In a move that will make Securities and Exchange Commission administrative proceedings look more like civil litigation in federal court, on July 13, 2016, the SEC announced that it had adopted amendments to its rules of practice. These rules appear similar to those the Commission proposed last September. For critics of the amendments, they may not go far enough, but the expanded discovery and clarifications regarding dispositive motion practice may address some of the issues previously raised regarding the Commission’s perceived home-court advantage.
On July 7, 2016, Judge Paul A. Magnuson of the United States District Court for the District of Minnesota granted Defendants’ Motions to Dismiss a shareholder class action that had been initiated following a 2013 holiday season data breach involving customers of Target Corporation (“Target,” or “the Company”). The data breach, which resulted in the release of information of approximately 70 million consumer credit and debit cards, made headlines as one of the biggest privacy hacks at the time. Initially disclosed to the public in December 2013, with an estimated 40 million credit and debit cards affected, Target subsequently revealed a little less than a month later that additional consumer data, including customers’ names, mailing addresses, phone numbers and email addresses, were also stolen, and increased its initial estimate to 110 million.
On June 27, 2016, SEC Administrative Law Judge Carol Fox Foelak dismissed the Division of Enforcement’s charges against IRA custodian Equity Trust Company in connection with the company’s processing of investments marketed by two convicted fraudsters. Judge Foelak’s decision—a complete defense victory for Equity Trust—shows that while the Division of Enforcement may still win most of its cases in administrative proceedings, it doesn’t win them all.
On June 30, 2016, the Delaware Chancery Court extended the Supreme Court’s holding in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), to two-step mergers under DGCL § 251(h). The Chancery Court concluded that acceptance of a first-step tender offer by a fully informed and uncoerced majority of disinterested stockholders insulates a two-step merger from challenge except on the ground of waste, even if a majority of directors were not disinterested and independent. See In re Volcano Corp. S’holder Litig., C.A. No. 10485-VCMR. In this situation, the business judgment rule is “irrebutable” and dismissal is typically appropriate given the high bar for proving “waste” and the unlikelihood that a majority of informed stockholders would approve such a transaction. In re Volcano is the latest decision underscoring the critical importance of securing an uncoerced and fully informed majority vote of disinterested stockholders if boards wish to benefit from this extremely deferential standard of review.
After four failed attempts at persuading federal appellate courts to hear constitutional challenges to SEC administrative courts, it is increasingly clear that defendants in SEC in-house proceedings will not be able to pursue an early out because of the manner in which SEC administrative judges are appointed. The latest loss came on June 17, when the Eleventh Circuit in consolidated cases Gray Financial Group Inc. et al. v. SEC, No. 15-13738 (11th Cir. Jun. 17, 2016), and Charles L. Hill v. SEC, No. 15-12831 (11th Cir. Jun. 17, 2016), agreed with the Second Circuit’s decision of three weeks ago in Tilton v. SEC, No. 15-2103 (2d. Cir. Jun. 1, 2016) (which we covered here) in ruling that respondents in an SEC administrative enforcement cannot bypass the Exchange Act’s review scheme by filing a collateral lawsuit in federal district court challenging the administrative proceeding on constitutional grounds. A different decision from the Eleventh Circuit would have created a circuit split and a heightened possibility of Supreme Court review, but instead it joined the Second, Seventh, and D.C. Circuits in an approach that is unanimous among the circuit courts to have considered the question. The constitutional legitimacy of SEC administrative law judges is thus likely to continue unchallenged, at least for now.
On June 9, 2016, the Securities and Exchange Commission (‘SEC”) awarded the second largest whistleblower bounty – $17 million – granted under the Dodd-Frank whistleblower rules to date. Previously, the highest whistleblower awards were a $30 million award in September 2014 and a $14 million award in October 2013. The $17 million award comes on the heels of $26 million in whistleblower awards given to five anonymous individuals over the last month alone. These awards serve as a warning to companies that the SEC takes its whistleblower program seriously and will continue to encourage and reward company insiders for coming forward with information that leads to successful enforcement actions. As Sean X. McKessy, Chief of the SEC’s Office of the Whistleblower – a department created by the SEC to give whistleblowers a place to submit their tips – said, “[W]e hope these substantial awards encourage other individuals with knowledge of potential federal securities law violations to make the right choice to come forward and report the wrongdoing to the SEC.”
On June 6, 2016, the Supreme Court of Delaware affirmed a decision of the Chancery Court finding that corporate directors and officers involved in a sales transaction breached a contract with option holders to fairly value their options (see here for a thorough explanation of the Chancery Court decision, and in particular, the Court’s criticism of the retained financial advisers that provided a valuation analysis). The Supreme Court decision also included a disproportionately lengthy dissent condemning both the Chancery Court’s findings and its reliance on “social science studies” to reach them.
On May 31, 2016, the Delaware Chancery Court rejected shareholders’ allegations of corporate wrongdoing in a derivative suit against a national healthcare company, Bioscrip, holding that Plaintiff failed to adequately allege demand futility with respect to Bioscrip’s board of directors. For the first time, the Delaware Court found that Plaintiff was required to demonstrate demand futility with respect to the board of directors that was in place after shareholders filed their derivative complaint. Park Emps.’ & Ret. Bd. Emps.’ Annuity & Ben. Fund v. Smith, No. 11000-VCG (Ch. May 31, 2016).
On June 1, the Second Circuit in Tilton et al. v. SEC, No. 15-2103 (2d. Cir. Jun. 1, 2016), echoed recent Seventh and D.C. Circuit decisions (respectively, Bebo v. SEC, No. 15-1511 (7th Cir. Aug. 24, 2015), cert. denied, 136 S. Ct. 1500 (Mar. 28, 2016), and Jarkesy v. SEC, No. 14-5196 (D.C. Cir. Sept. 29, 2015)) in finding that constitutional or other challenges to SEC proceedings cannot go forward in court until the administrative proceeding ends; review can only be sought as an appeal from a final decision by the Commission. The Second Circuit’s decision in Tilton creates unanimity among the circuit courts that have addressed the issue to date, although, as we previously reported, the Eleventh Circuit is likely to rule on the issue sometime this year in Hill v. SEC, No. 15-12831. Unless the Eleventh Circuit bucks this trend and creates a circuit split, it now looks unlikely that the Supreme Court will weigh in on this issue (particularly because the Supreme Court previously denied a petition to review the Seventh Circuit’s decision in Bebo).
Last week, the SEC’s Office of Inspector General (“OIG”) released its semiannual report to Congress, which details the OIG’s independent and objective audits, evaluations, investigations and other reviews of the SEC’s programs and operations in order to prevent and detect fraud, waste and abuse in SEC programs and operations, and other vulnerabilities the SEC faces. In the most recent report, the OIG was critical of various programs, but most notably: (1) recommended a new framework to increase the Office of Compliance Inspections and Examinations coverage of registered investment advisors, and (2) informed Congress it was conducting a further evaluation on the SEC’s enforcement investigations to ensure that investigations are coordinated internally and across SEC divisions and offices.