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Wednesday
Mar012017

Lanier v. Bats Exch. Inc.: Appellate Court Upholds SRO’s Motion to Dismiss

This is one of two posts discussing Lanier v. Bats Exch. Inc., 838 F.3d 139  (2d Cir. 2016). This post will specifically cover the breach of contract claims. The second post covers subject matter jurisdiction.

In Lanier v. Bats Exch. Inc., 2d Cir., No. 15-1683 (2d Cir. Sep. 23, 2016), the United States Court of Appeals for the Second Circuit affirmed the district court’s dismissal of Harold Lanier’s (“Plaintiff”) breach of contract claims against a group of national securities exchanges (“Defendants”) for failure to state a claim.

National security exchanges are self-regulatory organizations (“SRO”) subject to the Securities and Exchange Commission’s (“SEC”) approval and oversight. The SEC has the authority to revoke their status as SROs. The national exchanges are required to comply with the SEC’s rules and regulations, including those addressing the distribution of “[i]nformation with respect to quotations for or transactions in any security.” The quotation and transaction information must be distributed “on terms that are not unreasonably discriminate.”

According to the complaint, Plaintiff contracted with Defendants to receive consolidated data via a securities information processor about securities traded on the Defendants’ exchanges. Plaintiff alleges that Defendants disseminated the same market date sent to the processor directly to a group of preferred customers and, due to the preferred customers’ bandwidth, transfer protocol, and physical location of servers, these customers received data as quickly as “one microsecond” after the data was sent. Plaintiff claimed the preferred customers benefited from the speed at which they received the market data.  Plaintiff and other similarly positioned traders (collectively “Subscribers”), in contrast, received stale data. Plaintiff alleged Defendants breached their contracts because the preferred customers received market data up to 1,499 microseconds faster than Subscribers.

Plaintiff argued Subscribers should have received market data prior to or at the same time as the preferred customer to be fair and nondiscriminatory. The court disagreed and noted that the SEC appeared to interpret the requirement to mean data must be sent at the same time, not received. Moreover, the court found that if Plaintiff’s theory were allowed, it would undermine Congress’ intent to create uniform rules for governing the national market system, a task given to the SEC. Thus, Plaintiff’s interpretation of the contracts was preempted.

The court next turned to the breach of contract claims. To plead a breach of contract claim, the claim must have been premised on failure to fulfill contractual obligations independent of the obligations imposed by the SEC. The court failed to find any basis in the contract for the allegation that the preferred customers could not receive data prior to the processer. Nor could the contract be read to require that the processor be a “single source” of the NBBO. As the court concluded: “As Lanier has failed to identify any contractual promise independent of the relevant regulations that was breached by the prior receipt of data by Preferred Customers, he has failed to state a claim for breach of contract.”

Finally, the court found Plaintiff failed to exhaust all remedies at the administrative level. Under the exhaustion rule, a party may not seek federal judicial review of an adverse administrative determination until the party has first sought all possible review with the agency itself. The court noted Plaintiff still had the right to seek review before the SEC of any breach of contract claim. Consequently, the Plaintiff’s claims were not ripe for review.

Accordingly, the court affirmed the district court’s ruling and dismissed the complaint for failure to state a claim.

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

Wednesday
Mar012017

The U.S. District Court for the Northern District of California Denies Fitbit’s Motion to Dismiss Investors’ Exchange Act Violation Claims

This post is one of two posts discussing Fitbit’s allegedly false marketing claims regarding its heart rate monitoring devices. This post will specifically focus on claims made under the Securities Exchange Act of 1934 (“Exchange Act”). The other post covers claims made under the Securities Act of 1933.

In Robb v. Fitbit, Inc., et al., No. 16-cv-00151-SI 2016 BL 359028 (N.D. Cal. Oct. 26, 2016), Plaintiff Brian Robb filed a class action lawsuit on behalf of all persons who acquired Fitbit securities prior to the drop in Fitbit’s stock value, which was allegedly caused by inaccuracy of its heart rate monitors. Fitbit Inc. and Fitbit control persons James Park, William Zerella, and Eric Friedman, (collectively “Defendants”) filed a motion to dismiss claims made against them under the Exchange Act in connection with Fitbit’s marketing of its heart rate monitoring devices and its initial public offering (“IPO”). The district court denied the Defendants’ motion to dismiss and determined the plaintiff class (“Plaintiffs”) sufficiently alleged material misrepresentation or omission, scienter, and loss causation actionable under the Exchange Act.

According to the allegations, Fitbit in October 2014 announced its new “heart rate technology” and advertised heavily that it would be featured in two products. A January 2015 press release described the technology as superior tracking that “works no matter what you’re doing.” In June 2015, Fitbit completed its IPO with net proceeds reaching approximately $416 million. The IPO Prospectus described the new products as key revenue drivers. The sales of these devices led Fitbit’s revenues to reach $1.858 billion in 2015, up from $745.4 million in 2014. In August 2015, defendant Park made statements that the heart rate technology took many years to develop and Fitbit only launches products “when we feel they’re ready.” 

On January 5, 2016, Fitbit purchasers filed a class action lawsuit alleging inaccuracy of the heart rate monitoring technology, and on the same day, Fitbit’s stock dropped from $30.96 per share to $24.30 per share. On May 19, 2016 purchasers filed an amended complaint including study findings of the product’s inaccuracy and by that day’s closing Fitbit’s stock fell to $13.99 per share.

Plaintiffs filed the current lawsuit alleging Defendants violated Section 10(b) of the Exchange Act by making, knowingly, or with deliberate recklessness, misstatements and/or failing to disclose information about the technology’s inaccuracy. Plaintiffs asserted the impact of these products on Fitbit’s revenue motivated investment and gave Defendants incentive to inflate the devices’ performance. Two confidential witness statements from Fitbit data contractors reported Fitbit’s internal testing revealed the heart rate technology was inaccurate. Plaintiffs further alleged violations of Section 20(a) of the Exchange Act against the “control persons” by virtue of their roles in the company.

Defendants filed a motion to dismiss both claims on the basis that the Plaintiffs failed to sufficiently allege misstatements, scienter, and loss causation.

Section 10(b) of the Exchange Act prohibits any act or omission resulting in fraud connected with securities transactions. A plaintiff asserting a Section 10(b) claim must adequately allege the defendant’s material misrepresentation or omission, scienter, and loss causation. Section 20(a) of the Exchange Act holds “control persons” liable for violation of Section 10(b).

The court determined the alleged misstatements concerning the accuracy of the Fitbit products made in press releases and by control persons were statements upon which a reasonable investor would rely and were sufficient to state a claim for material misrepresentation. With respect to scienter, the court rejected Plaintiffs assertion that knowledge of the products “limited accuracy” could be inferred from the personal use of the device by some of the Defendants.  “Though defendants may have used the devices to track their own heart rates, there is no indication that they had any metric against which to compare these measurements in order to determine their accuracy. Their mere use of the devices thus fails to establish defendants' knowledge of inaccuracy and, taken individually, does not prove scienter.”

The court did, however, find that the statements by the confidential witnesses were sufficient to plead scienter. “In addressing the first prong of the CW analysis, both CW 1 and CW 2 held positions that exposed them directly to data and consumer complaints on the Charge HR and Surge, establishing their reliability and personal knowledge of the alleged inaccuracies. Second, both CW 1 and CW 2 reported directly to COO . . . indicating scienter by Fitbit executives.”

Finally, the court determined the correlation between the timing of the lawsuit questioning Fitbit’s technology and the drop in stock price was adequate to plausibly establish loss causation. Given these findings, the court held the Plaintiffs sufficiently alleged a claim for violation of Section 10(b), thus the claim for liability under Section 20(a) was also valid. Accordingly, the court denied the dismissal of either claim.

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

Monday
Feb272017

Moreno v. Deutsche Bank: Employees Sufficiently Plead Claims for Breach of Fiduciary Duty and Prohibited Transactions

In Moreno v. Deutsche Bank Am.s Holding Corp., No. 15 Civ. 9936 (LGS), 2016 BL 342731 (S.D.N.Y. Oct. 13, 2016), the United States District Court for the Southern District of New York denied in part and granted in part defendants’ motion to dismiss plaintiffs’ amended class action complaint against Deutsche Bank Americas Holding Corp. (“DBAHC”), DBAHC Executive Committee, Deutsche Bank Matched Savings Plan Investment Committee (the “Investment Committee”), Richard O’Connell, Deutsche Investment Management Americas Inc. (“DIMA”), and RREEF America, LLC (“RREEF”) (collectively, “Defendants”). The court held that Ramon Moreno and Donald O’Halloran, individually and on behalf of those similarly situated (“Plaintiffs”), sufficiently pleaded claims for breach of fiduciary duty and prohibited transactions under the Employee Retirement Income Security Act (“ERISA”), 29 U.S.C. § 1001 et seq. 

According to the allegations, Plaintiffs, from 2009 until February 2013, participated in the Deutsche Bank Matched Savings Plan (the “Plan”), a 401(k) plan with $1.9 billion in assets that offered Deutsche Bank employees various investment options. According to the complaint, the Plan included three proprietary index funds that charged excessive fees in relation to other comparable index funds managed by the Vanguard Group” and actively managed proprietary funds that charged fees up to five times higher fees than comparable funds.  The proprietary funds also allegedly underperformed “as measured by benchmark indices.”  For at least two of the proprietary funds, “the Plan was the only defined contribution plan among roughly 1,400 such plans with more than $500 million in assets to hold these funds.”

On December 21, 2015, Plaintiffs filed a complaint alleging Defendants were fiduciaries and that they breached their fiduciary duties of loyalty and care in selecting and managing the Plan investments. Plaintiffs alleged that the Plan’s inclusion of propriety funds resulted in prohibited transactions because DBAHC entities received monthly payment for services rendered to the funds. Moreover, Plaintiffs asserted that DBAHC, DIMA, and RREEF conducted prohibited self-dealing transactions by receiving consideration for investment services provided by DIMA and RREEF, subsidiaries of DBAHC.

Defendants moved to dismiss the complaint, arguing that the action was barred by ERISA’s statute of limitations, that Plaintiffs failed to state a claim, and that RREEF and DIMA lack fiduciary status.

Under 29 U.S.C. § 1104, a fiduciary owes duties of loyalty and care to act solely in the interest of the participants in the plan.  The standard looks to “whether a fiduciary employed the appropriate methods to investigate and determine the merits of a particular investment.” Prohibited transactions between a plan and a common trust fund managed by a trust company which is supervised by a State or Federal agency are exempt under 29 U.S.C. § 1108(b)(8) if: (1) the transaction involves selling or purchasing fund interests; (2) the trust company is not overcompensated; and (3) the transaction is expressly permitted by an authoritative party.     

The court held that Plaintiffs’ claims were not barred under ERISA’s statute of limitations, 29 U.S.C. § 1113, because, according to the allegations, Plaintiffs did not have actual knowledge of the violations until shortly before the complaint was filed. Next, the court found that Plaintiffs plausibly alleged that Defendants violated the obligation of care by including excessively costly proprietary funds in the Plan.  “Equally important, the Complaint alleges that Defendants stood to benefit from the alleged excessive fees because Deutsche Bank entities were paid investment management fees by these proprietary funds.” 

With respect to the statute of limitations, the court disagreed with Defendant contention that the period had begun when the initial decision was made to include the proprietary funds in the Plan.  Instead, the court noted that the Complaint alleged that the prohibited transactions were periodic service fees paid to Deutsche Bank entities. 

The court, however, agreed with Defendants’ assertion that DIMA and RREEF lacked fiduciary status under 29 U.S.C. § 1002(21)(A) because the complaint failed to sufficiently allege that DIMA and RREEF were compensated for providing investment advice that influenced the Plan’s investment decisions.

For the above reasons, the court dismissed DIMA and RREEF from the action and denied Defendants’ motion to dismiss. 

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

Friday
Feb242017

Lanier v. BATS Exch. Inc.: Court Finds It Has Proper Subject Matter Jurisdiction

This is one of two posts discussing Lanier v. BATS Exch. Inc., 838 F.3d 139 (2d Cir. 2016). This post will specifically cover subject matter jurisdiction. The second post covers failure to state a contract claim.

In Lanier v. BATS Exch. Inc., 2d Cir., No. 151683 (2d Cir. Sep. 23, 2016), the United States Court of Appeals for the Second Circuit held it had proper subject matter jurisdiction to consider the claims.

Defendants, national Securities Exchanges (the “Exchanges”), provide information about securities traded on the Exchanges to an exclusive securities processor (“Processor”) pursuant to Regulation National Market System (”Reg NMS”). Reg NMS standardizes the dissemination of market information by all exchanges trading U.S. securities under the authority of the Securities and Exchange Commission (“SEC”). The Processor consolidates data and makes it available to subscribers (“Subscribers”), who pay fees for access. The Exchanges also provided access to market data on proprietary distribution channels to customers who paid higher fees (“Preferred Customers”) than standard Subscribers. According to the complaint, Preferred Customers could access market data up to 1,499 microseconds faster than Subscribers due to the difference in processing time between the two services, and therefore trade on the data earlier.

Harold Lanier, on behalf of himself and others similarly situated (collectively, the “Plaintiffs”), filed suit against the Exchanges alleging that the Exchanges had breached their contract with the Plaintiffs by providing preferentially fast access to the Preferred Customers. The Exchanges argued that the district court lacked subject matter jurisdiction because the Plaintiffs were required to seek SEC review of their claims first, and then appeal any adverse decision directly to the court of appeals.

A district court lacks subject matter jurisdiction to hear claims when Congress creates a comprehensive regulatory scheme where it is fairly discernable Congress intended agency expertise would be brought to bear prior to any court review. In determining whether Congress implicitly precluded federal district court jurisdiction, the court must first determine if preclusion is discernable from the text, structure, and purpose of the statute. Second, the court must then decide whether the claim is of the type Congress intended to be reviewed within the statutory structure. Tilton v. Sec. & Exch. Comm’n, 824 F.3d 276, 281 (2d Cir. 2016). This second step is guided by three factors: (1) whether “a finding of preclusion could foreclose all meaningful judicial review”; (2) whether the suit is “wholly collateral to a statute’s review provisions”; and (3) whether the claims are outside of the agency’s expertise. Thunder Basin Coal Co. v. Reich, 510 U.S. 200, (1994).

The court elected not to address the first step of the Tilton analysis, as it determined the Plaintiffs’ contract claims are not the type Congress intended to be precluded from district court jurisdiction. Under the second step of the Tilton analysis, the court held the Plaintiffs’ claims were not “wholly collateral” because the claims were not substantively intertwined with the merits of an issue that, under the statute’s provisions, must first be heard by the SEC. The court further held that the SEC possessed no “agency expertise” that would make a district court less competent to hear the case, as the Plaintiffs’ claims are rooted in contract law, an area of law squarely within the district court’s competency. Finally, the court found the preclusion of district court jurisdiction would foreclose the Plaintiffs’ ability to obtain meaningful judicial review as the Plaintiffs principally seek monetary damages and the administrative review provisions of the Securities and Exchange Act do not provide for such damages.

Accordingly, the court held it had proper subject matter jurisdiction to hear the Plaintiffs’ claims.

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

Wednesday
Feb222017

Local No. 8 IBEW Ret. Plan & Tr. v. Vertex Pharm., Inc.: Plaintiff Unable to Prove Scienter

In Local No. 8 IBEW Ret. Plan & Tr. v. Vertex Pharm., Inc., 838 F.3d 76 (1st Cir. 2016), the United States Court of Appeals for the First Circuit affirmed the dismissal of Local No. 8 IBEW Retirement Plan & Trust’s (“Plaintiff”) claims against Vertex and six of its current and past employees (collectively “Defendants”). The court found that Plaintiff failed to plead facts that would allow the court to draw a reasonable inference that Defendants acted with the scienter required to show fraud under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) when Defendants allegedly misstated the interim results of its study on a cystic fibrosis combination treatment.

According to the allegations, Vertex received approval from the Food and Drug Administration (FDA) in early 2012 to market its drug, Kalydeco. Thereafter, Vertex began a three-phase clinical investigation on the effectiveness of the combination of Kalydeco and VX-809 in cystic fibrosis patients. During the second phase of the investigation, Vertex discovered forty-six percent patients improved by five percent and thirty percent improved by ten percent. Vertex issued a press release May 7, 2012 on the findings, which was followed by a stock increase from $58.12 per share to $64.85. 

Shortly thereafter, Vertex discovered the results had been overstated; only thirty-five percent of patients improved by five percent improvement and nineteen percent of the patients improved ten percent. Vertex issued a second press release May 29, 2012 correcting the findings. Subsequently, its stock dropped to $57.80 per share. 

Plaintiff acquired Vertex stock in reliance on the press release issued May 7, 2012. Two years later, Plaintiff filed a class action against Defendants on behalf of everyone who also acquired stock relying on the May 7, 2012 press release. Plaintiff alleged Defendants committed securities fraud under Section 10(b) by not double-checking interim results that seemed implausible before announcing results to the public. Plaintiff claimed the error was so obvious Defendants knew or should have been aware of the error. The complaint further alleged the increase in stock sales and the retirement of the Executive Vice president showed Defendants acted with a motive. 

Under Section 10(b), a securities fraud claim is found when alleged facts show a strong and compelling inference Defendants acted with scienter. Scienter is established “by showing that [D]efendants either consciously intended to defraud, or acted with a high degree of recklessness.” 

The court held Plaintiff failed to plead facts that showed Defendants acted with the requisite scienter. Plaintiff did not state facts that suggested the results were not obvious and implausible (i.e. there was no proof that cystic fibrosis scientist would have regarded the facts as obviously mistaken). Nor did the complaint allege facts which showed Defendants noticed the error. While the press release was followed with an increase in stock sales and the retirement of Vertex’s Executive Vice President, these facts were insufficient to demonstrate scienter. Particularly with the retirement of the executive, the court noted that “[a]lternative explanations” to fraudulent intent “abound[ed].”   

For the above reasons, the United States Court of Appeals for the First Circuit granted Defendants’ motion, dismissing Plaintiff’s complaint. 

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

Monday
Feb202017

Binning v. Gursahaney: Demand Futility Analysis Fails to Persuade Court

In Binning v. Gursahaney, No. 10586-VCMR, 2016 BL 145556 (Del. Ch. May 6, 2016), the Delaware Chancery Court granted ADT’s CEO Naren Gursahaney, other board members, and investment management firm Corvex Management LP’s (collectively the “Defendants”) motions to dismiss ADT stockholder, Jeran Binning’s (“Plaintiff”) Verified First Amended Stockholder Derivative Complaint (“FAC”). The court held the FAC was not alleged under Court of Chancery Rule 23.1 that pre-suit demand was futile.

According to Plaintiff’s allegations, ADT’s Board of Directors made several decisions designed to appease activist investor Keith Meister following his purchase, through Corvex Management LP, of ADT’s outstanding stock. Meister allegedly used his stockholder position to encourage the Board to issue debt securities to fund stock repurchases, repurchase stock from Corvex for over $450 million, and execute a standstill agreement that ensured Meister a seat on the Board. Plaintiff claimed the members of the board entrenched themselves, perceiving a threat to their positions from Mesiter’s actions, instead of acting in stockholders’ best interests.

On January 27, 2015, Plaintiff filed suit against the Board under Court of Chancery Rule 23.1. Court of Chancery Rule 23.1 enables a stockholder plaintiff to bring a derivative action on behalf of the corporation. Under the rule, plaintiffs must allege that they made demand on the board or state with particularity why pre-suit demand was futile. Defendants alleged a failure to adequately allege demand futility. In addition, Defendants sought dismissal on the basis of stare decisis. 

The stare decisis claim arose out of a suit “based on the same Board action” that had been previously dismissed. In Ryan v. Gursahaney, C.A. No. 9992-VCP, 2015 WL 1915911 (Del. Ch. Apr. 28, 2015), the Chancery Court dismissed the claim for failure to establish demand futility.  The court found that the “non-conclusory allegations in the Complaint . . . do not raise a reasonable doubt as to the Director Defendants' disinterestedness or independence based on this entrenchment theory.” Moreover, the court found that the shareholder had not rebutted the presumption of the business judgment rule by alleging particularized facts demonstrating gross negligence. 

The court in Binning agreed that the principle of stare decisis controlled the outcome of the decision. As the court noted, “the principle of stare decisis, therefore, counsels that Binning's Complaint should be dismissed absent a sufficient factual or legal distinction from Ryan.” The court examined the distinctions asserted by Plaintiff in the two suits and found them “insufficient to plead demand futility.” With respect to Plaintiff’s allegations of an ongoing SEC investigation, the court noted that plaintiff did not explain how the fact would support a finding of futility and that the case filed by the SEC had been dismissed. 

The court found that without more information to support the additional allegations, Plaintiff’s claims failed under Rule 23.1. The court concluded that the new allegations were insufficient to alter the demand futility analysis already found in Ryan. Accordingly, the court granted Defendants’ motions to dismiss all claims based on Plaintiff’s failure to bring a pre-suit demand to the Board or to show the pre-suit demand was futile, as required by Rule 23.1.

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

Friday
Feb172017

It’s Official: Trump Signs Resolution Repealing the Resource Extractive Industries Rule Pursuant to the Congressional Review Act: Now What?

President Trump recently signed Joint House Resolution 41, sponsored by Congressman Bill Huizenga, R-MI. This bill eliminates the resource extractive industries rule (discussed here and here). According to Rep. Huizenga, the “bill eliminates a burdensome regulation put in place by the Securities and Exchange Commission (SEC) that hurts our economy by putting American companies at a disadvantage globally.”  Whether one agrees with Rep. Huizenga or with others who view the resource extractive industries rule as a vital tool in fighting global corruption is an interesting debate, but there much more at stake here than this rule.  What is of greater import is the method by which the rule was repealed. 

The repeal of the resource extractive industries rule was done pursuant to the Congressional Review Act. It marks what is the first time this year the CRA has been used “successfully” and only the second time in history.  The first was in 2001 when then President George W. Bush signed a resolution of disapproval of an ergonomics rule adopted in 2000 during the Clinton Administration.   In order to understand the importance of this, a brief overview of the Congressional Review Act is in order.

The CRA, authored by Representative David McIntosh (R–IN), was signed into law by President Clinton in 1996 as part of the “Contract with America.”  The Act is intended to make it easier for Congress to repeal regulations.  Congress can of course stop any legislation it wants to but the CRA provides a streamlined process for Congress to disapprove a final rule and does not allow for filibuster.  Importantly, the CRA states that

A rule that does not take effect (or does not continue) under paragraph (1) may not be reissued in substantially the same form, and a new rule that is substantially the same as such a rule may not be issued, unless the reissued or new rule is specifically authorized by a law enacted after the date of the joint resolution disapproving the original rule.

The CRA Review Process

The CRA process begins with a notification to Congress from an agency that is has adopted a new regulation. The notification triggers a 60-day period in which Congress can introduce a “resolution of disapproval” of a rule. Rules that are still within this 60-day period when Congress adjourns will have a fresh 60-day review period at the start of the next Congress.  The 60-day period is calculated in terms of “legislative” days, not actual calendar days. As calculated by the Congressional Research Service (CRS), this means that rules adopted as far back as June 3, 2016, are still within this review period

As with all legislation, once approved by Congress, the resolution of disapproval goes to the President for signature or veto. If the President signs the CRA resolution into law, or Congress overrides a presidential veto, the regulation is deemed “disapproved” and will not take effect.  Moreover, as mentioned above, the CRA prohibits the agency from promulgating any rule which is “substantially the same” as the one disapproved. 

The Trump Administrations Use of the CRA

The repeal of the resource extractive industries rule is by no means the only use of the CRA by the Trump administration.  It is difficult to get an exact count of how many regulations are under attack given how quickly the motions to approve resolutions of disapproval are coming.  A recent Washington Post article estimated that in the first ten days of the Trump administration thirty-seven such motions have been made.  Regulations on tap for repeal include, among others, Rules under the Dodd–Frank financial regulation law, sick leave for federal contractors, offshore drilling rules, energy mandates for home appliances, and rule that would bar gun ownership by some who have been deemed mentally impaired by the Social Security Administration.  There is much to say about this unprecedented use of the CRA—for now however it is worth considering the legal limbo the SEC now finds itself in due to the repeal of the resource extractive industries rule. 

Legal Limbo Caused by the CRA 

Let us consider where the SEC is left after the repeal of the resource extractive industries rule.  Section 1504 of Dodd-Frank still stands.  Pursuant to that statute, the SEC must “issue final rules that require each resource extraction issuer to include in an annual report of the resource extraction issuer information relating to any payment made by the resource extraction issuer…”

So the SEC is legally required to issue a rule that satisfies the above requirement.  According to a CRA Fact Sheet, the agency has one year to do so-- “[i]f a statute or court establishes a deadline for promulgating a rule, the CRA joint resolution of disapproval does not prohibit an agency from issuing future rules as required by the deadline. Instead, the deadline to do so is extended by one year from the date of the joint resolution of disapproval.” Thus, the SEC has until February 2018 to issue a new rule.

However, recall that under the CRA the agency cannot issue a rule that is substantially the same as the rule that was subject to a resolution of disapproval.  So now what?  A court could seek to define what “substantially similar” means in the context of the CRA—something that has not yet been done. "There's no body of law on that, so everything that happens is going to be critically important," said Lisa Gilbert, director of Public Citizen's Congress Watch division.  But any judicial attempt to provide clarity may be hampered by a provision in the CRA that states, “no determination, finding, action, or omission under this chapter shall be subject to judicial review.”

Of course, this may become moot if Trump succeeds in totally gutting Dodd-Frank.  Nevertheless, until that happens we are in uncharted waters.

Wednesday
Feb082017

No-Action Letter for Microsoft, Corp. Prevents Exclusion of Proxy Access Bylaw Proposal

In Microsoft, Corp., 2016 BL 320577 (Sept. 27, 2016), Microsoft Corporation (“Microsoft”) asked the staff of the Securities and Exchange Commission to permit the omission of a proposal submitted by shareholder James McRitchie ("McRitchie") requesting that the board of directors amend certain provisions of its proxy access bylaw. The SEC denied the request for no-action relief, concluding that Microsoft may not exclude McRitchie’s proposal from its annual proxy statement under Rule 14a-8(i)(10).

Shareholder submitted a proposal providing:

RESOLVED, Shareholders of Microsoft (the “Company”) asks the board of directors (the “Board”) to adopt, and present for shareholders approval, an enhancement package of its Proxy Access for Director Nominations bylaw, with essential elements for substantial implementation as follows:

1. The number of shareholder-nominated candidates eligible to appear in proxy materials should   not exceed one quarter of the directors then serving or two, whichever is greater. Expansion of the  current number of director positions could substantially dilute the influence of shareholders under the  Company’s current proxy access provisions.

2.     No limitations on the number of shareholders that can aggregate their shares to achieve the 3% “Required Shares,” outstanding shares of the Company entitled to vote in the election of directors.  Under current provisions, even if the 20 largest public pensions funds were able to aggregate their shares, they would not meet the 3% criteria at most of the companies examined by the Council of Institutional Investors.

3.     No limitation on the re-nomination of shareholder nominees based on the number or percentage of votes received in any election.  Such limitations do not facilitate the shareholders’ traditional state law rights and add unnecessary complexity.

4.     To the extent possible, the Board should defer decisions about the suitability of the shareholder nominees to the vote of the shareholders.

Microsoft sought exclusion of the proposal from its proxy materials under subsection (i)(10) of Rule 14a-8. 

Rule 14a-8 provides shareholders with the right to insert a proposal in the company’s proxy statement. 17 CFR 240.14a-8. The shareholders, however, must meet certain procedural and ownership requirements. In addition, the Rule provides companies thirteen substantive grounds for exclusion of the proposal. For a more detailed discussion of the requirements of the Rule, see The Shareholder Proposal Rule and the SEC.

Rule 14a-8(i)(10) allows the exclusion of a shareholder proposal that has s already substantially implemented by the company. Specifically, companies can exclude proposals relating to matters that have already been “favorably acted upon” by the company. The SEC staff considers whether a company can demonstrate that its actions address the “essential objective” of the proposal.  For a more detailed discussion of this exclusion, see Aren Sharifi, Rule 14a-8(i)(10):  How Substantial Is “Substantially” Implemented in the Context of the Social Policy Proposals?

Microsoft argued the proposal should be excluded under subsection (i)(10) because it substantially implemented the proposal. Specifically, in August 2015, the Board adopted amendments to Microsoft’s bylaws to implement a proxy access bylaw. Microsoft’s bylaw differed from the shareholder proposal in a number of respects. While applying a 3% threshold, the bylaw permitted aggregation by no more than 20 shareholders. The bylaw also prohibited shareholders relying on proxy access from re-nominating “the same proxy access candidate for two years if that candidate failed to receive at least 25% of the votes cast for his or her election as a director.” The bylaw limited the number of directors to the greater of two or 20% and did not provide for deference to the suitability of a shareholder nominee.  

A letter on behalf of the proponent by John Chevedden took particular issue with the limit on the number of shareholders allowed to aggregate their interests. He argued that a proposal specifying a range allowed the board to implement the proposal at the high end or to round down to the nearest whole number. In the shareholder access context, however, boards should not be entitled under Rule 14a-8(i)(10) to round an infinite number of shareholders forming a group down to 20. That is not substantial implementation. In a letter by the proponent, he noted that the limit on the ability to aggregate would result in the inability of “individuals and all but the largest institutional investors” to “meaningfully participate in making proxy access nominations, except in the rarest of circumstances.”

The Commission disagreed with Microsoft’s reasoning. The Commission concluded Microsoft may not omit the proposal from its annual proxy statement in reliance on Rule 14a-8(i)(10) because Microsoft’s proxy access bylaw did not substantially implement the proposal. The staff reasoned Microsoft’s proxy access bylaw did not “compare favorably with the guidelines of the proposal.”

The primary materials for this case may be found on the SEC website.

Tuesday
Feb072017

The Dismantling of Dodd-Frank Begins

Two provisions of Dodd-Frank that I have blogged about extensively are under facing challenges seeking to repeal and/or significantly weaken them.

First up on the chopping block is Section 1504 and the implementing rule (the resource extractive industries rule) that requires companies to publically disclose payments made to foreign governments for oil, gas and mining resources. (the rule and its tortured history are discussed here and here).    Section 1504 of Dodd-Frank was specifically designed to increase transparency and eliminate corruption.  Supporters of the rule allege that the legislation helps tackle some of the more than one trillion dollars lost each year to corruption and tax evasion in the developing world.

 

  • "Section 1504 deters bribery, stops corruption and curbs tax evasion. It provides transparency protections for workers and vulnerable populations," according to Eric LeCompte who serves on United Nations expert groups that focus on tax and transparency issues. "We need more laws that promote transparency and financial disclosure. This is not a moment we can walk away from transparency." 

 

On Wednesday February 1, the House of Representatives is scheduled to consider a joint resolution of disapproval of the resource extraction rule.  This resolution is provided for under the Congressional Review Act that allows Congress to stop recently adopted regulations through a simple majority vote.  It was introduced by Capital Markets, Securities and Investment Subcommittee Chairman Bill Huizenga (R-MI).

Repealing the rule would mean that large oil companies could make secret payments to foreign governments.  It is worth noting that Trump-nominee for Secretary of State Rex Tillerson, led the fight in opposing Section 1504 when it was first introduced.  

Also under attack is Section 1502 and the implementing conflict minerals rule (discussed here and here).  On January 31st, acting SEC Chair Michael Piwowar announced he has directed agency staff to reconsider how companies should comply with the rule and whether "additional relief" from its requirements is necessary. 

This rule cannot be repealed under the Congressional Review Act because that law only applies to rules adopted since the end of May.  Still, Piwowar’s questions about the rule and his stated belief that it has done nothing to help the humanitarian crisis in Africa suggest that he may decide to have the agency issue interpretive guidance to scale back its requirements.  It is also possible that he could direct the staff not to enforce the rule.   And so it begins…..

Monday
Feb062017

Sharkey v. JPMorgan Chase & Co.: Summary Judgment Was Improper And Sharkey’s Case Lives To See Another Day In Court

In Sharkey v. JPMorgan Chase & Co., 2016 BL 296030 (2d Cir. Sept. 12, 2016), the Court of Appeals for the Second Circuit vacated the District Court for the Southern District of New York’s grant of the motion for summary judgment by J.P. Morgan Chase (“Defendant”) and remanded the case for further proceedings.

Jennifer Sharkey (“Plaintiff”) filed a complaint alleging that she was discharged in retaliation for protected whistleblowing activity in violation of Section 806 of Sarbanes-Oxley. Plaintiff was terminated approximately one week after she recommended that J.P. Morgan Chase end its relationship with a client after she suspected the client had been engaged in “illegal activity” for a number of months. Defendant asserted that Plaintiff had lied to her supervisor, a superior officer, about a different client.

The district court dismissed the claim.  Although the termination was temporarily proximate to the recommendation, the “purported lie to a superior about communicating with a different client convincingly demonstrated a legitimate intervening basis for her discharge.”   

To prevail on a Section 806 claim, the employee must show by a preponderance of the evidence that: (1) the employee engaged in protected activity; (2) the employer knew he or she engaged in the protected activity; (3) the employee suffered an unfavorable personnel action; and (4) the protected activity was a contributing factor in the unfavorable action. To survive summary judgment, a party must only show there is a triable issue of fact after drawing all inferences in their favor.

Defendant argued that Plaintiff failed to demonstrate a reasonable belief the client violated federal law, a necessary component to support a Section 806 claim, making summary judgment proper. In reviewing the record in the light most favorable to the Plaintiff, the court determined that Plaintiff sufficiently plead a reasonable belief of illegality since there was evidence the client had performed a number of activities that JP Morgan had identified in training materials as “red flags” for money laundering.  Although JP Morgan produced evidence indicating that the concerns were “unfounded,” the court found that this gave rise to a factual dispute. 

Further, the temporal proximity between the protected activity of reporting and her termination supported a prima facie inference that the protected activity was a contributing factor to the termination. Without deciding if a legitimate intervening basis, such as lying to a superior officer, could defeat this prima facie inference, the court noted that Plaintiff “dispute[d] lying to her supervisor”.  Thus, there were triable issues of fact for a jury to decide and summary judgment was improper.

Accordingly, the court vacated Defendant’s motion for summary judgment to dismiss the Section 806 claim, and remanded the case for further proceedings.

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

Friday
Feb032017

Laborers' Dist. Council Constr. Indus. Pension Fund v. Bensoussan: Delaware Court of Chancery’s Preclusion of Demand Futility Arguments in Support of Derivative Actions

In Laborers’ Dist. Council Constr. Indus. Pension Fund v. Bensoussan, No. 11293-CB, 2016 BL 188507 (Del. Ch. June 14, 2016), two pension funds, Laborers’ District Council Construction Industry Pension Fund and Hallandale Beach Police Officers and Firefighters’ Personnel Retirement fund (“Plaintiffs”), asserted derivative claims against Lululemon Athletica, Inc. (Lululemon or Company) and eleven individuals who were or currently are Lululemon directors (“Defendants”). Defendants moved to dismiss the claims on the basis that an action in the United States District Court for the Southern District of New York (“New York Action”) precluded litigation of these issues. The Delaware Court of Chancery agreed with Defendants and dismissed the claims on the basis of both issue and claim preclusion.

According to the allegations, Dennis Wilson, the founder of Lululemon, entered into an agreement with Merrill Lynch, Pierce, Fenner & Smith in December 2012 to enact a trading plan to sell portions of stock in Lululemon. The trading plan was adopted pursuant to Rule 10b5-1 of the Securities Exchange Act of 1934, which “permits insiders to implement written, pre-arranged stock trading plans when they are not in possession of material non-public information.” 17 CFR 240.10b5-1. 

Under the plan, Wilson granted Merrill Lynch authority and exclusive discretion to execute trades of his shares between Jan 10, 2013 and June 30, 2014. A maximum of one million shares could be sold per month. On June 5, 2013, Christine Day, then Lululemon’s CEO, informed Wilson that she would be resigning from her position and, two days later, informed the board.  On June 7, 2013, Merrill Lynch sold 607,545 of Wilson’s shares, maxing out the monthly allotment, resulting in over $49.5 million in proceeds. Day publically announced her resignation on June 10, 2013, which resulted in a 17% stock price drop the following day.  

As a result of the “remarkable timing” of the sale of Wilson’s shares, two stockholders filed suit in a New York Action, alleging “Wilson breached his fiduciary duties as a director of the company under Brophy… by using material non-public information to sell stock for his personal financial gain.” In April 2014, the New York Action was dismissed for failure to establish demand futility. In July 2015, after obtaining records from the Company under 8 Del. C. § 220, Delaware Plaintiffs’ filed an action asserting “a breach of fiduciary duty claim against the members of the Company’s board … for failing to investigate and take any action against Wilson relating to that sale” in addition to a Brophy claim against Wilson. Defendants moved to dismiss on the basis that the claims were precluded based on the New York Action.

The Delaware court found that the claims were precluded based on both issue and claim preclusion. Two requirements must be met to invoke issue preclusion: (1) “the party seeking the benefit of collateral estoppel must prove that the identical issue was necessarily decided in the prior action and is decisive in the present action,” and (2) “the party to be precluded from relitigating an issue must have had a full and fair opportunity to contest the prior determination.” Three requirements must be met to invoke claim preclusion: the party seeking to invoke claim preclusion must demonstrate that (1) “the previous action involved an adjudication on the merits; (2) the previous action involved the plaintiffs or those in privity with them; and (3) the claims asserted in the subsequent action were, or could have been, raised in the prior action.”

With regard to issue preclusion, the court held that the New York Action had already decided the demand futility claim (i.e. “that [Director Defendants] are not independent because they face a substantial likelihood of liability) asserted by Plaintiffs. Additionally, Plaintiffs’ failed to demonstrate their burden that they were deprived of a full and fair opportunity to litigate in the New York Action. Not only was there privity between different stockholders in derivative actions, but representation was also adequate because, although the New York plaintiffs’ failure to utilize 8 Del. C. 220 to seek books and records was an imperfect legal strategy, management of the case did not rise to the level of deficient.

With regard to claim preclusion, the court found that the claims were barred because: (1) the Plaintiffs’ were in privity with the New York Action plaintiffs, (2) the New York Action was adjudicated on the merits because, although the case was dismissed without prejudice, the dismissal was conditioned on the premise that plaintiffs could not attempt to re-plead demand futility, and (3) the present claims arose out of the same transaction “that formed the basis of the claims asserted in the New York Action.”

For the above preclusion reasons, the Delaware Court of Chancery dismissed Plaintiffs’ derivative claims against Defendants.

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

Wednesday
Feb012017

Schueneman v. Arena Pharmaceuticals: Sufficient Pleading of Scienter

In Schueneman v. Arena Pharmaceuticals, Inc., 840 F.3d 698 (9th Cir. 2016), the United States Court of Appeals for the Ninth Circuit reversed the District Court’s ruling of summary judgment for Arena Pharmaceuticals, Inc. (“Defendant”) based on an inadequate pleading of scienter. The Ninth Circuit held that a strong inference of scienter was properly pleaded by Schwartz (“Plaintiff”) under Fed. R. Civ. P. 9(b) and the Private Securities Litigation Reform Act (“PSLRA”).

Per Plaintiff’s allegations, Defendants disclosed that lorcaserin, a drug under development (the “Drug”), was not carcinogenic and supported the claim with references to animal studies.  Between September 2006 and July 2009, Defendant was in the midst of conducting clinical studies (testing on humans) and nonclinical studies (testing on animals). When Defendant filed its application for approval of the Drug with the FDA, an advisory panel published a briefing document that disclosed, for the first time, that rats used in the animal study were “getting cancer.”  The market was “surprised” by this information and stock prices “dropped significantly.”

Plaintiff’s complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (“Exchange Act”) and rule 10b-5 promulgated thereunder. Plaintiff claimed that Defendants, having raised the animal studies to support the FDA application, were obligated to reveal the rat study.   Failure to do so demonstrated scienter.

Under Fed. R. Civ. P. 9(b) a plaintiff must allege: 1) a material misrepresentation or omission by the defendant; 2) scienter; 3) a connection between the misrepresentation or omission and the purchase or sale of a security; 4) reliance upon the misrepresentation or omission; 5) economic loss; and 6) loss causation. The PSLRA requires that the complaint specify each statement alleged to have been misleading and the reason or reasons why the statement is misleading. In addition, the complaint must include allegations that give rise to a “strong inference” of scienter. A complaint will survive only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.

The court held Plaintiff had alleged scienter with sufficient particularity to survive a motion to dismiss. Specifically, the court stated that Defendants had a duty to disclose the animal studies because they had represented that the animal studies supported the Drug’s safety and therefore its likelihood of approval. Furthermore, Defendants’ failure to inform the market about the risk of non-approval or delay based on the FDA’s concerns about the rat study was “an extreme departure from the standards of ordinary care . . . .” Defendants did more than just express confidence in the Drug’s future, according to the court, they affirmatively represented that “all the animal studies” that had been completed “supported” the case for approval of the drug. According to the court, these statements could not be supported at the time and Defendants’ statement that all of the data was favorable to approval was inappropriate.

Accordingly, the Ninth Circuit reversed and remanded the case ruling that Plaintiff satisfied the scienter requirement under Fed. R. Civ. P. 9(b) and the PSLRA.

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

Monday
Jan302017

IBM’s Motion to Dismiss PLSRA Claims Granted 

This post is the one of two posts discussing claims brought against International Business Machines Corporation (“IBM”) in 2016 regarding a seventeen percent drop in the company's stock price. This post will specifically focus on claims made under the federal securities laws. The other post covers claims made under the Employee Retirement Income Security Act (“ERISA”). 

In Int’l Assoc. of Heat & Frost Insulators & Asbestos Workers Local #6 Pension Fund v. Int’l Business Machines Corp., No. 1:15-cv-02492-WHP, (S.D.N.Y. Sept. 7, 2016), the United States District Court for the Southern District of New York granted IBM’s (“Defendants”) motion to dismiss for failure to state a claim. The District Court held International Association of Heat and Frost Insulators and Asbestos Workers Pension Fund (“Plaintiffs”) did not support an inference of scienter under Fed. R. Civ. P. 9(b) and the heightened pleading requirements under the Private Securities Litigation Reform Act (“PSLRA”). 

According to the Plaintiffs allegations, Defendants in 2010 established a strategy to double its earnings per share (“EPS”) to $20 within five years. The strategy included divesting IBM of unprofitable business segments. On October 20, 2014, IBM announced it would pay GlobalFoundries $1.5 billion to accept Microelectronics, a business unit within IBM’s Software Systems and Technology business segment. Between 2012 and 2013 Microelectronics suffered operating losses of $1.358 billion. On the same day as the announcement of the deal to sell Microelectronics, IBM disclosed disappointing third-quarter financial results and the stock price dropped more than 17 percent. 

Plaintiffs alleged violations of Section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5 promulgated thereunder. Plaintiffs claimed: 1) Generally Accepted Accounting Principles (“GAAP”) required IBM and its corporate officers to record an earlier impairment to its microelectronics business unit; and 2) IBM’s stock price was overvalued and fell as a result of the divestiture announcement.

Under Fed. R. Civ. P. 9(b), a securities fraud complaint must state with particularity the facts giving rise to a strong inference of scienter. To plead a strong inference of scienter, plaintiffs must allege: 1) facts showing the defendant had both motive and opportunity to commit the fraud; or 2) constituting strong circumstantial evidence of conscious misbehavior or recklessness. In order to survive a motion to dismiss an allegation of a violation of rule 10b-5, a plaintiff must allege that the defendant: 1) made misstatements or omissions of material fact; 2) with scienter; 3) in connection with the purchase or sale of securities; 4) upon which the plaintiff relied; and 5) the plaintiff’s reliance was the proximate cause of its injury. 

The court held Plaintiffs’ complaint failed to raise a strong inference of scienter. Specifically, the court stated the complaint did not demonstrate a strong inference that a failure to write down Microelectronics’ business unit earlier amounted to fraud. Furthermore, the court ruled forward looking statements regarding Defendant’s projection for operating EPS of at least $20 in 2015 were within the “safe harbor” rule of the PSLRA for forward looking statements. Plaintiffs failed to explain how allegations that Defendants knew the $20 EPS mark would not be reached was supported by an inference of actual knowledge and lacked a reasonable basis of knowledge when Defendants stated they were on track to reach the $20 EPS mark.  

Accordingly, the District Court granted Defendants’ motion to dismiss for failure to state a claim. 

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

Friday
Jan272017

No-Action Letter for Chevron Corporation Did Not Permit Exclusion of Public Climate Change Policies Proposal

In Chevron Corporation, 2016 BL 92735 (Mar. 23, 2016), Chevron Corporation (“Chevron”) asked the staff of the Securities and Exchange Commission (“SEC”) to permit omission of a proposal submitted by Legal & General Assurance (Pensions Management) Limited on behalf of Hermes Equity Ownership Services, and from Wespath Investment Management on behalf of UMC Benefit Board, Inc. (collectively, the “Shareholders”) requesting that Chevron publish an annual assessment of long-term portfolio impacts of possible public climate change policies. The SEC declined to issue the requested no action letter under Rule 14a-8(i)(7) and 14a-8(i)(12)

Shareholder submitted a proposal providing that: 

  • RESOLVED, Shareholders request that by the Annual Meeting of Stockholders in 2017, Chevron Corporation (Chevron), with board oversight publishes an annual assessment of long-term portfolio impacts to 2035 of possible public climate change policies, at reasonable cost and omitting proprietary information. The report should explain how current capital planning processes and business strategies incorporate analyses of the short and long-term financial risks of a lower carbon economy. Specifically, the report should outline impacts of fluctuating demand and price scenarios on the company’s existing reserves and resource portfolio - including the International Energy Agency’s “450 Scenario,” which sets out an energy pathway consistent with the internationally recognized goal of limiting the global increase in temperature to 2 degrees Celsius.

 

Chevron sought exclusion of the proposal from its proxy materials under subsections (i)(7) and (i)(12) of Rule 14a-8. 

Rule 14a-8 provides shareholders with the right to insert a proposal in the company’s proxy statement. 17 CFR 240.14a-8. The shareholders, however, must meet certain procedural and ownership requirements. In addition, the Rule includes thirteen substantive grounds for exclusion. For a more detailed discussion of the requirements of the Rule, see The Shareholder Proposal Rule and the SEC.  

Rule 14a-8(i)(7) permits a company to omit a proposal that relates to the company’s “ordinary business” operations, including the company’s litigation strategy and legal compliance. “Ordinary business” refers to those issues that are fundamental to management’s ability to run the company on a day-to-day basis. As such, “ordinary business” issues cannot practically be subject to direct shareholder oversight.  For additional discussion of the exclusion, see Adrien Anderson, The Policy of Determining Significant Policy under Rule 14a-8(i)(7), 93 DU Online L. Rev. 183 (2016), and Megan Livingston, The “Unordinary Business” Exclusion and Changes to Board Structure, 93 DU Online L. Rev. 263 (2016).   

Under Rule 14a-8(i)(12)(ii), a stockholder proposal dealing with "substantially the same subject matter as another proposal or proposals that has or have been previously included in the company's proxy materials within the preceding 5 calendar years" may be excluded from the proxy materials "for any meeting held within 3 calendar years of the last time it was included if the proposal received . . . [l]ess than 6% of the vote on its last submission to shareholders if proposed twice previously within the preceding 5 calendar years."

Chevron asserted the proposal should be excluded under subsection (i)(7) because the company assesses the environmental impact on existing reserves and resource portfolio in the ordinary course of business. The Company argued the proposal focused on how Chevron responded to government regulation and public policy, which required an assessment of long-term portfolio impacts and business strategies that implicated ordinary business. While the proposal touched on a significant policy issue, the proposal focused on day-to-day business matters.

Chevron also argued that within the past five years it has included in the proxy materials at least two stockholder proposals, in 2011 and 2015, regarding the perceived financial risks to the Company associated with climate change and related public policies and the Company's actions to protect stockholders' investments in light of those risks. Chevron further pointed out that the proposals do not need to be identical, but rather the “substantive concerns” must be similar. As such, Chevron asserted the proposal should be excluded under subsection (i)(12).

In response, the Shareholders argued the proposal focused on a significant policy issue of climate change, an issue that the staff has repeatedly recognized. The Shareholders also claimed the prior proposals Chevron cited were fundamentally different from this proposal. Specifically, the 2015 proposal related to a dividend policy premised on global oil demand and climate change concerns, and the 2011 proposal sought a report on “impact to shareholder value” in relation to Chevron’s portfolios under different possible scenarios.

The Commission disagreed with Chevron’s reasoning and concluded Chevron may not omit the proposal from its proxy materials in reliance on Rule 14a-8(i)(7) because the proposal “focuses on the significant policy issue of climate change.” It also concluded Chevron could not exclude the proposal under subsection (i)(12). The staff noted “the proposal does not deal with substantially the same subject matter as the proposal included in the company’s 2015 proxy materials.” It expressed no position on whether the proposal deals with substantially the same subject matter as the proposal included in the company’s 2011 proxy materials. Accordingly, the Commission decided it would recommend enforcement action if Chevron omitted the proposal from its proxy materials in reliance on either Rule 14a-8(i)(7) or 14a-8(i)(12).

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

Wednesday
Jan252017

Doscher v. Sea Port Grp. Sec., LLC: The Second Circuits’ “Look Through” Approach in Determining Federal Question Jurisdiction in Federal Arbitration Act claims related to SROs 

 In Doscher v. Sea Port Grp. Sec., LLC, 832 F.3d 372 (2d Cir. 2016), the United States Court of Appeals for the Second Circuit dismissed, for lack of subject matter jurisdiction, Plaintiff Drew Doscher’s (“Appellant”) petition to vacate a Financial Industry Regulatory Authority (“FINRA”) arbitration award under section 10 of the Federal Arbitration Act (“FAA”). The Second Circuit remanded the case and instructed the district court that it could “look through” the petition to the underlying dispute in determining federal-question jurisdiction.    

According to the allegations, Appellant commenced arbitration against his former employers following his termination from Sea Port Group LLC and Sea Port Group Securities LLC. Appellant sought more than $15 million in damages, claiming breach of contract, retaliatory discharge, unjust enrichment, and securities fraud. The arbitration panel, however, awarded Appellant approximately $2.3 million in damages with the opportunity for additional commissions on a pending trade.  

In January 2015, Appellant filed a federal lawsuit pursuant to FAA section 10 to vacate and modify in part the low arbitral award. Appellant argued for vacatur on two grounds: “(1) the arbitration panel failed to ensure that documentary evidence was fully and timely made available to [Appellant], thereby warranting vacatur under § 10, and (2) the arbitration panel acted in manifest disregard of FINRA Rule 13505 requiring parties to cooperate in discovery.” Appellant asserted the district court had subject matter jurisdiction under two theories of federal question jurisdiction: (1) that the petition allows for the exercise of federal question jurisdiction on its face because FINRA Rule 13505 is federal law, and (2) the § 10 argument creates federal question jurisdiction. 

The Second Circuit rejected Appellant’s argument that the arbitration panel acted in manifest disregard of federal law.  The court declined to find that violations of internal rules of FINRA constituted federal law.  Instead, the allegations had to show a violation of the Exchange Act.  Plaintiff, however, had not done so.  As the court reasoned, “the Exchange Act itself imposes no duty to comply with FINRA rules either on the arbitrators or non-SRO parties to arbitration.”  

 In considering whether the petition created a federal question, the court addressed precedent holding that the issue had to be determined on the face of the petition and that a court could not “look through” the petition do determine whether the underlying dispute involved substantial questions of federal law.  The court, however, determined that the approach was no longer valid as a result of the Supreme Court’s decision in Vaden v. Discover Bank. As a result, district courts were no longer limited by the content of the petition but could “look through” the to the underlying claim.  As a result, the court vacated the district court decision and remanded for application of the look through doctrine “in the first instance.”      

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

Monday
Jan232017

No Action Letter for Acuity Brands, Inc. Advised Against Exclusion of Dividend Proposal

In Acuity Brands, Inc., 2016 BL 342505 (Oct. 12, 2016), Acuity Brands, Inc.’s (“Acuity”) asked the staff of the Securities and Exchange Commission to permit the omission of a proposal submitted by shareholder Stephen Kraus (“Kraus”) requesting that Acuity’s board of directors approve a dividend increase that would be commensurate with the company’s recent success. The Commission concluded it was unable to concur with Acuity that the proposal should be excluded from its proxy materials under Rule 14a-8(i)(7) and 14a-8(i)(13).

Kraus’s proposal provided:

  • RESOLVED: Shareholders request the Board of Directors to: Approve a dividend increase that is commensurate with this success that will not jeopardize future potential capital investment returns or attractive strategic acquisition opportunities but will allow the existing shareholders to deploy the company’s excess cash in a manner they find most appropriate.

Acuity sought to exclude the proposal from its proxy materials under subsections (i)(7) and (i)(13) of Rule 14a-8.

Rule 14a-8 provides shareholders with the right to insert a proposal in the company’s proxy statement. 17 CFR 240.14a-8. The shareholders, however, must meet certain procedural and ownership requirements. Additionally, companies may exclude proposals that fall under one of thirteen substantive exceptions provided in Rule 14a-8(i). For a more detailed discussion of the requirements of the Rule, see The Shareholder Proposal Rule and the SEC.

Rule 14a-8(i)(7) allows for the exclusion of proposals that relate to the company’s “ordinary business operations.” The Commission understands “ordinary business” to mean the issues that are fundamental to the company’s management abilities on a daily basis. Thus, proposals dealing with issues relating to “ordinary business” are not subjected to shareholder oversight. For additional discussion of the exclusion, see Adrien Anderson, The Policy of Determining Significant Policy under Rule 14a-8(i)(7), 93 DU Online L. Rev. 183 (2016), and Megan Livingston, The “Unordinary Business” Exclusion and Changes to Board Structure, 93 DU Online L. Rev. 263 (2016).

Rule 14a-8(i)(13) allows for the exclusion of proposals that relate “to specific amounts of cash or stock dividends.” The Commission interprets this phrase to include limit amounts or ranges of dividends, or formulas for determining dividends.

Acuity argued the proposal should be excluded under 14a-8(i)(7) because the proposal related to its ordinary business operations. Acuity pointed to how the staff has recognized decisions regarding the declaration and payment of dividends as a “core management function.” As such, it reasoned that dividend decisions are essential to the company’s capital management, financial activities, and growth strategies and are therefore integral to ordinary business operations.

Acuity also asserted that 14a-8(i)(13) allowed exclusion because “the Proposal relates to a specific amount of dividends.” Specifically, it argued the staff previously permitted exclusion of proposals that seek to increase the dividend or payout ratio because such proposals have the effect of establishing a formula for dividends. Acuity cited a dividend table Kraus included in his supporting statement as amounting to a formula to calculate the specific amount of dividend increases. Thus, it argued the proposal “seeks to tie future dividends to a specific formula based on historical performance.”

In response, Kraus argued dividend decisions do not affect the day-to-day operations of a company, but rather are decisions that rest with the Board of Directors. As such, a dividend policy is subject to shareholder oversight. Kraus further pointed to the fact that he qualified his proposal by excluding increases that could jeopardize “potential capital investment returns or attractive strategic acquisition opportunities.” Kraus also argued that the table he included in his supporting statement was not a proposal for specific dividend increases, but merely illustrates important information relevant to making dividend decisions.

The Commission agreed with Kraus’s reasoning, and concluded Acuity may not omit the proposal from its proxy materials in reliance on 14a-8(i)(7) and 14a-8(i)(13). The staff noted the proposal involved a “matter of policy outside the realm” of Acuity’s business operations.  In addition, the Commission determined the proposal did not relate to “specific amounts of cash or stock dividends.”

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

Monday
Nov212016

SEC v. MUDD: Summary Judgment Denied in Securities Fraud

In SEC v. Mudd, No. 11 Civ. 9202 (PAC), 2016 BL 58699 (S.D.N.Y. Feb. 29, 2016), the United States District Court for the Southern District of New York denied a motion for summary judgment by Daniel Mudd (”Defendant”), former CEO of Federal National Mortgage Association (“FNMA”), for claims brought by the Securities and Exchange Commission (“SEC”) alleging false and misleading statements made in public SEC filings and the media.

FNMA offered mortgage and loan services, including subprime mortgages made to “borrowers with weaker credit profiles.” FNMA offered such loans through tow programs; the Expanded Approval (“EA”) mortgages to “borrowers with blemished credit,” and MyCommunityMortgage (“MCM”) mortgages to “low- and moderate-income home buyers.”  From December 2006 to September 2008, FNMA used a variety of definitions in its SEC public filings and media to classify subprime mortgages including, among others, “a mortgage loan underwritten using lower credit standards than those used in the prime lending market,” “loans offered to borrowers with damages credit,” and loans that originated from specialized lenders “using processes unique to subprime loans,” or “original or resecuritized . . . securities that we hold in our portfolio, if the securities were labeled as subprime when sold.” FNMA also offered Alt-A loans, mortgages that did not require full financial disclosure.

According to the SEC, FNMA over time changed its definitions of subprime, but failed to quantify billions of dollars of loan exposure subprime mortgages.  Additionally, the SEC found FNMA did not quantify lender-selected loans in its Alt-A exposure, thereby omitting $300 billion from its disclosures. This led the SEC to believe FNMA made material misstatements about its subprime and Alt-A exposure, resulting in extensive financial losses.  In December, 2001, the SEC brought suit alleging specifically that Defendant (1) knowingly or recklessly made material statements regarding FNMA’s exposure to subprime and Alt-A loans in violation of Section 10(b) of the Exchange Act and Rule 10b-5; (2) violated Section 17(a)(2) of the Exchange Act by knowingly, recklessly, or negligently obtained money by means of material misstatements; (3) aided and abetted a primary securities violation against Section 10(b) and Rule 10b-5; (4) signed false certifications to the SEC in violation of Rule 13(A)-14(A) of the exchange act; and (5) aided and abetted violations of Section 13(A) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13.

The court found a jury could infer Defendant made false or misleading statements to obtain money, acted with scienter, aided and abetted SEC violations, and received money or property from material misrepresentations. The court determined a reasonable investor could expect EA and MCM to be included with subprime mortgages under FNMA’s definition, and could expect the definition of Alt-A to include investor-selected low-documentation loans. The court held misrepresentations could be material as the disclosures did not contemplate information relevant to subprime mortgages, nor do they preclude liability from fraudulent activity.

Additionally, court determined Defendant could have acted with scienter by making public statements and signing SEC disclosures while knowing FNMA’s disclosures and classifications could mislead buyers and that a jury could infer Defendant aided and abetted a securities fraud when he provided substantial assistance in making material misrepresentations.  Further, the court noted that any finding Defendant recklessly also shows he acted negligently. Finally, the court stated Defendant’s financial losses suffered in conjunction with FNMA’s decline did not preclude a jury from deciding whether he received “money or property” by means of material misrepresentations.

The court found material issues of fact in each claim and accordingly denied Defendant’s motion for summary judgment.

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

 

 

 

Friday
Nov182016

In re Biogen: United States District Court Dismisses Fraud Class Action Claims Against Biogen Inc. – Part II

This post is the second of two posts discussing In re Biogen Inc. Securities Litigation, No. 15-13189-FDS (D. Mass. June 23, 2016).

In In re: Biogen, the United States District Court for the District of Massachusetts granted Biogen Inc. and Biogen executives George Scangos, Paul Clancy, and Stuart Kingsley’s (“Individual Defendants”) (collectively, “Defendants”) motion to dismiss against GBR Group, Ltd.’s (collectively, “Plaintiffs”) putative class action.  The court found that Plaintiffs had not sufficiently alleged a “strong inference” of scienter.  

Plaintiffs claimed the Individual Defendants violated Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and SEC Rule 10b-5 (“Count One), that Defendants violated SEC Rules 10b-5(a) and 10b-5(c) (“Count Two”), and that the Individual Defendants violated Section 20(a) of the Exchange Act (“Count Three”).  The Plaintiffs allege the violations occurred when Defendants made materially misleading statements and omissions about Tecfidera, which caused class members to purchase Biogen’s stock at artificially inflated prices. 

Complaints under Section 10(b) of the Exchange Act, to state a claim for securities fraud, a private litigant must allege: (1) material misrepresentation or omission; (2) scienter; (3) a connection with the purchase or sale or security; (4) reliance; (5) economic loss; and (6) causation.  The Private Securities Litigation Reform Act of 1995 (“PSLRA”) requires complaints under Section 10(b) and Rule 10b-5 to show a strong inference of scienter, and that each statement was misleading and the reasons why.   Allegations of scienter must show intent to defraud or a high degree of recklessness.  The PSLRA also provides a safe harbor provision for “forward-looking” statements.

Under the element of scienter, Plaintiffs pointed to ten confidential witnesses (“CWs”) who “generally corroborat[ed]” that the Individual Defendants knowingly misled investors about the impact on Biogen of the PML Death.  Nonetheless, the court found the CWs failed to allege any specific facts suggesting fraud, and noted none of them ever spoke with any of the Individual Defendants.  See Id.  (“Notably absent from those allegations are any specific facts about the sales, such as a measurement of the sales decline, why sales were declining, whether the decline was due to lower new starts and switches or higher discontinuations, or how the sales decline affected the company's financial guidance.”). 

Plaintiffs also alleged that: (1) the Individual Defendants had the motive and opportunity to misrepresent Tecfidera’s growth; (2) Individual Defendants must have known Tecfidera’s revenue guidance was wrong as a result of their “positions and access to ‘prescription and sales information’”; and (3) that the Individual Defendant’s knew or were reckless in not knowing about the impact on sales because revenues was a “main source of revenues” and therefore part of Biogen’s “core operations.” 

The court dismissed each argument accordingly.  It noted that allegations of motive and opportunity needed to show more than usual executive concerns, the general and conclusory assertions provided did not support an inference of scienter, and courts were “hesitant” to apply the “core operations” standard without other significant evidence of intent or recklessness. See Id. (“Based on the complaint as a whole, plaintiffs' asserted inference of scienter may be plausible, but it is not strong, cogent, or compelling.”).

Accordingly, the court dismissed Count One. The court noted that Plaintiffs conceded Count Two for “scheme” liability in its opposition brief. Finally, the court found Count Three failed to state a claim for an underlying violation of the Exchange Act.

The court granted the Defendants’ motion to dismiss with prejudice.

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

 

 

 

Wednesday
Nov162016

No-Action Letter for Cardinal Health, Inc. Allowed Exclusion of Proxy Access Bylaw Proposal

In Cardinal Health Inc., 2016 BL 239828 (July 20, 2016), Cardinal Health (“Cardinal”) asked the staff of the Securities and Exchange Commission (“SEC”) to permit omission of a proposal submitted by Kenneth Steiner (“Shareholder”) requesting adoption of a “proxy access” bylaw requiring the company, in certain circumstances, to include in its proxy materials the name and certain information regarding candidates nominated by shareholders owning at least 3% of the outstanding shares.  The SEC agreed to issue a no action letter allowing for exclusion of the proposal under Rule 14a-8(i)(10). 

Shareholder submitted a proposal providing that:          

RESOLVED, shareholders request the board of directors to adopt, and present for shareholder approval, a “proxy access” bylaw as follows:

Require Cardinal to include in the proxy materials prepared for shareholder meetings at which directors are to be elected, Disclosure and Statement (as defined herein) of any person nominated for election to the board by a shareholder or an unrestricted number of shareholders forming a group (“Nominator”) that meets criteria established below.

The number of shareholder-nominated candidates appearing in the proxy materials should not exceed one quarter of the directors then serving or two, whichever is greater. This bylaw should supplement existing rights under Cardinal’s bylaws, providing that a Nominator must has beneficially owned 3% or more of Cardinal’s outstanding stock continuously for a least three years, and give Cardinal written notice of the information required by the bylaws and SEC rules about the nominee, and the nominator (“Disclosure”). The Nominator may submit with the Disclosure a statement not exceeding 500 words in support of the nominee (“Statement”). 

Cardinal sought exclusion under subsection (i)(10). 

Rule 14a-8 provides shareholders with the right to insert a proposal in the company’s proxy statement. 17 CFR 240.14a-8. The shareholders, however, must meet certain procedural and ownership requirements. In addition, the rule includes thirteen substantive grounds for exclusion. The University of Denver has published an entire issue on the various requirements of Rule 14a-8.  See  The Shareholder Proposal Rule and the SEC (2016).

Rule 14a-8(i)(10) permits a company to exclude a shareholder proposal from its proxy materials if the company has substantially implemented the proposal. The SEC has depended on "particular policies, practices, and procedures [that] compare favorably with the guidelines of a proposal" to determine "substantially implemented." For a thorough discussion of the evolution of the exclusion, see Aren Sharifi, Rule 14a-8(i)(10): How Substantial is "Substantially" Implemented in the Context of Social Policy Proposals?, 93 DU Online L. Rev. 301 (2016).  

Cardinal argued the proposal should be excluded under Rule 14a-8(i)(10) because the board had adopted a proxy access bylaw that addressed the proposal’s essential objective. Unlike the shareholder proposal, the Company limited the number of shareholders that could collectively submit a proposal to 20.  In addition, the Company’s version allowed for the nomination of not more than 20% of the board (compared with 25% in the shareholder proposal).  Cardinal further argued its no-action request should be granted because the proposal does not raise any novel issues.

The SEC agreed and concluded it would not recommend enforcement action if Cardinal omitted the proposal from the proxy materials in reliance on Rule 14a-8(i)(10). The staff noted that Cardinal’s Board had already “adopted a proxy access bylaw that addresses the proposal’s essential objective.” 

The primary materials for this no action letter can be found on the SEC Website.

Wednesday
Nov162016

No-Action Letter for BlackRock, Inc. Did Not Permit Exclusion of Executive Compensation Proxy Voting Practices Proposal 

In BlackRock, Inc., SEC No-Action Letter, 2016 BL 110890 (Apr. 6, 2016), the Commission staff (the “Staff”) declined to issue BlackRock, Inc. (“BlackRock”) the requested no action letter to exclude the proposal submitted by the Stephen M Silberstein Revocable Trust (“Proponent”). Proponent’s proposal requested that BlackRock’s Board of Directors issue a report evaluating the options for bringing the investment management company’s proxy voting practices regarding “say on pay” in line with its stated principle of linking executive compensation and performance. The Staff did not concur with BlackRock’s view that it could exclude the proposal under Rule 14a-8(i)(3). Further, the Staff did not concur with BlackRock’s view that it could exclude the proposal under Rule 14a-8(i)(7).

Proponent’s proposal requested that the Board issue a report including adopted changes to BlackRock’s proxy voting guidelines. Specifically, the proposal requested that:

the Board of Directors issue a report to shareholders by December 2016, at reasonable cost and omitting proprietary information, which evaluates options for bringing its voting practices in line with its stated principle of linking executive compensation and performance, including adopting changes to proxy voting guidelines, adopting best practices of other asset managers and independent rating agencies, and including a broader range of research sources and principles for interpreting compensation data. Such report should assess whether and how the proposed changes would advance the interests of its clients and shareholders.

BlackRock sought exclusion of the proposal from its proxy materials under subsections (i)(3) and (i)(7).

Rule 14a-8 permits shareholders to include proposals in the company’s proxy statement. 17 C.F.R. § 240.14a-8. Shareholders, however, must meet certain procedural and ownership requirements. Additionally, the Rule contains thirteen substantive grounds for exclusion, which a company may rely on as grounds for excluding a shareholder proposal. For a more detailed discussion of the requirements of the Rule, see The Shareholder Proposal Rule and the SEC.

Under Rule 14a-8(i)(3), a shareholder proposal may be excluded if the proposal or supporting statement is contrary to any of the Commission’s proxy rules. This subsection applies to Rule 14a-9, which prohibits materially false or misleading statements in a company’s proxy materials. In addition, the subsection permits the exclusion of proposals that are vague and indefinite, rendering a company’s duties and obligations unclear.

Rule 14a-8(i)(7) permits the exclusion of a shareholder proposal that relates to a company’s “ordinary business” operations. Ordinary business refers to those issues that are fundamental to management’s ability to run the company on a day-to-day basis. A proposal may not be excluded, however, when it addresses significant policy issues, such as executive compensation. To determine whether a proposal addresses significant policy issues, the Staff considers whether the proposal “would transcend the day-to-day business matters and raise policy issues so significant that it would be appropriate for a shareholder vote.” For additional explanation of these exclusions, see Megan Livingston, The “Unordinary Business” Exclusion and Changes to Board Structure, 93 Denv. L. Rev. Online 263 (2016), http://static1.1.sqspcdn.com/static/f/276323/26982504/1461117567937/Megan+Livingston_Ordinary+Business.pdf?token=YQG69tTsL1R5FBKzw3bxKKtYQcU%3D, and Adrien Anderson, The Policy of Determining Significant Policy Under Rule 14a-8(i)(7), 93 Denv. L. Rev. Online 183 (2016), http://static1.1.sqspcdn.com/static/f/276323/26992100/1461618846850/Adrien+Anderson_14a-8_FINAL.pdf?token=xOn1y2jI0dR+jaX6hdye2VaLaZo=.

BlackRock argued the proposal was materially false and misleading in violation of Rule 14a-9 and should be excluded under subsection (i)(3). 17 C.F.R. § 240.14a-9. BlackRock asserted the proposal substantially mischaracterized BlackRock’s voting policies by using the term “will” instead of “may.” The Proponent responded by requesting that the Staff allow for revision to substitute the term “may” for “will” to prevent any potential that the language could mislead investors.

In addition, BlackRock argued the proposal should be excluded under subsection (i)(7) because it dealt with the company’s proxy voting policies and practices, delving into the company’s ordinary business matters. In particular, BlackRock argued it has already established a committee that determines voting guidelines. BlackRock also argued voting policies should not be subject to direct shareholder oversight. In response, the Proponent asserted that the proposal focused on senior executive compensation, which the Staff has regarded as a significant policy issue and, thus, fell under the policy exception to the ordinary business exclusion. BlackRock rejected this argument, claiming that the proposal merely touched on a significant policy issue, but the significant policy issue was not the focus of the proposal.

The Staff did not permit BlackRock to omit the proposal under Rule 14a-8(i)(3) because it did not demonstrate objectively that the proposal was false or misleading. Moreover, the Staff did not permit BlackRock to omit the proposal under Rule 14a-8(i)(7) because the proposal focused on senior executive compensation.

The primary materials for this post may be found on the SEC website.