This area does not yet contain any content.

Your donation keeps us advertisement free


SEC v. Capital Financial Partners LLC. - Complaint

In a complaint filed on April 1, 2015 (“Complaint”), the SEC charged Capital Financial Partners, Capital Financial Holdings, and Capital Financial Enterprises (collectively, “Capital”), William D. Allen, and Susan C. Daub with violations of §10(b) of the Exchange Act, Rule 10b-5 of the Exchange Act, §17(a) of the Securities Act, and unjust enrichment. The SEC asserted that Allen and Daug knowingly schemed and defrauded investors through a “Ponzi” style business operation involving the use of professional athletes. 

The Complaint made the following allegations: 

Allen and Daub, acting through one Florida and two Massachusetts companies represented that they made loans loans to professional athletes "who need[ed] money while they wait[ed] to get paid under their sports contracts (i.e., during the off-season)." Investors were told that they could participate in loans for a "specific athlete."  The website indicated that the loans received a stated interest rate within a range of 9%-18%. Capital retained origination fees in the amount of 3% of the original loan. 

In April and May of 2014, Allen and Daub successfully raised $4 million from investors desiring to participate in a $5.65 million loan to a National Hockey League player.  According to the Complaint:  "The purported $5.65 million loan to the NHL player was a sham. The player did not sign the $5.65 million promissory note or the loan agreement shown to prospective investors. Capital Financial did not make a $5.65 million loan to the player."

In August 2014, Allen and Daub secured investors for a $300,000 loan for a Major League Baseball athlete. Allen and Daub represented to investors that Capital had already made the loan to the player. They provided investors with a promissory note and a copy of the loan agreement. According to the Complaint:  "However, Capital Financial's bank records reflect no payments to this player on or before the date ofthe supposed loan. Bank records indicate that Capital Financial used the money obtained from this investor to meet monthly payment obligations to other investors and to fund one of Allen's personal business ventures."  

Over a three-year period from July 2012 to February 2015, Capital received $13.2 million in repayments from athletes and paid $20 million to investors. As the Complaint described:  "Lacking any other significant source in revenue, it is apparent that Capital Financial managed to pay nearly $7 million more to investors than it received from athletes only because Allen and Daub recycled a substantial portion ofthe approximately $31.7 million raised from investors. In other words, they used money from some investors to pay other investors, while at the same time funneling millions ofdollars ofinvestor money to themselves -the hallmarks of a Ponzi scheme."

Based on these allegations, the SEC is pursuing this action against Capital. The complaint seeks final relief in the form of a judgment providing a preliminary injunction and freezing assets of the defendants; a permanent injunction prohibiting the defendants from engaging, directly or indirectly, in conduct to be described hereafter in violation of §10(b) of the Exchange Act, Rule 10b-5, and §17 of the Securities Act; and disgorgement of Defendants ill-gotten gains with directions to pay civil penalties pursuant to §21(d)(3) of the Exchange Act and §20(d) of the Securities Act. 

On June 12, 2015 the SEC announced the U.S. Attorney’s office in Massachusetts had filed criminal charges against Allen and Daub.  

The litigation release is here.  Other primary materials for the post are available on the DU Corporate Governance Website.


Special Projects Segment: Rewards-Based Crowdfunding, Gluten-Free Forever Magazine

Shortly after her first quarterly issue of Gluten-Free Forever hit the shelves in grocery stores across the nation, I had a telephone interview with Erika Lenkert. We discussed Lenkert’s vision for the new business venture, some of the obstacles encountered while raising capital with rewards-based crowdfunding, and thoughts on raising capital in the future now that the prospect of equity crowdfunding for non-accredited investors has emerged. Recently, with her Spring issue printed, we had another discussion over email about the status of Lenkert’s small business venture.

Gluten-Free Forever Magazine (“GFF”) began as Lenkert’s small vision to merge a world-class food magazine with gluten-free living. As a free lance journalist and culinary world traveler, Lenkert joined forces with Maren Caruso to create a magazine dedicated to delicious food that happens to be gluten-free.

On March 31, 2014, Lenkert and Caruso launched the GFF Kickstarter Campaign to reach a capital raising goal of $90,000 in 30 days. Because rewards-based crowdfunding cannot offer those who donate equity in the project, it is common to offer rewards instead. GFF rewarded its donors deliciously. Some of these rewards included:

•    $1 Donation—A sweet thank you card;
•    $40 Donation—A 1 year digital subscription; or
•    $5,000 Donation—A 1 year print plus digital subscription, two 1-page ads in the first and second issues (content appropriate), and an ad-page rate lock of $2,500 for the first two years in print.
The GFF campaign outlined how the raised capital would be spent, pricing and distribution, its long-term plan, risks and challenges, and some frequently asked questions.  \

On April 30, 2014—its last day on Kickstarter—with 822 backers, GFF successfully raised $94,587. The Inaugural Edition of GFF launched on October 2014. The Winter Issue followed in January 2015. And the Spring Issue printed in April 2015.

Lenkert shared her experiences with crowdfunding for small business capital raising with The Race to the Bottom. Overall, Lenkert expressed gratitude for the crowdfunding process as it provided a means to achieve her dream. She cautioned, however, there are many drawbacks with rewards-based crowdfunding for small businesses, especially if the business model focuses on a special niche, such as a gluten-free recipe magazine.

A major setback for the GFF campaign was joining the Kickstarter platform with the belief that there would be a preexisting “crowd” to support it. As the campaign progressed, Lenkert realized most of her backers were directed to the campaign by word-of-mouth. Lenkert and Caruso rallied the support of family and friends to participate in the campaign. This form of marketing, Lenkert said, “became exhausting and nearly an around the clock effort for the weeks leading up to the deadline.” It impacted not only her ability to prepare for the inaugural issue, but also her presence at home with her daughter. She expressed that this unexpected difficulty in finding a crowd cost her countless hours as she tried to hit capital targets. In retrospect, Lenkert wished she had formulated a marketing and promotion strategy prior to launching the GFF campaign.

Lenkert encountered a minor setback related to the Kickstarter transaction fee. Lenkert shared that joining Kickstarter under the presumption that there will be a preexisting crowd and committing to the 10% platform fee (which is 10% of the total raised capital) was unfortunate because much of the effort driving the campaign came from Lenkert and Caruso’s personal supporters, not a preexisting crowd. To small business owners like them, $9,458.70 was a steep fee to pay to host the GFF campaign on Kickstarter with little benefit other than the credibility behind its name. But Lenkert appreciates the draw that this business model creates—an assurance that if the project does not meet its capital goal, the pledged money will be returned to the backers and the small business entrepreneurs will not be penalized or charged a fee for failing to meet the objective.  

Now, with three issues printed, Lenkert and Caruso excitingly look to the future. The initial capital raised through Kickstarter provided seed money for GFF’s first year (4 issues). When discussing additional capital raising efforts for GFF’s future, Lenkert said she would not likely crowdfund again because of the substantial time demand. Instead, she and Caruso would rather seek like-minded private investors to join their culinary and artistic entrepreneurial vision. Lenkert believes that private investors would lower overhead campaign costs and allow the essential GFF personnel to focus their efforts on the business, which is their primary objective at this point.

I asked Lenkert to share her top 5 recommendations for other small business owners who may be considering rewards-based crowdfunding. She provided the following recommendations to consider before launching a crowdfunding campaign: (1) have a marketing and promotion plan in place; (2) consult with legal counsel; (3) form the legal structure; (4) weigh the cost of the transaction fee and the amount of time you will spend developing a crowd; and (5) consider realistic objectives for your project to ensure a sustainable business model after the initial crowdfunding period.


SEC v. Payton and Durant III: Memorandum in Support of Defendants’ Motion to Dismiss

In SEC v. Durant, S.D.N.Y., 1:14-cv-04644, Brief Feb. 23, 2015, ECF No. 29, the defendants, Benjamin Durant III and Daryl M. Payton (the “Defendants”) submitted a memorandum to the court arguing the SEC’s complaint (“Complaint”) failed to satisfy the basic pleading requirements for an insider trading scheme based upon the misappropriation theory, in violation of Section 10(b) of the Securities Exchange Act of 1934, against remote tippees. The Defendants argued that the Complaint failed to allege the existence of a personal benefit to the tipper and the Defendants’ knowledge of that personal benefit.  They relied extensively on the Second Circuit’s opinion in US v. Newman [United States v. Newman, 773 F.3d 438 (2d Cir. 2014)].  

According to the SEC’s allegations in the Complaint (as described in the Defendant's Memorandum): A junior associate at Cravath, Swaine & Moore LLP (“Cravath”) in the firm’s mergers and acquisitions group learned material, non-public information about IBM’s acquisition of SPSS, Inc., including the anticipated per share purchase price and the identities of the parties to the transaction (the “Information”). In May 2009, the associate, seeking "moral support" on the assignment, disclosed the Information to Martin.

Martin allegedly misappropriated the Information, made trades on it, and disclosed some of the Information to his roommate and nonparty, Thomas Conradt, a registered broker-dealer who worked with the Defendants. Conradt allegedly passed on this information to Payton.  With respect to the receipt of the Information by Durant, the Defendants describe the SEC's allegations as "entirely contradictory".  On July 28, 2009, when IBM’s acquisition of SPSS was announced, Durant and Payton allegedly netted profits of $53,000 and $243,000, respectively.

To prove tippee liability, the SEC must prove: (1) the corporate insider had a fiduciary duty; (2) the corporate insider breached his fiduciary duty by disclosing confidential information to a tippee in exchange for a personal benefit; (3) the tippee knew of the tipper’s breach; and (4) the tippee used that information to trade or tip another for personal benefit. 

In their first argument for dismissal, the Defendants asserted that the SEC’s only possible alleged source of a personal benefit arose out of Conradt's friendship with Martin.  The Second Circuit, however, held in Newman that a personal benefit may not be proved based solely on the mere fact of friendship. Thus, the allegations in the Complaint were insufficient to establish personal benefit.   

Second, the Defendants argued the Complaint was devoid of any allegation that they knew Martin was receiving a benefit or that the allegations in the Complaint were too speculative. According to the Defendants, the Complaint alleged their knowledge in a conclusory fashion by asserting that when Conradt disclosed the Information to Defendants, he also told them that Martin, his roommate, had disclosed the Information to him. 

Third, the Defendants argue the Complaint failed to show they knew or had reason to know the Information was obtained and disclosed in breach of a fiduciary duty. Rule 10b-5 requires that to be found liable for insider trading, a defendant must inherently believe the information received was acquired in breach of a fiduciary duty. The Complaint only asserted that Conradt told the Defendants the source of the information was his roommate and friend. 

Finally, the Defendants contended that the Complaint failed to allege Durant was involved in a misappropriation scheme at all. The Complaint presented contradictory positions on a critical issue, the identity of the person who tipped Durant. The Complaint stated in paragraph 3 that Conradt tipped “several other representatives associated with the broker-dealer . . . including Defendants Payton and Durant,” but paragraph 63 contended that Conradt “learned that the information had also been communicated to Durant . . . .” If the Court accepts these allegations as true, it must assume that Conradt learned Durant was tipped, and also that Conradt tipped Durant. The Complaint simply alleged that Conradt was aware Durant knew the same information, but not how. 

For the reasons discussed above, the Defendants argued the SEC’s complaint failed to satisfy the elements of insider trading and tippee liability and their motion to dismiss should be granted. 

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


In re Merrill Lynch, Pierce, Fenner & Smith: Failure to Supervise Allegations Result in $2.5M Fine

In In re Merrill Lynch, Pierce, Fenner, & Smith, Mass. Sec. Div., Docket No. E-2014-0002 (March 23, 2015), the Massachusetts Securities Division (“Division”) entered into a Consent Order (“Order”) with Merrill Lynch arising out of an investigation into its compliance policies and procedures required under the Investment Advisers Act of 1940 (“the Act”). On March 22, 2015, Merrill Lynch submitted an Offer of Settlement (“Offer”) to the Division for the purpose of disposing the allegations set forth in the Offer. 

According to the consent order (in which the facts are neither admitted nor denied), Merrill Lynch in 2010 created an Optimal Practice Model Team (“OPM Team”) that focused on developing a framework to assist financial advisors in delivering more consistent customer service. This team would, among other things, create internal presentations to train financial advisors. Merrill Lynch’s policies and procedures required its compliance department to provide prior approval of internal-use materials. As a result, the presentations were to be reviewed by a separate compliance team and then approved by a registered principle. 

The OPM Team developed an OPM Tools Presentation (“OPM Presentation”) focusing on suitability obligations and fiduciary standards for financial advisors. In late 2012, the OPM Team presented the OPM Presentation two times in Boston without any Merrill Lynch compliance approval. 

According to Merrill Lynch’s records, the OPM Team did not submit any version of the OPM Presentation for review until February 4, 2013. The Internal-Use Compliance team at Merrill Lynch did not approve any version of the presentation until shortly thereafter, nearly a month after the first Boston OPM Presentation. Upon review, it was determined that a required disclosure slide was not included in the Boston OPM Presentation. 

The Order indicated that the version of the OPM Presentation submitted to the Compliance team for review included different content than that what had been used during the Boston OPM Presentation. First, the version submitted for review contained the title “Optimal Practice Model: Tools,” which was much broader than the version used in Boston (which was titled “OPM Tools Overview, Optimal Book Management Tool and Business Calculator.”). Second, the version submitted for review did not include all of the slides presented during the Boston OPM Presentation, slides that were not part of the Boston presentation, and slides with content different from the Boston Forum.” 

The Division alleged that Merrill Lynch, by failing to comply with its internal-use policies and procedures, failed to observe equitable principles of trade in the conduct of its business, resulting in a violation of Section 204(a)(2)(B) of the Act. 

The Division also alleged that based on the reasons described, Merrill Lynch failed to reasonably supervise its OPM Team in connection with the Boston Forum, constituting a violation of Mass. Gen. Laws ch. 110A §204(a)(2)(J). 

As a result, Merrill Lynch agreed to the following undertakings as part of the Order. First, Merrill Lynch agreed to permanently cease and desist from conduct in violation of the Act and Regulations in the Commonwealth of Massachusetts. Second, Merrill Lynch agreed to pay a $2,500,000 administrative fine. 

Also, Merrill Lynch’s Chief Compliance Officer was required to provide a report to the Division within 120 days of the Order. This report must (1) certify a review of policies and procedures has been conducted, and (2) identify any changes or enhancements to Merrill Lynch Wealth Management practices, policies, and procedures that have been, or will be made. 


The primary materials for this Consent Order can be found at the DU Corporate Governance Website


The Continuing Problem of the Lack of Impartiality with Respect to the Disclosure of Preliminary Voting Tallies (Part 2)

We are discussing the remarks made by Mike Garland, the Assistant Comptroller for Corporate Governance and Responsible Investment at New York City Office of the Comptroller, on his experience obtaining preliminary voting results during the prior proxy season.  His remarks have been webcast, can be found here, and the relevant remarks start at 2:17.  The quotes were taken from the audio so may not be precisely accurate.  

During the prior proxy season, his Office engaged in a number of exempt solicitations in support of shareholder proposals seeking proxy access.  In his remarks, he addressed his experience in obtaining preliminary voting results.  How important is this information?  Very.  See 2:45 (describing the information as "among the most important.  That’s what really helps to inform strategic decisions and resource allocations.").  How successful was he in obtaining this important information?  Not very.   

Requests for preliminary results were made at 18 companies (or, as he put it, “what we [actually] requested was their agreement to permit Broadridge to provide us with preliminary tallies”).  Of that number:  “Eight companies failed to acknowledge even our request which was sent by email.  Three companies had the courtesy to respond and declined the request.  Seven companies agreed in some cases fairly readily.” 

So 60% of the companies either ignored the request or said no.

With respect to the seven companies that agreed to allow Broadridge to provide the preliminary voting information, the actual results were no better.  As Garland stated:  

  • But not withstanding their willingness to execute the Broadridge confidentiality agreement, Broadridge refused to provide the tallies because we did not pay Broadridge to distribute our materials to shareowners.  At that point we realized we had that problem we stopped making additional requests from companies because it became a moot point.    

Some of the companies did provide the information directly but that left the companies in the position of acting as gatekeeper with respect bot to timing and content.  Id. (“But I will say that some of these companies that did agree ended up sending us the tallies which we appreciate but it not a substitute for receiving them from Broadridge without the company having the right to play the role of gatekeeper.”).  

Later in the Q&A period, Garland was asked (by me) about the self-help efforts whereby CII, Corporate Secretaries and others sought to iron out a three party confidentiality agreement governing the release of preliminary results to shareholders (the discussion is at 2:44 on the video).  The talks, however, had broken down.    

Garland indicated that he had been a participant in the discussion.  He stated that the “process is not a substitute for SEC action.  Were it to make more headway, which it has failed to do, it would  potentially be a stopgap incomplete solution but it will never provide I think an acceptable solution.”  Instead, the he did not “think his problem will be fixed absent action by the Commission.”  

Why?  First, there was the problem of Broadridge’s refusal to provide the data even when companies agreed to disclosure.   

  • The good faith efforts with CII and the society of corporate secretary's.  What that was moving toward and came close to was a regime whereby if the company agreed and both parties with Broadridge all collectively executed a confidentiality agreement that Broadridge would then provide the preliminary information directly to the shareholder.  And as I mentioned previously it turns out A. Broadridge won't do that unless you actually distribute your materials through Broadridge so companies can pay them to distribute materials and they get the benefit of the preliminary tallies rules as a courtesy.  There's no requirement as you know. 

Second, the approach, even if it worked, puts the company in control of the disclosure process.  They could always decline.  

  • The problem even if it worked better it assumes that the information is the company's.  It puts the company in the position of being a gatekeeper; some companies will agree; some won't.  I don't think it’s our position that the voting information, the preliminary voting information, belongs to the company.  I'm not a lawyer but my understanding is that's an unsettled legal question. 

So where does this leave things?  As the IAC recommendation requested, the Commission needs to step into this space and ensure that preliminary voting information is disclosed not in a manner that favors one side over the other in an exempt solicitation but on an impartial basis.


The Continuing Problem of the Lack of Impartiality with Respect to the Disclosure of Preliminary Voting Tallies (Part 1)

Most shares of large public companies are held in street name accounts.  As a result, when these owners vote, they do so not by proxy (these are executed by record owners) but by executing voting instructions.  See generally The Shareholder Communication Rules and the Securities and Exchange Commission: An Exercise in Regulatory Utility or Futility?

Voting instructions legally must be sent back to the broker where the owner has an account.  As a practical matter, instructions are returned to Broadridge.  Broadridge acts as an agent for brokers and others in connection with the distribution of proxy materials to beneficial owners and the collection and tallying of voting instructions.  To the extent that proxy materials are distributed on an impartial basis and voting instructions are collected on an impartial basis, the actions by the broker (and by extension Broadridge) are exempt from the proxy rules, including the antifraud provisions.  See Rule 14a-2(a)(1).  

The voting instructions are eventually transferred to a proxy card (one for each broker) and submitted to the relevant company.  When the proxy card arrives (10 to 15 days before the meeting), the company is made aware of the voting results.  Learning how the results are trending before that date, however, can be valuable information. The information can be particularly important where shareholders are soliciting votes for or against a particular proposal. 

At one time, shareholders routinely received information on preliminary voting results from Broadridge.  Until 2013, a shareholder engaging in an exempt solicitation (a solicitation that did not require a separate proxy statement or card) could go to Broadridge and get preliminary results on the particular proposal subject to the solicitation.  Thus, issuers and shareholders were both in a position to make strategic decisions on the basis of the information.  In cases where the vote was close, for example, both sides might want to allocate additional resources to their efforts.  

In 2013, however, Broadridge stopped providing preliminary voting results to shareholders in exempt solicitations.  The decision was made during a battle over a shareholder proposal that sought the separation of chair and CEO at JP Morgan Chase.  Since that date, therefore, companies, but not shareholders, have been guaranteed access to this strategically important information. 

In October 2014, the SEC’s Investor Advisory Committee (IAC) adopted a recommendation asking the Commission to take action “to ensure that ensure that the exemption in Rule 14a-2(a)(1) is conditioned upon the broker (and any intermediary designated by the broker) acting in an impartial and ministerial fashion throughout the proxy process, including the disclosure of preliminary voting information.”  

The Commission has not, however, acted on the recommendation. As a result, an entire proxy season has taken place without exempt solicitors having a guaranteed right to preliminary voting information. 

In July 2015, the IAC scheduled a panel discussion on shareholder rights.  Mike Garland, Assistant Comptroller for Corporate Governance and Responsible Investment at the New York City Office of the Comptroller, spoke on the panel.   He provided an overview of his experience obtaining preliminary voting information in the absence of any requirement that Broadridge provide the information.  We'll examine his remarks in the next post but suffice it to say that results are not pretty.    


The Management Friendly Nature of the Delaware Courts: Teamsters Union 25 Health Services & Insurance v. Orbitz (Part 6)

We are discussing Teamsters Union 25 Health Services & Insurance v. Orbitz.  

Plaintiffs sought to show demand excusal by alleging that the applicable standard of review was entire fairness since the shareholder alleged to have a controlling interest "stood on both sides" of the transaction. Although finding that the argument had "superficial appeal," the court concluded that the approach was "inconsistent with controlling authority in my opinion." 

"Controlling authority" to defeat this "superficial appeal" was Aronson and Beam, neither of which actually addressed the issue.  Moreover, given the common nature of claims for breach of duty of loyalty, it was telling that the court was unable to find any real "controlling authority" in the three decades worth of decisions issued in the aftermath of Aronson.  

Moreover, the court's analysis -- that the only basis for showing demand excusal was to allege reasonable doubt as to the impartiality of a majority of the board -- was actually inconsistent with the two prong analysis in Aronson.    

Aronson allowed for demand excusal whenever there was reasonable doubt about board independence. Aronson also allowed for demand excusal where the decision of the independent board was not "the product of a valid exercise of business judgment" that will no longer be the case. Shareholders unable to show a lack of independence are, however, unlikely to be able to show a lack of impartiality. Thus, independence will effectively defeat both prongs, eliminating the second prong of the test.      

There is nothing unusual about the Orbitz case.  It is a logical outgrowth of the direction that the Delaware courts have been taking for the last couple of decades.  While the court incorrectly interpreted a number of legal doctrines (including the analysis in Aronson), the analysis may correctly anticipate the willingness of the Delaware Supreme Court to alter existing standards in a more management friendly manner.   


The Management Friendly Nature of the Delaware Courts: Teamsters Union 25 Health Services & Insurance v. Orbitz (Part 5)

We are discussing Teamsters Union 25 Health Services & Insurance v. Orbitz.  

We turn to the standard of review used by the court.  Plaintiff argued that, because the contract at issue was with a controlling shareholder, the applicable standard of review was entire fairness.  As a result of the application of this standard, demand was to be excused.  The court, however, noted that the audit committee, rather than the full board, had approved the agreement.  As a result, "the relevant focus for determining the standard of review for the breach of fiduciary duty claim . . . is on the members of the Audit Committee").  

Under this approach, the independence of the membership of the relevant committee is the sole issue; the independence of the entire board is irrelevant.  Thus, a board could have a majority of directors lacking in independence but gain the benefit of the business judgment rule as long as the decision was assigned to a committee that did have a majority of independent directors.  This approach entirely ignores the interested influence, including the fact that the interested directors likely created the committee, decided on its jurisdiction and membership, and, with the exception of audit/compensation committees of listed companies, authorized funding.

Unlike the NYSE, Delaware law does not require the presence of a majority of independent directors. Nonetheless, Delaware corporations have traditionally had an incentive to do so.  For one thing, they typically obtained the benefit of the business judgment rule.  This decision, however, creates a framework for eliminating that incentive.  Boards now need only have a committee of independent directors to obtain that benefit.


The Management Friendly Nature of the Delaware Courts: Teamsters Union 25 Health Services & Insurance v. Orbitz (Part 4)

We are discussing Teamsters Union 25 Health Services & Insurance v. Orbitz.  For purposes of demand excusal and the application of the business judgment rule, the court only needed to find that five of the nine directors were independent.  Since the shareholder only challenged the independence of five directors, the court only needed to find that the allegations were insufficient to establish reasonable doubt about the independence of one of the five directors.

The court also considered a claim by the plaintiff that the board had breached its fiduciary duties by incorrectly determining that three directors were independent.  The shareholder brought the a direct claim for false disclosure and a derivative claim for breach of fiduciary duty because the directors "violate[d] regulations applicable to the company."  The court, however, did not resolve the direct/derivative issue but instead held that the shareholder had "no standing" to raise a violation of a rule of the stock exchange.  

The court first found that the fiduciary duty claim was the "functional equivalent of a claim to enforce the NYSE Rules."  Having transformed a fiduciary duty claim into a claim for breach of the rules of the exchange, the court largely relied on federal case law finding that a private right of action did not exist for violations of the rules of the exchange.  Id. ("I find this federal authority to be persuasive, and I likewise conclude that Plaintiff has no standing to prosecute a violation of the NYSE Rules.").  

The court conceded that, under the duty of loyalty, directors could not violate positive law.  Moreover, the court apparently conceded that the rules of the exchange constituted "positive law."  Nonetheless, there could be no claim because "the Complaint does not allege that the NYSE, as a self-regulatory organization, has indicated that Orbitz violated the NYSE Rules and Plaintiff has no standing to assert or prove that Orbitz violated the NYSE Rules."  

The reasoning is unfortunate and impossible to sustain.  First, the plaintiff was not bringing a cause of action for violation of the NYSE rule.  The complaint alleged that the board violated its fiduciary obligations.  Equating the two was inappropriate.  They have different elements.  Merely establishing a violation of an exchange rule does not automatically mean that the board violated its fiduciary obligations.  

Second, the holding was based on the absence of a private right of action.  Plenty of "positive" requirements (particularly under the securities laws) do not give rise to a private right of action.  In addition to the rules of the exchanges (the idea that there is never a private right of action, by the way, is over broad, particularly given the use of congressionally mandated listing standards since SOX), numerous sections of the securities laws do not give rise to a private right of action (Section 17 of the 1933 Act) for example.  Apparently, boards apparently do not have a fiduciary obligation to adhere to these provisions since shareholders have no private right of action for enforcement.

Third, the court left open the possibility that shareholders could bring a claim for breach of an NYSE rule where the exchange "indicated" that a violation had occurred.  In addition to providing shareholders with an incentive to bring any claim to the attention of the relevant regulators, the holding effectively found that fiduciary duties depended not on the conduct at the time of the alleged violation but on the subsequent characterization following the behavior.  This is also inconsistent with the law with respect to fiduciary duties. Characterizations of behavior and subsequent consequences are generally viewed as irrelevant to an analysis of breach of fiduciary duty.  

Shareholders are protected by the broad nature of fiduciary obligations.  These duties apply to all actions by directors and ensure that the company is always managed in the best interests of shareholders.  It is black letter law that as part of that a board's fiduciary duties, they must follow legal requirements.  See In re Massey Energy, 2011 WL 2176479 (Del. Ch. May 31, 2011) ("For fiduciaries of Delaware corporations, there is no room to flout the law governing the corporation's affairs. If the fiduciaries of a Delaware corporation do not like the applicable law, they can lobby to get it changed. But until it is changed, they must act in good faith to ensure that the corporation tries to comply with its legal duties.").

Apparently not any longer, at least where there is no private right of action.  


The Management Friendly Nature of the Delaware Courts: Teamsters Union 25 Health Services & Insurance v. Orbitz (Part 3)

We are discussing Teamsters Union 25 Health Services & Insurance v. Orbitz.  For purposes of demand excusal and the application of the business judgment rule, the court only needed to find that five of the nine directors were independent.  Since the shareholder only challenged the independence of five directors, the court only needed to find that the allegations were insufficient to establish reasonable doubt about the independence of one of the five directors.  

The court found that shareholders had not raised reasonable doubts about the independence of a director who had worked for the allegedly controlling shareholder for 16 years and had been on the board of Orbitz less than three years since the employment relationship had ended.  The analysis had to covercome one additional uncomforatable fact:  The Orbitz proxy statement had concluded that the director was not independent under the rules of the NYSE.

In a Looking Glass sort of way, the company's own characterization of the director caused the court little concern.  The rules of the NYSE were not important.  Id. ("a board’s determination of director independence under the NYSE Rules is qualitatively different from, and thus does not operate as a surrogate for, this Court’s analysis of independence under Delaware law for demand futility purposes."). As a result, they were entitled to "little weight."  Id. ('Given the peculiarities of the NYSE Rules, the fact that [the director] was not designated as “independent” under the NYSE Rules in Orbitz’s April 2013 proxy statement carries little weight.").  

The interesting thing here is that in fact in past cases, the Delaware courts have taken an almost opposite approach.  As the Chancery Court concluded in MFW

  • MFW was a New York Stock Exchange-listed company. Although the fact that directors qualify as independent under the NYSE rules does not mean that they are necessarily independent under our law in particular circumstances, the NYSE rules governing director independence were influenced by experience in Delaware and other states and were the subject of intensive study by expert parties. They cover many of the key factors that tend to bear on independence, including whether things like consulting fees rise to a level where they compromise a director's independence, and they are a useful source for this court to consider when assessing an argument that a director lacks independence. Here, as will be seen, the plaintiffs fail to argue that any of the members of the special committee did not meet the specific, detailed independence requirements of the NYSE. 

In re MFW Shareholders Litigation, 67 A. 3d 496 (Del. Ch. 2013), aff'd, 88 A.3d 635 (2014).  Or as the Chancery court concluded in In re JP Morgan:   

  • the NYSE rules governing director independence focus on this subject, holding that employment of a child as an executive officer of the corporation may disqualify an outside director from serving as a disinterested member of the board. Delaware courts also recognize that familial ties to management can disqualify one from functioning disinterestedly. In this case, however, Bossidy's son is not an executive officer of JPMC, and the complaint does not allege that Bossidy and his son live in the same household. Under NYSE Corporate Governance rules, Bossidy was found to meet the criteria for certification as an outside, independent director.  

In re JP Morgan Chase Shareholder Litigation, 906 A.2d 808 (Del. Ch. 2005).  So apparently the rules of the NYSE carry little weight except when they do.  Moreover, the court in Orbitz never really explained why a prophylactic rule that disqualified directors because of employment relationships within the prior three years ought not to have applied in these circumstances.  Id. ("the factual allegations concerning Esterow’s former relationship with Travelport are insufficient in my view to cast reasonable doubt on his presumed independence under Delaware law.").  


The Management Friendly Nature of the Delaware Courts: Teamsters Union 25 Health Services & Insurance v. Orbitz (Part 2)

We are discussing Teamsters Union 25 Health Services & Insurance v. Orbitz.  For purposes of demand excusal and the application of the business judgment rule, the court only needed to find that five of the nine directors were independent.  Since the shareholder only challenged the independence of five directors, the court only needed to find that the allegations were insufficient to establish reasonable doubt about the indpendence of one of the five directors. 

The shareholder argued that a director was not independent because he had been an employee of Travelport (and its parent) for sixteen years, a relationship that had ended "almost three years before this action was filed in April 2014."  The court found that the mere fact that an "alleged controlling shareholder 'played some role in the nomination process should not, without additional evidence, automatically foreclose a director's independence."  

There are a few things to note about the court's approach.  First, lawsuit may have been filed in April but the agreement was actually approved by the audit committee in January.  Having become a member of the board in August 2011, the director would not have been on the board for "almost three years."  Second, the approach is inconsistent with the law in many other countries.  See UK Corporate Governance Code (excluding from independent those directors "represent[ing] a significant shareholder").   

Finally, the quote merely stated that election by controlling shareholders alone was not enough to "automatically" deprive a director of his or her independence.  Yet in this case there were two factors:  Election by the allegedly controlling shareholder and a sixteen year employment relationship with the controlling shareholder.  Nonetheless, those two combined were not enough to create reasonable doubt about the director's independence.  

So you only need to have as independent is a bare majority of directors to obtain demand excusal and the presumption of the business judgment rule.  Moreover, with respect to that bare majority, they can all be designated by a controlling shareholder and have been employees of the controlling shareholders within the prior three years and still be presumed to be independent.  That board, according to the Delaware courts, would be entitled to the presumption of the business judgment rule, even when dealing with the controlling shareholder. 

So says the Delaware courts.


The Management Friendly Nature of the Delaware Courts: Teamsters Union 25 Health Services & Insurance v. Orbitz (Part 1)

Sometimes the Delaware courts issue decisions that are nothing more than a straight forward application of state law, breaking no new ground.  In these moments of clarity, they often demonstrate the degree to which Delaware law favors management at the expense of shareholders.  They demonstrate why, as the decades progress. more and more areas of state corporate law will be preempted.

In Teamsters Union 25 Health Services & Insurance v. Orbitz, the board of Orbitz negotiated a new agreement with Travelport Limited, a large, arguably controlling, shareholder. Shareholders filed a derivative suit alleging among other things that directors of Orbitz violated their fiduciary duties by approving the agreement.  The case, as many do in Delaware, turned on whether demand was excused.   

The court had to weigh the independence of the board, both for purposes of demand excusal and to determine the standard of review.  Shareholders alleged that five of the nine directors were not independent.  The court noted that for demand excusal and application of the business judgment rule, it was enough that there be a majority of independent directors.  As a result, the court did not examine the allegations with respect to all five directors, but did so with respect to only one.  That four other directors might not be independent was irrelevant to the court's analysis.  

Step back and examine what this means.  Boards can have a bare majority of independent directors and still get the benefit of the business judgment rule.  The business judgment rule, as we have often noted, is an over broad presumption designed to protect risk taking.  Directors not subject to a conflict of interest know that they will get the presumption and almost never be liable.  They can take risks without meaningful fear of liability.    

But the logic of the over broad protection breaks down in cases involving the duty of loyalty. The business judgment rule protects risk taking; it is not intended to protect decisions motivated by unfairness or favoritism. In those instances, therefore, the law has traditionally imposed on the board the burden of establishing fairness.  

Somewhere along the way (the "way" is explained in The Irrelevance of State Corporate Law in the Governance of Public Companies). the courts in Delaware extended the protections of the business judgment rule to boards that contained a sizeable number of interested directors, so long as a majority of independent directors remained.  It was as if the interested influence did not exist or have any capacity to influence the decisionmaking.  Interested directors could participate in the discussion and even vote.  The only thing that mattered was the number of independent directors.  

Pretending that the interested influence didn't exist was bad enough.  But with interested directors often members of management or under the control of management, these directors had the potential to significantly influence any decision.  Nonetheless, these boards were treated as if the interested influence did not exist and the board deserved the protections of the business judgment rule.     

So back to Orbitz.  As long as five of the nine directors were, based upon the allegations, independent, everything that followed was as if the entire board was independent.  The court only needed to reach the number five.  That there was the possibility that four of the nine directors were not independent had absolutely no relevance to the analysis that followed.   


CEOs and Quarterbacks: The Mistaken Analogy

The WSJ recently carried a guest editorial titled "Misquided Political Attacks on CEO Pay."  The subtitle contended that the "best analogy" for CEO Comp is pro-quarterbacks. Why? "Not all become stars, but all are well paid in the hopes they will."  The editorial actually had little to say about quarterbacks (one reference to Russell Wilson who "will soon receive a package reportedly worth $20 million or more", a pittance compared to the highest paid CEOs), suggesting that the title was an invention of the editors.

In fact, the editorial was little more than a call to align CEO pay with performance, something that shareholders have long sought.  Id.  ("If chief executives were paid mostly in company stock, and comparatively little in annual salary, then the interests of the CEO, the shareholder and the worker will be much better aligned.").  

But the quarterback analogy still warrants a comment.  Quarterbacks negotiate for their salary against owners who have every incentive to pay the lowest amount possible.  Moreover, alternatives exist, something that likely keeps downward pressure on compensation.  Thus, the amounts are a product of third party negotiations.

CEOs, however, do not negotiate with the owners. They negotiate with a board consisting of directors who they have often helped select. See The Demythification of the Board of Directors.  The final dollar amount awarded in compensation is not, therefore, invariably the product of third party negotiations.  What difference does it make? Quarterbacks are subject to the market and get what they deserve. CEOs are not.    


The SEC's Investor Advisory Committee and the Recommendation on Background Searches of Financial Professionals

The SEC's Investor Advisory Committee met on Thursday, July 16 and, among other things, adopted a resolution titled "Empowering Elders and Other Investors:  Background Checks in the Financial Markets."  The recommendation is here

The Recommendation seeks to encourage the SEC to improve the ability of elders and other investors to obtain the necessary background information on anyone selling a financial product.  Already, the SEC is involved in the oversight of IAPD (the data base for investment advisers) and BrokerCheck (the database for brokers).  These data bases, however, do not include other types of financial professional (insurance agents, CFTC brokers, mortgage brokers, etc) and do not include persons who were sanctioned by the SEC or the states for securities violations but were not members of FINRA or registered as investment advisers.

The recommendation contains three components:

  • develop a disciplinary database for violations of the securities laws that will allow elders and other investors to easily conduct searches of any person or firm sanctioned for these violations;
  • take steps to reduce the complexity of background searches by taking steps to simplify the search process, including steps to ensure comparable quality between BrokerCheck and IAPD and the development of an appropriately named site that will permit elders and other investors, through a single search, to access information in all databases supervised in whole or in part by the SEC;
  • seek to obtain the agreement from other federal regulators, self-regulatory organizations, and state regulators for the development of a single site that will permit a search of all relevant databases that provide background information on financial market professionals.

As one member of the IAC noted, we have the technology to take pictures of Pluto; we should have the technology to create a one stop shop for obtaining the necessary background information on persons selling financial products. 


District Court Denies Zynga’s Motion to Dismiss Class Action Securities Complaint

In In re Zynga Securities Litigation, No. C 12-04007 JSW, 2015 BL 83862, (N.D. Cal. Mar. 25, 2015), the United States District Court for the Northern District of California issued an order denying the motion of Zynga, Inc. (“Zynga”), Mark Pincus, David M. Wehner, and John Schappert (“Defendants”) to dismiss lead plaintiff Mark H. DeStefano’s (“Plaintiff”) first amended consolidated complaint (“Complaint”).

Plaintiff alleged Zynga violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (claims under the Securities Act of 1933 were filed but abandoned). Relying on a number of confidential witnesses, the Complaint alleged that Zynga misled investors as to the growth in bookings, the strength of the new game pipeline, and changes to Facebook that would negatively affect bookings.

Zynga sought dismissal, arguing that Plaintiff did not plead: (1) with particularity that the statements were false or misleading; (2) facts demonstrating a strong inference of scienter; and (3) loss causation.

First, with respect to allegations that Zynga represented its bookings to be strong even though bookings were in fact decreasing, Defendants argued Plaintiff failed to plead facts with the requisite particularity to show the falsity of the statements. The court determined the inflated bookings allegations were based on the “sufficient personal knowledge” of the confidential witnesses, and found them sufficient.

Second, Plaintiff alleged Zynga represented its new game pipeline to be “strong” and “robust” and “very healthy,” even though long delays were occurring. The court found the alleged representations regarding the new game pipeline constituted “business puffery,” and, therefore, those allegations were inactionable.

Third, Plaintiff alleged Zynga did not disclose information it possessed about a specific pending change to Facebook that would adversely impact the company. Zynga had stated general warnings that changes to Facebook could affect the business. But a confidential witness alleged Zynga knew of a specific change to Facebook and failed to disclose that information, and the court found those allegations to be sufficient.

Finally, Plaintiff alleged Zynga issued incorrect projections for the year 2012. The court found that the projections for 2012 could be actionable to the extent premised upon the alleged misrepresentations concerning bookings and the change to the Facebook platform. Moreover, the allegations were sufficient to show that the Defendants were “aware of undisclosed facts tending seriously to undermine” the accuracy of their financial guidance.

With respect to the need for a strong inference of scienter, the court noted that a number of confidential witnesses had declared officers of Zynga “were aware of the bookings numbers on a consistent and daily basis.” Additionally, a confidential witness declared Zynga was similarly well aware of pending changes to Facebook. The court found Plaintiff’s complaint contained enough particularity to show a strong inference of scienter.

To establish loss causation, the allegations had to be sufficient to show that 1) the plaintiff paid an artificially inflated price for the company’s stock; and 2) the stock price fell after the truth became known. The court noted that when Zynga’s actual results and guidance were announced, the company’s stock price dropped significantly. The court also noted its findings that the bookings and Facebook change representations might be actionable misrepresentations. The court found the Plaintiff sufficiently pleaded facts supporting loss causation.

Accordingly, the court denied Zynga’s motion to dismiss the complaint.

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


A Papal Encyclical, Fossil Fuels, and an Economic Vocabulary

The Pope has received considerable attention for his encyclical on climate change (more accurately the Encylical On Care for Our Common Home).  The Encyclical specifically mentioned problems associated with the use of fossel fuels.  Id. ("The problem is aggravated by a model of development based on the intensive use of fossil fuels, which is at the heart of the worldwide energy system.").  

The Encyclical calls on the reduced reliance on these sources of fuel.  See Id. ("We know that technology based on the use of highly polluting fossil fuels -- especially coal, but also oil and, to a lesser degree, gas -- needs to be progressively replaced without delay. Until greater progress is made in developing widely accessible sources of renewable energy, it is legitimate to choose the less harmful alternative or to find short-term solutions.")

The Encyclical has been described as providing "a moral vocabulary for talking about climate change".  The question is whether it also becomes an economic vocabulary and affects business practices.  The Encyclical was certainly noticed by the socially responsible investment community.  The Encyclical also, however, provides an additional basis for pressuring investment funds to divest from companies engaging in practices criticized by the Pope.   

Whether the moral vocabulary will translate into economic practices will take time to determine.  Endowments held by Catholic universities and organizations are one place to look for early signs.  

In early June, Georgetown University, the oldest Jesuit University in the US, passed a resolution to divest from “companies whose principal business is mining coal for use in energy production.”  The resolution was adopted before the publication of the Encyclical but used a similar vocabulary.  See Georgetown University Resolution ("As a Catholic and Jesuit University, Georgetown has a responsibility to lead on issues of justice and the common good such as environmental protection and sustainability. Climate change is real and poses a serious threat.").    

An article in HuffPo described other Catholic Universities as in "no rush" to divest from fossil fuels.  But the Encyclical is only a few weeks old.  So the jury is and will remain out for some time on the economic impact of the Encyclical.  Nonetheless, one suspects that the terms of the debate, both morally and economically, will undergo revision.     


Judge Rakoff Strikes Back: US v. Salman (Part 2)

We are discussing Judge Rakoff's opinion in US v. Salman, a case where, sitting in the 9th Circuit by designation, he was able to directly disagree with a decision in the Second Circuit, the circuit that otherwise oversees his decisions as a district court judge.

In Newman, the Second Circuit interpreted Dirks, a seminal insider trading case, to require more than mere friendship to establish the requisite breach of duty.  Instead, there had to be "a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”  In short, friendship wasn't enough; there had to be some kind of tangible benefit to the friend or family member.

The SEC and the US Attorneys Office objected to the reasoning and sought en banc rehearing.  The en banc court, however, declined to take the case.  As a result, it represents the law of the Second Circuit and is binding on all of the trial judges, including Judge Rakoff.

In US v. Salman, however, the 9th Circuit panel (which included Judge Rakoff, sitting by designation), had to consider the issue of benefit in the context of friendship.  Salman involved an alleged tip by one brother to another.  For insider trading liability to apply to a tippee, there had to be a breach of fiduciary duty by the tipper/insider.  The panel found that it was enough to show that the tipper and tippee were brothers and had a close relationship.  No tangible benefit as a result of the tip was required.  

Defendant nonetheless raised the anlysis in Newman and argued that "evidence of a friendship or familial relationship between tipper and tippee, standing alone, is insufficient to demonstrate that the tipper received a benefit" and instead required some evidence of tangible  benefit.  

In analyzing Newman, Judge Rakoff started by praising the Second Circuit's expertise in insider trading cases. 

  • Of course, Newman is not binding on us, and our own reading of Dirks is guided by the clearly applicable language italicized above. But we would not lightly ignore the most recent ruling of our sister circuit in an area of law that it has frequently encountered.

Despite this expertise, however, the 9th Circuit knew better.   

  • To the extent Newman can be read to go so far, we decline to follow it. Doing so would require us to depart from the clear holding of Dirks that the element of breach of fiduciary duty is met where an “insider makes a gift of confidential information to a trading relative or friend.”

The alternative interpretation in Newman threatened to create a massive gap in the application of the prohibition on insider trading. 

  • If [Defendant's] theory were accepted and this evidence found to be insufficient, then a corporate insider or other person in possession of confidential and proprietary information would be free to disclose that information to her relatives, and they would be free to trade on it, provided only that she asked for no tangible compensation in return. Proof that the insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading.

The 9th Circuit (ala Judge Rakoff) have now directly contradicted the reasoning in Newman.  As a result, the Commission has greater latitude to decline to follow Newman in other circuits.  The decision also potentially creates a framework for overturning Newman.  

With a split in the circuits, the likelihood of a successful cert petition to the US Supreme Court has increased. To the extent that other circuits agree with Salman, and the 2nd Circuit becomes isolated in its reasoning, the Court may be willing to take the issue en banc and reverse Newman (it is after all inconsistent with Dirks).  In any event, the 2nd Circuit's recognized expertise in insider trading cases has at least temporarily been tarnished.  Judge Rakoff, therefore, set in motion a possible reversal of Newman and a challenge to the Second Circuit's reputation, something that would have been largely impossible as a district court judge in the Second Circuit.  


Judge Rakoff Strikes Back: US v. Salman (Part 1)

Judge Rakoff is a high profile federal district court judge in the Souther District of New York.  He has had a habit of overturning the status quo in securities cases, particularly those brought by the SEC.  Back in 2009, he rejected a high profile settlement between the SEC and Bank of America.  

A few years later, he did the same in connection with a settlement involving Citigroup.  In that instance, he essentially rejected the settlement because of the absence of admissions. His opinion is here. The decision set off a serious debate about the need for admissions when the SEC settled cases and likely contributed to a shift in policy in that regard at the SEC. 

But with respect to the decision itself, the Second Circuit ultimately issued a fairly sharp rebuke to Judge Rakoff, vacating his order and remanding the case.  See SEC v. Citigroup Global Markets, Inc., 752 F.3d 285 (2nd Cir. 2014).  Judge Rakoff presumably disagreed with the decision but in the federal courts, district court judges must follow the mandates of the appellate court.  He was stuck with the reasoning.

Yet despite this clear hierarchy, Judge Rakoff has found another way to disagree with the reasoning of the Second Circuit and this time there is no opportunity for that circuit court to reverse his analysis.  In US v. Salman, Judge Rakoff sat by designation in the 9th Circuit.  District court judges are allowed to sit at the appellate level by designation (essentially permission of the circuit court).  

The circuit courts benefit because they obtain an extra judge to help with the caseload.  They also can promote other, more intangible, benefits.  Some circuits have a practice of encouraging all district court judges within their boundaries to sit at the appellate court.  This presumably builds collegiality and provides insight into the types of issues of particular concern in appeals.  

Circuit courts also routinely accept appellate judges from other circuits, particularly senior judges who can largely control their schedule.  Retired Supreme Court justices may also sit by designation.  Indeed, Justice Souter, sitting by designation, recently wrote an opinion in a securities case.  See US v. Reda, 787 F.3d 625 (1st Cir. 2015).   

The situation with Judge Rakoff is a bit more unusual.  He is not a senior judge and he does not decide cases in the 9th Circuit.  Nonetheless, the 9th Circuit allowed him to set by designation.  Coincidentally, one of the cases heard by his panel, US v. Salman, involved an issue recently addressed by the Second Circuit in US v. Newman.  We will discuss his approach in the next post. 


Clawbacks, Fiduciary Duties, and Block-Tagging (Part 5)

The proposed rule on clawbacks had some interesting statistical data.  

Relying on a study by Audit Analytics, 2013 Financial Restatements: A Thirteen Year Comparison (2014), the release noted that "during 2012 and 2013, U.S. issuers who are not accelerated filers accounted for approximately 55 percent of total U.S. issuer restatements." Non-accelerated filers (as defined in Rule 12b-2) are small companies with a market value of less than $75 million.  These were the same companies that were exempted from the attestation requirement for internal controls that appeared in Section 404(b) of SOX.  See Exchange Act Release No. 62914 (Sept. 15, 2010).  

One suspects that had attestation been required, the number of restatements would have been higher.  


Clawbacks, Fiduciary Duties, and Block-Tagging (Part 4)

As we have previously noted on this Blog, XBRL and data tagging was, for awhile, at the forefront of SEC consideration then, after 2009, mostly disappeared.  That, however, changed.  The SEC's Investor Advisory Committee recommended increased using of tagging.  A number of commissioners have actively supported an increased use of structured data.  Few rules or proposals go forward without some evidence that tagging was at least considered.  

This increased focus on tagging could be seen in the clawback rule proposal (Rule 10D-1).  The provision would require certain specified disclosure in the proxy statement.  Specifically, the proxy statement would need to include, whenever there has been a triggering restatement, the amount of excess incentive based compensation, the amount still outstanding, and the identification of persons where the company decided not to persue the compensation, including the dollar amount of their excess incentive-based compensation.  

The proposal would require that the information be block-text tagged using XBRL.  Block-text tagging involves the tagging of narrative (in a block) rather than a specific financial term.  The proposal is significant for two reasons.  First, the SEC currently requires block text tagging in very narrow circumstances, limited mostly to footnotes in the financial statements  (although in some cases certain specific information within the footnote also must be tagged) and swap data repository financial resports.  See Exchange Act Release No. 74246 (Feb. 11, 2015) ("The Commission believes that block-text tags of complete footnotes and schedules in an SDR's financial reports will provide sufficient data structure for the Commission to assess and analyze effectively the SDR's financial and operational condition. Thus, the Commission believes that it is not necessary to impose additional costs on SDRs to provide detailed tagged footnotes and schedules in SDRs' financial reports.").  Second, the SEC currently does not require tagging of any kind in the proxy statement (although has proposed the tagging of the data in the proposed "pay versus performance" rule). 

The clawback proposal would, therefore, require block tagging of some of the narrative in the proxy statement. The pay versus performance proposal also would require some block tagging but in a much more limited fashion.  See Exchange Act Release No. 74835 (April 29, 2015) ("The proposal would require registrants to tag separately the values disclosed in the required table, and to separately block-text tag the disclosure of the relationship among the measures, the footnote disclosure of deductions and additions used to determine executive compensation actually paid, and the footnote disclosure regarding vesting date valuation assumptions.").  

The proposal, therefore, opens the door to block tagging of text in the body of an SEC filing, something that can be applied in other areas such as the MD&A.  See Exchange Act Release No. 59324 (Jan. 30, 2009) (noting commentator that supported "the application of interactive data format to MD&A because of a belief that interactive data format for MD&A disclosures would be more useful to investors than detailed tagging of the footnotes to the financial statements" and "recommended block tagging each section of the MD&A, with some level of detailed tagging for the numbers and tables.").   

Block text tagging would allow investors to use tools to extract this information in a cost effective manner, making the clawback process more transparent and facilitating comparisons among companies.  Proxy statements, in their current format, are largely unreadable.  See Remarks by Chair Schapiro, July 1, 2009 (" I have heard from both investors and companies a shared concern that our proxy statements are in danger of becoming unreadable, because there is so much information packed into them.").  Particularly for small investors, anything that allows information to be extracted and presented in a more accessible and informative manner will be an improvement and potentially increase the likelihood that these investors will return their proxy.

Commissioner Stein, in her public remarks, emphasized the importance of this step. 

  • In line with the Commission’s recent proposed rule on Pay Versus Performance, this proposal provides that disclosures will be tagged in eXtensible Business Reporting Language, or XBRL. As I have noted before, tagging increases comparability across companies. It also improves investors’ and other market participants’ ability to search for the information they care about.  I am pleased to see that we are continuing to include tagging in our proposed rules and are recognizing the importance of structured data going forward. 

Likewise, Commissioner Aguilar noted the proposed use of XBRL.  See Remarks by Commissioner Aguilar ("In addition, the required disclosures under these proposed rules would have to be provided in interactive data format using XBRL data tagging, making it easier for the SEC staff and investors to review.").  

Commissioner Piwowar, in his dissent, raised issues with the use of XBRL in the proxy statement.  As he stated: 

  • today’s proposal requires the disclosures to be coded and tagged in XBRL format as a separate exhibit.  This proposal, like pay versus performance, seeks to extend interactive data for proxy statements in a piece-meal fashion.  Would it be better to have a more comprehensive approach to providing interactive data contained in the proxy statement, as well as the non-financial section of the annual report on Form 10-K, rather than adding individual items in an ad hoc manner? 

Tagging the entire proxy statement would be beneficial.  Unfortunately, there is little likelihood such a possibility will surface anytime soon.  The Division of Corporation Finance is working on a disclosure effectiveness project but has focused on the periodic reports, with proxy disclosure relegated to a "later phase."   

Page 1 ... 6 7 8 9 10 ... 34 Next 20 Entries »