Your donation keeps us advertisement free


The Proxy Advisory Services Roundtable (The Issue of Concentration)

We are discussing the Roundtable recently held by the SEC on proxy advisory firms.

One of the issues in the debate that came up repeatedly was the concentration in the proxy advisory industry.  Commissioner Piwowar described proxy advisory firms as a "stable duopoly" (with the word "duopoly" becoming much repeated throughout the day).  There was some agreement on this.  Damon Silvers from the AFL-CIO (who began to speak around minute 37.10) acknowledged that the issue of concentration was "very real." Others took similar positions.  

Mike Ryan, Vice President, Business Roundtable, and former president and COO of Proxy Governance, Inc., speaking late in the day (around 2:09), made it clear, however, that this was not likely to change. Barriers to entry were simply too high.  He noted that the business was low margin.  Moreover, to enter, a firm would have to front the resources necessary to cover at least 10,000 securities (out of 40,000 globally), with approximately 4000 in the US and the remainder overseas.  The firm would also have to invest in robust technology and retain qualified staff.  At the same time, investors had incentives not to change firms.  They have invested in technology that allows them to interface with specific proxy advisory firms, making it costly to switch to a new entrant.         

The Roundtable also brought out that the problem of concentration is not limited to proxy advisory firms. Damon Silvers specifically referenced auditors (which he described it as a "quadropoly") and rating agencies.  If the concern was concentration, he indicated that, with respect to proxy advisory firms, "this is about the last place to start, that the really serious problems lie elsewhere."  

With respect to concentration, one intermediary that went unmentioned was Broadridge.  Broadridge is responsible for forwarding proxy materials on behalf of brokers.  For the most part, this is a plumbing sort of task and raises little controversy.  There have been exceptions, however.  During the JP Morgan battle over the separation of chair and CEO, Broadridge announced a policy change.  The company would no longer provide ongoing voting tallies to shareholders.  The same information would, however, be given to companies. 

Concentration is therefore a structural issue that exists in many places in the securities markets and the proxy process.  With respect to proxy advisory firms, regulatory changes can add expense and burdens to the existing firms but they are not likely to induce additional entrants into the market.   

The webcast of the Roundtable is here  


The Proxy Advisory Services Roundtable (Voting Decisions and the Need for Data Tagging)

We are discussing the Roundtable recently held by the SEC on proxy advisory firms.

A great deal of the discussion in the Roundtable was about the degree of reliance by advisers and other investors on recommendations by proxy advisory firms.  It would be much easier to discuss this issue in a concrete way if there were better data available.  One of the things that prevents the development of this type of data is the practical difficulty that arises with respect to the recovery of voting data from SEC filings.  

Mutual funds must file voting data on Form N-PX.  A description of the disclosure obligations is here.   In the current format, the Form is very difficult to use. As one commentator writing to the Investor Advisory Committee described:   

  • given how N-PX reports are currently submitted, in unstructured plain text formats, undertaking such a project requires considerable time and effort, since before one can compute these simple summary statistics, he or she needs to first reverse-engineer the formats the funds use to report their votes (and different funds do use many different formats, and even the same fund may switch from one format to another from one year to the next), then write and debug computer scripts to extract these votes, and only then it is possible to compute such summary statistics. Similarly, with unstructured data, there is no easy way to see how the voting patterns (e.g., the frequency of supporting management-proposed directors, or opposing shareholder proposals) of a particular fund evolve over time. With tagged data, such questions could be answered virtually instantly.

Michelle Edkins at BlackRock referenced the obligation to file the Form and recommended that advisers provide "high level" data about voting results.  This would be useful but an even better result would be to require the filing of the data in an interactive format.  This would allow investors and issuers to study voting patters and develop their own conclusions.  This approach is consistent with the recent  recommendation of the SEC's Investor Advisory Committee.  


The Proxy Advisory Services Roundtable (The Data)

We are discussing the Roundtable recently held by the SEC on proxy advisory firms.  

Relatively early in the day (around minute 47), Mark Chen, Associate Professor of Finance, Georgia State University, was asked to summarize the applicable data.  It was the only time he spoke of any significance but it helped frame the debate and discussion in a very useful way.

There is no question that negative recommendations by the two main proxy advisory firms can have an impact on the shareholder voting process.  Some critics of these firms view the increase in negative votes as a causal consequence of the recommendations of the proxy advisory firm.  Others see the shift as a correlation, the result of a recommendation that raises the profile of an issue.  

Professor Chen noted a group of studies that had examined the role of ISS vote recommendations "in uncontested elections and voting situations."  First, negative recommendations on management sponsored proposals are "associated with" about "13.6% to 20.6% fewer votes for management."  In the case of individual directors in uncontested elections, a negative recommendation resulted in 14% to 19% fewer votes.  Finally, with respect to say on pay proposals, some evidence indicated that a negative recommendation resulted in 24% fewer votes.  

Professor Chen also noted that the data was subject two different interpretations.  First, the data could demonstrate "total outsourcing," the rote use of recommendations by the proxy advisory firms to determine voting decisions.  Second, voting advice could instead "bring new information to the markets" that influences voting decisions.  He noted:  "At the current time, I don't believe we have the data to sort out these two interpretations."  He also noted that "free riding is not in and of itself a problem" so long as the entity making the recommendations is doing the right thing.   

The statements provided parameters for the discussion.  While there were a few speakers who essentially asserted that proxy advisory firms had an excessive ability to control voting decisions (Trevor Norwitz at Wachtell spoke about their power to vote $4 trillion worth of shares), this was not a topic that gained much traction.  Indeed, the evidence presented at the Roundtable indicated that the largest asset managers (BlackRock for example) viewed the recommendations as an input, not a controlling influence.  

Professor Chen's statements also helped elevate the importance of data in the discussion.  The most valuable comments were those made by speakers who referenced their own experiences (or those of the industry they represented) and those who could support broader claims with data.  

The webcast of the Roundtable is here


The Proxy Advisory Services Roundtable (The Participants)

So who attended and spoke?  There was a good cross section of views to say the least. Some were apologists for issuers and investors. Others were relatively agnostic but provided insight into assorted aspects of the debate. The speakers included:  
  • Karen Barr — General Counsel, Investment Adviser Association
  • Jeff Brown — Head of Legislative and Regulatory Affairs, Charles Schwab
  • Mark Chen — Associate Professor of Finance, Georgia State University
  • Michelle Edkins — Managing Director and Global Head Corporate Governance and Responsible Investment, BlackRock, Inc.
  • Yukako Kawata — Partner, Davis Polk & Wardwell LLP
  • Hoil Kim — Vice President, Chief Administrative Officer and General Counsel, GT Advanced Technologies, Inc.
  • Eric Komitee — General Counsel, Viking Global Investors LP
  • Jeff Mahoney — General Counsel, Council of Institutional Investors
  • Nell Minow — Co-Founder and Board Member, GMI Ratings
  • Trevor Norwitz — Partner, Wachtell, Lipton, Rosen & Katz
  • Harvey Pitt — CEO, Kalorama Partners
  • Katherine Rabin — CEO, Glass Lewis & Co. LLC
  • Gary Retelny — President, Institutional Shareholder Services, Inc.
  • Michael Ryan — Vice President, Business Roundtable, and former president and COO of Proxy Governance, Inc.
  • Anne Sheehan — Director of Corporate Governance, CalSTRS
  • Damon Silvers — Director of Policy and Special Counsel, AFL-CIO
  • Darla Stuckey — Senior Vice President of Policy and Advocacy, Society of Corporate Secretaries
  • Lynn Turner — Managing Director, LitiNomics, Inc.

The webcast of the Roundtable is here


The Proxy Advisory Services Roundtable (Introduction)

Last week, the SEC held a roundtable on proxy advisory firms. Roundtables are not an uncommon mechanism used by the Commission to discuss divisive and complicated issues.  They provide an opportunity to obtain a cross section of views and, in the era of webcasts, give the public an opportunity to watch a live debate over the relevant issue.  

To be frank, however, roundtables do not often move the issue forward.  Comments can be random or incomplete. In a room full of experts, they can be woefully unprepared and tendentious. Statements can be predictable and provide little additional value to the debate.   

This Roundtable, however, was different. It was very well done. The staff did a good job at assembling a group of commentators who, for the most part, were honest, direct, and concise. Many came with what amounted to prepared statements that were focused and useful. All in all, they engendered a lively debate

Most remarkably, it was, after four hours, possible to figure out the disagreements among the parties and, to a large extent, areas of agreement. Anyone addressing this debate would be well to watch this Roundtable and make it the first step on any reform proposal. We will venture some observations in the last post.   

The only real embarrassment was not a problem of content but a problem of technology.  The microphones often didn't function during the first half of the day, requiring speakers to resort to mobile microphones or forcing them to change seats in order to be heard.  In one case, Lynn Turner (minutes 1:03.45 - 1:09.30) spoke for six minutes without any recorded sound.  Keith Higgins (Director of CorpFin) later explained that the problem arose in part from too many people simultaneously activating their microphone.  It was another technology unprepared for the volume of use.  

For the next several posts, we will comment on the Roundtable and sum up some of the lessons learned from the discussion.


Ross v. Lloyds Banking Group, PLC: Securities Claims Related to Lloyds’s Halifax Acquisition Fail

In Ross v. Lloyds Banking Group, PLC, Nos. 12‒4600-cv(L), 13‒729‒cv(Con), 2013 WL 5273067 (2d Cir. Sept. 19, 2013) (unpublished), the Second Circuit Court of Appeals affirmed the dismissal of the plaintiff’s claims under § 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 for failure to meet the heightened pleading standards demanded by Fed. R. Civ. P. 9(b) as well as the Private Securities Litigation Reform Act (“PSLRA”). Finding no § 10(b) and Rule 10b-5 violations, the court also disposed of the plaintiff’s control-person claim under § 20(a) of the Exchange Act.

According to the allegations, Albert Ross was a holder of more that 10,000 American Depository Receipts in Lloyds Banking Group, PLC (“Lloyds”). In 2008, Lloyds acquired Halifax Bank of Scotland (“Halifax”).

Ross filed a putative class action against Lloyds, Lloyds’s Chairman Sir Victor Blank, and Lloyds’s CEO Eric Daniels (collectively, “Defendants”), for allegedly misleading shareholders by inflating Halifax’s perceived financial condition. Specifically, Ross averred Defendants: (1) falsely stated Halifax would contribute £60B in “highly liquid near cash” reserves to the combined entity; (2) falsely stated that Halifax had “meaningful incremental available assets” to submit to the Bank of England’s Special Liquidity Scheme (“SLS”); (3) falsely stated Lloyds would acquire £30B in net assets for £14B; and (4) failed to disclose that Halifax was actively participating in the Bank of England’s Emergency Liquidity Assistance (“ELA”) program.

Prior to addressing Ross’s alleged misrepresentations and omissions, the court noted that Fed. R. Civ. P. 9(b) requires that securities fraud, including scienter, be pled with particularity. Similarly, the PSLRA requires that the complaint state with particularity facts that give rise to a “strong inference” of scienter.

First, as to Ross’s claim concerning “highly liquid near cash” reserves, the court concluded that the facts as plead failed to demonstrate the falsity of the statement. Ross pointed to a letter from Lloyds’s counsel in 2011 explaining that the £60B was made up of “government-issued debt, residential mortgages, and personal and commercial loans,” assets he asserted could not be considered “liquid” or “near cash.” Nonetheless, the transcript of the conference call “ma[de] clear that the terms ‘liquid’ and ‘near cash’ were being used to refer to government-issued debt.”

Second, the court discounted Ross’s claim that Defendants misled shareholders concerning the amount of Halifax’s assets available for the SLS. The court found that the use of lower-quality assets by Halifax to participate in ELA did not give rise to an inference that Halifax lacked higher-quality assets to submit to the SLS. Nor could scienter be inferred from a report from the U.K. Financial Services Authority concluding that 75% of Halifax’s Corporate Division loan portfolio was sub-investment grade. “[T]he report concludes only that a portion of the Corporate Division’s assets were sub-investment grade; it does not conclude that the Corporate Division, or HBOS for that matter, had no assets of sufficient quality to submit to SLS, and thus it does not demonstrate the falsity of Tookey’s statement.”

Third, the court found that Defendants’ statements concerning the positive net effect of the acquisition were not misleading. Although Daniels publically stated that Halifax’s pro forma net assets equated to £31.5B, he qualified that statement by disclosing that “material negative adjustments” may be required in the future.

Fourth and finally, the court concluded that Defendants’ failure to specifically disclose Halifax’s participation in the ELA was not actionable. Although Defendants did not explicitly disclose such facts, disclosure was made that both Lloyds and Halifax were dependent upon ELA to meet funding obligations. This disclosure “preclude[s] a strong inference” that the lack of direct disclosure was intended to “deceive, defraud, or manipulate.”

As a final effort to revive his claim, Ross contended that the district court improperly denied his request to amend his complaint. Reviewing the district court’s decision for an abuse of discretion, the court explained that Ross had already been afforded the opportunity to amend once, and further, that he had not alleged any additional facts that would “cure the deficiencies.”   

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


SEC v. Schooler: General Partnership Investments May be Within the Reach of Federal Securities Laws

In SEC v. Schooler, 3:12-CV-2164-GPC-JMA., 2013 WL 3320364 (S.D. Cal. July 1, 2013), the United States District Court for the Southern District of California denied defendants’ 12(b)(6) motion to dismiss claims brought by the SEC under Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933 (“Securities Act”).

On September 4, 2012, the SEC brought suit against Louis V. Schooler and First Financial Planning Corporation d/b/a Western Financial Planning Corporation (collectively, “Defendants”).  The SEC alleged that, starting in 2007, Defendants violated and continued to violate the anti-fraud and registration provisions of the Securities Act.  According to the SEC’s complaint, Defendants failed to disclose to investors important material facts regarding the true value of underlying assets prior to offering and selling $50 million worth of general partnership units in various partnerships organized by the Defendants.

The court subsequently granted the SEC’s request for a temporary restraining order that the court later converted into a preliminary injunction.  Defendants argued that the interests in the general partnership units were not securities and that, as a result, the SEC lacked enforcement authority in this action.

Sections 2(a)(1) of the Securities Act and 3(a)(10) of the Exchange Act of 1934 name investment contracts in their definitions of a security.  The Court defined an investment contract as a “contract, transaction, or scheme whereby a person invests his money in a common enterprise . . . expect[s] profits solely from the efforts of [others].”  The requirement of solely from the efforts of others has been liberally construed to include the “undeniably significant” efforts that are “essential managerial efforts which effect the failure or success of the enterprise.”

For a general partnership unit to qualify as a security, one of the following factors must be present: (1) the general partnership agreement leaves “so little in the hands of the partners” that the arrangement in fact distributes power as would a limited partnership; (2) the partners are so inexperienced and unknowledgeable in the general partnership business affairs that they are incapable of intelligently exercising their partnership powers; or (3) the partners cannot exercise their partnership powers because they are dependent upon the managers.

First, the court held that the SEC provided a sufficient basis to establish the second factor.  Investors in the units included a pharmacist, a retired school teacher, and a water filter salesman.  Such investors are “often unsophisticated in business affairs” and lack the expertise to properly exercise their partnership powers.

Second, the court held that the SEC plead sufficient facts to establish the third factor.  A dependency relationship may exist where investors rely “on the managing partner’s unusual experience and ability in running a particular business.”  The court concluded that the fractional ownership of land among partners resulted in each partner being unable to exercise control and decision making over the entire property.  The investors were ultimately dependent upon Defendants to sell their respective properties because the agreement required the consent of all partnerships. 

The court also held that Defendants’ unique expertise created investor dependency.  Defendants’ had decades of experience of selling underdeveloped land in the southwest region and their sales managers admitted to using their extensive experience to negotiate land purchases at very steep discounts.

Considering the foregoing, the court determined that the SEC made sufficient pleadings for the violations charged and consequently denied the Defendants’ 12(b)(6) motion to dismiss on all grounds.

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


Callan v. Motricity Inc.: Motion to Dismiss Granted for Failure to State a Claim 

In Callan v. Motricity, Inc., No. C11-1340 (W.D. Wash. Oct. 1, 2013), the United States District Court for the Western District of Washington dismissed Plaintiffs’ suit for failure to state a claim.

According to the allegations, Defendant Motricity Inc. (“Motricity”) provided products and services that allowed wireless carriers to deliver mobile data services to their mobile phone subscribers. On June 17, 2010, Motricity made an initial public offering (“IPO”). Plaintiffs, shareholders of Motricity, alleged violations of Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934. Specifically, Plaintiffs alleged that Motricity made material misstatements in both its registration statement and post-IPO press releases.  

Section 11 prohibits materially false statements of fact or omissions of a material fact that would have misled a reasonable investor about the nature of his or her investment. Plaintiffs argued that the registration statement misled investors into believing that Motricity was healthier than it actually was. Plaintiffs asserted that the registration statement failed to address the ongoing “dramatic shift” in control of market share away from Motricity, and that it artificially inflated the ability of the Motricity's mCore product to provide Internet access relative to competitors.

The court rejected Plaintiffs’ arguments, finding insufficient allegations that Motricity was aware of any “dramatic shift” in its business. Furthermore, the court held the registration statement adequately disclosed that the mCore product was threatened by the open-access products offered by Apple and Google.

Section 10(b) prohibits any materially false or misleading statements. Additionally, Section 10(b) claims require the pleading to state with particularity facts giving rise to a strong inference of scienter.  The court found that the alleged misstatements did not involve any “specific or absolute characteristics” of the product and were instead examples of mere “puffery.”  As a result, they were not actionable under Rule 10b-5. 

The primary materials may be found on DU's Corporate Governance website.


Lauria v. BioSante Pharmaceuticals: Dismissal Granted with Leave to Amend

In Lauria v. BioSante Pharm., Inc., Thomas Norgiel and Jeffrey Rennell (“Plaintiffs”) asserted on behalf of themselves and others similarly situated that BioSante Pharmaceuticals (“BioSante”) and Stephen Simes (collectively, “Defendants”), BioSante’s Vice Chairman, President, and CEO, artificially inflated the price of shares in violation of the Securities Exchange Act of 1934.  Case No. 12 C 772, 2013 BL 242363 (N.D. Ill. Sept. 11, 2013).  The court granted the Defendants’ motion to dismiss with 28 days leave to amend the complaint.

According to the allegations, BioSante is a pharmaceutical company that specializes in products for female sexual health and oncology.  BioSante developed a new drug, LibiGel, which was developed using a traditional three-phase clinical trial model.  At the end of Phase II, data indicated that LibiGel was effective.  Throughout 2011, Simes publicly talked about the market potential of the drug and how remarkable the current LibiGel results were.  At the end of 2011, however, Phase III results showed that LibiGel was unsuccessful.  On the day of the announcement, BioSante’s stock plummeted 77%. 

Plaintiffs alleged that the Defendants conducted the trials inappropriately and that Defendants knew there was disagreement within the scientific community about female sexual dysfunction. Plaintiffs contended that this knowledge led to LibiGel being unsuccessful and stock prices falling.  A confidential witness in the case, who served as a senior project manager for the LibiGel Phase III trials, allegedly observed issues with the dropout rate of participants in the trial and noncompliant, expensive gifts being given to site investigators.  The confidential witness also noted that Simes made unauthorized decisions about participant eligibility in the Phase III trial.

A motion to dismiss should be granted if the plaintiff fails to state a claim that is plausible on its face.  For allegations of fraud, a plaintiff must “provide the time, place, and content of the alleged false representations, the method by which the representations were communicated, and the identities of the parties to those representations.”  The Private Securities Litigation Reform Act further requires that a securities complaint (1) “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed”; and (2) “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.”

Defendants argued that Plaintiffs’ complaint did not meet the required pleading standard because the complaint merely contained large blocks of text attributed to Defendants and allegeing that these statements were false and misleading.  Plaintiffs contended that the bolded and italicized portions of the text within the complaint formed the basis for the fraud claim.  The Plaintiffs’ complaint required the court and Defendants to locate the reasons why the bolded and italicized portions were misleading and to find the facts that established the Defendants’ required state of mind.  The court found that the Plaintiffs’ use of bolded and italicized portions in the complaint confusing and cryptic; therefore, the complaint did not meet the pleading requirements.  Accordingly, the court granted the Defendants’ motion to dismiss. 

Defendants argued that the motion to dismiss should be granted with prejudice because an amendment would be "futile."  The court acknowedled that, under Delaware law, “if a defendant files a motion to dismiss and the plaintiff files an answering brief opposing the motion instead of an amended complaint, a subsequent dismissal of the plaintiff’s claims pursuant to the defendant’s motion will be with prejudice unless dismissing with prejudice would not be just under all the circumstances.”  The court found this remedy to be drastic and that it was conceivable that the complaint could be corrected.

In declining to dismiss with prejudice, the court offered Plaintiffs some drafting advise if they chose to amend. 

  • When preparing their amended complaint, the plaintiffs should focus on the quality, not the quantity, of their allegations. They should also bear in mind that the current complaint “is disjointed as to the factual ground it covers and the statements it identifies. The amended complaint (if any) may be shorter, but it may even be longer. The key point for this case is to present the allegations in an easier-to-follow format.”

The court granted the motion to dismiss without prejudice and permitted the Plaintiffs to file an amended complaint within 28 days.

The primary materials may be found on the DU's Corporate Governance Site.


Northumberland County Retirement System v. Kenworthy: Court Denies Motion to Dismiss in Class Action Case

In Northumberland Cnty. Ret. Sys. v. Kenworthy, NO. CIV-11-520-D, 2013 BL 249536 (W.D. Okla. Sept. 16, 2013), the United States District Court for the Western District of Oklahoma denied the Defendants’ three motions to dismiss. The Defendants claimed that the Plaintiff failed to state a plausible claim for relief pursuant to Fed. R. Civ. P. 12(b)(6) (“12(b)(6)”), but the court found the Plaintiff’s claim for relief plausible.

The Oklahoma Law Enforcement Retirement System (“Plaintiff”), lead Plaintiff seeking to represent a putative class of those who purchased GMX Resources, Inc. (“GMX”) common stock, asserted three claims for relief based on allegations that GMX and its officers and agents (collectively, “Defendants”), violated several provisions of the Securities Act of 1933 (“1933 Act”). The Plaintiff argued that all Defendants violated Section 11, GMX and the underwriters violated Section 12(a)(2) (“Section 12”), and Ken L. Kenworthy, Jr. (“Kenworthy”) and James A. Merrill (“Merrill”) were liable as controlling persons of GMX for the Section 11 violation pursuant to Section 15 of the 1933 Act.

After the briefing on the motions, GMX filed for bankruptcy. After the notice of bankruptcy, the parties filed a Stipulation of Dismissal to dismiss all claims against GMX with prejudice. The Stipulation of Dismissal did not dismiss the claims against Kenworthy and Merrill.

Section 11 imposes civil liability against the security issuer and its underwriters when (1) material misstatements or omissions are made in the registration statement, and (2) the securities were acquired without knowledge of the material misstatements or omissions. A claim for relief under Section 11 must allege (1) that a registered security was purchased from the issuer or the aftermarket; (2) that the purchaser sufficiently participated in the offering giving rise to liability under Section 11; and (3) the registration statement contained a material omission or misstatement.

The Plaintiff claimed that "they acquired GMX securities 'pursuant to or traceable to the Offering Materials issued in connection with the Company's May 2009 Offering and October 2009 Offering.' ”  Although alleged to be "conclusory", the court found that the allegations were "sufficient to place all defendants on notice of the basis of Lead Plaintiffs' claims."  

Under Section 12, only those buying securities from the “statutory seller” had a cause of action. A person or entity is a “statutory seller” if she sells or issues the security to the buyer for value or the sale was solicited and was motivated by the financial interests of the seller or owner of the security.  A Section 12 claim must allege that the defendant was a statutory seller, the sale was brought about by a prospectus or oral communication, and the prospectus or oral communication contained a material omission or untrue statement of a material fact. 

The court found that the Plaintiff’s allegations met the requirements for a Section 12 claim.  Underwriters selling security interests for value meet the “statutory seller” requirement.  In addition, the court held that the Plaintiff did not have to specify that the securities were purchased from a particular underwriter but must allege that underwriters sold certificates for personal gain on specific dates. 

In order to have a Section 15 claim there must be an alleged violation of Section 11 or Section 12 and allegations that the defendant controled the violator.  Control is defined as the power to direct both the policies and the direction of management. Other courts have found that the signors of the registration statements were presumed to have control over the people who drafted the documents. In the present case, Kenworthy and Merrill executed SEC filings that were referenced in the GTX prospectus. Consequently, the court concluded that the Plaintiff stated a plausible Section 15 claim. 

The court also decided that the Plaintiff sufficiently showed loss or damage.  As the court noted:  “Sections 11 and 12(a)(2) ‘do not require a plaintiff to plead or prove loss causation.’ ” Instead, the decline in value was assumed to be due to the misrepresentation. Finally, the court found that the Plaintiff had a claim for plausible relief because it only had to allege material misstatements. The Plaintiff did not have to allege facts showing that that the misrepresentation was material.

For the foregoing reasons, the court denied the Defendants’ motions to dismiss.

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



Acknowledgement, Admission, Amercement – JPMorgan Chase Agrees to Pay $200 Million and Admits Wrongdoing to Settle SEC Charges

On September 19, 2013, the Securities and Exchange Commission ("SEC") issued a cease and desist order for current and any future violations of Section 13 of the Securities Exchange Act of 1934 against JPMorgan Chase (“JPMorgan”) for allegedly misstating financial results and the failing to maintain effective internal controls.  JPMorgan agreed to pay a $200 million civil penalty, admit some of the facts underlying the charges, and publicly acknowledge that it violated the securities law.   

The SEC had initially charged two of JPMorgan’s former traders with fraud after they allegedly attempted to hide hundreds of millions of dollars in losses in one of the firm’s trading portfolios. The SEC later charged the company with failing to properly monitor its traders and with depriving the board’s auditing committee of “critical information it needed” to properly assess the company’s financial position and ascertain whether the company provided accurate information to regulators and investors.

The Sarbanes‑Oxley Act requires public companies to establish and utilize internal controls to allow senior management to effectively communicate with the board of directors, and to assure investors that the company’s financial statements are reliable.  As the Commission’s order described:

Public companies are responsible for devising and maintaining a system of internal accounting controls sufficient to, among other things, provide reasonable assurances that transactions are recorded as necessary to permit preparation of reliable financial statements. In addition, the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) established important requirements for public companies and their management with respect to corporate governance and disclosure. For example, public companies are obligated to maintain disclosure controls and procedures that are designed to ensure that important information flows to the appropriate persons so that timely decisions can be made regarding disclosure in public filings. Commission regulations implementing Sarbanes-Oxley therefore require management to evaluate on a  quarterly basis the effectiveness of the company’s disclosure controls and procedures and the  company to disclose management’s conclusion regarding their effectiveness in its quarterly  filings.

JPMorgan’s internal controls, however, were not, according to the Commission, suited to this task. As the portfolio in question declined in value, JPMorgan conducted internal reviews to determine the effectiveness of its internal controls. Management found the controls to be inadequate in several respects.   Furthermore, senior management did not inform the board’s audit committee about these reviews.  As the SEC’s Order noted:

Because the Audit Committee was not apprised of the initiation of the reviews or facts learned as a result of those reviews, it was unable to provide input on the issues before the filing of JPMorgan’s first quarter report, and was unable to engage with those doing the work to ensure that it was sufficient from the perspective of the Audit Committee.

JPMorgan agreed to pay a $200 million civil penalty to the SEC that will be used to recompense damaged investors. Additionally, JPMorgan stipulated to admitting to several facts, including that its internal accounting controls were “woefully deficient” and that senior management’s failure to “adequately update” the board about the problems. 

Through the coordinated global settlement, JPMorgan also agreed to settle with the U.K. Financial Conduct Authority, the Federal Reserve, and the Office of the Comptroller of the Currency for penalties totaling $920 million.

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


Securities Exchange Commission v. Shavers: Court Finds Bitcoin-Related Investment Opportunities to be Securities

In Sec. Exch. Comm'n v. Shavers2013 BL 208180 (E.D. Tex. Aug. 6, 2013), the United States District Court for the Eastern District of Texas found certain Bitcoin-related investment opportunities were securities and, as a result, that it had subject matter jurisdiction over the action.

According to the allegations made by the Securities and Exchange Commission ("SEC"), Defendant, Trendon Shavers, the founder of Bitcoin Savings and Trust ("BTCST"), made a number of misrepresentations to investors regarding the nature of the "Bitcoin" investments. In seeking dismissal of the case, Shavers argued that the Bitcoin investments were not securities.

The court described Bitcoin as an electronic form of currency unbacked by any real asset. Bitcoin can be used for online and, in some cases, retail store purchases. In November 2011, according to the allegations, Shavers advertised an investment opportunity in BTCST in which investors could gain 1% interest on their investment "until either [they] withdraw the funds or [Shaver's] local dealings dry up and [he] can no longer be profitable." The BTCST investors collectively lost $1,837,303 on these investments. 

The term "security" is defined as "any note, stock, treasury stock, security future, security-based swap, bond . . . [or] investment contract . . . " 15 U.S.C. § 77b. An investment contract is any contract, transaction, or scheme involving (1) an investment of money, (2) in a common enterprise, (3) with the expectation that profits will be derived from the efforts of the promoter or a third party.

First, the court held that the BTCST investments constituted an investment of money. Although not regulated by any central bank or any other form of governmental authority, the court noted that Bitcoin could be used to purchase goods or services and could be exchanged for conventional currencies.

Second, the court held that the BTCST investments constituted a common enterprise.  The allegations were sufficient to show that investors “were dependent on Shavers' expertise in Bitcoin markets and his local connections” and that Shavers “allegedly promised a substantial return on their investments as a result of his trading and exchanging Bitcoin.”

Last, the court held that there was an expectation that profits would be derived from the efforts of the promoter because Shavers allegedly promised the investors up to 1% daily interest and at one point promised daily rates as high as 3.9%.

For the foregoing reasons, the Court held that the Bitcoin investment contracts were classified as securities and, therefore, fell within the scope of the Court’s subject matter jurisdiction.

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


Intesa Sanpaolo, S.P.A. v. Credit Agricole Corporate & Investment Bank: Understanding the Importance of Timeliness with Respect to 10(b) Claims

In Intesa Sanpaolo, S.P.A. v. Credit Agricole Corporate & Inv. Bank, No. 12 Civ. 2683 (RWS), 2013 BL 244911 (S.D.N.Y. Sept. 10, 2013), the U.S. District Court for the Southern District of New York granted defendants’ 9(b) and 12(b)(6) motions to dismiss claims brought by Intesa Sanpaolo, S.P.A. (“Intesa”) under Section 10(b) of the Securities and Exchange Act of 1934 (“Exchange Act”) and related state law claims for fraud and aiding and abetting fraud.

On February 13, 2013, Intesa filed its second amended complaint to cure the timeliness issue with respect to its initial complaint against Credit Agricole Corporate and Investment Bank, Credit Agricole Securities (U.S.A), Inc., The Putnam Advisory Company LLC, Magnetar Capital LLC, and Magnetar Capital Fund LP (collectively, “Defendants”).  The court previously dismissed Intesa’s 10(b) claims because they were time-barred pursuant to 28 U.S.C. § 1658(b) (“Section 1658 (b)”).

Pursuant to Section 1658(b), federal securities claims must be filed no later than the earlier of “(1) two years after the discovery of the facts constituting the violation; or (2) five years after such violation.”  In dismissing Intesa’s initial motion, the court indicated that a 10(b) claim might possibly be timely if misrepresentations existed in underlying documents to the swap agreement at issue.

Intesa contended that it cured the timeliness issue in its second amended complaint for three reasons.  First, it asserted that various agreements were incorporated by reference into the swap contract because the agreements were referenced in the contract.  However, the court noted that incorporation requires more than reference alone.  Incorporation requires the language to also “clearly communicate that the purpose of the reference is to incorporate the referenced material into the contract.”  Because the contract at issue lacked such language of purpose, the court rejected this contention.

Second, Intesa contended that an April 20, 2007 phone call in which a Putnam employee made potential misrepresentations remedied the timeliness issue.  Because the statement was a general statement of optimism, it was not actionable unless the “plaintiff . . . demonstrate[d] that the opinion was not honestly held.”  Intesa never alleged that the Putnam employee did not honestly hold his optimistic opinion. Consequently, the court rejected Intesa’s second contention.

Third, Intesa contended that it remedied the untimeliness issue of its original complaint because the Defendants provided Intesa with misrepresented valuations in March, April, and May of 2007.  However, the March and April valuations occurred more than five years after Intesa filed the complaint and were statutorily barred.  Additionally, the May valuation was received “after Intesa had already engaged in the swap transaction.”  Therefore, the court concluded as a matter of law that Intesa could not have relied on the allegedly misrepresented May 2007 valuation for the purpose of purchasing the swap contract.

As a result, the court granted with prejudice the Defendants’ motions to dismiss and declined supplemental jurisdiction over the state law claims.

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


Howard v. Chanticleer Holdings, Inc.: The Broad Reach of Section 11 of the Securities Act of 1933

In Howard v. Chanticleer Holdings, Inc., CASE NO. 12-81123-CIV-COHN/SELTZER, 2013 BL 254048 (S.D. Fla. Sept. 17, 2013), Francis Howard (“Howard”), filed a class action suit against Chanticleer Holdings, Inc. (“Chanticleer”), five of its officers and directors, two underwriters, and Creason & Associates, P.L.L.C. (“Creason”) alleging violations of Sections 11 and 15(a) of the Securities Act of 1933 (“Securities Act”). The United States District Court for the Southern District of Florida denied the motion to dismiss filed by Chanticleer and the five officers and directors (collectively, the “Chanticleer Defendants”), granted in part and denied in part the motion to dismiss filed by Creason, and denied Creason’s motion for more definite statement.  

According to the allegations, Chanticleer, an international Hooter’s franchisee, owned and operated several Hooter’s restaurants in South Africa and Australia. To initiate a public offering of its securities (“Offering”), Chanticleer filed an amended Registration Statement signed by the defendant officers and directors and a final Prospectus (collectively, the “Filings”) with the Securities and Exchange Commission (“SEC”) in June 2012. The Filings, which “included income-statement and balance-sheet line items” for the 2011 fiscal year (“FY 2011) and the first quarter of 2012 (“Q1 2012”), represented that the FY 2011financial statements were “audited.” The Filings also included a letter from Creason, Chanticleer’s auditor, stating that it did not audit the financial statements of Chanticleer’s South Africa operations, and in turn, relied upon the reports of other auditors in issuing its audit opinion on Chanticleer’s consolidated financial statements.

Shortly after the Offering commenced, Chanticleer disclosed that the “financial statements for FY 2011 and Q1 2012 could no longer be relied upon because the statements for the South Africa Operations had not, in fact, been audited.” Chanticleer subsequently “filed restated financial results for FY 2011 and Q1 2012.” Those audited statements revealed “that the earlier Filings had understated Chanticleer’s operating losses for FY 2011 by 33.8 percent and its losses for Q1 2012 by 44.6 percent.” Chanticleer’s stock price ultimately dropped approximately 54 percent down to $1.66 per share. 

Section 11 of the Securities Act “allows purchasers of a registered security to sue certain enumerated parties in a registered offering when false or misleading information is included in a registration statement.” Under Section 11, an action may be brought against all “parties who play a direct role in the registered offering.” To successfully bring a Section 11 claim, “a plaintiff need only show a material misstatement and/or omission in the registration statement” for securities he purchased. Except for the issuer, defendants “may avoid [Section] 11 liability by proving a ‘due diligence’ defense, which is essentially a ‘negligence standard.’ ”  

Additionally, Section 15(a) “imposes joint and several liability upon controlling persons for acts committed by those under their control that violate” Section 11. The plaintiff may establish a violation by proving the defendants “(1) each had power or influence over the controlled person and (2) each induced or participated in the alleged violation.” A defense may be established when “the controlling person had no knowledge of or reasonable ground to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist.” 

In their motion to dismiss, the Chanticleer Defendants argued that because Howard’s claims were based on allegations of fraud, he must “state with particularity the circumstances constituting fraud” as required by Fed. R. Civ. P. 9(b). The court, however, found that the heightened pleading standards of Rule 9(b) did not apply in this case because Howard’s Amended Complaint did not assert a separate securities fraud claim and contained no other fraud allegations. The court also held that Howard’s Amended Complaint did not allege facts that would facially establish a clear affirmative defense as asserted by the Chanticleer Defendants. Accordingly, the court denied the motion to dismiss. 

In its motion to dismiss, Creason asserted it could not be held liable for the misstatements in the relevant filings because it had not prepared or certified the inaccurate financial statements. While the court agreed that Creason did not audit the Q1 2012 statements, the court found that Creason had certified the FY 2011 consolidated financial statements by claiming it reviewed audit reports pertaining to Chanticleer’s South Africa operations. Accordingly, the court denied Creason’s motion to dismiss as to the FY 2011 financial statements and granted the motion as to the Q1 2012 statements. The court also denied Creason’s motion for more definite statement because it found that Creason could reasonably respond to Howard’s allegations as pled in his Amended Complaint. 

Therefore, the United States District Court for the Southern District of Florida denied the motion to dismiss filed by the Chanticleer Defendants, granted in part and denied in part the motion to dismiss filed by Creason, and denied Creason’s motion for more definite statement.

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


More Developments on Conflict Minerals

For those tracking the progress of the conflicts minerals rule and the challenges thereto comes word that oral arguments in the case have been scheduled for January 7, 2014.  The case will be heard by the DC Circuit Court of Appeals before Circuit Judge Srinivasan, and Senior Circuit Judges Sentelle and Randolph.

On a related matter, it is worth noting that the European Commission's legislative proposal on conflict minerals that was expected to be released shortly has instead been put on hold until next year.   The European legislation is meant to be compatible with the US legislation but is expected to differ in some respects.  The EU legislation may cover a wider geographical area (extending into Latin America) than the U.S. conflict minerals rule.  While the list of covered minerals remains the same (the 3G T) the EU legislation is expected to focus on smelters instead of targeting suppliers and end-users as the U.S. law does.

The delay in EU action comes after a speech in September by European Commissioner for Trade Karel De Gucht in which he indicated that a final version of the EU legislation would be issued by the end of this year.  No reason for the delay has been given, but it is known that the impact assessment report, which must be finalized before any legislative proposal can be brought, was rejected by the College of Commissioners. According to Judith Sargentini, Member of European Parliament (“MEP”), “the impact assessment was ready but was deemed not enough.” The Commissioners did not state a reason for their rejection of the report but speculation is rife that German mineral extraction firms lobbied hard against it—with apparent effect.

The Commission is now expected to present its impact assessment into the new conflict minerals law by the end of 2013, but no proposal is likely to be adopted until February or March 2014 at the earliest.

 “When the proposed rule does come out, it will be nearly final for all intents and purposes. The process will be unlike the U.S. process in which a proposed rule is often changed significantly after it is commented upon by interested parties. For the EU rule, the comment and lobbying is done at the front end,” said Dynda Thomas, a partner at law firm Squire Sanders.

The challenge to the US conflict minerals rule and the delay in enactment of EU legislation leave large question marks hanging over this whole topic.  Those question marks will not be helped if the M23 truly do lay down their arms and wind down the conflict the conflict minerals disclosure regimes are meant to be addressing.  That the rebels are “quitting” may or may not have a real impact on the conflict in the DRC—but if it does to what end is conflict mineral disclosure?  The problem with using disclosure to address political and social issues is that those issues are fluid and changeable in a way the legislation is not.


Wagner v. Royal Bank of Scotland Grp. PLC: Defendants’ Motion to Dismiss Denied in Insider Trading Lawsuit

In Wagner v. Royal Bank of Scotland Grp. PLC, No. 12 Civ. 8726 (PAC), 2013 BL 239950 (S.D.N.Y. Sept. 5, 2013), the United States District Court for the Southern District of New York denied Defendants’ motion to dismiss a securities claim seeking the recovery of short swing profits under Section 16(b) of the Securities Exchange Act of 1934 (“Section 16(b)”). 

The transactions at issue involved swap agreements between the Royal Bank of Scotland Group PLC and its affiliates (collectively, the “RBS Defendants”) as well as various counterparties.  According to the allegations, RBS Defendants swapped LyondellBasell Industries, N.V. (“LBI”) Class B shares for payments based on the shares’ increase in value or dividends paid on them. Because of the structure of the Class B shares, they were automatically converted to Class A shares upon the occurrence of a specific event shortly after the swap agreements were made. In addition, the “RBS Defendants beneficially owned more than 10% of outstanding Class A shares.”

A shareholder of LBI requested that LBI seek disgorgement of the RBS Defendants’ short-swing profits.  When this did not occur, Jeff Wagner (“Plaintiff”) brought this lawsuit against the RBS Defendants to recover the amount.

To succeed on a Section 16(b) claim, the plaintiff must prove that there was “(1) a purchase and (2) a sale of securities (3) by an officer or director of the issuer or by a shareholder who owns more than 10% of any one class of the issuer’s securities (4) within a six-month period.” Although they owned more than 10% of the outstanding Class A shares, the RBS Defendants moved to dismiss.

The RBS Defendants argued that the transactions did not involve a change in their “pecuniary interest” and were, therefore, exempt under Section 16.  See Rule 16a-13, 17 CFR 230.16a-13 (“A transaction, other than the exercise or conversion of a derivative security, or deposit into or withdrawal from a voting trust, that effects only a change in the form of beneficial ownership without changing a person's pecuniary interest in the subject equity security shall be exempt from Section 16 of the Act.”). 

The RBS Defendants argued, among other things, that the court should not apply Section 16(b) to the transactions at issue because they are “far afield from trading on inside information and do not implicate the concerns that animate Section 16(b).” The court noted that scrutiny of borderline transactions only occurred when an insider made an involuntary transaction with no access to inside information. This case, however, did not warrant heightened scrutiny because the RBS Defendants had “not yet demonstrate[d] that no such possibility” existed. 

Additionally, the RBS Defendants sought to rely on SEC No-Action Letters finding  Section 16(b) inapplicable to transactions where the parties had no pecuniary interest in the securities involved. The court, however, rejected reliance on these letters, finding that the transactions by the RBS Defendants were “quite different” from those discussed in the letter.  Therefore, because the RBS Defendants did not successfully argue that Section 16(b) was inapplicable, the court denied their motion to dismiss.

Primary materials are available on the DU Corporate Governance website


In re ProShares Trust Sec. Litig.: No Material Misrepresentations or Omissions Where Prospectuses Warn of Potential Loss and Volatility

In In re ProShares Trust Sec. Litig., No. 12-3981, 2013 WL 3779364 (2d Cir. July 22, 2013), the United States Court of Appeals for the Second Circuit affirmed the dismissal of a putative class action against ProShares Trust and ProShares Trust II (collectively “ProShares”) for alleged violations of Sections 11 and 15 of the Securities Act of 1933 (“1933 Act”).

According to the allegations, Defendant-Appellees, ProShares, offered shares of leveraged exchange traded funds (“ETFs”) from 2006 through 2009. ETFs are a type of security that “operate like indexed mutual funds but trade like stocks.” They typically “track an index, a sector of stocks, or a commodity or currency.” ProShares' ETFs sought to outperform an underlying index by investing daily in components of the index through the use of assorted financial instruments.

The ProShares prospectuses warned that the ETFs used “aggressive” investment tactics aimed at short-term gains through outperforming the daily index, and “that it did not use conventional stock research or analysis” in deciding to invest in certain, often “volatile,” financial instruments. It further stated that its investment techniques could result in “potentially drastic losses” even resulting in the “total loss of an investor’s investment.”  

The Plaintiff-Appellants (“Plaintiffs”), a group of investors who purchased those shares, claimed that ProShares made material omissions and misrepresentations in the ETFs prospectuses, which led the Investors to lose substantial portions of their investments.  The Plaintiffs contended that ProShares violated Sections 11 and 15 of the 1933 Act by failing to adequately warn them of the risk of loss, especially the risk of loss for investing in the ETFs for terms longer than a day.  

For a Section 11 claim to survive a motion to dismiss it must identify a material misrepresentation or omission. Section 15 requires the showing of a Section 11 violation and defendant control over the violator.  To be material, the information must have “significantly altered the total mix of information” in the eyes of a reasonable investor. Just because an omission or misrepresentation is important does not make it material. 

In light of the warnings in the prospectuses, the court found that the Plaintiffs failed to allege material misrepresentations and omissions. The court stated that “the role of the materiality requirement is not to attribute to investors a child-like simplicity.” The prospectuses used adequate language to put investors on notice of the potential losses they faced through investing in the ETFs. The Plaintiffs' Section 11 claim failed, and the Section 15 claim, which must be established in conjunction with a successful Section 11 claim, also failed. In the absence of an underlying violation, the claim under Section 15 was likewise dismissed.

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


Assessing the Judicial Philosophy of Supreme Court Nominees in Delaware

The news out of Delaware is that Chancellor Strine has applied to be the Chief Justice of the Delaware Supreme Court.  According to the WSJ, there are four candidates for the position, including Justice Berger. The other two are judges on the Superior Court, Jan Jurden and James Vaughn.  

The ultimate decision will be made by the governor.  Speculation on the outcome is only that.  Nonetheless, to the extent that one of the goals is a particular judicial philosophy, the current set of candidates provide a possible avenue for achieving this result.  

In determining how a Justice might resolve a particular issue, one possibility would be to examine the individual's professional background.  A better approach would likely be to examine an individual's actual record in resolving the very types of issues that will likely come before the Court.    

In Delaware, this type of information exists.  Those on the Chancery Court have a record that can be examined.  Assuming this information is used in the selection process, it would suggest that the Chancery Court can be a stepping stone to the Supreme Court.  And, in fact, it is.  Until the retirement of Chief Justice Steele, three of the jurists on the Supreme Court (CJ Steele, and Justices Berger and Jacobs) first served on the Chancery Court. 

Chancellor Strine has a long record on the Chancery Court.  As a result, anyone seeking to determine his judicial philosophy will have a considerable number of decisions (and articles) to examine.  Moreover, his appointment would result in the Supreme Court again consisting of a majority of Justices with Chancery Court experience.  This will occur if he is appointed as Chief.  It will also occur if Justice Berger is appointed Chief and Chancellor Strine is appointed to fill her vacancy.  


Update on the Iran Threat Reduction And Syria Human Rights Act

Earlier posts discussed the Iran Threat Reduction and Syria Human Rights Act  and Section 219 of the Act.  That section added a new subsection (r) to Section 13 to the Exchange Act imposing disclosure requirements on public companies with respect to compliance with the Act.   Section 219 went into effect on February 6, 2013 so there have now been two reporting periods covered by the Section and more than 400 instances of disclosure have been made and accompanying IRANNOTICEs filed.

As noted in earlier discussions, the disclosure requirements are both broad and vague.  The requirements attach to “the issuer or any affiliate of the issuer” on a world-wide basis.  The SEC defines affiliate broadly to include any entity controlled by the issuer as well as any person or entity that controls the issuer or is under common control with the issuer.  Reporting companies are required to disclose the “nature” of certain types of “transactions or dealings” neither of which term is defined.  In addition, reporting companies must disclose the gross revenues and net profits attributable to reportable activities but there is no specification as to how such disclosures should be made.  Nor is there any materiality qualifier or de minimis exception.

So what have we learned? The over-reporting discussed in earlier posts continues.  For example, Costco disclosed that it processed transactions for four cardholders from Iranian embassies. Gross revenue from these transactions was approximately US $5,178 from the Iranian embassy cardholders and profit of less than US $160. It also processed a transaction for a cardholder affiliated with Iran Air, but no revenue or profit was attributable to that transaction.

Credit Suisse Group AG (a Swiss Company) disclosed that during 2012, it processed a small number of de minimis payments related to the operation of Iranian diplomatic missions in Switzerland and to fees for ministerial government functions such as issuing passports and visas. Processing these payments is permitted under Swiss law and Credit Suisse intends to continue processing such payments.

Tata Communications Limited (an Indian company) disclosed that one of its affiliates received US $41 and US $65 from supplier of services agreements it had with Telecommunications Company of Iran, an instrumentality of the Iranian government.

Other examples are readily available.  The “value” of these disclosures can certainly be questioned.  What cannot be questioned and should not be forgotten is the burden these types of disclosures are putting on reporting companies.  They must step up their internal controls possibly by expanding sanctions compliance procedures and broadening the scope of parties screened so as to include any possible “affiliate.”  Pre-Act screens are not sufficient because Section 219 requires disclosure of activities that are not prohibited under US law and therefore probably not previously watched for.

Are the burdens worth it?  If the goal of the Act is to decrease transactions with Iran, the answer is maybe.  US sanctions in place before ITRA already effectively prevent US companies from doing business in or with Iran or Iranian companies.  To date, no issuers have been the subject of the investigatory process permitted under ITRA.  Are issuers pulling out of activities that would have to be reported to avoid the need to disclose?  Perhaps.  It is impossible to know.  Some commentators point to the level of detail provided by reporting companies and their care to disclose even de minimis transactions as evidence that issuers are worried about the “name and shame” impact of the Act.  “The fact that companies are going to such lengths to distance themselves from potentially prohibited Iran-related activities indicates that the public disclosure of this in sensitive SEC filings is having the desired effect of making doing business in Iran toxic,” said Gary Emmanuel, a securities attorney at the law firm Sichenzia Ross Friedman Ference LLP.

However, even if the disclosure regime is having some impact it cannot be separated from larger political trends that drive company behavior.  Political relations with Iran have been the focus of media attention lately and that may also be contributing to company choices.  The impossibility of proving causal effect highlights another difficulty with tasking the SEC with disclosures concerning social and political concerns rather than matters that fall more naturally within the agency’s mandate.

Another, as yet undiscussed, problem with the ITRA and Section 219 (and a concern that is also relevant to the conflict minerals rule) is what happens when the political impetus for the disclosure requirement changes?  The US and other world powers are currently in talks with Iran that could lead to the lessening of sanctions.  If that does occur, what will happen to the disclosure of Iran related activity?  It certainly could still be reported but to what end?  When the SEC is tasked with drafting disclosure regulations that are concerned with matters outside their core mission (as is becoming increasingly common) unforeseen problems such as these are bound to continue to arise.


Amending Regulation D: General Solicitations, Empirical Evidence, and Investor Protection (Part 5) 

We are discussing proposed amendments to Regulation D.  The rule proposal is here.  The proposed changes include: a requirement to file a Form D prior to the use of a general solicitation under Rule 506(c) and a closing amendment for any offering relying on Rule 506; the imposition of a penalty for the failure to file the Form D in the form of a one year time out for offerings under the Rule; the inclusion of legends and other disclosure in solicitation materials; and, on a temporary basis, the obligation to file solicitation materials with the Commission.  The Release also proposes a number of changes to the content of Form D and describes a “work plan” that will be undertaken by the staff to determine the “effectiveness of Rule 506(c)”. 

The Release also invited comments on the definition of accredited investor.  The definition will likely be addressed in future rulemaking endeavors.  Currently, individuals can be come accredited base upon income or net worth.  The definition has been complicated by the fact that the standards for determining net worth and income are also used to determine investment limits in the context of crowdfunding.  

There have been no changes to the dollar amounts used to determine accredited investor status since the 1980s.  As a result, the amounts have been effectively reduced through inflation, significantly increasing the number of investors who meet the standard.  

The most problematic portion of the definition concerns net worth.  Investors can have a high net worth because of the ownership of illiquid assets (land but not the primary residence) or assets in retirement accounts.  To the extent having sufficient assets but little income, investors acquiring securities in private offerings under Rule 506 will need either to borrow or to invade illiquid accounts.   

Changes in the dollar threshold need to be considered.  In addition, however, the Commission should begin the process of excluding assets from the net worth calculation that do not provide sufficient indicia of sophistication or that should not be used in connection with private offerings under Regulation D.  Most noticeably, this ought to apply to assets in retirement accounts.  

Investors who are retired or close to retirement may qualify as accredited primarily or solely because of these assets.  Given the increased risk and accompanying illiquidity of offerings under Regulation D, restricted securities sold pursuant to these exemptions will generally not be an appropriate investment for many such individuals.  Moreover, to the extent cash poor, retirees seeking to invest may be encouraged to liquidate retirement assets, potentially replacing low risk investments with high risk securities.   

The accredited investor test is designed to use income and net worth as an objective substitute for sophistication.  Investors who meet the test primarily because of retirement assets do not have sufficient indicia of sophistication.  As a result, the asset should be removed from the calculation.  In addition, consideration should be given to the exclusions of funds recently withdrawn from retirement plans, much the way Rule 501 addresses equity from the primary residence.   

For more commentary on the rule proposal, see Data Collection, the SEC, and Regulation D: A Comment on Securities Act Release No. 9416 (July 10, 2013).

Page 1 ... 4 5 6 7 8 ... 37 Next 20 Entries »