Topics In This Issue

• SEC Adopts New Short Selling Restrictions
• IRS and the Department of the Treasury Release Guidance on Foreign Bank Account Reports
• The Delaware Chancery Court Analyzes Fiduciary Duties of LLC Controlling Members and Managers and Addresses Third Party Vote Buying Claims
• SEC Issues Statement on Global Accounting Standards and Publishes a Work Plan to Study Potential Adoption of IFRS for U.S. Issuers

SEC Adopts New Short Selling Restrictions
On February 24, the Securities and Exchange Commission approved a new rule, Rule 201 of Regulation SHO, commonly referred to as the “alternative uptick rule,” restricting short selling when a security “is experiencing significant downward price pressure.” As adopted, the rule’s restrictions on short selling would be imposed when the price of a “covered security” declines by at least 10 percent in any given trading day from the price at the prior day’s close of trading. When triggered, short selling would only be permitted if the price of the security is above the current national best bid. Once triggered, the price restriction will be in effect for the remainder of the trading day, as well as the following trading day.

According to SEC Chair Mary Schapiro, once the “circuit breaker” has been tripped, long sellers will be able to stand in the front of the line and sell their shares before any short sellers. Chairman Schapiro stated that “the rule is designed to preserve investor confidence and promote market efficiency, recognizing short selling can potentially have both a beneficial and a harmful impact on the market.”

The alternative uptick rule was adopted by a 3-2 vote of the commissioners on party lines, with both Republican commissioners voting against. Commissioner Troy Paredes issued a lengthy dissent, arguing that the new rule amendments are just as likely, if not more likely “to erode investor confidence” as they are to boost it. Commissioner Paredes further asserted that there is “an insubstantial empirical basis to support the Commission in adopting the rule, especially in light of the rigorous economic analysis that led the SEC to repeal the ‘original’ uptick rule in 2007 after years of study.” The original uptick rule, former Rule 10a-1, adopted in 1938, provided that, subject to certain exceptions, a listed security could be sold short (i) at a price above the price at which the immediately preceding sale was effected (plus tick), or (ii) at the last sale price if it was higher than the last different price (zero plus tick).

In her speech at the SEC open meeting regarding the adoption of the new short sale restrictions, Chairman Schapiro declared that since the repeal of the original uptick rule in 2007, “global economic environment has changed dramatically,” which has led the SEC to adopt a number of measures restricting short selling, including the alternative uptick rule.

The new rule includes the following provisions:

Securities Covered by Price Test Restriction: The rule generally applies to all equity securities that are listed on a national securities exchange, including securities traded in the over-the-counter market.

Short Sale-Related Circuit Breaker: The price restriction would be triggered for a security any day in which the price of the security declines by 10 percent or more from the prior day’s closing price.

Duration of Price Test Restriction: Once the circuit breaker has been triggered, the alternative uptick rule would apply to short sale orders in that security for the remainder of the day as well as the following day.

Order Marked as “Short Exempt”: Following the trigger of the circuit-breaker, the short sale of an affected security may be executed or displayed if a broker or dealer has marked the order as “short exempt.” Provided that certain conditions are met, a broker or dealer submitting a short sale order of the affected security may mark the order “short exempt” if the broker or dealer identifies the order as being at a price above the current national best bid at the time of submission.

Policies and Procedures: Trading centers will be required to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a prohibited short sale.

Effective and Compliance Dates: The rule will go into effect 60 days after publication in the Federal Register, and market participants will have six months following the effective date to comply with the rule’s requirements. top

IRS and the Department of the Treasury Release Guidance on Foreign Bank Account Reports
United States persons having a financial interest in, or signature or other authority over, certain financial accounts in a foreign country are required to report those accounts to the Department of the Treasury by filing a Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (“FBAR”), if the aggregate value of such financial accounts exceeded $10,000 at any time during the calendar year. For each calendar year for which an obligation to file an FBAR exists, such FBAR must be filed with the Department of the Treasury on or before June 30 of the succeeding year.

On February 26, 2010, the Internal Revenue Service (“IRS”) issued Notice 2010-23, 2010-11 I.R.B., and Announcement 2010-16, 2010-11 I.R.B., providing guidance with respect to certain persons who may be required to report certain foreign financial accounts on an FBAR by June 30, 2010, for the 2009 calendar year, and, in certain circumstances, earlier calendar years.

Under Notice 2010-23, the IRS provided administrative relief to certain persons who may be required to file an FBAR for the 2009 and earlier calendar years. Persons with signature authority over, but no financial interest in, a foreign financial account for which an FBAR would have otherwise been due on June 30, 2010, now have until June 30, 2011, to file an FBAR for the 2010 and prior calendar years. Further, persons with a financial interest in, or signature authority over, a foreign commingled fund that is a “mutual fund” are required to file an FBAR by June 30, 2010, for the 2009 and earlier calendar years (unless another filing exception applies). Also, persons with a financial interest in, or signature authority over, foreign commingled funds which are not “mutual funds” are not required to file an FBAR with respect to those accounts for the 2009 and prior calendar years. Importantly, taxpayers with such an interest in foreign hedge funds and foreign private equity funds need not file FBARs with respect to those funds for the 2009 and earlier calendar years. Additionally, provided the taxpayer has no other reportable foreign financial accounts for the year in question, a taxpayer who qualifies for the filing relief provided in Notice 2010-23 should check the “no” box in response to FBAR-related questions found on U.S. federal tax forms for 2009 and earlier years that ask about the existence of a financial interest in, or signature authority over, a foreign financial account.

Under Announcement 2010-16, the IRS suspended, for persons who are not United States citizens, United States residents, or domestic entities (corporations, partnerships, trusts, or estates), the requirement to file an FBAR for the 2009 and earlier calendar years.

On February 26, 2010, the Financial Crimes Enforcement Network, a bureau of the Department of the Treasury, issued a notice of proposed rulemaking, which contains proposed changes and revisions to the regulations implementing the Bank Secrecy Act regarding FBARs (the “Proposed Regulations”). The Proposed Regulations (1) clarify which persons will be required to file an FBAR, (2) clarify which accounts will be reportable, (3) exempt certain persons with signature or other authority over foreign financial accounts from filing FBARs, and (4) prevent certain United States persons from avoiding an FBAR filing requirement. The Proposed Regulations reflect congressional concern that foreign financial institutions were being used to evade domestic criminal, tax, and regulatory laws. Written comments on the Proposed Regulations may be submitted, as described in the Proposed Regulations, on or before April 27, 2010. top

The Delaware Chancery Court Analyzes Fiduciary Duties of LLC Controlling Members and Managers and Addresses Third Party Vote Buying Claims
The Delaware Court of Chancery recently addressed two important aspects of Delaware corporate law: default principles of fiduciary duties in limited liability companies and “third party vote buying” in corporations. In Kelly v. Blum, C.A. No. 4516-VCP (Del. Ch. Feb. 24, 2010), the Court addressed the issue of whether managers and members of a limited liability company (“LLC”) owe traditional fiduciary duties to each other or to the LLC. The Court held that in the absence of an explicit provision in the LLC agreement to the contrary, managers and controlling members owe the traditional fiduciary duties of loyalty and care to the members and to the LLC. In Kurz v. Holbrook, C.A. No. 5019-VCL (Del. Ch. Feb. 9, 2010), the Court addressed the issue of vote buying in the context of a consent solicitation for control of a corporation. The Court held that where the alleged vote buying does not involve corporate funds (so called “third party vote buying”), the acquisition of voting shares is generally permissible, so long as the purchase is not otherwise tainted by insider trading, fraud or some other improper purpose.

In Kelly v. Blum, the plaintiff, who was founder and a member of Marconi Broadcasting Company, LLC (“Marconi”), brought suit against the managers and controlling members of Marconi claiming that the they entered into a self-interested transaction to squeeze out the plaintiff and unfairly seize control of Marconi. The plaintiff claimed that, by virtue of the defendants’ status as members or managers of Marconi, the defendants each owed various fiduciary duties to the plaintiff as minority equity owner. The defendants asserted that they did not owe a fiduciary duty of loyalty to the plaintiff because any fiduciary duties must be explicitly set forth in the LLC agreement.

The Court conceded that Delaware’s LLC Act does not specify a statutory default provision regarding the fiduciary duties of managers and members, but that it implies that some default fiduciary duties may exist at law or in equity. Building on previous Delaware cases interpreting the Delaware Revised Uniform Limited Partnership Act, the Court determined that “unless the LLC Agreement in a manager-managed LLC explicitly expands, restricts, or eliminates traditional fiduciary duties, managers owe those duties to the LLC and its members and controlling members owe those duties to minority members.” The Court also considered whether the LLC agreement limited the application of these default fiduciary duties. Because the relevant language in Marconi’s LLC agreement did not explicitly restrict or eliminate the applicability of the default fiduciary duties, the Court held that the defendants were required to treat the plaintiff in accordance with traditional fiduciary duties. In its ruling, the Court offered a word of caution to would-be practitioners, “Having been granted great contractual freedom by the LLC Act, drafters and parties to an LLC agreement should be expected to provide parties and anyone interpreting the agreement with clear and unambiguous provisions when they desire to expand, restrict, or eliminate the operation of traditional fiduciary duties.”

In Kurz v. Holbrook, two competing factions of stockholders of EMAK Worldwide, Inc. (“EMAK”) launched consent solicitations for control of EMAK. A few days prior to the consent solicitation deadline, Donald Kurz, a stockholder and director of EMAK, was informed that his faction’s consent solicitation needed an additional 116,325 votes to pass. Kurz subsequently contacted a former employee and current stockholder of EMAK. After negotiations, Kurz agreed to purchase 150,000 shares of EMAK stock from the former employee, and Kurz then voted his newly-acquired shares of EMAK stock in favor of his faction’s consent solicitation.

The defendants argued that Kurz engaged in illegal vote buying by purchasing the swing votes in the final days of the consent solicitation. In reviewing the facts, the Court noted that the transaction did not involve corporate funds, and was so-called “third party vote buying,” which was an undeveloped area of Delaware law. The Court pointed out that where voting rights are manipulated, including the decoupling of economic interests from voting rights, such actions could prove improper if such practices proved deleterious to stockholder voting. Further, the Court identified several broad concepts that would govern its analysis in cases of “third party vote buying,” including (i) whether the practices were actually disenfranchising, (ii) whether the arrangement was the product of fraud or the disparity of information, and (iii) whether the transaction created a misalignment of the voting interest and the economic interest of the shares.

Because the EMAK stock purchased by Kurz in the final days of the consent solicitation constituted the “swing votes,” the Court held that the transaction was potentially disenfranchising and should be subject to the vote buying analysis. However, the Court found no evidence of fraud, that the seller must have been aware of the purpose of the transaction and its significance to the consent solicitation, and that Kurz had assumed the economic risks of ownership and that he did not have any competing economic or personal interests that might create an overall negative economic ownership in EMAK. Accordingly, the Court concluded that Kurz did not engage in improper vote buying and that his faction’s consents validly effected corporate action. top

SEC Issues Statement on Global Accounting Standards and Publishes a Work Plan to Study Potential Adoption of IFRS for U.S. Issuers
On February 24, the Securities and Exchange Commission published a statement (the “Statement”) outlining its position with respect to global accounting standards and supporting the move towards a single set of high-quality global accounting standards, although no decision has been made yet to make the change to any such standard. The SEC reaffirms in the Statement that it continues to support “the convergence of U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards (“IFRS”) in order to narrow the differences between the two sets of standards.” In her remarks at the SEC open meeting on February 24, SEC Chair, Mary Schapiro, stressed the need for careful consideration and deliberation regarding the incorporation of IFRS into the U.S. financial reporting system and, in the event of a change, the need for adequate transition time to comply with the new standards.

The Statement directs the SEC staff to develop and carry out a Work Plan, which outlines specific areas and factors for the staff to analyze before considering a transition from the current U.S. financial reporting system to a system incorporating IFRS. The staff’s Work Plan is intended to address many of the issues highlighted by commenters on the “Proposed Roadmap,” a series of milestones proposed by the SEC in November 2008, to guide the SEC in determining whether to transition U.S. capital markets to IFRS. In addition, the Statement contemplates that the Financial Accounting Standards Board and the International Accounting Standards Board will continue and intensify their efforts towards improving and converging their respective accounting standards.

In accordance with the Statement, the SEC staff is required to provide public progress reports on the Work Plan, beginning no later than October 2010. The SEC anticipates determining whether to proceed with a transition to IFRS by 2011.

In response to comments received on the Proposed Roadmap indicating that U.S. issuers would need approximately four to five years to transition their financial reporting systems to incorporate IFRS, the SEC indicated in the Statement that it anticipated that the first time U.S. issuers would report under any new system would be no earlier than 2015. The precise transition period will be determined at a later date. top

Contributors to this issue are Greg Matlock, Jerod Neas, Mara Rogers, Jack Taylor and Alexis Thomason.