Securities Mosaic® Blogwatch
August 26, 2014
ABA: Throwing Stones in Glass Houses?
by Randi Morrison

Jim Brashear addresses cybersecurity issues in this guest post:

At the ABA's 2014 annual meeting earlier this month, delegates approved a resolution that "encourages all private and public sector organizations to develop, implement and maintain an appropriate cybersecurity program." When you consider that some pundits characterize lawyers as technology Luddites and law firms as "the soft underbelly" of data security in corporate America, it may seem odd for the legal industry to be lecturing other organizations about getting their cyber houses in order.

Law Firms Are Targets of Cyber Attacks

The ABA Cybersecurity Legal Task Force report accompanying the draft resolution warns that "the threat of cyber attacks against law firms is growing." It notes that law firms collect and store large amounts of critical, highly valuable corporate records. The report points out that "lawyers and law offices have a responsibility to protect confidential records from unauthorized access and disclosure, whether malicious or unintentional, by both insiders and hackers." Unfortunately, many lawyers don't fully appreciate the scope of that responsibility, particularly as it applies to data transmitted via the internet or stored in the Cloud.

Data in Transmission is At Risk

A survey conducted in March 2014 by LexisNexis found that 89% of law firms use email daily for business purposes, but only 22% of law firms are encrypting email. A recent post in Law Technology News urges that It's Time to Secure Privileged Communications. The post notes that "attorneys should be concerned about the general uncertainty of privacy expectations for email." Those risks to email confidentiality are not merely a theoretical concern.

For example, in February the New York Times reported that a foreign spy agency intercepted email messages between a large U.S. law firm and its foreign government client and then shared the information with the U.S. National Security Agency. In a carefully worded statement, the law firm said: "There is no indication, either in the media reports or from our internal systems and controls, that the alleged surveillance occurred at the firm." The statement misses the point, because unencrypted email is intercepted, undetectably, while it is being transmitted or stored outside the firm's internal network.

That news report prompted the ABA to ask the NSA to explain how the agency deals with attorney-client privileged communications. As discussed in the post, Law Firm Email Security Questions The ABA Should Be Asking, the ABA was conflating legal privilege with client confidentiality and asking the wrong questions of the wrong organization.

Standards of Care

The fundamental question is whether the firm's lawyers were taking reasonable steps in the circumstances in order to secure sensitive email communications. The ABA report acknowledges that "law firms are businesses and should take special care to ensure that they have a strong security posture and a well-implemented security program." Many lawyers say the NIST Cybersecurity Framework can serve as a general guide for information security oversight and risk assessments, in order to establish that reasonable care was taken. The NIST Cybersecurity Framework includes an assessment of whether "data-in-transit is protected."

Email fundamentally is a convenient but unsecure method of transmitting and storing data in the Cloud. There are many simple steps that lawyers can take to protect sensitive data that they exchange with clients and third parties, including email encryption. State bar associations, however, continue to draw an unfounded distinction between the data security measures required when transmitting and storing data "in the Cloud" versus those required for email.

Be sure to tune into our pair of cybersecurity webcasts coming up soon: "Cybersecurity: Working the Calm Before the Storm" (9/16) and "Cybersecurity Role-Play: What to Do & Who Does What, When" (9/22).

GC's Current Skill Set Should Include Understanding of Technology

I previously blogged about tips for GCs to respond to increasing governance demands based on this new study, which also identified key competencies GCs need to succeed in today's environment.

In this Law Technology News article, Theodore Banks, Scharf Banks Marmor, argues that - as processes in every function of the business are being increasingly automated, the list of the GC's key competencies needs to include an understanding of the automation side of the business. Here is his list of technology tools and concepts that he suggests every GC should be familiar with:


  • Cloud resources vs. local servers and storage.
  • Work flow systems to control legal review processes.
  • Document assembly and contract management programs.
  • Document management systems.
  • Secure remote access systems.
  • Audio and video meeting apps and services.
  • Matter and budget management systems.
  • Secure mobile device management.
  • Legal hold management system.



Are you familiar with the laws governing e-business in each of the areas where the company operates?

  • Securities laws
  • Tax laws
  • Identity theft
  • Advertising
  • Children's online access
  • Defamation
  • Trademark and copyright



  • What is the corporate records management system?
  • How are compliance inquiries (e.g., hotline) managed?
  • How is risk assessment conducted? Updated?
  • How are reports generated on issues for board or audit committee?
  • Are policies available to all employees?
  • Is there an automated procedure in place to ensure that policies are current?
  • Is there a system to demonstrate compliance with each requirement of the Federal Sentencing Guidelines?



  • Are there rules regarding employee use of social networks?
  • Are there internal social networks and how are they managed?
  • Are there corporate rules for management of personal devices?
  • Are their rules of personal use of company email?
  • Are their retention rules for company email?
  • Are corporate automated marketing and sales tools reviewed for compliance with laws and regulations (e.g., the Federal Trade Commission and the Food and Drug Administration)?
  • Are the computers in the company (particularly in the law department) compliant with ISO security procedures?
  • What procedures are in place to prevent company systems from being penetrated by viruses or spyware?
  • Does the company have a robust computer security policy for its data, including the data of customers, consumers?
  • Do third parties (such as dealers or franchisees) have access to company computer systems that could give rise to security breaches?
  • Does the company follow privacy rules of the US and other countries?
  • Is business done electronically (e.g., ordering, payment)? Are safeguards in place?

More on "The Mentor Blog"

We continue to post new items daily on our blog - "The Mentor Blog" - for members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

- Auditor Engagement Letters: No Company Intervention in Auditor-Directed Work
- PCAOB Roundtable: Mixed Views of Proposed Changes to Auditor's Report
- Perceived Board Effectiveness Linked to How Board Allocates its Time
- FINRA: Pre-IPO Selling Procedures Need to Be Adequately Supervised
- Board Trends at the S&P 1500

- by Randi Val Morrison

August 26, 2014
The Hidden Costs and Underpinnings of Debt Market Liquidity
by June Rhee

Editor's Note: The following post comes to us from Amar Bhide, Thomas Schmidheiny Professor at The Fletcher School.

Even as rabble rousers rail against financiers, the powers that be prize the breadth and liquidity of financial markets. Flash traders are investigated for unsettling stock markets and violators of securities laws receive jail sentences on par with violent criminals. The Federal Reserve has spent trillions with the avowed aim of pumping up the prices of traded securities, while expressing little more than the pious hope that this largesse might spill over into old-fashioned, illiquid loans.

In my article, The Hidden Costs and Underpinnings of Debt Market Liquidity, I offer a skeptical view of pro-liquidity policies. A good financial system may be vital for a thriving economy, but what warrants favoring liquid over illiquid claims? Yes, the United States - the world's leading economic power since 1914 - has exceptionally broad and liquid financial markets. But, "industry led and finance followed." The transformation of the US from agrarian society to industrial powerhouse occurred before the smoothly functioning stock and bond markets became indispensable stars of American capitalism. The NYSE even shut down for nearly six months in 1914 without paralyzing the economy. Britain, the birthplace of the Industrial Revolution, actually lost its economic leadership, even as financial markets flourished in the City of London. Meanwhile, in spite of defeats in two World Wars, Germany's economy and industry surpassed Britain's, powered by businesses with illiquid stocks and banks making illiquid loans.

Economic theories that extol "complete" markets where people can trade all risks and claims at low cost are themselves incomplete: they leave out the "on-the-spot" knowledge sacrificed to sustain liquidity. Liquidity isn't manna that rains down from the sky. Liquid markets, where buyers place unconditional bids for goods or claims offered by competing sellers, requires standardization of what is sold and how. Standardization in turn limits consideration of case-specific details - or makes them irrelevant.

Standardized terms for trading many physical commodities aren't onerous for the typical producer or user. Buyers of copper for instance care about purity, not where and when the metal was mined. Exchanges can therefore easily sustain a liquid market in copper by specifying purity and some delivery terms. And customized transactions can piggy-back off transactions on an exchange: for instance, copper of lower than standard purity can be sold at negotiated discount to its exchange traded price.

However commodities whose buyers usually care about the same few attributes are exceptional. Desirable goods commonly combine several valued attributes: it isn't just the size of a house or the horsepower of a car that matters to buyers. Moreover, goods belonging to the same general category often comprise distinctive combinations that hold a different appeal to different buyers. Proximity of a residential property to a high school can be highly attractive to some but a nuisance to others. And purchasers with idiosyncratic preferences usually won't buy distinctive goods sight unseen. Houses cannot be sold by the square foot the way copper is sold by the ton. Rather, homebuyers examine properties to assess whether they match what they are looking for. Scrutinizing distinctive attributes also helps decide how much to bid: because houses are not interchangeable, the prices of similar properties are just a starting point.

In financial markets, as with tangible goods, the value of detailed case-specific information is different for different claims. Buyers of U.S government bonds expect little information beyond their maturity and coupon payments: investors' assessments of risks and returns are based on data and forecasts about the overall economy. And, as with physical commodities, when buyers do not value case specific details, liquid markets do not require burdensome restrictions.

In other kinds of claims, purchasers care a lot about case-specific details. Venture capitalists (VCs) spend considerable effort researching startup businesses they might invest in. The research helps VCs assess the risks and returns and whether a startup matches the VCs' expertise and portfolios. Detailed information also helps negotiate terms and prices. And, as with residential properties, the high value placed on detailed information, hinders sight-unseen trading. Investors would not normally buy shares in a startup without access to the confidential information that startups provide only to credible VCs, under non-disclosure agreements.

Then there are the in-between cases. For instance a bank can extend credit to a business by making a loan or it can purchase the businesses' publicly-traded bonds. The bank can secure confidential information from the borrower if it makes a loan but not if it purchases a bond. Purchasing an easily tradable bond however provides the well-known benefits of low-cost diversification and the option of raising cash quickly to meet unexpected needs. And historically banks and other lenders have been willing to forgo access to confidential details mainly for large-blue chip borrowers whose creditworthiness could be reliably assessed from public data. (Limitations on the on-going information that can be disclosed to bondholders also impels differences in covenants and other contractual terms such as renewal of the credit through evergreen provisions).

In the last thirty years however the scope of liquid markets in financial claims has dramatically increased. The exceptional breadth and depth of US stock exchanges has become commonplace, while US markets have grown by trading "securitized" claims on bundles of loans, particularly mortgages, that lenders once held to maturity. Advocates hail the shift as a Schumpetarian advance spurred by innovations in information technology and finance, although they acknowledge that making more claims liquid can increase the misalignment of incentives.

I advance three propositions to critique this favorable assessment.

First, the expansion of liquid financial markets has entailed suppressing detailed case-specific information. The liquidity of stock markets has been undergirded for instance by tough insider trading rules to ensure that stocks are bought without knowledge of confidential details about the issuer's plans and prospects. Likewise the securitization mortgages and other small loans has been undergirded by mechanistic lending practices that rely on abridged or condensed information rather than detailed information about borrowers.

Second, suppressing case-specific information imposes costs (over and beyond increased opportunities to shirk, lie or steal) that can offset the benefits of liquidity. Insider trading rules that sustain the liquidity of stocks for instance impair governance by discouraging investors from serving on company boards. Likewise using parsimonious models to screen loan applications can lead to the unwarranted extension of credit to bad borrowers and the denial of credit to good borrowers. Mechanistic securitization practices and the liquidity they help create also leads to a hazardous conjoining of risks in the banking system. Credit exposures are more heterogeneous in traditional lending where banks make loans that match their expertise.

Third I claim that regulation, rather than autonomous advances in financial and information technologies, has spurred the growth of liquid markets. The once-exceptional breadth and depth of US equity markets was the result of its unusually robust securities rules. As these rules spread, so did US style stock liquidity. Similarly small loans have been securitized to an exceptional degree in the US because of the strong bias of US housing policies, securities laws and banking rules in favor of mechanistic liquefaction.

Without such a policy bias, technological advances might have had dramatically different effects. The internet and e-commerce have revolutionized the matching of buyers and sellers of differentiated goods and services ranging from books to concert tickets to restaurant reservations. Real estate brokers routinely post pictures, maps and numerous other details of properties on their websites that help buyers quickly zero in on the ones that they would seriously consider purchasing and helps sellers reach far-flung buyers. Banks too could have similarly harnessed technology to improve their use of rich data for selecting borrowers and monitoring loans.

Rebottling the genie is difficult however. Traditional practices encouraged financiers to specialize in particular domains - say lending to restaurateurs or property developers - so that they could effectively secure and use detailed information. The declining use of detailed information had made the matching of issuers of claims and financiers with the right expertise superfluous. And to the extent the expertise is acquired through practice, even if policies favoring liquid markets are reversed, relationship-based finance will not quickly return.

The full paper is available for download here.

August 26, 2014
Sullivan & Cromwell discusses Berkshire Hathaway's Civil Penalty for Hart-Scott-Rodino Act Violation
by Yvonne S. Quinn


Berkshire Hathaway Inc. has agreed to pay a civil penalty of $896,000 concerning its conversion of notes into voting securities of USG Corporation in December 2013, which was more than five years after Berkshire's HSR Act filing to acquire an initial USG stock position and thus past the expiration date of the original HSR. In addition, Berkshire previously had made a corrective filing in July 2013 concerning the acquisition of voting securities of a different issuer and was, therefore, treated as a repeat offender by the Federal Trade Commission.


On Wednesday, August 20, the Federal Trade Commission ("FTC") announced that Berkshire Hathaway Inc. ("Berkshire") had agreed to pay a civil penalty of $896,000, the maximum civil penalty that could have been imposed, for its alleged violation of the premerger notification and filing requirements of the Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR Act") in connection with its 2013 acquisition of voting securities of USG Corporation.

As background, according to the FTC's complaint, Berkshire had made a corrective filing in July 2013 concerning an acquisition of voting securities of Symetra Financial Corporation. The FTC took no action against Berkshire following that violation but sent Berkshire a letter on December 5, 2013, including its standard language cautioning that Berkshire "is accountable for instituting an effective program to ensure full compliance with the [HSR] Act's requirements."

Under Rule 802.21(a) of the HSR Act Rules, once an acquiring person submits an HSR Act filing and observes the waiting period, subsequent acquisitions of voting securities of the same issuer are exempt from the HSR Act's reporting requirements for a period of five years from the expiration of the waiting period, provided the acquisitions do not cross a higher notification threshold. Once that five year period expires, however, the protection provided by the initial filing no longer exists.

The Berkshire Complaint alleges that in January 2006, Berkshire properly submitted an HSR Act filing concerning its acquisition of 19% of the voting securities of USG Corporation. On December 9, 2013, five days after it received the FTC letter concerning its corrective filing in Symetra - and more than five years after the waiting period applicable to its initial HSR Act filing relating to USG had expired - Berkshire, without first submitting an HSR Act filing, converted certain USG notes that it owned into USG voting securities. As a result of this acquisition, Berkshire held approximately 28% of USG's voting securities, valued at more than $950 million. Berkshire submitted a corrective filing concerning this conversion/acquisition on January 3, 2014.

In the FTC's press release concerning this matter, Deborah Feinstein, the Director of the FTC's Bureau of Competition, stated:

"Although we may not seek penalties for every inadvertent error, we will enforce the rules when the same party makes additional mistakes after promises of improved oversight. Companies and individual investors alike should ensure that they have an effective program in place to monitor compliance with HSR filing requirements."

This proceeding highlights the fact that parties that have already submitted corrective filings for an HSR Act violation must successfully establish and monitor effective compliance programs to avoid future violations and significant civil penalties. In addition, it also serves as a reminder that the conversion of notes into voting securities is treated as an acquisition of voting securities that may be subject to the HSR Act and that the benefits of an HSR Act filing expire within five years. Once that period expires, even the proposed acquisition of a single additional share of voting securities can require the submission of a new HSR Act filing.

The full and original memo was published by Sullivan & Cromwell LLP on August 21, 2014, and is available here.

August 26, 2014
Record Number of FINRA Enforcement Cases Expected
by Mark Astarita

Last month we learned that FINRA Enforcement fines were up, and set to surpass last year's fines. If you need any more convincing that now is the time to insure that your policies and procedures are compliant, FINRA is saying that it is on pace to file "a record number of cases this year."

According to FINRA the top compliance failures are in the areas of suitability, cybersecurity and anti-money laundering andFINRA continues to see a "significant" number of single broker malfeasances, including petty theft, dishonesty, forgery and failure to report on their U-4.

FINRA enforcement continues to have a strong caseload, with a record number of cases on the same pace this year as last," Brad Bennett, FINRA's chief of enforcement,

For more information - FINRA on Record Enforcement Pace in '13, Enforcement Chief Says

--- The attorneys at Sallah Astarita & Cox include veteran securities litigators and former SEC Enforcement Attorneys. We have decades of experience in securities litigation matters, including the defense of enforcement actions and representation of investors, financial professionals and investment firms, nationwide. For more information call 212-509-6544 or send an email.

August 26, 2014
Morrison, the Second Circuit, and the Reverse Effects Test: ParkCentral Global Hub Limited v. Porsche Automobile Holdings (Part 2)
by J Robert Brown Jr.

We are discussing the Second Circuit's decision in ParkCentral Global Hub Limited v. Porsche Automobile Holdings, a case that effectively created a "reverse effects test" that was contrary to the Supreme Court's analysis Morrison v. National Australia Bank.   

In ParkCentral Global Hub Limited v. Porsche Automobile Holdings, the court addressed the full implications of the reasoning in Morrison.  The case involved foreign defendants, foreign companies, foreign conduct, and losses based on price movements of foreign securities.  Nonetheless, the transaction was alleged to have occurred in the United States.

The court had to squarely confront whether in fact conduct and the nature of the action were irrelevant to the analysis as Morrison indicated.  The court concluded that while the transaction had to be domestic or involve a listed security, such a condition was necessary but not sufficient.  Id.  ("we conclude that, while a domestic transaction or listing is necessary to state a claim under § 10(b), a finding that these transactions were domestic would not suffice to compel the conclusion that the plaintiffs' invocation of § 10(b) was appropriately domestic."). 

The opinion reasoned by negative implication, noting that Morrison never said that such factors were sufficient. It also concluded that the alternative would conflict with the determination that Section 10(b) did not have extraterritorial application.

The reasoning of the opinion is thin.  Having found that the test in Morrison could largely be disregarded, the court simply concluded that Congress, back in 1934, did not intend in a sub silentio manner to permit actions that could conflict with the laws of foreign jurisdictions.  The court relied not on citations to the legislative history or to the language of the statute but to what it viewed as an "obvious" possibility that must have been considered.

The reasoning reflects a result oriented decision.  The court was concerned that, by allowing actions based solely on the domestic/listed nature, actions would be permitted under Section 10(b) that had few domestic implications.  Nonetheless, such an implication was hardly lost on the Supreme Court.  The Supreme Court deliberately sought to render the nature of the parties and the location of the fraudulent behavior irrelevant.  

The Second Circuit was appropriately concerned with the implications of the test set forth by the Supreme Court in Morrison.  But by implementing an effects test, the Second Circuit did so in only one direction.  By allowing consideration of the effects only for transactions that were domestic or for securities that were listed, the effects test was only used to deny the availability of Rule 10b-5.  

Nothing in the test employed by the Second Circuit suggested that it would be used to allow shareholders to bring an action under the antifraud provisions that clearly implicated US interests but did not involve a domestic transaction or listed security.  This could occur, for example, where a US shareholder bought shares in a US company and alleged fraudulent behavior that occurred in the US but was prohibited from using Section 10(b) under the Morrison framework because the sale closed outside the United States.  Yet while the Second Circuit devised a formula that would exclude actions by foreign shareholders that did not reflect a sufficient domestic interest, the court did not seek to expand the test to include actions by domestic shareholders that did have such an interest.  In short, the Second Circuit developed a reverse effects test. 

The court effectively acknowledged the almost legislative nature of the decision, suggesting that the task was more appropriately handled by Congress or the Commission.  In fact, a legislative change is sorely needed in this area.  The current test for applying Section 10(b) (the location of the transaction or the listed nature of the security) is based upon an arbitrary formula that does not reflect the domestic interests of the parties or the location of the behavior.  The decision in Porsche has made the standard even more arbitrary.

August 25, 2014
A Strict Liability Regime for Rating Agencies
by R. Christopher Small

Editor's Note: The following paper comes to us from Alessio Pacces and Alessandro Romano, both of the Erasmus School of Law at Erasmus University Rotterdam.

In our recent ECGI working paper, A Strict Liability Regime for Rating Agencies, we study how to induce Credit Rating Agencies (CRAs) to produce ratings as accurate as the available forecasting technology allows.

Referring to CRAs, Paul Krugman wrote that: "It was a system that looked dignified and respectable on the surface. Yet it produced huge conflicts of interest. Issuers of debt [...] could choose among several rating agencies. So they could direct their business to whichever agency was most likely to give a favorable verdict, and threaten to pull business from an agency that tried too hard to do its job."

However, the conflicts of interest stemming from the issuer-pays model and rating shopping by issuers are not sufficient to explain rating inflation. Because ratings are valuable only as far as they are considered informative by investors, in a well-functioning market, reputational sanctions should prevent rating inflation.

The economic literature shows that the problem is more complex. If a large proportion of investors are naïve, the market will fail to punish rating inaccuracy. The same result occurs if there are enough investors that reap sizable regulatory benefits from investing in highly rated assets, because those investors always prefer rating inflation. Moreover, ratings may turn out to be inaccurate ex-post because the forecasting technology available to CRAs is imperfect and hence they make mistakes. Because the relative importance of these problems is not known and is likely to vary across different contexts, we argue that accuracy of ratings cannot be fostered by detailed regulations of the markets in which they are supplied. On the contrary, we argue that an appropriately crafted strict liability rule supports rating accuracy simply by recreating opposing interests between supply and demand for ratings.

The imposition of liability on CRAs has been part of the regulatory debate following the global financial crisis, but so far, only negligence rules have been considered. We overcome the ambiguities of setting and enforcing a diligence standard by designing a simple and legally workable strict liability rule: CRAs should be liable to pay damages whenever a bond or a company they rate defaults. This leaves us with three problems. Firstly, the default of a large issuer could be enough to bankrupt any CRA irrespective of rating accuracy. Secondly, because we do not live in a world of perfect foresight, CRAs should not be liable if they make mistakes due to Knightian uncertainty. Thirdly, under a strict liability rule CRAs would be acting as de facto insurers against the risk of defaults. As the defaults of firms and financial assets can be significantly correlated, CRAs need to be shielded from systemic risk to avoid crushing liability.

We introduce three corrections to address each of these issues. To begin with, we introduce a damage cap to limit CRAs' exposure to liability. Liability should be calculated multiplying the income received from the issuer by the inverse of the highest probability of default associated with the rating class in which the issuer (or its asset) is included. This liability regime disallows profits from rating inflation without discouraging ratings altogether. The CRAs will prefer to supply lower ratings in order to reduce their expected liability, whereas issuers and regulated investors will prefer higher ratings. Under this mechanism CRAs earn zero profits if, and only if, their predictions are not inflated, whereas issuers only purchase ratings if those do not underestimate their creditworthiness. The ratings produced in such a market will reflect all available information about the creditworthiness of issuers and their bonds.

Because we do not live in a world of perfect foresight, even under ideal incentives the CRAs will be prone to making mistakes. To address this problem we introduce a parameter - alpha - allowing CRAs to choose the desired degree to exposure to liability. The smaller alpha is, the more mistakes CRAs are allowed to make without suffering losses (and the more economic profits they can make if their ratings are accurate). By announcing alpha to investors, the CRAs commit to a certain degree of confidence in their own forecasting models and they are expected to compete on this credibility variable, along with the rating level, in order to attract issuers. In theory, CRAs may opt out of liability even entirely, unless they want their ratings to be relevant for regulation. In order to avoid that the market equilibrium is again determined by regulated investors' demand for high ratings, we require regulation to set a minimum alpha as a precondition for rating to generate regulatory benefits. Otherwise, the key feature of alpha is its contractibility. Being a standardized commitment device supported by an enforceable strict liability rule, the alpha generated by the market can be as low as to keep CRAs in business and as high as to make ratings informative even for naïve investors.

Lastly, we introduce corrections to protect CRAs from systemic risk, which we define simply as correlated defaults. Because ratings are uninformative about systemic risk, CRAs should not be liable when defaults depend on it. This outcome is easily achieved for corporate bonds, whose defaults are strongly correlated only in the medium to long term: the CRAs liability for these bonds should expire three months (the typical "watchlist" timing) after the production or the confirmation of a rating. Defaults of structured finance products, however, can be correlated also in the short run and the exposure to systemic risk is particularly severe for the higher tranches (for which the liability exposure is also higher). Therefore, we recommend that CRAs liability for such products be conditional on rating inflation being observed for the population of rated assets over a certain period, for instance one year. Importantly, this period can be extended backwards by a public authority, for instance up to the average maturity of the products in question, upon declaration of financial crisis status. This solution is countercyclical, because it rewards the CRAs that were more conservative in rating structured finance products during economic booms.

The full paper is available here.

August 25, 2014
The Battle Against Multiforum Stockholder Litigation
by Theodore Mirvis

Editor's Note: Theodore N. Mirvis is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. The following post is based on a Wachtell Lipton memorandum by Mr. Mirvis, David A. Katz, William Savitt, and Ryan A. McLeod. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Just over a year ago, the Delaware Court of Chancery upheld the facial validity of exclusive forum bylaws adopted by corporate boards as a means of rationalizing stockholder litigation. In the time since Chancery's landmark Chevron opinion, numerous corporations have adopted exclusive forum bylaws, and courts in New York, Texas, Illinois, Louisiana, and California have enforced such bylaws against stockholders bringing duplicative lawsuits in violation of their terms. The result, as one commentator recently noted, has been to disincentivize duplicative filings and reduce the concomitant litigation "deal tax" on merging parties. Yet, despite this progress, pernicious multijurisdictional litigation persists. A recent decision from a court in Oregon (Roberts v. TriQuint SemiConductor, Inc., No. 1402-02441 (Or. Cir. Ct. Aug. 14, 2014)) illustrates the potential harm from such litigation and the importance of continued authoritative articulation of the law to ensure the efficacy of exclusive forum bylaws.

The TriQuint case involved a challenge to the stock-for-stock merger between TriQuint Semiconductor and RF Micro Devices. Cognizant of the heightened risk of wasteful, duplicative litigation attendant to merger transactions, TriQuint's board adopted a bylaw in connection with its approval of the transaction designating Delaware courts as the exclusive forum for intracorporate stockholder litigation. Following the announcement of the deal, and as the board had feared, TriQuint stockholders filed duplicative lawsuits in Delaware and Oregon courts challenging the transaction and alleging that TriQuint's directors entered into the merger only to fend off an activist stockholder's proxy contest threat. In a June opinion, Vice Chancellor Noble of the Delaware Court of Chancery denied expedition, holding that the stock-for-stock transaction was due business judgment deference under longstanding precedent from the Delaware Supreme Court and that the plaintiffs failed to articulate even a colorable claim against the directors.

Defendants then moved to dismiss the Oregon suits as barred by the exclusive forum bylaw and for failure to state a claim. The Oregon court denied the motions. While the court acknowledged Chevron's teaching that "bylaws are not contractually invalid simply because they were adopted unilaterally," it nevertheless relied on non-Delaware authority, expressly disapproved in Chevron, to conclude that the board acted "inequitably" because it "enacted the bylaw in anticipation of this exact lawsuit" and without some undefined "ample time" the court believed was needed "for the shareholders to accept or reject the change." Then, even though it conceded that the stock-for-stock merger was entitled to business judgment review, the Oregon court declined to dismiss the lawsuit, apparently finding potential merit in the same Delaware law claims the Delaware Court of Chancery had already ruled were not even colorable.

The Oregon rulings, which stray far from settled and binding Delaware authority, highlight the indefensible cost and procedural unfairness of duplicative multiforum corporate litigation. We continue to believe exclusive forum provisions remain a viable deterrent against such wasteful duplicative litigation. In light of the TriQuint case and pending further elaboration and acceptance of the legal principles governing forum bylaws, however, boards should consider adopting such provisions on a "clear day" in advance of any particular anticipated litigation.

August 25, 2014
Latham & Watkins discusses New York's Proposed Virtual Currencies Regulations
by Alan W. Avery

On July 23, 2014, the New York State Department of Financial Services (NYSDFS), the governmental agency that regulates the financial services and insurance industries in New York, released proposed regulations governing the use of virtual currencies in New York State (Proposed Rule).[1] The Proposed Rule is open to a 45-day public comment period that will end on September 5, 2014, after which the NYSDFS will consider the comments and possibly amend before deciding on the final form of the regulations. This Client Alert discusses the history of virtual currencies, provides an overview and summary of the key requirements of the Proposed Rule, highlights some of the similarities between the Proposed Rule and other NYSDFS rules that regulate aspects of the financial services industry in New York, and discusses the potential impact of the Proposed Rule on the virtual currency industry.

Virtual Currencies: A Brief History

Virtual currencies and other cryptocurrencies, such as Bitcoin, are financial and technological instruments that incorporate characteristics of money, accounting, networks and remittances into one concept. Bitcoin has been gaining traction as a decentralized, digital currency since it was officially launched in 2009. Although virtual currencies are not considered "lawful money" in the United States, the number of virtual currency users is growing rapidly beyond the scope of the banking industry. As such, the need to implement regulations to reduce the operational and systemic risks associated with the virtual currency industry and to protect consumers from financial harm is paramount to ensure the survival of a multibillion-dollar system with more than one million users.

To date, federal and state banking regulators have failed to reach a consensus as to how to both classify Bitcoin and regulate such an industry. Various federal regulatory agencies have acknowledged the existence of the virtual currencies industry, but only a few have addressed how such an industry might be regulated. Federal Reserve Chair Janet Yellen has called Bitcoin "a payment innovation that is taking place outside of the banking industry," but the Federal Reserve has not indicated whether the supervision and regulation of the virtual currencies industry should fall under its purview. Other federal regulators, such as the Department of the Treasury's Financial Crimes Enforcement Network (FinCEN) and the Consumer Financial Protection Bureau (CFPB), have made some clarifying remarks as to how virtual currencies might fit into their respective regimes, but neither FinCEN nor the CFPB has issued any corresponding regulatory proposals.[2] At the state level, while most states regulate money transmission in some form, prior to the NYSDFS's issuance of the Proposed Rule no state had issued proposals relating specifically to establishing a regulatory framework for virtual currencies.[3]

Overview and Summary of the Proposed Rule

With the introduction of the Proposed Rule, the NYSDFS has established itself as the first regulatory agency, at either the state or federal level, to develop a framework for oversight of the virtual currency industry. Drawing heavily from New York's banking industry regulations, the Proposed Rule establishes a strict regulatory regime that will require companies currently operating under the virtual currency model to drastically change their business practices.

Definition of "Virtual Currency"

"Virtual Currency," as defined under the Proposed Rule, means any type of digital unit that is (i) used as a medium of exchange or a form of digitally stored value or (ii) incorporated into payment system technology. In addition, Virtual Currency includes digital units of exchange that may:

Have a centralized repository or administrator

Be decentralized and have no centralized repository or administrator

Be created or obtained by computing or manufacturing effort

Carve-outs from the definition of Virtual Currency include digital units that are (i) used solely within online gaming platforms with no market or application outside those gaming platforms or (ii) used exclusively as part of a customer affinity or rewards program and can be applied solely as payment for purchases with an issuer and/or other designated merchants, but cannot be converted into or redeemed for any government-issued currency that is designated as legal tender in its country or issuance through government decree, regulation or law (Fiat Currency).

Licensing Requirement to Engage in a "Virtual Currency Business Activity"

Perhaps the most significant aspect of the proposed new regulatory regime for Virtual Currencies in New York is the requirement that a "Person" (defined below) would only be permitted to engage in a "Virtual Currency Business Activity" (defined below) if such Person is granted a license by the Superintendent of Financial Services (Superintendent). Person, as defined under the Proposed Rule, includes an individual, partnership, corporation, association, joint stock association, trust or other business combination or entity, however organized. Virtual Currency Business Activity means any of the following activities involving New York or any Person that resides, is located, has a place of business or is conducting business in New York:

Receiving Virtual Currency for transmission or transmitting Virtual Currency

Securing, storing, holding or maintaining custody or control of Virtual Currency on behalf of others

Buying and selling Virtual Currency as a customer business

Performing retail conversion services, including the conversion or exchange of Fiat Currency or other value into Virtual Currency, the conversion or exchange of Virtual Currency into Fiat Currency or other value, or the conversion or exchange of one form of Virtual Currency into another form of Virtual Currency

Controlling, administering or issuing a Virtual Currency

Notwithstanding the above licensing requirement, Persons that fall under the following two categories are exempt under the Proposed Rule from the requirement to obtain a license to engage in any Virtual Currency Business Activity:

Persons chartered under the New York Banking Law to conduct exchange services and who are approved by the Superintendent to engage in a Virtual Currency Business Activity

Merchants and other consumers who use Virtual Currency only for the purchase or sale of goods or services

Application for Licensing Submission Process

In order to be considered for a Virtual Currency Business Activity license under the Proposed Rule, an applicant would be required to provide the Superintendent with a variety of information designed to remove the anonymity previously associated with parties engaged in virtual currency transactions and to introduce a level of transparency to provide consumers with an idea of the type of person with whom the consumer is conducting business. To this end, applicants would be required to provide the Superintendent with extensive information, including, but no limited to, the following:

The exact name of the applicant

The jurisdiction where such applicant is organized or incorporated

Biographical information for each individual applicant, each director and certain specified officers and/or beneficiaries and/or stockholders, as applicable

State Division of Criminal Justice Services and Federal Bureau of Investigation background checks for each individual applicant, for all employees of such applicant and for certain specified officers and/or beneficiaries and/or stockholders, as applicable

An organizational chart and management structure of the applicant

A current financial statement for the applicant and certain specified officers and/or beneficiaries and/or stockholders, as applicable

A projected pro forma balance sheet and income expense statement for the next year of the applicant's operation

Details of all banking arrangements

An explanation of the methodologies used to calculate the value of Virtual Currency in Fiat Currency

The Proposed Rule's list of licensing requirements is not exhaustive, and the Superintendent would have discretionary authority to require applicants to provide additional information as needed.

Superintendent's Consideration of Application for Licensing

Upon the filing of an application for licensing, the Superintendent would have a period of 90 days, which may be extended on a discretionary basis, to approve or deny an application. During this period, the Superintendent would evaluate an applicant's ability to engage in a Virtual Currency Business Activity by investigating such applicant's financial condition and responsibility, financial and business experience, and character and general fitness.

Compliance Regime for Persons Engaged in a Virtual Currency Business Activity

In addition to requiring any Person duly licensed by the Superintendent to engage in a Virtual Currency Business Activity (Licensee) to comply with all federal and state laws, rules and regulations applicable to Virtual Currencies, each Licensee would also be subject to an extensive enforcement regime under the Proposed Rule. Such a regime would involve compliance with anti-fraud, anti-money laundering, cyber security, privacy and information security, and other such policies. The Proposed Rule sets forth the various requirements for maintaining and documenting compliance with the various polices listed above. In addition to requiring the Licensee’s board of directors or equivalent governing body to review and approve each such documented compliance policy, the Proposed Rule provides that the Superintendent would also conduct periodic examinations at least once every two calendar years. During such examinations, the Superintendent would review and evaluate the Licensee's compliance policies, among other practices.

Comparison to New York State Financial Services Industry Regulations

The proposed virtual currency regulatory framework and compliance regime includes many notable parallels with the current regulatory framework for participants in the financial services industry in New York, including banks and non-banking financial services entities, such as money transmitters. With the exception of cyber security, the parallels include requirements to maintain minimum capital standards, place in custody and safeguard customer assets, maintain books and records, submit to periodic examinations by the Superintendent, and comply with ongoing reporting and disclosure obligations as well as consumer protection disclosures.

Potential Impact on the Virtual Currency Industry in New York

The Proposed Rule would require any potential Licensee, regardless of size, to invest substantially in compliance resources to ensure that all current and future Virtual Currency Business Activities are compliant with the new regulatory regime. The costs associated with such compliance requirements may have the unintended consequence of stifling innovation and development on the virtual currency front by preventing individuals or small start-ups with limited budgets from establishing a presence in New York. The NYDFS has acknowledged this possible consequence and has assured the industry it intends to balance innovation, economic development and safety and soundness in the final rule.


As the first state to propose an established framework for the virtual currency industry, the dialogue surrounding the Proposed Rule and the final form of the rule likely will significantly impact the ways in which other state and federal regulators adopt virtual currency standards. While New York's proposed virtual currency regulations are the first of their kind in the United States, the similarities to the regulatory regimes for both banks and non-bank financial services providers will require potential virtual currency licensees to understand both the virtual currency industry and the financial services regulatory regimes. In navigating this new regulatory landscape, potential licensees should enlist the assistance of experts with expertise in both the virtual currency and bank regulatory worlds.

[1] 23 NYCRR Part 200 (proposed), available at

[2] FinCEN issued guidance on March 18, 2013, clarifying that Bitcoin operates similarly to real currency and therefore should be treated like currency for purposes of US anti-money laundering regulations and should be subject to FinCEN's registration, reporting and record-keeping requirements, including Know Your Customer rules. In addition, the CFPB recently indicated that it is working in conjunction with other federal regulators to develop consumer protection regulations relating to the virtual currency industry.

[3] A few states, including California, Kansas and Texas, have addressed the topic of virtual currencies without proposing any such regulations. California's state legislature approved a bill on June 30, 2014, that lifted a ban on the use of Bitcoin and other alternative currencies to make such currency legal in purchasing goods and transmitting payments. In Kansas, the Office of the State Bank Commissioner issued guidance on June 6, 2014, regarding the regulatory treatment of virtual currencies pursuant to the statutory definitions under the Kansas Money Transmitter Act. On April 3, 2014, the Texas Department of Banking issued a supervisory memorandum outlining its policy with respect to virtual currencies.

The full and original memo was published by Latham & Watkins LLP on August 1, 2014, and is available here.

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