Friday, November 27, 2015

Experts Summarize Pressing Issues Facing Corporate Counsel

By Jacquelyn Lumb

University of Texas law professor Henry Hu opened the Practising Law Institute’s thirteenth annual directors’ institute on corporate governance with a talk about decoupling, also known as empty voting, and the challenges posed by financial innovation. Hu said the SEC’s disclosure rules were adopted in a simpler time and recommended that the staff consider the implications of decoupling under its disclosure effectiveness project. The transparency challenges posed by financial innovation can undermine stock-based compensation, the monitoring of management performance, the market for corporate control, and other governance mechanisms, he explained.

Hu noted that the primary government response to transparency challenges was the adoption of a parallel disclosure system for major financial institutions with large derivatives holdings. This parallel disclosure system, developed by bank regulators, is not directed at investor protection and market efficiency, so it conflicts with the goals of the SEC’s disclosure mandates, he advised. A resolution will require Congressional action, but in the near-term Hu called on the SEC, the Federal Reserve, and others to harmonize the disclosure system.

Shareholder activism. Theodore Mirvis with Wachtell Lipton talked about activism and its impact on short-term versus long-term planning by companies. Institutional investors are more willing to support activist campaigns in proxy fights, which is a much different world than it was five to 10 years ago, he said. He also talked about accumulation strategies that take advantage of the reporting regulations and loopholes. Wachtell Lipton filed a rulemaking petition with the SEC in 2011 seeking to shorten the reporting deadline for Schedule 13D and to expand the definition of beneficial ownership, a measure that activists oppose.

Proxy access. With respect to the 2016 proxy season, Zach Oleksiuk with BlackRock said he believes proxy access and private ordering will persist as key issues. BlackRock views proxy access as an accountability mechanism for management, he said. He noted that many companies embark on communications programs with their top investors and those which can effectively explain their approaches to governance will be more successful in warding off shareholder initiatives.

Oleksiuk believes that proxy access is inevitable, with three years of ownership and a three percent threshold as the market standard. He added that the three percent threshold is a high hurdle, even for pension funds. He also would like to see a pause in the adoption of new governance measures to weigh how the many new initiatives are working.

Audit committees. Another panel addressed audit committee overload. The panelists noted that many companies add cybersecurity to the list of issues for which the audit committee is responsible. Nicholas Donofrio, who serves on a number of boards, said it was not a good idea. It may be convenient but cybersecurity requires special expertise. In his view, cybersecurity is an IT issue and it poses a huge risk to place it with the audit committee. He added that if a company does not currently have a risk committee, perhaps it should review the need for one.

The panelists noted that the SEC’s concept release on updating the audit committee report did not have a warm reception in the marketplace, and criticized its list of 74 questions. With respect to the PCAOB, the panelists felt that its presence has improved audit quality, but questioned the need for audit quality indicators, an initiative currently under consideration. A proposal will likely go out in 2016, but with fewer AQIs, in one panelist’s view.

Cyber security. Two special agents from the FBI’s cyber branch provided an update on the types of activities they are investigating. Timothy O’Brien said there has been a blurring of activities by nation states and hackers acting on their own behalf. Spearfishing is the main attack method in which an email is crafted for someone at a particular organization. It has become harder to discern that an email is not legitimate, he said, and once someone clicks on a link or an attachment, the malware is downloaded. O’Brien said it takes an average of 240 days before a company realizes it has been attacked.

Mike Dvilyanski said weak passwords, default passwords, and unpatched vulnerabilities enable some cyber attacks. Prevention is difficult since everyone will receive emails, but prompt detection will put companies in a better position for recovery, and a strong defense may lead hackers to go elsewhere. When asked whether the authorities are beginning to get cyber attacks under control, Dvilyanski said no—it is too easy to penetrate networks, so the crime is not going away.

Wednesday, November 25, 2015

‘Flash Crash’ Suit Fares No Better on Second Go-Around

By Mark S. Nelson, J.D.

An investor who claimed that Congress failed to oversee the SEC’s policing of stock markets cannot sue the government for losses he says he sustained in the May 2010 “Flash crash.” The Tucker Act deprived the court of jurisdiction over unilateral and implied-in-fact contract claims seeking to hold the government liable for its regulatory and sovereign acts related to securities markets (Grady v. U.S., November 23, 2015, Kaplan, E.).

The Flash Crash happened over five years ago and resulted in an estimated $200 million in investor losses after stop-loss orders produced unintended stock sales at below actual market prices. These sales were etched in traders’ memories when the Dow Jones Industrial Average fell almost 1,000 points in just 30 minutes. The plaintiff claimed that Congress failed to keep tabs on the SEC’s handling of regulatory and market evolutions which, if they had been properly regulated, could have averted the Flash Crash and the plaintiff’s claimed loss of $106,000.

Despite the Tucker Act’s jurisdiction-conferring qualities, it does little to create substantive claims. The court here reasoned that the government’s sovereign and regulatory functions created no contractual rights, nor did the plaintiff allege a meeting of the minds between himself and the government. Moreover, the court said there was no need to deal with the government’s collateral estoppel argument related to an earlier suit because the court had no jurisdiction over the latest claim.

Previously, the plaintiff had sued over the SEC’s failure to police the stock market, but lost in both the claims court and the Federal Circuit. The Supreme Court later declined to hear that case. Still, despite the similarities between the two suits, the judge dismissed this latest case without prejudice.

The case is No. 1:15-cv-746.

Tuesday, November 24, 2015

Proposals on Gender Pay Gap, Compensation Principles Will Not Reach Apple Shareholders

By John Filar Atwood

Apple Inc. will not be including three shareholder proposals—two on reducing the gender pay gap and one on adopting new compensation principles—in the proxy materials for its upcoming shareholder meeting. The SEC confirmed that the proposal on compensation principles may be omitted by the company, and the two gender gap proposals have been withdrawn by the proponents.

Compensation principles. The proposal regarding new compensation principles was submitted by Jing Zhao, and called for Apple to reform its compensation committee to include outside independent experts from the general public to adopt new compensation principles responsive to America’s general economy, such as unemployment, working hour and wage inequality. Zhao expressed concern at the high salaries earned by Apple managers, and cited articles suggesting that wage inequality was one of the sources of financial instability in the U.S.

He noted that Apple’s chief financial officer was paid $68.5 million in 2012, its operations senior vice president was paid $68.7 million in 2012, and its retail and online stores senior vice president was paid $73.3 million in 2014. Zhao requested that these pay levels and his proposal be evaluated in the context of Apple’s overall compensation policy, including the pay and working conditions for supply-chain workers in China, where most of Apple’s products are made.

Ordinary business exclusion. In its letter to the Commission, Apple argued that Zhao’s proposal was excludable under Rule 14a-8(i)(7), which permits a company to omit proposals that relate to a company’s ordinary business operations. The company pointed out that as noted in Staff Legal Bulletin No. 14A (July 12, 2002), the staff permits exclusion under Rule 14a-(8)(i)(7) of proposals that concern general employee compensation matters.

The Staff Legal Bulletin stated that the compensation of a company’s general workforce is considered to be so fundamental to management’s day-to-day operation of the company’s business that it is not appropriate for shareholder oversight through the shareholder proposal process. These proposals are differentiated from proposals that relate solely to the compensation of senior executives and directors, which are often deemed to involve a significant policy issue.

Apple argued that Zhao’s proposal is concerned with compensation principles that apply to all of its employees, not just Apple’s senior executives and directors. The SEC staff concurred with Apple, and stated that the company may omit Zhao’s proposal from its proxy materials on the grounds that it relates to compensation that may be paid to employees generally and is not limited to compensation that may be paid to senior executive officers and directors.

Gender gap proposals. The proposals on gender-based pay inequality were submitted by Pax World Mutual Funds and Arjuna Capital/Baldwin Brothers Inc. on behalf of Adam Seitchik. Specifically, the shareholders asked Apple to prepare a report by September 2016 on its policies and goals to reduce the gender pay gap. They said that in order for investors to assess Apple’s strategy and performance, the report should include the percentage pay gap between male and female employees, policies to improve performance, and quantitative reduction targets.

In support, the shareholders said that despite evidence linking management diversity and financial performance and more robust decision-making, the technology industry still struggled to attract and retain women employees. At Apple, 31 percent of the company’s U.S. employees are women, and they account for 28 percent of the company’s leadership, according to the proponents.

The proponents cited a report which found that pay equity appears to be an important driver of gender diversity, and actively managing pay equity is associated with higher female representation at the professional through executive levels. The proponents argued that well-managed companies should understand the equity attributes of their pay at all levels of the corporation, by gender as well as other factors such as race, ethnicity, experience, background and discipline.

Ongoing dialogue. In Apple’s letter to the SEC, it noted that after discussions with the company, both proponents agreed to withdraw their gender gap proposals. The proponents said that this was the result of a commitment by Apple to engage in an ongoing dialogue regarding gender pay equality with both shareholders.

Monday, November 23, 2015

Stockholder ‘Slept’ on Quasi-Appraisal Claim, Barred by Laches

By Lene Powell, J.D.

The Delaware Court of Chancery dismissed an action alleging that a company director breached his fiduciary duty in a merger, ruling that although the statute of limitations had not expired, the action was barred by laches as a matter of equity. The plaintiff’s decision to wait until after a related action failed in Minnesota before bringing suit in “a rather leisurely fashion” in Delaware was unreasonable and caused the defendants prejudice in defending the suit and pursuing indemnification rights (Houseman v. Sagerman, November 19, 2015, Glasscock, S.).

“It is in light of the foreseeable hardship…caused by Mrs. Houseman’s sleeping on her rights that I find that her 27-month delay in pursuing this action clearly unreasonable,” said Vice Chancellor Glasscock.

Background. In 2006, Nancy Houseman and her husband sold a company to Universata, Inc. for a seven-year stream of payments. Three years later, Universata had trouble making the payments and negotiated a new arrangement in which it converted part of the remaining payments to shares of Universata common stock and appointed Mr. Houseman to the board of directors. In addition, the Housemans entered into an agreement with then-Chairman Thomas Whittington that gave the Housemans a right to force Whittington personally to purchase up to all their Universata shares at a specified price (the Put Contract).

On May 10, 2011, Universata announced it had entered into a preliminary agreement to be acquired by HealthPort Technologies. Universata sent stockholders, including Mrs. Houseman, an information statement describing the stockholders’ right to seek appraisal. The preliminary merger agreement provided that Universata stockholders would receive $1.02 per share in cash and other consideration. In the following weeks, Universata CEO Eric Sagerman urged the Housemans to waive their appraisal rights because he feared that postponing the waiver would jeopardize the merger. Opposed to the merger and believing that it would not close if she did not waive her appraisal rights, Mrs. Houseman did not execute a waiver. The merger agreement was executed a few weeks later and stockholders received $1.02 per share in cash.

After the merger closed, the Housemans refused to tender their shares, instead seeking to “put” their shares to Whittington pursuant to the Put Contract. The Housemans filed suit in Minnesota state court for breach of the Put Contract, but the action was dismissed in February 2012. A year and a half later, they brought suit in Delaware for breach of fiduciary duty and other claims. In April 2014, the Court of Chancery dismissed all counts except one for “quasi-appraisal” against HealthPort and a demand for an accounting by Whittington regarding escrow distributions.

Quasi-appraisal. The court explained that quasi-appraisal is not itself a cause of action but a remedy that, where appropriate, awards stockholders damages based on the going-concern value of their previously owned stock upon a finding of a breach of fiduciary duty, such as the duty to disclose. Mrs. Houseman argued that she was unable to make an informed decision regarding her appraisal rights because the defendants breached their fiduciary duties by failing to give stockholders the final version of the merger agreement, failing to give stockholders the correct version of the appraisal statute, and incorrectly informing the Housemans that the merger would not proceed unless the Housemans waived their statutory appraisal rights. The defendants moved for summary judgment, arguing that even if this were all true, the action should be barred by the equitable doctrine of laches because Mrs. Houseman unjustifiably delayed bringing the action in Delaware.

Laches. Observing that “equity aids the vigilant, not those who slumber on their rights,” the court ruled that the defendants had met the three-factor test for laches. First, Mrs. Houseman had knowledge of a fiduciary duty claim when the merger closed on June 1, 2011. She knew she had appraisal rights, and after the merger was completed, knew that she had been deceived by Whittington into believing the merger could not be finalized without her waiver of her appraisal rights. Therefore, for purpose of a laches analysis, Mrs. Houseman was aware of her claims no later than June 1, 2011.

Second, Mrs. Houseman unjustifiably delayed bringing the action. She could have pursued a breach-of-duty action in Delaware at the same time she brought the breach-of-contract action in Minnesota, but held off until after she lost in Minnesota. Although the analogous statute of limitations was three years, this did not control a court sitting in equity. The court found unavailing Mrs. Houseman’s reasons for not bringing the two actions simultaneously. Litigation costs were part of the tactical decision but were not relevant for purposes of a laches analysis, and the foreseeable hardship to defendants rendered the 27-month delay unreasonable.

Finally, the delay caused prejudice to the defendants. The defendants lost the ability to use escrow funds to offset their litigation costs and could no longer file a D&O insurance claim, as the insurance had lapsed by the time the complaint was filed. In addition, the defendants no longer had access to the information necessary to defend a position as to the value of the company as a going concern, because valuation becomes progressively harder to do as the valuation date grows more remote.

Partial summary judgment granted. The court granted partial summary judgment to the defendants on the quasi-appraisal claim. The accounting action remained pending.

The case is No. 8897-VCG.

Friday, November 20, 2015

New Jersey Enacts Crowdfunding Exemption

By Jay Fishman, J.D.

The New Jersey State Legislature enacted an intrastate offering exemption (crowdfunding) to help small businesses raise capital in the state.

Qualifications. To qualify for the exemption, an issuer must be a business entity organized under New Jersey law and authorized to do business in the state. The issuer’s transaction must meet Securities Act Section 3(a)(11) and SEC Rule 147 requirements. The issuer must not have previously sold securities in reliance on this exemption.

Disqualifications. The transaction may not be a blind pool offering. The New Jersey Securities Bureau must, by rule, set forth additional disqualifying events that may include certain criminal convictions, injunctions, and court, false representation or stop orders.

Aggregate offering amount. The aggregate offering amount from all cash and consideration received for sales except for sales made to accredited or institutional investors may not exceed $1 million. Offers or sales to the issuer’s officers, directors, partners, trustees, persons occupying a similar status or persons owning at least 10 percent of the outstanding securities will not count toward the aggregate monetary limit.

Single investor limit. An issuer may not accept more than $5,000 from any single investor unless the investor is an accredited investor or institutional buyer.

Residency requirement. Investors must be New Jersey residents.

Investor certification. Investors must certify electronically or writing that they understand: (1) the high-risk speculative nature of the business in which they are investing; (2) that the investment has not been reviewed or approved by any federal or state securities regulatory authority; (3) that the securities are illiquid and may not have a ready market for their sale; (4) that the investor may be taxed on the taxable income and losses of the company; and (5) any additional information the Bureau finds relevant.

Legend. The Bureau must create a legend for issuers to provide their prospective purchasers, which contains: (1) a statement that the securities have not been registered with either the SEC or the Bureau; (2) a statement that the securities are subject to resale limitations; and (3) any other information the Bureau finds relevant for the legend.

Escrow. The issuer must execute an escrow agreement with a New Jersey-located bank, savings bank, savings and loan association or credit union. Investor funds must be deposited with the designated financial institution, which may not release the offering proceeds to the issuer until the aggregate capital raised from all investors equals or exceeds the minimum offering amount specified in the issuer’s business plan. The escrow agreement must additionally provide that all investor funds will be returned to investors within 60 days of the stated date in the required disclosures if the minimum offering amount is not raised.

Internet site/operator. The offering must be made exclusively through an Internet site that is registered with the Bureau. An Internet site operator, which does not include a broker-dealer, must be a business entity organized under New Jersey law that is authorized to do business in the state. The Internet site operator is not required to register as a broker-dealer in New Jersey if: (1) the Internet site operator is an Exchange Act-registered broker-dealer or a Securities Act-registered funding portal; (2) the SEC has adopted rules governing funding portals; (3) the Internet site operator files with the Bureau Chief the Internet site operator’s SEC-filed documents that the Bureau Chief requires by rule (or otherwise); and (4) the Internet site operator consents to service or process and pays a Bureau-determined fee.

Disclosure document. An issuer must disclose to prospective purchasers on the Internet site the following information:

(1) a copy of the legend (mentioned above);

(2) evidence that the issuer is a business organized under New Jersey law that is authorized to do business in the State;

(3) a description of the company, its form and date of business organization, the address and telephone number of its principal office, its history, its business plan, a description of material agreements and the intended use of the offering proceeds;

(4) the identity of all persons owning at least 10 percent of the ownership interests of any class of the company’s securities (with a description of the outstanding options or other contingent securities);

(5) the identity of the executive officers, directors, managing members, and other persons occupying a similar status or performing similar functions on the issuer’s behalf (with a description of the outstanding options or other contingent securities);

(6) the terms and conditions of the securities being offered and of any outstanding securities of the company, the minimum and maximum amount of securities being offered, if any, and the percentage ownership of the company represented by the offered securities and the valuation of the company implied by the price of the offered securities; the minimum offering amount that is necessary to implement the business plan, and a notice that the funds will only be released to the issuer if the minimum offering amount is raised;

(7) the time and date, which may be no more than 12 months from the date of the offering, by which the minimum offering amount must be raised before the funds will be returned to investors;

(8) a provision stating that investors may cancel their commitment to invest for up to 30 days following the date the investment is made, except that investors who invest within 30 days of the time and date by which the minimum offering amount must be reached will only have the amount of time left before the time and date by which the minimum offering amount must be reached in which to cancel their commitment to invest, even if that amount of time is less than 30 days;

(9) the identity of any person who has been or will be retained by the issuer to assist the issuer in conducting the offering and sale of the securities, including any Internet site operator, but excluding persons acting solely as accountants or attorneys and employees whose primary job responsibilities involve the operating business of the issuer, rather than assisting the issuer in raising capital;

(10) a description of the consideration being paid to each person who assists the issuer in conducting the offering;

(11) a description of any litigation or legal proceedings involving the company or its management;

(12) a discussion of significant factors that make the offering speculative or risky;

(13) a description of any conflicts of interest;

(14) financial statements, including a balance sheet, income statement, cash flow statement, and capitalization of issuer;

(15) a statement of current liabilities outstanding, including obligations past due and obligations due within 12 months;

(16) the Internet site address at which the quarterly report (mentioned below) will be made available; and

(17) any additional information material to the offering.

Notice filing. The issuer must file a notice with the Bureau not less than 10 days before the security offering begins. The notice must be on a Bureau-determined form accompanied by a Bureau-determined fee. The notice must contain the information required to be posted on the Internet site (disclosure document mentioned above).

Records. The issuer and Internet site operator must maintain records of all securities offers and sales effected through the Internet site, and provide the Bureau with ready access to the records on request.

Quarterly report. Issuers must provide a quarterly report to investors, free of charge.

Thursday, November 19, 2015

Administrative Proceeding Against Ironridge Halted

By Amy Leisinger, J.D.

The SEC has been preliminarily enjoined from conducting its administrative proceeding, including its upcoming scheduled hearing, against Ironridge Global Partners and its subsidiary. According to the court, the plaintiffs demonstrated a substantial likelihood of success on the merits of their claim that the SEC has violated the Appointments Clause of Article II of the U.S. Constitution with its use of administrative law judges, as well as the potential for irreparable harm if the proceeding is not halted (Ironridge Global IV, Ltd. v. SEC, November 17, 2015, May, L.).

Background. In June 2015, the SEC brought an administrative action against Ironridge, accusing the company of acting as an unregistered broker-dealer by engaging in serial underwriting activity, offering investment advice, and receiving and selling billions of shares of stock in microcap companies. Joining a long list of SEC targets attacking the agency’s in-house proceedings as unconstitutional, Ironridge filed suit in the Northern District of Georgia after it was accused of being in violation of the SEC’s broker-dealer registration provisions. The company complained that the proceeding was unconstitutional because it was conducted by an inferior officer that was insulated by tenure protection and not appointed by SEC Commissioners, in violation of Article II.

ALJs and the Constitution. The U.S. Constitution requires that “inferior officers” be appointed by the president, the heads of departments, or courts of law. Opponents of the administrative regime contend that the proceedings are unconstitutional because ALJs are similar to persons deemed to be “inferior officers,” are “established by law,” and carry out “important functions,” such as taking testimony, conducting trials, ruling on the admissibility of evidence, and possessing the power to enforce discovery compliance. The plaintiffs claim that SEC ALJs are inferior officers because they exercise “significant authority pursuant to the laws of the United States” while the SEC contends ALJs are “employees” based on congressional treatment and the fact that they cannot issue final orders or grant certain types of injunctive relief.

Injunction granted. The court rejected the SEC’s contention that the tribunal lacks subject matter jurisdiction over the action, noting that congressional language allowing both district court and administrative actions shows no intent to make an administrative proceeding an exclusive forum. A district court is a viable forum for Commission claims, the court continued, and Congress could not have intended the review process to be exclusive because it expressly provided for district courts to adjudicate both constitutional issues and violations of the federal securities laws.

In addition, the court stated, under the test articulated by the Supreme Court in Free Enterprise Fund v. Pub. Co. Accounting Oversight Bd., a federal district court has jurisdiction over pre-enforcement challenges to agency action if three criteria are met: (1) absence of jurisdiction could foreclose all meaningful judicial review; (2) the plaintiff’s claim is “wholly collateral” to any Commission orders or rules from which review might be sought; and (3) the plaintiff’s claim is “outside the agency’s expertise.” Barring Ironridge’s claims until after the administrative process would prevent meaningful judicial review, the court found, as it could then raise constitutional arguments only after going through the process alleged to be unconstitutional and the alleged harm (being forced to litigate in an unconstitutional forum) would have already been inflicted. “Because the courts of appeals cannot enjoin an unconstitutional administrative proceeding which has already occurred, those claims would be moot and the meaningful review contemplated would be missing,” the court explained. Further, according to the court, Ironridge’s constitutional claims are not so “inescapably intertwined” with the merits of the SEC action against them so as to warrant delayed judicial review and, in fact, are wholly collateral to the administrative proceeding itself. Finally, the court concluded, constitutional claims are not part of the type of issues “routinely considered” by the SEC and fall outside the agency’s expertise. As such, the court found subject matter jurisdiction over the matter.

As Ironridge has demonstrated a likelihood of success on the merits, including the propriety of the chosen venue and the arguable “inferior officer” status of ALJs and a substantial threat of irreparable injury from an unconstitutional administrative proceeding if the injunction is not granted, the court preliminarily enjoined the SEC administrative proceeding to allow the it more time to consider the matter on the merits.

The case is No. 1:15-CV-2512-LMM.

Wednesday, November 18, 2015

DOJ Ramping Up FCPA Prosecution, Companies Urged to Self-Disclose

By Kevin Kulling, J.D.

As federal prosecutors increase their focus on the investigation and prosecution of corruption under the Foreign Corrupt Practices Act, the government is strongly encouraging companies who become aware of misconduct to voluntarily self-disclose, fully cooperate, and timely and appropriately remediate, according to remarks from Leslie Caldwell, the U.S. Assistant Attorney General for the Criminal Division. Caldwell said that the DOJ was increasing the size of its FCPA force. Three fully operational squads were added to the FBI’s international corruption unit, and 10 new prosecutors are slated to join the Fraud Section’s FCPA Unit.

Caldwell made the remarks in an address to the American Conference Institute’s Conference on the FCPA, held in National Harbor, MD.

Efforts to increase transparency. Caldwell noted that there were limits to how much the government can disclose about investigations and prosecutions, particularly for investigations that do not result in charges being brought. However, Caldwell said that the Criminal Division was attempting to be clearer about its expectations in corporate investigations and the bases for corporate pleas and resolutions, especially involving mitigation.

Self-disclosure. To be considered for mitigation credit, prosecutors consider cooperation alone to be insufficient, according to Caldwell’s remarks. But when a company voluntarily self-discloses, fully cooperates and remediates, it is eligible for a full range of consideration with respect to both charging and penalty determinations. Companies that fail to self-disclose but nonetheless cooperate and remediate will receive some credit, although measurably less credit than had it also self-reported, according to the remarks.

Caldwell noted that overseas bribery schemes can be especially difficult to detect, investigate and prosecute. Individual FCPA offenders and relevant evidence often are located overseas. The company is often best positioned to fully investigate in an efficient and timely fashion. Accordingly, voluntary self-disclosure in the FCPA context does provide a tangible benefit when it comes time to make a charging decision, according to Caldwell.

Caldwell also noted that self-disclosure means that within a reasonably prompt time after becoming aware of an FCPA violation, the company discloses the relevant facts known to it, including all relevant facts about the individuals involved in the conduct.

Disclosure must occur before an investigation is underway or is imminent, including a regulatory investigation by an agency such as the SEC. Disclosures that the company is required to make by law, agreement, or contract do not qualify.

Cooperation. Companies seeking credit must affirmatively work to identify and discover relevant information about the individuals involved, through independent, thorough investigations. Companies cannot just disclose facts relating to general corporate misconduct and withhold facts about the individuals involved.

In addition to identifying the individuals involved, full cooperation includes providing timely updates on the status of the internal investigation, making officers and employees available for interviews to the extent that is within the company’s control, and proactive document production, especially for evidence located in foreign countries, Caldwell said.

Remediation. Remediation includes the company’s overall compliance program as well as its disciplinary efforts related to the specific wrongdoing at issue. Whether and how the company has disciplined the employees involved in the misconduct will be considered. There will also be an examination of the company’s culture of compliance, including employee awareness that criminal conduct will not be tolerated.

The DOJ will be looking for a well-designed and fully implemented compliance program, with sufficient resources, relative to the company’s size, made available to train employees on their legal obligations and to uncover misconduct in its earliest stages. Compliance personnel should be sufficiently independent in order to be free to report misconduct, even if committed by high-ranking officials.

Caldwell reiterated that there was no requirement that a company self-disclose, fully cooperate, or remediate FCPA offenses. However, for serious, readily provable offenses, companies seeking leniency on the basis they took steps to mitigate the offense after it was discovered are on notice of what the Criminal Division looks for when considering mitigating factors.

Tuesday, November 17, 2015

House Oversight Leader Opposes SEC’s Delegation of Waiver Authority

By Anne Sherry, J.D.

The ranking minority member of the House Oversight Committee opposes the SEC’s plan to recognize other regulators’ waivers of bad actor disqualifications for security-based swaps. Under a proposed SEC rule, waiver requests granted by the CFTC and self-regulatory organizations would obviate the need to file a separate application with the SEC. In a letter to Chair White, Rep. Elijah Cummings (D-Md) noted that the SEC has never granted executive authority to another entity without a congressional mandate.

Proposal. Under proposed Rule of Practice 194, if the SEC has not barred or suspended an associated person, a separate application would not have to be made if the CFTC, the National Futures Association, or an SEC-regulated self-regulatory organization has made an affirmative finding that association with the security-based-swaps (SBS) dealer is permissible. Commissioner Stein opposed the rule when it was proposed in August, saying that the unconditional recognition of waivers granted by other regulators “undermines the accountability we have to Congress and to the public.”

Statutory framework. Representative Cummings’s letter echoes the commissioner’s concerns. He points out that Dodd-Frank added Section 15F to the Exchange Act to ensure that entities disqualified from participating in the SBS market cannot continue to act on behalf of another SBS dealer or major SBS participant. “Through the Exchange Act, Congress granted to the Commission regulatory, executive, and adjudicatory authority over the whole of the nation’s securities laws … Congress has not granted the CFTC the authority to regulate the SBS market,” he wrote. As to self-regulatory organizations, he said that while they can enforce their own bylaws, “they do not have the impartiality necessary to make decisions regarding the best interests of the public.” Waiver decisions should be reviewed by the SEC and voted on by its commissioners, he concluded.

Other comments. The congressman also said that the Commission should make waiver applications public, unless it makes a good-cause determination to keep an application under seal. The proposed rule contains a confidentiality provision for waiver applications, although orders would be public. Finally, Rep. Cummings noted that the SEC is considering whether a waiver should be made permanent if the agency does not act within 180 days. “I believe no waiver should be granted simply because the Commission is constrained in its resources and cannot make a decision within a limited amount of time,” he wrote.

Monday, November 16, 2015

Spanish Audit Firm Settles PCAOB Proceeding for Failure to Report Disciplinary Actions

By Jacquelyn Lumb

BDO Auditores, S.L.P., an accounting firm headquartered in Madrid, Spain, and registered with the PCAOB, has settled charges that it failed to timely disclose certain reportable events on Form 3 as required by the Board’s rules. The firm was named as a respondent in two separate disciplinary proceedings initiated by Instituto de Contabilidad y Auditoria de Cuentas (ICAC), Spain’s auditor oversight authority, and failed to report those proceedings within 30 days as required. The Board censured BDO, imposed a civil money penalty of $10,000, and required the firm to establish policies and procedures to ensure compliance with its reporting requirements. BDO consented to the Board’s order without admitting or denying the findings (In the Matter of BDO Auditores, S.L.P., Release No. 105-2015-039, November 12, 2015).

Reports on Form 3. Under PCAOB Rule 2203, accounting firms must file a special report on Form 3 to report certain specified events, including a matter arising out of the firm’s conduct in the course of providing professional services for a client in which the firm becomes a defendant or a respondent in a civil or alternative dispute resolution proceeding initiated by a government entity, or in an administrative or disciplinary proceeding other than in a Board disciplinary proceeding. The services do not have to involve an audit.

Proceedings against BDO. According to the Board’s order, BDO became aware on or about May 11, 2012 that it had become a respondent in a disciplinary proceeding initiated by ICAC in which ICAC found that the firm violated certain auditing standards. The firm’s appeal to the Spanish Courts of Justice is currently pending. On or about February 27, 2014, the firm became aware that it had become a respondent in another proceeding initiated by ICAC. Those proceedings have not been concluded.

The firm failed to file a Form 3 with respect to either proceeding until May 5, 2015, after the PCAOB commenced its investigation and well after the 30-day reporting deadline.

Settlement. As part of the settlement, in addition to revising its policies and procedures to ensure compliance, the firm agreed to provide annual training with respect to the PCAOB’s reporting requirements. The order also requires the firm to assign the oversight of compliance with PCAOB reporting matters to a person who possesses adequate knowledge and experience and to have that person certify compliance with the order within 120 days.

Friday, November 13, 2015

Uncertain Future for Conflicts Minerals Rule

By Mark S. Nelson, J.D.

The D.C. Circuit has denied a request by the SEC and Amnesty International USA for the full court to rehear the panel decision in the conflicts minerals case. The SEC and the human rights group had both hoped the appeals court would take yet another look at the commercial speech issue presented by the case in light of the court’s en banc ruling in a related case over a year ago (National Association of Manufacturers v. SEC, per curiam, November 9, 2015).

First Amendment worries. The three-judge panel had twice struck down the SEC’s requirement that companies post these disclosures on their websites as a violation of the First Amendment. The SEC and Amnesty International saw a glimmer of hope in the D.C. Circuit’s AMI decision, which extended the Supreme Court’s Zauderer precedent into new territory. But a two-judge majority upon panel rehearing in the conflict minerals case hewed closely to its earlier opinion, although it offered a second basis for its decision in order to account for the AMI case.

As a result, the SEC’s rule and the Dodd-Frank Act provision are unconstitutional to the extent they require regulated entities to report to the Commission and to state on their website that any of their products have “not been found to be ‘DRC conflict free.’” Business groups that challenged the SEC’s rule had argued that the disclosure requirement was akin to compelling them to confess blood on their hands.

Little can be gleaned from the court’s terse order denying en banc rehearing, except that two judges would have refused to let the Tobacco Control Legal Consortium file a friend of the court brief backing the SEC. That brief urged the full court to rehear the conflict minerals decision because of its potential impact on organizations that depend on mandated public disclosures to help inform the public about health and environmental issues. The AMI decision had overruled other D.C. Circuit cases to the extent they had improperly limited Zauderer, including the conflict minerals decision and the FDA’s case involving R.J. Reynolds Tobacco Co.

The conflict minerals provision in the Dodd-Frank Act required the SEC to implement rules for public companies to disclose information to the Commission and to investors about their supply chains for so-called conflict minerals that are mined in the Democratic Republic of the Congo and which may aid the financing of armed groups there and in adjoining countries. The sense of Congress accompanying the provision noted the need to spotlight instances of sexual- and gender-based violence in the DRC that contributes to a humanitarian emergency.

Few options but issues persist. The SEC’s options are now dwindling, but a rule rewrite or an appeal to the Supreme Court are at least possible. Still, the debate over the types of disclosures companies may be required to make in their future SEC filings is likely not going away.

In July, Rep. Carolyn Maloney (D-NY) introduced the Business Supply Chain Transparency on Trafficking and Slavery Act of 2015 (H.R. 3226) that would require firms to disclose if their supply chains involve labor that may be the product of human rights abuses. Senator Richard Blumenthal (D-Conn) also has re-introduced S. 1968, a bill he previously said would achieve many of the same goals as the Maloney bill.

The case is No. 13-5252.

Thursday, November 12, 2015

Adviser Rules to Clarify Gift-Giving, Aid Market Integrity

By Mark S. Nelson, J.D.

The Commission approved a bundle of rule changes urged by the Municipal Securities Rulemaking Board to update existing bans and exclusions for some types of gifts common in municipal securities markets. The rules are designed to clarify the dealings of municipal advisers and their associated persons who were brought into a new regulatory regime by the Dodd-Frank Act. The changes are set to take hold on May 6, 2016 (Release No. 34-76381, November 6, 2015).

MSRB Executive Director Lynnette Kelly emphasized that the rules are designed to promote the integrity of municipal markets. “Applying the MSRB’s existing gifts rule for dealers to municipal advisors will help ensure that municipal advisory business is awarded on the basis of merit and not special favors,” said Kelly.

Gift rules extended. The new rules extend to municipal advisers the general dealer ban on making gifts of over $100 per person per year. Exclusions from the $100 limit also apply to municipal advisers, including an existing one for employment contracts and compensation for services, a new one for bereavement gifts, and other items covered by guidance in the MSRB’s gifts notice and a FINRA notice to members.

Moreover, the rules bar a regulated entity from being reimbursed for entertainment expenses from the proceeds of a municipal offering. But the revisions will not subject municipal advisers to limits for non-cash compensation in primary offerings.

Lucite souvenirs. The Commission asked for public comments on the MSRB’s proposal in September. While the agency’s latest release noted general industry support for the MSRB’s new rules, only three industry players offered public comments.

The National Association of Municipal Advisors said that it was unclear if the MSRB’s proposal applied to some employees of municipal entities or obligated persons given the definition of “municipal advisory activities.” NAMA also pressed for a $250 aggregate gifts limit.

A letter from the Securities Industry and Financial Markets Association urged reconsideration of the records mandate. Specifically, SIFMA noted that the record retention requirement for brokers, dealers and municipal securities dealers is a year longer than for municipal advisers. But SIFMA otherwise backed the MSRB’s proposal.

According to the Investment Company Institute’s comment, the MSRB should go further in referencing older FINRA guidance, including provisions permitting the Lucite tombstones that often are given to celebrate business deals.

The Commission found that the MSRB had replied to the commenters’ worries, and the commenters’ letters sometimes noted the rules would likely address their views. The MSRB’s reply letter said it had already addressed NAMA’s concerns, but the Commission observed that the MSRB also explained that the $100 limit was lower than the limit in a different MSRB rule because the other rule is directed at pay-to-play political corruption and had to be narrowly tailored for constitutional purposes.

Lastly, the MSRB said SIFMA’s records issue could be addressed in another proposal. As for the Lucite blocks, the MSRB said the description of decorative items covered them without imposing a dollar cap.

Small municipal advisers. Although the Commission said the overall goal of the MSRB’s rules amendments is to foster merit- and price-based competition in municipal markets as a whole, the new rules may impact smaller advisers differently. Still, the Commission found the benefits of the rules to investors compelling and the burden to smaller advisers worth bearing in order to ensure the integrity of municipal securities markets.

The release is No. 34-76381.

Wednesday, November 11, 2015

Massad Says CFTC is Focused on Automated Trading Controls, Not Speed

By Lene Powell, J.D.

As the CFTC mulls an upcoming proposal on automated trading, the agency is considering what controls are needed to safeguard against market disruptions rather than any change to the speed of trading itself, said CFTC Chairman Timothy Massad. The CFTC has seen problems from things like faulty algorithms, fat-finger errors, and algorithms that weren’t adequately tested. In a televised interview at a SIFMA event, Massad said the CFTC is considering a number of controls including maximum order limits, execution throttles, kill switches, and a requirement to test algorithms before unleashing them on the market.

“We’re not looking right now to change the speed with which our markets operate, but rather, to make sure there are sufficient controls to prevent disruptions,” said Massad.

Massad has previously said that any new rules would be principles-based and consistent with best practices already followed by many firms.

Clearing. Chairman Massad said that clearinghouse resiliency is a focus of the CFTC going forward because the health of clearinghouses is very important. Risk can build up in bilateral transactions, and clearinghouses reduce that risk by interposing someone in the middle. Using clearinghouses doesn’t eliminate risk, but it does allow regulators to monitor and mitigate it, said Massad.

Asked whether it’s good that some firms including Goldman Sachs and Credit Suisse are attempting to restart the single-name credit default swaps (CDS) market by moving these trades into a clearinghouse, Massad noted that single-name CDS are under the jurisdiction of the SEC, not the CFTC. However, he agreed that clearing of these types of standardized transactions is generally a good thing.

Tuesday, November 10, 2015

Ironridge Dealt Setback as ALJ Refuses Summary Disposition on Dealer Claims

By Amanda Maine, J.D.

An SEC administrative law judge denied a motion for summary disposition by Ironridge Global Partners, LLC (Global Partners) and its subsidiary. The ALJ rejected the argument that the Ironridge subsidiary was not a dealer under the Exchange Act and was not subject to the Act’s registration requirements. This development is the latest setback for Ironridge, which has filed a motion in federal court to enjoin the SEC’s administrative claims against it on constitutional grounds (In the Matter of Ironridge Global Partners, LLC, November 5, 2015, Grimes, J.).

Administrative proceeding. In June 2015, the SEC initiated an administrative proceeding against Global Partners and its subsidiary, Ironridge Global IV (Global IV, collectively, “respondents”). Global IV’s business model involved buying the debt of microcap issuers and then settling the acquired claims against the issuers through exchanges under the Securities Act Section 3(a)(10) exemption. Global IV participated in over 30 exchanges involving claims of $35 million and acquired and sold over five billion shares of issuers’ stock. The SEC brought an administrative proceeding against Global IV and Global Partners, asserting that Global IV operated as a “dealer” by engaging in serial underwriting activity without registering as a dealer as required by the Exchange Act. The respondents moved for summary disposition on the ground that Global IV is not a dealer, and if it were a dealer, it would be exempt from registration on other grounds.

Dealer allegations. ALJ James E. Grimes noted that the “definition of the term dealer casts a wide net.” Covered persons and entities include those who engage in the business of buying and selling securities for their own account. He acknowledged that there was a facial appeal to the respondents’ arguments that Global IV is neither an underwriter nor a dealer, but as the inquiry is fact-specific, summary disposition would be inappropriate. The facts alleged in the SEC’s order instituting administrative proceedings could support the inference that Global IV’s business model involves acquiring and selling securities.

ALJ Grimes rejected the respondents’ assertion that the definition of the term “distribution” regarding securities should be that under Regulation M, which distinguishes a distribution from “mere trading” by the magnitude of the offering, noting that the respondents cited no precedent for that limitation. He also advised that no-action letters relied upon by the respondents in support of their position are merely persuasive and cannot require a particular outcome sufficient to warrant summary disposition. Finally, he noted that the respondents argued that they are exempt from registration through Section 3(a)(10) of the Securities Act, but concluded that Global IV is not exempt from the dealer registration provisions of the Exchange Act by virtue of having acquired shares through a Securities Act exemption.

Foreign dealer exemption. The respondents argued that Global IV, a foreign company located in the British Virgin Islands, should be exempted from the registration requirement under Exchange Act Rule 15a-6. ALJ Grimes rejected this assertion at the present stage of the proceeding, finding that the alleged facts were sufficient to show that Global IV’s participation in the securities transactions would put it outside the exemption.

Controlling persons. Finally, ALJ Grimes advised that Global Partners could not, at this stage in the proceeding, claim not to be subject to liability under Section 20(b) of the Exchange Act as an entity that “controlled” its subsidiary. He pointed out that Section 20(b), unlike Section 20(a), does not contain the word “control.” Even if “control” is an element of a claim under Section 20(b), it is a question of fact that is not appropriate for summary disposition at this point, ALJ Grimes wrote.

As the SEC had shown that material facts were in dispute, ALJ Grimes found that summary disposition would be unwarranted and denied the respondents’ motion.

The release is No. AP-3298.

Monday, November 09, 2015

Bebo Denied Rehearing in ALJ Challenge

By Matthew Garza, J.D.

Laurie Bebo was denied rehearing of her federal case challenging the constitutionality of the SEC’s administrative enforcement regime in a brief order issued by the Seventh Circuit. The court said the judges on the original panel voted to deny the petition, and no other judges requested a vote on the petition for rehearing en banc (Bebo v. SEC, November 5, 2015).

Bebo, former CEO of Assisted Living Concepts, Inc., was fined $4.2 million by an SEC ALJ after being charged for various accounting shenanigans in December of 2014.

The federal district court in Milwaukee dismissed her constitutional challenge to the SEC proceeding, a decision the Seventh Circuit affirmed on appeal in August of this year. She is currently seeking SEC review of the ALJ’s initial decision. The SEC recently granted her a two-week filing extension, giving Bebo until November 13 to file her review petition.

The case is No. 15-1511.

Friday, November 06, 2015

Ceresney and Former SEC Enforcement Directors Tackle Recent Enforcement Developments

By Amanda Maine, J.D.

The director of the SEC’s Division of Enforcement, Andrew Ceresney, was joined by several former enforcement directors for a spirited discussion about recent developments concerning SEC enforcement issues. The discussion took place at this year’s Securities Enforcement Forum in Washington, D.C.

Penalties. In his opening remarks, Ceresney noted that the Division obtained $4.2 billion in remedies last year from enforcement actions. He highlighted cases involving financial reporting (including a recent action against BDO), market structure, asset management, and computer hacking, as well as high-profile actions against Blackstone and UBS.

Moderator Bradley J. Bondi of Cahill Gordon & Reindel asked whether the penalties obtained against wrongdoers actually deterred misconduct. Ceresney said that financial institutions have increased spending on compliance and noted that every case that the Division brings results in publicity that can influence institutions.

William R. McLucas of WilmerHale, who served as Enforcement Director for eight years, was less enthusiastic about the SEC’s approach to penalties, stating that it is difficult to determine how the SEC calculates penalty amounts. In his personal experience, he said that the staff had proposed during settlement negotiations a $25 million penalty for his client, but would not reveal how they arrived at that number. The SEC can make a general assessment to get to a particular number, he said, but it is done by feel and by precedent, rather than based on particular statutory violations.

George S. Canellos of Milbank Tweed said that the scope of penalties is affected by the political climate of the Commission. The political makeup of the Commission can get whipsawed from anti- to pro-regulation depending on who is in office, he said. Practitioners cannot rely on precedent to determine what kind of penalty might be applied given that a change of administration can lead to very different policies, according to Canellos.

Bondi noted that there has been an increased number of public dissents among the commissioners and inquired about the impact of these dissents. Former Commissioner and Enforcement Director Irving Pollack said he thought that such public dissents were “destructive” and that commissioners that disparage the SEC do not help the SEC’s overall image. Bondi polled the panel and, with Ceresney abstaining, none of them thought that such dissents were productive. McLucas said that there used to be battles behind closed doors, but in the end, the commissioners would find a way to obtain a consensus. In today’s Commission, that has broken down, he said.

Political influence. Responding to a question by moderator Bondi about political influences on the Commission and on the Enforcement Division, former director Robert Khuzami, now at Kirkland & Ellis, agreed that the overall gestalt of the political landscape does affect the SEC’s priorities; however, he emphasized that it is just one input among many. As an example, Khuzami said the Division brought cases relating to the credit crisis and its aftermath, but rather than that being a result of pressure from politicians or the media, the SEC was addressing the misconduct that led to the crisis.

Compliance officers. Piggybacking on a discussion of the SEC’s policing of gatekeepers, Bondi inquired about recent enforcement actions against Chief Compliance Officers (CCOs), what CCOs should take from those actions, and whether the SEC should issue guidance for CCOs. Former Enforcement Director Linda Chatman Thomsen, now at Davis Polk, questioned the usefulness of such guidance, noting that CCOs must use a great deal of judgment to deal with facts that can be very nuanced. If compliance officers rely on SEC cases for guidance, they might actually end up doing less or even get out of the business entirely.

McLucas echoed the sentiment that CCOs might look at the Commission’s actions against CCOs, while still low in number, and wonder if the job is worth the potential liability. He said there should be a difference between a “wholesale failure” of adhering to the compliance function and simply not turning in a “blue-ribbon performance.”

Admissions. Bondi asked Ceresney and the former directors about their views on the SEC’s policy, announced two years ago, on requiring admissions of wrongdoing as a condition of settling charges in certain cases. Ceresney said the policy was an additional tool in the SEC’s enforcement arsenal and holds respondents accountable for their actions. Khuzami, while not disagreeing with the policy, wondered if requiring admissions actually had a deterrent effect given that penalties in general have increased. Thomsen also questioned their deterrent effect, and agreed with Bondi that the SEC may be using the admissions policy as leverage in settlement negotiations by stating that they are seeking a certain dollar amount in penalties “but not admissions…for now.”

ALJ proceedings. Ceresney rejected the suggestion that the recent cases involving the SEC’s administrative proceedings have caused the SEC to pull back from bringing such proceedings. He also noted that the SEC has taken steps to address the controversy, including outlining publicly the factors the Commission considers when selecting in which forum to bring an action and a recent proposal to modernize its rules of practice.

Retired U.S. District Judge Stanley Sporkin, who served as SEC Enforcement Director for seven years, said that the perception that the SEC’s administrative law judges have a bias in favor of the Commission has become a reality, and suggested an “economic crimes court” under Article I of the Constitution. Canellos agreed that the commissioners could not help to have at least some bias, given that in administrative proceedings, the SEC plays the role of both prosecutor and judge.

Thursday, November 05, 2015

Congressman Proposes to Enhance BDC Capabilities

By Amy Leisinger, J.D.

A South Carolina congressman has introduced legislation to amend the Investment Company Act to modernize the regulation of business development companies (BDCs) in order to facilitate the flow of capital to small businesses. Specifically, the Small Business Credit Availability Act removes certain restrictions on BDCs’ ability to own securities of investment advisers and other financial companies and alters requirements relating to the capital structure of these entities. The Financial Services Committee approved the bill by a vote of 53-4.

Introduced by Rep. Mick Mulvaney (R-SC), H.R. 3868 expands BDCs’ access to capital by amending Sections 55 and 61 of the Act to expand the scope of permissible assets and to provide that asset coverage requirements applicable to BDCs must be 200 percent, except that the requirements will be 150 percent in certain circumstances. These circumstances include when a BDC discloses its approval and the aggregate value of the senior securities issued by such company and the asset coverage percentage as of the date of its most recent financial statements or when a BDC that issues equity securities registered on a national securities exchange files disclosures regarding the amount of indebtedness, the asset coverage ratio of the company, and the principal risk factors. The application of certain provisions to senior securities of stock depends on whether the securities are issued to and held by qualified institutional buyers.

The legislation also directs the SEC to revise certain of its rules and forms relating to BDCs to ease restrictions on offerings, registrations, and ongoing filings. According to the bill, if the Commission fails to complete the revisions in a timely manner, BDCs will be entitled to treat the affected rules as officially changed.

Wednesday, November 04, 2015

Petition Accused Second Circuit of Ignoring Omnicare

By Rodney F. Tonkovic, J.D.

A petition for certiorari has been filed accusing the Second Circuit of ignoring the Supreme Court’s decision in Omnicare. According to the petition, the Second Circuit relied on a rule requiring that a plaintiff show that an issuer must subjectively believe that its statements are false when made. Per se rules like this were rejected by Omnicare, which was decided while the petitioners’ appeal was pending, but was ignored by the Second Circuit in its decision, the petition asserts. The petitioners maintain that they should have a chance to plead their Section 11 omissions claims under the Omnicare standard (NECA-IBEW Pension Trust Fund v. Lewis, October 29, 2015).

Background. In January 2010, petitioner Denis Montgomery filed a class action alleging violations of Securities Act Sections 11 and 12 in connection with three Bank of America public offerings in January and May of 2008. The first amended complaint was dismissed and a magistrate judge recommended denial of plaintiffs’ motion to file a proposed second amended complaint on the grounds that the amendments would be futile. The magistrate concluded that the claims were time-barred and that the petitioners failed to establish that any of the statements of belief and omissions at issue were false or that any of the defendants did not hold the opinions or beliefs on which the claims were based when the alleged misrepresentations were made. The magistrate’s recommendation was adopted by the district court in December 2013.

Second Circuit and Omnicare. The petitioners appealed in early 2014, asserting, among other claims, that they were entitled to the relation-back doctrine for allegations stating a viable claim under the Securities Act. Following the petitioners’ formal briefing of their appeal, the Supreme Court decided Omnicare, holding that a statement of opinion can form the basis for a securities fraud suit if the speaker did not sincerely hold the opinion or the speaker omitted material facts regarding his underlying knowledge that resulted in the opinion being misleading. In May 2015, the petitioners filed a letter brief regarding Omnicare, stating that the decision was applicable to their omissions-based claims and the lower court’s denial of leave to amend. In June 2015, the Second Circuit, in a summary order, affirmed the district court’s decision on statute of limitations grounds without addressing the issues raised by Omnicare. A subsequent petition for rehearing was denied.

The petition asks whether the Second Circuit is required to follow the Supreme Court’s decision in Omnicare, and whether the petitioners stated a valid Section 11 claim under Omnicare. According to the petitioners, the Second Circuit improperly relied on its rule set forth in Fait v. Regions Financial Corp. (2011) that a plaintiff must plead that an issuer’s opinions were both objectively false and subjectively disbelieved at the time they were made. Omnicare, the petition explains, rejected Fait-type per se rules due to the difficulty of showing subjective falsehood.

The petitioners maintain that they should have a chance to plead their omissions claims under Omnicare. The class action complaint raises the same issue as Omnicare, the petition asserts, and the Court should follow “its ordinary practice of remanding” for a determination of whether the petitioners have stated a viable omissions claim. A court on remand could reasonably conclude, the petitioners observe, that the respondents’ opinions on risk factors did not align with the information in their possession at the time.

Finally, the erroneous application of Fait also affected the conclusion that the petitioners’ claims were time barred. The petitioners claim that the lower courts failed to distinguish between the PSAC’s omissions claims versus affirmative misrepresentation claims as required by Omnicare. Here, the petitioners contend that they first learned of the omissions at issue in January 2009, and the complaint was filed less than one year afterwards.

The petition is No. 15-562.

Tuesday, November 03, 2015

‘Me Too’ Bondholders Want Argentina to Pay Debts

By Mark S. Nelson, J.D.

A federal judge in Manhattan added one more item to Argentina’s list of debt woes by ruling that a group of funds holding the country’s defaulted bonds can get specific performance of a key term in the bond agreement at issue in the case. The bondholders already had obtained a partial win when the court determined that Argentina was still violating the pari passu term in the agreement (NML Capital, Ltd. v. The Republic of Argentina, October 30, 2015, Griesa, T.).

The dispute is rooted in an earlier attempt by Argentina to pay some bondholders under a different arrangement that involved exchange offers. While most bondholders took that offer, others still want payment of the bonds they originally bought.

The court’s latest order grants 49 bondholders specific performance of their bonds. That means Argentina must make ratable payments on those bonds any time it pays out on the bonds subject to the exchange offers. Judge Griesa said specific performance was justified because no money remedy adequately protects these so-called “me too” plaintiffs and the equities favor this relief.

According to the court, Argentina has defaulted on the exchange bonds, and yet the country has indicated its ability to make some payments. Under the court’s order, the me-too plaintiffs will have equal status with the lead plaintiffs. Moreover, the judge said the Foreign Sovereign Immunities Act was inapt because the court need not take dominion over sovereign assets and Argentina can pay bondholders with any assets its chooses.

But as a practical matter, the court’s ruling focuses on the equality of footing between the different sets of bondholders. As a result, if Argentina makes payments to some bondholders, it must also pay the me-too plaintiffs. And yet compliance by Argentina with the court’s injunction can occur even if it never pays up because Argentina need only give the same treatment to the different holders of its external debt.

The case is No. 11-cv-4908.

Monday, November 02, 2015

Merrill Lynch Escapes Claim After Court Admits ‘Material Misapprehension’ of Law

By Matthew Garza, J.D.

A claim against Merrill Lynch for aiding and abetting a breach of duty by directors of Zale Corporation was dismissed after the Delaware Court of Chancery accepted that it had misinterpreted the correct standard to apply to the underlying breach-of-duty claim. Merrill Lynch’s reversal of fortune originated one day after the Chancery Court first refused to dismiss the aiding and abetting claim, when the Delaware Supreme Court issued an opinion in a case involving KKR Financial Holdings LLC. That opinion convinced Chancellor Parsons that he had incorrectly applied an enhanced Revlon standard of review instead of the proper business judgment rule standard to the claim against Zale directors (In re Zale Corporation Stockholders Litigation, October 29, 2015, Parsons, D.).

Merger. The dispute arose from a 2013 merger between two jewelry companies, Signet and Zale. Merrill Lynch advised Zale on the merger and represented that it had “limited prior relationships and no conflicts with Signet,” when in fact it had received $2 million in fees from the company and just one month previously had made a presentation to Signet regarding a possible acquisition of Zale. The merger was approved in February 2014 by a slim majority of Zale stockholders. Holders of Zale common stock then filed suit charging the Zale directors with breaching their fiduciary duties of loyalty and care, and Signet and Merrill Lynch with aiding and abetting those breaches.

Zale’s directors were insulated from the claims through an exculpatory provision in its corporate charter, even though a breach of the duty of care was found to be sufficiently pleaded by the court under the Revlon standard. Signet was let off the hook because it was not shown to have known about Merrill Lynch’s disclosure failure, but Merrill Lynch was unable to shake the aiding and abetting claim because investors pleaded that its representative consciously chose not to disclose the conflict.

Clarifying holding. The Delaware Supreme Court affirmed in the KKR Financial Holdings LLC case that the fully informed vote of a majority of disinterested stockholders invokes a business judgment rule review in cases in which Revlon otherwise would apply. The court found that the Zale-Signet merger was approved by a majority of disinterested stockholders in a fully informed vote, but despite this, Chancellor Parsons said “I declined to follow this Court’s holding in that case because I interpreted the Supreme Court’s decision in Gantler v. Stephens as holding that ‘an enhanced standard of review cannot be pared down to the business judgment rule as a result of a statutorily required stockholder vote, even one rendered by a fully informed, disinterested majority of stockholders.’”

Gantler, however, was a narrow decision focused on defining the term “ratification,” wrote the Chancellor, and he misapprehended the law regarding the cleansing effect of a fully informed, statutorily required vote by a disinterested majority of stockholders, as was the case in the Zale matter.

After determining that the business judgment rule was in fact the appropriate standard, the court found that the plaintiffs could not show that the Zale board’s acceptance of the offer after a fully informed vote of shareholders met the standard for waste under Delaware law. The court also found that it was not reasonably conceivable that the Zale directors were grossly negligent as to their engagement of Merrill Lynch. Merrill Lynch’s belated disclosure of its earlier involvement with Signet was “troubling,” said the court, and the Zale board could have done more to probe their advisor’s independence, but the conduct did not amount to “reckless indifference or a gross abuse of discretion,” found the court. There was therefore no predicate fiduciary duty breach and the aiding and abetting claim against Merrill Lynch was dismissed.

The case is C.A. No. 9388-VCP.

Friday, October 30, 2015

Senior SEC Staff Discusses Issues, Concerns with IPOs, Regulation A+

By John Filar Atwood

On the eve of the SEC’s consideration of crowdfunding proposals, Commission staff members and industry experts took the opportunity to review the impact of Regulation A+ and other capital-raising initiatives at Practising Law Institute’s securities regulation conference. The emerging growth company (EGC) provisions of the JOBS Act have had a measurable impact, according to SEC Chair Mary Jo White, as EGCs have accounted for 85 percent of IPOs since the JOBS Act was enacted.

The confidential filing provision of the JOBS Act has been particularly effective at encouraging companies to move down the path toward an IPO, said Davis, Polk & Wardwell’s Richard Truesdell. Virtually all companies that are eligible take advantage of this provision, he noted. It allows a company to test the offering process before having to disclose critical strategic information to competitors, he added.

Areas of focus. Keith Higgins, director the SEC’s Division of Corporation Finance, noted that there have been about 1,000 confidential filings since the JOBS Act was put in place. When reviewing the filings, the staff focuses on accounting issues, metrics and non-GAAP measures, he advised.

The staff examines issues of predecessor accounting, which determines which company’s financials need to be disclosed. Higgins acknowledged that this is a complicated question since the definition of predecessor is not clear. He urged companies to contact the staff before filing to let the staff walk them through the financial statements process.

Use of metrics. The staff is very concerned with metrics, and how companies present their results, Higgins said. IPO filings are very important, he noted, because they are a company’s first chance to form a strategy of what investor s are going to see in the company’s public documents.

Companies should clearly define what metrics they are using, and describe any important assumptions, Higgins advised. He said that if a company’s metrics are different from its industry competitors the staff will ask about it. It is okay for a company to be an outlier, he noted, as long as its metrics are meaningful. He added that if a company discusses a metric in the prospectus summary, but not in the MD&A section, it will get an inquiry from the staff.

Non-GAAP measures always get the staff’s attention, according to Higgins. He said that it is okay for companies to use them, but the staff expects clear disclosure surrounding them. He noted that the staff has not seen any particular problems in this area as companies generally do a good job with disclosure surrounding non-GAAP measures.

The staff places a lot of emphasis on trends information in its review of IPO filings, Higgins said. Checking for the forward-looking information that MD&A requires is an important part of the staff’s review, he added.

Higgins said that his staff wants to make the filing process as efficient as possible, and that communication is a key to accomplishing that. He advised that if a company has gone through two rounds of staff comments without a resolution, it is time to call the staff. If the issues are not getting resolved, the staff can work through it more quickly on a call than by passing letters back and forth, he said.

Truesdell advised IPO filers to be prepared to show the SEC copies of all testing the waters materials they have used. With IPOs, the first thing the staff asks is what the company has been telling, and distributing to, investors, he noted.

Regulation A+. Sebastian Gomez Abero, head of the Office of Small Business Policy in the Division of Corporation Finance, reviewed statistics that have been compiled on new Regulation A+, which pertains to offerings of up to $50 million. To date, 34 companies have publicly filed Form 1A, and 16 non-public companies have submitted draft offering statements, he said. The staff has seen a variety of issuers among the filers, he noted, although scale is tilting slightly toward real estate companies. He said that the filing advice that Higgins provided for IPOs also applies to these offerings.

Private offerings. Abero also discussed the Commission’s 2013 lifting of the ban on general solicitations for certain private offerings under Rule 506(c). The staff has been surprised that more companies have not taken advantage of Rule 506(c), choosing instead to continue to make private offerings under Rule 506(b). As of June 2015, the number of 506(b) offerings was 12 times greater than 506(c) offerings, and the money raised under 506(b) was 30 times more than the 506(c) total.

He said that it is difficult to tell if there is a single reason behind the imbalance. The 506(c) offerings are not causing a drop in 506(b) statistics, so the answer may be simply that more capital raising is getting done, he noted.