but we all know that ratings are not a substitute for the ability to do one’s own due diligence and an in-depth analysis of what are usually a complex set of contractual rights and undertakings related to a project. To make matters worse, unlike in registered offerings of securities in the United States which mandate public filings of not only the prospectus, but also of all material contracts, Regulation S and Rule 144A offerings which are exempt from registration do not typically involve distribution to potential investors of the underlying documents related to a project. Thus, potential bond buyers have to rely exclusively on the disclosure document to understand the project and analyze the risks associated with the investment. They do not receive the underlying documents, nor have any realistic opportunity to review or negotiate these documents prior to finalization, or to discuss anything with external advisors and consultants. Although lawyers representing the sponsor company and the underwriters will typically render negative assurance letters on the disclosure document as well as some other opinions related to the accuracy of the descriptions of the contracts included in the offering memorandum, investors generally have no recourse to these professionals and their assurances are not given to them; opinions are addressed only to the underwriters as part of their due diligence defense. Can bond investors make an intelligent investment decision to finance a project based on a disclosure document describing complex contractual arrangements with unique construction risks, and maybe an hour-long roadshow meeting with project sponsors and their underwriters? It has been challenging for those types of risks to be easily assimilated by this market segment.

Why Some Project Bonds Have Been Successful How do some project bonds get done then? There are usually two things that can help mitigate this situation, and sometimes they are both present in some fashion in any particular transaction. First, some or all of the construction risk can be mitigated by transferring it to another person, such as a financial guarantor, the sponsors themselves or some third-party credit enhancer. To the extent some or all of the construction risk is eliminated by assuring bond investors of debt service until the revenue stream comes “online,” they are much more likely to get comfortable with the investment. Alternatively, you can allow investors, or at least some subset of them, to conduct due diligence and thus effectively convert a capital markets offering into a hybrid transaction where some elements of bank financing or institutional investor financing are allowed to play a role — in other words, get investors in direct privity with the project and the underlying documents. In many of the Peruvian project bond transactions, local pension funds who are very familiar with the macro-economic and other risks associated with Peru engage more directly with project sponsors and the placement agents. Indeed, these investors have agreed to multiple drawdowns of the bond over time to mitigate negative carry, a feature that is more prevalent in institutional private placements. These types of transactions are offered in the capital markets, but generally are sold only to a handful of investors — in this respect, the transactions are more of a hybrid form of private placement than a true capital markets offering to traditional bond market investors. Mitigating Construction Risk The first option of mitigating construction risk by credit enhancement during construction was the business model of the “monoline” insurance companies that provided financial guaranties for debt service on bonds issued to finance construction projects. The insurer took the construction risk, did its own extensive due diligence on

the project and negotiated the credit documentation with the sponsors. Since the financial crisis and the disappearance of most of the monoline insurers, these types of financial guaranties have generally not been available. Furthermore, even if they became available, many bond investors might have second thoughts about relying completely on financial guaranty insurance to the extent it is issued by companies replicating the previous business model. We all know how that worked out. Other alternatives have included partial guaranties from multilateral lending institutions, full sponsor guaranties of debt service during construction, government co-financing during construction, support from existing revenue sources in the case of brownfield projects or some combination of the foregoing. All of these alternatives serve to mitigate construction risk. Multilateral lenders are usually thought to be at the top of the pecking order for credit support because of their credit ratings as well as their perceived political clout with host countries. If creditworthy sponsors agree to fully guarantee debt service during construction (which is often controversial for them because the debt then becomes full recourse to the sponsors and likely part of their own balance sheets), bond investors may become comfortable with the risks of project completion. Understanding and Accepting Construction Risks There have not been many examples of the second alternative. It is one thing is to mitigate construction risk by essentially shifting it to another person, and it is another thing to be prepared to accept the risk itself without credit support, or at least one that is not a full financial guaranty, through one’s own assessment of the risk. One variation of this second alternative is to have a senior bank credit facility funded alongside a bond offering in the capital markets. The banks might be pari passu

or structurally senior to the bonds, but the main point would be that during construction, the banks — who are principals lending their own money to the project — would be the adult supervision minding the store so that bondholders would have at least some assurance that a pari passu group of creditors is looking after their collective interests during the construction phase of the project, even if the banks retain control of decision-making. This is not unlike the position of the monoline insurers who functioned as the controlling creditor as long as they were ensuring that payments were being made on the bonds. On the other hand, many projects may not be candidates for a financing package where bank lending and a bond offering are made available at the same time since it may not be justified economically. In many cases, the bank facility, if available to cover construction costs, would logically precede the bond offering which would serve more of a take-out financing than a concurrent construction financing. Some projects have arranged bank financing commitments as a stand-by facility that is available to the extent a bond offering cannot be completed. Another approach might be to have an anchor group of institutional investors take on a more active analytical and due diligence role prior to the bond offering and then participate in the bond offering as a defined group. Such a group might commit to purchase bonds in the offering and the disclosure in the offering memorandum would indicate this prior commitment. This anchor group might retain certain voting and control functions during the construction phase of the project that are more significant than the rest of the bondholders. How this would play out in terms of lock-up and transfer restrictions, indemnification, economic compensation and related matters would have to be negotiated, but the concept would be that the “public” holders of bonds would have some assurance that

an anchor group of investors with skin in the game had undertaken a thorough review of the project risks beyond the disclosure document and the one-hour roadshow presentation for the bond offering. They would have understood and accepted the construction risk, something that bond holders are not generally in a position to do. Can an independent engineer or some other professional advisor take on the role of protector of the senior creditor group? It is clear that indenture trustees will not undertake these responsibilities. While many transactions include significant roles for the independent engineer during construction, they are not principals and do not have their own money at stake. Furthermore, there are liability concerns which often make them reluctant to take on a role which effectively puts them in a position of making commercial decisions on behalf of bondholders. What may be more attractive is having them be involved with the anchor group of controlling party investors as an independent technical advisor to that group. Alternatives Need to Be Explored to Make Project Bonds More Attractive Some of these concepts will have to be analyzed in the context of particular projects and tested to determine whether they are feasible. Of course one should not overlook the fact that attractive yields also play an important role and investors often are prepared to assume greater risks in exchange for greater returns. However, in the absence of mitigating construction risk through third-party credit support, some form of enhanced creditor due diligence and supervision during construction or some peculiar feature of the project that is unique, the traditional bond market may continue to struggle with “greenfield” project bond offerings. 

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TRANSACTION PROFILE

Lessons from the Trenches: Muni Bonds Paving the Roads Ahead By Lucia Benabentos

Earlier this year, Chadbourne represented the successful bidder in the public-private partnership for the I-69 Section 5 Project (the “I-69 Project”), which involved the financing, design, construction, operation and maintenance related to the upgrading of an existing four-lane median-divided highway to an interstate highway in Indiana, including four new interchanges, 12 new bridge structures, improvements to the existing interchanges and overpasses, and a new operations and maintenance management center. The public-private partnership included a concession with approximately a 35-year operating and maintenance period and payments during construction in the form of payments for satisfaction of certain construction milestones and, after construction, in the form of availability payments for the operation and maintenance of the project, each made from funds that are ultimately appropriated by the General Assembly of the State of Indiana. The I-69 Project was financed through the issuance of tax-exempt private activity bonds or “PABs” in the U.S. municipal securities market as well as from certain equity contributions made by the sponsors of the I-69 Project. This article highlights certain features of PABs as they relate to the capital markets practice. What are PABs? PABs were created to facilitate access to the capital markets by communities, which act as conduits for businesses. The community issues bonds but the credit of the business rather than the community provides the financial backing for the bonds. Communities are thus able to access financing through the municipal markets at low rates for the development of projects. The Revenue and Expenditure Control Act of 1968 and the Tax Reform 4


Act of 1986 established the current structure of PABs under the Internal Revenue Code (the “Code”), which classifies state and local bonds as either governmental bonds or private activity bonds and sets forth the related tax regulations. Governmental bonds are used for projects that benefit the general public, while PABs are used for projects that, while generating a profit for private entities, operate for the public benefit. PABs are securities issued by a state or local government the proceeds of which are used in accordance with Section 141 of the Code, which requires that (i) more than 10% of the proceeds of the offering be used for a private business use (the “private business use test”) and payment of principal and interest be secured by or payable from property used for a private business use (the “private security or payment test”) or (ii) the amount of proceeds used to make loans to nongovernmental borrowers exceeds the lesser of 5% of the proceeds or US$5 million (the “private loan financing test”). What are Tax-Exempt PABs? The Tax Reform Act of 1986 established the current regime for PABs and provides that, although PABs interest is generally taxable for federal income tax purposes, certain facilities carrying on specified exempt

activities operating for the public benefit are excepted so that interest on those taxexempt PABs is excluded from federal gross taxable income. To be tax exempt, a PAB must (i) be a “qualified bond” within the meaning of Section 141(e) of the Code, (ii) not be an “arbitrage bond” within the meaning of Section 148 of the Code, and (iii) in the case of certain registered required bonds (any bond which is not of a type offered to the public or has a maturity date of one year or less), be issued in registered form within the meaning of section 149 of the Code (which can be met through a book-entry system requirement for a transfer of the bond). Pursuant to Section 141(e) of the Code, “qualified bonds” include exempt facility bonds, qualified mortgage bonds, qualified veterans’ mortgage bonds, qualified small issue bonds, qualified student loan bonds, qualified redevelopment bonds and qualified 501(c)(3) bonds, each as defined by the Code. Qualified redevelopment bonds are bonds used for the development of projects and are defined by the Code as bonds issued as part of an issue 95% or more of the net proceeds of which are to be used for one or more redevelopment purposes. The number of eligible private activities has gradually increased, from 12

to 21, and the list currently includes airports, docks and wharves, mass commuting facilities, facilities for the furnishing of water, sewage facilities, solid waste disposal facilities, qualified residential rental projects, facilities for the furnishing of local electric energy or gas, local district heating or cooling facilities, qualified hazardous waste facilities, high-speed intercity rail facilities, environmental enhancements of hydro-electric generating facilities, qualified public educational facilities and highway and freight transfer facilities.

package for the Bonds. In addition, certain entities agreed to make, as sponsors for the I-69 Project and as indirect owners of the Project Company, certain equity contributions. The IFA is a body politic and corporate, not an agency of the state of Indiana and has no taxing power. Therefore, the Bonds are not payable from taxes made by the General Assembly of the State of Indiana and do not constitute an indebtedness, or a pledge of the full faith and credit, of the

Qualified redevelopment bonds are bonds used for the development . . . and the list currently includes airports, docks and wharves, mass commuting facilities . . . high-speed intercity rail facilities, environmental enhancements of hydro-electric generating facilities, qualified public educational facilities and highway and freight transfer facilitates. Deal Structure for Tax-Exempt PABs In a typical PAB offering, an agency of the state or local government acts as a conduit issuer of the securities and loans the offering proceeds to the project company in a back-to-back loan. There is no credit support by the government (including the conduit issuer) other than its obligations under the underlying project documents (such as the concession or project agreement) with the project company. The I-69 Project involved the issuance of US$243,845,000 tax-exempt PABs, Series 2014 (the “Bonds”) by the Indiana Finance Authority (the “IFA”), as conduit issuer. The proceeds from the offering were then loaned to I-69 Development Partners LLC (the “Project Company”) pursuant to a senior loan agreement for the financing of construction costs of the I-69 Project. The Project Company provided an “all assets” security package and an equity

state of Indiana or any political subdivision thereof. As the IFA only operates as a conduit issuer, the Bonds constitute special and limited obligations of the IFA, payable solely from, and secured exclusively by, the security package provided by the Project Company, including the payments to be made by the Project Company to the IFA under the senior loan agreement. All documentation which the IFA entered into was governed by Indiana law. The split between the conduit issuer and the private company also affects the role of counsel. The conduit issuer engages special legal counsel (“bond counsel”) in addition to counsel to the private company and the underwriters. This practice predates PABs and became necessary due to widespread defaults and extensive litigation in the late 1800s relating to the validity of certain bonds, in particular municipal bonds, due to a governmental issuer’s ability to avoid debt that was issued ultra

vires. Thus, opinions of bond counsel on the validity of bonds provided sufficient comfort to investors. However, with the Revenue and Expenditure Control Act of 1968, the opinion of bond counsel has expanded to include analysis of extensive and complex federal tax and securities legislation and regulation of municipal bonds. In addition, bond counsel can perform other functions such as preparation and supervision of certain transactional documentation and process, assisting parties in obtaining governmental approvals, structuring investments of bond proceeds, advising the issuer as to ongoing obligations with respect to the bonds, assisting in the preparation of tax-related documents, and assisting in the presentation of information to rating agencies and other market participants, among others. Bond counsel can also act as advisor to the issuer or the underwriters. Chadbourne acted as special counsel to the Project Company and Isolux Infrastructure Netherlands B.V. as to New York law, and Indiana counsel issued and delivered the requisite legal opinion as bond counsel. Relatively Long Underwriting Commitments The issuance of PABs is often part of the financing package contemplated by the bidding process for U.S. highway and transit PPP projects. Since sponsors are generally committed to close without a financing condition if they are awarded the project, they look to enter into commitment letters with bond underwriters also required by the bidding rules. The underwriting commitment letter generally sets out terms that are similar to definitive underwriting agreements for corporate bonds, including a firm commitment to underwrite the bonds, representations of underwriters (as to certain due diligence matters performed in connection with the bid) and the sponsor companies (as to the accuracy of the information provided to the underwriters), detailed termination events and market disruption events that allow for the termination of the commitment, fees, expenses and indemnity provisions. However, given that there is significant time between the commitment letter and financial close, the term of the CHADBOURNE

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commitment is for a much longer period of time than an underwriting commitment for corporate bonds, which is generally three to five business days. Underwriters have accepted this exposure because there is no price commitment and the market for PABs is generally more consistent and liquid and has the benefit of tax exemptions, an attractive feature for a large segment of the bond market, thus ensuring sufficient demand. In addition, the procurement authority will often agree to undertake a large portion of the risk of credit spreads and changes in interest rates from an established benchmark, thus decreasing the risk to underwriters. The underwriting commitment letter is submitted as part of the bidding package, but parts of it can be subsequently redacted before being made publicly available. Regulatory Framework Under the Securities Laws PABs are exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), pursuant to Section 3(a)(2) of the Securities Act and Section 3(a)(12)(A) of the Exchange Act,1 respectively. However, PABs are subject to the antifraud provisions of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Therefore, as with any capital markets offering, the disclosure regime generally focuses on the materiality of the information to the investment decision and whether the disclosure makes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. Congress created a regulatory scheme in response to increasing participation of retail investors in the municipal securities market. This regulatory framework focuses on registration of broker-dealers and banks dealing in municipal securities and includes the creation of the Municipal Securities Rulemaking Board 1

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(the “MSRB”) with the authority to promulgate rules governing the sale of municipal securities by broker-dealers and municipal securities dealers and, most importantly, the adoption of Exchange Act Rule 15c2-12 (the “Rule”). Pursuant to the Rule, underwriters may not underwrite an offering of municipal securities with an aggregate principal amount of US$1,000,000 or more unless such underwriter complies with (or is exempted from) the requirements of the Rule, which mainly include filing an official statement, distribution of the official statement, and certain continuing disclosure obligations of the issuer and the obligors. Pursuing market participants for materially misleading statements and omissions in disclosure documents relating to municipal securities has been a specific focus by the SEC over the past 20 years. More recently, in 2013, the SEC began enforcement proceedings against municipalities, government officials, financial advisors and underwriters related to municipal securities offerings. The SEC initiated proceedings against the state of Illinois for misleading investors by failing to inform them of the impact of problems with a pension funding schedule prior to offering and selling more than US$2.2 billion in municipal bonds, against the City of Harrisburg for making misleading public statements and providing incomplete or outdated financial information (this marked the first time the SEC charged a municipality for misleading statements made outside of its securities disclosure documents), and against the city of Miami and its former budget director for making materially false and misleading statements and omissions on certain interfund transfers in three bond offerings totaling US$153.5 million and misleading statements in the city’s fiscal year 2007 and 2008 annual financial reports. FILING OF THE OFFICIAL STATEMENT

The Rule provides that the final official statement must be filed with the MSRB through the Electronic Municipal Market Access (EMMA). Under the Rule, a final

official statement is a document or set of documents prepared by an issuer of municipal securities or its representatives that is complete as of the date delivered to the underwriters and that sets forth (i) information concerning the terms of the proposed issue of securities; (ii) information, including financial information or operating data, concerning such issuers of municipal securities and those other entities, enterprises, funds, accounts, and other persons material to an evaluation of the offering; and (iii) a description of the continuing disclosure undertakings and of any instances in the previous five years in which the issuer or the company failed to comply, in all material respects, with any previous continuing disclosure undertakings in a written contract or agreement. As this description is broad, much like private placements, market practice and municipal securities practitioners using the materiality standard of Rule 10b-5 have dictated the content of the official statement. Therefore, disclosure is focused on whether the information in the official statement makes “an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” The official statement is prepared collectively by counsel to the private company and the underwriters as well as bond counsel, and each counsel provides separate legal opinions and negative assurance letters at closing. The official statement for the Bonds included standard sections for a corporate bond, such as a summary of the I-69 Project and the Bonds, a description of the Bonds, risk factors, as well as a description of the principal project documents (e.g., the publicprivate agreement and the design-build contract) and the financing documents (e.g., the collateral agency agreement, equity contribution agreement and the loan agreement), projected sources and uses of funds, description of accounts and cash flows, description of project participants and technical reports. In addition, in accordance with the Rule, the official statement described the continuing disclosure obligations of

Section 15B of the Exchange Act sets out the principal rules and regulations for municipal securities. In particular, sub-section (d)(1) of Section 15B provides that neither the SEC nor the Municipal Securities Rulemaking Board (“MSRB”) is authorized to require any issuer of municipal securities to file with the SEC or the MSRB, prior to the sale of such securities by the issuer, any application, report or document in connection with the issuance, sale or distribution of such securities. CAPITAL MARKETS NEWSWIRE | WINTER 2014

the IFA and the Project Company and their compliance with all of their continuing disclosure contracts during the last five years. Unlike a private placement, there is no need to include transfer restrictions since the Bonds are exempt from the registration requirements of the Securities Act under Section 3(a)(2) and are not considered “restricted securities.” The Rule specifies the “pricing” information that may be excluded from the preliminary official statement, such as the offering price, interest rate, selling compensation, aggregate principal amount, principal amount per maturity, delivery dates, any other terms or provisions required by an issuer of such securities to be specified in a competitive bid, ratings, other terms of the securities derived from such matters and the identity of the underwriter. Nevertheless, market practice has been to include all pricing information and note it in the official statement as “preliminary, subject to change.” In particular, PABs used for development activities include information on expected sources and uses of funds that is typically based on a financial model that assumes a certain schedule of construction and operating costs as well as a specific interest rate and maturity of the securities. This gives investors an idea of the funding and financing of the project based on the financial model. DISTRIBUTION OF THE OFFICIAL STATEMENT AND SETTLEMENT

The final official statement must be filed with EMMA within seven business days from the date of pricing. In addition, market practice is that PABs generally settle on a more delayed basis than corporate bonds although the Rule is silent on settlement periods, with settlement occurring between two to three weeks after pricing, rather than the three to five days customary for corporate bonds. This delay is due to a variety of factors which also affect the final official statement, including additional time required by the government entity issuing the PABs to approve the documentation and the finalization of documentation of a relatively complex nature. As this has become market practice, there is generally no specific disclosure on

this point other than to indicate the expected settlement date. CONTINUING DISCLOSURE OBLIGATIONS

The Rule requires the periodic disclosure of material information to the market, including (1) annual financial information; (2) audited financial statements, if not included in the annual financial information; (3) notice of certain material events that may affect the bonds or the rights of bondholders under the bonds, including failure to pay principal or interest, nonpayment related defaults, adverse tax opinions or events affecting the tax-exempt status of the bonds, modifications to rights of bondholders, bond calls, defeasances, and rating changes, among others; and (4) notice of a failure to provide required annual financial information on or before the date specified in the written agreement. Information must be filed with the MSRB to ensure accurate and timely disclosure of information to investors. In connection with this requirement, the issuer and the project company enter into a continuing disclosure agreement with a dissemination agent whereby the issuer and the project company agree to provide the required information to the dissemination agent for submission to the MSRB through EMMA. RECENT SEC ENFORCEMENT INITIATIVE

The MSRB and the SEC have recently focused on the continuing disclosure obligations under the Rule as compliance by issuers has been faulty in the past. On March 10, 2014, the SEC announced its Municipalities Continuing Disclosure Cooperation Initiative (the “MCDC Initiative”) that was intended to address potentially widespread violations of the federal securities laws by municipal issuers and underwriters of municipal securities in connection with certain representations about continuing disclosures in bond offering documents. Pursuant to the MCDC Initiative, issuers and underwriters are required to self-report to the SEC possible violations involving materially inaccurate statements relating to prior compliance with the continuing disclosure obligations

specified in the Rule, by accurately completing a questionnaire within the applicable time periods (for underwriters, the deadline for submissions ended September 10, 2014, and for issuers, it ended December 1, 2014). The SEC has stated that it will recommend favorable settlement terms to issuers and underwriters of such offerings if they self-report in accordance with the MCDC Initiative, with caps on civil penalties faced by underwriters. Where do we go from here? PABs are not the only financing used for infrastructure development in the municipal markets. In October of this year, two toll road bonds were issued in the municipal markets: the Texas Transportation Commission issued US$1.26 billion in municipal bonds; and the San Joaquin Hills Transportation Corridor Agency, in southern California, sold approximately US$1.4 billion in municipal bonds for the refinancing of the highway between Newport Beach and San Juan Capistrano. The allocation of PABs for highway and freight transfer facilities authorized by Section 11143 of Title XI of SAFETEA-LU (the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users) limits the total amount of such bonds to US$15 billion and directs the Secretary of Transportation to allocate this amount among qualified facilities. According to the Federal Highway Administration, as of September 17, 2014, over US$4.8 billion PABs have been issued for 13 projects for highway and freight transfer facilities in Virginia, Texas, Colorado, Illinois, Kentucky, New York and Indiana. In addition, US$5.4 billion have been approved by the U.S. Department of Transportation for seven projects in Alaska, Illinois, North Carolina, Ohio, Texas, Pennsylvania and Maryland. Any increases to this program cap require the approval of Congress. The question remains whether Congress, in light of this increase in investor appetite in the municipal markets, will increase the statutory cap and provide the support to a program that has great potential to pave the road ahead for infrastructure development financing in the United States. 

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INTERVIEW

Jill Wallach, BTG Pactual Jill Wallach is currently an associate partner and chief legal counsel of the international offices of BTG Pactual. She was selected by The Legal 500 as one of the top 100 in-house Corporate Counsel in Latin America in 2014 and in the United States in 2013. In her current role, she is responsible for legal and regulatory for the bank’s commodities, asset management, investment banking and private banking divisions. She serves as a director on various BTG Pactual global investment funds. From November 2000 to July 2008, she served as senior counsel in the investment banking department of Merrill Lynch & Co. and Credit Suisse Securities (USA) LLC. Prior to that, Ms. Wallach was an associate with Cadwalader, Wickerham & Taft and Linklaters (London), both leading international law firms. While at these firms, she represented a wide variety of large investment banking and corporate clients. Ms. Wallach holds an LL.M. in international business law from the University of Salzburg in Austria. She earned her J.D. from New York Law School in 1992 and a B.A. from the State University of New York in Albany in 1986. The Newswire staff recently sat down with Ms. Wallach to go through a series of questions related to specific practice points as well as more general franchise protection issues that often come up in the context of cross-border securities offerings and how she sees these types of issues in her role as internal counsel to the underwriter. QUESTION: You have an enormous amount of experience working as investment banking counsel at several major international investment banks during the last 14 years. What do you see as the major challenges and risks for investment banks in the current legal and financial environment, particularly in the cross-border area? ANSWER: The major challenges and risks for investment banks or any institution in the financial industry are hands down those related to regulatory issues. The increase in the pace and complexity of regulation, plus the increase in extraterritoriality being asserted by regulators 8


globally means the world is more complicated and it is something that in-house counsel’s time and energy is increasingly focused on. Q: Outside counsel representing the investment bank on a securities offering often misunderstand the role that internal counsel plays on transactional matters and when they are expected to consult with internal counsel on issues. How would you define your role in the securities offering context and what should outside counsel be aware of in order to better manage this relationship? A: The principal role internal counsel plays is to ensure that the long term interests of the bank are protected during the execution of an investment banking transaction, both in terms of exposure to liability and reputation. In capital markets transactions, that means working with external counsel in drafting and negotiating transaction documents (principally the underwriting agreement) for the inclusion of

representations and warranties, covenants and indemnities that the institution has determined to be critical and including fulsome disclosure on the issuer, including risks investors face when participating in the transaction. The most important role outside counsel can play is to raise critical issues as early as possible during the course of the transaction so that there is adequate time to address them through conversations with the banking team, issuer’s counsel and the client. Key points to flag include proposals by the issuer/auditors for atypical financial statements, inclusion/exclusion of pro forma financial information, resistance from issuers on giving standard representations and warranties, covenants and indemnities, lack of “comfort” on key financial indicators and legal opinions to be delivered by external counsels. Raising these issues early not only helps provide internal counsel adequate time to liaise with the deal team in order to find solutions, but it also allows them time to notify

senior members of the legal and risk management teams internally. On the other hand, one common misperception by external counsel is that internal counsel is required to approve every document related to the deal before it is distributed to the working group. Given the large volume of transactions internal counsel customarily supervises at any given time, the deal team relies on external counsel to produce and distribute documentation in an efficient manner to meet the timing needs of the transaction. Internal counsel at each of the banks will most likely have deep seated personal views on which documents require their prior internal review and it is helpful for external counsel to reach out to them at the outset of the deal to see which documents are required to be approved prior to distribution, and which documents can be distributed subject to continuing review. Q: There is obviously a lot of fee pressure on lawyers these days, and the capital markets practice is no exception. Do you sometimes worry that fee pressures will erode the quality of legal service or affect the amount of attention partners will pay to the transaction? In particular, where negative assurance on disclosure is being delivered, does it worry you that lawyers may not be undertaking an adequate level of diligence and attention to drafting? A: Fee pressure has been a major issue in recent years in many of the jurisdictions where we are helping raise capital. We have seen fee proposals dropping from many major law firms in order to attract business volume and, in some cases, this has certainly limited the presence of partners on the transactions. That being said, the firms with which we work most closely continue to have a clear commitment to quality, despite their low fee proposals, which invariably leads to fees ultimately exceeding their original proposals. In that case, there is regularly a negotiation that takes place post-closing between external counsel and the issuers (who are usually paying for external counsel for the banks) to come to an agreed upon price.

In terms of due diligence, we believe that the requirement to provide a 10b-5 letter at closing keeps pressure on law firms to conduct adequate diligence, regardless of the fees they quoted. Q: As issuer’s counsel, we are often asked to review and comment on investment banks’ mandate or engagement letter for securities offerings. What sort of issues do you often run into when negotiating these documents with issuer’s counsel? A: Customarily, mandate letters are handled solely in-house both on the bank and issuer’s side, as the legal provisions have become quite standard and the principal issues to discuss are generally business terms. We have found external counsel for the banks to be generally reluctant to get involved in negotiations of mandate letters, due to the significant amount of back and forth among the banks and the limited need for review of key legal provisions. However, it is not in our interest or in the interest of the company if a key business term in a mandate letter is not clear to management of the company, and the issuer’s external counsel can play a helpful role in assisting them to that end. Q: Increasingly there appears to be a trend in securities offerings that issuers, including first-time issuers, throw their weight around and designate the counsel that the investment banks must use for the offering. This can occur either before or after the investment banks have been mandated. How do you feel about that practice and what has your experience been where that situation has occurred? A: Issuers who have pre-existing relationships with external counsel commonly look to influence the selection of bank counsel in a given capital markets transaction. Our policy has been that BTG’s legal department, working together with IBD and ECM/DCM, will select three to four firms who we believe to be the most suited to provide experienced service to the banks, given the nature of the transaction in question. In the event we believe that any of the three or four firms are equally suited to the transaction, we may, if requested,

permit issuers to select among the firms we have pre-selected. However, we have a firm policy against permitting the issuers from exercising any greater control over choosing external counsel than described above, due to the obvious potential for conflicts of interest and the wide disparity of quality of service in the market. Q: In an effort to save on legal costs, it is sometimes proposed to have one international counsel be “transaction counsel” and effectively represent both the investment bank as well as the issuer in the context of a securities offering. How do you feel about that, and does it make a difference if the offering is made exclusively outside the United States under Regulation S of the Securities Act? A: For Regulation S transactions, we sometimes rely on deal/transaction counsel to represent both the issuer and underwriters. The experience has been mostly positive, in that the issuer is able to significantly save on transaction expenses, while transaction counsel has historically continued to prepare high quality disclosure documents. Complications typically arise in discussions on the underwriting agreement (or placement agreement) between the issuer and the banks, which can, at times, place deal counsel in an awkward situation. We have addressed this issue by asking that deal counsel’s role be limited to giving their general view on what provisions have become market standard and which are outliers, to help the company and the banks find a balanced agreement. The critical point in using transaction counsel is that the issuer must be advised at the outset that fundamentally, the counsel’s professional duties are owed to the banks, and that counsel cannot be used to advance a position adverse to them. If at any time they believe that they need separate counsel, it will be their responsibility to engage them at their own expense. Q: Over the past several years, there have been increasing amounts of local offerings that have been marketed directly to U.S. institutional investors, but the extent of the marketing efforts depends on the structure and size of the deal CHADBOURNE

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and the familiarity of the U.S. investor base with the issuer and the country of domicile. Obviously, most investment banks doing a significant targeted offering in the United States would require an English-language offering memorandum, comfort letters from the auditors and negative assurance letters from outside counsel. Under what circumstances would you feel comfortable allowing U.S. offers and sales without the full panoply of protections that are typically involved in, say, a Rule 144A offering, and what other bells and whistles would you insist on? A: We have seen a recent limited trend of equity offerings, mostly outside of Brazil, where the potential U.S. investor base is significantly less than what you would expect for a customary 144A offering. These deals tend to have one to five large U.S. institutional investors that are familiar with the jurisdiction and industry of the issuer and are well-known to the banks. In those limited situations, we have become comfortable marketing equity offerings to a very limited number of U.S. investors, without the benefit of receiving a 10b-5 letter or comfort letters, provided that the level of disclosure contained in the offering memorandum is still in line with what would be provided in a 144A deal, a big four accounting firm has included audited financials in the offering documents and external counsel delivers standard corporate opinions (particularly a no-registration opinion). In addition, even if the auditors do not provide a comfort letter, we expect them to review and comment on the disclosure document as if they were delivering a comfort letter. Q: Comfort letters have been an integral part of the due diligence defense “tool kit” for investment banks in underwritten securities offerings in the United States for decades. What sort of evolution

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have you seen in the practice in the last few years? Has there been a dilution in the types of comfort given or on the process for the delivery of comfort letters? Have you seen the practice outside the United States evolve in ways that are different from the way it has evolved in the United States? A: We have certainly seen a trend in recent years of auditors being less willing to “comfort” certain numbers in an offering memorandum, particularly relating to non-GAAP financial information such as EBITDA and Adjusted EBITDA. For non-GAAP measures whose components are made-up of GAAP figures (such as EBITDA), we have been comfortable receiving CFO certificates confirming the accuracy of the numbers, and request that our own bankers perform due diligence on the numbers as well. In addition, we have seen issues arise where companies do not provide auditors with timely financial information during the “stub” period, which leads to limited negative assurance in the comfort letter. In that case, we will look to our bankers to review preliminary numbers provided by the company and to conduct extensive due diligence sessions with the issuer’s CFO to discuss trends and expected results for the upcoming fiscal period. Q: After the U.S. Supreme Court’s decision in Gustafson v Alloyd back in 1996 eliminating Section 12 liability for offerings which are not registered under the Securities Act, there is really not much left of Securities Act liability in the context of unregistered securities offerings in the United States. Effectively, only Section 10(b) and Rule 10b-5 under the Securities Exchange Act remain as remedies to false or misleading statements in offering materials. Despite this, investment banks still manage the financial

intermediation process as though the law had not changed and Section 12 continues to apply. What drives this continued dependence on the due diligence process, with lawyers’ negative assurance and auditor’s comfort letters, and do you think that over time with competitive pressures the practice may shift to a less conservative position by investment banks? A: From a technical analysis, despite the absence of Section 11 and Section 12 liability, a complete due diligence investigation of the issuer (including the receipt of comfort letters and 10b-5 letters) helps to negate the “scienter” element of a 10b-5 claim against the banks. Accordingly, from a pure legal analysis, we continue to believe these tools provide important protections to the bank. However, and more importantly, regardless of the standard of liability, we continue to believe that in order to provide the highest quality services to our clients and to maintain both our reputation and integrity, it is critical that we provide potential investors with fulsome and accurate disclosure in connection with their investment decision on transactions we are underwriting/placing. Our external legal advisors and independent auditors are key to this process, in that they have the staff and expertise to confirm all operational and financial information in the disclosure documentation. By requiring 10b-5 letters from external advisors and comfort letters from auditors, we are able to ensure that these firms are dedicating sufficient resources towards the transaction and carefully reviewing the disclosure we are providing to the market. We have strongly resisted any changes to these procedures that have been adopted and will continue to do so. 

ISSUER’S COUNSEL CORNER

Updates on Procedures For Submission of SEC Confidential Treatment Requests By Patrick Dorime and Sey-Hyo Lee In recent months, the staff of the Division of Corporation Finance of the Securities and Exchange Commission (“SEC”) has made certain clarifications and changes to the procedure for submitting a Confidential Treatment Request (“CTR”) pursuant to Rule 406 under the Securities Act of 1933 and Rule 24b-2 under the Exchange Act of 1934 with respect to documents (including exhibits) required to be filed in connection with registration statements and periodic reports filed with the SEC under the Securities Act or the Exchange Act. Beginning in 1997, the SEC staff set forth its views on the requirements for submitting a CTR under Rules 406 and 24b-2 in Staff Legal Bulletin No. 1 (“SLB No. 1”), which was most recently updated in 2011. The clarification relates to the procedure for requests for confidential treatment of documents under Rule 406 or Rule 24b-2 CTRs. In addition, the SEC also announced changes in its notification procedure for granting CTRs and the procedure for redacting personal identifying information in exhibits to registration statements, periodic reports and other documents required to be filed under the Securities Act or Exchange Act. Updated Procedure for Submitting a CTR Under Rule 406 or Rule 24b-2 In connection with the SEC staff’s efforts to standardize its procedures for the submission of CTRs under Rules 406 and 24b-2, the SEC staff has been reaching out to issuers and their counsel to clarify the SEC procedures for Rule 406 and 24b-3

CTRs, including clarifying that issuers submitting a CTR should not send a courtesy copy of any kind, including a copy without exhibits, to the FOIA Office as mandated under Rule 83 of the SEC’s Rules of Practice. Rather issuers seeking confidential treatment under Rule 406 or Rule 24b-2 should only send an unredacted version of the filing to the SEC’s Office of the Secretary. These clarifications only affect the procedures for Rule 406 and 24b-2 CTRs. They do not impact Rule 83 requests made outside the context of Rule 406 and 24b-2 CTRs described below, such as seeking confidential treatment of information included in responses to SEC comment letters. • Address mailed CTR submissions to: Office of the Secretary Room 10915 Mail Stop 1090 Securities and Exchange Commission 100 F Street, NE Washington, DC 20549-1090 • Submit hand-delivered CTR submissions to: • SEC mailroom, which is accessible by proceeding East on F Street to 3rd Street. Turn North on 3rd Street. Continue until H Street. Turn West on H Street. The mailroom is accessible via H street, between 3rd and North Capital Streets. • Hours of operation are 8:00 a.m. to 5:30 p.m., Monday through Friday, excluding Federal holidays.

• Do not include additional information on the envelope: • Place no other information on the envelope other than the address noted above and a return address. • This includes not adding additional items to the address such as “attn:” or the name of the staff member handling the CTR. • Do not include redacted version: • Send an unredacted version of the filing as an exhibit to the CTR. • Do not send a redacted version of the filing as an exhibit to the CTR. The SEC will use the redacted version filed on EDGAR to adjudicate the CTR. • No CTR needed for personal identifying information: • It is not necessary to submit a CTR for personal identifying information (e.g., address, social security number or bank account number). • The issuer should simply redact the relevant personal identifying information in the version of the document filed on EDGAR. Changes to Notification Procedure for CTRs Granted Without Comment The SEC will no longer directly notify issuers, orally or in writing, regarding the grant of CTRs under Rules 406 and 24b-2 in cases where the SEC has issued an order granting such a CTR without providing

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comment. These orders, however, will continue to be posted through EDGAR. Thus, an issuer can determine if the SEC has granted an application without comment by reviewing the issuer’s filings on EDGAR. Orders will appear on EDGAR under the Form Type “CT ORDER”. These recent changes place the burden on issuers and their counsel to review the issuers’ EDGAR filings online after filing a CTR. However, subscription to an EDGAR filing watch service should alleviate that burden. The notification process for Rule 406 and 24b-2 CTR determinations made with comment or any such CTRs denied without comment will remain the same. As such, if the SEC decides to comment before determining whether to grant or deny a Rule 406 or 24b-2 CTR, the SEC

will (i) address any comments with the issuer, (ii) advise the issuer if the CTR has been denied or granted and (iii) post the final order granting or denying the CTR on EDGAR. If the SEC decides to deny the CTR but does not comment on that determination, the SEC will advise the issuer in writing. Confidential Treatment of Supplemental Materials The staff is reminding issuers of a change in its position regarding the requirement to submit a copy of the application to the FOIA Office. The SEC has a separate procedure under Rule 83 of the SEC’s Rules of Practice for issuers seeking confidential treatment of information submitted to the SEC but not required to be disclosed under

the Securities Act or the Exchange Act. Originally, SLB No. 1 stated that requests for confidential treatment of supplemental materials, including the application for confidential treatment, made in connection with a Rule 406 or 24b-2 CTR, should be made following the Rule 83 procedure, including a requirement to submit a copy of the application for confidential treatment to the Freedom of Information Act (FOIA) Office. However, in 2011, the staff changed its position to instead have all requests for confidential treatment relating to a Rule 406 or 24b-2 CTR, including the application for confidential treatment, made under the Rule 406 and 24b-2 procedures. The staffs’recent clarification does not affect any of the procedure for a Rule 83 confidential treatment request for supplemental materials. 

Study Finds SEC Comment Letters Prompt Insider Sales By Mikaela C. Cavalli Study Findings A recent study conducted by three professors at the Haas School of Business of the University of California at Berkley found that insider sales were nearly 70 percent higher than normal selling patterns in the five business days prior to public disclosure of SEC comment letters involving revenue recognition. The study focused on comment letters questioning a company’s revenue recognition practices on the theory that such issues are substantial enough to get the attention of management and are potentially material to investors. Pursuant to SEC policy, the SEC does not make comment letters public until 20 business days following completion and

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resolution of the SEC staff’s review. The study determined that “corporate insiders take advantage of this opportunity and unload shares prior to the public disclosure of SEC comment letter correspondence pertaining to material financial disclosure and reporting issues.” Based on these findings, the authors of the study concluded that “the current practice of delaying the real-time disclosure of SEC comment-letter correspondence is problematic and support[s] concern from the investment industry that the disclosure delay appears to best serve the interests of corporate insiders.”

Moving Forward As the authors of the study note, the results of this study suggest that the SEC should encourage corporate boards to implement insider-sale blackout periods during the comment-letter review process. Other suggestions for mitigating these insider sales include changing the SEC policy to shorten the 20-day time lag in releasing the comment letters and improving online access to these letters. As for companies, the authors of the study suggest they should review their insider trading policies to ensure that they are worded in such a way as to prohibit insider trading during the comment letter review process. 

Regulation A+: Gallagher’s Re-Proposal For Venture Exchanges By Stephanie DiFazio On September 17, 2014, SEC Commissioner Daniel M. Gallagher presented remarks before the Heritage Foundation emphasizing the need for a reduction of the regulatory burdens in order to encourage more startups to go public. In addition to finalizing the Regulation A+ provisions, he recommends that the SEC raise the Regulation A+ cap on securities offerings from $50 million to $75 or $100 million and exempt Regulation A+ shares from the registration requirements of Section 12(g) of the Exchange Act. Gallagher calls for the creation of “venture exchanges”— exchanges with trading and listing rules tailored for smaller companies, including those engaging in issuances under Regulation A or A +. Gallagher

explains that shares traded on these exchanges would be exempt from state blue sky registration, the SEC’s national market structure, and unlisted trading privileges rules. Such venture exchanges would “recreat[e] some of the ecosystem supportive of small companies that has been lost over the years.” Gallagher’s proposal is not new. He had called for such venture exchanges over a year ago, claiming that these special exchanges would provide the “proper runway” for small companies to grow while providing investors with the material disclosures they need to make informed decisions. Many of Gallagher’s proposals, including those for venture exchanges, have been heavily criticized by state securities

regulators and investor advocates who have warned that such proposals go too far in cutting back investor protections and make it easier for bad actors to pitch fraudulent schemes to inexperienced investors. Despite these criticisms, Gallagher believes that venture exchanges could have a transformative impact on small business capital-raising. He realizes that his proposal needs further development. As such, he has called out to practitioners, academics and other interested parties to help refine his proposal by evaluating the legal and practical issues. With this type of assistance, perhaps Gallagher’s proposal will make it on the SEC’s agenda. 

Designated Offshore Securities Markets Under Regulation S: You’d Be Surprised at Who’s Not on the List By Sey-Hyo Lee Rule 904 of Regulation S under the Securities Act of 1933, as amended, provides an exemption from the registration requirements of the Securities Act for certain offers and sales deemed to occur outside the United States if they meet the following conditions: • The offers or sales are made in an “offshore transaction”; • No directed selling efforts are made into the United States; and • Certain other restrictions are imposed on resales by dealers and persons receiving selling concessions.

For purposes of Rule 904, an offer or sale of securities is made in an “offshore transaction” if the offer is not made to a person in the United States and either: • At the time the buy order is originated, the buyer is, or the seller or any person acting on its behalf reasonably believe that the buyer is, outside the United States; or • The transaction is executed in, on or through the facilities of a “designated offshore securities market” and neither the seller nor any person acting on its behalf knows that the transaction has been pre-arranged with a buyer in the United States.

“Designated offshore securities markets” are the foreign securities exchanges or markets listed in Rule 902(b)(1) and any additional foreign securities exchange or non-exchange market designated by the SEC by a no-action letter considering certain attributes specified in Rule 902(b) (2). Unfortunately, the list of “designated offshore securities markets” in Rule 902(b) (1) has not been updated since Regulation S was last amended in February 1998 and the SEC does not compile a list of the current “designated offshore securities markets”. As a result, it is not always a simple task to determine whether an offshore resale is eligible for the resale exemption under Rule 904 in reliance on the provision related to transactions on “designated offshore CHADBOURNE

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securities markets”. Otherwise, a seller would need to undertake the due diligence required to determine, or substantiate a reasonable belief, that the buyer is outside the United States. Following this article is a list of the current “designated offshore securities markets” based on Rule 902(b)(1) and subsequent SEC no-action letters designating additional markets and reflecting mergers, name changes and closings of certain markets. Surprisingly, there are a number of significant offshore securities markets which are not designated as “designated offshore securities markets” for purposes of the Rule 904 resale exemption, particularly

in emerging markets such as Argentina, Brazil, Chile, China, India and Russia. As a result, sellers reselling securities into those markets seeking to rely on the Rule 904 resale exemption will need to undertake the appropriate due diligence to confirm, or establish a reasonable belief, that the buyers are outside the United States. In addition to offshore resales of securities under Regulation S, the concept of “designated offshore securities market” is also relevant to a broker or dealer’s ability to publish research reports on foreign private issuers in connection with registered, Rule 144A and Regulation S offerings. Rule 139 under the Securities Act provides a safe harbor for publication or distribution of research reports by brokers or dealers

participating in the offering. Among the issuer-related requirements, one condition requires that the foreign private issuer either (i) has equity securities trading on a “designated offshore securities market” and has had them so traded for at least 12 months or (ii) has a worldwide market value of outstanding common equity held by non-affiliates of US$700 million or more. Therefore, the absence of certain offshore securities markets from the list of “designated offshore securities markets” could also limit the ability of brokers and dealers to publish or distribute research reports on certain foreign private issuers traded in those markets if the issuer cannot satisfy the US$700 million public float test. 

Designated Offshore Securities Markets (AS OF DECEMBER 1, 2014)

• Eurobond market (as regulated by the International Securities Market Association) • The Australian Stock Exchange Limited • The Bahamas International Securities Exchange • The Barcelona Stock Exchange • The Berlin Stock Exchange • The Bermuda Stock Exchange • The Bilbao Stock Exchange • The Cairo and Alexandria Stock Exchanges • The Canadian National Stock Exchange (including Pure Trading) • The Channel Islands Stock Exchange • NASDAQ OMX Copenhagen A/S (formerly the Copenhagen Stock Exchange) (including First North) • The Eurolist Market (formerly Bourse de Paris) and the Alternext Market as operated by Euronext Paris • Euronext Amsterdam N.V. (formerly the Amsterdam Stock Exchange) • Euronext Brussels S.A./N.V. (formerly the Bourse du Bruxelles) 14


• The Frankfurt Stock Exchange

• The Oslo Stock Exchange

• NASDAQ OMX Helsinki Ltd. (formerly the Helsinki Stock Exchange) (including First North)

• The Panama Stock Exchange

• The Stock Exchange of Hong Kong Limited (including the Growth Enterprises Market) • The Irish Stock Exchange • The Istanbul Stock Exchange • The Johannesburg Stock Exchange • The Korea Exchange (formerly the Korea Stock Exchange) • The Bolsa de Valores de Lima • The London Stock Exchange (including the Alternative Investment Market (AIM)) • The Bourse de Luxembourg • The Madrid Stock Exchange • The Bursa Malaysia Securities Berhad • The Malta Stock Exchange • The Mexico Stock Exchange • The Borsa Valori di Milano • The Montreal Stock Exchange

• The Prague Stock Exchange • The Stock Exchange of Singapore Ltd. • NASDAQ OMX Stockholm AB (formerly the Stockholm Stock Exchange) (including First North) • The SWX Swiss Exchange (formerly the Zurich Stock Exchange) • The Taiwan Stock Exchange • The Tel-Aviv Stock Exchange Ltd. • The Tokyo Stock Exchange (including the Market of High Growth and Emerging Stocks (Mothers)) • The Toronto Stock Exchange • The TSX Venture Exchange (formerly The Canadian Venture Exchange Inc. and the Alberta and Vancouver Stock Exchanges) • The Valencia Stock Exchange • The Vienna Stock Exchange (Wiener Börse) • The Warsaw Stock Exchange

UNDERWRITER’S COUNSEL CORNER

Trends in Anti-Corruption and AML Representations and Warranties; Strict Liability for Issuers By Claude S. Serfilippi and Christian Urrutia When investment banks act as underwriters, they require that issuers make certain representations and warranties regarding compliance with anti-corruption laws, including, for example, the Foreign Corrupt Practices Act (“FCPA”), the UK Bribery Act, the OECD Convention on Combating Bribery in International Business Transactions and local anti-corruption laws. Underwriters also typically require issuers to represent and warrant as to compliance with US Anti-Money Laundering Laws (“AML”) and the Bank Secrecy Act (“BSA”). In recent years, underwriters have increasingly sought to allocate a greater amount of risk to issuers in regard to potential violations of anti-corruption laws and AML. A decade ago, an underwriter’s inhouse counsel might have accepted knowledge qualifiers in an anti-corruption or AML representation and warranty. In the current market, however, it is becoming increasingly common for underwriters to require issuers to make these representations and warranties “flat,” without any knowledge qualifier. Without a knowledge qualifier, the entire risk of the violation is upon the issuer, which is exactly what the underwriter desires. The theory behind who should take the risk of an unknown noncompliance

is that as between the issuer and the underwriter, it is “more appropriate” for the issuer to take this risk, and this has generally become standard market practice. In addition to requiring that anti-corruption and AML representations and warranties be given without knowledge qualifiers, the scope and breadth of these warranties have also expanded in recent years. In determining the appropriate breadth of an anti-corruption or AML warranty, underwriters might consider taking a risk-based approach, as recommended by the United States Department of Justice and the Securities and Exchange Commission in FCPA: A Resource Guide to the US Foreign Corrupt Practices Act. Such an approach would analyze the relevant risks present in the geography(s) and industry(s) in which the particular issuer is active. Whether it is appropriate to include broad language or more narrow language would depend on the industry in which the issuer operates, the geography in which the issuer operates, the extent of diligence conducted by the underwriters on the issuer’s anti-corruption and AML programs, the quality of the issuer’s anticorruption and AML programs, the risk of non-compliance by the issuer and the history of the issuer’s compliance.

In addition to requiring that anti-corruption and AML representations and warranties be given without knowledge qualifiers, the scope and breadth of these

Underwriters will also often require a foreign issuer who might not legally be required to comply with the FCPA (because it does not have sufficient contacts to the United States) to represent and warrant that it nonetheless complies with the FCPA. By extracting this representation and warranty, underwriters get comfort that the issuer has complied with the rigorous prohibitions against bribery and illegal payments contained in the FCPA. Issuers are, not surprisingly, often reluctant to provide this representation and warranty. Because it is not subject to the FCPA, the foreign issuer would unlikely have in place the necessary internal procedures and controls needed to ensure FCPA compliance. Accordingly, it could be risky for a foreign issuer that is not legally required to comply with the FCPA to provide an FCPA compliance representation and warranty. In light of greater regulatory scrutiny on investment banks and a heightened awareness of potential risk, it is likely that investment banks will not attempt to take a risk-based approach to anticorruption and AML representations and warranties and will continue to require foreign issuers to represent and warrant to FCPA compliance (whether or not the foreign issuer is legally required to comply with the FCPA). Because it is simply safer and easier, underwriters will also likely continue to demand broadly drafted anti-corruption and AML representations and warranties without knowledge qualifiers. It looks like at least for now, if an issuer wants to raise money in the capital markets, it will have to take the risk of any violation by it of anti-corruption or anti-money-laundering laws. 

warranties have also expanded in recent years.

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Section 3(c)(7) Procedures: SolarCity Securitizations By Beth R. Kramer, Alex M. Herman and Mikaela C. Cavalli SolarCity Securitizations SolarCity Corporation (“SolarCity”) completed what was reported to be the first securitization of distributed solar energy assets in November 2013. Since then, SolarCity has completed two additional securitizations of distributed solar energy assets in April and July 2014. All of these securitizations were private placement offerings utilizing the Section 3(c)(7) exemption of the Investment Company Act of 1940 (the “1940 Act”). 1940 Act Background While corporations such as SolarCity are not what one traditionally considers to be an investment company, the broad definition of “investment company” in the 1940 Act has resulted in many issuers inadvertently falling within the purview of the 1940 Act’s restrictions on offering and selling securities. In the 1940 Act, “investment company” includes not only traditional mutual funds and private funds, but in some cases may also include structured finance issuers, foreign holding companies and other nonfund entities. The Section 3(c)(7) exemption from registration under the 1940 Act can sometimes provide an efficient way for these non-traditional “investment companies” to access the U.S. capital markets without being subject to the burdensome 1940 Act requirements, so long as the offering is conducted in a specific fashion.

Relying on Section 3(c)(7) In order to rely on the Section 3(c)(7) exemption, a U.S. issuer must have a “reasonable belief” that all of its investors (U.S. and non-U.S.) are “qualified purchasers” (QPs), including initial purchasers as well as subsequent transferees, and must not make a public offering. QPs include certain high net worth individuals and institutional investors, subject to certain restrictions. For non-U.S. issuers, relying on the Section 3(c)(7) exemption is less burdensome because the “reasonable belief” requirement regarding the QP status of investors is limited to U.S. investors. In addition, non-U.S. issuers can disregard the monitoring requirements regarding U.S. persons who acquire the securities in the secondary market, subject to certain conditions. In a typical Section 3(c)(7) offering, each purchaser that is required to be a QP must sign representations attesting to its QP status. However, these non-traditional “investment companies” frequently wish to deposit their securities into book-entry facilities such as The Depositary Trust Company (DTC), making it impossible to require each purchaser to sign a QP representation due to the difficulty associated with monitoring transfers. These book-entry securities are generally offered in private offerings in the U.S. and sold only to qualified institutional buyers (“QIBs”) in transactions exempt from

The Section 3(c)(7) exemption . . . can sometimes provide an efficient way for these non-traditional “investment companies” to access the U.S. capital markets without being subject to the burdensome 1940 Act requirements.

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registration in reliance on Rule 144A under the Securities Act of 1933 (“Securities Act”). QIBs include corporate entities that own and invest at least $100 million (or $10 million for broker-dealers) on a discretionary basis. Therefore, as was the case in all three SolarCity securitizations, the securities were offered pursuant to both the Rule 144A and the Section 3(c)(7) purchaser restrictions (i.e., to QIBs who are also QPs) – a process which is not unduly burdensome because of the large overlap between the two categories. Section 3(c)(7) Procedures A concern for these non-traditional “investment companies” exists with respect to establishing the required “reasonable belief” that each QIB is also a QP. The following procedures are generally recognized to enable these non-traditional “investment company” U.S. issuers to establish the required “reasonable belief” to satisfy the Section 3(c)(7) exemption:1 • Transfer restrictions. • Legend on the notes. • Include representations by the issuer regarding the issuer’s and initial purchaser’s reasonable belief in the QIB/ QP status of the purchasers in the note purchase agreement. • The issuer has the right to force holders who are determined not to be both QIBs and QPs to sell to a person that does satisfy the requirements pursuant to the terms of the Notes, and that such right is included in the offering document. • Provisions in transaction documents that the indenture trustee will periodically send notices to noteholders reminding them of the transfer restrictions.

• A certificate from the issuer certifying compliance with the procedures, including that there will not be a meaningful offshore interest in the notes, and if that changes that the issuer will direct the clearing agency to take such actions necessary for book-entry securities issued in reliance on Rule 144A and Section 3(c)(7). • Issuer agrees to take customary actions to instruct DTC and Bloomberg to include certain information regarding transfer restrictions on the notes.

• Evaluate the offering to determine whether it is a public offering, and obtain an opinion to that effect. Future Deals Non-traditional “investment companies” intending to rely on Section 3(c)(7) in the future should also be mindful of the Volcker Rule. The Volcker Rule, passed in December 2013, imposes limitations on the ability of “banking entities” (as such term is defined in the rule) to invest in companies relying on the Section 3(c)(7) exemption, subject to certain narrow activity- and

amount-based exceptions.2 The Volcker Rule technically restricts banking entities and not the companies in which they invest, but any issuer that plans to rely on the Section 3(c)(7) exemption pursuant to these procedures should consider whether any banking entity will hold or own its securities. Practically, the limitations under the Volcker Rule may mean that banking entities serving as underwriters will have a more limited universe of buyers to sell to in future transactions of this kind, which can in turn impact the structure and terms of the issuer’s transaction. 

1

A detailed description of the procedures recommended for U.S. issuers by Securities Industry and Financial Markets Association (“SIFMA”) is available at https://www.sifma.org/services/ standard-forms-and-documentation/cross-product/cross-product_recommended-policies-and-procedures-for-secondary-market-trading-in-book-entry-section-3(c)(7)-securities/. As noted above, for non-U.S. issuers, relying on the Section 3(c)(7) exemption is slightly less burdensome.

2

See OCC, Federal Reserve, FDIC and SEC, Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds, 79 Fed. Reg. 5536-5806 (Jan. 31, 2014).

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NOTES FROM THE BENCH

In this section we highlight certain recent judicial developments and enforcement cases that impact the capital markets practice.

SEC Awards First Dodd-Frank Whistleblower Award to a Compliance and Audit Professional On August 29, 2014, for the first time ever, the SEC awarded a compliance and audit professional with a Dodd-Frank whistleblower award. The award of more than $300,000 constituted twenty percent of the amount the SEC recovered from the whistleblower’s employer in its related enforcement action. Section 21F of the Exchange Act—enacted as part of the Dodd-Frank reforms—provides that whistleblowers who provide the SEC with original information leading to an enforcement action with sanctions greater than $1 million may be awarded anywhere between ten and thirty percent of the amounts recovered. Prior to this award, there was some speculation as to whether compliance officers and internal auditors, the very employees that companies hire to help them prevent, detect and address wrongdoing internally, could be rewarded for reporting wrongdoing to the SEC. The award makes clear, however, that such employees can be eligible for an award if they first internally report allegations of misconduct to their supervisor, chief legal or compliance officer, or to an audit committee, and the company fails to take reasonable steps to respond to the allegations or report them to the SEC within 120 days. The SEC’s award highlights the pitfalls, in the form of potential enforcement actions, that a company may face if it fails to

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promptly address internal complaints of both general employees and members of the company’s audit or compliance group. Firms should accordingly investigate and respond promptly to all credible allegations of wrongdoing. Firms should also keep complainants apprised of the progress of the investigation so that complainants cannot later claim that no reasonable response to their allegations was taken. - Alan Raylesberg, Seth M. Kruglak and Brittney Renzulli

Second Circuit Holds Dodd-Frank Anti-Retaliation Whistleblower Protections Do Not Apply Extraterritorially In August 2014, the Second Circuit held in Liu Meng-Lin v. Siemens AG, 763 F.3d 175 (2d Cir. 2014), that Dodd-Frank’s antiretaliation provisions (which are designed to protect employees who report wrongful conduct from employer retaliation) do not apply extraterritorially. The Second Circuit grounded its decision in the Supreme Court’s rulings in Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), and Kiobel v. Royal Dutch Petroleum Co., 133 S. Ct. 1659 (2013), holding that absent clear intent to the contrary, a statute enacted by Congress is presumed to have no application outside the territory of the United States. The Second Circuit found no such intent in connection with DoddFrank’s anti-retaliation provisions. While what facts constitute “extraterritoriality” will be determined on a case by case basis, here the outcome was fairly clear. A foreign national plaintiff employed by a Chinese subsidiary of a German corporation claimed that those entities retaliated

against him for reporting internally what he believed to be FCPA violations which occurred outside the United States. The only connection to the United States was that the German corporation had ADRs listed in the United States. Liu Meng-Lin provides assurances to multinational firms that they will not subject themselves to unlimited liability under Dodd-Frank’s anti-retaliation provisions merely because they are listed in the United States. However, the outcome might have been different had there been a closer connection with the United States, such as if the plaintiff reported the alleged wrongdoing to a corporate office in New York. Irrespective of the inapplicability of Dodd-Frank’s antiretaliation provisions to extraterritorial conduct, firms should take care to comply with all applicable local labor laws in their respective international jurisdictions. - Alan Raylesberg, Seth M. Kruglak and Lisa Schapira

Second Circuit Holds Domestic Securities-Based Swap Transaction Not Sufficient to Invoke Section 10(b) Fraud Liability In its August 2014 decision in ParkCentral Global Hub Ltd. v. Porsche Automobile Holding SE, 763 F.3d 198 (2d Cir. 2014), the Second Circuit held that domestic securities-based swap transactions are insufficient to invoke Section 10(b) of the Exchange Act when the underlying claims and facts are so predominantly foreign as to constitute an impermissibly extraterritorial application of the Section. The Second Circuit’s holding is an important clarification of the Supreme Court’s

Morrison v. National Australia Bank Ltd. decision, 561 U.S. 247 (2010), which held that Section 10(b) does not apply extraterritorially and therefore liability only exists when predicated on (1) transactions in securities listed on domestic exchanges, or (2) domestic transactions in other securities. Here the Second Circuit explained that with respect to the latter, a domestic transaction in securities is necessary—but not in and of itself sufficient—for Section 10(b) to apply. In ParkCentral, certain international hedge funds sued Porsche and individual defendants for violating Section 10(b) alleging that the defendants made false statements that Porsche had no plans to takeover Volkswagen (VW). The hedge funds were parties to securities-based swap agreements that were designed to replicate short sales of VW stock, which was listed only on foreign exchanges. Plaintiffs claimed that the defendants’ misrepresentations regarding Porsche’s intention to takeover VW, when revealed as false, created a “short squeeze” and damaged the hedge funds that had to cover their short sales of VW at allegedly artificially inflated prices. Although the Second Circuit assumed, for purposes of the motion to dismiss at issue, that the alleged swap transactions were entered into in the United States, because the alleged statements by defendants were primarily made in Germany concerning stock which traded only on European exchanges—and plaintiffs did not allege that Porsche was a party to swap agreements referencing VW stock or participated in the market for such swaps—the Second Circuit concluded that “the claims in this case are so predominantly foreign as to be impermissibly extraterritorial.” The Second Circuit, however, remanded the case to provide plaintiffs the opportunity to file a motion for leave to amend the complaints.

In light of ParkCentral, firms based outside the United States and not listed on a domestic exchange can take comfort, at least within the Second Circuit, that they will not be haled into court to face Section 10(b) claims merely because unrelated third parties enter into securities-based transactions in the United States. However, the Second Circuit made clear that its holding was based on the facts of the case and it was not announcing a bright line rule. Ultimately the jurisprudence surrounding what conduct is “enough” to trigger the application of Section 10(b) to foreign conduct will develop over time. For now it will be a case-by-case determination. - Alan Raylesberg, Seth M. Kruglak and Lisa Schapira

Section 11 Liability: Potential to Expand? On November 3, 2014, the Supreme Court heard arguments concerning whether to expand the scope of potential liability under Section 11 of the Securities Act. In Omnicare v. Laborers District Council Construction Industry Pension Fund, 719 F.3d 498 (6th Cir. 2013), the Sixth Circuit held that statements of opinion made in a registration statement that were objectively false (i.e., turned out not to be true)—but which the speaker subjectively believed were true at the time the statement was made—are actionable under Section 11’s strict liability regime prohibiting material misstatements of fact or omissions in registration statements. The Sixth Circuit’s ruling created a split in the Circuits and the Supreme Court granted certiorari to answer the following question: “For purposes of a Section 11 claim, may a

plaintiff plead that a statement of opinion was ‘untrue’ merely by alleging that the opinion itself was objectively wrong, as the Sixth Circuit has concluded, or must the plaintiff also allege that the statement was subjectively false—requiring allegations that the speaker’s actual opinion was different from the one expressed—as the Second, Third and Ninth Circuits have held?” In Omnicare, the registration statement contained statements characterized by the Sixth Circuit as “legal compliance” opinions, such as that the issuer entered into “legally and economically valid” contractual arrangements which, it turns out, plaintiff investors dispute because they contend the issuer’s activities included illegal kickback arrangements and the submission of false claims to federal government programs. The Sixth Circuit held that in contrast to Section 10(b) of the Exchange Act and Rule 10b-5—which has a scienter requirement—because Section 11 “is a strict liability statute[,] . . . [n]o matter the framing, once a false statement has been made, a defendant’s knowledge is not relevant to a strict liability claim.” The securities bar is closely watching Omnicare. Should the Supreme Court affirm the Sixth Circuit, corporate disclosure might be curtailed if liability exists for stating opinions that are honestly held, but ultimately turn out to be false. The Solicitor General and the SEC have weighed in with an amicus brief where they argue that the Sixth Circuit “correctly held that a Section 11 plaintiff need not allege that the defendant disbelieved the opinion” but argued that the “court erred in suggesting that a statement of opinion is actionable whenever it is ultimately proved incorrect” because “Section 11 liability should be determined based on the facts at the time the statement

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was made, not at a later time.” They argued that liability should attach to statements of opinion that either are “not genuine” or “lack[ ] a reasonable basis . . . because it ensures that registration statements are both literally true and do not omit information that would matter to a reasonable investor.” The Supreme Court’s decision is expected to be issued by June 2015. - Alan Raylesberg, Seth M. Kruglak and Lisa Schapira SEC Unfurls Welcome Mat to Foreign Tipsters and Awards $30 Million to Whistleblower In the wake of recent court rulings limiting the application of U.S. securities laws to foreign conduct, the SEC’s September 22, 2014 award of at least $30 million to a foreign tipster sends a strong signal that foreigners may still be rewarded handsomely by the SEC. The whistleblower award regime created by Dodd-Frank rewards tipsters who provide high quality, original information that results in an enforcement action where sanctions exceeding $1 million are ordered. Typically, the tipster’s award will range between 10 to 30 percent of the monetary sanctions collected. The SEC concluded in its award determination that “there is a sufficient U.S. territorial nexus whenever a claimant’s information leads to the successful enforcement [by the SEC] of a covered action brought in the United States, concerning violations of U.S. securities law.” It took pains to distinguish rewarding foreign whistleblowers on the one hand, from the Second Circuit’s decision in Liu Meng-Lin v. Siemens AG, 763 F.3d 175 (2d Cir. 2014), which held the anti-retaliation provisions of Dodd-Frank

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did not apply extraterritorially to a whistleblower located abroad who allegedly was retaliated against after reporting misconduct that occurred outside of the United States to his employer, who was also located abroad. The SEC distinguished Liu MengLin by reasoning that the purpose of the whistleblower award provisions of DoddFrank, which were designed to further effective enforcement of U.S. securities laws, were different from anti-retaliation provisions of the statute, which were designed to protect employment relationships. The SEC chastised the award recipient for failing to come forward sooner and reduced the award to account for the delay. Despite the reduction, the award – which is somewhere between $30 and $35 million – is the largest award issued since the inception of the whistleblower program. The previous high was an October 2013 award in the amount of $14 million. According to the SEC, four tipsters in FY 2013 and nine tipsters in FY 2014 have been given awards. The SEC also reported that 11% of its tips have been provided by tipsters located abroad. Here, the size of the award might encourage tipsters who previously were “on the fence,” as to whether to report wrongdoing, to reach out to the SEC. - Alan Raylesberg, Seth M. Kruglak and Lisa Schapira

SEC’s “Broken Windows” Enforcement: It’s Time to Sweat the Small Stuff In October 2013, SEC Chair Mary Jo White announced that the agency would emulate the “broken windows” strategy employed in New York City by former

Mayor Rudolph Giuliani to prevent crime to “pursu[e] all types of violations of our federal securities laws, big and small.” She reasoned that “[t]he same theory can be applied to our securities markets—minor violations that are overlooked or ignored can feed bigger ones, and, perhaps more importantly, can foster a culture where laws are increasingly treated as toothless guidelines.” Not everyone agrees with Chair White. Recently, at the 2014 Securities Enforcement Forum, SEC Commissioner Michael Piwowar criticized White’s “broken windows” strategy, stating that “if every rule is a priority, then no rule is a priority.” The SEC’s efforts, however, are picking up steam. In September 2014, the SEC filed civil charges against nearly three dozen individuals and companies for allegedly violating requirements that they promptly document transactions by executives trading in their own stock. Nearly all of the defendants settled, including six publicly traded companies. Here the largest penalty against any one defendant did not exceed $375,000, and with respect to many of the other defendants the penalty amounted to much less. Plainly, small violations remain on the SEC’s radar and cannot be ignored. Companies should therefore heed the SEC’s warning and implement robust compliance programs in order to prevent violations, both large and small. - Alan Raylesberg, Seth M. Kruglak and Brittney Renzulli

From Meats to Minerals: Petitions for Panel Rehearing in Conflict Minerals Case Granted On April 14, 2014, the U.S. Court of Appeals for the D.C. Circuit issued a ruling in National Association of Manufacturers v. Securities and Exchange Commission (“NAM”), holding that one specific provision of Section 13(p) of the Securities Exchange Act and the SEC’s conflict minerals rules violate the First Amendment by unconstitutionally compelling speech to the extent they require issuers to report to the SEC and disclose on their website that any of their products have “not been found to be ‘DRC conflict free’” (which according to the Court is a metaphor that conveys moral responsibility for the Congo war). Following this decision, the SEC and Amnesty International (as IntervenorsAppellees) filed petitions with the D.C. Circuit requesting a rehearing en banc and a panel rehearing regarding the First Amendment issue. On August 15, 2014, following the resolution of a similar issue in American Meat Institute v. U.S. Dept. of Agriculture (D.C. Cir. 2014) (“AMI”), Amnesty International filed a brief in

support of its petitions for rehearing arguing, among other things, that the ruling in AMI makes clear that the Court erred in failing to apply the rational-basis standard for First Amendment review set forth in Zauderer v. Office of Disciplinary Counsel (1985) (“Zauderer”). In its response brief, the National Association of Manufacturers argues that the standard for rehearing is not met because the decision in NAM presents no conflict with the decisions of the D.C. Circuit, the Supreme Court or other Courts of Appeals, and the case does not involve a question of exceptional importance. Further, the National Association of Manufacturers argues that the Court should amend its decision in light of AMI to clarify that the compelled statement is not eligible for rational-basis review under Zauderer because the term does not constitute “purely factual and uncontroversial information.” On November 18, 2014, the D.C. Circuit granted the petitions of the SEC and Amnesty International for panel rehearing and deferred the petitions for an en banc rehearing pending resolution of the panel rehearing. The Court’s order granting the

petitions directs the parties in the NAM case to file supplemental briefs addressing the following questions: (1) what effect, if any, does the Court’s ruling in AMI have on the First Amendment issue in NAM regarding the conflict mineral disclosure requirement; (2) what is the meaning of “purely factual and uncontroversial information” as used in Zauderer and AMI; and (3) is determination of what is “uncontroversial information” a question of fact. Issuers should understand that the NAM ruling impacts only one aspect of the conflict minerals rules with respect to the requirement that issuers report that certain products have “not been found to be ‘DRC conflict free’” (and therefore does not impact the “country of origin” inquiry, due diligence investigation or other aspects of the conflict mineral rules). As such, issuers should continue their efforts to comply with these provisions of the conflict minerals rules pending further developments. -Sey-Hyo Lee and Patrick Dorime

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REGULATORY ROUNDUP

In this section we highlight selected recent legislative and regulatory developments that impact the capital markets practice.

SEC Flexes its Muscle on ABS Offerings On November 24, 2014, the revisions to Regulation AB, commonly known as Reg AB II, took effect. The regulations usher in extensive new disclosure, reporting and offering requirements for issuers conducting registered offerings of asset-backed securities (ABS). But the SEC chose to limit the application of AB II to a narrow class of ABS – exempting managed pools among others from the new rules. Beginning November 23, 2015 issuers will need to file registration statements using two new forms (SF-1 and SF-3). ABS shelf filings will require CEO certifications at the time of any offering attesting to the accuracy of ABS-related disclosure in the prospectus and must file the preliminary prospectus three days in advance of the first sale. Only a single prospectus may be filed for each shelf takedown, eliminating the use of a base prospectus with a supplement. Transaction documents must provide investors with a right to review the underlying assets by a third party for compliance with representations and warranties if deficiencies rise above a specified percentage. By November 23, 2016, more extensive loan-level disclosure for certain assets, including residential and commercial mortgages, automobile loans and leases, debt securities will be required. Equipment loans and leases, student loans and floorplan financings were all spared for now, but the

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SEC is almost assuredly weighing future action in this area. Watch this space. http://www.sec.gov/rules/final/2014/339638.pdf SEC Adopts Show and Tell Rules For Diligence Reports in ABS In August, the SEC adopted new rules affecting issuers of asset-backed securities and, unlike Reg AB II, these new rules impact both registered and on-shore unregistered offerings. Curiously, the SEC adopted the Exchange Act’s broader definition of ABS for this rule rather than the more narrow one used in AB II. Beginning June 15, 2015, the issuer or underwriter of any ABS rated by a nationally recognized statistical rating organization (NRSRO) must furnish a form via EDGAR five days before any sales describing the findings of any third-party diligence report obtained by the issuer or underwriter. The form must be signed by an officer of the depositor or the underwriter. The SEC defined diligence reports broadly, including a catch-all provision designed to capture any future types of reports. These reports differ from the review of assets required under Reg AB, although if an issuer uses a third party report in its Reg AB review it must include the findings and conclusions of the report in the prospectus and obtain consent from the third party. The third-party author of the report will also be required to deliver a certificate to each NRSRO producing a credit rating. The certification is signed by a representative

of the provider, who must represent that it performed a thorough review and that the information in the certificate (listing the due diligence performed and the conclusions reached) is accurate in all significant respects. The certificate will be not be furnished via EDGAR, but rather published on a password-protected site the arranger will maintain. Other NRSROs will be able to access the site for the purpose of credit monitoring. http://www.sec.gov/rules/final/2014/3472936.pdf Improving the Effectiveness of Disclosure The SEC is conducting a broad review of existing disclosure practices pursuant to the JOBS Act in an effort to improve the usefulness of disclosure for investors. While its not seeking necessarily to reduce the volume of disclosure, the SEC has indicated interest in streamlining existing disclosure to eliminate repeated information as well as potentially adding additional disclosure that may be sought by the markets. One fundamental shift under consideration is a principles-based approach, in which issuers would be given more leeway to disclose information deemed material to investors. The SEC is encouraging questions and comments from the public, which may be submitted to [email protected]. Retail Investors Get a Voice With Hiring of SEC Ombudsman The SEC hired its first ombudsman, Tracey L. McNeil, who began working in late

September. The position was created pursuant to the Dodd-Frank Act and is designed to facilitate communications with retail investors. Tracey worked in the private sector and was most recently senior counsel in the SEC’s Office of Minority and Women Inclusion. http://www.sec.gov/News/PressRelease/ Detail/PressRelease/1370542869949#. VByPtJ0pCmR House Proposal Aims to Increase Tax Bill For Companies With Outsized CEO Pay Packages Speaking of CEO pay, Representative Chris Van Hollen wants to make it more expensive for companies to pay CEOs and other employees high compensation packages. . Rep. Van Hollen, the ranking Democrat on the House Budget Committee, introduced The CEO-Employee Pay Fairness Act, which would add conditions to common corporate tax deductions. Publicly held companies would be required to increase salaries of workers who make less than $115,000 in line with cost of living and productivity increases or forego certain tax deductions employees for employees with salaries over $1 million. Under the current code, companies may deduct unlimited amounts of performance-based pay for executives, according to Van Hollen’s office. http://democrats.budget.house.gov/ fact-sheet/fact-sheet-ceo-employeepay-fairness-act

New Environmental, Social and Governance Disclosure Requirements For Large European Companies Approximately 6,000 European companies with be required to disclose information on environmental, social, employee, human rights, diversity, anti-corruption and bribery matters. While the European Commission has signaled that it does not expect extensive disclosure nor must any specific form be followed, it expects companies to focus on their governing policies, related risks and the management of such risks. Member states will have two years to transpose the Directive into national legislation and the disclosure will need to be included in annual reports by the 2017 fiscal year. Some have speculated that the SEC may monitor the effort as part of the ongoing disclosure effectiveness review. Keep the Numbers Fresh Here is your staleness calendar for financial statements in SEC filings for 2015: • 2014 Q3 Financials – March 2 for Large Accelerated Filers, March 16 for Accelerated Filers and March 31 for everyone else. • 2014 Annual Financials – May 11 for Large Accelerated Filers and Accelerated Filers, May 14 for everyone else. • 2015 Q1 Financials – August 7 for Large Accelerated Filers and Accelerated Filers, August 12 for everyone else. • 2015 Q2 Financials – November 6 for Large Accelerated Filers and Accelerated Filers, November 12 for everyone else.

SEC Pushes Pay-Related DoddFrank Rulemaking to 2015 The SEC expects to adopt pay ratio rules as well as proposed clawback and other compensation-related rules by October 2015. The clawback rules would direct stock exchanges to bar securities from trading unless a company had a policy to clawback executive pay dispensed as a result of improper accounting. The pay ratio rules would require a company to disclose the ratio of compensation of its chief executive officer to the median compensation of its employees. In recent public statements, SEC Chair Mary Jo White included this rule making, which is mandated by the DoddFrank reforms, among her top priorities. The statement prompted House Financial Services Committee Chairman Jeb Hensarling and Representatives Scott Garrett and Bill Huizenga sent a letter to SEC Chair Mary Jo White asking the SEC to slow down “non-essential” projects, such as the pay ratio rules, and focus on other areas of the SEC’s mandate.  - Nicolas Ferre

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CALENDAR OF EVENTS

DECEMBER MONDAY

TUESDAY

1

Annual Disclosure Documents 2014 (PLI; CLE 15.5); New York*

WEDNESDAY

2

Annual Disclosure Documents 2014 (PLI; CLE 15.5); New York*

THURSDAY

Form 10-K in-depth workshop (PLI; CLE 16); New York*

3

Accounting for Derivatives & Hedging Activities Workshop 2014 (PLI); New York

FRIDAY

Form 10-K in-depth workshop (PLI; CLE 16); New York*

4

5

MD&A In-Depth Workshop 2014 (PLI); New York

Accounting for Derivatives & Hedging Activities Workshop 2014 (PLI); New York New Developments in Securitization 2014 (PLI; CLE 7.5); New York* U.S. Companies Trading on the London Stock Exchange and the Impact of EU Regulations Requiring Mandatory Electronic Settlement (PLI; CLE 1); Webcast Taking on Dodd-Frank (NYSBA); New York

8

Advanced Accounting & Reporting for SEC Professionals Workshop 2014 (PLI); San Francisco*

15

24

9

Advanced Accounting & Reporting for SEC Professionals Workshop 2014 (PLI); San Francisco* 2014 Global Trading and Market Structure Conference (ICI); London

10

2014 Securities Law Developments Conference (ICI); Washington; DC

Upcoming Changes to Dealer Continuing Education Requirements (MSRB); Webinar

11

Understanding the Securities Laws Fall 2014 (PLI; CLE 15.5); New York*

12

Understanding the Securities Laws Fall 2014 (PLI; CLE 15.5); New York*

Chapter meeting (Society of Corporate Secretaries); New York**

16

17

18

19

22

23

24

25

26

29

30

31


JANUARY MONDAY

TUESDAY

WEDNESDAY

THURSDAY

FRIDAY

1

2

8

9

15

16

NEW YEAR’S DAY

Understanding Financial Products 2015 (PLI; CLE 15); New York*

5

12

Chapter meeting: Directors tell it like it is (Society of Corporate Secretaries); Dallas**

19

26

7

13

14

20

21

22

23

28

29

30


Chapter meeting: Shareholder Activism – No one is immune! (Society of Corporate Secretaries); Fairfield Westchester** MARTIN LUTHER KING DAY

6

Understanding Financial Products 2015 (PLI; CLE 15); New York*

Chapter meeting: SEC Hot Topics Institute (Society of Corporate Secretaries); Mayfield Heights**

27

Taxation of Financial Products & Transactions 2015 (PLI; CLE 7); New York*

Essentials Seminar 2015 (Society of Corporate Secretaries); Orlando**

FEBRUARY MONDAY

TUESDAY

2 9

16

23

WEDNESDAY

THURSDAY

3

4

10

11

17

18

2015 ICI Capital Markets Conference (ICI); New York

24

Anti-Money Laundering and Financial Crimes Conference 2015 (SIFMA); New York

25

Anti-Money Laundering and Financial Crimes Conference 2015 (SIFMA); New York

FRIDAY

5

6

12

13


19

SEC Reporting and Practice Skills Workshop for Lawyers 2015 (PLI); New York*

26

20

SEC Reporting and Practice Skills Workshop for Lawyers 2015 (PLI); New York*

27

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KEY CONTACTS NEW YORK

WASHINGTON, DC

MOSCOW

MARC A. ALPERT

NOAM AYALI

KONSTANTIN O. KONSTANTINOV

MARIAN BALDWIN FUERST

DANA FRIX





WILLIAM GREASON

SEAN P. MCGUINNESS



CHARLES E. HORD, III

MEXICO CITY


MARC M. ROSSELL

+52 (55) 3000-0605 [email protected]

SEY-HYO LEE


SÃO PAULO

J. ALLEN MILLER

CHARLES JOHNSON


+55 (11) 3372-0001 [email protected]

KESSAR NASHAT

DANIEL SPENCER


+55 (11) 3372-0003 [email protected]

TALBERT I. NAVIA

LONDON


CHAREZ X. GOLVALA

+44 (0) 20-7337-8020 [email protected]

MARC M. ROSSELL


NIKOLAI MIKHAILOV

+44 (0) 20-7337-8018 [email protected]

CLAUDE S. SERFILIPPI


PARTHA PAL

+44 (0) 20-7337-8032 [email protected]

EDWARD P. SMITH


DEARBHLA QUIGLEY

+44 (0) 20-7337-8079 [email protected]

KEVIN C. SMITH


NEW YORK LONDON

WASHINGTON, DC MOSCOW

WARSAW

MARTIN THOMAS

+44 (0) 20-7337-8069 [email protected]

LOS ANGELES ISTANBUL

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