Social Media, Public Disclosure and Netflix

Under the federal securities laws, public disclosure is a defense to a number of possible violations.  One definition of insider trading, for example, is the purchase or sale of securities on the basis of non-public information.  To the extent the information used to make the trades was public, there is no violation. 

Similarly, under Regulation FD, companies are not allowed to selectively disclose material non-public information to investors or analysts (among others).  To the extent that the information is distributed to these persons, it must also be disclosed to the public.  As the adopting release noted: 

The timing of the required public disclosure depends on whether the selective disclosure was intentional or non-intentional; for an intentional selective disclosure, the issuer must make public disclosure simultaneously; for a non-intentional disclosure, the issuer must make public disclosure promptly.

Exchange Act Release No. 43154 (Aug. 21, 2000). 

All of this begs the question as to what constitutes public disclosure.  The issue has come up because of reports that the SEC is looking into efforts by Netflix to disclose information over social media, particularly Facebook.  According to the WSJ, the SEC warned Netflix about disclosure over Facebook that Netflix "exceeded 1 billion hours of video streaming in a month for the first time."  

Using Facebook to reply, the CEO of Facebook equated disclosure over Facebook with disclosure to the public. 

• He said further disclosure at the time wasn't necessary because he has more than 200,000 subscribers to his Facebook page, which makes it a "very public" forum. Netflix had also disclosed on its blog in June that it was nearing the 1 billion streaming hours milestone, he said. Mr. Hastings, who is also on the board of Facebook, added that, at any rate, such information isn't a "material" event to investors.

The interaction, therefore, raises the question as to whether disclosure over social media constitutes public disclosure under the federal securities laws.  The answer is a decided "maybe." 

The SEC discussed this issue in the adopting release for Regulation FD.  The Release noted that public disclosure could occur through "press releases distributed through a widely circulated news or wire service, or announcements made through press conferences or conference calls that interested members of the public may attend or listen to either in person, by telephonic transmission, or by other electronic transmission."  Although social media was not in existence at the time of the release, the same rational would apply.

But it was not enough to simply post the information or diclose it in a conference call open to the public.  As the SEC noted, the "public must be given adequate notice of the conference or call and the means for accessing it."  The Commission, however, recognized that sometimes the public would be aware that important information was revealed through a web site.  See Id.  ("As technology evolves and as more investors have access to and use the Internet, however, we believe that some issuers, whose websites are widely followed by the investment community, could use such a method."). 

In 2000, when the release was issued, use of the Internet was uneven.  Companies often did not have web sites.  Move forward more than a decade and things have changed.  Most if not all public companies have web sites and most regularly post press releases, SEC filings, and other important information.  Today, disclosure over the Internet for most public companies likely meets the defintion of public disclosure.

Social media is not in the same position.  At least right now it does not appear to be a common avenue for the exclusive distribution of material nonpublic information.  Thus, it is not enough to contend that the information is accessible to large swathes of the public (as it surely is).  The issue is whether the information is regularly accessed by the investment community.

Eventually, social media will be a regular method of disseminating material nonpublic information.  In the short term, companies can enhance this possibility by giving notice of impending announcements so that the public (and the investment community) will know to access the source.  Moreover, as information is regularly distributed in this fashion, analysts and other members of the investment community will regularly access the source, making notice unnecessary. 

But for now, in this transitional period, companies are better off using social media as an additional rather than exclusive source of public disclosure. 

Rule 506 and Eliminating the Ban on General Solicitations: A 2-1-2 Decision

The Commission by a 4-1 vote recently proposed to lift the ban on general solicitations in Rule 506 of Regulation D.  The proposal came as a result of Section 201 of the JOBS Act.  The substance of the proposal will be worth some serious discussion over the next few months.  For now, though, we take a few minutes to examine the process used by the Commission to implement the proposal.

In fact, an examination of the statements issued by the five commissioners indicates a much more serious division than even the 4-1 vote suggests.  In a statement by the Chairman, she determined that the proposal was consistent with the "narrow mandate" required by Congress in Section 201 of the JOBS Act.  She noted other concerns raised in connection with the lifting of the ban and indicated that the Commission would "take a thorough look at the private placement market in the future."  Specifically, she noted the requirement in Dodd-Frank that the accredited investor standard be reviewed in its "entirety" beginning four years after the enactment of the Act. 

Commissioner Aguilar cast the one dissenting vote.  As he rightfully noted, the elimination of the ban on general solicitations was likely to result in an uptick in fraud.  This was not speculation but, as Yogi Berra would have said, deja vu all over again.  The SEC eliminated the general solicitation ban under Rule 504 in 1992 and had to reinstate it in 1999 because of the rise in microcap fraud.  Commissioner Aguilar declined to support a proposal that contained "no consideration of any of the commenters’ proposals that would have decreased investor vulnerability."  He noted a pair of them, including amending the definition of accredited investor and amending Form D. 

Commissioner Walter voted for the proposal but was "disappointed" that comments suggesting ways to "mitigate the risks that the proposed rule might pose" were not subject to a "meaningful[] discussion" in the release.

The two remaining commissioners voted for the proposal but objected to the failure to implement the rule as an interim final rule.  An interim final rule allows the rule to be effective immediately but permits comments in the post-effective period that may or may not be used to modify the rule at some later date.  In other words, they objected to the use of notice and comment prior to the effective date.  

Some of the anger was apparently derived from a sudden change in plans at the SEC.  Commissioner Paredes noted that "[f]or some time the Commission was set to consider an interim final rule" but that the Chairman "abruptly decided to change the rulemaking’s course, turning what was an interim final rule into a proposal."  He asserted that an interim final rule "would have allowed us to satisfy the clear statutory directive of the JOBS Act while setting the stage for a later rulemaking that would account for the actual consequences that resulted once issuers were given flexibility to more readily reach investors when raising capital."

Commissioner Gallagher made it clear that while voting yes "as a matter of substance" he "would certainly vote 'no' on the process that led up to" the proposal.  He noted that "[f]or months, the Commission had been told that the Staff was recommending that we vote on an interim final rule." Nevertheless, "earlier this month, we were told that the Chairman had reconsidered the draft interim final rule and wanted to re-cast it." 

In objecting to the approach, he took the position that the Commission can, "for good cause" adopt an "interim final release - a way to go ahead and make the required change, while at the same time soliciting market reactions to how the change actually works." Or, as he said later in his remarks, "I want to leave no doubt that, charged with quickly implementing Congress's explicit direction to implement a bottom-line mandate simply to remove the prohibition on general solicitation and general advertising in two well-traveled rules, we had plenty of 'good cause' to employ an interim final rule as our chosen procedural tool."

Putting aside the sudden shift in administrative strategy, the decision to avoid an interim final rule must be seen in the context of Business Roundtable v. SEC, the DC Circuit decision that struck down the shareholder access rule.  It is clear from that decision that all controversial rules are vulnerable to challenge and that the DC Circuit will provide little deference to the Agency.  To have undertaken an interim final rule, the SEC would have had to show "good cause."  Good cause is a term of art that means notice and comment was "impracticable, unnecessary, or contrary to the public interest." 5 USC 553(b).   

Courts do not allow notice and comment to be set aside easily.  They do so when there is an emergency.  They do not, typically, do so when the justification is a missed deadline for rulemaking.  See Petry v. Block, 737 F.2d 1193, 1203 (DC Cir. 1984) ("strict congressionally imposed deadlines, without more, by no means warrant invocation of the good cause exception.").  There are exceptions but they do not appear applicable in this case. 

Comments in the press suggested that litigation risk played a role in the Chairman's decision to not adopt an interim final rule.  See WSJ ("An SEC spokesman said implementing rules too hastily could expose the agency to court challenges.").  In the past, the pros and cons of rules were mostly resolved at the agency level.  In the Business Roundtable era, that is simply no longer the case.

Shareholders, the SEC and Mandatory Rotation of Auditors: A Commissioner Speaks

We are discussing the issue of executive compensation.  Later in the day we will begin a series of posts that discuss the recent adoption by the SEC of Rule 10C-1, the rule regulating compensation committees for listed companies.  But for now, we engage in a brief interlude. 

We have, on this Blog, questioned the position taken by the SEC staff with respect to the exclusion of shareholder proposals seeking board consideration of mandatory rotation of auditors.  The staff allowed the proposals to be deleted from the proxy statement under the "ordinary business" exclusion in Rule 14a-8.  The letters are discussed here. 

The issue has been taken up by Commissioner Aguilar at the SEC.  In a recent speech before the NAPPA 2012 Legal Education Conference, the Commissioner took issue with the characterization of mandatory rotation as an "ordinary business" matter.  See id.  ("I am not convinced that the engagement of the independent auditor should necessarily be considered a matter relating to 'ordinary business operations' within the meaning of the Federal proxy rules.").  He pointed both to applicable legal authority and to the longstanding role of shareholders in the auditor selection process. 

In addition, Commissioner Aguilar took issue with the staff's determination that the public policy exception to the ordinary business exclusion was inapplicable. 

In those cases in which a proposal's underlying subject matter transcends the day-to-day business matters of the company and raises significant policy issues, the proposal is generally not excludable on such grounds.  This is particularly the case when an issue has emerged as a topic of “widespread public debate,” as this issue has been.  Given the extensive public discussion occasioned by the PCAOB’s concept release, and the long history of debate on this issue, a strong case can be made that shareholder proposals relating to auditor independence and objectivity and audit quality raise significant policy issues and should not be excluded on ordinary business grounds.

Mandatory rotation of auditors is an important matter of governance.  The staff's position interferes with the ability of shareholders and managers to collectively resolve the issue.  Perhaps it is time for the staff to reconsider its position.   

Auditor Rotation and the Impediments to Private Ordering (Part 5)

By depriving shareholders of the right to vote on proposals regarding the rotation of auditors, the Commission is making a mandatory rule inevitable.  It is shareholder access all over again.

Pressure for shareholder access originally centered on the right of shareholders to submit bylaws that would require companies to include nominees in their proxy statements.  This would have allowed for a system of private ordering.  The Commission, however, opted to allow for the exclusion for these types of proposals.  As a result, pressure built for more direct access whereby shareholders could submit nominees for inclusion without having to first adopt the requisite bylaw.  Such a rule was adopted but was not implemented because of a weakly reasoned decision of the DC Circuit.  For an analysis of that case, go here. 

The same thing is likely to happen here.  Because auditors are paid by the companies they audit, there is always pressure to act in the interests of management rather than the company (and by extension shareholders).  Abuses will sometimes surface, something more likely to be uncovered with the creation of the PCAOB and its more rigorous approach to inspections.  Pressure will, therefore, build for reform.  In particular, pressure will continue to build for mandatory rotation of auditors.

Allowing shareholders to submit and vote on proposals that would require rotation take off some of the pressure for a mandatory and categorical rule.  Moreover, these proposals are not likely to be adopted except in companies that have shown through past behavior the need for greater auditor independence.

Yet by allowing for the exclusion of shareholder proposals regarding auditor rotation and independence, the staff at the Commission merely permits the pressure for reform to grow.  Shareholders and other interest groups will not get relief appealing to state law since these are management friendly jurisdictions and not likely to increase the authority of shareholders at the expense of management. 

They can appeal to other agencies, such as the PCAOB.  But as SOX has shown with respect to the separation of auditing and non-auditing functions and Dodd-Frank has shown with respect to say on pay, the more accommodating forum will be Congress.  Eventually when the right accounting scandal erupts, Congress will act and, when it does, the rule concerning rotation will likely be categorical.

Predicting the future is not easy, but in this case the direction is clear enough.  As long as the SEC gives shareholders no meaningful role in ensuring auditor independence, shareholders will seek, and eventually get, the authority from other sources.  

Finally, it should be noted that this issue with respect to staff interpretation is not limited to auditor independence.  In fact, the staff needs to essentially get out of the role of determining both "ordinary business" and public policy.  But that issue, discussed in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors, is for another day.

Auditor Rotation and the Impediments to Private Ordering (Part 4)

Moreover, the staff has gone further than banning proposals that seek to require rotation.  Even proposals that call for reports on auditor independence have been allowed to be excluded.  In connection with Dell, shareholders submitted a proposal asking management to create a report on auditor independence.  Specifically, the proposal requested: 

Therefore, Be It Resolved: That the shareholders of Dell Inc. request that its Board Audit Committee prepare and disclose to Company shareholders an annual Audit Firm Independence Report that provides the following:

1. Information concerning the tenure of the Company's audit firm if such information is not already provided, as well as the aggregate fees paid by the Company to the audit firm over the period of its engagement; 2. Information as to whether the Board's Audit Committee has a policy or practice of periodically considering audit firm rotation or seeking competitive bids from other public accounting firms for the audit engagement, and if not, why; 3. Information regarding the mandated practice of lead audit partner rotation that addresses the specifics of the process used to select the new lead partner, including the respective roles of the audit firm, the Board's Audit Committee, and Company management; 4. Information as to whether the Board's Audit Committee has a policy or practice of assessing the risk that may be posed to the Company by the long-tenured relationship of the audit firm with the Company; 5. Information regarding any training programs for audit committee members relating to auditor independence, objectivity, and professional skepticism; and  6. Information regarding additional policies or practices, other than those mandated by law and previously disclosed, that have been adopted by the Board's Audit Committee to protect the independence of the Company's audit firm.

Dell (May 3, 2012).  The staff again allowed for exclusion, again because the proposal intruded into the ordinary business of the corporation.  As the staff reasoned:

There appears to be some basis for your view that Dell may exclude the proposal under rule 14a-8(i)(7), as relating to Dell's ordinary business operations. In this regard, we note that while the proposal addresses the issue of auditor independence, it also requests information about the company's policies or practices of periodically considering audit firm rotation, seekig competitive bids from other public accounting firms for audit engagement, and assessing the risks that may be posed to the company by the long-tenured relationship of the audit firm with the company. Proposals concernng the selection of independent auditors or, more generally, management of the independent auditor's engagement, are generally excludable under rule 14a-8(i)(7).  Accordingly, we will not recommend enforcement action to the Commission if Dell omits the proposal from its proxy materials in reliance on rule 14a-8(i)(7).

The analysis was repeated in letters to Xilnx, McKesson, Computer Sciences Corporation, and CA, Inc.

In addition to the questionable analysis about the application of the ordinary business exclusion (and non-application of the public policy exception), these proposals raise another more critical issue.  The truth is that most companies submit the auditor to shareholders for approval.  This is discussed in see Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.

But the disclosure companies must give when submitting the matter to shareholders provide no meaningful basis for shareholders to determine the quality of the services provided.  For the most part, companies only have to disclose fees, dividing them into audit and non-audit services. Specifically, Item 9 of Schedule 14A does not require any meaningful qualitative disclosure. 

It does require disclosure of audit related fees, tax fees, and all other fees.  But this information is out of date and not particularly useful in the shareholder voting process.  These categories were developed prior to SOX when shareholders needed to know the relationship between audit and non-audit fees.  In SOX, however, Congress largely prohibited auditors from performing most non-audit services, rendering the disclosure for the most part irrelevant.

Thus, these proposals are designed to fill a gap left by the SEC's disclosure regime.  They seek to ensure that shareholders when approving auditors have available meaningful information on the qualitative aspects of the relationship. 

Auditor Rotation and the Impediments to Private Ordering (Part 3)

We are discussing the issue of mandatory rotation of auditors and the impediments imposed by the staff of the SEC in permit the development of a system of private ordering on the issue.

As we noted, the SEC has allowed for the exclusion of auditor rotation proposals under Rule 14a-8, agreeing that they constitute "ordinary business" and therefore fall into subsection (i)(7).  The staff, however, is wrong on this issue.

First, this is not a matter of ordinary business.  This is not the case where shareholders are asking the board to open a new office or change a term of employment.  This is an instance where shareholders are asking the board to ensure that a gatekeeper designed to protect the interest of shareholders can better peform that task.  For most of the history of the SEC, the staff took the position (as have the courts) that shareholders had a right to participate in the auditor selection process.  See Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.

Second, it is a matter of important public debate.  To argue otherwise is extraordinary.  The PCAOB issued a concept release on whether auditor rotation should be made mandatory.  The release chronicles the very public nature of the debate, something that has been ongoing for more than two decades. The release has generated a deluge of statements, meetings, and comments.  For a review of the 639 comment letters (as of May 24, 2012), go here.  That the matter is somehow deemed not sufficiently important to take it out of the ordinary business exclusion is to show the ruderless and standard less nature of the application of that provision. 

The staff, therefore, has gotten the analysis wrong.  Moreover, the burden with the exclusion of a proposal is supposed to rest with the party seeking exclusion.  Finally, to the extent companies disagree, they have yet another forum to litigate the issue.  If shareholders pass a resolution mandaing rotation, companies can challenge the provision in state law, arguing that it is a matter left to the discretion of the board. 

Auditor Rotation and the Impediments to Private Ordering (Part 2)

We are discussing the issue of mandatory rotation of auditors and the impediments imposed by the SEC staff to any resolution of the issue through private ordering.

The ordinary business exclusion in Rule 14a-8 provides that management may exclude from the proxy statement matters that fall within the ordinary or day to day business of the company. The theory is that state law vests in the board, not shareholders, the authority to make ordinary business decisions.  The problem, however, is that there is very little state law dileneating what is and is not an ordinary business decision.  As a result, for the most part, the matter is within the discretion of the staff, unguided by state law, to determine. 

Moreover, whatever state law suggests, the SEC has grafted onto the exclusion an exception that is not contained in state law.  Since 1976, the staff has allowed the inclusion of proposals that implicate this exclusion so long as it implicated issues of important public or social policy.  The SEC was forced into this position after a history of allowing the exclusion of proposals that called for the end of segregation on buses and the production of napalm.  All of this is discussed in detail in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.

This is another area where the staff has no meaningful guidance.  These are not terms of art.  There are no recognized standards.  And, because it is not an exception recognized under state law, there is not even meaningful philosophical guidance on when to apply the public/social policy exception.  Thus, this is determined entirely by the staff, a matter not within its traditional expertise and one that changes from Commission to Commission (another matter discussed in Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors). 

The problems with the interpretation of the ordinary business exclusion can be seen with particular vigor in connection with the auditor rotation issue. 

In AT&T Inc. (Jan. 5, 2012), for example, shareholders submitted a proposal that called for the following:  

Be it Resolved: That the shareholders of AT&T Inc. hereby request that the Company's Board Audit Review Committee establish an Audit Firm Rotation Policy that requires that at least every seven years the Company's audit firm rotate off the engagement for a minimum of three years.

The staff, however, allowed for the exclusion of the proposal.  The reason?  It fell within the "ordinary business" of the company.  As the staff reasoned:

There appears to be some basis for your view that AT&T may exclude the proposal under rule 14a-8(i)(7), as relating to AT&T's ordinary business operations. In this regard, we note that the proposal relates to limiting the term of engagement of AT&T's independent auditors. Proposals concerning the selection of independent auditors or, more generally, management of the independent auditor's engagement, are generally excludable under rule 14a-8(i)(7). Accordingly, we will not recommend enforcement action to the Commission if AT&T omits the proposal from its proxy materials in reliance on rule 14a-8(i)(7).

The analysis was repeated in a number of other letters.  See ITT Corp. (Jan. 13, 2012), ConocoPhillips (Jan. 13, 2012), Dominion Resources (Jan. 4, 2012).  Moreover, the staff took the position irrespective of the particular circumstances at each company.  Thus, the staff allowed GE to exclude a mandatory rotation proposal (See GE (Dec. 23, 2011)) despite the fact that GE has been sanctioned for accounting problems (See SEC v. General Electric, Litigation Release No. 21166, Aug. 4, 2009) and appears to have a very, even excessively, close relationship with its auditor.

We will discuss the analysis use by the staff in the next post.

Auditor Rotation and the Impediments to Private Ordering (Part 1)

Last year, the PCAOB issued a concept release on whether there should be mandatory rotation of accounting firms.  The release is here.  It is a tough issue.  There is the disurption that comes from mandatory rotation.  At the same time, there is concern over the complacency that sets in when the same auditor peforms that function for decades or more. 

The debate for the most part is over a mandatory rule.  In other words, the proposal would potentially require all public companies to rotate their auditor after a specified number of years.  In general, this again triggers the debate over the choice between mandatory rules and private ordering.  Private ordering contemplates that each company will select the appropriate approach depending upon the company's particular circumstances.  In theory, private ordering involves a debate between owners and managers.  Thus, the approach contemplates some say in the matter by shareholders.  

Because management (specifically the audit committee) already has the right to select (and change) the auditor, a system of private ordering requires the creation of a mechanism for involvement by shareholders.  The obvious mechanism is Rule 14a-8, the shareholder proposal rule.  Under the rule, shareholders can submit proposals calling for mandatory rotation. 

To the extent a proposal is allowed, management can campaign against them and try to ensure their defeat by shareholders.  Alternatively, management can conceded the point or negotiate over a compromise to get the shareholders to withdraw the proposal.  Either way, shareholders have a say in the decision and mandatory rotation is resolved on a company by company basis.

Only the staff at the SEC has shut the door to proposals concerning mandatory rotation.  A series of noaction letters have found that these type of proposals can be deleted under Section (i)(7), the infamous "ordinary business" exclusion. We will discuss the use of this exclusion in greater detail in subsequent posts.  In the meantime, for a detailed history and analysis of the ordinary business exclusion, see Essay: The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors.

The Antifraud Provisions and Advertisements: SEC v. Ruettiger

At the end of last week, the SEC brought two very interesting cases.  The one that garnered the most attention was the case against executive officers of Fannie Mae and Feddie Mac (along with a non-prosecution agreement against the entities). 

The other case, SEC v. Ruettiger, was described as a "classic pump and dump scheme" that gained publicity mostly because it named Daniel Ruettiger as a defendant.  Ruettiger was apparently the ndividual who "inspired" the 1993 movie "Rudy."  We think that SEC v. Ruettiger deserves some attention for more than just the connection to "one of the best 25 sports movies of the previous 25 years". 

In the traditional pump and dump scheme, the pump consists of false statements designed to encourage investors to enter the market, pushing up share prices.  In the Internet era, the statements are often distributed electronically, particularly through emails.  As interest increases and price/volume rise, the perpetrators of the fraud dump their shares.  When the shares are sold and the fraudulent statements stop or are exposed, the market price collapses.  The last one to hold shares watches his or her value plumet.

Usually the statements intended to pump the market are directorly related to earnings.  The SEC has brought cases alleging that the market was primed by statements included a "baseless share projection," business with nonexistent customers, relationships with well known public companies that in fact did not exist, and false claims about the nature of the company's business.       

In Ruettiger, however, the allegations were a bit more subtle and perhaps more long term.  According to the complaint, the scheme involved a company that manufactured a sports drink that was intended to compete in the national market.  As part of the pump process, the SEC alleged that the information was distributed that falsely claimed the company had partnership agreements with "two large soft drink distributors."  See Complaint, at P. 70. 

In addition, however, statements were made that in “a major southwest test, Rudy outsold Gatorade 2 to 1!”  Emails sent to prospective investors represented that in “several blind taste tests, Rudy outperformed Gatorade and Powerade by 2:1.”  See Complaint, P. 75.  The SEC alleged that both statements were "materially false or misleading."  Id.  

This latter group of misstatements for the most part went to the quality of the product.  They essentially asserted that "Rudy" was better than Gatorade.  The SEC's action, therefore, suggests that companies can be sued under the antifraud provisions on the basis of statements about product quality.  Moreover, the statements need not appear in missives sent directly to investors.  They can, for example, be in advertisements.  See In re Carter-Wallace, Inc. Secur. Litig., 150 F.3d 153 (2nd Cir. 1998).

It should be noted, though, that there were a number of factors that made SEC v. Ruettiger an easier case.  First, given the apparent importance of the sports drink to the company, the materiality of the statements about the sports drink seemed clear.  Second, the statement about quality included objective elements.  The statements about quality were dependent upon a "major southwest test" and "blind taste tests".  To the extent that these did not occur, the statement is objectively inaccurate.  Third, the material was sent directly to investors, demonstrating an attempt not to influence consumers but investors. 

Nonetheless, the case is a reminder of the reach of the antifraud provisions. 

The SEC and the Defense of "Neither Admit Nor Deny"

The Commission has approved a decision to appeal the order issued by Judge Rakoff in the Citigroup case.  The statement is here.  As Director Khuzami described:

• We believe the court was incorrect in requiring an admission of facts — or a trial — as a condition of approving a proposed consent judgment, particularly where the agency provided the court with information laying out the reasoned basis for its conclusions. Indeed, in the case against Citigroup, the SEC filed suit after a thorough investigation, the findings of which were described in extensive detail in a 21-page complaint.

• The court’s new standard is at odds with decades of court decisions that have upheld similar settlements by federal and state agencies across the country. In fact, courts have routinely approved settlements in which a defendant does not admit or even expressly denies liability, exactly because of the benefits that settlements provide.

Litigation carries risks.  Moreover, the SEC had alternatives.  It could have terminated the suit and refiled as an administrative proceeding.

But the appeal is the right step (and one we suggested on this Blog).  When courts make bad law, the SEC should not leave the matter unaddressed.  That is exactly what the Commission is doing.

SEC v. Aronson: Operators of Alleged PermaPave Ponzi Scheme Charged

In SEC v. Aronson, No. 11 CIV 7033 (S.D.N.Y. Oct. 6, 2011), the Securities and Exchange Commission (“SEC”) brought charges against defendants Eric Aronson, Vincent Buonauro, Robert Kondratick, Fredric Aaron, the PermaPave companies (PermaPave Industries, LLC, PermaPave USA Corp., PermaPave Distributions, Inc., Permeable Solutions, Inc., and Verigreen, LLC), and Interlink-US-Network, Ltd (collectively, “Defendants”).  The SEC also brought charges against relief defendants Caroline Aronson, Deborah Buonauro, Aron Holdings, Inc., DASH Development, LLC, PermaPave Construction Corp., Dymoncrete Industries, LLC, Dymon Rock LI, LLC, and Lumi-Coat, Inc. (collectively, “Relief Defendants”).

The SEC alleged that Defendants engaged in a Ponzi scheme that promised investors high yields on stone pavers, defrauding over 140 people out of $16 million.  From March 2006 until 2010, according to the complaint, Aronson, Kondratick, and Buonauro sold unregistered securities to inexperienced investors.  These defendants used $10 million to repay earlier investors in “Ponzi-type payments” and $11 million to pay themselves and the Relief Defendants.  Aronson, Kondratick, and Buonauro were said to have spent investors’ money on home mortgage payments, luxury cars, Las Vegas gambling trips, and gentlemen’s club bills. 

According to the SEC’s complaint, Aronson founded PermaPave Industries in October 2006.  The company told its investors that it would buy and ship “permeable paving stone comprised of small rocks glued together” from Australia to be sold in the United States.  Aronson hired his brother-in-law, Kondratick, Buonauro, and Aaron, an attorney.  Aronson, Kondratick, and Aaron subsequently formed the other PermaPave companies.  For the next four years, Aronson, Kondratick, and Buonauro sold securities in the form of promissory notes and “use of funds” agreements.  The securities provided for annual rates of return between 94% and 400%.  Both men stated that the stone pavers were in high demand and the profits generated by the companies would be used to repay investors.  In reality, according to the SEC, the PermaPave companies and the stone pavers had never been profitable. 

The complaint alleged that when investors began demanding the return of their money in 2009, Aronson and Aaron persuaded them to convert their promissory notes and use of funds agreements into different securities that paid lower interest rates and deferred payments for two years.  In addition, “Aronson told investors that exchanging their promissory notes and use of funds agreements for convertible debentures was their only choice because the interest rates on the notes and agreements were usurious, and investors had committed a ‘class C felony’ by signing them for which Aronson could have had them arrested.” 

Among several other claims, the SEC asserted that Aronson, Buonauro, Kondratick, the PermaPave companies, and Interlink violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 by engaging in fraudulent transactions and obtaining investments by making “untrue statements of a material fact.”  The SEC also claimed that the Relief Defendants incurred unjust enrichment. 

The SEC is seeking a permanent injunction barring Defendants from engaging in similar practices and an order requiring Defendants and Relief Defendants to disgorge their ill-gotten gains plus prejudgment interest.  The SEC is also seeking to impose civil penalties upon the PermaPave companies, Aronson, Buonauro, Kondratick, and Aaron under Section 20(d) of the Securities Act, and to bar Aronson, Kondratick, and Aaron from serving as an officer of any publicly traded company or from participating in a penny stock offering.

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

The Citigroup Decision: The Director of the Division of Enforcement Responds

What is the Commission's reaction to the Citigroup decision?  There has been no official response.  Nonetheless, Robert Khuzami, the Director of the Division of Enforcement, gave a talk before the Consumer Federation of America's Financial Services Conference on December 1.  The entire talk is here and is worth a read. 

For now, we focus on his discussion of the "commentary" on the “neither admit nor deny” policy.  First, he had this to say about settlements. 

• When the Division of Enforcement recommends that the Commission settle a case, it is because our informed judgment tells us that what we are obtaining in settlement is within the range of outcomes we reasonably can expect to get after we prevail at trial, taking into account the strength of the case as well as the delay and resources required for a trial and the benefits of returning money to harmed investors quickly – not to mention the chances that we might lose at trial, or win but be awarded less than what the settlement achieves.

Refusing to approve such a settlement was in his view an "unwise policy."  As for the purported fear of going to trial, Khuzami noted that the Division was not "reluctant to try cases."  Cases were settled for "the right reasons."  To believe otherwise, he noted, it would be necessary to believe:

• That we established and funded an entirely new specialized unit directed solely at investigating fraud related to structured and mortgage-related products that gave rise to the credit crisis … that we staffed that unit with dedicated and talented SEC staffers, some of whom have spent their careers in public service, and all of whom are committed to uncovering fraud in these markets and transactions … we hired private sector experts with market experience to cut through the jargon and the complexities and help us zero in on the possible areas of misconduct … we set up extensive training programs to teach these staffers the complexities of structured products and the markets in which we operate; the staff then went out and spent years pouring over millions of pages of documents, e-mails and 500-page prospectuses and indentures and flow charts to find evidence of fraud … then spent months and years in conference rooms questioning witnesses about these transactions in painstaking detail … and then we put together our case, charging both the company and the persons who were responsible for the deal.

Given that the SEC was going forward with a trial against the individual charged, the idea "that we nonetheless intentionally settle the case against the company on the cheap because we just don’t like to try cases, or for other, even more ridiculous reasons" reflected a "fundamental misunderstanding about the professionalism and commitment of the SEC staff".

Khuzami's discussion reflects the complex considerations that go into settlements and the use the "neither admit nor deny" approach.  The discussion demonstrates why implementation ought to be left to the Agency and the parties and not be a matter of judicial fiat.

The Citigroup Decision and the Harm to Investors

The decision in Citigroup rejecting the $285 million settlement has resulted in plenty of critical commentary, much of it suggesting that the SEC was not tough enough on the large financial institution.  The problem in general with such criticism is that the trial court did not reject the settlement because it was not tough enough.  Indeed, the fact that Citigroup did not have to make factual admissions likely meant that the complaint was far more pointed and telling than it otherwise would have been.  In other words, it probably tells more of the truth than what would have emerged had Citigroup been forced to make factual admissions.

But more importantly, the reasoning of the case ultimately threatens to harm shareholders and investors by forcing the SEC to litigate more cases. 

Litigation is expensive and uses up resources.  The SEC has already had an exceptionally hard time getting an adequate budget out of Congress.  To the extent having to litigate more cases, this would likely require the Agency to strip resources from other areas and other projects.  Most logically, at least some of the funds would come out of the budget used to pay those who investigate possible violations.  In short, there will be fewer investigations and fewer resources seeking the next Madoff.

Yet there is another even darker implication of this approach.  Given that big financial institutions have an almost unlimited budget to pay attorneys, they can afford to litigate cases to the bitter end.  Smaller entities and individuals may not have the same ability.  The result might be fewer cases against large businesses. 

And, indeed, this is something the WSJ implicitly suggested ought to happen.  An editorial in the paper had this to say about the consequences of making the SEC litigate more cases. 

• we might learn whether these cases have legal merit or are merely easy attempts to extort a deep-pocketed target. The SEC knows companies want to avoid reputational and legal costs, not to mention the risk of a trial lawyer pile-on. But how many cases would the SEC bring if it knew it had to prevail in court?

To the extent that the SEC lost at trial, it might "cause the SEC to bring fewer of these grandstanding cases against the corporate villain of the moment—for now, it's Wall Street—and focus more on real financial criminals like Bernie Madoff."

In other words, by forcing more trials, the SEC would stop bringing cases against the "corporate villain of the moment." Instead, it ought to redirect its efforts not at Wall Street but at the Bernie Madoff's.  Of course, Bernie Madoff would probably be surprised to learn that he was not part of Wall Street.  But mostly the approach suggested by the editorial would result in fewer cases against large entities and more against smaller players in the securities markets.  And, indeed, this is a possible outcome of the decision in Citigroup. 

Citigroup Settlement Rejected (Part 3)

The decision to reject the settlement because it came without factual admissions throws a singificant potential wrench into the SEC's approach to enforcement. 

To some degree, the decision stands for the proposition that this type of language is never acceptable, at least where the relief is substantial.  The court itself all but said this.  See SEC v. Citigroup ("It is not reasonable, because how can it ever be reasonable to impose substantial relief on the basis of mere allegations?").  Of course, one could argue that injunctive relief enforced by contempt is always "substantial."  Were this to be the case, the SEC could no longer rely on settlements of this kind.  

This could significantly increase the number of cases that were litigated.  Particularly where the SEC sought to charge a scienter based claim, defendants would have considerable incentive to litigate, either in an effort to win or to provide delay.  Delay might, for example, give defendants time to settle any private litigation before there was a ruling in the SEC case.  Because the SEC has limited resources, more litigation would mean less money for other administrative activities.  The Commission could strip funds away from operating divisions and give them to Enforcement.  Or Enforcement would, within its own budget, be forced to spend more on litigation and less on investigations.  

Alternatively, the decision could paradoxically result in less protection for the public.  This could push the SEC to bring more settlements as administrative proceedings.  These proceedings are not subject to court approval.  Moreover, because violations are not enforceable through contempt proceedings, the public arguably gets less protection.

Certainly, the same court's opinion in SEC v. Gupta suggested that the SEC should have a strategic justification selecting an injunctive versus administrative forum.   Ease of negotiating and approving a settlement ought to qualify.  

Citigroup Settlement Rejected (Part 2)

The decision to reject the Citigroup settlement essentially entails a rejection of the Commission's practice of allowing defendants to neither admit nor deny the allegations in the complaint.

The decision poses numerous problems for the Commission.  For one thing, it is internally inconsistent. 

The court characterized these settlements as having little evidentiary or other value.  The criticism is overbroad.  SEC cases provide can provide plaintiffs with a roadmap for their own action, often involve obtaining relief that cannot be obtained by private parties (as the court noted, the SEC can recover amounts for negligent behavior, private parties cannot), and they may have some evidentiary value.  See THE ANSCHUTZ CORPORATION v. MERRILL LYNCH, 785 F. Supp. 2d 799, 821 (ND CA 2011)(declining to dismiss motion to strike references to various investigations and resulting settlements conducted by the New York Attorney General and the SEC because "regulatory investigations and settlements may be relevant to issues in this case"). 

But more importantly, even to the extent true, the court declined to approve the settlement because of its very importance.  Thus, the SEC was seeking "substantial injunctive relief, enforced by the  Court's own contempt power".  Or, said another way, the SEC was asking the court "to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt". In other words, it was the serious impact of the settlement (which presumably equated to a public benefit) that required the court to insist on factual findings. 

The court also effectively overstated the value of factual admissions.  The parties could, for example, renegotiate the settlement and agree to a thin list of admissions.  To the extent the SEC continued to charge Citigroup only with negligence under Section 17, private litigants would still have to prove scienter. To the extent the facts admitted merely established an aiding and abetting standard, private litigants would still have to prove a primary violation.  In other words, the mere elimination of the "neither admit nor deny" language does not automatically result in substantial benefit to private litigants. 

Citigroup Settlement Rejected (Part 1)

Yesterday, Judge Rakoff rejected the settlement between the SEC and Citigroup.  This was the one that involved a payment of $285 million by Citigroup but where the financial institution neither admitted nor denied the allegations in the 21 page complaint.

It is clear that Judge Rakoff does not like the settlement on substantive grounds.  He was unhappy with the amount (noting that investors lost $700 million) and viewd the settlement as inconsistent with the one reached in the Goldman case.  See note 7.  Nor was the court happy with the standard of fault charged in the complaint.  Although language in the separate action against an individual "would appear to be tantamount to an allegation of knowing and fraudulent intent ("scienter," in the lingo of securities law), the S.E.C., for reasons of its own, chose to charge Citigroup only with negligence". 

The rejection of the settlement, however, was not on this basis.  Instead, the court rejected the settlement because it has not been provided with "any proven or admitted facts upon which to excercise even a modest degree of independent judgment." Said another way, the court did not approve the settlement because it allowed Citigroup to "neither admit nor deny" the allegations in the complaint (language that he suggested may violate the first amendment, see note 5).  As the court reasoned:

• Purely private parties can settle a case without ever agreeing on the facts, for all that is required is that   a plaintiff dismiss his complaint.  But when a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable    judicial power of contempt, the court, and the public, need some knowledge of what the underlying     facts are:   for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated       on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of  obvious public importance.

In part the court based its reasoning on the perception that settlements involving the "neither admit nor deny" language had no public benefit.  They had "no evidentiary value".  They were often viewed by the business community "as a cost of doing business imposed by having to maintain a working relationship with a regulatory  agency, rather than as any indication of where the real truth lies."  This type of settlement served only the "various narrow interests of the parties."   Moreover, the settlement interfered with the public's right to know the truth.

• in any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the  truth.    In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers.     Even in our nation,  apologists for suppressing or obscuring the truth may always be  found.  But the S.E.C., of all  agencies,  has a duty, inherent in its statutory mission, to see that the truth emerges;    and if fails to do so, this Court must not, in the name of deference or convenience, grant judicial  enforcement to the agency's contrivances.

In effect, therefore, the court suggested that settlements, at least those involving "substantial relief", could not be approved where the defendant made no admissions of fact.  Indeed, the court itself asked rhetorically, "how can it ever be reasonable to impose substantial relief on the basis of mere allegations?"

We'll consider the implications of this case in the next post.  The opinion has been posted on the DU Corporate governance web site. 

Record Penalty in Rajaratnam Case

The SEC obtained a record penalty from Raj Rajaratnam, the hedge fund manager recently convicted of insider trading.  The SEC obtained a penaly of $92.8 million.  The penalty is the largest against an individual. 

The penalty was imposed in an order granting the SEC summary judgment in its civil suit against Rajaratnam.  An injunction was a foregone conclusion.  Given his criminal conviction, Rajaratnam "conceded that, because of the criminal conviction, he was collaterally estopped from contesting liability for insider trading on the five stocks here in issue, and that he did not oppose having an injunction entered against him based on this liability." 

Moreover, given the $53.8 million forfeiture in the criminal case, the SEC conceded that its "request for $31.6 million in disgorgement was moot."

The only real issue was the amount of the penalty.  Defendant essentially argued that, given the $38 million penalty imposed in the criminal case, "further civil penalties are unwarranted."  Judge Rakoff, however, disagreed.  Criminal penalties, according to the judge, were designed to address defendant's "moral blameworthiness."  In contrast:

• SEC civil penalties, most especial in a case involving such lucrativeive misconduct as insider trading, are designed, most importantly, to make such unlawful trading "a money-losing proposition not just for this defendant, but for all who would consider it, by showing that if you get caught, you are going to pay severely in monetary terms.

In calculating the penalty, the court agreed that the facts justified the highest possible penalty of three times the profit gained or loss avoided.  Moreover, the court declined to reduce the penalty by amounts attributed not to insider trading but to the market.  As the court reasoned:

• By its plain language, Congress instructed the Court not to eliminate from the calculation of "profit gained" or "loss avoided" any amount attributable to market factors other than the defendant's inside information. Rather, once the Court identifies the trading price of the security at a "reasonable period after public dissemination of the nonpublic information," the Court should simply calculate the difference between that price and the price the defendant paid for that security in order to arrive at the profit gained or loss avoided.

The profits/losses did, however, have to be computed based upon the trading price of the relevant shares "a reasonable period after public dissemination of the nonpublic information."  15 USC 78u-1(f).  Using 24 hours as a reasonable period, the Commission computed the gain/loss avoided as $33,512,929, while defendant came up with $30,935,235. 

The court refused to resolve the discrepancy.  The court simply determined that anything over $90 million was enough and, as a result, accepted the defendant's calculation since it yielded the requisite minimum penalty.

• the Court determines that it need not resolve these somewhat technical differences, since for present purposes the Court can accept the lower figure and still fulfill all the purposes of a civil penalty this case. Specifically, the Court determines that these purposes can all be achieved by a trebling of the base figure as long as that trebling results in a fine amount of at least $90,000,000.

As for paying the $92,805,705, the court noted that certified check, bank cashier's check, or United States postal money order made payable to the United States Securities and Exchange Commission would be sufficient. 

We will have Judge Rakoff's order posted shortly on the DU Corporate Governance web site.

SEC v. Peterson & Peterson: Denver Father and Son Plead Guilty to Insider Trading

In SEC v. H. Clayton Peterson and Drew Clayton Peterson, No. 11-CV-5448 (SDNY, Filed Aug. 5, 2011), the Securities and Exchange Commission (“SEC”) brought charges against Clayton Peterson and his son Drew Peterson (collectively “Defendants”) for insider trading under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)-5.  Clayton Peterson was a CPA and former Managing Director of Arthur Anderson in Denver, Colorado.  His son, Drew Peterson, was a registered investment advisor in Denver. 

Clayton Peterson served on the board of directors for Mariner Energy Inc. (“Mariner”), a publicly traded oil and gas company.  Apache Corporation (“Apache”), also a publicly traded oil and gas company, was expected to announce its acquisition of Mariner on April 15, 2010.  The SEC alleged that Clayton Peterson gave his son material, non-public information about the acquisition prior to the announcement date.  The SEC noted that Clayton Peterson specifically told his son to purchase shares of Mariner for family members.  Acting on his father’s advice, Drew Peterson purchased Mariner’s securities for himself, relatives, the investment advisory firm where he was employed, and Blind Seven LLC, an investment club founded by Drew.  Drew purchased 1,200 shares of Mariner for himself, 5,000 shares for his relatives, 2,500 shares for Blind Seven, 500 shares for a friend, and 4,100 shares for four of his clients. 

Drew forwarded the tip about Apache’s acquisition of Mariner to a friend working as a portfolio manager at a registered investment advisor in Denver referred to as “Hedge Fund A Portfolio Manager” throughout the SEC’s complaint.  Hedge Fund A’s Portfolio Manager purchased 200,000 shares of Mariner stock valued at $3.3 million and 5,000 option contracts on Mariner just days before the announcement.  This was the first time Hedge Fund A had ever traded Mariner stock or options.  The portfolio manager also purchased 25,000 shares of Mariner and 400 options contracts for relatives and his personal accounts. 

Following the April 15^th announcement of the acquisition, Mariner’s stock increased from $18.09 per share to $25.68 per share.  Drew Peterson made over $100,000 in profits from his trades.  Hedge Fund A made $4.6 million in profits while the portfolio manager made $435,000 for his relatives and himself. 

The SEC claimed Defendants violated Section 10(b) of the Exchange Act and Rule 10(b)-5.  The SEC’s complaint stated that Clayton Peterson “recklessly disregarded, or should have known, that he owed a fiduciary duty” to Mariner and the information about the acquisition was material, non-public information.  The SEC applied this same standard to Drew Peterson and states that Drew “recklessly disregarded, or should have known” the tip his father gave him was inside information. 

The SEC sought permanent enjoinment against Defendants from violating Section 10(b) and Rule 10(b)-5 again, civil monetary penalties, and disgorgement of all profits that resulted from the insider trading, including those profits gained by Hedge Fund A and the portfolio manager for a total of $5.2 million.  The SEC also asked the court to bar Clayton Peterson from serving as an officer or director of any publicly traded company. 

Both Clayton Peterson and Drew Peterson pled guilty to insider trading charges.  Sentencing is on January 12, 2012.  The probation office has recommended Clayton Peterson not receive any jail time as reported here. 

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

SEC v. Todd: The SEC Reclaims Victory

In SEC v. Todd, the SEC appealed the district court’s granting of Gateway Inc. officials John Todd and Robert Manza’s motions for judgment as a matter of law, which set aside the jury verdict against them on Section 10(b), Rule10b(5), and Rule 13b2-2 claims; they also appealed the district court’s granting of motions for summary judgment regarding alleged securities violations by Jeffrey Weitzen, Gateway’s CEO and president.  Sec. Exch. Comm’n v. Todd, 2011 U.S. App. LEXIS 12692 (9th Cir. June 23, 2011). 

The SEC claimed that Gateway’s CFO, Todd, and lead CPA, Manza, unlawfully misrepresented Gateway’s financial condition to meet earnings and revenue expectations in the third quarter of 2000. Their claims revolved around transactions between Gateway and Lockheed Martin, VenServ Inc., and AOL. 

In 2000, according to the SEC, Gateway entered into an agreement with Lockheed Martin to sell $47.2 million of fixed assets in the form of IBM and Sun Microsystems servers.  Gateway planned to then lease back the servers, booking the initial transaction as revenue.  This technique was not in accordance with revenue recognition under Generally Accepted Accounting Principles (“GAAP”).  Gateway booked this one time gain as revenue in its third quarter report.  During that same quarter, Gateway included $21 million from a transaction with Venserv.  However, when it was recorded, the Venserv sale was incomplete because Gateway did not fulfill the services stipulated in the contract.  Gateway also modified the AOL agreement to be able to book revenue sooner, creating a one-time revenue boost during the third quarter of $72 million.

The Lockheed transaction involved the defendants recording the sale of fixed assets as revenue; Manza and Todd argued that the Lockheed transaction did not violate a specific provision of GAAP while the SEC presented experts that disputed that claim.  However, Manza testified that while he did not believe their actions violated a specific GAAP provision, if he were the CFO he would not have recorded the transaction as revenue.    

The SEC alleged that the actions constituted securities fraud under Rule 10b-5.  Violations of § 10(b) of the Act require “a material representation, in connection with the purchase or sale of a security, with scienter, by means of interstate commerce.”  SEC v. Dain Rauscher, Inc., 254 F.3d 852, 855-56 (9^th Cir. 2001).   The SEC also claimed that Todd and Manza’s signing of the management representation letter sent to Price Waterhouse Coopers amounted to a violation of rule 13b2-2 for improper reporting to accountants.  Although the SEC prevailed at trial, the district court set aside the jury verdict, holding that the evidence was insufficient to establish scienter or the materiality of the alleged misstatements.   

On appeal, the Ninth Circuit reversed.  The appellate court found ample evidence in the Lockheed and VenServ transactions for the jury to have found a material misrepresentation.  In the Lockheed transaction, the jury heard expert opinions of how the transaction should have been recorded as well as testimony that Gateway had violated its own internal accounting policy by booking the transaction as revenue.  Both parties agreed that the Venserv transaction was not complete and improperly recognized.

With respect to scienter, the court held that the mental state embraced both an “intent to deceive, manipulate or defraud” and recklessness.  In the Lockheed transaction, Todd and Manza allegedly kept information from their internal auditors because Manza said “they wouldn’t go for it.”  In the Venserv transaction, evidence was presented which showed that the defendants knew the sale was incomplete at the time it was recognized.

A violation of rule 13b2-2 requires an officer to knowingly making a false or misleading statement to an accountant.  The Ninth circuit found that the same evidence sufficient for scienter with regard to Section 10(b) violations was sufficient to show Todd and Manza knew the financial documents were not accurate when they signed the management representation letters.

The Ninth Circuit reversed the trial court’s grants of summary judgment for Weitzen with regard to his liability under § 10(b), Rule 10b-5, and control person liability under §20(a) of the Securities Act of 1933.  Despite the nature of the transactions that were recorded in Gateway’s third quarter earnings report, Weitzen repeatedly referred to revenue growth as accelerated during conference calls with analysts.  The court drew from this a genuine issue of material fact regarding whether Weitzen materially misrepresented Gateway’s revenue and acted with scienter in doing so. The court again found a genuine issue of fact as to whether Weitzen could be considered a “control person” with regard to Gateway.  The control person must have power or control over the primary violator of the Act.

 The Ninth Circuit upheld summary judgment for Weitzen with regard to the rule 13b2-2 claim of improperly reporting to accountants.  The court also affirmed the district court’s order denying defendants Todd’s and Manza’s motions for a new trial and motions for judgment as a matter of law on aiding and abetting claims.

Further posts on SEC v. Todd can be found here.

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

SEC Opts not to Appeal Shareholder Access Rule

 The SEC won't seek en banc consideration of the DC Circuit's decision with respect to Rule14a-11 or review in the Supreme Court.  It would have been a very difficult case to win in the DC Circuit since three of the nine judges could be counted on to oppose Commission efforts.  Yet it leaves in place a very bad precedent that will come back to haunt the SEC with respect to future rulemaking efforts, particularly in the corporate governance area.  We have a few more posts on the DC Circuit's decision and the extent to which it went beyond any other court in imposing cost-benefit burdens on the SEC.

As we have written before on this blog, this is access delayed, not access defeated.