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Delaware and the Consequences of an Excessively Management Friendly Approach to Corporate Governance (Part 1)

As we have noted before on this Blog, there was a time when the Delaware courts, albeit always management friendly, occasionally made decisions favorable to shareholders.  Van Gorkom and Unocal are two examples.  Those days are over. 

A bylaw friendly to shareholders that sought reimbursement for shareholders who successfully elected a director?  Struck down.  A bylaw favorable to management forcing shareholders to litigate cases in a designated forum (mostly Delaware), upheld.  Inspection rights denied because documents were going to be used in litigation (see the lower court case in Central Laborers Pension Fund v. News Corp); inspection rights denied because documents could not be used in litigation (due to the statute of limitations) (Wolst v. Monster Beverage).  

Cases that benefited shareholders in the past (Blasius) are under attack and not likely to survive much longer.  Standards in mergers with controlling shareholders have been weakened, with entire fairness replaced in some cases by the business judgment rule.  Process continues to replace substance yet the process is given little meaning (except perhaps in Vice Chancellor Laster's courtroom). 

The most obvious consequence of this approach has been efforts by shareholders and investors to seek reform in other forums.  For the most part, this has meant appeals to, and preemption by, Congress.  Congress intervened and set standards for audit and compensation committees of the board.  Congress intervened and required a shareholder vote on compensation (say on pay) and mandated that boards seek clawbacks of certain performance based compensation in the event of restatements.  Congress has begun to impose qualifications on directors, essentially requiring the presence of a financial expert.  

In preempting state law, Congress has used a variety of methods.  In the case of say on pay, the requirement was imposed on all public companies (those registered under Section 12(g) of the Exchange Act).  In the case of audit and compensation committees, Congress did so through the imposition of mandatory listing standards.

All of these areas were traditionally matters of state law.  No longer.  Which brings us to bylaws designed to limit judicial process.  Bylaws in general regulate the internal affairs of a corporation.  They can adjust the relationship between shareholders and managers.  Fee shifting bylaws, however, do not fall into this category.  First, they are not limited to cases arising out of the internal affairs of a corporation but generally apply to any action against the company or the board.  Second, they are not limited in application to shareholders but generally apply to a broader category of plaintiffs.

Yet in addressing these provisions, the Delaware Supreme Court engaged in a simplistic, management friendly analysis of Section 109.  The Section permits bylaws that are "not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees".  From the Court's perspective, nothing in the language prohibited a bylaw that regulated judicial process.

As we will see in the next post, the door opened by the Delaware court is quite wide.  It has the potential to alter the rights of shareholders and investors by limiting their rights to challenge behavior in court.  We will discuss the implications of this approach and an example of the door being pushed open even wider in the next post.  


The Meaningful Return of Shareholder Access (Part 3)

The effort at private ordering instigated by the NYC Comptroller through the Board Accountability Project ought not to have been necessary. 

In 2010, the Commission adopted a rule requiring public companies to offer access to their proxy statement to 3% shareholders who held the shares for at least three-years. See Exchange Act Release No. 62764 (Aug. 25, 2010). Had that rule been left in place boards would probably already be more diverse, compensation would be less extreme, and climate change would have a higher profile in the governance process.

Nonetheless, the rule was not allowed to go into effect, having been struck down by the DC Circuit on process grounds. The court relied on a questionable interpretation of the arbitrary and capricious standard. In contrast to what is required in these sorts of cases, the court gave almost no deference to agency interpretation and adopted a view of cost-benefit analysis that exceeded the bounds of all prior interpretations. See Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC.  

The weakness in the analysis used by the opinion was made abundantly clear by the recent study produced by the CFA Institute on shareholder access. See Proxy Access in the United States: Revisiting the Proposed SEC Rule. According to the Study: 

  1. Limited examples of proxy access and director nominations globally, coupled with the limited availability of corresponding market impact data, challenge whether a more detailed cost–benefit analysis was possible in the context of the court’s decision.
  2. The results of event studies suggest that proxy access has the potential to enhance board performance and raise overall U.S. market capitalization by between $3.5 billion and $140.3 billion.
  3. Assessing and measuring increased board accountability and effectiveness is challenging. None of the event studies indicate that proxy access reform will hinder board performance.

In short, there is little evidence that access was harmful and significant evidence that it benefited shareholders. Likewise, the Study suggested that there was little to be gained by an even more extensive cost-benefit analysis. 

The CFA Study likewise expands the analysis by taking the discussion out of the realm of theory and into realm of actual practice. The Study noted that shareholder access is already a fixture in countries such as the UK, Australia, and Canada. The actual experience of these countries is available to shed light on the role access plays in the governance process. The data shows modest use; according to the CFA Study:

  • We found that over the past three years, proxy access has been used only once in Canada to nominate directors to a board (where it was used successfully). In Australia, proxy access was used 11 times in the past three years, only once successfully. In the United Kingdom, proxy access was used 16 times over the past three years; it was successful on 8 occasions and was defeated 6 times, and nominees’ names were withdrawn on 2 occasions. These data suggest that proxy access is a rarely used shareowner right that is typically used only when other outlets for shareowner concerns about a company or its board—such as engagement between shareholders and companies—have been exhausted or have otherwise proved unfruitful.

Add to this data the fact that a number of companies in the United States now have access provisions in place and none have apparently been used. 

All of this suggests that access will not be particularly disruptive and will benefit companies by better focusing directors on the interests of shareholders. Given these conclusions, perhaps the time has come for an end to private ordering and a reexamination of the need for rulemaking to make access a more categorical part of the governance landscape.     


The Meaningful Return of Shareholder Access (Part 2)

In the aftermath of the Business Roundtable, shareholder access has largely been left to private ordering. A number of shareholder proposals have been submitted to public companies asking management to provide shareholders with access to the proxy statement.  A number have received majority support, although the numbers have been modest.    

This may change, however, with the advent of the Board Accountability Project.  Spearheaded by the NYC Comptrollers Office, the Project involves the submission of shareholder access proposals to 75 separate public companies.  The list of companies is here.  

Each of the proposals calls on companies to provide shareholders owning 3% of the voting shares for at least three years with the right to include a short slate of directors (not more than 25% of the number then serving) in the proxy statement.  The proposals largely mimics the requirements of the SEC rule struck down by the DC Circuit in Business Roundtable.   

A significant number will likely receive majority support.  This is the case for a number of reasons.  First, most will go to a vote.  These proposals are difficult to exclude from the proxy statement.  As a memo from Wachtell noted:  "The current wave of proxy access proposals has evolved to cure most substantive vulnerabilities and, absent procedural defects, the SEC has generally been unsympathetic to proxy access exclusion requests."

Whole Foods is seeking to demonstrate otherwise.  The company has sought no action relief, arguing that an access proposal (permitting shareholders owning 3% for 3 years) should be excluded because it has submitted an alternative (permitting shareholders owning 9% for five years).    

As a result, companies will likely be able to avoid a shareholder vote on an access proposal only if they prevail on the NYC Comptroller to withdraw the proposal.  That in turn will presumably require concessions by the company.  

Second, the category of companies have been carefully selected.  The companies receiving the proposals fell into three categories.  As the Comptroller's Office described, they included:

  • 33 carbon-intensive coal, oil and gas, and utility companies;
  • 24 companies with few or no women directors, and little or no apparent racial or ethnic diversity; and
  • 25 companies that received significant opposition to their 2013 advisory vote on executive compensation (“say-on-pay”)

These are not a particularly sympathetic group of companies.  Take diversity (or the lack thereof).  Given the number of qualified women and ethnic/racial minorities, it is not convincing claim to contend that a lack of diversity can be explained by an inadequate pool of candidates.  Instead, other reasons likely explain the absence of such candidates, not the least of which is the preference for directors who will reliably support management.  See The Demythification of the Board of Directors.  

Third, the Project already has significant support, particularly from other large institutional investors. According to the NYT, CALPERS has already signed on:   

  • Working with Mr. Stringer’s office to drum up support are officials at the California Employees' Retirement System, the nation’s largest public pension fund.  Calpers said it would hire a proxy solicitor to discuss the proposal with other institutional shareholders. “We view this as a five-year project and will be back again and again as needed,” said Anne Simpson, senior portfolio manager and governance director at Calpers. “But making the commitment and getting an alliance formed on this issue is so important.”

Other public pension plans "supporting the effort" include plans from Connecticut, Illinois and North Carolina.  

Fourth, these proposals have proven popular.  Last week, for example, an access proposal at Oracle received about 45% of the vote (1,578,053,610 shares in favor; 1,946,813,794 shares against).  The percentage was even more significant given that Larry Ellison held 26% of the shares and presumably voted against the proposal.  As CALSTRS (a joint sponsor of the proposal) stated: 

  • Independent shareholders overwhelmingly supported CalSTRS’ proposal opening the corporate proxy to shareholder candidate nominations for the Oracle Corporation Board of Directors. While it received approximately 45 percent of the overall vote, it did not pass due to Larry Ellison’s large inside ownership. However, CalSTRS believes shareholders today sent a strong signal to the board of directors and we expect more accountability from them, as a result.

These efforts are likely to renew interest in shareholder access.  Ultimately, however, private ordering is not the best way to approach this issue.  The proxy statement is a corporate document that ought to be available for nominees from both management and shareholders.  For that, SEC rulemaking will be necessary.   


The Meaningful Return of Shareholder Access (Part 1)

Directors are not chosen by shareholders.  In the case of most public companies, shareholders can only vote for a single slate of directors in something that resembles an old style Soviet election.  The decision as to who gets to serve on the board, therefore, is made not when shareholders vote but when the slate submitted to shareholders is selected.  The slate is invariably determined by the board, with input (explicit or implicit) from the CEO.  (For a discussion of this influence, see The Demythification of the Board of Directors).  The result is a system whereby directors seeking to remain on the board have greater incentive to side with management than with shareholders. 

Assorted reforms designed to ensure greater board independence and orientation towards shareholders have been tried.  The definition of director independence at the stock exchanges (but not Delaware law) has been tightened.  Listed companies must have a nominating committee that consists only of independent directors.  Nonetheless, these approaches have largely failed.  Id.  The definition of director independence does not ensure independence in fact.  Nominating committees may consist of independent directors but they can still consult with management and accept their nominees.

The one reform that did have the potential to work, however, was shareholder access.  (for a history of the SEC's efforts in this area, see The SEC, Corporate Governance, and Shareholder Access to the Board Room) as a rule by the SEC, shareholder access allowed large shareholders (or groups of shareholders) to submit a minority of directors for inclusion in the company's proxy statement.  Shareholder access made it more cost effective to run nominees not selected by incumbent management.  Access also had the potential to more closely focus directors on the interests of shareholders in order to avoid the submission of competing nominees.

The SEC's shareholder access rule was struck down by the DC Circuit on administrative grounds.  (for a discussion of the case and the weak reasoning, see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC).  The opinion was poorly reasoned and had the appearance of a result oriented decision.  Nonetheless, the decision eliminated the SEC's categorical rule on the subject. 

Since then, shareholder access has been a matter of private ordering, with shareholders submitting a modest number of proposals at specific companies calling for access.  A number received majority support.  Nonetheless, its safe to say that for the most part, shareholder access was not at the forefront of investor concerns, probably more a result of exhaustion than disinterest.

As we will discuss in the next post, that is about to change. 


American Meat Institute COOL Rehearing Request Denied

On Oct. 31, the United States Court of Appeals for the District of Columbia Circuit denied a request for a rehearing on a motion for preliminary injunction to block implementation of the United States Department of Agriculture’s May 2013 final rule on country-of-origin (COOL) labeling for red meat. The rehearing request focused on the provisions of the rule prohibiting the commingling of meat, arguing that the requirement exceeded the authority of the Agricultural Marketing Service (AMS). That issue was not addressed by the en banc panel that decided American Meat Institute v. USDA (discussed here).

In a statement, AMI Interim President and CEO James Hodges noted “[t]he ban on commingling, which was the subject of this rehearing request, is a key component that made the 2013 rule even more onerous and burdensome than the previous rule, as was confirmed by the World Trade Organization’s recent report.” He also said, “The court’s refusal to rehear our motion will allow those harms to continue. We will evaluate our options.”

The challenge is all the more interesting because the World Trade Organization ruled last month, for the second time, that the United States has not done enough to fix the COOL law. Specifically, the WTO compliance panel found that the rule was less favorable to meat imports from Canada and Mexico and more favorable to domestically produced meats.

The Obama administration has 60 days to decide whether to appeal the ruling. In the interim, the COOL Reform Coalition, a group of agriculture interests said in a letter to Congress that if Mexico and Canada retaliate it could cost U.S. businesses billions of dollars in lost sales. The COOL Reform Coalition, said tariffs could be slapped on $1.3 billion in Iowa exports, with pork, corn, and soybeans among some products expected to be targeted.

"We request that Congress immediately authorize and direct the secretary of agriculture to rescind elements of COOL that have been determined to be non-compliant with international trade obligations by a final WTO adjudication,” the letter said.

Such action seems unlikely in light of a recent statement from Sen. Chuck Grassley, R-Iowa, and Sen. Tim Johnson, D-S.D. who said Congress should wait to see how the Obama administration responds. Grassley, a member of the Senate Agriculture Committee, said he did not believe Congress would do anything until the Agriculture Department and the United States trade representative decide if they will appeal the decision at the WTO. "We'll have to wait and see if the White House believes there is anything else that can be done administratively to bring COOL into compliance," Grassley said.

Why is this of any interest to corporate lawyers?  Recall that part of the initial challenge to the COOL law was that it improperly compelled corporate speech in violation of the First Amendment. That argument was rejected by the DC Court of Appeals who extended the rationale expressed in Zauderer v. Office of Disciplinary Counsel, to apply rational review to compelled corporate speech aimed at more than preventing consumer deception. The WTO’s objections to the COOL law is that it doesn’t not go far enough—that it does not provide sufficient information to consumers. If the United States does not appeal the WTO ruling, and instead attempts to amend the COOL law to address the WTO concerns by requiring more disclosure, we may see an opportunity to again explore the contours of compelled corporate speech, an issue with ramifications far beyond the meat industry.


Fee Shifting Bylaws and Senator Blumenthal

Senator Blumenthal sent a letter to the Chair of the SEC, Mary Jo White, calling on the SEC to take steps with respect to the implementation of fee-shifting bylaws. The letter described a number of negative ramifications that could arise from the bylaws. 

  • The potential ramifications from this decision are immense. No rational investor, even with significant financial interests at stake and when presented with clear evidence of corporate misconduct, will brave litigation when the corporate defendant can force the investor to face financial ruin unless he substantially wins on every point. While ATP Tour only affects corporations headquartered in Delaware, Delaware is home to many of the country’s largest public companies. Further, the Delaware Supreme Court’s action is already beginning to have a ripple effect in other jurisdictions, leading other state courts to reconsider longstanding doctrine in this area. 

The letter likewise called on the SEC to act.     

  • I call upon the Commission to commence investigation of Alibaba Group Holding, Ltd., one of several companies that have elected to include fee-shifting provisions in their governing documents but failed to disclose it in offering statements. The SEC should label such provisions as major risk factors and require corporations to publicly disclose them before any initial public offering. More broadly, the SEC should clarify that fee-shifting provisions are inconsistent with federal securities law. At a minimum, I urge the SEC to refuse to permit registration statements to move forward for any company that includes these provisions in violation of our federal securities laws.

The letter seeks to pressure the SEC to take steps to minimize the impact of these bylaws. Even if the SEC takes the steps suggested by Senator Blumenthal, the bylaws may still proliferate, albeit in a more limited manner (applicable, for example, only to derivative suits).  

A permanent solution could come from Delaware, with the courts or the legislature rejecting the applicability of the bylaws to for profit companies. To the extent that this does not occur, the issue will likely represent a candidate for federal preemption.    


Omnicare and Oral Argument at the Supreme Court

The Supreme Court heard oral argument on the Omnicare case yesterday.The primary issue was whether an opinion could be false absent allegations of subjective disbelief.  I was counsel of record on a brief on behalf of law and business faculty who argued that the statement at issue was not an opinion. For a copy of the brief, go here.  

One of the statements alleged to be false stated that:  "We believe that our contracts with pharmaceutical manufacturers are legally and economically valid arrangements".  The complaint alleged that the statement was false "when made."  

In part, the case raises the issue of whether a statement in a registration statement prefaced by "we believe" amounts to an opinion.  The issue came up during oral argument came up as evidenced by the following colloquy:   

  • CHIEF JUSTICE ROBERTS:  So if I say or the company says in a prospectus, we believe that we have 3.5 million units of inventory in our secret inventory warehouse, so long as they say we believe, they can't you know, it turns out they have none, that's all right?  They're still protected?
  • MR. SHANMUGAM:  I think that that would probably be a statement of opinion, but it is much closer to the line between statements of opinion and statements of fact.  Let me explain
  • CHIEF JUSTICE ROBERTS:  Really, you think it's an open question if they say it's a very precise number for something that only they know anything about, and it's wildly off, you think they're protected or may be simply by saying "We believe"?
  • MR. SHANMUGAM:  Well, I ­­ I think that ­­the reason why I think it's a close question as to whether or not that would be a statement of opinion is simply because the second restatement's definition of  what constitutes a statement of opinion, which we think is a useful guide, includes not just statements on matters of judgment, like the statements we have at issue here, but also statements that express uncertainty about factual matters.  And I think in your hypothetical, Mr. Chief Justice, you can view that statement as being the equivalent of a factual statement that along the lines of, we have approximately 3 million units or widgets in our inventory, such that if they had nowhere near that, that statement would be an objectively false statement of fact and, therefore, actionable.

The oral argument primarily focused on whether an opinion subjectively believed was required to have a "reasonable basis," something the Government asserted (as did the law faculty brief).  While opinions are difficult to predict, there seems to be a clear majority for the proposition that opinions issued by the company in a Section 11 context must have some support.  

The only question is whether the Court will find that an opinion can be false if subjectively believed but lacking in a reasonable basis or if the lack of a reasonable basis is prima facie evidence that the opinion was not subjectively believed.  The two positions are not equal.  Note the following colloquy between counsel for Petitioner and Justice Alito:   

  • MR. SHANMUGAM:  But, again, our view is that for purposes of pleading a claim, a plaintiff is not restricted to smoking gun evidence that the speaker did not possess the stated belief.  And so, again, if a plaintiff is able to come forward with allegations that cross the pleading threshold of plausibility to suggest that the speaker, in fact, did not hold the stated belief, that will, in fact, be sufficient. 
  • JUSTICE ALITO:  Well, that may be true, but do you deny the fact that there can be situations in which a person makes a ­­ makes a statement of belief and believes that to be true, but lacks a reasonable basis for stating the belief?  There is a difference between those two situations, isn't there?  
  • MR. SHANMUGAM:  I think there is a difference between those two situations, and I think this illustrates an important conceptual distinction.  I think in a case where a speaker has no basis whatsoever for the stated belief, there will be comparatively few cases ­­ and I'm certainly not aware of any case from the reported cases in this area ­­ where the speaker held the stated belief but lacked any basis for it whatsoever.

The other issue was whether the adoption of the reasonable basis standard for opinions subjectively believed required reversal of the 6th Circuit opinion.  While the outcome is difficult to predict, the tenor of the opinion was that the Justices would opt for something like the reasonable basis standard (there was discussion about the precise formulation of the standard) and probably send the case back to the 6th Circuit to apply the standard (and to determine whether it had been sufficiently alleged).  

Our prediction?  A substantive victory for Respondents (opinions can be subjectively believed but still false) but a reversal of the 6th Circuit's decision.   


The SEC and Structured Data (Part 2)

We are discussing the recent speech by Mark Flannery, the new director of DERA.  See The Commission’s Production and Use of Structured Data, Data Transparency Coalition’s Fall Policy Conference, Washington, DC, Sept. 30, 2014 

Of interest was the discussion of "Inline XBRl."  Inline allows for the incorporation of XBRL tags into the HTML formatted document.  As a result, companies do not need to submit an HTML version and a separate file that contains the financial statements using XBRL.  Mark Flannery had this to say about Inline: 

  • DERA staff is working with outside contractors on “Inline-XBRL.” Consistent with its name, this new technology would allow companies to integrate (or embed) the XBRL tagging of the financial statements directly into their standard HTML formatted 10-K and 10Q filings.  This effectively eliminates the need to reconcile separate HTML and XBRL versions of the financial statement content, thus reducing the possibility of rekeying or similar errors.  Work is also proceeding on a prototype viewer that would allow users to display and search the integrated XBRL tagging while viewing the familiar HTML view of the financial statements.  In short, then, SEC staff are committed to improving the availability of financial information through the presentation and analysis of structured data.  

This is another important and serious step forward.  Inline will eliminate some of the data quality issues that have arisen with respect to financial statements submitted in an XBRL format.  In particular, Inline will eliminate the problem of discrepencies between the html and XBRL versions of the finanical statements.  It will not solve the problem of excessive use of custom tags and other issues associated with quality but it represents an important step forward in increasing the usability of tagged data. 


The SEC and Structured Data (Part 1)

The SEC collects massive amounts of data. Much of the data is submitted in html, a format that is difficult to search. Ten years or so ago, the SEC started to require the filing of some information in an interactive format. The format permitted analysis of large amounts of data through the use of "tools" (software).   

The roll out of structured data engendered significant criticism. The requirement that financial statements be submitted in an xbrl format was criticized as the imposition of an expense with little value. Indeed, the House has adopted a bill that would eliminate tagging for emerging growth companies. See HR 5405

Nonetheless, recent developments suggest that the Commission is returning to, and promoting the use of, structured data.  In 2012, the Commission proposed a rule requiring disclosure by resource extraction issuers that had to be filed using XBRL.  See Exchange Act Release No. 67717 (August 22, 2012).  The decision was not a new found interest in data tagging but a result of congressional command.  See Section 1504of Dodd Frank (“The rules issued under subparagraph (A) shall require that the information included in the annual report of a resource extraction issuer be submitted in an interactive data format.”).   Indeed, a contemporaneous rulemaking concerning conflict minerals did not provide that the newly created form would be tagged.     

Nonetheless, by 2013, much stronger evidence of a shift in the Commission’s position began to take shape. First, the agency announced, without notice and comment rulemaking, that Forms 13F would be required to be filed using an online form and filers would be required to “construct their Information Table according to the EDGAR XML Technical Specification.”   

Added impetus was provided by the recommendation of the SEC’s Investor Advisory Committee. In July 2013, the IAC recommended that the Commission adopt a “Culture of Smart Disclosure,” something designed to promote the “collection, standardization, and retrieval of data filed with the SEC using machine-readable data tagging formats.” The rule proposal that year for Regulation A+ and crowdfunding both include forms that would, if adopted, be tagged. Regulation AB likewise required the disclosure of certain information in a machine readable format.

Perhaps the most interesting addition was the speech by Mark Flannery, the recently appointed chief economist and director of DERA. See The Commission’s Production and Use of Structured Data, Data Transparency Coalition’s Fall Policy Conference, Washington, DC, Sept. 30, 2014. The talk emphasized the Commission’s commitment to making data “useable” by the public. See Id.  (“Making useable data available to the public is a key function of many of the Commission’s disclosure rules, and one of the strategies identified in the Commission’s Strategic Plan.”). 

He confirmed that the requirement of machine-readable formats for financial disclosures had become “a routine part of the rulemaking process.” Nothing was automatic. Future endeavors were to consider the appropriateness of tagging (“anticipating what information would be most useful to investors”), the proper format (“Deciding on the right data format involves many considerations, including the complexity of the financial information, need for validation of the reported elements, and the availability of pre-existing industry standards”) and the need to “avoid unnecessary implementation challenges.” 

The speech also discussed a sore spot with respect to structured data, particularly in connection with financial statements: data quality. As the speech pointed out: “Unnecessarily high usage of custom tags by a filer can therefore impair certain financial analyses,” also noting that the “Commission staff is aware" of the issue. Indeed, the speech noted that DERA would continue, “where appropriate,” to “work closely with the Division of Corporation Finance to provide guidance to filers based on these observations.” This looked to be a warning that the DERA/CorpFin partnership could yield additional letters like the CFO Letter concerning XBRL deficiencies, issued in July 2014. 

The speech also set out in specific terms what could be expected from the Agency:   

  • Hence, expect to see more staff observations and updates of filer practices posted on the SEC website.  DERA staff will continue its outreach to corporate filers through seminars, webinars, conferences, and other educational programs. DERA staff are also exploring ways to make aggregated XBRL data available to investors and financial researchers so that they can more easily access and analyze the financial information reported through XBRL submissions. 

The speech, therefore, suggests significant progress toward the goals of increasing the use of structured data and ensuring the quality of the data received by the SEC. The partnership between DERA and CorpFin will provide additional impetus for progress and will reduce the concern that decisions are made in a silo. It is strong movement in the right direction.


SEC v. Cole: Failure to Cooperate with Court Orders

In SEC v. Cole, No. 12-cv-8167 (RJS), 2014 BL 263123 (S.D.N.Y. Sept. 22, 2014), the United States District Court for the Southern District of New York granted the Securities and Exchange Commission’s (“SEC”) motion for relief against Defendants Lee Cole and Linden Boyne (“Defendants”).

The SEC alleged that Defendants, among other things, “lied to the investing public” and “secretly funnel[ed] millions of shares” to certain entities they controlled. Their actions were alleged to have violated several Sections of the Securities Act of 1933 and the Securities Exchange Act of 1934. 

The court entered default judgment against Defendants for failure to comply with five court orders. Notably, Defendants failed to: appear for a deposition, respond to sanctions, or make an appearance during the motion for default judgment. Hence, on November 8, 2013, the court entered default judgment against Defendants.

Unless vacated, a default judgment is deemed “final.” The factual allegations in the complaint are treated as true “except those relating to damages.” Following the determination, the SEC filed a motion seeking (1)  disgorgement, (2) civil penalties, (3) permanent injunctions, (4) a bar from serving as officers or directors of any public company, and (5) a bar from participating in any activities involving the offer of penny stocks.

First, the SEC requested Defendants to disgorge their “ill-gotten gains” and pay prejudgment interest on any monies they had illegally obtained. The court applied a two-part burden-shifting framework to determine the amount of disgorgement. First, the SEC had to show that its calculations were reasonably calculated to the amount of Defendants’ unjust gains. The burden of proof then shifted to the Defendants to show that the SEC’s estimates were “inaccurate, or that some of the gains were not the result of wrongdoing.” Defendants were unable to refute the SEC’s proposed disgorgement figures. Thus, the court found Defendants jointly and severally liable for a total of $14,670,750.99.

Second, the SEC argued that each Defendant should pay civil penalties. Courts may impose civil fines on Defendants for violations of 15 U.S.C. §§ 77t(d)(2) (the Securities Act) and 78u(d)(3)(B) (the Exchange Act). These statutes impose a tiered system of penalties. As the court noted:  “The egregiousness of their conduct and lack of cooperation with the Court warrant a severe third-tier civil penalty.” Thus, the court imposed $7,500,000 in civil penalties for each Defendant.

Third, the SEC sought to permanently enjoin Defendants from (1) violating the securities laws, (2) serving as officers or directors of any public company, and (3) participating in any activities involving the offer of penny stocks.

To enjoin Defendants from violating the securities laws, a court considers whether the defendant has violated the securities laws and there is a “reasonable likelihood that the wrong will be repeated.” Given the lack of care Defendants used, even after the SEC brought its allegations, the court found a permanent injunction was appropriate. 

Fourth, the SEC sought an officer and director bar. To prohibit Defendants from serving as officers or directors of any public company, the court must consider: “(1) the egregiousness of the underlying securities law violation; (2) the defendant’s repeat offender status; (3) the defendant’s role or position when he engaged in the fraud; (4) the defendant’s degree of scienter; (5) the defendant’s economic stake in the violation; and (6) the likelihood that misconduct will recur.” Here, the court determined Defendants' actions required a complete bar.

Fifth, the SEC sought a penny stock bar. The court’s analysis to merit a penny stock bar “essentially mirrors that for imposing an officer-or-director bar.” Therefore, the court also enjoined Defendants from participating in any activities involving penny stocks.

Accordingly, the United States District Court for the Southern District of New York granted the SEC’s motion for penalties and remedies in its entirety.

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


The Shareholder Protection Act of 2013: Another Invisible Initiative

This post is in continuation of a series of posts that address rulemaking and shareholder disclosure after Citizens United.

On April 25, 2013, Congressman Michael E. Capauano re-introduced the Shareholder Protection Act of 2013, H.R. 1734, (“Act”) to the United States House of Representatives, which would amend the Exchange Act to require: (1) a majority vote of shareholder authorization prior to corporate political expenditures; (2) a Board of Directors vote authorizing any expenditure over $50,000; and, (3) a quarterly disclosure of the corporate expenditures to the shareholders, the Securities and Exchange Commission (“SEC”), and the public, with significant expenditures being disclosed on-line within 48 hours.

Congressman Capuano first filed the Act in 2010 in response to the then recent Supreme Court opinion in Citizens United v. Federal Elections Commission, 558 U.S. 310 (2010). The Court noted that “Government may regulate corporate political speech through disclaimer and disclosure requirements” and that today’s advanced technology would allow prompt disclosure to shareholders and the public. Prompt disclosure, in turn, would facilitate the exercise of control over the expenditures by shareholders.

With the advent of the Internet, prompt disclosure of expenditures can provide shareholders and citizens with the information needed to hold corporations and elected officials accountable for their positions. Shareholders can determine whether their corporation’s political speech advances the corporation’s interest in making profits, and citizens can see whether elected officials are “ ‘in the pocket’ of so-called moneyed interests.” Disclosure would, therefore, provide transparency and facilitate accountability to shareholders. 

According to a press release, Congressman Capuano supported the Act because he believed the decision in Citizens United gave corporations an “outsized voice in the political process.” Senator Robert Menendez also supported the Act, stating “[e]nough is enough. Individual citizens should determine the outcome of our elections, not multi-billion-dollar corporate interests, or worse, a foreign government, so it’s time we pass this legislation to give shareholders a voice over how their corporate dollars are spent on elections.” Thirty-six House Representatives, comprised entirely of Democrats, co-sponsored the Act. 

In addition to congressional support, a coalition letter was submitted, expressing concern not only for shareholders and the public, but also for the electoral system. The letter noted that unregulated corporate political spending would foster more negative attack ads, compounding the present public cynicism associated with elections. 

Although the Act was referred to the House Committee on Financial Services (“Committee”) the same day it was introduced, the Committee has not proceeded with the Act. At this juncture, it seems highly unlikely that Congress will enact the Act. In fact, gives it a 0% chance of being enacted. 


Securities and Exchange Commission v. Braverman 

On September 16, 2014, the Securities and Exchange Commission (“SEC”) charged Dmitry Braverman, an employee in an IT department of an international law firm, with insider trading. The SEC alleged that Braverman violated Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5, Section 14(e) of the Exchange Act, and Rule 14e-3 by using nonpublic information to obtain more than $300,000 in unlawful profits.

Braverman’s insider trading allegedly began in 2010 when he used nonpublic information to purchase stock in accounts in his own name. After charges were filed against a lawyer at his same firm for insider trading, Braverman allegedly liquidated the stock purchased on the basis of the inside information. After waiting 18 months, he was alleged to have resumed trading through an account in the name of a Russian relative. The account originally used an email address employed by Braverman on earlier accounts. Braverman, however, changed the address to one that contained the first name of the Russian relative. The relative is named as a relief defendant for purposes of seizing the illegally obtained profits held in the account under his name.

The U.S. Attorney’s Office for the Southern District of New York also brought criminal charges against Braverman related to the matter.  

The primary materials for this case, including the complaint filed by the SEC, may be found on the DU Corporate Governance website.


The Consequences of FEF v. PCAOB

After the adoption of Sarbanes Oxley, which created the PCAOB, a rigorous constitutional challenge to the PCAOB emerged. 

The main line of attack was the novel structure of the governance of the body.  Members to the PCAOB were appointed by the SEC for a term of five years and could only be removed by the SEC for cause.  Because SEC commissioners could also only be removed for cause (a limitation on removal that is not in the statute but is conventional wisdom), the structure provided a significant barrier to influence by the President in the appointment and removal of members of the PCAOB. 

On that basis, the "for cause" restriction on removal was struck down.  PCAOB members became at will appointees who could be removed by the Commission at any time with or without cause.  The Supreme Court decision and assorted filings/briefs can be found at the DU Corporate Governance web site.  As such, the independence of the body was reduced and the control by the Commission (particularly the Office of the Chief Accountant) was significantly enhanced. 

From an administrative perspective, the decision was a poor one.  It restricted an approach to government regulation that sought to increase private sector sensitivities while both avoiding capture by the industry subject to regulation and minimizing the direct role of the bureaucracy.  The PCAOB was structured as a non-profit that was not subject to many of the bureaucratic restrictions on activities (including limits on compensation).  This allowed the body to have a closer connection to the private sector.  At the same time, however, the governance structure was not controlled by industry (minimizing the risk of capture) but by the SEC.  By limiting removal to cause (with cause defined in part as the failure to enforce its own rules), however, the PCAOB also retained independence from the SEC and could therefore avoid some of the problems associated with government bureaucracies. 

The Supreme Court's decision to strike down the limitation on removal of PCAOB members changed all of that.  The efforts by Congress to thread the gap between the Scylla of industry capture and the Charybdis of excessive bureaucratic oversight was disrupted.  While the PCAOB remains in place, Congress is less likely to use this model of governance in other circumstances.  With SEC control enhanced, there is little reason (other than funding) to not simply include this type of oversight directly in the relevant regulatory body, eliminating all pretenses of private sector influence.

All of this brings us to a more recent consequence of the decision.  It turns out that in our federal system of government, there are other instances of the persons subject to a double "for cause" removal limitation.  This is apparently the case with respect to the appointment of administrative law judges.  According to a recent law suit, ALJs at the SEC can only be removed "for cause."  The law suit, therefore, challenges the constitutionality of these decision makers.  For the time being, we offer no views on the case except to say that but for the Supreme Court's decision with respect to the PCAOB, this suit would likely not have been brought.    


The Recommendations of the SEC's Investment Advisory Committee

The SEC's Investor Advisory Committee met in the first half of October and made two recommendations. The link to the IAC's page was on the home page of the SEC's site but has since been removed from that prominent location. But the site can be found here.  

One recommendation concerned the definition of accredited investor. The SEC was instructed in Dodd-Frank to study the definition to determine appropriate reforms. The definition for individuals focuses on income and net worth but contains thresholds that have not changed since 1982. The definition does not screen for actual sophistication (based upon education or experience).

The other recommendation concerned the impartiality of brokers in the proxy process with respect to the disclosure of interim voting data. Brokers are obligated to forward materials to beneficial owners, including voting instructions. Brokers (and their agent, Broadridge) are exempt from the proxy rules for forwarding the materials as long as the task is undertaken in an impartial fashion. The practice has arisen, however, whereby voting data is collected and, on an interim basis, sometimes given to only one side in a contest over a matter submitted to shareholders. The recommendation calls for the application of the concept of impartiality to the disclosure of interim voting information. 


Commercial Banks, the Securities Markets, and the Need for Glass Steagall: The OIG Report on the Supervision of JP Morgan

The OIG at the Fed just issued a report on the Fed's oversight of JP Morgan Chase in connection with the London Whale incident in 2012. A summary of the report is here

The report made findings that the Fed's oversight was inadequate. Interestingly, the report noted that the FRB New York was aware of the risks posed by the trading in London but did not share the concerns with the OCC or conduct its own inspections of the London operations. As the report noted: 

  • We acknowledge that FRB New York's competing supervisory priorities and limited resources contributed to the Reserve Bank not conducting these examinations. We believe that these practical limitations should have increased FRB New York's urgency to initiate conversations with the OCC concerning the purpose and rationale for the planned or recommended examinations related to the CIO. Even if FRB New York had either initiated conversations with the OCC to discuss the planned or recommended examinations in accordance with SR Letter 08-9 or conducted the planned or recommended activities, we cannot predict whether completing any of those examinations would have resulted in an examination team detecting the specific control weaknesses that contributed to the CIO losses.

The report also found that the Fed and OCC staff "lacked a common understanding of the Federal Reserve's approach for examining Edge Act corporations" and that "FRB New York staff were not clear about the expected deliverables resulting from continuous monitoring activities." Finally, the report concluded that "FRB New York's JPMC supervisory teams appeared to exhibit key-person dependencies."   

So what were the recommendations? There were 10. Some of them went to better coordination among banking agencies. Mostly, though, the recommendations focused on improvements in the inspection process. These included: the issuance of "guidance detailing expectations for documenting and approving the deliverables of continuous monitoring activities, tracking identified issues, and performing follow-up activities," the mitigation of "key-person dependency," and the hiring of "additional supervisory personnel with market risk and modeling expertise."   

The Report will likely result in more intense inspections of commercial banks (the section on the response to recommendations indicated little patience by the FRB New York with the recommendations),  particularly with respect to activities in the securities markets. That in turn will likely result in banks becoming more risk averse. Risk aversion is good for commercial banking but bad for the securities markets.

Prior to the repeal of Glass Steagall, increased risk aversion among commercial banks would have had little impact on the securities markets. The securities markets were dominated by a class of investment banks that could not engage in commercial banking (and visa versa) and were therefore outside the scope of oversight of bank regulators. With the repeal of Glass Steagall, though, the commercial banks have ousted the independent investment banks, a dynamic that was eminently predictable. See The "Great Fall": The Consequences of Repealing the Glass-Steagall. With the demise of Lehman, the acquisition of Merrill and Bear Stearns by commercial banks, and the conversion of Morgan Stanley and Goldman, there are no more large investment banks that fall outside the oversight of bank regulators.

The securities markets are about risk taking. Limitations on risk taking in turn hurts the securities markets. Regulatory oversight of commercial banks seeks to reduce risk taking. This has the potential to impose long term harm on United States capital markets.   


Delaware and the Myopic Nature of a "Neutral" Board: In re KKR Financial Holdings

The business judgment rule represents an over-inclusive protection designed to protect risk taking by directors. Boards know that even if they take risks that in hindsight prove to be mistaken and harmful, they will escape liability. The presumption is not, however, designed to protect decisions arguably motivated by a conflict of interest. The judicial erosion of fiduciary duties by the Delaware courts was on display in In re KKR Financial Holdings.   

In that case, KKR formed KKR Financial Corp., a Maryland real estate investment trust. The "primary asset [of KFN] was a portfolio of subordinated notes in collateralized loan transactions that financed the leveraged buyout activities of KKR." The duties of KKR Financial were ultimately assumed by KFN. KFN in turn assigned the day to day management duties to KKR Financial Advisors LLC. KKR, however, owned less than 1% of the shares of KFN. Moreover, the operating agreement for KFN provided that "the business and affairs of [KFN] shall be managed by or under the direction of its Board of Directors." The board of KFN contained 12 directors, two of whom were described as "high-level KKR employees".    

Ultimately, KKR sought to purchase KFN. The board formed a "transaction committee" After back and forth negotiations, the committee recommended approval of the merger. The board met and, with the two "high level KKR employees" excluded, voted to approve the merger.   

Plaintiffs challenged the transaction and argued that KKR "controlled" KFN. As a result, the applicable standard of review should be entire fairness. In rejecting that assertion, the court had this to say:  

  • In my opinion, the allegations of the complaint do not support a reasonable inference that KKR was a controlling stockholder of KFN within the meaning of this Court’s precedents. Although these allegations demonstrate that KKR, through its affiliate, managed the day-to-day operations of KFN, they do not support a reasonable inference that KKR controlled the KFN board—which is the operative question under Delaware law—such that the directors of KFN could not freely exercise their judgment in determining whether or not to approve and recommend to the stockholders a merger with KKR.

The analysis was no surprise. While REITS are typically dependent upon their advisor, KFN carefully preserved the legal authority of the board to oversee the activities of the advisor. Moreover, with less than 1% of the shares, KKR did not have the ability to legally control the board.

What the court ignored, however, was the presence of a potential conflict of interest within the board room.  The board of KFN excluded from approval of the merger the two KKR employees. Nonetheless, the court noted that, based upon plaintiff’s allegations, it was “reasonably conceivable that two other directors . . . would not be found independent of KKR.” One had “longstanding ties to KKR and, among other things, served as a Senior Advisor to KKR and as Chairman of KKR affiliate . . . at the time of the merger.” The other was the dean of a business school “which recently received a $100 million donation from KKR co-founder Kravis, an alumnus.” 

The court went on to determine whether a majority of the board lacked independence and concluded that it did not.  As the court determined:  “I conclude that plaintiffs have failed to allege facts that support a reasonable inference that eight of the twelve KFN directors, constituting eight of the ten who voted on the transaction, were not independent from KKR. Thus, plaintiffs have failed to rebut the presumption that the business judgment rule applies to the KFN board’s decision to approve the merger.”

In other words, as has been discussed before (see Returning Fairness to Executive Compensation) the Delaware courts have created the fiction that boards with a majority of independent directors essentially expunge the taint of any conflict that arises from the presence of directors who are interested or lacking in independence. Having expunged the taint, the applicable standard becomes the all but impenetrable duty of care and the business judgment rule. 

The approach is inconsistent with the theory behind the business judgment rule. As discussed in Returning Fairness:

  • The business judgment rule represents an over-inclusive protection designed to protect risk taking by directors. Boards know that even if they take risks that prove in hindsight to be mistaken and harmful, they will escape liability. The presumption is not, however, designed to protect decisions motivated by a conflict of interest. 

Where potential conflicts of interest exist in the decision making process, which is when there are directors participating in the debate and voting on the final resolution who are arguably interested or not independent, the application of the business judgment rule and a presumption of fairness is inappropriate. In those circumstances, the presumption may be protecting risk taking or it may be protecting a decision influenced or motivated by the interests of the directors allegedly lacking in independence. 

Yet in Delaware that ship has sailed. It is so well established that boards get the presumption of the business judgment rule so long as they have a majority of disinterested and independent directors that the matter was not even discussed in In re KKR


SEC Commissioner Once Again Bemoans Conflict Minerals Disclosure Mandate

From the moment the SEC was charged with drafting disclosure regulations to implement Dodd-Frank Section 1502 (the conflict minerals provision) members of the agency have voiced their unhappiness with being handed the task.  At a recent speech at Fordham University School of Law SEC Commissioner Gallagher once again bemoaned the mandate, along with others.

  • To be blunt, many, if not most, of the 100 mandates imposed upon the Commission by the Dodd-Frank Act do not by any measure represent the best use of the Commission’s time and resources.  Most obviously, whether one views the SEC as a disclosure agency or an enforcement agency, sociopolitical issues such as conflict minerals and extractive resources, while perhaps worthy of attention by the right entities, should not be part of the SEC’s agenda.  Rulemakings for such issues contribute neither to the maintenance of fair, orderly, and efficient markets, nor the facilitation of capital formation, nor investor protection.  They are the creations of special interest groups every bit as strong as K Street lobbyists, and they severely sap the finite bandwidth of the SEC.  As Chair White rightfully noted in this very same venue last year, “[T]he independence of the agency . . . should be respected by those outside, including the industry, other agencies, Congress and the courts.  That independence – and the agency’s unique expertise – should be, for example, respected by those who seek to effectuate social policy or political change through the SEC’s powers of mandatory disclosure.”

Commissioner Gallagher suggests that “[c]ritics of the SEC should focus their attention on whether the SEC is tasked with the right duties.”  But is isn’t criticism of the SEC that leads many, myself included, to argue that conflict minerals disclosure should not be regulated by that agency.  As noted by Commissioner Gallagher “the SEC faces a crushing burden of Congressional mandates that will interfere with our blocking-and-tackling work for years to come if we let them….“Why isn’t there more scrutiny of how we spend our time?”

The real question is one of allocational efficiency and agency competency.  Why do all the vast majority of disclosure regulations seeming automatically get placed on the SEC’s agenda?  It is certainly true that the agency has strong competencies in the disclosure realm—but only when such disclosures pertain to its core mission—that of maintaining free and fair markets.  Social and political issues are not with the purview of the SEC and they are not the best suited to regulate them—despite constant pressure on the agency to do so—pressure that is currently being strongly exerted in the area of corporate political spending. 

Commissioner Gallagher proposes some solutions to the problem of overburdening the SEC.

  • First, we need to affirmatively engage Congress and the Administration and work with them to remove the useless or counterproductive elements of the Dodd-Frank Act.  The emphasis is on affirmatively engaging – we cannot remain passive observers, speaking only when spoken to by policymakers, and expect to succeed in reforming Dodd-Frank.  Second, we need to become a savvier agency – specifically, an agency that serves as an efficient overseer of the capital markets and an aggregator and analyzer of critical market information through the better use of technology.  Finally, we need to affirmatively engage other regulators and relevant policymakers in the critical policy debates of the day – and for that matter, of the past five years.  I have been doing so since the beginning of my term and have found that most stakeholders are receptive to our participation in such debates.  We can learn from their perspective, and they from ours.

These are not radical suggestions—but if the convolute history of the conflict minerals rule is any indication, they are not likely to come to fruition any time soon.


Fee Shifting Bylaws: Strougo v. Hollander (Part 2)

The complaint sets out the text of the bylaw adopted by First Aviation that is being challenged in Strougo v. Hollander. The bylaw provides: 

  • Section VII.8. Expenses for Certain Actions. In the event that (i) any current or prior stockholder or anyone on their behalf (collectively a “Claiming Party”) initiates or asserts and (sic) claim or counterclaim (collectively a “Claim”), or joins, offers substantial assistance to or has a direct financial interest in any Claim against the Corporation or any director, officer, assistant officer or other employee of the Corporation, and (ii) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Claim the Claiming Party has a direct financial interest) does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought, then each Claiming Party shall be obligated jointly and severally to reimburse the Corporation and any such director, officer, assistant officer or employee for all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses) that the parties may incur in connection with such Claim. 

The bylaw is relatively typical. It applies to any current or prior shareholder and anyone acting on their behalf. The bylaw also requires a shifting in any claim or counterclaim and is not limited to derivative actions. Finally, the bylaw provides for a shifting of fees unless the plaintiff obtains a judgment on the merits that "substantially achieves" the full remedy sought (something described by the plaintiffs as an "impossibly high standard of success").    

Primary materials, including the complaint, can be found at the DU Corporate Governance website.


Fee Shifting Bylaws: Strougo v. Hollander (Part 1)

As the Delaware legislature continues to remain inactive with respect to fee shifting bylaws, the next move looks to come from the courts. 

The case where this is currently most likely to occur is Strougo v. Hollander. The complaint in the case alleged a breach of fiduciary duty arising out of a reverse stock split. The transaction was announced on May 16, 2014. According to the complaint, the transaction was consummated on May 30, 2014 and a fee shifting bylaw adopted on June 3, 2014. As the complaint states:

  • Bylaw VII.8 was adopted on June 3, 2014, following the announcement of the Transaction, to deter stockholders such as Plaintiff from pursuing litigation challenging the Transaction. The Bylaw imposes an obligation on Plaintiff to pay “for all fees, costs, and expenses of every kind and description” incurred by defendants if Plaintiff fails to “obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought.” First Aviation Bylaws VII.8.  

Because the company is not public (it deregistered as a public company in 2007), there is no obligation to make bylaws or changes in the bylaws public. See Item 5.03 of Form 8-K (requiring amendments to bylaws to be filed within four business days). As a result, shareholders alleged that they were unaware of the bylaw until after a suit challenging the fairness of the stock split was filed.  

Again, according to the complaint:    

  • No public announcement has been made notifying First Aviation stockholders about the existence of a fee-shifting provision, nor has the text of the Bylaw been made publicly available to First Aviation’s stockholders. Plaintiff’s counsel was only allowed access to the text of the Bylaw after Plaintiff caused formal discovery requests to be served on defendants. . . . Plaintiff discovered the existence of the Bylaw shortly after filing this action, when counsel for defendants contacted Plaintiff’s counsel and announced that the Board had adopted a fee-shifting provision.

The complaint also alleges that the bylaw "was adopted to discourage litigation challenging the Transaction." Or as the complaint provides: 

  • It is obvious from the timing of this Bylaw that it was adopted with the goal of stifling litigation arising out of the Transaction. The Bylaw was enacted on June 3, 2014, mere weeks after First Aviation publicly announced the Transaction in a press release on May 16, 2014. Further, it is entirely possible that the Bylaw was adopted after Plaintiff spoke with a member of the Board and expressed his discontent over the Transaction. The Bylaw was not voted upon by First Aviation stockholders. In fact, it was never even publicly announced to First Aviation stockholders. Plaintiff only learned of the Bylaw when defense counsel threatened Plaintiff’s counsel with the Bylaw after Plaintiff filed the instant action. Plaintiff and his counsel were only able to obtain a copy of the Bylaw after serving a formal discovery request on Defendants and their counsel.

The timing of the bylaw may affect the analysis. In Kastis, it was clear that the timing of the bylaw mattered (although the bylaw was adopted after litigation commenced). To the extent that the court does take into account the close proximity of the bylaw to the challenged transaction, the effect will be to encourage even more companies to adopt fee shifting bylaws. They will know that for litigation purposes its better to have them in place as a prophylactic, well before any possible decision or transaction that can be challenged.    

Primary materials, including the complaint, can be found at the DU Corporate Governance website.


Cost of Compliance with SEC Conflict Minerals Rule High—Even If Not As High As Feared

According to a survey recently issued by Tulane University's Payson Center for International Development, issuers spent more than $700 million to comply with Dodd-Frank Section 1502 and the SEC's conflict minerals rule promulgated thereunder. The survey was based on responses from 112 of the 1,300 issuers that filed Form SD (the form on which conflict minerals disclosures must be made). These costs break down as follows: 

Total compliance cost for issuers

•The total aggregated and extrapolated expenses of the 1,300 issuers to comply with Dodd-Frank Section 1502 was $709.7 million by June 2014.

•Thus, on average, an issuer expended $545,962 to comply with the law.

$ value

A. Internal company time


B. Non-IT related external resources


C. IT gap / needs analysis


D. IT project element supporting conflict minerals traceability processes and reporting


E. Independent Private Sector Audit (IPSA)


Total  $709,751,142


These numbers are interesting as it appears that despite the allegation made in the original suit challenge the SEC’s conflict minerals rule that the agency failed to conduct an appropriate cost-benefit analysis, the SEC actually came quite close—far closer than Tulane’s original estimate. At the time of original prognosticating, Tulane assessed the costs of implementation to be approximately $7.93 billion—more than one hundred times greater than the estimate prepared by the SEC of $71.2 million (the lowest estimate was $387 million). Why such a differential in the original cost estimates and the final actual costs? In part, it might be explained by the fact that many issuers simply stated their products were “DRC conflict undeterminable” or it may be that the SEC was just right. Regardless, it cannot be denied that the aggregate cost is large—and of questionable impact.

The survey also asked issuers whether they would like to see any changes made to either Section 1502 or the conflict minerals rule to which 65% said yes, 4% said no and 31% had no comment. Included in the changes issuers would like to see are: 


stipulate a de minimis exemption

clarify rule

focus on importation of 3TG

render disclosure voluntary

offer supply chain degree threshold exemption

extend indeterminable period

provide information on and certify SORs

align with the EU proposed legislation

promote standard process and systems across industry

remove audit requirements

expand scope to include diamonds

remove mandatory disclosure 

Given that the conflict minerals rule is still under challenge it is possible that some of the items on issuers’ wish lists will be met. It is not likely however that most of them will as the only portion of the rule not upheld was the requirement to label products as being “non-conflict free.”