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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.

Monday
Nov142016

The Race to the Bottom, The Proxy Process and Rule 14a-8

The Race to the Bottom has long been a faculty-student partnership.  Student pieces typically involve analysis of current cases, whether private actions or administrative proceedings. Often the cases involve decisions in Delaware and touch on fiduciary duties.  They also commonly entail an examination of decisions interpreting the anti-fraud provisions under the federal securities laws, particularly Rule 10b-5.

The staff of the Blog have, however, decided to add yet another area for student review.   The Blog intends to focus student analysis on no action letters issued under Rule 14a-8.  The decision in part reflects the importance of shareholders proposals in the corporate governance process.  The decision also, however, reflects a growing expertise by students at the DU Sturm College of Law with respect to the Rule.

In April of 2016, students at the Law School (and all members of the Blog) wrote eleven truly remarkable articles (all published collectively as an issue of the DU Online Law Review) on Rule 14a-8.  Each piece addressed a single exclusion or procedural requirement of the Rule.  The papers examined the administrative history of the provision and waded through the hundreds (sometimes thousands) of no action letters reflecting the staff's interpretation of the requirement.  They end with policy recommendations.  The papers are listed below.

Students will include a second issue on Rule 14a-8 in 2017 that will address additional exclusions and procedural requirements not already addressed.  As a result of these efforts, students have developed an impressive understanding of the intricacies of Rule 14a-8.  Posts examining SEC no action positions under Rule 14a-8 will build on this understanding.  

 

The articles in the issue published in April 2016 include:

The Policy of Determining Significant Policy under Rule 14a-8(i)(7)

Adrien Anderson

 

Appealing No-Action Responses under Rule 14a-8:  Informal Procedures of the SEC and the Availability of Meaningful Review

Courtney E. Bartkus

 

Rule 14a-8 and the Exclusion of Proposals that Violate the Law

Jason Haubenreiser

 

Issuer Opposition and Shareholder Disagreement:  Rule 14a-8(m)

Alex Hinz

 

Shareholder Proposals, Director Elections, and Proxy Access: The History of the SEC’s Impediments to Shareholder Franchise

Nicole L. Jones

 

SEC Rule 14a-8(i)(5): Is it Still Relevant?

Kathryn R. Kaoudis

 

The “Unordinary Business” Exclusion and Changes to Board Structure

Megan Livingston

 

SEC Rule 14a-8(i)(9): The Conflict with Conflicting Proposals

Philip Nickerson

 

The Evolution of Rule 14a-8(j): The Good Cause to Clarify Good Cause

Mark G. Proust

 

Rule 14a-8(i)(10): How Substantial is “Sub­­stantially” Implemented in the Context of Social Policy Proposals?

Aren Sharifi

 

The Exclusion of Duplicative Proposals under Rule 14a-8(i)(11)

Hillary Sullivan

 

Wednesday
Nov092016

SEC v. Ryan: Summary Judgment and Release of Funds Granted

In SEC v. Ryan, No. 1:10-CV-513, 2015 BL 287568 (N.D.N.Y. Sept. 4, 2015), the United States District Court for the Northern District of New York found that defendants Matthew John Ryan, Prime Rate and Return, L.L.C., and American Integrity (collectively, “Defendants”) had admitted to facts establishing securities fraud in Ryan’s guilty plea and did not offer any opposition to Securities and Exchange Commission’s (“SEC”) allegations. Thus, the court granted the SEC’s motions for summary judgment and release of funds to the clerk of the court.

According to Ryan’s plea agreement, from February 2002 through May 2010, Ryan, founder, owner, and sole managing member of Prime Rate and Return, L.L.C. (“Prime Rate”) conducted business as American Integrity Financial Co. (“American Integrity”), soliciting and receiving money from investors as a representative of American Integrity. According to the plea agreement, Ryan “falsely represented to investors that American Integrity was a substantial Manhattan-based financial services firm with numerous employees and for which he was merely a representative” and “made false representations to a number of investors that their investments were safe, by representing that investments were insured up to specific dollar amounts, by the Securities Investor Protection Corporation (SIPC).”

In May 2010, the SEC brought a civil action against Defendants alleging securities fraud and seeking declaratory judgment, injunction, and disgorgement of ill-gotten gains. In April 2013, the court entered judgment against Defendants and ordered disgorgement. Additionally, the Government indicted Ryan on counts of securities fraud and mail fraud, to which Ryan pleaded guilty.

The Commission filed a motion for summary judgment. The court held all elements of the securities fraud claims pursuant to Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 were unambiguously established as a result the plea agreement. Additionally, the court concluded the SEC established the element of scienter because Ryan’s admissions demonstrated his intent to defraud investors. Thus, the court determined the SEC was entitled to summary judgment on both causes of action.

With regard to the SEC's claim of Section 5(a) and 5(c) violations – alleging Defendants failed to file a registration statement for American Integrity securities and sold such securities using interstate commerce – the court granted the SEC motion for summary judgment. The court concluded that plea agreement sufficiently established the elements of a Section 5 violation. See Id. (“Ryan’s plea agreement establishes that he offered and sold securities as to which there was no registration statement and that he used interstate commerce to do so. Defendants do not argue that the transactions are exempted under 15 U.S.C. § 774d, nor is there any factual basis upon which defendants could successfully make such an argument.”). As a result, the court held there was no material question of fact.

In addition to summary judgment, the SEC sought a permanent injunction against Ryan to restrain him from committing future securities violations. A motion for permanent injunction requires the SEC to demonstrate future violations of illegal securities conduct are substantially likely to occur. In its decision, the court considered the fact that Ryan pleaded guilty to the violations and admitted to committing “repeated, calculated fraudulent acts involving more than 50 people and millions of dollars,” yet in the SEC action “maintained that his past conduct was blameless.” Based on these considerations, the court found the permanent injunction was warranted. Id. (“In view of Ryan’s extensive experience in the securities and investment industry, the egregious nature of his criminal conduct as discussed above, and his adamant refusal to acknowledge his wrongdoing or its impact on his victims, there is great potential that Ryan will again engage in illegal securities conduct.”). The court also granted the disgorgement based on all these circumstances.

Finally, the court granted the motion for release of all funds the SEC received from Defendants to the clerk of the court for distribution according to the Restitution Order in the criminal action. Because both the SEC’s action and the criminal prosecution were based on the same fraudulent conduct, the court held the restitution decision would best reflect the most reasonable and fair outcome.

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

 

Monday
Nov072016

United States v. Musante: Denied Guilty Plea Withdrawal

In United States v. Musante, No. 15-4241, 2016 BL 71357 (4th Cir. Mar. 09, 2016), the United States Court of Appeals for the Fourth Circuit (“Plaintiff”) affirmed the district court’s decision denying Matthew Musante’s (“Defendant”) appeal to withdraw his guilty plea for conspiracy to commit insider trading and transactional money laundering.

There is a strong presumption a guilty plea is final and binding, and to overcome this presumption, a defendant must "show a fair and just reason for requesting the withdrawal." In determining a motion to withdraw, the key factor the court considers is whether the defendant offered credible evidence that his plea was not knowing or voluntary. Defendant argued there was credible evidence his plea was not knowing or voluntary based on a recent decision in United States v. Newman because he did not know the benefit to the insider from the improperly disclosed information.

The district court held the defense derived from Newman was not supported based on the facts of Defendant’s case. The court concluded that the lower court did not commit an abuse of discretion.

Accordingly, the court affirmed the district court’s ruling and denied the Defendant’s motion to withdraw the guilty plea.

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

Thursday
Nov032016

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

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

In In re Biogen the District Court in the District o Massachusetts held that the complaint brought by lead plaintiff GBR Group, Ltd. on behalf of a class of similarly situated persons (“Plaintiffs”) against three Biogen executives (“Individual Defendants”)(collectively, “Defendants”) did not contain sufficient allegations of scienter.

According to the complaint, Biogen sells the pharmaceutical, Tecfidera, which was the company’s core product from the third quarter 2013 through December 2015. In October 2014, a patient died from progressive multifocal leukoencephalopathy while using Tecfidera (“PML Death”) as part of a clinical study. Despite the death, Individual Defendants and Biogen made and released statements projecting optimism. During an earnings call on October 22, 2014, Clancy stated “There is meaningful, still meaningful growth in Tecfidera.”

Plaintiffs alleged the Individual Defendants violated: Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 (“Count One”), Defendants violated: Rules 10b-5(a) and 10b-5(c) under a theory of “Scheme liability” (“Count Two”), and Individual Defendants violated Section 20(a) of the 1934 Exchange Act (“Count Three”). The Plaintiffs alleged 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.

Section 10(b) of the Exchange Act and Rule 10b-5 provides a cause of action for certain misstatements or omissions.  To sufficiently make out a claim, a plaintiff 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”) added a safe harbor for certain “forward-looking information.”  Such statements will not be actionable if “accompanied by a meaningful cautionary statement” or not made “with actual knowledge”.  15 U.S.C. § 78u–5(c)(1)

In addressing the claims made by Plaintiffs, the court first determined that a number of the alleged misrepresentation constituted forward-looking statements. The court found that statements in Biogen’s fourth-quarter-earnings press release and statements by Clancy during earnings calls were accompanied by sufficient cautionary language and therefore were protected by the safe-harbor provision. 

The court did determine, however, that Plaintiffs had sufficiently alleged the falsity of statements suggesting that the PML death “was having little or no negative impact on Tecfidera sales”.  Although not the “only inference” that could be drawn from the statements, the court agreed that it was “at least plausible” that the statements were false and misleading. 

As for the Section 20(a) claims, the court found the statements made by Individual Defendants were not actionable since they did not state a claim for an underlying violation.

Accordingly, the court granted Defendants’ motion to dismiss Section 10(b), Rule 10b-5(b), and Section 20(a) claims. In Plaintiffs’ opposition to Defendants’ motion to dismiss, Plaintiffs conceded that the Rule 10b-5(a) and (c) claims should be dismissed.

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

Wednesday
Nov022016

IMPACT OF CONFLICT MINERALS RULING BEGINS TO BE SEEN

Many posts on this blog have discussed Nat’l Ass’n of Mfrs. v. SEC (“NAM”) ( see here, here, and here).  Perhaps the most important result of the long and tortured legal proceedings in that case is the ultimate finding that the requirement that issuers in certain circumstances must label their products as “non-DRC conflict free” violates their First Amendment rights.  At the time the ruling came out I postulated that it might open a door for many other challenges to compelled corporate disclosure and that very thing has already come to pass.

On October 24, just before the Fair Pay and Safe Workplaces Final Rule (“Fair Pay Rule”) was scheduled to go into effect, Judge Marcia A. Crone in the Eastern District of Texas issued a nationwide preliminary injunction prohibiting key provisions of the rule from taking effect. In the absence of an injunction, the so-called “blacklisting” rule would have mandated, among other things, that companies bidding on certain federal contracts and subcontracts publicly disclose information regarding “labor law violations” as part of the bidding process.  The court found that this was compelled speech because it

 

  • Impose[d] an immediate disclosure requirement that obligates federal contractors and their subcontractors for the first time to report for public disclosure any “violations” of the fourteen federal labor laws occurring since October 25, 2015, regardless of whether such alleged violations occurred while performing government contracts, and without regard to whether such violations have been finally adjudicated after a hearing or settled without a hearing, or even occurred at all.
  • Far from being narrowly tailored, the disclosure requirement forces contractors to disclose a list of court actions, arbitrations, and “administrative merits determinations,” even where there has been no final adjudication of any violation at all, and regardless of the severity of the alleged violation.
  • [T]housands of “administrative merits determinations” are issued against employers of all types each year, many of which are later dismissed or settled and most of which are issued without benefit of a hearing or review by any court. The arbitration decisions and civil determinations, including preliminary injunctions, that will have to be reported under the FAR Rule are likewise not final and are subject to appeal. The Executive Order’s unprecedented requirement, as implemented by the FAR Rule and DOL Guidance, thus compels contractors to engage in public speech on matters of considerable controversy adversely affecting their public reputations and thereby infringing on the contractors’ rights under the First Amendment. 

 

The court found support for its position by citing to NAM, specifically calling out the most problematic findings of that case.  Taking them one by one:

 

Disclosure of “controversial” information warrants heighted scrutiny

NAM said that if the compelled disclosure required communication of “controversial information” the government bore a heavy burden to prove that forcing businesses to speak publicly about such activities in the form of public reports was narrowly tailored to advance a substantial government interest.

 

With respect to the Fair Pay Rule the court found that

 

  • contractors are not being required to disclose purely non-controversial, factual information. By defining “labor law violation” to include “administrative merits determinations,” the government is requiring the disclosure of merely the opinions of agency employees who chose to issue notices, send letters, issue citations, or lodge complaints accusing a contractor of violating a labor law as if those opinions were actually labor law violations. These allegations are certainly controversial in nature, and they may prove not to be factual at all, if, after full exhaustion of the administrative and judicial remedies afforded employers by the statutes, the contractor is absolved of liability and found not to have violated the labor laws. 

 

 

NAM requires evidence that the required disclosures will achieve its stated goal

In NAM the court found that for a compelled disclosure to pass constitutional muster it must be shown that the required disclosures will achieve the stated goal—a hurdle the conflict minerals rule could not get over.  Similarly, the Fair Pay court found

 

  • It must also be noted that the FAR Council and the DOL have failed to support the basic premise of the Executive Order and the new Rule, namely that public disclosure of non-adjudicated determinations of labor law violations on private projects correlates in any way to poor performance on government contracts. The studies cited by the FAR Council for this premise did not examine the universe of administrative merits determinations, regardless of severity. 81 Fed.
  • None of the studies purported to show a relationship between mere nonadjudicated, unresolved allegations of labor law violations and government contract performance. Instead, the various studies cited in the Rule’s preamble, with few exceptions, rely on the most severe findings of labor violations by agencies and courts, which have been closed and penalties paid. In any event, the Executive Order, FAR Rule, and DOL guidance have expanded their reach far beyond any claimed impact on government procurement and instead rely entirely on speculation in claiming that the burdensome new disclosures of non-final determinations demonstrate any likelihood of poor performance on government contract

 

 

NAM PROHIBITS DISCLOSURES THAT REQUIRE COMPANIES TO STIGMATIZE THEMSELVES 

In NAM the court said the conflict minerals rule essentially required issuers to confess to “blood on their hands” and stated “[r]equiring a company to publicly condemn itself is undoubtedly a more ‘effective’ way for the government to stigmatize and shape behavior than for the government to have to convey its views itself, but that makes the requirement more constitutionally offensive, not less so.” 

The Fair Pay court found: 

 

  • The Executive Order, FAR Rule, and DOL Guidance share the same constitutional defect as the conflict minerals rule in NAM, only more so. The Order, Rule, and Guidance compel government contractors to “publicly condemn” themselves by stating that they have violated one or more labor or employment laws. The reports must be filed with regard to merely alleged violations, which the contractor may be vigorously contesting or has instead chosen to settle without an admission of guilt, and, therefore, without a hearing or final adjudication. 

 

It is likely that this decision will be appealed to the Fifth Circuit.  What will happen there is anyone’s guess.  If that circuit agrees with the NAM court it will add powerful ammunition to those who want to curtail the use of compelled disclosures beyond their original purpose.

Wednesday
Nov022016

In re Cobalt Int'l Energy, Inc. Sec. Litig.: Claims of Security Act and Exchange Act Violations Survive Motion to Dismiss by Company

In In re Cobalt Int'l Energy, Inc. Sec. Litig.2016 BL 12955, 15 (S.D. Tex. Jan. 19, 2016), the District Court for the Southern District of Texas granted in part and denied in part Cobalt's motion to dismiss the consolidated class action complaint by St. Lucie County Fire District Firefighters' Pension Trust Fund, Fire and Police Retiree Health Care Fund San Antonio, and GAMCO (collectively "Plaintiffs").

According to the allegations, Cobalt formed in 2005 as an exploration and production company. In 2007, it negotiated an agreement with Sonangol, an Angolan national oil company, for oil exploration of three blocks in offshore Angola. Cobalt drilled two exploration wells: Lontra, which yielded substantially more gas than estimated to which Cobalt had no rights, and Loengo, which did not yield any oil.

In May 2015, the Plaintiffs, who were purchasers of Cobalt securities, filed a consolidated amended class action complaint against Cobalt, its executives, various entities that administered the distribution of Cobalt's securities ("Underwriter Defendants"), and various entities that had the authority to control the company (Control Defendants). This complaint alleged Cobalt and its executives violated: Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. Plaintiffs further alleged: Cobalt, its directors, and the Underwriter Defendants violated Section 11; the Control Defendants violated Section 15 of the Securities Act; and the Underwriter Defendants violated Section 12(a)(2) of the Securities Act.

A 10(b) claim for publicly traded securities must show: (1) a material misrepresentation or omission, (2) in connection with the purchase or sale of a security, (3) scienter by the defendant, (4) justifiable reliance by the plaintiff, (5) damages, and (6) the material misrepresentations caused the loss.

Further, for a Section 11 claim, a plaintiff must prove reliance on the misrepresentation in the registration statement if the plaintiff acquired the security after the issuer made an earning statement available for at least 12 months. Section 11 claims are barred by a three-year statute of repose after the security was offered to the public and have a one-year statute of limitations from the discovery of the untrue statement or omission that created the claim.

The court determined that Plaintiffs had adequately alleged falsity with respect to statements that  two wells were "large and oil-focused" with oil quantities potentially exceeding one billion barrels when Cobalt ostensibly knew that Lontra was primarily gas and that Loengo did not have “even a remote chance” of producing oil. Additionally, the court found testimony of confidential witnesses and Cobalt insiders was sufficient to show scienter. The court reasoned that the Plaintiffs' allegations about the market for Cobalt common stock adequately demonstrated reliance because the bonds were convertible to common stock. Finally, because Plaintiffs adequately alleged violations of Section 10(b) and Section 11, the court held claims for violations of Section 20 and Section 15 are not subject to dismissal.

 The court also determined the Plaintiffs timely filed their original complaint less than three-years after Cobalt's registration statement, and within the statute of repose. However, the court was unable to determine as a matter of law when the statute of limitations began to run and thus granted the Underwriter Defendants' motion to dismiss with leave for Plaintiffs, who purchased Cobalt securities after April 30, 2013, to replead a Section 11 claim.

 Accordingly, the court denied Cobalt's motions to dismiss the Section 10(b) and Section 20(a) of the Exchange Act claims, and the Section 12 and Section 15 of the Securities Act claims. However, the court granted the Underwriter Defendants' motion to dismiss the Section 11 claim with leave to replead.

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

Tuesday
Nov012016

In Re Zoernack: Cease-and-Desist Proceedings against Steven Zoernack and EquityStar Capital

In In the Matter of Steven Zoernack, Securities Act Release No. 10051 (admin proc Mar. 8, 2016), the Securities and Exchange Commission (“SEC”) filed an order instituting administrative and cease-and-desist proceedings against Steven Zoernack (“Zoernack”) and EquityStar Capital Management, LLC (“EquityStar”) (collectively, “Defendants”) for alleged violations of Section 17(a) of the Securities Act of 1933 (“Securities Act”), Section 10b of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 promulgated thereunder, Sections 206(1) and 206(2) of the Investment Advisers Act of 1940 and Rule 206(4)-8 promulgated thereunder.

According to the SEC’s allegations, from May 2010 through March 2014, Defendants violated anti-fraud provisions of the federal securities laws in connection with the offer and sale of interests in Global Partners Fund, LLC (“Global”) and Momentum Growth Fund, LLC (“Momentum”). In the order, the SEC alleged that Zoernack took extensive steps to conceal his criminal background and financial troubles. Specifically, the SEC claimed Zoernack paid an “internet-based search engine manipulator” to make negative information about himself “appear less prominently in search engine results.” 

Additionally, the SEC alleged Zoernack provided false and misleading information to Morningstar, an independent investment research firm, in order to obtain a five-star rating for the Momentum fund by indicating the fund had been in existence since 2009 with returns in the top 20% of all funds and had $120 million under management. The SEC asserted the fund had only been in existence since 2012 and the returns provided to Morningstar were the result of “back-testing,” not actual performance, and the fund never had more than $3 million in assets. Moreover, the SEC claimed Zoernack made misleading statements to investors about the performance of Global and Momentum funds by using the “back-tested” returns as actual performance and not disclosing that the results were based on “pro-forma back-testing.” Lastly, the SEC asserted that Zoernack misused investor’s funds by making unauthorized withdrawals in the amount of more than $1 million.

Section 17(a) of the Securities Act and Rule 10b-5 under the Exchange Act “prohibit fraudulent conduct in the offer and sale of securities and in connection with the purchase or sale of securities.” Furthermore, Sections 206(1), 206(2), 206(4) and Rule 206(4)-8 of the Advisers Act “prohibit making an untrue statement of a material fact . . . to any investor . . . in a pooled investment vehicle and engaging in any act, practice, or course of business that is fraudulent or deceptive with respect to any investor or prospective investor in a pooled investment vehicle.”

In light of the SEC’s investigation and allegations, the SEC deemed it “necessary and appropriate in the public interest that public administrative and cease-and-desist proceedings” begin to determine the validity of the allegations, and to determine  if any remedial action would be appropriate,  including but not limited to disgorgement and civil penalties. The SEC ordered a public hearing before an Administrative Law Judge, and ordered Defendants to file an answer to the allegations contained in the order.

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

Friday
Oct282016

In re Xoom Corp. Stockholder Litigation: $50,000 Attorneys Fee Awarded in a Mootness Proceeding related to PayPal Merger

In re Xoom Corp. Stockholder Litigation, No. 11263-VCG, 2016 BL 252274 (Del. Ch. Aug. 4, 2016), the Delaware Court of Chancery awarded representatives of the shareholder class (“Plaintiffs”) $50,000 in attorneys’ fees during mootness proceedings against the directors of Xoom Corporation (“Individual Defendants”)(collectively, “Defendants”).

According to the allegations, PayPal Holdings, Inc. (“PayPal”) and Xoom Corporation (“Xoom”) announced on July 1, 2015, a merger through which PayPal would acquire Xoom for $25 per share (“Merger”). On July 21, 2015, Plaintiffs filed suit alleging Individual Defendants breached their fiduciary duties by filing a false and materially misleading Preliminary Proxy to the Securities and Exchange Commission (“SEC”) in order to induce Xoom shareholders in supporting the merger. Two days later, as a response to the complaint, Xoom filed a Definitive Proxy supplementing the initial disclosures in the Preliminary Proxy. As a result, Plaintiffs voluntarily dismissed the action with prejudice while reserving the right to seek attorney fees.

Plaintiffs sought $275,000 in attorney fees claiming as a direct result of their efforts in bringing litigation, Xoom provided additional disclosure that mooted their claim. Defendants conceded that the disclosures occurred as a result of the litigation. Defendants, however, argued that the fee application should be denied “in its entirety” because the supplemental disclosures did not significantly alter the total mix of information. In the alternative, Defendants argued that the factors set out in Sugarland Indus., Inc. v. Thomas, 420 A.2d 142 (Del. 1980) factors did not support an award of $275,000. 

Delaware follows the American Rule regarding attorney fees and costs, which provides that parties are responsible for their own fees. The Rule has exceptions.  The “mootness fee” is a “subspecies of the common-benefit doctrine,” which provides for the award of fees and costs in connection with litigation that benefited “the group or its successor."  In resolving the issue, the court looked to the factors enumerated in Sugarland, characterizing the “benefit worked” as the “most important here”. 

The court held that the disclosures cumulatively provided a “modest benefit” to the stockholders. The court noted that the decision to bring a contingency fee case following the announcement of a merger “involves significant risk” to counsel and that the court needed to “aware a fee sufficient to encourage wholesome levels of litigation.”  After considering the other Sugarland factors and the stage of litigation, the court awarded fees and costs of $50,000 instead of the requested $275,000.

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

Thursday
Oct272016

Derivative Suit Against Wynn Resorts for Alleged Quid Pro Quo Bribe Dismissed 

In La. Mun. Police Emps.’ Ret. Sys. V. Wynn, 829 F.3d 1048 (9th Cir. 2016) the United States Court of Appeals for the 9th Circuit affirmed the district court’s holding, dismissing the shareholders (“Plaintiffs”) complaint against Wynn Resorts, Limited, a Nevada Corporation (“Wynn Resorts”) and eleven individuals who sit or sat on the board of directors (“Board”) (collectively, “Defendants”). The 9th Circuit ruled the district court found Plaintiffs failed to show why a demand to the Board to bring a derivative suit on behalf of the corporation would be futile.

According to the allegations in the complaint, Wynn Resorts attempted to execute a lease for a new resort and casino with the city of Macau, China (“Government”), but the lease application sat idle for five years. At this time, the Board authorized a donation to the University of Macau and its Development Foundation totaling $135 million over a ten-year period (“Donation”). The Development Foundation “is presided over by many of the same government officials who have substantial control over gaming matters and real estate in Macau.” Following the Donation, the Government accepted Wynn Resorts’ application for a second lease.

Both the Securities and Exchange Commission and the Nevada Gaming Commission Board investigated the Donation, but neither brought an action or found a violation of the law. Meanwhile, a former Director, Kazuo Okada, demanded a separate investigation into the Donation. An investigator retained “hired” by Stephen Wynn, the Chairman and CEO (“Wynn”), concluded that Okada was “unsuitable” to own shares in Wynn Resorts. As a result, the Wynn Resorts redeemed his shares.   

Plaintiffs considered the Donation as a “quid pro quo“ bribe. Specifically, they alleged the Board breached its fiduciary duties and committed corporate waste by approving the Donation. In doing so, the Donation caused Wynn Resorts to “incur legal expenses and be exposed to potential liability.” Plaintiffs further alleged Defendants breached their fiduciary duties by redeeming Okada’s shares because such action had no legitimate purpose and merely encumbered Wynn Resorts with a higher debt load.

Before a derivate suit can be brought, the shareholders must either make a demand on the board of directors or explain why such demand would be futile. “Demand futility” must meet the heightened pleading standard set out in the Federal Rules of Civil Procedure. Shareholders must state with particularity the efforts to obtain make demand or the reasons for not doing so.  Plaintiffs made no demand and argued futility for three reasons: (1) a majority of the Board was “beholden” to Wynn; (2) the Board could not be impartial because they were subject to personal liability for approving the Donation; and (3) the Board could not be impartial due to a reasonable doubt as to whether its decision to redeem Okada’s shares would be given the benefit of the business judgment rule.

First, the court addressed whether the non-interested directors lacked sufficient independence. To lack Independence, a director must have material ties to the interested party such that the director cannot objectively fulfill his or her fiduciary duties. The material relationship may be personal or financial. In examining the relationships between Wynn and the non-interested directors, the court found that none were sufficient to deprive the directors of their independence. The allegations included, among other things, assistance by Wynn of a director in his political campaigns, various business connections between a director and Wynn and Wynn’s family (with the court noting that the social ties failed to show that the relationships were “as thick as blood relations”), and the receipt by a director of an ownership stake in Wynn Resorts. 

Second, the court rejected the allegation that the directors feared that they would face personal liability for the Donation. Under Nevada law, to be subject to liability, the circumstances required the “intentional misconduct, fraud or a knowing violation of law” on the part of the director. The court noted that the complaint acknowledged that the Board had obtained a “legal opinion blessing” for the transaction and that the Nevada and SEC investigations ended without any enforcement proceedings. Moreover, to the extent the complaint could be read to allege negligence, “Nevada law required “knowledge or intent before directly liability” could attach.   

Third, the court concluded that shareholders had not sufficiently alleged reasonable doubt about the availability of the business judgment rule.  With respect to the redemption of the Okada shares, Plaintiffs alleged that the conversion of Okada from an equity to a debt holder provided no protection for the company’s gaming license.  The court disagreed and pointed to state law which treated equity and debt holders differently. “As a consequence, it does not follow logically, and it is not reasonable to infer, that the board was acting dishonestly, in bad faith, or without an informed basis—or otherwise had no legitimate business purpose—when it voted to convert Okada's shares from equity to debt in response to the report of former FBI director Freeh.”

Accordingly, the court affirmed the district court’s holding dismissing the complaint.

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

Wednesday
Oct262016

Tenth Circuit Court of Appeals Upholds Motion to Dismiss ZAGG, Inc. Shareholders’ Derivative Suit Against Company Officers and Directors

In Pikk, et al. v. Pedersen, et al., No. 15-04001 2016 BL 196060, (10th Cir. Jun 20, 2016), ZAGG, Inc. shareholders (“Plaintiffs”) appealed the district court’s motion to dismiss their complaint against five of the company’s past and present officers and directors (“Defendants”), alleging breach of fiduciary duty to ZAGG. The court of appeals upheld the lower court’s dismissal based on the Plaintiffs’ failure to make demand on the ZAGG Board of Directors and the failure to adequately allege the futility of such a demand.

According to the allegations, defendant Pedersen resigned from his position as Chairman of the Board and CEO of ZAGG in August 2012. Defendants explained that forced sales of over two million ZAGG shares pledged by Pedersen to his margin account prompted the resignation. Neither ZAGG’s 10-K nor its proxy statement disclosed Pedersen’s pledge of the shares. Three days after the resignation, a press release announced defendant Larabee as the new Board Chair and defendant Hales as interim CEO, after which ZAGG stock fell 13% the following trading day. A month later, Pedersen signed a $910,000, one-year consulting agreement with ZAGG and four months later, ZAGG appointed Hales as permanent CEO.

In June 2013, Plaintiffs filed a complaint alleging Defendants executed a “secret succession plan” to appoint Hales as CEO and breached their fiduciary duty as directors and officers. Plaintiffs did not make a demand to the Board of Directors before filing suit and alleged it would have been futile to do so. Plaintiffs alleged the Director Defendants, constituting three of the six Board Members, would be materially affected by liability for violation of Exchange Act §14(a), 15 U.S.C. § 78n(a) in not disclosing shares pledged as security in proxy statements. Plaintiffs further alleged the same three Defendants lacked independence because they had personal and business relationships with Pedersen, the former CEO. 

Both parties agreed Nevada state law applied. Nevada recognizes a shareholder’s right to sue on behalf of the corporation after first making a demand before the board or asserting sufficient reason for belief that the board members would be materially affected by the suit or influenced by interested parties. Shoen v. SAC Holding Corp., 137 P.3d 1171, 1179 (Nev. 2006). Demand to a board with an even number of members is futile if at least half are compromised. Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040, 1046 n.8 (Del. 2004).

The court determined Plaintiffs failed to prove Defendants knowingly violated their fiduciary duty through nondisclosure of the pledged shares, thus liability was unlikely. The court further determined Plaintiffs’ theory about Defendants’ “secret succession plan” was “far-fetched.”

The court also held the Plaintiffs’ futility claim was unfounded as the lack of independence allegation concerned only three of the six Board Members. The court determined one of these members had no relationships of a “bias-producing nature.” The court did not consider the allegations against the other two challenged Directors as the inadequacy of the allegations against one mooted the futility argument that at least half of the board was compromised.

As the Plaintiffs failed to support the allegation that a demand on the Board would have been futile, the court upheld the dismissal.

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

Tuesday
Oct252016

Lindeen v. SEC: D.C. Circuit Denies Petitioners’ Challenge to Regulation A-Plus Preemption

In Lindeen v. SEC, 825 F.3d 646 (D.C. Cir. 2016), the United States Court of Appeals for the D.C. Circuit denied a consolidated petition for review of a challenge to the principles in Regulation A+ that preempted state law. 

In 2012, Congress passed the Jumpstart Our Business Startups Act (“JOBS Act”), which added section 3(b)(2) to the Securities Act of 1933 (“Securities Act”). Section 3(b)(2) directed the SEC to revamp Regulation A, a historically underutilized set of regulation exemptions to allow small businesses to increase their access to capital. Among other things, the provision provided that state law would be preempted with respect to shares sold to a “qualified purchaser” but left the definition of the term to the Commission. 

The SEC adopted Regulation A-Plus on March 25, 2015.  The Regulation created a new category of offerings up to $50 million and stipulated a number of investor safeguards (“Tier-2 Securities”). Regulation A-Plus also defined qualified-purchaser as “any person” purchasing securities in a Tier 2 offering.  Securities could be purchased either (1) by an “accredited investor”, or (2) by a non-accredited investor who refrains from purchasing securities valued at more than 10 percent of their worth or annual income.

Secretary William F. Gavin of the Massachusetts Securities Division and Commissioner Monica J. Lindeen of the Montana State Auditor Office (collectively, “Petitioners”) alleged that because the SEC declined to adopt a qualified-purchaser definition limited to investors with sufficient wealth, revenue, or financial sophistication to protect their interests without state protection, Regulation A-Plus failed both parts of the test for administrative deference stipulated in Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43 (1984). The Petitioners further alleged that Regulation A-Plus was arbitrary and capricious because it failed to adequately explain how it protected investors.

Step 1 of Chevron requires a showing of the ambiguity of the statute administered by the agency.   Petitioners argued the SEC’s qualified-purchaser definition, which did not restrict the sale of Tier-2 Securities to wealthy or sophisticated investors, contravened the plain meaning of the Securities Act. Specifically, Petitioners asserted the new qualified-purchaser definition (1) contradicted the exclusionary nature of the plain meaning of the word “qualified”, (2) the definition was not consistent with the public interest and the protection of investors, (3) the regulation renders the word “qualified” superfluous, (4) federal securities law had always linked the term “qualified” with investor wealth and sophistication, and (5) legislative history showed Congress intended for the SEC to limit the qualified-purchaser definition to one of a certain level of wealth or sophistication.

The court disagreed, reasoning when Congress explicitly authorized an agency to define a term, “it ‘necessarily suggests that Congress did not intend the word to be applied in its plain meaning sense.’”  Legislative history demonstrated that Congress had permitted the SEC to vary the definition depending upon the “categories of securities” involved and that Congress explicitly granted the SEC discretion to determine how to best protect the public and investors.

At Step 2 of Chevron, a court must defer to the agency’s interpretation so long as reasonable.  Petitioners asserted that (1) Congress’ preemptive purpose was not “clear and manifest” from the statute, (2) the SEC failed to provide a reasoned explanation for its definition, and (3) the SEC failed to explain why its definition changed from the one it had initially proposed in the rule-making process. The court again disagreed, reasoning that Congress’ decision to exempt “qualified purchasers” from state requirements was clear and manifest, the SEC had in fact provided a sufficient explanation of how its definition would provide a meaningful addition to existing capital formation options of smaller companies while maintaining important investor protections, and the SEC had no obligation to adopt the definition it had proposed at the outset of the rule-making process.

Finally, the court found that the interpretation was not arbitrary and capricious. A rule is arbitrary and capricious if an agency fails to consider factors required by the statute.  Section 2(b) of the Securities Act requires the SEC to to consider whether the action will promote efficiency, competition, and capital formation. 15 USC 77b(b).  The court found the SEC’s analysis of investor protections and mitigating costs on issuers to comply with these statutory obligations. The SEC did not have the data necessary to precisely quantify the risks of preemption for investors and the costs of state law compliance for issuers.

Accordingly, the consolidated petition for review was denied by the court.

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

Monday
Oct242016

National Credit Union Administration Board v. RBS Securities, Inc.

In National Credit Union Administration Board v. RBS Securities, Inc., No. 13-56620, 2016 BL 263034 (9th Cir. Aug. 15, 2016), the Court of Appeals for the Ninth Circuit reversed and remanded the ruling by the United States District Court for the Central District of California that the lawsuit was time-barred under the Securities Act of 1933. The National Credit Union Administration Board’s (“NCUA”), as liquidating agent for Western Corporate Federal Credit Union (“Wescorp”), filed a lawsuit against RBS Securities and Nomura Home Equity Loan (collectively “Defendants”) stating that the banks misrepresented the real value of residential mortgage-backed securities purchased by Wescorp. The district court reasoned that 12 U.S.C. § 1787(b)(14) (the “Extender Statute”) of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) did not supersede and replace all preexisting time limitations in any action by the NCUA acting as conservator or liquidating agent and applies to statutory claims.

According to the allegations, the NCUA is an independent federal agency responsible for chartering and regulating federal credit unions and regulating federally insured state-chartered credit unions. Pursuant to their statutory authority, the NCUA placed Wescorp, the second largest corporate credit union in the United States, into conservatorship on March 20, 2009 and later into liquidation after it failed due to heavy losses on its mortgage investments. The NCUA, with its authority to pursue claims on behalf of credit unions in conservatorship or liquidation under FIRREA, initiated a lawsuit on behalf of Wescorp against Defendants for violations of § 11 and § 12(a)(2) of the Securities Act of 1933 (the “1933 Act”) on July 18, 2011.

Pursuant to §13 of the 1933 Act, a private investor pursuing a claim under § 11 or § 12(a)(2) ordinarily must bring suit: (1) within one year after discovering a violation, and (2) within three years after the security was offered or sold. The three year period is a statute of repose, equivalent to a cutoff or an absolute bar to any claim under those sections.  FIRREA, however, included an Extender Statute that lengthened the statute of limitation for claims be brought by the NCUA as conservator or liquidating agent.  The district court held that the Extender Statute did not apply to the statute of repose in the Securities Act. 

In reviewing the determination, the court relied on the plain language of the Extender Statute.  The provision provided that "the" statute of limitations for "any action" brought by the NCUA as conservator or liquidating agent "shall be" as specified. As a result, “the Extender Statute’s plain meaning ‘indicates that it . . . supplants all other time limits.’”  The court also found that FIRREA used the term "statutes of limitations" broadly, to include what are technically statutes of repose. Likewise, the legislative history demonstrated that Congress meant any ambiguity in the term “statute of limitations” to be construed broadly to maximize potential recoveries by the Federal Government.

Finally, the circuit court found that the Defendants' heavy reliance on the Supreme Court's decision in CTS Corp. v. Waldburger, 134 S. Ct. 2175 (2014) was misplaced. In that case, the Supreme Court found that the term “statute of limitations” in another provision did not extend to statutes of repose.  The 9th Circuit, however, concluded that FIRREA's Extender Statute was "fundamentally different". 

Finally, the 9th Circuit held that Extender Statute applied to both common law and statutory claims.  The text of the Extender Statute applied to "any action," language deemed unambiguous.  Similarly, the legislative history confirmed that FIRREA was enacted to "significantly increase the amount of money that can be recovered by the Federal Government through litigation, and help ensure the accountability of the persons responsible for the massive losses the Government has suffered through the failures of insured institutions." Therefore, FIRREA reflected that Congress intended the Extender Statute to apply to statutory claims. 

Accordingly, the Ninth Circuit Court of Appeals vacated the district court's judgment and remanded the case for further proceedings consistent with the opinion.

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

 

 

Friday
Oct212016

Importance of Actual Status of Stockholders in Fraud Claims

In Pogue v. Hybrid Energy Inc., C.A. No. 11563–VCG, the Court of Chancery of Delaware granted Hybrid Energy Inc. (“Defendant”) a motion for summary judgment and denied James Pogue (“Plaintiff”) the right to inspect record rights under 8 Del. C. § 220.

According to the allegations in the complaint, Plaintiff received, at the time he was hired by Defendant, a stock certificate representing one million shares of common stock. According to the record, however, Defendant, at the time, had no treasury shares available to distribute; its certificate of incorporation authorized the issuance of only 1,500 shares, which were all then outstanding and held by its principal, Thomas Lull.  According to Plaintiff, he received “dividends” and was listed as the owner on the Defendant’s stock ledger.  Nonetheless, Plaintiff “concede[d] that the issuance was void”. 

Plaintiff sought books and records under Section 220 of the Delaware General Corporation Law (“DGCL”). Defendant responded that Plaintiff was not a stockholder and therefore had no standing to request such records.

Section 220 provides that "[a]ny stockholder" has inspection rights.  "Stockholder," in turn, is defined as "a holder of record of stock . . . or a person who is the beneficial owner of shares of such stock."  Section 220 grants such rights to stockholders. A plaintiff who seeks inspection of records other than the stock ledger or list has the burden of establishing stockholder status.

In general, the presence of a shareholder on the stock ledger will suffice to make a prima facie case for ownership.  Id.  (“ the stock ledger controls record-stockholder status, and a stockholder may point to the stock ledger to show, prima facie, that she is in fact a holder of record.”).  Nonetheless, stock ledger creates a presumption that can be rebutted.  To conclude otherwise “would be nonsensical and inimical to the purpose of the statute.”  Rebuttal requires “clear and convincing evidence.” 

The court reasoned that the stock issuance was void.  As the court reasoned:  “The Plaintiff . . .  received a void, allegedly fraudulent stock certificate. This gives him a chose-in-action, a contract or fraud claim against the issuer or its principal. It does not, however, make him a stockholder with an ownership interest in the corporation, and to find standing to vindicate such a non- existent interest would not advance the purpose of the statute.”  Accordingly, the Defendants motion for summary judgement arguing the Plaintiff lacks standing was granted.

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

Thursday
Oct132016

The Director Compensation Project: The TJX Companies (TJX)

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 2016’s Fortune 500 and using information found in their 2016 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 TJX Companies’ (NYSE: TJX) 2016 proxy statement. According to the proxy statement, the company paid the directors the following amounts:

Name

Fees Earned or Paid in Cash

($)

Stock Awards

($)

Total

($)

Zein Abdalla*

88,156

154,517

242,673

José B. Alvarez

100,000

177,282

277,282

Alan M. Bennett

106,000

177,282

283,282

David T. Ching

124,000

168,171

292,171

Michael F. Hines

111,000

178,908

289,908

Amy B. Lane

108,000

175,070

283,070

John F. O’Brien*

148,611

188,095

336,706

Willow B. Shire

103,000

189,269

292,269

William H. Swanson*

85,000

200,272

285,272

* Mr. Abdalla joined the Finance Committee in June 2015. Mr. O’Brien served on the Executive Compensation Committee until June 2015. Mr. Swanson is not standing for election at the 2016 Annual Meeting.

Director Compensation. During fiscal year 2016, TJX held seven board of directors meetings, and the independent directors met separately at regularly scheduled executive sessions. Each current director attended at least 75% of all meetings of the Board and committees of which he or she served. While each committee has designated responsibilities, each committee may act on behalf of the entire Board. The committees regularly report on their activities to the entire Board. Non-employee directors receive an annual retainer of $75,000 and two annual deferred stock awards for each non-employee director, each representing shares of our common stock valued at $75,000. The Audit Committee Chairman receives an additional annual retainer of $28,000 and the other members of this committee receive additional annual retainers of $15,000. The Chairman of the subcommittee of the Audit Committee receives an additional annual retainer of $26,000. The Executive Compensation Committee Chairman receives an additional annual retainer of $23,000 and the other members of this committee receive an additional annual retainer of $10,000. The Corporate Governance Committee Chairman and the Finance Committee Chairman receive an additional annual retainer of $18,000, and the other members of these committees receive an additional retainer of $8,000. The Lead Direction receives an additional annual retainer of $70,000. Employee directors do not receive separate compensation for their service as directors.

Director Tenure. Mr. Shire is the longest serving director, having served since 1995. Mr. Herrman is the shortest serving director, having joined in 2015. Mr. Hines is a director of GNC Holdings, Inc., where he serves as non-executive Chairman, and Dunkin’ Brands Group, Inc. Ms. Lane is a director of GNC Holdings, Inc., NextEra Energy, Inc. and a member of the board of trustees of Urban Edge Properties. Mrs. Meyrowitz is a director of Staples, Inc. Mr. O’Brien is a Non-Executive Chairman and a director of Cabot Corporation, a director of LKQ Corporation, and a director of a family of 93 registered mutual funds managed by BlackRock, Inc. Mr. Swanson is a director of Next Era Energy, Inc.

CEO Compensation. Carol Meyrowitz, Chief Executive Officer of TJX from January 2007 to January 2016, President from October 2005 to January 2011, Executive Chairman of the Board since January 2016, and a director since September 2006, earned total compensation of $19,559,697 in fiscal year 2016. She earned a base salary of $1,575,002, stock awards of $10,000,030, option awards of $631,618, incentive compensation of $5,706,608, deferred earnings of $1,597,465, and other compensation totaling $48,974. Ernie Herrman, Chief Executive Officer of TJX since January 2016, President since January 2011, and a director since October 2015, earned total compensation of $20,180,755 in fiscal year 2016. He earned a base salary of $1,382,309, stock awards of $14,106,551, option awards of $527,072, incentive compensation of $3,614,627, deferred earnings of $160,103, and other compensation totaling $390,093. Other compensation components include retirement benefits, deferred compensation, and perquisites, which "consist generally of automobile allowances, legal, financial and tax planning services and payment of insurance premiums."

Wednesday
Oct122016

The Directors Compensation Project: Amazon.com, Inc. (AMZN)

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 2016’s Fortune 500 and using information found in their 2016 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).

Directors do not receive cash compensation for their services as directors or as members of committees of the board, but Amazon (Nasdaq: AMZN) does pay reasonable expenses incurred for attending meetings. According to the 2015 proxy statement, the company compensated directors with the stock awards. In 2015, restricted stock awards were approved for three directors, Ms. Gorelick and Messrs. Brown and Monié, each vesting in three equal annual installments, with the first vest date occurring approximately one year after the final vest under the director’s previous restricted stock unit award. As the proxy statement noted:  “The 2015 awards were designed to provide approximately $265,000 in compensation annually based on an assumed value of the restricted stock units vesting in each year, which compensation represents the 50th percentile for annual director compensation among a group of peer companies.”

Name

Fees Earned or Paid in Cash

($)

Stock Awards

($)

Option Awards

($)

All Other Compensation

($)

Total

($)

Jeffery Bezos*

0

0

0

0

0

Tom Alberg

0

0

0

0

0

John Seely Brown

0

979,395

0

0

979,395

William B Gordon

0

0

0

0

0

Jamie Gorelick

0

979,395

0

0

979,395

Judith McGrath

0

0

0

0

0

Alain Monie

0

979,395

0

0

979,395

Jonathan Rubinstein

0

0

0

0

0

Thomas Ryder

0

0

0

0

0

Patricia Stonesifer

0

0

0

0

0

* Employee director (CEO)

Director Compensation. During fiscal year 2015, Amazon held four board meetings and thirteen committee meetings. Each director serving during 2015 attended at least 75% of the aggregate of the meetings of the board and committees on which they served. All directors attended the 2015 Annual Meeting of Shareholders.

Director Tenure. Mr. Bezos has been Chairman of the Board since founding the company in 1994. Bezos holds the longest tenure as a member of the board. Mr. Weeks holds the shortest tenure joining the board in February of 2016. Two of Amazon’s directors sit on other boards: Ms. Gorelick has served as a director of VeriSign, Inc. since January 2015. Mr. Ryder has been a director of Starwood Hotels & Resorts Worldwide, Inc. since April 2001, a director of RPX Corporation since December 2009, and a director of Quad/Graphics, Inc. since July 2010.

CEO Compensation. The highest paid officer in 2015 was Brain T. Olsavsky, Senior Vice President and Chief Financial Officer. Mr. Olzavskys base salary was $160,000 and his total compensation was $7,786,573. The second highest paid officer in 2015 was Jeffrey Bezos, Amazon’s Chief Executive Officer. Mr. Bezos earned a base salary of $81,840 and his total compensation was $1,681,840. Due to Mr. Bezos substantial ownership in Amazon, Mr. Bezos again requested not to receive additional compensation in 2015 and has never received annual cash compensation in excess of his current amount. The primary component of a named executive officers’ total compensation is stock-based compensation in order to closely tie total compensation to long-term shareholder value. Because the compensation program is designed to reward long-term performance and operate over a period of years, named executives may not necessarily receive stock-based awards every year.

Tuesday
Oct112016

The Director Compensation Project: World Fuel Services Corporation (INT)

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 2016’s Fortune 500 and using information found in their 2016 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 World Fuel Service’s (NYSE: INT) 2016 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 ($)

Ken Bakshi

120,250

139,984

-

-

260,234

Jorge L. Benitez

73,750

139,984

-

-

213,734

Richard A. Kassar

107,000

139,984

-

-

246,984

Myles Klein

70,000

139,984

-

-

209,984

John L. Manley

98,000

139,984

-

-

237,984

J. Thomas Presby

114,000

139,984

-

-

253,984

Stephen K. Roddenberry

92,083

139,984

-

-

232,067

Paul H. Stebbins

60,000

129,978

-

-

189,978

 

Director Compensation. During 2015, World Fuel Services held seven Board of Directors meetings. Each current director who served during 2015 attended at least 75% of the total number of meetings of the Board and the total number of meetings held by each of the Board committees on which he or he served. All non-management directors are reimbursed for travel, food, lodging and related expenses incurred in connection with attending board, committee and shareholder meetings, as well as continuing education programs.

Director Tenure. Mr. Kasbar, Mr. Klein, and Mr. Stebbins have each held the longest tenures in their positions as members of the Board of Directors since 1995. Mr. Benitez holds the shortest tenure, as he joined in 2015. Currently, three directors sit on other boards. Mr. Benitez serves as director and member of the risk and compliance committee of Fifth Third Bancorp. Mr. Presby serves as director and chairman of the audit committee of Exam Works Group, Inc., and as a director for First Solar, Inc. Mr. Stebbins serves as director for First Solar, Inc. and The Silk Road Project.

Executive Compensation. Michael J. Kasbar, World Fuel Services’ Chairman, President and Chief Executive Officer, earned a total compensation of $2,125,100 in 2015. His total compensation was comprised of a base salary of $750,000, stock awards of $436,208, incentive compensation of $650,000, option awards of $221,700, and other compensation totaling $67,192. Ira M. Birns, Executive Vice President and Chief Financial Officer, earned a total compensation of $1,076,552 in 2015. His compensation consisted of a base salary of $500,000, stock awards of $184,102, incentive compensation of $250,000, option awards of $88,680 and other compensation totaling $53,770. Other compensation included insurance benefits, club membership dues, and matching contributions paid under the companies 401(k) plan.