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Another Say on Pay Suit Dismissed: Swanson v. Weil

In Swanson v. Weil, the federal district court in Colorado dismissed another case seeking to establish a breach of fiduciary obligations at least in part based upon a negative say on pay vote.  This case involved the board of directors of Janus Capital, a company that received a negative vote on pay in 2011.  As has been the case for most of these suits, the decision was issued in the context of a motion to dismiss for failure to make demand. 

The court found first that the plaintiffs had not alleged sufficient facts to meet the Aronson test.  The facts were not sufficient to show that the board was interested because of the potential for liability arising out of the litigation.  In doing so, the decision noted the holding in NECA-IBEW Pension Fund ex rel. Cincinnati Bell, Inc. v. Cox, No. 11-cv-451, 2011 WL 4383368 (S.D. Ohio Sept. 20, 2011), but found the decision not to be "persuasive." 

In addressing the negative shareholder vote on executive compensation, the court emphasized that "Dodd-Frank expressly states, however, that such a vote may not be construed 'to create or imply any change' to existing fiduciary duties."  The court also rejected the argument that the "resounding no vote" by shareholders combined with a decline in share prices sufficied to remove the presumption of the business judgment rule. 

[the argument] contradicts the express language of Dodd-Frank and well-established Delaware law. Dodd-Frank states that a shareholder vote does not “overrul[e]” a decision by a board or “create or imply any additional fiduciary duties” to rescind or otherwise respond to a say on pay vote. See 15 U.S.C. § 78n-1(c). . . . I also note that the result of the advisory say on pay vote cannot rebut the business judgment presumption because it occurred after the Board approved the 2010 executive compensation. Delaware law forbids using events subsequent to the challenged action to second guess a board’s business judgment.

The decision, therefore, continues a clear trend with respect to legal challenges involving negative say on pay votes.  With the exception of Cincinnati Bell, courts have not been willing to allow cases involving a negative say on pay allegation to get past the demand excusal stage.  Some have used language that suggests a negative vote is irrelevant to the analysis, mostly relying on the language in the statute stating that the advisory vote does not alter fiduciary obligations.  See 15 U.S.C. § 78n-1(c).  A few cases have noted that a negative vote can be a factor in determining whether the board is entitled to presumption of the business judgement rule but, standing alone, does not suffice to rebut the presumption. 

The short term consequences of these decisions is to remove some of the legal risk associated with negative say on pay votes by shareholders.  Boards in general can be comforted by knowing that the fact alone does not significantly increase the risk of a violation of the board's fiduciary obligations.

In the long term, however, the cases likely will make advisory votes less effective.  Aware that a negative say on pay vote does not significantly increase risk, boards will have greater freedom to ignore them.  To the extent that this occurs, advisory votes will have less impact on the compensation process.  In countries where say on pay has not had the intended effect on compensation practices, countries have sometimes put in place second generation statutes that provide shareholders with some binding authority.  This has occurred, for example, in Britain. 


Bill Moyers on “The United States of ALEC”

The following is excerpted (under a Creative Commons license) from “The United States of ALEC: Bill Moyers on the Secretive Corporate-Legislative Body Writing Our Laws,” available on here.

Democracy Now! premieres "The United States of ALEC," a special report by legendary journalist Bill Moyers on how the secretive American Legislative Exchange Council has helped corporate America propose and even draft legislation for states across the country. ALEC brings together major U.S. corporations and right-wing legislators to craft and vote on "model" bills behind closed doors. It has come under increasing scrutiny for its role in promoting "stand your ground" gun laws, voter suppression bills, union-busting policies and other controversial legislation. Although billing itself as a "nonpartisan public-private partnership," ALEC is actually a national network of state politicians and powerful corporations principally concerned with increasing corporate profits without public scrutiny....

BILL MOYERS: ALEC is a nationwide consortium of elected state legislators working side by side with some of America’s most powerful corporations. They have an agenda you should know about: a mission to remake America, changing the country by changing its laws one state at a time. ALEC creates what it calls "model legislation," pro-corporate laws … that its members push in statehouses across the country. ALEC says close to a thousand bills, based at least in part on its models, are introduced every year, and an average of 200 pass. This has been going on for decades, but somehow ALEC managed to remain the most influential, corporate-funded political organization you had never heard of …. Lisa Graves, a former Justice Department lawyer, runs the Center for Media Democracy. That’s a nonprofit investigative reporting group in Madison, Wisconsin. In 2011, by way of an ALEC insider, Graves got her hands on a virtual library of internal ALEC documents. …

LISA GRAVES: Bills to change the law to make it harder for Americans to vote, those were ALEC bills. Bills to dramatically change the rights of Americans who are killed or injured by corporations, those were ALEC bills. Bills to make it harder for unions to do their work were ALEC bills. Bills to basically block climate change agreements, those were ALEC bills….

BILL MOYERS: It sounds like lobbying. It looks like lobbying. It smells like lobbying. But ALEC says it’s not lobbying. In fact, ALEC operates not as a lobby group but as a nonprofit, a charity. In its filing with the IRS, ALEC says its mission is education, which means it pays no taxes and its corporate members get a tax write-off. Its legislators get a lot, too….

STATE REP. STEVE FARLEY: I just want to emphasize, it’s fine for corporations to be involved in the process. Corporations have the right to present their arguments. But they don’t have the right to do it secretly. They don’t have the right to lobby people and not register as lobbyists. They don’t have the right to take people away on trips, convince them of it, and send them back here, and then nobody has seen what’s really gone on and how that legislator has gotten that idea and where is it coming from.

BILL MOYERS: Farley has introduced a bill to force legislators to disclose their ALEC ties, just as the law already requires them to do with any lobbyist.

STATE REP. STEVE FARLEY: All I’m asking in the ALEC Accountability Act is to make sure that all of those expenses are reported as if they are lobbying expenses, and all those gifts that legislators received are reported as if they are receiving the gifts from lobbyists, so the public can find out and make up their own minds about who is influencing what.

BILL MOYERS: Steve Farley’s bill has gone nowhere. ALEC, on the other hand, is still everywhere, still hiding in plain sight. Watch for it coming soon to a statehouse near you.

PS--Relatedly, you might find my article "Finding State Action When Corporations Govern" of interest.


Universal Banks, Market Risk and Efforts to Have It Both Ways

The Economist opposes the break up of large banks but is also critical of some of the regulatory limitations gradually being imposed on these financial institutions.  The two positions, in the messy real world, have an air of inconsistency.  

What are the arguments for leaving the size of large financial institutions untouched?  According to the Economist, there are three reasons why some favor a break up of the large banks:  there is something rotten about investment banking that infects commercial banking; there is a threat to financial stability because of the added complexity that comes with size and involvement in the securities markets; and universal banks "are a dreadful deal for investors."

Having defined the problem in a particularly inapt way, the Economist then demolishes each of its own characterization.   As it notes:  "The idea that all finance’s problems stem from the investment-banking 'casino' is a misdiagnosis."   But of course no one says that all problems in finance stem from involvement in the securities markets, only that involvement increases risk. 

What about financial stability?  The main argument is that involvement in securities markets permits commercial banks to diversify their investment portfolio, with a mix of loans and securities activities.  That is, of course, true, but it does not in any way assess the risks associated with particular types of investments.

As for the "dreadful deal" for investors, the article simply noted that this was "open to question."  Perhaps.  But isn't the issue a bit broader than that?  If we were only concerned about investors, there would be no problem with "too big to fail."  Let them fail and wipe out the equity holders.  Too big to fail is decidedly not a doctrine focused on investors but the impact of a failure on the financial system. 

Finally, the Economist did note that while "it is easy to call for banks to be carved up, it would be hellishly difficult in practice."  True.  But that goes to execution (no small matter).  It is not a commentary on the broader issue of whether a break up should occur.  Thus, the comment that they should not be broken up because "most are so large that simply slicing them in two would not solve the problem" begs the question of how deep to slice in any downsizing endeavor. 

Nonetheless, recognizing the problem of too big to fail, the Economist noted the proposal by the British Government to adopt a "ring fence" around retain and investment banking activities.  As the article noted: 

that would force the retail and investment-banking arms of universal banks to have their own capital buffers, shielding depositors from losses in the investment bank but retaining some diversification benefits. Add in new rules requiring all types of banks to hold more capital, and (crucially) efforts to impose losses on private creditors of a failing institution, and the case for radical surgery is blunted.

Put aside the logistical issues that would arise in connection with the implementation of such a scheme.  The solution of the Economist was do not downsize, but increase regulation.  

But having proposed additional regulation in place of downsizing, it did not take the Economist very long to criticize efforts to increase the regulatory framework for investment banks.  In a subsequent article, the Economist noted the inevitable consequences of increased regulation, a decline in profitability.  

regulations on capital and liquidity are starting to bite. These are reducing returns earned by banks as well as forcing them to shrink their balance-sheets and cut back on trading. Many banks are also starting to position themselves for proposed rules that are not yet in force, such as America’s Volcker rule, which aims to stop banks trading for their own account, and regulations that will shove over-the-counter derivatives, which command fat margins, onto clearing-houses and exchanges.

So regulation designed to more tightly regulate investment banking activities is starting to hurt, at least when measured by profitability.

It is a set of arguments that seek to have it both ways.  Start with the presumption that banks are in fact too big to fail.  Why?  The NYT Magazine said it nicely: 

The main lesson of Lehman’s collapse is that the response to a troubled financial system is, ultimately, determined not by technical regulation, but by politics. The F.D.I.C. can use its new powers only after receiving the consent of the Treasury secretary. And its new powers pertain only to those banks deemed systematically important, a designation determined by political appointees. So while the F.D.I.C. is working to formalize the rules governing its new powers, investment-bank lobbying has grown by nearly 60 percent since the crisis began. Bankers learned that they need to be closer than ever to politicians.

So there really are only two solutions.  One is to downsize the banks and make them small enough that they can fail without creating a political question.  The second is to increase the regulation of universal banks, not because it is good for investors, not because it makes the financial system more stable over all, but because it reduces the risk profile of universal banks and makes a failure less likely, reducing the instances of a possible failure. 

This is not an argument for either position.  Both solutions are difficult to implement and will cause plenty of problems.  It is mostly a commentary on those who seem to argue against both approaches.  There is a viable basis for doing so:  that too big to fail is a reality and should simply be accepted.  But to the extent there is concern with too big to fail, they can at least be ameliorated through adjustments in size and/or adjustments in risk.  For more thoughts on this subject, see The "Great Fall": The Consequences of Repealing the Glass-Steagall Act


Federal Housing Finance Agency v. The Royal Bank of Scotland: The Private Securities Litigation Reform Act is not Applicable to the Federal Housing Finance Agency

The Federal Housing Finance Agency (“FHFA) brought a claim as a conservator for the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) against The Royal Bank of Scotland (“RBS”) and multiple other defendants, alleging violations of federal securities laws.  Defendants sought to invoke the automatic stay of discovery contained in the Private Securities Litigation Reform Act (“PSLRA”). See 15 U.S.C. § 78u-4(b)(3)(B). The United States District Court for the District of Connecticut ruled that the present claim was not a private action under the PSLRA and, as a result, declined to order a stay of discovery. Fed. Hous. Fin. Agency v. The Royal Bank of Scotland Group PLC, No. 3:11-cv-01383 (D. Conn. Aug. 17, 2012).

Fannie Mae and Freddie Mac were formed in order to “make the secondary mortgage market more competitive and efficient.” Both companies are federally chartered. In 2008, Congress created the FHFA and gave it the power to place regulated entities into conservatorship. In 2008, the FHFA became the conservator for Fannie Mae and Freddie Mac for the purpose of stabilizing the two corporations.

In the action brought by FHFA, the defendants filed a motion to dismiss while the plaintiff filed a motion to commence discovery.  In response to plaintiff's motion, defendants sougth a stay of discovery, noting that under the PSLRA, “all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss . . .”  The defendants asserted that because the plaintiff stepped into the shoes of two private corporations, it had become a private plaintiff.  As a result, plaintiff’s action was private, subject to the PSLRA, and subject to the stay of discovery. 

In resolving the applicability of the PSLRA, the court reasoned that “the material distinction for purposes of determining whether an action is a ‘private action’ under the PSLRA is the nature of the plaintiff, not the cause of action.” Thus, the PSLRA applied to actions brought by private plaintiffs, but not those brought by government agencies, such as the Securities and Exchange Commission. The court concluded that the FHFA, did not lose its status as a government agency simply by acting as a conservator for private parties.

In the alternative, the defendants argued that Rule 26(c) of the Federal Rules of Civil Procedure required a stay of discovery during this time period. However, the court ruled that the defendants had not met their burden of “showing that good cause exists” to justify an order to stay the plaintiff’s discovery.

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


Auto. Indus. Pension Trust Fund v. Textron Inc.: Pleading Fails To Meet the Scienter Element Under Heightened PSLRA Standards

On June 7, 2012, the First Circuit Court of Appeals affirmed the district court’s decision to grant Textron Inc.’s (“Textron”) motion to dismiss Appellees’ securities fraud class action claim.  Auto. Indus. Pension Trust Fund v. Textron Inc., No. 11-2106, 2012 WL 2038098 (1st Cir. 2012).  Automotive Industries Pension Trust Fund was the lead appellee for a class of plaintiffs (collectively, “Appellees”) who invested in Textron.

According to the complaint, Textron, which wholly owns Cessna Aircraft Company (“Cessna”), made statements over the course of 2007 and 2008 assuring its investors of its financial strength due to the depth of its backlog of orders at Cessna.  For instance, Textron allegedly stated that the backlog would carry the company through difficult economic times.  For sixteen months leading up to January 2009, Textron management reassured investors that its backlog was resilient and cancellations were minimal.  On January 29, 2009, however, Textron reported a disappointing fourth quarter in 2008, with “few orders, 23 cancellations, and ‘an unprecedented number of deferrals’ of delivery dates by customers.”  After the report’s release, Textron stock declined thirty-one percent. 

To allege a claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5,  plaintiffs must plead “1) material misrepresentation or omission; 2) scienter; 3) a connection to the purchase or sale of a security; 4) reliance on the representations; 5) economic loss; and 6) loss causation.”  To reduce the number of securities lawsuits, Congress enacted the Private Securities Litigation Reform Act (“PSLRA”), which requires plaintiffs to allege each specific misleading statement, state why it is misleading, and allege a “strong inference” that the defendant acted with scienter.  Adequate scienter is the “intent to deceive, manipulate, defraud” or act recklessly with an indifference to deceit.

Appellees’ claim relied on twenty-three confidential witnesses who allegedly revealed weaknesses in Cessna’s backlog.  The weaknesses included lowered credit standards for buyers, customer deposits that Cessna fully financed, and generous loan repayment terms.  Cessna encouraged customers to delay their orders instead of canceling them; additionally, many customer orders were contingent, intended only to be delivery placeholders and not actual orders.  Appellees alleged that Textron made false statements about cancellation figures, including an announcement that Cessna had only two cancellations as of July 2008.   Appellees’ main claim, however, was that Textron failed to disclose information about the weakness of its backlog orders.

The court held that Appellees’ complaint failed to plead facts sufficient to infer scienter.  Nothing in the complaint implied that Textron’s management believed, or was reckless in not knowing, that the backlog had been compromised by loose underwriting standards.  Allegations that Textron’s management was unaware of Cessna’s unstable backlog would establish negligence, but negligence was not sufficient to prove scienter under PSLRA standards.  The court stated that a concealed change in company policy could support an inference of scienter; however, Appellees did not plead those facts. 

A strong inference of scienter can also arise from stock sales that are unusual in amount.  Appellees highlighted some stock sales by Textron management during the class period, but Appellees did not provide comparative sales from outside the class period to suggest that these were unusual.  Additionally, the confidential witness statements about backlog cancellations occurring “suddenly” in “late summer” corroborated Textron’s statements and did not establish scienter.  None of Appellees’ scienter allegations were sufficient to meet the burden of the PSLRA’s heightened pleading standards; therefore, the appellate court affirmed the dismissal of the claim.

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



Koehler on the FCPA

Mike Koehler (SIU) has posted Foreign Corrupt Practices Act Enforcement as Seen through Wal-Mart's Potential Exposure on SSRN with the following abstract:

High-profile instances of Foreign Corrupt Practices Act scrutiny focus attention on the law and its enforcement across a broad spectrum. In spring 2012, arguably the most high-profile instance of scrutiny in the FCPA’s 35-year history occurred as Wal-Mart’s alleged conduct in Mexico dominated the news cycle. Wal-Mart’s scrutiny has been instructive in many ways at a key point in time for the FCPA. This article uses Wal-Mart’s potential FCPA exposure as a prism to view the current FCPA enforcement environment.


Yudell v. Gilbert: Distinguishing Direct and Derivative Claims

In Yudell v. Gilbert, 2012 N.Y. Slip Op. 05896, 2012 WL 3166788 (N.Y. App. Aug. 7, 2012) the Appellate Division of the New York Supreme Court affirmed the dismissal of an action brought by a joint venture, holding that the breach of fiduciary duty claim was derivative, not direct, and the plaintiffs, a few members of a joint venture, failed to plead demand futility with requisite particularity.

In 1965, Baldwin Harbor Associates (BHA) was formed as a joint venture for the purpose of constructing and managing a shopping center. BHA hired Jerrold Gilbert (“Gilbert”) as the managing agent for the shopping center, responsible for billing and collecting rents and maintaining and repairing the premises. Gilbert later became a trustee of one trust set up as the successor venture partner to a deceased partner of BHA.

In 2008, the plaintiffs filed suit against Gilbert as an individual, the other members of BHA, and BHA as a nominal defendant, alleging both direct and derivative claims. On appeal were five causes of action pled by the plaintiffs stemming from Gilbert’s alleged failure to timely and regularly collect additional rents and charges including tax obligations and common area maintenance as required by the leases, and his decision to enter into third-party contracts on behalf of BHA. The specific claims against Gilbert were for his failure to properly account to the joint venture partnership, breach of the management agreement, negligence, breach of the joint venture agreement, and breach of the fiduciary duty he owed to BHA and each of the joint venture partners.

To bring derivative claims, a plaintiff must first make demand on the board of directors. The demand requirement may be waived if it would be futile. Futility will occur where the board is not independent or the decision is not protected by the business judgment rule. The plaintiffs alleged demand futility, but did not plead futility with the required degree of particularity. The plaintiffs argued that the pleading requirement was unnecessary because the fiduciary duty claim was direct rather than derivative.

The court adopted the Delaware framework to determine whether a claim was direct or derivative. This required the court to

look to the nature of the wrong and to whom the relief should go. The stockholder’s claimed direct injury must be independent of any alleged injury to the corporation. The stockholder must demonstrate that the duty breached was owed to the stockholder and that he or she can prevail without showing an injury to the corporation.

A court should, therefore, look to “(1) who suffered the alleged harm (the corporation or the stockholders); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders individually).”

Accordingly, the court held that the plaintiffs’ claim of breach of fiduciary duty was derivative because any loss suffered by the plaintiffs derived from a loss to BHA. Additionally, any recovery on the claims would equal the value of lost rent and charges that would be to the benefit of BHA; the plaintiffs would receive their proportionate share of the recovery after BHA received its recovery and divided it among the members of the entity.

Because the plaintiffs’ failed to sufficiently plead demand futility, the claims were properly dismissed. As the lower court dismissed the claims without prejudice, the plaintiffs would be afforded the opportunity to amend the complaint and refile.

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


When in Doubt, Don’t Show Up: DC Circuit Reversed and Remanded SEC’s Default Order in Rapoport v. SEC

In Rapoport v. SEC, the D.C. Circuit Court of Appeals granted petitioner Rapoport’s petition for review, vacated the Security and Exchange Commission’s (“SEC”) default order, and remanded for further proceedings.  The court concluded that the SEC had arbitrarily applied Rule 155(b) of its Rules of Practice and failed to provide a comprehensible standard for what constituted a reasonable time to file a motion to set aside a default.  Rapoport v. SEC, 2012 WL 2298772 (D.C. Cir., June 19, 2012). 

The SEC entered a default judgment against Dan Rapoport (“Rapoport”), a Russian citizen, for failing to respond to administrative proceedings alleging violations of Section 15(a) of the Exchange Act. According to the SEC’s Order Instituting Proceedings (“OIP”), Rapoport “solicited institutional investors in the United States to purchase and sell thinly-traded stocks of Russian companies . . . without registering as a broker-dealer as required by Section 15(a) of the Exchange Act” or meeting an exemption under Rule 15a-6.  17 CFR 240.15a-6. 

Rapoport filed a motion to set aside the default.  Under Rule 155(b) of the Exchange Act, a motion to set aside a default must (1) be made within a reasonable time; (2) state the reasons for the failure to appear or defend; and (3) specify the nature of the proposed defense to the original proceeding. 17 C.F.R. § 201.155(b).  If the SEC finds “good cause shown,” the default can be set aside at any time.

The SEC determined that Rapoport failed to file his motion within a reasonable time and that his reason for failing to defend the OIP lacked merit.  Because the first two prongs of Rule 155(b) were not met, the SEC did not consider the merits of Rapoport’s defenses. 

The court held that by failing to consider Rapoport’s defenses, the SEC departed from its previous interpretation of Rule 155(b) and did so without justifying the inconsistency.  The court stated that “[a]lthough the Commission is not bound to follow its precedent, it may not depart from its precedent without offering a reasoned explanation.”

The DC Circuit also held that the Commission “failed to provide any intelligible standard to assess what constitutes a ‘reasonable’ amount of time for filing a motion to set aside a default order under Rule 155(b).”  It was unclear when the “reasonable time” clock started ticking and what amount of time was reasonable to file a motion to set aside a default after the clock had begun.    

Finally, the court suggested that the SEC review the sanctions it applied in the default judgment.  Rapoport was charged with a second-tier penalty for each year of the alleged violations.  There were, however, no specific allegations of Rapoport’s violations to support the charges. The SEC instead relied on conclusory allegations that Rapoport willfully violated Section 15(a), which alone are not enough to justify maximum second-tier penalties without further explanation.  The court held that the SEC’s further explanation “was not just superficial, it was non-existent.”

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


A Brief Comment on Greenfield’s Stakeholder Strategy

Earlier this month, Kent Greenfield published an essay entitled, “The Stakeholder Strategy: Changing corporations, not the Constitution, is the key to a fairer post-Citizens United world.”  In the essay, Greenfield “urges progressives to cease their efforts to amend the constitution to weaken corporate ‘personhood.’”  Instead, he advocates two corporate governance changes:

First, the law of corporate governance should expand the fiduciary duties of management to include an obligation to consider the interests of all stakeholders in the firm…. [S]econd … alter the actual structure of company boards to allow for the nomination and election of board members who embody or can credibly speak for the interests of stakeholders.

Greenfield notes that these two changes would most likely require an additional third change—the [further] federalization of at least some meaningful portion of state corporate law:

In order to make these changes meaningful, they would have to be accomplished in a way that minimizes Delaware’s dominance. Otherwise, companies could avoid these changes by fleeing—on paper—to Dover or Wilmington. The most obvious answer to this problem is an assertion of a national corporate-law standard. If the federal government required, for example, companies of a certain size be chartered as national corporations, it would be simple to add the robust fiduciary duties and the requirement that boards include employee representatives. A national corporate-law standard would be a straightforward application of Congress’s Commerce Clause power even in this era of its parsimonious application.

Greenfield’s essay has much more to offer than these main points, and I highly recommend you go read the whole thing.  However, I did want to note one particular reaction I had in reading his proposals.  

To begin with, the general notion of encouraging corporate boards to consider stakeholders is not new.  In fact, the most recent edition of Klein, Ramseyer, and Bainbridge's Business Associations casebook notes that:

A Pennsylvania provision, enacted in 1990, provides, as part of its rules on duties of directors, that directors ‘‘may, in considering the best interests of the corporation,’’ consider the effects of their actions on ‘‘any or all groups affected by such actions, including shareholders, employees, suppliers, customers and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located.’’ Penn.Consol. Statutes, Title 15, § 102(d).

However, while I believe at least one state had a mandatory stakeholder statute at one time, the permissive nature of the typical stakeholder statute obviously distinguishes Greenfield’s proposal.  Furthermore, granting stakeholders a right of action to enforce the obligation helps negate a typical criticism of more traditional stakeholder statutes, which is that they primarily serve as a further defense for directors against shareholder suit but impose no offsetting accountability. 

Having said all that, what currently intrigues me is thinking about the role of disclosure in all of this.  I believe requiring boards to disclose the substance of their deliberations as to each covered stakeholder could produce an independent benefit.  For example, if every relevant proxy statement included a section entitled “Impact on Employees and Local Communities,” the ensuing debate would likely be enriched and, as Greenfield notes in discussing the board-composition proposal: “Another benefit of requiring corporations to take into account the interests of a broader range of stakeholders in corporate decision-making is that the quality of the decisions themselves will improve.”  Even more provocatively, imagine if this type of disclosure requirement was imposed on political speech decisions.  Corporations could be required to explain how their political spending improves the welfare of each covered stakeholder.  Wouldn’t you like to be a fly on the wall while the advisors tried to craft that disclosure?

Obviously, there will be times (perhaps many) when the the interests of stakeholders conflict, and this is a common criticism of stakeholer statutes that remains relevant to Greenfield's proposal.  However, one possible solution to this problem is to direct boards to resolve all such conflicts in favor of the long-term sustainability of the enterprise.  (Relatedly, David Westbrook just sent around an email to the bizlaw listserv noting an upcoming conference on Rethinking Financial Markets that focuses in part on "Custodial Regulation," which advances the notion that "the practice of financial regulation should shift focus from fostering the formation and allocation of capital to maintaining the stability of the institutions, now all perforce monetary institutions, on which contemporary social life depends.”)

PS--Bainbridge also posted a response to Greenfield's piece here.


Platinum Partners Value Arbitrage Fund LP v. Chicago Board Options Exchange: Regulatory Immunity Does Not Apply to Private Disclosure of a Regulatory Action

In Platinum Partners Value Arbitrage Fund LP v. Chicago Board Options Exchange, No. 1-11-2903 (Ill. App. Aug. 10, 2012), the appellate court reversed the trial court’s dismissal of the plaintiff’s securities and fraud claims, holding that the doctrine of regulatory immunity did not apply to the private disclosure of a stock option price adjustment by a self-regulatory organization (“SRO”).

The plaintiff, a hedge fund, alleged that an unnamed employee at one of the defendants Chicago Board Options Exchange (“CBOE”) or Options Clearing Corporation (“OCC”) disclosed a pending adjustment to the strike price of options in India Fund, Inc. (“IFN”) to insider market participants before making a public disclosure of that adjustment. The plaintiff further alleged that because it purchased 50,000 IFN put options after the private disclosure but before the public disclosure, it was harmed by the defendants’ private disclosure. The trial court dismissed the case, holding that the CBOE and OCC were absolutely immune from suit because the conduct at issue was undertaken as part of their regulatory duties as SROs.

Regulatory immunity applies to allegations concerning conduct “within the bounds of the government functions” delegated to an SRO. The test for whether conduct is within those bounds is objective and depends on whether “specific acts and forbearances were incident to the exercise of regulatory power.” The court reasoned that although the strike price adjustment was itself an exercise of regulatory power, the private disclosure, which served no regulatory purpose, was not. Thus, the private disclosure was not within the scope of regulatory immunity.

The defendants argued that, even absent regulatory immunity, the plaintiffs had failed to state a claim. The court, however, held that the plaintiffs had properly stated a claim of fraud under sections 12(F) and 12(I) of the Illinois Securities Law (which closely tracks federal securities law), the Illinois Consumer Fraud and Deceptive Business Practices Act, and common law. Section 12(F) claims require that “a complainant must allege that the defendant (1) made a misstatement or omission, (2) of material fact, (3) in connection with the purchase or sale of securities, (4) upon which the plaintiff reasonably relied and (5) that reliance proximately caused the plaintiff’s injuries.” Here, the defendants had a duty to disclose the strike price adjustment, and the plaintiffs adequately pleaded the requisite omission of that disclosure, materiality, reliance, and injury. In addition, the plaintiffs adequately pleaded the scienter element necessary for the other three claims.

Because the defendants’ private disclosure of the strike price adjustment was not within the scope of regulatory immunity, and because the plaintiffs adequately pleaded four fraud claims, the court reversed the trial court’s dismissal of the plaintiff’s claims. It also held that the plaintiff should be allowed to amend its complaint to include new facts and allegations discovered by its replacement counsel, because it was “in the best interests of justice.”

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


Richman v. Goldman Sachs Group: CDOs and Wells Notices

In Richman v. Goldman Sachs Group, Inc., WL 2362539 (S.D.N.Y. June 21, 2012), the court dismissed Plaintiffs' claim regarding Goldman Sachs Group, Inc.’s (“Goldman”) failure to disclose its receipt of Wells Notices but denied Defendants’ motion to dismiss claims pertaining to Goldman’s alleged conflicts of interest in several Collateralized Debt Obligation ("CDOs") placements.

Plaintiffs are purchasers of Goldman's common stock between February 5, 2007 and June 10, 2010 (“Plaintiffs”). Defendants are Goldman Sachs & Co (“Goldman”), Goldman Chairman and CEO Lloyd C. Blankfein, Goldman CFO David Viniar and Goldman COO Gary D. Cohn (“Individual Defendants.”) Plaintiffs claimed that Defendants made misstatements and omissions about Wells Notices the company received from the Securities and Exchange Commission (“SEC”), and about the conflicts of interest arising out of Goldman's role in structuring the CDOs known as Abacus, Hudson Mezzanine Funding ("Hudson"), Anderson Mezzanine Funding ("Anderson") and Timberwolf I.

In the Abacus transaction, for example, Goldman allegedly allowed one of its favored hedge fund clients, Paulson & Co., to select assets for inclusion in the CDO. At the same time, however, Goldman falsely identified ACA Management as the sole portfolio selection agent for the transaction.  Goldman also allegedly told investors that it had "aligned itself with the Hudson program by investing in a portion of equity," while at the same time it failed to disclose that it had the entire short position on the deal (in other words, Goldman did not disclose that its $6 million equity holding in the CDO was dwarfed by the $2 billion short position held in it). Plaintiffs also alleged other examples of undisclosed conflicts.  

The court found that Plaintiffs plausibly alleged that Goldman made material omissions regarding its arrangement with Paulson & Co. in the Abacus transaction because Defendants "knowingly allowed Paulson to select the assets for the Abacus CDO, and knew that Paulson was selecting assets that it believed would perform poorly or fail." Similarly, the court found that Plaintiffs plausibly alleged that in the Hudson, Anderson, and Timberwolf I CDO transactions, Goldman represented that it held a long position in the equity tranches and did not disclose its substantial short positions. As the court said:

 "having allegedly affirmatively represented [Goldman] had a particular investment interest in [these synthetic CDOs]—that it was long—in order to be both accurate and complete, Goldman ... had a duty to disclose [it] had a [greater] investment interest [from its] short [position] ... [because that was] a fact that, if disclosed, would significantly alter the ‘total mix’ of available information."

Finding that Plaintiffs established duty, the court turned to the scienter analysis. Scienter could be  inferred when defendants "knew facts or had access to information suggesting that their public statements were not accurate." Here, Defendants allegedly assured shareholders that Goldman complied with the law and that it had "procedures in place to address 'potential conflicts of interest.'" Alternately, Goldman allegedly fostered a conflict of interest in the Abacus CDO and acted against investor interest in Hudson, Anderson and Timberwolf I. The court found that "Goldman knew or should have known that its statements about complying with the letter and spirit of the law, and its disclaimers regarding ‘potential’ conflicts of interest were inaccurate and incomplete." The court agreed with Plaintiffs that a strong inference of scienter could be drawn from Goldman's actions in the four CDO deals.

The court also found that Plaintiffs had sufficiently alleged loss causation and claims against the Individual Defendants.  The Individual Defendants allegedly helped prepare the SEC filings at issue. Moreover, scienter was established through allegations that the Individual Defendants actively monitored the status of the relevant CDO assets and were intimately acquainted with the CDO operations.    

With respect to the Wells Notices, Goldman, according to Plaintiffs, failed to disclose the receipt of the Wells Notices from the SEC in connection with the investigation of the Abacus transaction.  Plaintiffs asserted that Defendants' disclosures about governmental investigations triggered a duty to disclose receipt of Wells Notices, and that by failing to do so caused the public to mistakenly believe that “no significant developments had occurred which made the investigation more likely to result in formal charges." The court noted that the delivery of a Wells Notice, while reflecting the SEC Enforcement Division’s determination on bringing charges, did not necessarily mean that charges would be filed.  The court found that failure to disclose receipt of the Wells Notices did not render Goldman’s statement misleading and that Defendants' violation of FINRA's Wells Notice disclosure requirement was not grounds upon which a section 10(b) or Rule 10b-5 claim could be based.   The court also rejected the argument that a FINRA rule requiring disclosure of a wells notice triggered a duty to disclose under the antifraud provisions. 

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


How Women Can Change Corporate Boards: The Effects of Achieving a Critical Mass of Female Directors

This post was co-authored and submitted to The Race to the Bottom by Anna Catalano and Nick Slavin. Ms. Catalano serves on the boards of directors of Mead Johnson Nutrition, Willis Group Holdings, Chemtura, and Kraton Polymers. Her leadership blog can be found here. Mr. Slavin wrote this when he was a corporate attorney with Skadden, Arps, Slate, Meagher & Flom LLP.  

As the number of qualified women in the corporate director candidate pool grows, companies are reconsidering the business case for gender diversity on boards. The most familiar arguments involve the optical value of having a board’s members reflect the company’s diverse employees, customers, shareholders, and other stakeholders, and the strategic value of women’s diverse “perspective” in the boardroom. In recent years, however, the arguments have come into sharper focus as some commentators have made the controversial claim that women may have higher ethical standards in business than do men,[1] and studies have more precisely articulated the benefits women can provide in the boardroom and the circumstances in which such benefits occur. 


Although the causal mechanisms are difficult to pinpoint, the correlations between women directors and ethical governance are beginning to show a pattern. A 2009 study in Corporate Reputation Review found that Fortune 500 companies with higher percentages of women directors were more likely to be found on Ethisphere Magazine’s “World’s Most Ethical Companies” list.[2] Other studies identify a correlation between women directors and higher scores on measures of corporate social responsibility.[3] Data from the Journal of Financial Economics suggest that these positive effects might be due in part to the effects they have on the other board members, showing that a greater number of female directors is correlated with better attendance and engagement of male directors.[4]

Recent research analyzes how boardroom dynamics change as the number of female directors increases. Kramer, Konrad, and Erkut’s (2006) Critical Mass study observes that the benefits of a gender diverse board only fully appear upon reaching a “critical mass,” or tipping point, of women directors.[5] Their research shows that while one woman may have a potential impact in the boardroom, the presence of three or more substantially increases the magnitude of women’s influence. Reaching this threshold number gives women the support and validation they need to be the most effective directors.

In some European countries, reaching this threshold is now mandated. Required gender-based quotas for public company boards have been introduced in Norway, France, Iceland, and Spain, while countries such as Switzerland, Israel and South Africa have introduced quotas for government-owned companies.[6] Norway’s mandated quota, introduced in 2003, called for women to comprise at least 40% of public boards by 2008.[7] Proponents argue that Norway’s model has not adversely affected corporate valuations as some feared, and Norwegian board members interviewed about their experiences report that the markedly increased female presence has at a minimum made preparation material more comprehensive and processes more formal, both of which tend to be associated with good governance.

Solo female directors, however, remain common in the United States. Catalyst, a nonprofit organization that advocates women in business, reports that in 2005, 182 companies in the Fortune 500 had just one female director, while 53 companies still had no female representation on their boards.[8] While strong women can make a substantial difference as solo flyers, those who serve as the lone woman director often report feelings of isolation as fellow board members may view their competence cautiously. Though two women with different styles and areas of expertise can help dispel some feelings of tokenism (particularly if their backgrounds include significant profit-and-loss and financial experience), women who serve on boards with only two female directors say they dislike being stereotyped as the “women’s contingent.”[9] The Critical Mass study indicates that boards that follow the “rule of three” normalize women’s presence in the boardroom, where they are viewed more as contributing individuals rather than as representatives of their gender. In contrast to the Norwegian model, relatively few American companies benefit from this phenomenon: last year, just over one-fifth of companies in the Fortune 500, where average board size is over 11, had three or more women directors.[10]

Moving boards beyond the lone token woman requires companies to see the value of a gender-diverse board, and a number of recent studies have highlighted the benefits of gender diversity. They note that women more often consider multiple stakeholders, not just stockholders, when making decisions, and have a greater connection to the complex human context of the business. According to some, women are more likely to ask tough questions and demand comprehensive answers, and their collaborative leadership style and direct manner of communication can improve board dynamics as well. The Norwegian data also support previous studies observing that boards with more women tend to be more engaged, better prepared, and more observant of formalities.

Still, the subtle and often ambiguous benefits that female directors bring continue to be debated, with many arguing that women directors are not preferable to serve on boards than similarly qualified male candidates. A 2010 study surveying 400 male and female board members of primarily American companies concluded that while 90% of female directors believed women bring unique attributes and perspectives to the boardroom, only about half of male directors shared the sentiment.[11] The same study showed that male directors were less likely than female directors to support the SEC rule mandating an explanation of diversity’s role in board member selection (43% vs. 62%, respectively). Likewise, 25% of surveyed women supported diversity quotas and regulations, while just 1% of men reported so.

Perhaps these differences of opinion in part reflect the reality that with diversity comes potential risks: miscommunication, conflict, exclusion, and loss of camaraderie. Qualified directors must be chosen carefully and the chairman must have the ability to temper the wider range of opinions at the table with an overall sense of group cohesion.

While the benefits of gender diversity on boards remain controversial, recent research, as well as the effects of quotas in certain countries in Europe and elsewhere, have helped to articulate clearer rationales for boards adding strong female directors, at least until a “critical mass” is achieved.

[1] Lisa Yoon, “On Boards, Are Women the Fairer Sex?,”, April 10, 2003. Retrieved from

[2] Bernardi, Richard A., Susan M. Bosco, and Veronica L. Columb, “Does Female Representation of Boards of Directors Associate with the ‘Most Ethical Companies’ List?” Corporate Reputation Review 12.3 (2009): 270-280. Business Source Complete. Web. 13 June 2012.

[3] Bernardi, Richard A., and Veronica H. Threadgill, “Women Directors and Corporate Social Responsibility.” Electronic Journal of Business Ethics and Organization Studies 15.2 (2010): 15-21. Retrieved from

[4] Adams, Renée B., and Daniel Ferreira, “Women in the Boardroom and Their Impact on Governance and Performance.” Journal of Financial Economics 94.2 (2009): 291-309. Elsevier. Retrieved from

[5] Kramer, Vicki W., Alison M. Konrad, and Sumru Erkut, “Critical Mass on Corporate Boards: Why Three or More Women Enhance Governance.” Wellesley Centers for Women 11 (2006): 1-74.

[6] Wintrob, Suzanne, “Mandated Diversity Quotas Won’t Make Corporate Governance Any Better,” Financial Post Magazine, June 19, 2012. Retrieved from

[7] Ibid.

[8] Soares, Rachel, Baye Cobb, Ellen Lebow, Allyson Regis, Hannah Winsten, and Veronica Wojas, “2011 Catalyst Census: Fortune 500 Women Board Directors.” Catalyst (2011): 1-2. Retrieved from

[9] Kramer, Konrad, and Erkut, 30.

[10] Soares et al.

[11] Connor, Michael, “Men and Women Disagree Sharply on Governance.” Business Ethics, October 7, 2010. Retrieved from



Stock Exchanges and the Implications of Demutualization

The WSJ reported that the SEC was clamping down on the efforts by stock exchanges to "bolster profits by pumping out products that increasingly have catered to high-speed traders."  As the article noted:

  • Since the flash crash of May 2010, SEC Chairman Mary Schapiro has been personally involved in driving inquiries about whether exchanges are improperly favoring customers whose rivers of buy and sell orders drive exchange profits, according to a person familiar with her thinking.
  • The agency is investigating whether exchanges have provided such clients order-routing privileges that give them an edge over ordinary investors.

The article comes on the heels of the decision by the SEC to fine the NYSE $5 million for violations of Rule 603 (a)(1) of Regulation NMS.

The article suggests that the stock exchanges are motivated by profit maximization in the introduction of new products.  They should be.  Both have converted to for-profit companies with the accompanying obligation to profit maximize.  At the same time, however, they are self regulatory organizations with legal and regulatory responsibilities.  As the SEC described:

National securities exchanges, such as NYSE, are critical elements of the national market system.   Because of this central role, an exchange is required to satisfy among the most significant regulatory responsibilities of any market participant.  These regulatory responsibilities implicate both an exchange’s own operations and its role as a self-regulatory organization that acts as a co-regulator with the Commission and other authorities.

While the exchanges strive to profit maximize while protecting the regulatory function (the NYSE for example has created a separate nonprofit subsidiary with an independent board to perform regulatory functions), one has to wonder whether, in the end, the NYSE (and Nasdaq) would benefit from sheering off any remaining regulatory responsibilities.  That would not prevent the SEC from adopting rules (such as Rule 603) and bringing actions against companies that violated the rules.  But it would give the exchanges greater freedom to act as the "for profit" companies that they have become.  


Taneja v. Familymeds Group, Inc. and the Importance of Process

Delaware has a reputation for producing management-friendly decisions in the corporate governance area.  The evidence can be seen from the jurisprudence emanating from the state, but it also can be seen from the fact that plaintiffs increasingly seek to litigate governance issues in other jurisdictions.    The thinking, presumably, is that they will get a better result in other states, even when the courts are applying Delaware law.  

A possible example of this occurred in Taneja v. Familymeds Group, Inc., 2012 Conn. Super. LEXIS 2127 (Conn. Aug. 21, 2012).  Shareholders brought a derivative action against the board, essentially alleging mismanagement.  The business mostly operated in Connecticut but was incorporated in Nevada.  The court noted that Nevada, in the absence of controlling law, viewed Delaware as persuasive.  As a result, the court found itself interpreting Delaware law.   

In the derivative action, defendants were represented by a law firm ("Law Firm").  The original case was dismissed for failure to make demand.  Plaintiffs thereafter made demand.  The directors were represented by the same Law Firm.  The Law Firm conducted an investigation into the allegations and ultimately issued a report concluding that "the allegations of the plaintiffs' demand were not substantiated."  The report was approved by the two directors "not subject to a conflict because of the pending demand allegations."  

Plaintiffs challenged the board's decision to reject demand.  The court noted that, under Delaware law, it was limited to "an analysis of the board's good faith and the reasonableness of the board's investigation of the demand." The court concluded that the designation of the Law Firm to undertake the investigation had not been done in good faith.  

The court essentially found that the Law Firm wore two hats:  Independent investigator and advocate for defendants.  The two positions could not be reconclied. 

At the time of the delegation, the directors were not disinterested. The assumption and the expectation were that the investigation's conclusion was predetermined, and that it was to be in the board's favor. The obligation of [the Law Firm] was to defend their client first and foremost. The undertaking of the investigation commenced while this purpose was in mind. This "asks too much of human nature . . ."  

Nor did approval by the disinterested directors change the outcome.  "The two remaining directors who voted . . . 'controlled neither which facts they heard nor the legal guidance given to them to put the evidence into the proper context.'" So long as the decision was based upon "the report of a conflicted law firm, then their conclusions are not entitled to the presumption that they were reasonable."

In the area of demand refusal, courts primarily rely on process to protect shareholders.  In this case, the court did not really question the quality of the investigation.  It was enough that the integrity of the process was in doubt.  Would Delaware courts have agreed?  Plaintiffs avoided having to find out by maintaining the action in Connecticut. 


Central States Law Schools Association 2012 Scholarship Conference

The Central States Law Schools Association 2012 Scholarship Conference will be held October 19 and 20, 2012, at the Cleveland-Marshall College of Law, in Cleveland, Ohio.  I've attended the conference multiple times and highly recommend it for anyone interested in getting helpful feedback on a work-in-progress in a very supportive environment.  Abstracts are due September 22, 2012.  For more information, go here.


Independent Agency Regulatory Analysis Act of 2012: S 3468 (Part 3)

There is another critically important issue raised by the Independent Agency Regulatory Analysis Act that represents a significant and historical shift in the treatment of independent agencies.

The term "independent agency" has multiple definitions.  Sometimes it is used to mean a free standing agency.  Under that definition, the EPA is an independent agency because it is not buried in another department.  The IRS is not an independent agency because it is in the Department of Treasury.  This definition is mostly a matter of geography and says nothing about the powers of the particular agency.

The term also, however, has a constitutional significance.  There are agencies that are "independent" because they are "independent" of the President.  Independence can come from a variety of powers given to an agency that allow them to act without consulting those in the White House (Justice Breyer lists some of them in his dissent in the PCAOB case).

But in truth there is only one attribute that truly matters for purposes of independence and that is the limitation on the President's ability to remove agency heads "for cause."  To the extent that an agency head cannot be removed at will, the agency head has greater independence and at least sometimes can deflect political considerations in making policy. 

The Independent Agency Regulatory Analysis Act of 2012 provides that the President can, by executive order, regulate the rulemaking process of "independent" agencies.  Independent is defined as those agencies listed in 44 USC 3502(5). The agencies listed in this section include:

  • the Commodity Futures Trading Commission, the Consumer Product Safety Commission, the Federal Communications Commission, the Federal Deposit Insurance Corporation, the Federal Energy Regulatory Commission, the Federal Housing Finance Agency, the Federal Maritime Commission, the Federal Trade Commission, the Interstate Commerce Commission, the Mine Enforcement Safety and Health Review Commission, the National Labor Relations Board, the Nuclear Regulatory Commission, the Occupational Safety and Health Review Commission, the Postal Regulatory Commission, the Securities and Exchange Commission, the Bureau of Consumer Financial Protection, the Office of Financial Research, Office of the Comptroller of the Currency, and any other similar agency designated by statute as a Federal independent regulatory agency or commission;

The definition also includes the Federal Reserve Board but the legislation specifically exempts the Fed from its requirements. 

For the most part, these agencies have commissions or agency heads that can only be removed for cause, although there is considerable variation.  The OCC enabling act, for example, provides that the Comptroller may be removed "upon the reasons" communicated by the President to the Senate.  See 12 USC 2.  The SEC commissioners are treated as removable only for cause but the enabling statute does not actually say that (it does provide for five year terms).  See Section 4 of the Exchange Act, 15 USC 78d (also requiring that no more than three commissioners be from the same political party). 

As a result of this limitation on presidential removal authority, the general view is that these agencies are less subject to political influence.   Moreover, in the folklore of administrative law, there is a view that Congress has a greater proprietary interest in the independent agencies.  Commissions (like the SEC) must have representation from more than one political party.  And the parties in Congress are keen to make sure that, in appointing commissioners, their views are represented.  The presence of genuine representatives of both parties can reduce the influence of the President.   

The Independent Agency Regulatory Analysis Act of 2012, therefore, does two things.  First, it increases the potential for politicizing the rulemaking (and policy making) process of the listed agencies.  Whether the SEC and the securities markets, or the OCC/FDIC and banking policy, or the NRC and nuclear power policy, these matters will be susceptible to greater political intrusion.  OIRA and its so called "nonbinding" assessments will provide plenty of room for interference.  Moreover, the exception in the legislation for the Fed shows that the sponsors understood that this could occur and at least sometimes thought it a bad idea.  There is no explanation, however, why this exception was applied only to one agency. 

Second, it is, frankly, a give away of authority from Congress to the President.  In truth, the President can probably already subject independent agencies to rulemaking oversight.  The issue is constitutional.  In the past, the courts viewed the independent agencies as outside the executive branch (in the interstices between the branches if you can believe that). 

After Morrison v. Olson, 487 US 654 (1988), it is relatively clear that the independent agencies are in fact in the executive branch.  As a result, there is a very strong argument (but not one completely free from doubt) that the President can, absent affirmative prohibitions in the statute, subject all executive branch agencies to a common set of rulemaking policies, including those designated as independent.  

Indeed, past Presidents have concluded that they have the authority to do so.  See Richard H. Pildes & Cass R. Sunstein, Reinventing the Regulatory State, 62 U. Chi. L. Rev. 1, 28 (1995) ("Under President Reagan, the Department of Justice concluded that the President had the legal authority to extend the orders [imposing centralized control over the regulatory process of independent agencies]").  They have not done so, however, at least in part for political reasons.  See Id. ("President Reagan declined to include the independent agencies within the requirements of his two executive orders. In part, this appears to have been a political judgment. The Democratic Congress, skeptical of the executive orders in general, might well have been outraged by an assertion of presidential authority over the independent agencies, which Congress often considers 'its own.'").

This legislation will resolve the issue.  It is true that the legislation removes any remaining legal uncertainty about the President's authority to subject these agencies to rulemaking oversight.  But mostly what it does is give the President permission to exercise the same level of control over independent agencies that it does over traditional executive branch agencies.  In exercising the judgment, Presidents will not need to worry any more about legislative outrage in asserting increased control over these agencies. 


Independent Agency Regulatory Analysis Act of 2012: S 3468 (Part 2)

The Independent Agency Regulatory Analysis Act raises some significant concerns and reflects an effort to make even more difficult the rulemaking process for independent agencies like the SEC. 

The additional procedures that can be imposed on independent agencies under the legislation are triggered by executive orders issued by the President.  In other words, every time the presidency changes, a new president can effectively impose additional rulemaking procedures on independent agencies.  Moreover, the OIRA can be given 90 days to conduct an assessment of the independent agency's compliance with applicable "regulatory analysis requirements."   All of this allows for shifting standards and increased delay.  

What are the consequences of delay?  The SEC's proposal to repeal the ban on general solicitations was sharply criticized in some quarters because it was issued as a proposal rather than an interim final rule.  In other words, the SEC was criticized for delay.  Yet had this Act been in place and the SEC was required to submit the proposal to OIRA, there would have been additional delay.

The assessment by OIRA is described as "nonbinding."  To the extent that OIRA finds that the independent agency did not follow the required procedures, however, the head of the agency must provide "an explanation" for the noncompliance.  Rather than acknowledge noncompliance as part of the rulemaking process, an agency head is likely to "comply" with any issue raised by OIRA.  As a practical matter, therefore, the so called "nonbinding" review by OIRA will in fact be "binding."

Finally, the approach will simply discourage rulemaking, a trend already underway as a result of decisions like Business Roundtable v. SEC (see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC).  The consequence is not necessarily less regulation.  Agencies may not be willing to update their regulatory framework, leading to an ossified regulatory structure, or may rely on more informal methods of implementing regulations.  The SEC can use no action letters, enforcement proceedings, phone advice, and other informal mechanisms to set out regulatory positions.  The integration of the Internet into the private offering process (through password protected web sites) was, for example, done as part of an informal process mostly through the mechanism of no action letters. 

Informal positions are less transparent and do not have to go through notice and comment.  Nor do they necessarily result in better outcomes.  Nonetheless, informal positions will not need to go through OIRA. 


Independent Agency Regulatory Analysis Act of 2012: S 3468 (Part 1)

Legislation is being taken up in the Senate to further impose limits on rulemaking by the SEC (and other independent agencies).  The Independent Agency Regulatory Analysis Act of 2012 would subject "independent regulatory agencies" to the "regulatory analysis"  requirements applicable to executive agencies."  The legislation is sponsored by Senators Portman, Warner, and Collins.  

Under the provision, independent agencies can be subject to an executive order that requires the "regulatory analysis" otherwise imposed on traditional executive branch agencies.  In addition, the President can require that an independent agency submit a proposed or final rule to the Office of Information and Regulatory Affairs for "review."  OIRA can take up to 90 days to determine whether "the agency has complied with the regulatory analysis requirements made applicable by Executive order." 

To the extent OIRA determines that the independent agency has not met the requirements, the Agency head is obligated to address the findings in the rulemaking record.  The Agency must include a "clear statement" of the issues engendering agreement and disagreement with OIRA.  To the extent that the head of the agency determines that, in fact, the rule complies with the relevant executive order but must include "an explanation of that determination."  Alternatively, there must be an explanation "why the independent agency did not comply" with the relevant requirements.

The legislation has a number of implications.  We will discuss them in the next post. 


Proxy Statements: Part 1 & Part 2

One of the issues that has arisen in the corporate governance area is the concern over information overload.  The Proxy Statement has become increasingly crowded with disclosure that is relevant to shareholders but adds to the length and complexity of the document. 

Proxy statements are already long.  Take the one filed by Apple.  The document was 51 pages long.  Executive compensation took up 14 pages (pp. 21-35), with another page devoted to equity compensation plans. 

Each time the Commission proposes a new disclosure requirement for the proxy statement, one of the criticisms invariably involves the added length and complexity.  In adopting Rule 10C-1, for example, the Commission noted that commentators raised:  

concerns about extending already lengthy proxy statement discussions of executive compensation and expressing doubt that additional disclosure of the process for selecting advisers would provide any useful information to investors.

Exchange Act Release No. 67220  (June 20, 2012).  The concerns apparently had an effect on the final rule.  As the Commission concluded:  

Consistent with the proposed rule, the final rule does not require listed issuers to describe the compensation committee's process for selecting compensation advisers pursuant to the new listing standards. We are sensitive to the concerns of commentators that adding such disclosure would increase the length of proxy statement disclosures on executive compensation without necessarily providing additional material information to investors.

Pressure for additional disclosure in the proxy statement will only continue. The Commission has been called upon to require increased disclosure on a number of corporate governance issues, including political contributions, sustainability reporting, shareholder approval of auditors, and global warming.  Whatever the merits of each of these proposals, they will presumably add to the length and complexity of the proxy statement.

It is, therefore, time to consider a Part 1 and Part 2 of a proxy statement, much the way the Commission already divides registration statements.  Part 1 could be the material that had to be distributed directly to shareholders.  It could be formatted in XBRL and written in plain English. 

Part 2 could include some of the more complicated disclosure mandated by the proxy rules but of interest only to a small minority of investors.  Part 2 could then be posted on the Internet.  One suspects, for example, that much of the disclosure in the Apple Proxy Statement on executive compensation could be in the Part 2.    

The approach would allow for the distribution of a simpler proxy statement while making the full disclosure easily available to anyone interested.  A shorter proxy statement would entail costs savings, reducing the distribution expenses.  At the same time,  it would hold out the promise of a proxy statement that retail investors might actually read, potentially increasing the possibility that they would return their voting instructions.   


An Expanded Role in Governance for the SEC: Iran Threat Reduction and Syria Human Rights Act

In the realm of corporate governance, the SEC has traditionally been responsible for disclosure while substance fell to the states.  The basic separation forced the Commission to use disclosure in order to change substantive behavior, an approach that worked with varying levels of success (or lack of success).  See Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure

The neat division, however, no longer exists.  Congress has increasingly given the SEC a much more substantive role in the corporate governance process.  The authority ranges from drafting listing standards for audit committees (see Rule 10a-3) and compensation committees (see Rule 10C-1) to seeking clawbacks of executive compensation.  It is the SEC, not the states, that oversees the advisory vote by shareholders on compensation (say on pay). 

Congress, however, has gone further and injected the Commission into the area of corporate social responsibility.  In Dodd-Frank, the SEC was assigned the task of implementing disclosure requirements for conflict minerals.  Some have described the information as important to investors but for the most part the disclosure requirements were designed to affect corporate behavior.  The approach likely would reduce the willingness of companies to purchase conflict minerals and reduce funding for military groups in and around the Democratic Republic of the Congo.  Disclosure imposed on resource extraction companies also has goals consonant with corporate social responsibility. 

The recent adoption of the Iran Threat Reduction and Syria Human Rights Act has pushed the SEC in yet another direction. The legislation was designed to, among other things, impose sanctions on Iran in order to stop the development of nuclear weapons.  Section 219 of the Act added a new subsection (r) to Section 13 to the Exchange Act and imposed disclosure requirements on public companies with respect to compliance with the Act.   Like the conflicts mineral requirements, the disclosure is less about investor information and more about ensuring substantive compliance. 

The provision went further, however, and required the Commission to post information about non-compliance on its web site.  Companies subject to the Act must provide the Commission with a separate notice whenever they report activity under the Act.  The Commission is then required to transmit the relevant report to the President and Congress.  In addition, however, the Commission must "make the information provided in the disclosure and the notice available to the public by posting the information on the Internet website of the Commission."

Presumably this means something other than disclosure through Edgar.  The SEC will likely have to set up a separate page that discloses reports filed pursuant to the Act.  The idea of disclosure on the SEC website has been tried before.  A number of problems arose.  Because circumstances changed, there were concerns over the timeliness of the information.  Moreover, it raised a fundamental question about the role of the SEC in publicizing these types of activities, particularly given the public nature of the disclosure.  Some of these issues may resurface in the implementation of this provision. 

The prior example was voluntary and, when confronted with all of the difficulties, abandoned.  This one, however, is mandated by Congress.  It puts the SEC into the job of disclosing on its web site certain types of corporate behavior.  Its not clear why the SEC needs to have this role but one suspects the instances of this type of requirement will increase.