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Thursday
Feb112016

The Director Compensation Project: AT&T (T)

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation. We are for the most part including companies from 2015’s Fortune 500 and using information found in their 2015 proxy statements.

NASDAQ and the NYSE have similar rules with respect to director independence. NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors. A director does not qualify as “independent” if he or she has a “material relationship with the company.” NYSE Rule 303A.02(a). In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years. The NYSE imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3) (see Rule 303A.06) and requires consideration by the board of directors of certain specified factors in designating directors for the Compensation Committee.  See NYSE Rule 303A.02(a)(ii).

Finally, as the Commission has noted with respect to director independence: 

  • All compensation committee members must meet the general independence standards under NYSE’s rules in addition to the two new criteria being adopted herein. The Commission therefore expects that boards, in fulfilling their obligations, will apply this standard to each such director’s individual responsibilities as a board member, including specific committee memberships such as the compensation committee. Although personal and business relationships, related party transactions, and other matters suggested by commenters are not specified either as bright-line disqualifications or explicit factors that must be considered in evaluating a director’s independence, the Commission believes that compliance with NYSE’s rules and the provision noted above would demand consideration of such factors with respect to compensation committee members, as well as to all Independent Directors on the board.

 

Exchange Act Release No. 68639 (Jan. 11, 2013); see also Exchange Act Release No. 68641 (Jan. 11, 2013).

Independent directors are compensated for their service on the board. The amount of “total compensation” can be seen from examining the director compensation table from the AT&T’s (NYSE: T) 2015 proxy statement. According to the proxy statement, the company paid the directors the following amounts:

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Option Awards
($)

All Other Compensation
($)

Total
($)

Reuben V. Anderson

200,600

150,000

0

92,803

443,403

James H. Blanchard*

54,467

0

0

306,832

361,299

Jaime Chico Pardo

143,800

150,000

0

15,102

308,902

Scott T. Ford

137,900

150,000

0

102

288,002

Glenn H. Hutchins*

74,217

0

0

26,330

100,546

James P. Kelly

140,000

150,000

0

102

290,102

William E. Kennard*

19,833

0

0

17

19,850

Jon C. Madonna

172,100

150,000

0

102

322,202

Michael B. McCallister

142,000

150,000

0

17,876

309,876

John B. McCoy

151,900

150,000

0

15,102

317,002

Beth E. Mooney

130,600

150,000

0

102

280,702

Joyce M. Roché

157,600

150,000

0

13,646

321,246

Matthew K. Rose

134,600

150,000

0

22,064

306,664

Cynthia B. Taylor

147,400

150,000

0

5,102

302,502

Laura D’Andrea Tyson

144,000

150,000

0

5,600

299,600

*Mr. Blanchard retired from the Board in April 2014. Mr. Hutchins joined the Board in June 2014. Mr. Kennard joined the Board in November 2014.

Director Compensation. The board held ten meetings. Each director attended at least 75% of the total number of board and committee meetings on which he or she served. All directors attended the 2014 Annual Meeting of Shareholders. Non-employee directors receive an annual retainer of $95,000, as well as $2,000 for each board meeting or corporate strategy session attended in person. The Chairman of each committee receives an additional annual retainer of $15,000, except for the Audit and Human Resources committee Chairmen who receive an additional annual retainer of $25,000. The Lead Director receives an additional annual retainer of $60,000. Under AT&T’s Non-Employee Director Stock and Deferral Plan, directors may elect to defer their fees and all or part of their retainers into a cash deferral account or deferred stock units. Non-employee directors also receive an annual grant of fully earned and vested deferred stock units valued at $150,000.

Director TenureAll of the directors hold directorships with other organizations. Ms. Roché is the longest serving director, having served since 1998. Mr. Kennard and Mr. Hutchins are the shortest serving directors having joined the board in 2014. Mr. Kennard serves as a director for Duke Energy Corporation, Ford Motor Company, and MetLife, Inc. Mr. McCallister served as a director for Humana Inc. and serves as a director for Fifth Third Bancorp and Zoetis Inc. Ms. Mooney serves as a director for KeyCorp. Ms. Roché serves as a director of Dr Pepper Snapple Group, Inc., Macy’s Inc., and Tupperware Brands Corporation. Mr. Rose serves as a director of BNSF Railway Company, Burlington Northern Sante Fe, LLC, and Fluor Corporation.

CEO CompensationMr. Randall L. Stephenson serves as Chairman, Chief Executive Officer, and President and has been with AT&T since 1982. Previously, he served as Chief Financial Officer from 2001 to 2004 and Chief Operating Officer from 2004 to 2007. In 2014, Mr. Stephenson earned a total of $23,984,315. He received a base salary of $1,691,667, stock awards of $14,248,893, incentive compensation of $4,350,000, deferred compensation of $3,206,277, and other compensation totaling $487,478. Mr. John Stephens, Senior Executive Vice President and Chief Financial Officer, was the second highest compensated AT&T executive. In 2014, he earned a total of $10,711,097. He received a base salary of $765,833, stock awards of $4,294,312, incentive compensation of $1,425,000, deferred compensation of $3,733,775, and other compensation totaling $492,177. Other compensation included personal benefits, Company-paid life insurance premiums, and Company matching contributions to deferral plans for 2014.

Wednesday
Feb102016

The Director Compensation Project: Wells Fargo & Company (WFC)

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation. We are for the most part including companies from 2015’s Fortune 500 and using information found in their 2015 proxy statements.

NASDAQ and the NYSE have similar rules with respect to director independence. NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors. A director does not qualify as “independent” if he or she has a “material relationship with the company.” NYSE Rule 303A.02(a). In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years. The NYSE imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3) (see Rule 303A.06) and requires consideration by the board of directors of certain specified factors in designating directors for the Compensation Committee.  See NYSE Rule 303A.02(a)(ii).

Finally, as the Commission has noted with respect to director independence: 

  • All compensation committee members must meet the general independence standards under NYSE’s rules in addition to the two new criteria being adopted herein. The Commission therefore expects that boards, in fulfilling their obligations, will apply this standard to each such director’s individual responsibilities as a board member, including specific committee memberships such as the compensation committee. Although personal and business relationships, related party transactions, and other matters suggested by commenters are not specified either as bright-line disqualifications or explicit factors that must be considered in evaluating a director’s independence, the Commission believes that compliance with NYSE’s rules and the provision noted above would demand consideration of such factors with respect to compensation committee members, as well as to all Independent Directors on the board. 

Exchange Act Release No. 68639 (Jan. 11, 2013); see also Exchange Act Release No. 68641 (Jan. 11, 2013).

Independent directors are compensated for their service on the board. The amount of “total compensation” can be seen from examining the director compensation table from the Wells Fargo & Company’s (NYSE: WFC) 2015 proxy statement. According to the proxy statement, the company paid the directors the following amounts:

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Option Awards
($)

All Other Compensation
($)

Total
($)

John D. Baker II

165,000

160,035

0

0

325,035

Elaine L. Chao

107,000

160,035

0

0

267,035

John S. Chen

103,000

160,035

0

0

263,035

Llyod H. Dean***

152,000

160,035

0

0

312,035

Elizabeth A. Duke**

 

 

 

 

 

Susan E. Engel

143,000

160,035

0

0

303,035

Enrique Hernandez, Jr.***

194,000

160,035

0

5,000

359,035

Donald M. James

109,000

160,035

0

0

269,035

Cynthia H. Milligan***

150,000

160,035

0

0

310,035

Frederico F. Pena

138,000

160,035

0

0

298,035

James H. Quigley***

150,500

160,035

0

0

310,535

Howard V. Richardson****

8,750

0

0

0

8,750

Judith M. Runstad***

172,000

160,035

0

0

332,035

Stephen W. Sanger***

183,000

160,035

0

0

343,035

Susan G. Swenson

119,000

160,035

0

0

279,035

John G. Stumpf*

0

0

0

0

0

Suzanne M. Vautrinot**

 

 

 

 

 

*Employee director

**Joined the Board in 2015.

*** Received an annual cash retainer of $10,000, payable quarterly in arrears, and a fee of $2,000 per separate meeting not held concurrently with or immediately prior to or following a Company Board or committee meeting.

****Resigned effective January 31, 2014.

Director CompensationDuring fiscal year 2014, Wells Fargo held nine board of directors meetings and thirty-four committee meetings. Each current director attended at least 75% of the total number of board and committee meetings on which he or she served. Overall attendance of current directors at meetings of the board and its committees averaged 98.95%. Directors are reimbursed for expenses incurred from board service, including cost of attending board and committee meetings.      

Director TenureIn 2014, Ms. Milligan, who has held her position as a member of the Board of Directors since 1992, held the longest tenure. Mr. Hutchins and Mr. Kennard hold the shortest tenure as they joined in 2014. All but three of the directors sit on other boards: Ms. Chao serves as a director for News Corp. and Vulcan Materials Company, Mr. Chen serves as a director for BlackBerry Limited and The Walt Disney Company, Mr. Hernandez serves as a director for Chevron Corp., McDonald’s Corp., and as chairman for Nordstrom, Inc., Ms. Milligan serves as a director for Calvert Funds, Kellogg Company, and Raven Industries, Inc., and Mr. Quigley serves as a director for Hess Corp. and Merrimack Pharmaceuticals, Inc.

CEO CompensationJohn Stumpf, Wells Fargo’s President and Chief Executive Officer since 2007 and Chairman of the Board since 2010, earned total compensation of $21,426,391 in 2014. He earned a base salary of $2,800,000, stock awards of $12,500,029, incentive compensation of $4,000,000, deferred earnings of $2,108,162, and other compensation totaling $18,200. Timothy J. Sloan, Senior Executive Vice President of Wholesale Banking, earned total compensation of $10,448,138 in 2014. He earned a base salary of $1,829,885, stock awards of $7,000,053, incentive compensation of $1,600,000, and other compensation totaling $18,200.

Tuesday
Feb092016

No-Action Letter for HomeTrust Bancshares, Inc. Allowed Exclusion of Dividend Proposal

In HomeTrust Bancshares, Inc., 2015 BL 289659 (Aug. 31, 2015), shareholder, William R. Dossenbach (“Dossenbach”) proposed HomeTrust Bancshares (“HomeTrust”) issue an annual dividend equal to 50% of after tax profits. The Securities and Exchange Commission (the “Commission”) ultimately concluded it would not recommend enforcement action if HomeTrust omitted the proposal from its annual proxy statement.

Dossenbach’s proposal requested the following: "Effective for fiscal year 2016 and thereafter HomeTrust Bank shall annually pay a dividend of 50% of after tax profits. The dividend shall be paid in 4 quarterly payments with a Special 5th payment, after year end, to complete the 50%."

HomeTrust argued the Commission consistently permitted the exclusion of proposals that created a specific formula for payment of cash or stock dividends. HomeTrust argued that Dossenbach’s proposal was effectively identical to many of these proposals. Dossenbach did not respond to HomeTrust’s arguments.

Rule 14a-8 provides the substantive and procedural requirements for when a company must include a shareholder proposal in its proxy materials. A company may exclude a shareholder proposal if the proposal does not meet the eligibility or procedural requirements of Rule 14a-8. To be eligible for the Rule, a shareholder must own the lesser of 1% of the voting securities of the company or hold $2,000.  The proposal cannot be more than 500 words. Additionally, companies may exclude proposals that fall under one of thirteen substantive exceptions provided in Rule 14a-8(i).  Subsection (i)(13) allows for the exclusion of proposals that relate “to specific amounts of cash or stock dividends.”

The Commission agreed with HomeTrust’s reasoning. On August 31, 2015, the Commission decided it would not recommend enforcement action if HomeTrust omitted the proposal from its proxy materials under 14a-8(i)(13) because the proposal related to specific calculations of cash dividends.

The primary materials for this post can be found on the DU Corporate Governance website.

Monday
Feb082016

Plaintiffs Prevail Over Motion to Dismiss Due to Factual Record of Misleading Representation and the Effect on Stock Price

In Marcus v. J.C. Penney Co., No. 6:13-cv-736-MHS-KNM (Sep. 29, 2015), the United States District Court for the Eastern District of Texas overruled J.C. Penney Company, Inc., Kenneth Hannah, and Myron Ullman III’s (collectively, “Defendants”) objections to the Magistrate Judge’s Report and Recommendation (“Recommendation”) denying Defendants’ motion to dismiss. The court’s decision affirmed the Magistrate Judge’s ruling and denied Defendants’ request for oral hearing. The court also granted Alan B. Marcus’s (“Plaintiff”) request for judicial notice. 

According to the allegations, Defendants made statements on August 20, 2013 stating that inventory was sufficient in size and availability. Plaintiff asserted that statement referred to the status of the company’s inventory on August 3, the end of the second quarter, rather than the date of the statement “without informing investors of the temporal distinction.”  In Sept. 2013, an officer further stated at an “investor meeting” that the company ended the year with “sufficient liquidity.” On September 24, 2013, Goldman Sachs, Inc. issued a report including information regarding J.C. Penney’s need to build “a bigger liquidity buffer.”  J.C. Penney’s stock “dropped to a 13-year intra-day low.”

On July 18, 2014, Plaintiff filed suit alleging violations of Rule 10b-5 under the Securities Exchange Act of 1934. Defendants filed a motion to dismiss.  The magistrate recommended a denial of the motion.  Defendants filed three objections to the magistrate recommendation:  (1) the complaint contained no actionable statements; (2) Plaintiff did not demonstrate causation regarding the drop in stock price; and (3) the Magistrate Judge erroneously applied safe harbor law. 

The court held the complaint: (1) adequately alleged Defendants made a misleading representation regarding inventories at the end of the second fiscal quarter (“Plaintiffs have alleged enough facts to plausibly show that Defendants represented that they had sufficient inventory as of the end of 2Q13 and that this statement was misleading when made”); (2) the “cautionary warnings” were insufficient to result in the application of the safe harbor for forward looking statements “as a matter of law” and (3) that causation had been adequately alleged.  Id. (“The Complaint further states that the ‘decline cannot properly be attributed to any market or industry event or force, but rather was a direct result of the disclosure.” Id. Plaintiffs clearly pled sufficient facts to show causation.’”). 

Accordingly, the court affirmed the Recommendation, denied Defendant’s motion to dismiss, and granted Plaintiff’s request for judicial notice.

The primary materials for this post can be found on the DU Corporate Governance website.

Friday
Feb052016

SEC Moves Against Alleged Pyramid Scheme in Colorado

In Securities and Exchange Commission v. Johnson  No. 1:15-cv-00299-REB (D. Colo. Feb. 12, 2015), the Securities and Exchange Commission (“SEC”) alleged Kristine Johnson, Troy Barnes, and Work With Troy Barnes, Inc. (collectively, the “Defendants”) operated a fraudulent Ponzi scheme and misappropriated investor funds. Achieve International, LLC (“AI”) was named as a Relief Defendant.

According to the allegations in the SEC’s complaint (at least some based “on information and belief”), Johnson or Barnes incorporated Work With Troy Barnes, Inc. (“WWTB”) in March 2014. WWTB was later rebranded as The Achieve Community (“TAC”), described in the complaint as “trade name of d/b/a [doing business as] for WWTB.”  TAC allegedly offered and sold “positions” to potential investors at $50 each.  Investors were “promised” a pay-out of $400, or a 700% return.  TAC claimed that it was “able to pay out these investment returns as a result of a “triple algorithm” and “matrix” that Johnson and Barnes created.”

The SEC alleged that the Defendants operated a Ponzi scheme.  As the complaint stated:

Contrary to TAC’s explicit representation, TAC is a pure Ponzi and pyramid scheme. Earlier investors are paid their returns from the funds of newer investors. Similarly, investors must wait to progress through the “matrix” before their returns are paid to them.

The SEC also alleged that “Defendants have misappropriated investor funds for Johnson and Barnes’ own personal use.” 

The Complaint alleged violations of Section 17(a) of the Securities Act of 1933 and Rule 10b-5 of the Securities Exchange Act of 1934.  Achieve International has been named as a relief defendant “for the purpose of recovering ill-gotten gains from the scheme in its accounts.”

The primary materials for this post can be found on the DU Corporate Governance website.

Wednesday
Feb032016

SEC v. Ferrone: Civil Remedies Against Douglas McClain, Sr. and Douglas McClain, Jr.

In SEC v. Ferrone, No. 11 C 5223, 2015 BL 347120 (N.D. Ill. Oct. 21, 2015), the United States District Court for the Northern District of Illinois denied in part and granted in part the Security and Exchange Commission’s (“SEC”) request for: (1) unconditional officer-director bars against Douglas McClain Sr. and Douglas McClain Jr. (collectively, “Defendants”); (2) disgorgement, in the amount of $335,000, from McClain Jr.; (3) permanent injunctions against Defendants; and (4) a $130,000 civil penalty against McClain Sr.

According to the allegations, McClain Sr. learned that the FDA had blocked Argyll Biotechnologies, LLC (“Argyll”) from beginning SF-1019 clinical trials on human subjects. From April-October 2007, McClain Jr. began selling hundreds of thousands of his Argyll shares. McClain Sr. allegedly made misleading statements to investors regarding the FDA’s approval process.

The SEC filed a claim against the Defendants on August 1, 2011 for various violations of Section 17(a) of the Securities Act of 1933 (“1933 Act”) and Sections 10(b), 13(a), 14, and 16(a) of the Securities Exchange Act of 1934 (“Exchange Act”). The court granted the SEC’s motion for summary judgment on its securities fraud claims against the Defendants in October 2014.

The SEC sought relief from the Defendants, including (1) permanent injunctive relief against the Defendants under section 20(b) of the 1933 Act and Section 21(d) of the Exchange Act; (2) a permanent ban as an officer or director for the Defendants under antifraud provisions of Sections 20(b) and 21(d) of the 1933 Act and the Exchange Act; (3) disgorgement of the Defendants profits from fraudulent activities; and (4) a civil penalty against McClain Sr.

Section 20(d) of the Exchange Act allows a court to prohibit, conditionally or unconditionally, a person from acting as an officer-director of a public company. 15 USC 78u(d). To determine officer-director fitness, a court weighs: (1) the underlying violation’s egregiousness; (2) a defendant’s repeat offender status; and (3) a defendant’s degree of scienter, based on the totality of the circumstances surrounding the alleged violation. A plaintiff may seek permanent injunctive relief if a court determines there is reasonable likelihood a defendant will reoffend.  Finally, a third-tier penalty may be imposed if a defendant used fraud, deceit, or manipulation, which created significant risk of, or resulted in, substantial loss to others.  

First, the court held Defendants’ illegal conduct was “flagrant, recurrent, and committed with a high degree of scienter,” and determined the Defendants would likely reoffend. As a result, the court permanently enjoined Defendants under Section 20(b) of the 1933 Act and 21(d) the Exchange Act. In addition, the court declined to grant a bar prohibiting the Defendants from ever serving as an officer or director or a public company. Instead, the court barred Defendants from serving as directors-officers of any public biopharmaceutical company. Id.(“The officer-director bar imposed against the McClains should be tailored to the facts of this case. Therefore, I find that the McClains are permanently unfit to serve as an officer or director only of any public biopharmaceutical company.”) The court also ordered $429,839.99 in disgorgement for McClain Sr. but concluded the proposed amount against McClain Jr. unsupported by evidence after finding the method used to calculate disgorgement was inappropriate. Finally, the court found the SEC’s requested $130,000 civil penalty against McClain Sr. was appropriate and a necessary deterrent against future securities fraud.

As such, the court denied in part, and granted in part, SEC’s request for penalties against Defendants for violations of the 1933 Act and the Exchange Act.

The primary materials for this case may be found on the DU Corporate Governance website.

Tuesday
Feb022016

N.Y. Court Denies Summary Judgment In Unique RMBS Case Involving Sophisticated Investors

In Basis Pac-Rim Opportunity Fund (Master) v. TCW Asset Mgt. Co., 2015 BL 342991 (N.Y. Sup. Ct. Oct. 16, 2015), the Supreme Court of New York denied TCW Asset Management Company’s (“Defendant”) motion to dismiss securities fraud claims brought by two Cayman Island hedge funds, Basis Pac-Rim Opportunity Fund (Master) and Basis Yield Alpha Fund (Master) (collectively, “Plaintiffs”).

According to the allegations, Defendant promoted a system for “navigating” the residential mortgage backed securities (“RMBS”) market that could identify good investments from bad ones. The investment strategy operated through a collateralized debt obligation (“CDO”) known as Dutch Hill Funding II, Ltd. (“Dutch Hill”), which served as an investment vehicle for taking a net long position on risky RMBS. In May 2007, Plaintiffs invested in the riskiest parts of Dutch Hill, with over $28.1 million in total investments. Over the following months, however, the RMBS market declined and, by July 2007, Plaintiffs’ investment in Dutch Hill had lost most of its value, rendering it worthless.

On November 21, 2012, Plaintiffs filed a complaint, pursuant to NY law, alleging Defendant made fraudulent misrepresentations that persuaded Plaintiffs to invest in Dutch Hill. Specifically, Plaintiffs claimed Defendant failed to select Dutch Hill’s RMBS collateral in the manner represented and that Defendant allegedly marketed “an investment strategy in 2007 it did not believe it could profitably execute.” 

To prove securities fraud in New York, a party must show: (1) a material misrepresentation; (2) scienter; (3) reasonable reliance; and (4) proof of transaction causation and loss causation.

The court noted the issue was different from normal RMBS fraud cases because Plaintiffs were not “duped” into thinking that “RMBS were generally a sound asset class” but were aware of the risks associated with the RMBS market. Id. (“[T]his is a case where all parties recognized the problems in the housing market prior to [Basis'] investment.”). Instead, the allegations turned the “purported unique abilities” of the Defendant. Id. (“Hence, the issue in this case is not whether it was objectively reasonable for a sophisticated investor to make long RMBS bets in May 2007. Rather, the question is whether a sophisticated investor such as [Basis] could have reasonably believed in TCW's purported unique abilities.”). 

The court agreed that issue raised enough questions of fact to defeat summary judgment on the inherently fact-intensive inquiries into materiality, scienter, and reasonable reliance. With respect to the alleged misrepresentations, the court found that Plaintiff “has met its burden of proffering evidence from which a reasonable juror could conclude that TCW's internal views of the subject RMBS collateral differed from the representations made to Basis.” Evidence showing that Defendant’s “internal views” did not “align” with views “publicly expressed to investors was enough to create a question of fact as to intent. 

Satisfying causation required a showing of a casual link between the alleged misrepresentation and the economic harm. The court also held Plaintiffs alleged enough facts to raise a question of loss causation. Id. (“Since TCW's investment strategy was premised on navigating an admittedly problematic RMBS market, lying about navigating the market in the manner advertised would surely be causally related to Basis' loss, as Basis having its money invested in knowingly troublesome RMBS was precisely the risk Basis sought to avoid by investing with TCW.”). 

As for Defendant’s argument that the RMBS market crash was of such dramatic proportions that Plaintiffs’ losses would have occurred at the same time and extent regardless of the alleged fraud, the court disagreed. Id. (“TCW would have the court believe that the crash of the RMBS market is akin to the flood and the falling tree-that is, an unforeseen event that causes a loss, which occurrence was not made more likely by TCW misrepresentations. The court disagrees.”). As a result, it did “not matter what else [Plaintiff] would have done with its money if it did not invest with [Defendant].” 

Accordingly, the court denied Defendant’s motion for summary judgment.

The primary materials for the post are available on the DU Corporate Governance website.

 

Monday
Feb012016

Federated National Holding Company Allowed to Exclude Proposal to Make Changes to By-Laws

In Federated National Holding Company, 2015 BL 327418 (Oct. 2, 2015), the SEC issued a no-action letter permitting Federated National Holding Company (“FNHC”) to exclude several   shareholder proposals submitted by Larry Seal (“Seal”).

Rule 14a-8 gives shareholders the right to include proposals in the company’s proxy statement.  17 CFR 240.14a-8.  The rule includes 13 substantive grounds of excluding a proposal.  A company seeking to exclude a proposal must submit its reasons for doing so to the Securities and Exchange Commission (“SEC”).  In addition, the rule also permits exclusion on a number of procedural grounds. 

Specifically Rule 14a-8(e) provides that a shareholder proposal must be received at the company’s principal executive offices not less than 120 calendar days before the company’s release of the proxy statement in connection with the previous year's annual meeting. The date for submission must be disclosed in the company’s proxy statement. 

The shareholder proposal requested that FNHC change the by-laws in regards to its directors and officers. In particular, the proposal sought to (1) change the minimum number of directors to seven members, (2) require a minimum percentage of the directors be independent, and (3) to modify the titles and who occupies specific offices on the board of directors.  The proposal specifically requests:

  • ·      “The Company’s Board of Directors shall consist of not less than seven (7) nor more than 15 members…”
  • ·      “[a]t least 66% of the directors shall be independent as defined in the NASDAQ listing standards”; and
  • ·      “[t]he offices of President and Chairman shall be separate and shall not be held by the same person.”

 FNHC argued that the company did not receive the proposal by the deadline it set forth in Rule 14a-8(e).  FHNC did not receive Seal’s proposal until July 24, 2015, well after the deadline.  Ultimately, the SEC agreed with FNHC’s reasoning. On October 2, 2015, the SEC announced it would not seek enforcement action should FHNC omit the proposal from their proxy statement under 14a-8(e)(2).

The primary materials for this post can be found on the SEC Website.

Friday
Jan292016

SEC v. Lauer: $60 Million Verdict Affirmed  

In SEC v. Lauer, No. 13-13110, 2015 BL 112518 (11th Cir. Apr. 21, 2015), the Eleventh Circuit affirmed a judgment of over $60 million against Michael Lauer (“Defendant”) and declined to vacate the judgment as void pursuant to Federal Rule of Civil Procedure 60(b)(4) (“FRCP”) and to vacate the judgment for fraud on the court pursuant to FRCP 60(d)(3).

On appeal, Lauer raised three arguments: (1) the judgment of the district court was void pursuant to Rule 60(b)(4); (2) the judgment of the district court was void pursuant to Rule 60(d)(3) because the SEC committed a fraud on the court; and (3) Lauer was entitled to additional discovery or an evidentiary hearing. To prevail in voiding a judgment, pursuant to Rule 60(b)(4), an appellee must show there was a due process violation. A “mere error” in jurisdiction does not afford relief under Rule 60(b)(4).

Lauer made six arguments in an attempt to demonstrate the judgment of the district court was void under Rule 60(b)(4): (1) the asset freeze was a denial of due process; (2) the SEC never approved of the action against Lauer; (3) the court lacked subject matter jurisdiction; (4) the SEC interfered with Lauer’s attorney-client privilege; (5) Chief Judge Zloch failed to recuse himself and influenced the reassignment of the case; and (6) the court granted prejudgment interest.

The court rejected these arguments.  With suspect to the asserted non-approval of the action by the SEC, Lauer asserted that four commissioners had signed the “Request for Commission Action.”  In two cases, however, “the commissioners had two sets of initials next to their names, and the second pair of initials did not match each respective commissioner's initials.”  Lauer asserted that the evidence established that, in fact, a majority of the commissioners had not approved the action.  As the court reasoned:  

The Commission used its seriatim process to initiate the action. Under that process, the commissioners individually consider the matter and then report their votes to the Secretary. 17 C.F.R. § 200.42(a). Lauer has pointed to no statute or regulation that requires a commissioner to use only his personal signature to report his vote. And the minor potential irregularity does not overcome the “presumption to which administrative agencies are entitled—that they will act properly and according to law.”

Lauer also sought to have the judgement vacated because the Chief Judge “behaved impermissibly”.  Lauer alleged that the Chief Judge should have recused himself upon Lauer’s motion and had “impermissibly influenced the reassignment of the case”.  The court found that Lauer had not established that the Chief Judge was “personally biased” or that the reassignment process had been mishandled.  Id. (“But the change in judge was hardly mysterious. The case was selected for random reassignment to a new judge to maintain a balanced workload within the district. Judge Cooke, to whom it was reassigned, recused herself, so the case was returned to Chief Judge Zloch. Chief Judge Zloch then recused himself so that the case would be randomly reassigned again, and this time it was Judge Marra who drew the assignment.”). 

The court also rejected the argument that the SEC committed a fraud on the court. “Lauer argues that we must vacate the judgment because the Commission committed a ‘fraud on the court’ when it told the district court that it planned to call witnesses who asserted their Fifth Amendment right against self-incrimination and refused to be deposed.” 

To prevail under Rule 60(d)(3), fraud must be shown by clear and convincing evidence. This fraud is limited to serious transgressions against the legal process. The court initially noted Lauer failed to raise this issue in his merits appeal. The court also determined that Lauer had not sufficiently established that the Commission “intentionally deceived the district court”.  Id. (“Lauer has not established by “clear and convincing evidence,” that the Commission intentionally deceived the district court when it stated that it would call Barbarosh, Isaacson, and Levie as witnesses. “[W]hatever else it embodies, [fraud on the court] requires a showing that one has acted with an intent to deceive or defraud the court.” Lauer has not established that the Commission knew that these witnesses would never testify.”) (citations omitted).    

Accordingly, the Court affirmed the $60 million judgment against Lauer.

The primary materials for this post can be found on the DU Corporate Governance website.

Wednesday
Jan272016

Shankar v. Imperva, Inc.: Motion for Failure to State a Claim Granted with Leave to Amend Complaint Permitted

In Shankar v. Imperva, Inc., No. 14-cv-1680-PJH, 2015 BL 303541 (N.D. Cal. Sept. 17, 2015), the United States District Court for the Northern District of California granted Imperva, Inc.’s (“Imperva”) motion to dismiss for failure to state a claim regarding a class action filed by Viswanath Shankar on behalf of himself and Imperva shareholders (“Plaintiff”).

The complaint alleged violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Act”) and Rule 10b-5 thereunder. According to the allegations, Imperva’s stock price declined 44% after the release of 2014 first quarter results, which fell short of the company’s revenue forecast by nearly $6 million. As a result, the Plaintiff alleged Imperva’s CEO and CFO made several false and misleading statements regarding the company’s competitive position, superior technology, and strong financial results, while failing to disclose its loss of business to competitors.

To prove violations of Sections 10(b) and 20(a) of the Act and Rule 10b-5 thereunder, a plaintiff must show: (1) a material misrepresentation or omission in connection with the sale or purchase of a security; (2) scienter; (3) reliance; (4) economic loss; and (5) loss causation. In addressing the issues, the court divided the alleged misleading statements into three separate categories as follows: (1) statements about Imperva’s competitive success; (2) statements about Imperva’s technology; and (3) statements providing revenue guidance for Q1 2014.  

First, the court concluded the statements regarding Imperva’s competitive success were vague, optimistic, and suggestive. Because the Plaintiff failed to allege facts that undermined Imperva’s statements, which were not capable of objective verification, the court held these statements were not actionable under the federal securities laws.

Second, the court held Imperva’s statements regarding its technology could not be considered false or misleading because the Plaintiff failed to offer any explanation for why the statements rendered the company’s technology inferior to competitors. 

Lastly, the court held the statements regarding Imperva’s Q1 2014 revenue guidance were not false or misleading because they qualified for safe harbor as forward-looking statements. To qualify as forward-looking, statements must be identified as such and accompanied by cautionary statements that identify factors potentially leading to materially different results. The court found Imperva’s reference to the risk factors in its 10-Qs, which specifically detailed warnings regarding potential impacts of competition, were sufficient as cautionary statements. 

Accordingly, the court dismissed the Plaintiff’s complaint for failure to state a claim, but permitted leave to amend with respect to the already identified statements regarding Imperva’s competitive success and revenue guidance for Q1 2014. 

Primary materials for this case may be found on the DU Corporate Governance website.

Tuesday
Jan262016

SEC v. Dubovoy: Asset Freeze for Illegal Trading

In Securities and Exchange Commission v. Dubovoy, No. 15-6076, 2015 BL 341390 (D.N.J. Oct. 16, 2015), the United States District Court for the District of New Jersey granted the Securities and Exchange Commission’s (“SEC”) motion for a preliminary injunction freezing assets against David Amaryan, Intertrade, Ocean Prime, Copperstone Capital, and Copperstone Alpha Fund (collectively, the “Amaryan Defendants”). The court found the SEC successfully raised a strong inference that the Amaryan Defendants violated federal securities laws. 

The complaint arose out of an alleged scheme to trade on information hacked from newswire services.  The information came from three publishers: Marketwired, PRN, and Businesswire (“Newswire Services”).  The Newswire Services electronically stored press releases on its servers before the subsequent release to the public. 

Two “Hacker Defendants” allegedly hacked Newswire Services’ computer systems and stole thousands of press releases before they were released to the public. The Hacker Defendants then allegedly passed the information to the Trader Defendants, including the Amaryan Defendants, who then traded the hacked information. The Trader Defendants collectively produced more than $100 million in illegal profits, with the Amaryan Defendants allegedly generating over $8 million. Accordingly, the SEC sought a preliminary injunction to maintain the freeze on the Amaryan Defendants’ assets. 

To be successful in a preliminary injunction to maintain an asset freeze, a plaintiff must show either: (1) a likelihood of success on the merits; or (2) that an inference can be drawn that the party violated federal securities laws. The court may also factor in concerns that a defendant will dissipate their assets or transfer them beyond jurisdiction of the United States. The burden of proof increases depending on the potential hardship an asset freeze will create for a defendant. 

The court held the SEC satisfied its burden to maintain the asset freeze.  The SEC offered evidence of Amaryan Defendants’ suspicious trading activity and provided expert statistical analysis for corroboration. The court found it persuasive that the Amaryan Defendants’ trading activity mirrored the pattern of the Hacker Defendants’ access to the Newswire Services.  Id. (“The SEC first demonstrated that, during the relevant period, the Amaryan Defendants’ trading activity mirrored the Hacker Defendants’ oscillating access to the Newswire Services.”).

The court further reasoned that the Amaryan Defendants’ trading pattern overlapped with other Trader Defendants accused of illegal trading activity.  Id. (“At times, other Trader Defendants would take a position in a security during the window within mere minutes of the Amaryan Defendants.”). 

The court also found the timing of the Amaryan Defendants’ trades suspicious, as they almost always traded during the narrow window of time between the upload of the press releases to Newswire Services and public dissemination. Id. (“The SEC next demonstrated that the Amaryan Defendants almost always traded during the narrow window of time between upload of the press release to the newswire service and the public dissemination of that press release.”).  Finally, the court found convincing, the statistical analysis of the SEC’s retained expert, which analyzed, “questioned,” and “challenged” trades by the Amaryan Defendants and found strong correlations in the trading patterns.

Amaryan Defendants’ expert, however, who purported to establish the existence of a legitimate trading strategy citing fundamental methodological flaws, did not persuade the court. The court found the expert’s conclusions about the profitability of trades failed to account for a single anomalous trade consisting of virtually all of the $25.4 million in profits, and dismissed the expert’s conclusion that the timing of the trades was industry custom given that investors frequently traded in periods surrounding earnings releases. Finally, the court reasoned that no potential hardship due to an asset freeze would justify lifting the restraint.

Accordingly, the court granted the SEC’s preliminary injunction to freeze the Amaryan Defendants’ assets.

The primary material for this case can be found on the DU Corporate Governance Website.

Monday
Jan252016

Buttonwood Tree Value Partners, LP. v. Sullivan: Board of Directors Did Not Violate Fiduciary Duty by Refusing Offer to Purchase

In an unexpectedly brief opinion, the Delaware Supreme court in Buttonwood Tree Value Partners, LP. v. Sullivan, 2015 BL 348912, (Del. Oct. 22, 2015)  affirmed the Court of Chancery's ruling to dismiss Buttonwood Tree Value Partners’ (“Buttonwood”) claim that Sullivan and other directors of the Central Steel and Wire Company (“Central Steel”) violated their fiduciary duty by not entertaining Buttonwood's offers to acquire the company.

 According to the allegations, the directors both managed Central Steel and acted as trustees for a charitable trust that owned a majority of the company’s shares.  After the directors refused to consider an offer to acquire the company, Buttonwood filed a claim for breach of fiduciary duty. Specifically, Buttonwood alleged that the directors of Central Steel made "a nice living from their roles" and, as a result, their decision was motivated by disloyalty. The lower court dismissed the claim under the ruling in Gantler v. Stephens by concluding that the refusal to consider an offer was not actionable absent allegations other than "the typical entrenchment motive".

 The Supreme Court decided the case on a different basis. The Court noted that a controlling shareholder was not required to consider offers to sell its share. This did not change solely because directors served at both the company and the trust. According to the Court, a controlling stockholder usually had affiliated managers serving as top managers at the controlled company. “That those affiliated managers derive all or a substantial part of their living from their positions does not mean that an independent claim for breach of fiduciary duty arises when the controlling stockholder does not wish to sell its shares and those affiliates therefore do not entertain a takeover offer dependent on the controller's willingness to sell. In other words, there was nothing here that distinguishes this case from the long-standing rule that a controller does not have to entertain offers.”  To bring an action against a controlling shareholder required allegations of interested transactions or other such conduct that violated the duty of loyalty. 

As a result, the Court affirmed the dismissal of the action.

The primary materials for this post are available on the DU Corporate Governance website

Friday
Jan222016

SEC v. Helms: Ponzi Schemes Still Not Legit

In SEC v. Helms, 2015 BL 270501 (W.D. Tex. Aug. 21, 2015), the United States District Court for the District of Texas granted the Securities and Exchange Commission’s (“SEC”) motion for summary judgment and sanctions against Robert Helms, Janniece Kaelin, Deven Sellers, and Roland Barrera (collectively, “Defendants”) for alleged involvement in a Ponzi scheme and securities fraud. 

According to the allegations, Defendants Helms and Kaelin operated and controlled several entities including Vendetta Royalty Partners (“Vendetta”) and Iron Rock Royalty Partners (“Iron Rock”), organized as limited partnerships that held and distributed royalties from oil and gas investments. Vendetta began soliciting investors in July 2011 with the goal of raising $300 million in less than a year. Sellers and Barrera worked for Helms and Kaelin soliciting and negotiating investments in Vendetta, Iron Rock, and other entities. Helms and Kaelin raised roughly $31,422,861 selling limited partnership interests in Vendetta and Iron Rock to 129 investors, indicating 99% of funds would be used to buy royalty interests. 

On October 3, 2013, the SEC alleged Helms and Kaelin violated Section 17(a) of the Securities Act of 1933 (“Securities Act”), Section 10(b) of the Exchange Act of 1934 (“Exchange Act”), and Rule 10b-5 promulgated thereunder. Specifically, the SEC alleged Helms and Kaelin misappropriated at least $8,442,116 of the funds for personal use and at least $12,851,455 for business expenses. The SEC further contended the royalty revenues from Vendetta and Iron Rock were inadequate to pay the royalty distributions, which were eventually paid using subsequent investors’ money.  

In addition, the SEC alleged both Helms and Kaelin: (1) greatly overstated their professional backgrounds as well as the performance of prior investment portfolios to induce investments; (2) fabricated an audit letter regarding the holdings of Vendetta to present to potential investors; (3) falsely indicated they were not involved in litigation; and (4) orchestrated “round-trip transactions” to create fictitious income.

Finally, the SEC alleged Sellers and Barrera violated Section 17(a) of the Securities Act, Sections 15(a) and 10(b) of the Exchange Act, and Rule 10b-5. Specifically, the SEC contended the Private Placement Memorandum provided to potential investors misrepresented commissions earned by Sellers and Barrerra for each transaction as small. 

The SEC filed motions for summary judgment requesting permanent injunction, joint and several liability for disgorgement, and a civil money penalty. Because the Defendants did not respond or provide rebuttal evidence, the court accepted the SEC’s evidence as true. 

Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5, function similarly, prohibiting the offer or sale of securities through interstate commerce to: (1) make any attempt to defraud; (2) obtain money or property by means an untrue statement or omission of a material fact; or (3) engage course of business which operates as deceit upon the purchaser. All three require scienter—established by showing a defendant intended to deceive, defraud, or manipulate or acted with severe recklessness. 

The court first granted the SEC’s motion for sanctions against Kaelin for her refusal to comply with discovery obligations  In asserting that Kaelin had not done so, the Commission asked the court to strike her pleadings and draw adverse inferences from the behavior.  The court reviewed the allegations and agreed that the disclosure violations were “willful.”  The court agreed to strike her pleadings and enter a default judgment.  The court likewise agreed to draw adverse inferences.

Due to Kaelin's repeated refusal to participate in the discovery process, the Court finds it necessary to "issue further just orders" to remedy the prejudice to the SEC. This is especially true considering the fact that Kaelin's co-defendant Helms frequently stated in his deposition that Kaelin could explain questions that Helms could not answer. The Court therefore infers, based on Kaelin's bad faith refusal to testify, that her answers to the SEC's deposition questions would have been unfavorable to her.

The court found sufficient evidence that Helms and Kaelin were running a Ponzi scheme. The court also found Helms and Kaelin misrepresented material facts regarding: (1) the intended use of funds invested in Vendetta and other entities; (2) their professional backgrounds; (3) their involvement in litigation; and (4) the value of Vendetta’s Portfolio.  It made no difference that some of the funds were used for legitimate purposes.  Id. (“Although the evidence shows Helms and Kaelin used some of the investments to purchase royalty interests, the existence of a Ponzi scheme is not negated. Engaging in some legitimate business operations does not counteract the existence of a Ponzi scheme because the distributions made to investors were nevertheless funded by other investors' money.”). 

The court therefore held Helms and Kaelin violated 17(a), 10(b), and Rule 10b-5. Here, the court enjoined Helms and Kaelin from future securities violations, imposed joint and several liability for disgorgement of in ill-gotten gains of $31,422,861 with prejudgment interest of $3,873,043, and ordered Helms and Kaelin to each pay $4,221,058 in third-tier civil penalties.

With regard to Sellers and Barrera, the court found sufficient evidence that they materially misrepresented their commissions.  The court also found Sellers and Barrera, because they were not registered with the SEC as broker dealers, violated Section 15(a) of the Exchange Act. Here, the court reasoned that Sellers and Barrera were at least severely reckless in their misrepresentations and the conduct warranted permanent injunctive relief, joint and several liability for disgorgement in the amount of $423,500, subject to prejudgment interest of $36,243.87, and third-tier civil penalties of $150,000 each. 

Accordingly, the court granted the SEC’s motion for sanctions against Kaelin and motion for summary judgment against the Defendants, ordering the SEC to file a proposed final judgment detailing the injunctive relief, disgorgement amounts, and civil penalties.

The primary materials for this post can be found on the DU Corporate Governance Website.

Thursday
Jan212016

Even the Wall Street Journal Seems to Question Director “Independence”

 

In a front page article on January 20, the Wall Street Journal called to attention the close ties that exist between nominally independent directors and the companies on whose boards they sit.  Prime examples included in the article are:  (1) John Hennessy, the president of Stanford University who serves as an “independent” director at Google while at the same time the company has given Stanford “$24.9 million in donations scholarships and payments for research services and patent licenses” and (2) Andrew McKenna, an independent director at McDonalds who served in that role for over a quarter century while also serving on the board and holding stakes in companies that provided McDonalds with “a combined $71 million of French-fry bags and other goods.”

The article is careful to point out that meet the stock exchange rules governing independence but also notes that McDonald’s shares have “underperformed the restaurant industry over the past 15 years…” McDonald’s naturally responds “[t]his is not a go-along, get-along board.”

While the article never directly condemns the closeness of the ties between directors and the corporations on whose boards they serve it is not difficult to glean the condemnation in its tone.  Commentators have long decried the lack of true independence of many directors (see here and here among many others.  It is encouraging to see the venerable Wall Street Journal taking up the charge.

 

Tuesday
Jan192016

Espinoza v. Zuckerberg & Facebook, Inc.: Challenging Non-Executive Board Compensation 

In Espinoza v. Zuckerberg, No 9745-CB, 2015 BL 353714, (Del Ch. Oct. 28, 2015), Ernesto Espinoza (“Plaintiff”), a derivative stockholder of Facebook, Inc. (“Facebook”), filed a lawsuit on the behalf of Facebook against Facebook’s Board of Directors (“Board”) and Facebook’s CEO Mark Zuckerberg (“Zuckerberg”). The lawsuit against the Board and Zuckerberg (collectively, “Defendants”) sought damages and limits on board compensation. The Delaware Court of Chancery denied the Defendants’ requests for summary judgment regarding the breach of fiduciary responsibilities and unjust enrichment claims, but dismissed the claim for waste of corporate assets.

According to the allegations, Facebook’s Compensation Committee in August 2013 provided the Board recommendations on increasing the annual cash retainer for the Audit Committee members from $50,000 to $70,000 and provided non-employee directors an RSU grant equivalent of $300,000 per year.  Zuckerberg, a shareholder controlling over 61% of the company’s voting power, attended the meeting.  A few weeks later, the Board approved the recommendations.

In June 2014, Plaintiff filed a lawsuit.  The lawsuit asserted three claims against Defendants: (1) breach of fiduciary responsibilities by awarding excessive salaries and stock awards; (2) unjust enrichment of Board at Facebook’s expense; and (3) duty of care breach through waste of corporate assets. Specifically, Plaintiff alleged Defendants failed to meet approved stockholder ratification methods when it approved the Board’s 2013 compensation without a formal process and because the Board’s compensation was 43% higher than the average company in Facebook’s peer group.

Because the Board benefited from the decision, the duty of loyalty presumptively applied as the standard of review.  Defendants, however, argued that the transaction was approved by Zuckerberg, a controlling shareholder.  Defendants further asserted that approval constituted shareholder ratification, resulting in the application of the business judgment rule. Zuckerberg, according to the opinion, “expressed his approval of the 2013 compensation for the non-management directors in a deposition and an affidavit.”

For shareholders to act, they typically vote shares at a meeting.  In addition, Section 228 of the Delaware General Corporation Law, 8 Del. C. §228 (“Section 228”), sets out the authority for shareholders to act by consent in lieu of a meeting.  Under the provision, consents must be in writing.  According to the Delaware Court of Chancery, Section 228 was established to protect minority shareholder interests and provide transparency, including board compensation approvals.

The court did not treat Zuckerberg’s expression of approval as ratification. The court determined Zuckerberg, like any majority group of stockholders, must follow Section 228 requirements. Zuckerberg’s use of an affidavit did not meet statutory formalities.  As the court noted, “if affidavits are sufficient, what about meeting minutes, press releases, conversations with directors, or even ‘Liking’ a Facebook post of a proposed corporate action?”  Failing to adhere to corporate formalities also “impinges on the right of minority shareholders.”  Having relied only on ratification as a basis for summary judgment on the fiduciary duty claim, the court denied the motion.  For similar reasons, the court declined to grant the motion with respect to the claim for unjust enrichment. 

The court did, however, grant Defendants’ motion to dismiss Plaintiff’s claim for waste of corporate assets.  Specifically, the court found the Plaintiff failed to allege facts sufficient to show that the Board’s 2013 compensation was so extreme that Facebook did not receive adequate consideration for corporate duties.  Id.  (“Such allegations are essentially complaints that some portion of defendants' 2013 Compensation was above and beyond what they deserved for their performance. As such, the allegations fall far short of demonstrating that such compensation constitutes a gift or gratuity for which the corporation received no consideration.”).   

For the above reasons, the court denied Defendants’ motions for summary judgment as to Plaintiff’s breach of fiduciary duty and unjust enrichment claims, but granted Defendants’ motion to dismiss Plaintiff’s waste of corporate assets claim.

The primary material for this post can be found on the DU Corporate Governance website.

Monday
Jan182016

SEC v. Garfield Taylor, Inc., et al.: Section 20(d) used in Ponzi Scheme Judgment

In SEC v. Garfield Taylor, Inc., No. 11-2054 (RC), 2015 BL 313363 (D.D.C. Sept. 28, 2015), the United States District Court for the District of Columbia granted the Security and Exchange Commission’s (“SEC”) request to assess civil monetary penalties against Gibraltar Asset Management Group, LLC (“GAM”), Jeffrey A. King (“King”), and Garfield Taylor, Inc. (“GTI”) (collectively, “Defendants”). The court granted the SEC’s motion for entry of final judgment against proposed organizer GTI.

SEC alleged Defendants operated a Ponzi scheme that persuaded over 130 individuals and charitable organizations to invest in promissory notes GTI claimed would earn above-market interest rates and would carry little or no risk. Specifically, the SEC alleged GTI defrauded, through material misrepresentations and omissions, those investors in over $27 million in investments. SEC’s allegations stated GTI received $17,183,061.66 in pecuniary gains. On September 17, 2012, the court granted unopposed default judgments against Defendants and, therefore, viewed Defendant’s defaults as a concession to SEC’s allegations.

The SEC requested the court impose “substantial” civil monetary penalties against Defendant under Section 20(d) of the Securities Act of 1933 (the “Act”). The SEC alleged the conduct was severe enough to establish maximum 20(d) third-tier application. GTI contested the imposition of disgorgement, prejudgment interest, and the civil penalties assessed.

Section 20(d) of the Act allows the court to impose a penalty upon a person who violated the Act to deter future violations, and establishes three tiers of penalties. 15 USC 77t(d).  The third and most severe tier applies to violation(s) that involve fraud resulting in substantial loss or creation of financial risk loss to another. Under tier three, the court may impose a penalty for each violation not exceeding the greater of: (i) $150,000 for a natural person or $725,000 for any other person, including a corporate entity; or (ii) the gross amount of a defendant’s pecuniary gain resulting from violation. To determine a Section 20(d) penalty amount, courts consider a defendant’s conduct, knowledge, and financial condition. Additional factors include frequency of conduct and severity of loss to victims. A disgorgement amount is an approximation of any profits causally connected to an Act violation and enables plaintiffs to recover full amount of a defendants’ unjust enrichment.

The court found GTI’s conduct was both egregious and recurrent, arising from a single scheme and therefore imposed a third-tier penalty under Section 20(d) ($725,000 for GTI). While GTI’s gross pecuniary gain fell below the tier three requirement, the court found this penalty appropriate because GTI was central to the fraudulent conduct, and GTI failed to set forth any evidentiary support the SEC’s figure did not represent a reasonable approximation. The court acknowledged that civil monetary penalties provide a critical financial disincentive to engage in securities fraud that are not similarly served by a disgorgement judgment alone. Accordingly, the court granted the SEC’s assessment against GTI, GAM and King, and the final judgment against GTI.

The primary materials for this case may be found on the DU Corporate Governance website.

Monday
Dec212015

Better Late than Never: SEC Reproposes Resource Extractive Industries Rule Pursuant to Dodd-Frank Section 1504

After long delay, on December 11 the SEC reproposed the resource extractive industries rule that was first adopted in 2012 but was struck down by down by a D.C. federal district court in July 2013 after the American Petroleum Institute and other industry groups sued to block it. (The court said the SEC rule improperly required public disclosure and failed to allow any exemptions from the disclosure requirements when payments were made in countries where such disclosures would be illegal.

The SEC’s hand was forced by Oxfam who won a suit in Massachusetts in September compelling the “SEC to file with the Court in 30 days an expedited schedule for promulgating the final rule. The court will make further orders as necessary. As such, the Court shall retain jurisdiction to monitor the schedule and “to ensure compliance” with its order.”

Details of the proposed rule are here.  Interestingly, the public filing requirement that caused the first rendition of the rule such trouble remains in place.  The SEC did provide for a “case-by-case” exemption although SEC staff indicated that the exact process for an issuer to get an exemption hasn't yet been determined.  The reproposed rule will put the US in line with Canada and the EU, each of which have adopted similar rules.  The reproposed rule will allow reporting companies to submit to the SEC their disclosures from other jurisdictions, provided those jurisdictions have substantially similar rules to the SEC's. The proposal is “consistent with the emerging global consensus to fight corruption through enhanced disclosure of resource extraction payments to governments,” Commissioner Luis Aguilar said.

The substituted compliance could allow many companies to file only one disclosure report, rather than having to prepare several for multiple jurisdictions, Anderson said.

“That drastically cuts back on some compliance concerns and I think it's a welcome change,” she added.

 Initial comments on the proposal are due by January 25th and reply comments are due by February 16th. 

Thursday
Dec172015

Du Pont, Delaware, and "Empty Governance"

The announced merger between Du Pont and Dow Chemical will result initially in a single entity, DowDupont. The combined company plans to maintain two headquarters, one in Michigan (where Dow is based) and one in Wilmington Delaware (where Dupon is based).  At least one article, however, suggested that the dual headquarters structure would be "fleeting" and that ultimately the headquarters in Delaware could be closed. See DuPont merger: A 'sad day' for Delaware, Delaware Online, Dec. 12, 2015 ("The dual headquarters structure of the newly merged DowDuPont will likely be fleeting as the new company deals with the expenses and inefficiencies of maintaining two central locations. The decision could leave Delaware without a DuPont headquarters for the first time in 213 years.").   

Dupont is, of course, incorporated in Delaware (as is Dow).  That is no surprise; some 60% or more of the Fortune 500 are incorporated in the state.  What makes Dupont unusual is that it is actually headquartered in Delaware.  Of the Fortune 500, only two have headquarters in Wilmington:  Dupont (no. 87) and Navient (no. 463).  Dover, the second largest city in the state, has none.  To the extent that Dupont (or any of the resulting entities spun off from DowDupont) cease to be headquartered in the state, Delaware will find itself setting the law for largest public companies without actually having any of them within its jurisdiction.  

Sound familiar?  See Genger v. TR Investors, 26 A.3d 180 (Del. 2011) ("even if the Proxy language was ambiguous on that point, public policy considerations relating to the separation of voting control from underlyingeconomic stock ownership, which would result in 'empty voting,' required construing the Proxy strictly against any implied reservation of voting power.").  Perhaps, if this comes to pass, Delaware will be engaging in "empty governance."  

Wednesday
Dec162015

SEC v. Big Apple: Court of Appeals Affirms; Rule 10b-5 and § 17(a)(2) Not Analogous

In SEC v. Big Apple Consulting USA, Inc., 783 F.3d 786, 2015 BL 100537 (11th Cir. 2015), the Court of Appeals for the Eleventh Circuit affirmed the district court’s ruling that Big Apple Consulting USA, Inc. (“Big Apple”), its wholly owned subsidiary MJMM Investments, LLC (“MJMM”), Marc Jablon, and Mark C. Kaley (collectively, “Defendants”) violated the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) in an action brought by the Securities and Exchange Commission (“SEC”).

According to the complaint, MJMM executed a consulting agreement with CyberKey Solutions, Inc. (“CyberKey”) on June 15, 2005. The parties agreed Big Apple and its subsidiaries would promote CyberKey’s business in exchange for shares of CyberKey stock. James Plant, CEO of CyberKey, informed Defendants of a fictitious contract with the Department of Homeland Security (“DHS”) worth $25 million. On December 8, 2005, Plant publicized the DHS contract in a press release. From 2005 to 2007, MJMM received 77 million shares of CyberKey stock in exchange for services rendered and an additional 648 million shares through the exercise of options. During this time, Big Apple’s call center aggressively promoted CyberKey to securities brokers and dealers.

The SEC alleged that Defendants “violated § 17(a) of the Securities Act and aided and abetted violations of § 10(b) of the Exchange Act and SEC Rule 10b-5, in violation of § 20(e) of the Exchange Act.” At the time of the action, Section 20(e) “authorized the SEC to bring an action against any person who ‘knowingly provides substantial assistance’ to a primary violator of the Exchange Act.”

At trial, the jury found Defendants violated § 17(a) and § 20(e) with “both actual knowledge and severe recklessness.” On appeal, Defendants claimed the trial court erred by submitting the § 17(a) claims to the jury and that the jury was given improper instructions.

Section 17(a)(2) of the Securities Act makes it “unlawful for any person…to obtain money or property by means of any untrue statement of a material fact.” Defendants argued the holding in Janus Capital Group, Inc. v. First Derivative Traders should apply to § 17(a)(2) claims since the language of Rule 10b-5 and § 17(a)(2) were analogous. Applying this logic, Defendants claimed CyberKey had ultimate authority over the content of CyberKey’s press release, and thus the Defendants were not liable because they did not “make” the material misrepresentation.

The court rejected this argument, finding the language in § 17(a)(2), which focused on obtaining property by means of an untrue statement, was broader than that of SEC’s Rule 10b-5(b), which focused on the action of making an untrue statement. Here, the court concluded the text of § 17(a)(2) suggested that “it is irrelevant for purposes of liability whether the seller uses his own false statement or one made by another individual.” For these reasons, the court affirmed the lower court’s decision and found Defendants liable under § 17(a)(2).

Defendants also argued the lower court erred in failing to apply the “actual knowledge” standard for violation of § 20(e) of the Exchange Act. The court affirmed the district court’s decision that a finding of “severe recklessness” was sufficient to prove violation of § 20(e) of the Exchange Act.

The SEC further alleged that “Big Apple, MJMM, and Marc Jablon violated § 5(a) and (c) of the Securities Act.” These defendants asserted the applicability of § 4(a)(1) of the Securities Act, which exempts “transactions by any person other than an issuer, underwriter, or dealer.” The court affirmed the lower court’s determination, on a motion for summary judgment, that the exemption was unavailable because these persons were underwriters.

Accordingly, the Court of Appeals affirmed the lower court’s decision on all grounds in favor of the SEC.

The primary materials for this case may be found on the DU Corporate Governance website.

Tuesday
Dec152015

Dempsey v. Vieau: Motion to Dismiss Granted; Insufficient Allegations of Scienter

In Dempsey v. Vieau, 2015 BL 289745 (S.D.N.Y. Sept. 08, 2015), the United States District Court for the Southern District of New York granted David Vieau (“Vieau”), David Prystash (“Prystash”), John Granara III (“Granara”), and Jason Forcier’s (“Forcier”) (collectively, “Defendants”) motion to dismiss the Amended Complaint (“Complaint”) filed on behalf of all purchasers of A123 Systems, Inc. (“A123”) securities for securities fraud pursuant to Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5.

According to the allegations, A123 contracted with Fisker Automotive, Inc. (“Fisker”) to manufacture lithium-ion batteries for Fisker’s battery operated vehicle, the Fisker Karma. Plaintiffs alleged Defendants knew of defects in A123’s batteries but issued public statements contradicting this knowledge. Further, Plaintiffs alleged Defendants knew Fisker defaulted on the loan agreement from the Department of Energy (“DOE”), which was essential to Fisker’s business. A123 filed bankruptcy after it failed to deliver acceptable batteries to Fisker.

Plaintiffs alleged that Defendants deceived investors about A123’s inability to produce and ship adequate batteries to Fisker, and about Fisker’s inability to pay A123 for the batteries.

The court found Plaintiffs did not sufficiently demonstrate a material misrepresentation with regard to the defective batteries. The court also concluded that Plaintiffs insufficiently alleged scienter, which is “an intent to deceive, manipulate, or defraud.” A “strong inference of scienter” may be alleged through facts that either “defendants had both motive and opportunity to commit the fraud” or there was “strong circumstantial evidence of conscious misbehavior or recklessness.”

Scienter based on stock sales by insiders requires evidence of transactions unusual or suspicious in timing or amount. Plaintiffs alleged Defendants inflated the value of A123 stock by stating Fisker would purchase the batteries while knowing Fisker was “effectively insolvent.” Since Prystash and Granara had not sold A123 shares during the class period and Vieau and Forcier sold shares pursuant to a Rule 10b5-1 plan which “does not give rise to a strong inference of scienter,” the court held Plaintiffs failed to plead the transactions were unusual or suspicious in amount or timing.

The court dismissed Plaintiffs’ allegation of scienter based upon conscious misbehavior or recklessness. Plaintiffs argued Defendants knew or should have known Fisker would be unable to purchase batteries from A123. The court, however, found that Plaintiffs did not plead facts demonstrating that Fisker’s business was “plainly unsalvageable.” As a result, “the nonculpable inference that Defendants believed that Fisker would eventually recover and contribute to A123's revenue is more compelling than the alternative version asserted by Plaintiffs.”

Finally, the court found that Plaintiffs did not sufficiently claim a “strong inference” of scienter with respect to alleged violations of Generally Accepted Accounting Principles (“GAAP”).  Plaintiffs alleged that A123 failed to file an “other than temporary impairment” (“OTTI”) report of its investment in Fisker. The court, however, found that it was “more likely that Defendants believed that Fisker would be able to secure the necessary funds to continue production of the Karma and uphold its contract with A123 and that, therefore, there was no OTTI to report.”

Additionally, the court dismissed the § 20(a) claim because Plaintiffs failed to adequately plead a predicate Exchange Act violation.

Accordingly, the court granted Defendants’ motion to dismiss the Amended Complaint in its entirety.

The primary materials for the post are available on the DU Corporate Governance website.