Persons receiving inside information may be liable for securities fraud even if they are not corporate insiders and owe no direct duty to the source of the information. This theory of liability is known as the misappropriation theory, and its application to individuals who receive material, nonpublic information (commonly referred to as “tippees”) was recently ad-dressed by the Second Circuit.

In SEC v. Obus, the Second Circuit broadly interpreted the standard for tip-per and tippee liability in Section 10(b) and Rule 10b-5 insider trading actions brought under the misappropriation theory, ruling that a tippee may be liable for insider trading violations if he knew, or should have known, that the tipper breached a duty to his employer in dis-closing the information. SEC v. Obus, 693 F.3d 276 (2d. Cir. Sept. 6, 2012). In so ruling, the Second Circuit reasoned that the misappropriation theory targets persons who are not corporate insiders but who have received material nonpublic information in confidence, and who breach a duty to the source of the information to gain personal profit.

While liability will attach only if someone knows, or should have known, that the tipper is breaching a fiduciary duty, the Obus case indicates that knowledge of a breach may be inferred by circumstantial evidence. Further, the Second Circuit’s opinion suggests that sophisticated tip-pees may be presumed to know that a tipper has breached a fiduciary duty as a result of the tipper’s disclosure of information.

On September 25, 2012, the Supreme Court granted certiorari in SEC v. Gabelli, 653 F.3d 49 (2d Cir. Aug. 1, 2011), to consider when the statute of limitations period begins to run in SEC civil actions brought under federal securities laws. Although there is no express statute of limitations for SEC civil actions, numerous courts have held, and the SEC has acknowledged, that a five-year statute of limitations applies to SEC enforcement actions. Unanswered, however, is the point in time at which the SEC‘s claim first arises.

The Fifth Circuit, for instance, recently rejected the SEC’s claim that the clock began when the claim was discovered, and concluded that because the “plain language” of the statute contains no reference to the discovery rule, the SEC’s claim for civil penalties accrued at the time of the defendants’ alleged violations and not upon discovery of the violation. SEC v. Bartek, No. 11-10594 (5th Cir. Aug. 7, 2012).

In Gabelli, the SEC claimed that a registered investment adviser permitted a favored client to engage in a form of market timing called “scalping” from 1999 until 2002. The District Court for the Southern District of New York granted Gabelli’s motion to dismiss, however, holding that SEC’s claims were time-barred by the statute of limitations. The Second Circuit reversed the District Court. The Supreme Court’s decision in this case is expected before the end of June 2013.

Until now, FINRA arbitration has been available for investor or industry complaints involving securities firms and broker-dealers or their associated persons, but the President of FINRA’s Office of Dispute Resolution, Linda Fienberg, recently disclosed that FINRA will be opening its arbitration system to claims involving Registered Investment Advisers. She noted that the already have a few Investment Adviser cases in FINRA’s system. Feinberg said that this change is not related to FINRA’s effort to become a self-regulatory organization for Investment Advisers. Most observers are skeptical about her pronouncement.

On August 8, 2012, the Second Circuit of the Court of Appeals issued a decision in SEC v. Apuzzo, where the Court clarified the pleading standard for alleging aiding and abetting securities fraud claims in SEC enforcement actions. The Second Circuit made it easier for the SEC to establish aiding and abetting liability under Section 20(e) of the Securities Exchange Act. The Court held that to satisfy the “substantial assistance” element of an aiding and abetting claim, the SEC only has to allege that the defendant associated himself with a fraudulent scheme in some way and knowingly participated in the scheme. This decision reversed the trial court’s ruling that proximate causation of the ultimate harm was required to establish substantial assistance.

The district court had ruled that the SEC’s allegations established a “ ‘but for’ causal relationship” between the defendant’s conduct and the violation, but not the proximate causation that the Court held was required to prove the substantial assistance element of an aiding and abetting claim. The district court, however, acknowledged that the SEC’s allegations established that the defendant had knowingly participated in the fraudulent scheme, but the Court found that “mere awareness and approval” to be insufficient to demonstrate that the defendant proximately caused any harm. The Second Circuit, nonetheless, found that this very awareness and approval fit squarely within the scope of conduct that aiding and abetting claims are designed to capture.

On February 24, 2012, the CFTC issued final rules amending Part 4 of its regulations to rescind the exemption from CPO registration for persons offering certain qualifying pools under CFTC Reg. §4.13(a)(4). Persons that operate a pool(s) pursuant to a 4.13(a)(4) exemption may continue to do so until December 31, 2012. After that date, in order to continue operating the pool, the person operating the pool must either be registered as a CPO and as an NFA Member or qualify for exemption from registration under CFTC 4.13(a)(3). A person operating a 4.13(a)(4) pool that does not qualify for an exemption under 4.13(a)(3) may, after registering as a CPO, be able to obtain relief from certain regulatory requirements for the pool if the pool qualifies for an exemption under CFTC Reg. §4.7, §4.12 or CFTC Advisory 18-96.

To assist persons currently operating a pool under a §4.13(a)(4) exemption that will qualify for an exemption under CFTC Reg. §4.7, §4.12 or CFTC Advisory 18-96, the NFA is modifying its Electronic Exemption System to permit these persons to pre-file for the applicable exemption, with an effective date of January 1, 2013. By choosing the pre-filing option, the operator will not become subject to the additional reporting and disclosure requirements related to the newly claimed exemption until 2013.

All exemptions other than an exemption under CFTC Advisory 18-96 must be filed through NFA’s Electronic Exemption System at http://www.nfa.futures.org/NFA-electronic-filings/exemptions.HTML. An exemption under CFTC Advisory 18-96 must be filed in hard copy form with the NFA’s Compliance Department and it must indicate that the filer is pre-filing for a January 1, 2013 effective date.

Ruling May Result in More Expungement Cases

On August 23, 2012, a California appellate court issued a ruling that could make it easier for brokers to have customer complaints and disciplinary actions expunged from their records. The California Court of Appeal for the First Appellate District in San Francisco ruled that brokers may have their records expunged under a principle of basic fairness or equity. This ruling flies in the face of FINRA’s efforts to provide more and more information to the public about brokers on BrokerCheck. Indeed, in August 2010, FINRA began disclosing all complaints, regardless of age. Before then, unproven allegations were not disclosed after two years. Under Dodd-Frank, FINRA is considering disclosing exam scores, broker termination information, and more historical data on the BrokerCheck system.

This issue is far from being resolved. The appellate court remanded the plaintiff’s case to the trial court for an additional hearing. Moreover, the SEC’s jurisdiction is at stake. It must approve all of FINRA’s rules. The SEC will not stand by while a California court tries to preempt its authority.

The SEC recently approved FINRA Rule 5123, which will become effective on December 3, 2012, to require each FINRA member firm that sells an issuer’s securities in a private placement, subject to certain exemptions, to file a copy of any private placement memorandum, term sheet or other offering document the firm used with FINRA within 15 calendar days of the date of the sale, or indicate that it did not use any offering documents. Member Firms must file the offering documents electronically with FINRA through Gateway. The rule applies prospectively to private placements that begin selling efforts on or after that date. Member Firms must submit filings regarding their own private offerings (MPOs), as required by FINRA Rule 5122 (Private Placements of Securities Issued By Members), through Gateway.

As of October 1, 2012, FCMs that are regulated by a U.S. prudential regulator or that are registered in some capacity with the SEC must have a designated Chief Compliance Officer (“CCO”) under CFTC Reg. §3.3, and that person must be a listed as a principal of the firm. Those FCMs will have to file a CCO Annual Report as of the date of the firm’s first fiscal year end after October 1, 2012.

Designating a Chief Compliance Officer

If the designated CCO is not a listed as a principal of the FCM currently, the FCM must file a Form 8-R for that individual, along with a set of fingerprint cards, and the CCO must verify the accuracy of the Form 8-R.

The FCM must also update its Form 7-R by filling-in the CCO’s Contact Information. The Form 7-R must be updated to include information for a new CCO principal and for a CCO who is already listed as a principal of the firm.

All forms must be completed through NFA’s Online Registration System, which may be accessed at http://www.nfa.futures.org/NFA-electronic-filings/ORS.HTML.

Annual Report

The FCM’s CCO must prepare an annual report under CFTC Reg. §3.3(e). The first Annual Report must be prepared as of the date of the FCM’s fiscal year end and it must cover the period from October 1, 2012 through the date of the fiscal year end. The Annual Report must be submitted electronically to the CFTC through the WinjammerTM system not more than 90 days after the end of the FCM’s fiscal year. In order to file the annual report through the WinjammerTM system, the FCM must create a “Regulation Notice” in the filing index section of WinjammerTM as of the date of the report and then select the CCO Report filing type. After selecting the appropriate notice, the FCM must upload a PDF of the report.

CCO Requirement for other FCMs and other NFA Members

All other FCMs (i.e., FCMs that are not currently regulated by a U.S. prudential regulator or that are not also registered in some capacity with the SEC must comply with the CFTC’s CCO requirements by March 29, 2013. IB, CPO and CTA Members are not required to have a CCO. However, if the firm appoints a person to be a CCO, then the FCM must list that person as a principal of the firm.

Section 16 of the NFA’s Financial Requirements requires FCMs to submit certain financial information to the NFA on a monthly, semi-monthly and daily basis. This financial information will be made available on NFA’s website to help the public evaluate FCMs through its BASIC system. The NFA is adding new sections to each FCM’s BASIC page to disclose this information. The public will be able to review three FCM Reports: (1) Capital Report; (2) Customer Segregated Funds Report; and (3) Customer Secured Funds Report.

Capital Report (Updated Monthly)

The Capital Report will show an FCM’s most recent month’s adjusted net capital; required net capital; and excess net capital. The same information for the previous 12 months will be available as well.

Customer Segregated Funds Report (Updated Semi-Monthly)

The Customer Segregated Funds Report will show: (a) total funds held in an FCM’s segregated accounts; (b) total funds required to be held in the FCM’s segregated accounts; and (c) the FCM’s excess segregated funds.

This report will also show the percentage of segregated funds that are held in cash and each of the permitted investment categories under CFTC Reg. §1.25. The report will note whether the FCM held any funds at a depository that is an affiliate of the FCM during that month. The report will show the most recent semi-monthly information as well as the information for the previous 12 months.

Customer Secured Amount Funds Report (Updated Semi-Monthly)

This report is the same as the Customer Segregated Funds Report except that it will report the information with respect to customer secured amount funds. NFA plans to add the FCM Financial Reports to each FCM’s BASIC page by November 1, 2012. (The semi-monthly information will be updated shortly after the filing of the required semi-monthly financial information and the monthly information will be updated shortly after the filing of the required monthly financial information.)

FCMs that do not hold customer segregated or customer secured amount funds are not required to file any information with NFA. The FCM’s capital information will be extracted from the firm’s monthly Form 1-FR or FOCUS Report for the FCM’s Capital Report.

The CFTC codified Part 165 of its Regulations to implement its Whistleblower Program.  CFTC Reg. 165.19 states that pre-dispute arbitration agreements will not require a party to arbitrate a whistleblower claim. NFA Members that have entered into pre-dispute arbitration agreements with their employees should make sure they exclude whistleblower claims arising under Part 165 of the CFTC’s Rules.  Members should be aware that although NFA’s Member Arbitration Rules provide that disputes between Members and Associates must be arbitrated at the election of the person filing the claim, NFA will not honor any pre-dispute arbitration agreement that requires an Associate to arbitrate a claim that arises under the Whistleblower Rules.  Under Section 2(b) of the Member Rules, however, a Member must arbitrate a whistleblower dispute if the Associate voluntarily elects to file the claim against the Member firm in NFA Arbitration.

The SEC will not be adopting an interim rule at this time that would allow issuers of private securities, like hedge funds, to begin making solicitations to the public.  Rather, the SEC will issue a proposed rule with a public comment period, according to SEC spokesman John Nester.  Mr. Nester said that SEC Chairman Mary Schapiro “believes it is important for the general solicitation rule to be proposed for public comment, as is our typical practice in rulemaking”.   The SEC is scheduled to meet late this month to consider the rule, which would permit the general solicitation for private securities issued under SEC Rule 506 of Reg. D.  The Jumpstart Our Business Startups Act will require the adoption of a rule to allow this.  State regulators, consumer groups and unions urged the SEC to delay passage of a rule that would have allowed hedge funds to solicit the public to invest in private securities immediately.  Republicans in Congress and President Obama have urged the SEC to remove the current prohibition as soon as possible. Rule 506 is used frequently as an exemption from securities registration that allows issuers to raise unlimited amounts of money from accredited investors. Currently, the general solicitation or advertising of private offerings is prohibited.  State regulators claim that additional protections are required, such as more stringent verification mechanisms to make sure only accredited investors purchase private securities.