-------------------- BEGINNING OF PAGE #1 ------------------- SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 228, 229, 230, 239, 240, and 274 [Release Nos. 33-7106; 34-34923; IC-20670; File No. S7-31-94] RIN 3235-AE14 Disclosure Concerning Legal Proceedings Involving Management, Promoters, Control Persons and Others AGENCY: Securities and Exchange Commission. ACTION: Proposed Rulemaking. SUMMARY: The Commission is publishing for comment amendments that would expand the types of legal proceedings required to be disclosed in Commission filings, add such disclosure to certain investment company filings, and increase to 10 years the reporting period for such legal proceedings disclosure. DATES: Comments must be submitted on or before [date to be inserted 60 days after publication in the Federal Register]. ADDRESSES: Comments should be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-6009. Comment letters should refer to File No. S7-31-94. All comments received will be available for public inspection and copying in the Commission's Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549-6009. FOR FURTHER INFORMATION CONTACT: James R. Budge, Office of Disclosure Policy, (202) 942-2910, Division of Corporation Finance (Mail Stop 3-12); with regard to investment company issues, Kathleen K. Clarke, Office of Disclosure and Investment Adviser Regulation, (202) 942-0721, Division of Investment Management (Mail Stop 10-6), Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-6009. SUPPLEMENTARY INFORMATION: The Commission today is publishing for comment proposed amendments to paragraphs (f) and (g) of Item 401 -[1]- of Regulation S-K -[2]- and paragraph (d) of Item 401 -[3]- of Regulation S-B -[4]- under the Securities Act of 1933 ("Securities Act") -[5]- and the Securities Exchange Act of 1934 ("Exchange Act"). -[6]- The Commission also proposes to conform legal proceedings disclosure items in Form 1-A -[7]- under the Securities Act, and Schedules 13D, -[8]- 13E-3, -[9]- -[1]- 17 CFR 229.401(f) and (g). -[2]- 17 CFR Part 229. -[3]- 17 CFR 228.401(d). -[4]- 17 CFR Part 228. -[5]- 15 U.S.C. 77a et seq. -[6]- 15 U.S.C. 78a et seq. -[7]- 17 CFR 239.90. -[8]- 17 CFR 240.13d-101. -------------------- BEGINNING OF PAGE #2 ------------------- 14A -[10]- and 14D-1 -[11]- under the Exchange Act. The Commission also is proposing to add legal proceedings disclosure requirements to various forms used by registered investment companies under the Securities Act or the Investment Company Act of 1940 ("Investment Company Act"), -[12]- including Forms N-1A, -[13]- N-2, -[14]- N-3, -[15]- N-4, -[16]- N-5, -[17]- N-8B-2, -[18]- N-8B-3 -[19]- and N-8B-4. -[20]- I. EXECUTIVE SUMMARY The Commission's current regulations require disclosure of legal proceedings -[21]- involving executive officers, directors, persons nominated to become directors, promoters, significant shareholders, participants in proxy contests, and other specified persons ("designated persons"). -[22]- The principal provisions -[9]-(...continued) -[9]- 17 CFR 240.13e-100. -[10]- 17 CFR 240.14a-101. -[11]- 17 CFR 240.14d-100. -[12]- 15 U.S.C. 80a-1 et seq. As discussed in Section IV, below, investment companies currently are specifically required to disclose legal proceedings only in proxy statements related to the election of directors and not in registration statements or other disclosure documents. -[13]- 17 CFR 274.11A. -[14]- 17 CFR 274.11a-1. -[15]- 17 CFR 274.11b. -[16]- 17 CFR 274.11c. -[17]- 17 CFR 274.5. -[18]- 17 CFR 274.12. -[19]- 17 CFR 274.13. -[20]- 17 CFR 274.14. -[21]- The term "legal proceeding," as used in this release and in current Item 401, includes criminal convictions, as well as findings, orders or sanctions in civil and administrative actions, that have not been reversed, suspended or vacated. It also includes criminal actions pending at the time a disclosure document is filed, and the initiation of bankruptcy or similar proceedings. With respect to proposed Item 401, the term also encompasses sanctions issued by securities and commodities self-regulatory organizations that have not been reversed or otherwise rendered of no effect. -[22]- As used in this release, "designated person" includes the persons identified in the following disclosure provisions, forms and schedules: S-K Item 401(f) and (g) and S-B Item 401(d) -- executive officers, directors, persons nominated to become directors, as well as promoters and control persons of newly public (continued...) -------------------- BEGINNING OF PAGE #3 ------------------- are found in Items 401(f) and (g) of Regulation S-K and Item 401(d) of Regulation S-B, -[23]- but a number of forms and schedules require similar disclosure, as discussed below. -[24]- A review of current requirements has raised questions about the adequacy of the five-year period for reporting such proceedings. In light of these questions, as well as the enactment of the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 ("Remedies Act"), -[25]- the Commission proposes to expand -[22]-(...continued) companies; Schedules 13D, 13E-3, and 14D-1 -- the person filing the schedule. In addition, if the filer is a general or limited partnership, syndicate or other group -- the individual general partners of general or limited partnerships, each member of such syndicate or group and each person controlling such partner or member; if such general partner, member or person controlling such partner or member is a corporation, or if the filer is a corporation -- the corporation's directors and executive officers, persons controlling such corporation, and directors and executive officers of any corporation ultimately in control of such corporation; Proxy statements relating to election contests -- any participant in an election contest, as defined by Instruction 3 to Item 4 of Schedule 14A (in addition to the Item 401 disclosure generally required in a proxy statement involving an election of directors, contested or otherwise); Regulation A Offering Circular (Model B) -- executive officers, directors and persons nominated to become directors; Prospectuses Relating to Oil and Gas Programs (Securities Act Industry Guide 4) -- management and operating companies (in addition to the disclosure required by the appropriate registration form); Registration Statements Relating to Interests in Real Estate Limited Partnerships (Securities Act Industry Guide 5) -- the persons making investment decisions (in addition to the disclosure required by the appropriate registration form). -[23]- In order to simplify references to the legal proceedings disclosure requirements, references to Item 401(f) or 401(g) hereafter should be read to include the comparable provisions in Regulation S-B Item 401(d). -[24]- In addition to provisions requiring disclosure of legal proceedings involving designated persons, Regulation S-K Item 103 [17 CFR 229.103] requires disclosure of material pending legal proceedings involving the registrant. -[25]- Pub. L. No. 101-429, 104 Stat. 931 (1990). The Remedies Act amended the federal securities laws to provide for: civil money penalties in civil actions for violations of the federal securities laws; Commission authority to issue cease-and-desist orders; court enforcement of cease-and-desist orders and imposition of civil money penalties for failure to comply; affirmation of power of federal courts to order officer and director bars and suspensions; and civil money penalties, disgorgement, and orders of accounting (continued...) -------------------- BEGINNING OF PAGE #4 ------------------- the disclosure provisions and the time frame of the current requirements and to eliminate the differences in requirements among various forms. The amendments proposed today would consolidate and clarify existing legal proceedings disclosure provisions, as well as add requirements to disclose the following: Federal and state agency receivership appointments involving a designated person, any partnership in which such person was a general partner, and any corporation in which such person served as an executive officer; -[26]- All judicial and administrative findings, orders and sanctions based on alleged violations of federal or state securities, commodities, banking and insurance laws and regulations; -[27]- Civil and administrative proceedings resulting from a designated person's involvement in mail fraud, wire fraud, and fraud in connection with activities related to a business entity; -[28]- Civil and administrative actions relating to a designated person's breach of a fiduciary duty owed to a corporation, partnership, business trust or similar entity; -[29]- Administrative orders restricting a designated person's business practices; -[30]- -[25]-(...continued) in Commission administrative proceedings. Congress granted these new judicial and administrative remedies to increase both the Commission's ability to deter those who violate the securities laws and its flexibility to adapt remedies to the varying circumstances of particular conduct and violators. -[26]- Current requirements limit disclosure to court-appointed receiverships. -[27]- Existing provisions require disclosure of court orders restricting certain business activities subject to federal or state securities, commodities, banking and insurance laws, administrative restrictions on such activities that exceed 60 days, and court limitations on any business practice. Disclosure also is required of judicial and administrative findings of violations of federal or state securities or commodities laws. -[28]- Disclosure of fraud-related legal proceedings currently is limited to criminal fraud actions and to the types of proceedings listed in n.27, above, that involve fraud. -[29]- Disclosure currently is required if the breach of fiduciary duty resulted in one of the restrictions identified in n.27, above. -[30]- Administrative restrictions on business practices currently must fall within one of the categories (continued...) -------------------- BEGINNING OF PAGE #5 ------------------- Disciplinary sanctions imposed against a designated person by securities and commodities self-regulatory organizations ("SROs"); and Comparable foreign legal proceedings. -[31]- Disclosure would be required for 10 years following the specified event, expanding the current five-year provision. The proposals would rescind the general provisions that currently permit disclosure to be omitted if the registrant believed that the information would be neither material to investors in evaluating the ability and integrity of management, nor to a voting or investment decision; provisions relating to bankruptcy or insolvency proceedings, however, would retain the materiality language. In addition, the provision limiting disclosure to administrative orders that restrict activities for periods of more than 60 days would be deleted. -[32]- The proposals also conform the requirements in various forms and schedules under the Securities Act and the Exchange Act. Finally, the Commission is proposing to add legal proceedings disclosure to investment company registration statement forms. II. BACKGROUND OF LEGAL PROCEEDINGS REQUIREMENTS Disclosure of information regarding legal proceedings involving directors, executive officers, control persons, promoters and others has been required in various filings under the federal securities laws for many years. In 1956, the Commission adopted the current provisions requiring participants in proxy contests involving the election or removal of directors to disclose criminal convictions (other than traffic violations or similar misdemeanors) that occurred within the past 10 years. -[33]- Since their adoption in 1968, large shareholder beneficial -[30]-(...continued) identified in n.27, above, before disclosure is required. -[31]- Current provisions do not distinguish between criminal and civil proceedings brought within the United States and those pursued in foreign jurisdictions. The proposals would make it clear that disclosure is required of any foreign criminal or civil proceeding if its domestic counterpart would be required to be disclosed and would add provisions requiring disclosure of foreign administrative and bankruptcy actions. -[32]- The provisions of paragraphs (f) and (g) of Regulation S-K Item 401 would be consolidated into a single paragraph (f). -[33]- Release No. 34-5276 (January 17, 1956) [21 FR 577]. This originally was adopted as a provision of Schedule 14B, and a summary of this information was required to be furnished in election contest proxy statements. In October 1992, the Commission eliminated the Schedule 14B filing requirement and moved the legal proceedings disclosure provision from that Schedule into Item 5(b)(1)(iii) of Schedule 14A. See Release No. 34- 31326 (October 16, 1992) [57 FR 48276]. That provision currently requires disclosure of any criminal conviction of a "participant" in the election contest that has occurred in the last 10 years. -------------------- BEGINNING OF PAGE #6 ------------------- ownership reports -[34]- also have required disclosure of criminal convictions with respect to the person or persons filing the report. -[35]- More than 20 years ago, the Commission began requiring disclosure of legal proceedings involving directors in registration statements and annual reports filed under the Exchange Act. -[36]- In 1970, Exchange Act registration statements -[37]- and annual reports -[38]- were amended to require disclosure of the initiation of bankruptcy or other insolvency proceedings, court appointments of receivers, criminal convictions and pending criminal actions if these actions involved a director of the registrant and were material to an evaluation of the director's ability and integrity. Disclosure also was required if a court restricted activities involving the purchase or sale of securities or certain activities in the securities, commodities, banking and insurance industries. -[39]- In the administrative context, disclosure of similar restrictions was required if a suspension or bar exceeded 60 days. Disclosure was required if the action was taken within the past 10 years. In 1973, the legal proceedings disclosure provisions were expanded to include executive officers. -[40]- Comparable requirements were added at that time to the general form for registration under the Securities Act -[41]- and the registration -[34]- Schedule 13D. Release No. 34-8370 (July 30, 1968) [33 FR 11015]. -[35]- The ten year disclosure requirement originally found in the Schedule 13D was revised to a five year requirement in 1977. Release No. 33-5808 (February 24, 1977) [42 FR 12342]. -[36]- In March 1969, the Commission's Disclosure Policy Study recommended increased disclosure of legal proceedings involving management in Securities Act registration statements and Exchange Act registration statements, proxy statements and annual reports. Disclosure to Investors: A Reappraisal of Administrative Policies under the '33 Act and '34 Act, Report and recommendations to the Securities and Exchange Commission from the Disclosure Policy Study, March 1969, pp. 93-95. -[37]- Form 10, 17 CFR 249.210, Release No. 34-8996 (October 14, 1970) [35 FR 16537]. -[38]- Form 10-K, 17 CFR 249.310, Release No. 34-9000 (October 21, 1970) [35 FR 16919]. -[39]- Specifically, disclosure was required if the director had been restricted from acting as an investment adviser, underwriter, broker or dealer in securities, or as an affiliated person, director or employee of any investment company, bank, savings and loan association or insurance company. Disclosure also was required if the court imposed any other restriction on activities associated with the position. -[40]- Release No. 33-5395 (June 1, 1973) [38 FR 17202]. -[41]- Form S-1 [17 CFR 239.11]. At the same time, prospectuses relating to interests in oil and gas (continued...) -------------------- BEGINNING OF PAGE #7 ------------------- form used for certain development stage companies. -[42]- In July 1978, the legal proceedings disclosure requirements for Securities Act registration statements, as well as those in the Exchange Act registration statement and annual report, were consolidated into Regulation S-K, and the individual provisions were replaced with references to the Regulation S-K Item. -[43]- The disclosure requirements also were extended to real estate company registration statements and proxy and information statements. -[44]- The disclosure requirements were expanded at -[41]-(...continued) programs also were required to include disclosure of legal proceedings involving management and operating companies, because the Industry Guide applicable to such programs contained a provision requiring disclosure of the background information called for by Form S-1 with respect to those persons. See Release No. 33-5036 (January 19, 1970) [35 FR 1233], adopting Guide 55, subsequently redesignated Guide 4 [17 CFR 229.801(d)]. In 1976, through the operation of a newly adopted Securities Act Industry Guide for registration statements relating to interests in real estate limited partnerships, comparable disclosure was required in such registration statements respecting individuals responsible for a partnership's investment decisions. See Release No. 33-5692 (March 17, 1976) [41 FR 17403], adopting Guide 60, subsequently redesignated Guide 5 [17 CFR 229.801(e)]. -[42]- In 1973, the then Form S-2 was used for development stage companies (other than insurance, investment or mining companies) that had not had any substantial gross returns from the sale of products or services, or any substantial net income from any source, for any fiscal year ended during the past five years, had not succeeded to any business that had such returns or net income, and did not have any subsidiaries (other than inactive subsidiaries with no more than nominal assets). -[43]- Regulation S-K Item 401 [17 CFR 229.401]; Release No. 33-5949 (July 28, 1978) [43 FR 34402]. The disclosure requirements originally were included in Regulation S-K Item 3 (Directors and executive officers), subsequently redesignated Item 401. Release No. 33-6383 (March 3, 1982) [47 FR 11380]. -[44]- Provisions requiring the disclosure called for by Regulation S-K Item 401 were added to Form S-11 (for registration of securities of real estate companies) [17 CFR 239.18] and the proxy statement requirements in Schedule 14A. This new provision did not replace the requirement to disclose criminal proceedings involving participants in an election contest, discussed above in n.33, but rather, was included as an additional requirement. The amended proxy statement requirements also applied to information statements prepared in accordance with Schedule 14C [17 CFR 240.14c-101] of the Exchange Act, which incorporates many of the proxy statement requirements, and to proxy statements under Rule 20a-1 of the Investment (continued...) -------------------- BEGINNING OF PAGE #8 ------------------- that time to include information relating to persons nominated to become directors and to require disclosure of court orders imposing restrictions on any business practice, as well as injunctions prohibiting future violations of federal or state securities laws. -[45]- Disclosure of findings of securities law violations by a court or by the Commission also was added. Finally, the time period for the disclosure was reduced from 10 to five years from the time the action was taken. -[46]- Substantive revisions to the legal proceedings disclosure -[44]-(...continued) Company Act [17 CFR 270.20a-1], which makes the Schedule 14A disclosure requirements applicable to investment companies. -[45]- Section 3(a)(47) of the Exchange Act [15 U.S.C. 78c(a)(47)] defines "federal securities laws" to mean the Securities Act, the Exchange Act, the Public Utility Holding Company Act of 1935 [15 U.S.C. 79a et seq.], the Trust Indenture Act of 1939 [15 U.S.C. 77aaa et seq.], the Investment Company Act, the Investment Advisers Act of 1940 ("Investment Advisers Act") [15 U.S.C. 80b-1 et seq.], and the Securities Investor Protection Act of 1970 [15 U.S.C. 78aaa et seq.]. -[46]- Subsequent to these changes, the Commission incorporated the Item 401(f) requirements into other disclosure documents. In April 1980, the Commission amended Form S-8 (17 CFR 239.16b), for securities issued pursuant to employee benefit plans, to require the incorporation by reference of the issuer's latest Exchange Act annual report, including its legal proceedings disclosure, into the registration statement. Release No. 33-6202 (April 2, 1980) [45 FR 23653]. In March 1982, Securities Act Industry Guides 4 and 5 were amended to require the information specified in Regulation S-K Item 401, replacing the reference to the requirements of Form S-1. Release No. 33-6384 (March 3, 1982) [47 FR 11476]. See n.41, above, and current Item 11 of Guide 4 and Item 9.A. of Guide 5. At that time, the Commission also adopted current Form S-2 [17 CFR 239.12], for registration under the Securities Act of securities of certain issuers, and Form S-3 [17 CFR 239.13], for registration under the Securities Act of securities of certain issuers offered pursuant to certain types of transactions. Release No. 33-6383 (March 3, 1982) [47 FR 11380]. These forms incorporate by reference information required in the Form 10-K, including the legal proceedings disclosure. In the same year, the Commission adopted Form S-18 [17 CFR 239.28] (optional registration form for small issuers) Release No. 33-6406 (June 4, 1982) [47 FR 25126] and Form S-20 [17 CFR 239.20] (optional registration form for standardized options), Release No. 33-6426 (September 16, 1982) [47 FR 41950]. Both forms required disclosure of the legal proceedings specified in Regulation S-K Item 401. Form S-18 was rescinded in connection with the small business initiatives in 1992. Release No. 33-6949 (July 30, 1992) [57 FR 36442]. For information relating to the adoption of Form S-4 [17 CFR 239.25], see n.49, below. -------------------- BEGINNING OF PAGE #9 ------------------- requirements were made most recently in 1984. -[47]- The amendments required disclosure of legal proceedings involving federal commodities laws -[48]- and applied the disclosure requirements to promoters and control persons of newly public companies. -[49]- In 1992, the Commission adopted Regulation S-B as part of its small business initiatives, which included an Item 401(d), governing legal proceedings disclosure, patterned on the requirements of Item 401(f) and (g) of Regulation S-K. -[50]- This disclosure is required in connection with Securities Act registration statements on Form SB-2, -[51]- Exchange Act registration statements on Form 10-SB, -[52]- and Exchange Act annual reports filed by small businesses. -[53]- Other disclosure documents include legal proceedings disclosure requirements separate from those found in Regulation S-K or Regulation S-B. Schedule 14D-1, -[54]- the tender offer schedule adopted in 1977, -[55]- requires disclosure if during the last five years the person filing the schedule was convicted -[47]- Release No. 33-6545 (August 9, 1984) [49 FR 32762]. -[48]- Specifically, Regulation S-K Item 401(f) was amended to require disclosure of judicial and administrative restrictions on activities regulated by the Commodity Futures Trading Commission ("CFTC"), as well as court restrictions on engaging in activities involving the purchase or sale of a commodity or the violation of federal commodities laws. A provision requiring disclosure of findings of federal commodities law violations by courts or the CFTC also was added. -[49]- The amendments added Item 401(g) [17 CFR 229.401(g)], which provided that registrants that have not been subject to the reporting requirements of Exchange Act Sections 13(a) [15 U.S.C. 78m(a)] or 15(d) [15 U.S.C. 78o(d)] for the 12 months immediately prior to the filing of the registration statement, report or other document to which Item 401 is applicable, are required to disclose the Item 401(f) information with regard to control persons if the event occurred within the past five years and was material to a voting or investment decision. In cases where such registrants were organized within the past five years, the Item 401(f) disclosure is to be included with respect to promoters as well. In April 1985, the Commission adopted Form S-4 (for registration of securities issued in business combination transactions), which requires disclosure of the Item 401 information. Release No. 33-6578 (April 23, 1985) [50 FR 18990]. -[50]- Release No. 33-6949 (July 30, 1992) [57 FR 36442]. -[51]- 17 CFR 239.10. -[52]- 17 CFR 249.210b. -[53]- Form 10-KSB [17 CFR 249.310b]. -[54]- 17 CFR 240.14d-100. -[55]- Release No. 33-5844 (July 21, 1977) [42 FR 38341]. -------------------- BEGINNING OF PAGE #10 ------------------- in a criminal proceeding (excluding traffic violations or similar misdemeanors), or was the subject of a judicial or administrative order that enjoined future violations of, or prohibited activities subject to, federal or state securities laws, or that included findings of violations of those laws. In 1978, Schedule 13D was amended to include legal proceedings disclosure provisions comparable to those included in Schedule 14D-1, -[56]- and when Schedule 13E-3, for going private transactions, -[57]- was adopted in 1979, the same disclosure was required. -[58]- Unlike the Regulation S-K Item 401(f) requirements, disclosure is required of the enumerated proceedings without regard to the filer's determination as to their materiality, and disclosure of administrative proceedings is not limited to suspensions or bars exceeding 60 days. The offering circular furnished to investors at or prior to the offer or sale of securities made in reliance upon an exemption under Regulation A was amended in 1981 to require legal proceedings disclosure. -[59]- Issuers are required to disclose in the circular criminal convictions, the initiation of bankruptcy or other insolvency proceedings, and appointments of receivers if those actions involved any director, person nominated to become a director or executive officer, if the information is material to an evaluation of the person's ability or integrity, and if the action was taken within the past five years. -[60]- III. PROPOSED AMENDMENTS The amendments proposed today would retain and clarify current legal proceedings disclosure requirements, expand the scope of existing provisions, and lengthen the time period for -[56]- Release No. 33-5925 (April 21, 1978) [43 FR 18484]. -[57]- 17 CFR 240.13e-100. -[58]- Release No. 33-6100 (August 2, 1979) [44 FR 46736]. -[59]- Release No. 33-6340 (August 7, 1981) [46 FR 41766]. This requirement currently is found in Offering Circular Model B, Part II of Form 1-A, the Regulation A Offering Statement [17 CFR 239.90]. On April 28, 1993, the Commission adopted Form SB-1 [17 CFR 239.9], an optional registration form for use by certain small businesses. See Release No. 33-6996 (April 28, 1993) [58 FR 26509]. Form SB-1 affords filers the option of providing the disclosure required by the Model B offering circular found in Form 1-A, including its legal proceedings disclosure requirements. -[60]- Issuers not subject to Exchange Act reporting obligations that sell securities pursuant to an exemption in accordance with Section 230.505 or Section 230.506 of Regulation D (governing the limited offer and sale of securities without registration under the Securities Act [17 CFR 230.501 - 230.508]) to a purchaser that is not an accredited investor must provide the disclosure, including legal proceedings information, required by Regulation A (if the issuer is eligible to rely on that exemption) or by the prospectus requirements of the registration statement the issuer is eligible to use. -------------------- BEGINNING OF PAGE #11 ------------------- which disclosure is required. With one exception, -[61]- the proposals also would delete the provisions permitting a registrant to omit disclosure where it concludes that the information would not be material to investors in evaluating the ability and integrity of management, -[62]- or would not be material to a voting or investment decision. -[63]- Consequently, under the proposals, like other line item disclosure requirements, information concerning legal proceedings would be required if specified by the item. -[64]- The proposed amendments would require disclosure of any identified legal proceeding unless it was subsequently reversed, suspended, vacated, annulled or otherwise rendered of no effect, -[65]- and would codify the current staff interpretation that disclosure is not required if a conviction is reversed. The proposals also would make it clear that disclosure is required while a legal proceeding is pending appeal. -[66]- Currently, it is the practice to disclose legal proceedings background information for each general partner of a partnership and each trustee of a real estate investment trust. A new -[61]- See discussion of bankruptcy and insolvency disclosure in Section III.A.1, below. -[62]- Current Item 401; current Item 8(d) of Part II, Offering Circular (Model B), Form 1-A. -[63]- Current Item 401(g)(1) and (2). The provisions of Item 401(g) requiring disclosure of legal proceedings involving promoters and control persons of newly public companies would be incorporated into proposed Item 401(f). See proposed Item 401(f)(2). -[64]- Current Instruction 2 to Item 401(f), which states that registrants may voluntarily advise the staff that the disclosure was not required based on a determination that it is not material to an investment or voting decision, would be inapplicable to most disclosure requirements. The substance of the instruction would be moved to a note to the bankruptcy provisions found in proposed Item 401(f)(1)(i). -[65]- See proposed Item 401(f)(1), representing a consolidation of similar provisions found in paragraphs (3), (4), (5) and (6) of current Item 401(f). Under current and proposed rules, an order or sanction need not be disclosed if it has been reversed or otherwise set aside on the basis of the underlying law or facts. However, a registrant must disclose a permanent injunction involving a designated person during the entire disclosure period even if equitable relief from the injunction has been granted before the close of such period. -[66]- Instruction 1 to Item 401(f) would be amended to indicate that disclosure of final convictions, orders, judgments, decrees or sanctions is required from the date of entry. If appealed, disclosure would continue to be required. If ultimately reversed, suspended, vacated, annulled or otherwise rendered of no effect, disclosure no longer would be required. Disclosure of preliminary orders, judgments, decrees and sanctions would be required from the date that any right to appeal the preliminary action expired. -------------------- BEGINNING OF PAGE #12 ------------------- instruction would be added to codify this practice and to expand the requirement to provide such disclosure with respect to trustees of any registrant that is a trust, as well as any other persons providing comparable services to such entities. Disclosure also would be required relating to any person who performs, either directly or indirectly, director or executive officer functions pursuant to a management contract, service contract, such as those used by asset-backed pools, or otherwise. -[67]- While specific requests for comment are made throughout with respect to the proposals discussed in detail below, commenters are requested to comment generally on the need for revision of the legal proceedings disclosure requirements. Is the approach proposed adequate to address investor concerns about the background of those who direct the affairs of public companies, or would some other method be more effective? A. Disclosure of Judicial and Administrative Proceedings 1. Bankruptcy and Insolvency Proceedings The current provision requiring disclosure of the court appointment of a receiver, fiscal agent or similar officer with respect to a business in which a designated person served as an executive officer would be expanded to include a similar appointment made by a federal or state agency. -[68]- For example, disclosure would be required where a state insurance commissioner appointed a conservator to take control of the business and assets of an insurance company for which a designated person had served as an executive officer within two years prior to such appointment. -[69]- Disclosure also would be required of the appointment by a bank regulatory authority of a receiver or conservator to operate, sell or liquidate a financial institution. -[70]- While in most instances the provisions allowing registrants -[67]- See proposed Instruction 5 to Item 401(f). -[68]- Proposed Item 401(f)(1)(i). -[69]- See, e.g., Ariz. Rev. Stat. Ann. 20-169 (authorizing the director of insurance to take possession of, or to appoint a conservator for, an insolvent insurance company); Texas Insurance Code Ann. 21.28A (authorizing the commissioner of insurance to undertake supervision of or to appoint a conservator for, an insolvent insurance company). -[70]- See, e.g., Section 203 of the Bank Conservation Act [12 U.S.C. 203] (authorizing the Comptroller of the Currency of the United States to appoint a conservator for a national bank), and Cal. Financial Code 8250 (authorizing the California Savings and Loan Commissioner to appoint a receiver for a savings and loan association). As used in this release, "financial institution" means any bank, bank holding company, savings association, or savings and loan holding company, as defined in Section 3 of the Federal Deposit Insurance Act [12 U.S.C. 1813], any federal or state credit union, as defined in Section 101 of the Federal Credit Union Act [12 U.S.C. 1752], or any system institution of the Farm Credit System, as defined in Section 5.35 of the Farm Credit Act of 1971 [12 U.S.C. 2271], or any substantially equivalent foreign institution. See proposed Instruction 3 of Item 401(f). -------------------- BEGINNING OF PAGE #13 ------------------- to omit disclosure of legal actions based on their materiality would be eliminated under the proposals, as discussed elsewhere in this release, -[71]- the Commission proposes to retain a provision permitting filers to weigh the materiality of bankruptcy and insolvency proceedings involving designated persons prior to disclosure. -[72]- Unlike the other legal proceedings to be disclosed under Item 401, bankruptcy proceedings include proceedings as to which the designated person's responsibility could vary considerably. Comment is solicited as to whether this materiality provision should be retained with respect to bankruptcy and insolvency proceedings, as proposed, or whether such actions should be disclosed without exception. The Commission also solicits commenters' views on whether the current provisions should be expanded to require disclosure where the designated person served as a director of a company within two years before the initiation of bankruptcy or insolvency proceedings or the appointment of a receiver or conservator with respect to that company. Currently, disclosure is required only if the person was an executive officer of the entity. Commenters should identify the reasons for or against such an expansion. Further, comment is sought as to whether the current provision requiring disclosure where the designated person served as an executive officer within two years of the identified bankruptcy or insolvency actions should be retained, as proposed, or whether the two-year time period should be shortened or lengthened, for example, to one year, or three or five years. Commenters also should address whether disclosure should be required where a designated person was an executive officer of a financial institution whose operation or sale is supervised by an administrative authority in the absence of the formal appointment of a receiver or conservator. -[73]- 2. Criminal Proceedings Like the current Item, the proposals would require disclosure where a designated person was convicted in a criminal proceeding or was the named subject of a pending criminal action (excluding traffic violations and other minor offenses). -[74]- However, the proposal clarifies that the Item requires disclosure of a criminal conviction resulting from a designated person's entry of a plea of nolo contendere. 3. Civil and Administrative Proceedings a. Money Penalty Consent Decrees and Other Orders or Sanctions Disclosure concerning civil and administrative proceedings involving designated persons now is limited to judicial orders restricting specified business activities, -[75]- administrative -[71]- See Section III.A, above, and Section III.E, below. -[72]- Proposed Item 401(f)(1)(i). -[73]- See, e.g., Tex. Rev. Civ. Stat. Ann. art. 342-801a (authorizing the Texas Banking Commissioner to supervise the activities of a bank) and N.Y. Banking Law 606 (authorizing the New York Superintendent of Banks to take possession of, operate or liquidate a banking organization). -[74]- Current Item 401(f)(2) and proposed Item 401(f)(1)(ii). -[75]- Current Item 401(f)(3). -------------------- BEGINNING OF PAGE #14 ------------------- orders restricting such activities for more than 60 days, -[76]- and judicial or administrative findings of securities or commodities law violations. -[77]- As proposed, any judicial or administrative finding, order or sanction relating to violations of federal and state securities and commodities laws and regulations, or laws and regulations respecting financial institutions or insurance companies, would trigger disclosure. -[78]- The exemption from disclosure of administrative proceedings that impose restrictions for periods of less than 60 days would be eliminated. Comment is solicited as to whether this exemption should be retained, but with a shorter time period, such as 20, 10 or five days. As a result of the proposed amendments, disclosure would be required of any order or sanction resulting from proceedings brought under the federal securities laws, including court-imposed civil money penalties and judicial orders temporarily barring an individual from serving as an officer or director of a public company, as authorized by the Remedies Act. -[79]- Disclosure of such orders or sanctions would be required, whether or not the court makes a finding that securities laws were violated. -[80]- Similarly, disclosure explicitly would be required of any judicial or administrative finding, order or sanction issued or imposed against the designated person under the enforcement provisions of the federal laws and regulations governing financial institutions, as amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), -[81]- -[76]- Current Item 401(f)(4). -[77]- Current Item 401(f)(5) and (6). -[78]- Proposed Item 401(f)(1)(iii)(A)(1) and (2). -[79]- See, e.g., Section 20(d) and 20(e) of the Securities Act [15 U.S.C. 77t(d) and (e)]. -[80]- While courts may issue orders upon a proper showing without finding securities law violations, all administrative orders issued by the Commission contain findings of a violation or violations of securities laws and regulations, even when the order is the result of a settlement agreement. Consequently, disclosure of all orders or sanctions issued by the Commission, such as cease-and-desist orders, pursuant to the enforcement provisions added by the Remedies Act would be required under both current and proposed provisions. -[81]- Pub. L. No. 101-73, 103 Stat. 183 (1989). FIRREA amended the enforcement provisions of the Federal Deposit Insurance Act ("FDIA") [12 U.S.C. 1811 et seq.], the Federal Reserve Act [12 U.S.C. 221 et seq.], the Home Owner's Loan Act of 1933 [12 U.S.C. 1461 et seq.], the Bank Holding Company Act of 1956 [12 U.S.C. 1841 et seq.], the Bank Holding Company Act Amendments of 1970 [12 U.S.C. 1971 et seq.], the Bank Protection Act of 1968 [12 U.S.C. 1881 et seq.], and the Federal Credit Union Act [12 U.S.C.A. 1751 et seq.]. The enforcement provisions relating to the Farm Credit Administration are found in the Farm Credit Act of 1971 [12 U.S.C. 2001 et seq.]. -------------------- BEGINNING OF PAGE #15 ------------------- as well as under similar state statutes and regulations. -[82]- For example, the proposed disclosure requirements would reach a civil money penalty imposed pursuant to a settlement agreement between a designated person and a bank regulator, where the final order neither included findings of violations of the law nor imposed any limitation on that person's acting in any capacity related to banks or savings and loan associations. b. Fraud In Connection with a Financial Institution, Insurance Company, or Other Business Entity The proposals would expand current provisions by requiring disclosure of legal proceedings involving alleged violations by a designated person of any law or regulation prohibiting fraud in connection with a financial institution, insurance company or other business entity. Disclosure of legal proceedings involving fraud currently is limited to criminal fraud proceedings, civil and administrative actions involving fraud in connection with violations of securities or commodities laws, and orders restricting the designated person from acting as a director, employee or affiliated person of a bank, savings and loan association or insurance company or from engaging in related activities based on that person's fraudulent conduct. Consequently, in addition to the actions for which disclosure is currently required, the proposals would require disclosure of a court order enjoining the designated person from knowingly defrauding a financial institution, whether or not the court imposed restrictions on the person's future business relationship with the institution. -[83]- Another example of required disclosure would be a court judgment against a designated person for violating consumer fraud statutes in connection with that person's business. -[84]- -[82]- E.g., Cal. Financial Code 5000-12000 (California laws governing savings and loan associations); N.Y. Banking Law 10-46 (New York laws establishing the New York Banking Department, the Superintendent of Banks, and their supervisory and regulatory powers). -[83]- See 18 U.S.C 1345 (allowing civil actions by the United States to enjoin the execution of a scheme or artifice to knowingly defraud a financial institution, as prohibited by 18 U.S.C. 1344 [Bank fraud]). -[84]- See, e.g., Del. Code. Ann. tit. 6, 2513 et seq. -------------------- BEGINNING OF PAGE #16 ------------------- c. Civil Mail and Wire Fraud The proposals also would require disclosure of civil and administrative proceedings relating to mail and wire fraud. -[85]- Thus, for example, court orders enjoining violations of mail or wire fraud statutes, -[86]- as well as U.S. Postal Service orders requiring a designated person to cease and desist from conducting a scheme or device for obtaining money or property through the mail by false representations, -[87]- would be disclosed. d. Fiduciary Duties The proposed amendments would extend disclosure to legal actions involving laws and regulations governing fiduciary obligations owed to corporations, partnerships, business trusts and similar business entities. -[88]- If, for example, a designated person was subject to a court order resulting from a breach of a fiduciary duty imposed by the Employee Retirement Income Security Act of 1974 ("ERISA"), -[89]- or had been found to have breached a fiduciary duty as a director of a corporation, in violation of state corporation or common law, disclosure would be required. e. Restrictions on Any Business Practice The current provision requiring disclosure where a court enjoins or otherwise limits the designated person from engaging in any business practice -[90]- would be expanded to require disclosure of similar orders issued by administrative authorities. -[91]- Under the proposals, for example, Federal Communications Commission orders requiring a designated person to cease and desist from engaging in activities that violate regulations governing telecommunications, -[92]- International -[85]- Proposed Item 401(f)(iii)(A)(3). -[86]- Generally, legal actions involving mail or wire fraud would be criminal proceedings [see 18 U.S.C. 1341, providing criminal penalties for fraud and swindles accomplished through the mails and 18 U.S.C. 1343, providing criminal penalties for schemes and artifices to defraud by means of wire, radio or television]; however, the Attorney General of the United States may commence a civil action in any federal court to enjoin ongoing or prospective violations of federal mail or wire fraud statutes. 18 U.S.C. 1345. -[87]- See 39 U.S.C. 3005. -[88]- Proposed Item 401(f)(1)(iii)(A)(2). One type of a "similar business entity" under the proposed rule is a limited liability company, which strictly speaking is neither a corporation or a partnership, but has characteristics of both. See Del. Code Ann. tit. 6, 18-101 et seq, for an example of a state statute (Delaware) providing for the organization of limited liability companies. -[89]- See Section 409 of ERISA [29 U.S.C. 1109] (providing for equitable remedies against fiduciaries who breach fiduciary duties imposed by ERISA). -[90]- Current Item 401(f)(3)(ii). -[91]- Proposed Item 401(f)(1)(iii)(B). -[92]- See 47 U.S.C. 312. -------------------- BEGINNING OF PAGE #17 ------------------- Trade Commission orders restricting such person from engaging in unfair practices in the importation of articles into the United States, -[93]- Federal Trade Commission orders requiring the person to cease and desist from engaging in unfair methods of competition, -[94]- and other similar federal or state administrative actions would be required to be disclosed. f. Request for Comment Concerning Civil and Administrative Proceedings The proposed provisions discussed above relating to civil and administrative proceedings require disclosure if a finding, order or sanction relates to an alleged violation by a designated person of securities, commodities, banking and insurance laws and regulations and other designated laws and regulations, as well as orders restricting a designated person from engaging in any business practice. Comment is requested as to whether the requirement to disclose restrictions on any business practice is sufficient to apprise investors of the backgrounds of those who direct the affairs of public companies. Comment also is sought as to whether disclosure relating to violations of laws governing corporations, partnerships or other entities should be restricted to violations of a fiduciary duty provision, as proposed, or restricted further to violations of a fiduciary duty involving fraud. Commenters also are requested to address whether those proposals should be expanded to require disclosure of findings, orders and sanctions entered in proceedings involving alleged violations of any laws respecting such business entities. Finally, comment is requested as to whether there is any category of civil or administrative proceeding that should be excluded from the disclosure requirements and the reason for the recommended exclusion. B. Disclosure of Disciplinary Actions by Self-Regulatory Organizations Under the proposals, a requirement would be added to describe disciplinary sanctions imposed by any securities or commodities industry self-regulatory organization ("SRO") that oversees the business conduct and sales practices of its members. -[95]- -[93]- See 19 U.S.C. 1337. -[94]- See 15 U.S.C. 45. -[95]- Proposed Item 401(f)(1)(iv). Section 3(a)(26) of the Exchange Act [15 U.S.C. 78c(a)(26)] defines self-regulatory organization as any national securities exchange registered under Section 6 of the Exchange Act [15 U.S.C. 78f] (e.g., the New York Stock Exchange), any securities association registered under Section 15A of the Exchange Act [15 U.S.C. 78o-3] (e.g., the National Association of Securities Dealers ("NASD")), and any clearing agency registered under Section 17A of the Exchange Act [15 U.S.C. 78q-1] (e.g., the National Securities Clearing Corporation). The Municipal Securities Rulemaking Board ("MSRB") also falls within the statutory definition of a self-regulatory organization, but the MSRB refers all disciplinary actions to the NASD. Regulations under the Commodity Exchange Act [7 U.S.C. 1 et seq.] define self-regulatory organization as contract markets registered under Section 5 of the Commodity Exchange Act [7 U.S.C. 7] (e.g., the Chicago Board of Trade) and futures associations registered under Section 17 [7 U.S.C. (continued...) -------------------- BEGINNING OF PAGE #18 ------------------- The Commission requests comment as to whether there are any classes of SRO disciplinary proceedings that should be excluded, such as summary proceedings by an SRO wherein the designated person is fined not more than $2500 for minor or technical violations of the SRO's rules and procedures. -[96]- C. Disclosure of Comparable Foreign Legal Proceedings While current provisions relating to disclosure of a designated person's involvement in criminal and civil actions do not distinguish between foreign legal actions and those taken within the United States, the proposed amendments explicitly would require disclosure of foreign criminal convictions and civil proceedings before foreign courts. Moreover, provisions would be added requiring disclosure of actions by foreign administrative authorities. Thus, disclosure would be required of any foreign legal proceeding that is comparable to a domestic legal proceeding requiring disclosure. These proposals reflect the ever-increasing international character of financial transactions and the important role played by foreign authorities in assuring safe and efficient financial markets world-wide. -[97]- Comment is requested as to whether there are any other types of legal proceedings before foreign authorities that should be specifically required, as well as whether any foreign legal proceedings should be excluded from the disclosure requirements. D. Other Legal Proceedings 1. Arbitration Proceedings While not specifically included in the amendments proposed today, the Commission requests comment on whether disclosure should be required concerning the results of arbitration proceedings arising out of allegations of violations of securities or commodities laws and regulations, or breaches of the laws and regulations relating to other commercial transactions. Given the widespread use of arbitration clauses, as well as statutes and court rules that require or permit claims -[95]-(...continued) 21] of that Act (e.g., the National Futures Association). 17 CFR 1.3(ee). Clearing organizations, as defined in 17 CFR 1.3(d) (e.g., the Commodity Clearing Corporation), also are included in the definition of self-regulatory organization found in 17 CFR 1.59(a)(1). -[96]- Such proceedings would include action taken pursuant to an SRO minor rule violation plan or similar plan. See Rule 19d-1(c)(2) [17 CFR 240.19d-1(c)(2)]. -[97]- The International Securities Enforcement Cooperation Act of 1990 ("ISECA") [Sections 201-207 of the Securities Acts Amendments of 1990, Pub. L. No. 101-550, 104 Stat. 2713 (1990)] granted the Commission the authority to sanction regulated entities and associated persons if they have been convicted of certain crimes by a foreign court of competent jurisdiction within 10 years of filing an application with the Commission, or have been found by a foreign financial regulatory authority to have violated laws and regulations that are substantially equivalent to federal securities and commodities laws. See Sections 203 and 205 of ISECA, amending Section 15(b)(4) and (6) of the Exchange Act [15 U.S.C. 78o(b)(4) and (6)], Section 9(b)(4) of the Investment Company Act [15 U.S.C. 80a-9(b)(4)], and Section 203(e)(7) of the Investment Advisers Act [15 U.S.C. 80b-3(e)(7)]. -------------------- BEGINNING OF PAGE #19 ------------------- to be submitted to arbitration rather than to courts, investors may consider information regarding a designated person's involvement in arbitration proceedings material to their investment decisions. The Commission invites comment on whether disclosure should be required concerning arbitration awards where the action would have been disclosed had the claim been pursued before a court, administrative body or SRO. In addition, commenters should address whether there are other types of alternative dispute resolution that should trigger disclosure. Comment also is requested as to whether there are any arbitration proceedings that should be exempt from disclosure in light of the nature of the issues involved or the insignificant dollar amount of the award. Finally, comment is solicited as to whether there should be dollar amount thresholds that govern disclosure and whether such thresholds should be cumulative figures based on multiple arbitration awards. 2. Rule 2(e) Proceedings The Commission also solicits comment as to whether filers should be required to disclose all administrative actions brought by the Commission against a designated person pursuant to Rule 2(e) of the Commission's Rules of Practice. -[98]- Rule 2(e) provides for the suspension or disbarment of certain professionals, usually attorneys and accountants, from practicing before the Commission. -[99]- Where Rule 2(e) orders relate to violations of the federal securities laws, -[100]- disclosure would be required under both the current and proposed rules. Should the requirements be expanded to encompass Rule 2(e) orders based on lack of professional qualifications, -[101]- lack of character or integrity, or unethical or improper professional misconduct, -[102]- the conviction of a felony or of a misdemeanor involving moral turpitude, or the disbarment or revocation of a license to practice as an attorney, accountant, -[98]- 17 CFR 201.2(e). -[99]- "Practicing before the Commission" is defined in Rule 2(g) [17 CFR 201.2(g)] to include "transacting any business with the Commission" as well as "the preparation of any statement, opinion or other paper by any attorney, accountant, engineer or other expert, filed with the Commission in any registration statement, notification, application, report or other document with the consent of such attorney, accountant, engineer or other expert." -[100]- See Rule 2(e)(1)(iii) [17 CFR 201.2(e)(1)(iii)], allowing the Commission to suspend or disbar a professional that has been found by the Commission in a Rule 2(e) proceeding to have violated federal securities laws, and Rule 2(e)(3) [17 CFR 201.2(e)(3)], which provides for a summary disbarment or suspension by the Commission where a court has enjoined the professional from future violations of the federal securities laws, or where the person has been found by a court or by the Commission in a separate proceeding to have violated those laws. -[101]- Rule 2(e)(1)(i) [17 CFR 201.2(e)(1)(i)]. -[102]- Rule 2(e)(1)(ii) [17 CFR 201.2(e)(1)(ii)]. -------------------- BEGINNING OF PAGE #20 ------------------- engineer or other expert? -[103]- If not, commenters should provide specific reasons for any recommended exclusions. If it is determined that all Rule 2(e) orders should be disclosed, should disclosure of disciplinary sanctions imposed by other federal and state authorities or non-government professional associations, such as bar associations, for violations of standards of professional conduct also be required? E. Disclosure Period Expansion to 10 Years The Commission proposes to expand the time during which disclosure is required from five to 10 years, -[104]- and to delete in most instances the provisions allowing registrants to omit information they determine is neither material to an evaluation of the ability or integrity of the designated person -[105]- nor to a voting or investment decision. -[106]- Based on its experience since 1978, when the original disclosure period was reduced from 10 to the current five years, -[107]- the Commission believes that many legal proceedings remain material beyond five years. -[108]- Of course, the inclusion of the information would continue to be required beyond 10 years where necessary to render statements otherwise made in the registration statement, report or document not misleading. -[109]- -[103]- Rule 2(e)(2) [17 CFR 201.2(e)(2)]. -[104]- Proposed Item 401(f)(1). -[105]- Current Item 401 and Item 8(d) of the Regulation A offering circular (Model B). -[106]- Current Item 401(g)(1) and (2). As discussed in Section III.A.1, above, the materiality provision would be retained with respect to bankruptcy and insolvency proceedings. -[107]- See Section II, above, for background relating to this requirement. -[108]- This comports with the President's Commission on Organized Crime's 1986 recommendation that disclosure of all legal proceedings required by Item 401 of Regulation S-K be extended to at least 10 years to provide adequate notice to investors and government agencies as to the background of corporate officials. See President's Commission on Organized Crime, THE EDGE: Organized Crime, Business, and Labor Unions; Report to the President and the Attorney General p. 345 (March 1986). -[109]- Rule 408 [17 CFR 230.408] under the Securities Act, Rule 12b-20 [17 CFR 240.12b-20] under the Exchange Act, and Rule 8b-20 under the Investment Company Act [17 CFR 270.8b-20] require registrants to disclose, in addition to the information expressly required to be included in a registration statement or report, any further material information as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading. Cf. Releases No. 33-5758 (November 2, 1976) [41 FR 49493] and No. 33-5949 (July 28, 1978) [43 FR 34402] stating that information regarding events occurring outside the five-year period may be material and should be disclosed. For examples of civil actions finding legal (continued...) -------------------- BEGINNING OF PAGE #21 ------------------- Since some types of legal proceedings may have a greater impact on voting and investment decisions than others, the Commission requests comment as to whether there are specific actions that should be disclosed for periods less than 10 years. For example, should misdemeanors be described for a lesser period than felony convictions? Commenters favoring that approach should specify the types of proceedings to which the current five-year provision should continue to apply. On the other hand, disclosure may be appropriate for periods longer than 10 years with respect to certain types of legal proceedings -- for example: criminal fraud convictions; civil, administrative and SRO actions based on fraud involving securities, commodities, financial institutions, insurance companies or other businesses; actions involving mail and wire fraud; and, proceedings resulting in the removal or bar from acting in a decision-making capacity in connection with a financial institution or other business. Should these types of legal proceedings be disclosed for longer periods, such as 15 or 20 years, or indefinitely? Should disclosure be required so long as the designated person is subject to the order? Commenters should provide an analysis in support of any specific time period recommended. Many legal proceedings based on violations of federal, state or other laws or rules or SRO rules result in orders or sanctions that remain in place for indefinite periods. For example, many injunctions, cease-and-desist orders and industry bars are imposed permanently and remain in force until further judicial or administrative action is taken to vacate the order. -[110]- Should the current five-year disclosure period be maintained, with the exception that any injunction, cease-and-desist order, industry bar or other continuing order or bar would be required to be disclosed for as long as the designated person is subject to the order or sanction, even when the order or sanction was imposed more than five years ago? Would that have the effect of providing sufficient disclosure of the conduct most relevant to investors' voting decisions? If such a provision were adopted, would it be appropriate to provide some outer limit (such as 10 or 15 years) after which disclosure could be discontinued? F. Form and Schedule Amendments As outlined above, -[111]- legal proceedings disclosure requirements vary among certain forms and schedules. The -[109]-(...continued) proceedings over five years old to be material, see SEC v. Scott, 565 F.Supp. 1513 (S.D.N.Y. 1983) (prospectus deemed materially false and misleading, in part because 1961 Canadian fraud conviction not disclosed in 1980 prospectus); Bertoglio v. Texas Int'l Co., 488 F.Supp. 630 (D. Del. 1980) (1964 Commission bar should have been disclosed in 1979 proxy materials notwithstanding five-year disclosure requirement). See also Calderon v. Tower Associates Int'l, Civil No. 88-1240-FR (D. Ore. March 28, 1989) (order compelling answers to interrogatories) (criminal securities law violations occurring in 1977 and 1979 deemed material and discoverable notwithstanding Item 401(f) five-year provisions). -[110]- For a discussion of disclosure where a court grants relief from a permanent injunction based on conduct occurring after imposition of the order, see n. 65, above. -[111]- Section II, above. -------------------- BEGINNING OF PAGE #22 ------------------- Commission proposes to amend the requirements found in Schedules 13D, 13E-3, 14A -[112]- and 14D-1 and the Regulation A offering circular (Model B) to conform with those of Regulation S-K Item 401. -[113]- The Commission solicits comment as to whether any schedule or form identified above should not be conformed with proposed legal proceedings requirements, and requests that commenters provide the specific rationale for any exclusion recommended. As discussed above, the Item, forms and schedules identify persons for whom the legal proceedings disclosure is required; -[114]- the proposed amendments would specify that disclosure is required where the function performed by a designated person is performed by others, directly or indirectly, pursuant to a management or service contract, or otherwise. -[115]- Comment is requested as to whether there is any class of persons not currently subject to legal proceedings disclosure that should be. For example, should disclosure relating to promoters or control persons be required beyond the current 12 month period following an initial public offering, thus requiring disclosure in Exchange Act annual reports? Is there any class of persons currently identified as designated persons that should not be? Should the Regulation S-K Item 401 provisions be expanded to require disclosure relating to persons participating in the offering of a penny stock if the disclosure document is furnished in connection with such an offering? -[116]- -[112]- This proposed change would only affect disclosure relating to participants in election contests, which currently requires disclosure only of criminal convictions within the past 10 years. See current Item 5(b)(1)(iii) of Schedule 14A. Of course, all proxy statements involving the election of directors would be affected by the rule proposals generally because Item 7(b) requires that the information specified in Item 401 be included with respect to directors, officers and director nominees. -[113]- The changes to these forms and schedules are found in proposed Item 2(d) of Schedule 13D; proposed Item 2(e) of Schedule 13E-3; proposed Item 5(b)(1)(iii) of Schedule 14A; proposed Item 2(e) of Schedule 14D-1; and proposed Part II, Offering Circular Model B, Item 8(d) of Form 1-A. -[114]- See n.22, above. -[115]- For a discussion of disclosure obligations relating to registrants that are partnerships or trusts, or whose management services are provided by outside parties pursuant to management contracts, service agreements or otherwise, see introduction to Section III, above. -[116]- Section 504 of the Penny Stock Reform Act [Title V of the Securities Enforcement Remedies and Penny Stock Reform Act, Pub. L. No. 101-429] amended Section 15(b)(6) of the Exchange Act [15 U.S.C. 78o(b)(6)] to authorize the Commission to bar or take other administrative action against a "person participating in the offering of penny stock." As amended, Section 15(b)(6) defines a person participating in the offering of a penny stock to include "any person acting as any promoter, finder, consultant, agent or other person who (continued...) -------------------- BEGINNING OF PAGE #23 ------------------- Finally, the Commission solicits comment as to whether legal proceedings disclosure provisions should be added to any forms, schedules or other documents where not required currently. For example, should legal proceedings involving persons issuing securities pursuant to an exemption under Regulation B, -[117]- relating to fractional undivided interests in oil and gas rights, be required to be disclosed in the offering sheet delivered to investors? IV. INVESTMENT COMPANY ACT DISCLOSURE The Commission is proposing to add legal proceedings disclosure, as proposed to be amended, to investment company registration statement forms and to expand the scope of legal proceedings disclosure in proxy statements. Currently, legal proceedings disclosure is specifically required only in investment company proxy statements related to the election of directors. -[118]- Investment Company Act disclosure documents are intended, among other things, to inform investors and investment company shareholders about matters that concern the background and qualifications of those persons who oversee (such as directors) or manage (such as investment advisers) an investment company and its assets. The Commission believes that disclosure of information concerning legal proceedings may be material to investors and shareholders and is, therefore, proposing to require this disclosure in investment company disclosure documents. The proposed amendments would require Item 401(f) disclosure in investment company prospectuses. -[119]- Because most -[116]-(...continued) engages in activities with a broker, dealer, or issuer for purposes of the issuance or trading in any penny stock, or inducing or attempting to induce the purchase or sale of any penny stock." -[117]- 17 CFR 230.300-230.346. -[118]- Item 22(b)(4) of Schedule 14A. Prior to the recent amendments to the proxy rules applicable to investments companies, which consolidated the disclosure requirements in Item 22 of Schedule 14A (Release No. IC-20614 (October 13, 1994) [59 FR 52689]), Rule 20a-1 under the Investment Company Act required legal proceedings disclosure by reference to Item 7 of Schedule 14A. -[119]- Proposed amendments to: Item 5 of Form N-1A (open-end investment companies); Item 9 of Form N-2 (closed-end investment companies) Item 6 of Form N-3 (separate accounts that offer variable annuity contracts that are registered under the Investment Company Act); Form N-4 (separate accounts that offer variable annuity contracts which are registered under the Investment Company Act as unit investment trusts); Items 11, 12, and 16 of Form N-5 (small business investment companies); Item 28 of Form N-8B-2 (unit investment trusts); Items 26, 27, and 28 of Form N-8B-3 (investment companies issuing periodic payment plan certificates); Items 29 and 34 of Form N-8B-4 (face amount certificate companies). The Commission also is proposing amendments to Schedules A (continued...) -------------------- BEGINNING OF PAGE #24 ------------------- investment companies are externally managed by investment advisers, the Commission also is proposing to require disclosure concerning not only directors and officers of the investment company, but also "managerial persons" of the investment adviser. -[120]- For the purposes of the legal proceedings disclosure, "managerial persons" would mean "affiliated persons" of the investment adviser as that term is defined in section 2(a)(3) of the Investment Company Act -[121]- who are engaged in the management, direction, supervision, or performance of any activities related to the investment company. -[122]- This definition would include, for example, officers or employees of the investment adviser whose duties are related to the management of an investment company. -[123]- On the other hand, the definition is not intended to require disclosure with respect to persons affiliated with the investment adviser who have no managerial or similar responsibilities with respect to the -[119]-(...continued) and B of Regulation E [17 CFR 230.610a] under the Securities Act which would require offering circulars used by small business investment companies and business development companies relying on the Regulation E exemption to include the information specified in proposed Item 401(f) as to each director, executive officer and advisory board member of the issuer and as to managerial persons of the investment adviser of the issuer. -[120]- In the case of an investment company registered as a separate account on Forms N-3, N-4 or N-8B-2, disclosure would be required of legal proceedings involving the directors, officers and employees of the sponsoring insurance company, or its affiliates, who participate directly in the management or administration of the separate account. -[121]- 15 U.S.C. 80a-2(a)(3). An affiliated person is: (i) a person who directly or indirectly owns or controls more than 5% of the voting securities of a person; (ii) a person of which more than 5% of the voting securities is owned or controlled by a person; (iii) a person that is controlled, controlled by, or under common control with, a person; (iv) any officer, director, partner, or employees of a person; (v) if such person is an investment company, the investment adviser or any member of the advisory board thereof; and (vi) if the person is an unincorporated investment company without a board of directors, the depositor thereof. -[122]- The term "managerial persons" is similar to, but not the same as, the term "management person" used in Rule 206(4)-4 under the Investment Advisers Act [17 CFR 275.206(4)-4]. Rule 206(4)-4 requires investment advisers to disclose to their clients certain financial and disciplinary information about the investment adviser or a management person of the adviser. For purposes of Rule 206(4)-4, a management person is defined as a person who controls the adviser or determines the general investment advice given to clients. -[123]- This disclosure would include a fund's portfolio manager as well as any member of a portfolio management committee. -------------------- BEGINNING OF PAGE #25 ------------------- investment company. -[124]- The Commission requests comment on whether the proposed definition of "managerial persons" will result in appropriate disclosure that will provide material information to investment company investors and shareholders. -[125]- The Commission also is proposing to conform the legal proceedings disclosure in proxy statements to the registration statement forms, as proposed to be amended. The proposed disclosure in proxy statements for officers and directors of the investment company and managerial persons of the investment adviser would be required both in connection with the election of directors, as currently required, and in proxy statements seeking approval of an investment advisory contract. -[126]- Legal proceedings disclosure may be as relevant to a shareholder's assessment of an investment advisory contract as it is to the election of directors. V. GENERAL REQUEST FOR COMMENT Any interested persons wishing to submit written comments on the proposed rule and form amendments or suggest additional changes or comment on other matters that might have an impact on the amendments set out in this release are invited to do so by submitting them in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-6009. Comment is requested on the impact of the proposals from the point of view of the public, the entities or persons making filings affected by the proposals, and the persons with respect to whom disclosure would be made. The Commission further requests comment on any competitive burdens that might result from adoption of the proposals. Comments on this inquiry will be considered by the Commission in complying with its responsibilities under Section 19(a) of the Securities Act, -[127]- Section 23(a) of the Exchange Act, -[128]- and Section 38(a) of the Investment Company Act. -[129]- Comment letters should refer to File No. S7-31-94. All comments received will be available for public inspection and copying in the Commission's Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549-6009. VI. COST-BENEFIT ANALYSIS To assist the Commission in its evaluation of the costs and -[124]- For a large company with investment advisory services and other types of businesses, monitoring and reporting legal proceedings about all persons affiliated with the company could be costly and result in lengthy disclosure. -[125]- The proposed legal proceeding disclosure would require information concerning persons, otherwise barred under section 9(a) of the Investment Company Act [15 U.S.C. 80a-9(a)], who have been permitted by the Commission under section 9(c) of the Investment Company Act [15 U.S.C. 80a-9(c)] to be associated with an investment company. -[126]- Proposed item 22(a)(3)(vii). -[127]- 15 U.S.C. 77s(a). -[128]- 15 U.S.C. 78w(a). -[129]- 15 U.S.C. 80a-37(a). -------------------- BEGINNING OF PAGE #26 ------------------- benefits that may result from the proposed changes to disclosure requirements contained in this release, commenters are requested to provide views and data relating to any costs and benefits associated with these proposals. It is expected that the enhanced legal proceeding disclosure provisions will modestly increase most registrants' costs and compliance burdens. A requirement to provide additional information for longer periods of time than currently required in documents filed under the Securities Act, Exchange Act and Investment Company Act should not significantly increase the burden on company resources, since many registrants and others already are required to gather information regarding the backgrounds of directors, officers and others. It appears, however, that any additional expense may be justified in view of the material information that would be made available to investors. VII. SUMMARY OF INITIAL REGULATORY FLEXIBILITY ANALYSIS An initial regulatory flexibility analysis has been prepared in accordance with 5 U.S.C. 603 concerning the proposed amendments to Item 401 of Regulations S-K and S-B, the Regulation A offering circular (Model B), Schedules 13D, 13E-3, 14A and 14D-1, Forms N-1A, N-2, N-3, N-4, N-5, N-8B-2, N-8B-3 and N-8B-4, and Regulation E. The analysis notes that the proposed amendments are intended to provide investors with more information regarding the background of those who exercise control over the affairs of public companies. As discussed more fully in the analysis, the proposed changes would affect persons that are small entities, as defined by the Commission's rules. It is expected that increased reporting, recordkeeping and compliance burdens would result from the changes. The analysis also indicates that there are no current federal rules that duplicate, overlap or conflict with the revised legal proceedings disclosure provisions. As stated in the analysis, several possible significant alternatives to the proposals were considered, including, among others, establishing different compliance or reporting requirements for small entities or exempting them from all or part of the proposed requirements. As more fully discussed in the analysis, the alternatives were either addressed in the proposals, inconsistent with the purposes of the federal securities laws, or otherwise without justification. Written comments are encouraged with respect to any aspect of the analysis. Such comments will be considered in the preparation of the Final Regulatory Flexibility Analysis if the proposed revisions are adopted. A copy of the analysis may be obtained by contacting James R. Budge, Office of Disclosure Policy, Division of Corporation Finance, at (202) 942-2910, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-6009. VIII. STATUTORY BASIS FOR RULES AND FORMS The Commission is proposing amendments to Item 401 of Regulations S-K and S-B, Regulation A and Regulation E pursuant to Sections 3(b), 6, 7, 8, 10, and 19 of the Securities Act. Other amendments to Item 401 and amendments to Schedules 13D, 13E-3, 14A and 14D-1 are proposed pursuant to Sections 12, 13, 14, 15(d) and 23 of the Exchange Act. The Commission also is proposing amendments to the proxy rules applicable to investment companies and to investment company registration statement forms pursuant to Sections 8(b), 20(a) and 38(a) of the Investment Company Act. List of Subjects in 17 CFR Part 228, 229, 230, 239, 240, and 274 Investment companies, Registration requirements, Reporting -------------------- BEGINNING OF PAGE #27 ------------------- and recordkeeping requirements, Securities.