Month: September 2013

How Much Latitude Do Directors Have In Setting Executive Compensation?

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Executive compensation decisions are core functions of a board of directors and, absent unusual circumstances, are protected by the business judgment rule.  As Delaware courts have repeatedly recognized, the size and structure of executive compensation are inherently matters of business judgment, and so, appropriately, directors have broad discretion in their executive compensation decisions.  In light of the broad deference given to directors’ executive compensation decisions, courts rarely second-guess those decisions.  That is particularly so when the board or committee setting executive compensation retains and relies on the advice of an independent compensation consultant.

Nevertheless, despite the high hurdle to challenging compensation packages, shareholder plaintiffs continue to aggressively challenge executive compensation decisions, in particular at companies that have performed poorly and received negative or low say-on-pay advisory votes. READ MORE →

Don’t Get Caught In The Crosshairs When The SEC Deploys Its Full Enforcement Arsenal

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On September 26, SEC Chair Mary Jo White gave an important speech to the Council of Institutional Investors in Chicago.  The speech, entitled “Deploying the Full Enforcement Arsenal,” provides the first detailed roadmap to the Commission’s enforcement priorities in the White administration.  While some of the SEC’s enforcement program going forward will involve a continuation and reinforcement of efforts begun during the administration of former Chair Mary Schapiro and former Enforcement Director Robert Khuzami, much of it will entail new initiatives.  The bottom line is that — not surprisingly — Chair White, a former U.S. Attorney, is committed to a vigorous, prosecutorial-minded enforcement program.

Here are the key takeaways from the speech:
Individuals First.  Perhaps most importantly, Chair White stated that the “core principle of any strong enforcement program is to pursue responsible individuals wherever possible.”  Accordingly, she has “made it clear that the staff should look hard to see whether a case against individuals can be brought.  I want to be sure we are looking first at the individual conduct and working out to the entity, rather than starting with the entity as a whole and working in.”  She also indicated that the Commission is likely to seek more industry and officer-and-director bars against individuals.  Chair White described this focus on individuals first as a “subtle” shift in approach, but it is one that, if followed in practice, will have significant consequences, particularly when paired with some of the other initiatives described below. READ MORE →

The Meaning of Life Settlements: Are They Securities Or Not?

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People at a Table

“Life settlements” are financial transactions in which the original owner of a life insurance policy sells it to a third party for an up front, lump sum payment.  The amount paid for the policy is less than the death benefit on the policy, yet greater than the amount the policyholder would otherwise receive from an insurance company if the policyholder were to surrender the policy for its cash value.  For the life settlement investor that buys the policy, the anticipated return is the difference between the death benefit and the purchase price plus the amount paid in premiums to keep the policy in force until the death benefit is payable.

Some commentators have deemed life settlements as essentially a “bet” on the life of the insured.  The longer the insured lives, the lower the rate of return on the investment.  Critics of life settlements are quick to point out that investors have a financial interest in the early demise of the insured person.  The life settlement industry has been subject to extensive litigation for several years.

An important and as yet unsettled question is whether life settlements are “securities” as defined under federal and state securities law.  This basic question has important ramifications for how life settlement contracts will be treated by courts and regulators. READ MORE →

A Tale of Two Paychecks; Ralph Lauren Makes 1,900 Times More than You and the SEC Thinks You Should Know

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Gavel and Hundred-Dollar Bill

On September 18, 2013, the SEC voted to propose a new rule that would require public companies to disclose the ratio of compensation of its CEO to the median compensation of its employees.

The new rule, required under the Dodd-Frank Act, gives companies flexibility to determine the median annual total compensation of its employees in any way that best suits their particular circumstances when calculating the ratio.  SEC Chair, Mary Jo White stated that the SEC is very interested in receiving comments to the proposed approach and the flexibility it provides.

SEC Commissioner Michael S. Piwowar, in a strongly worded statement, expressed his dissatisfaction with the proposed rule.  Quoting from Charles Dickens’ A Tale of Two Cities – “it was the best of times, it was the worst of times” – Piwowar declared that the pay ratio disclosure proposal “represents what is worst about our current rulemaking agenda.”  Piwowar’s concerns were twofold.  First, that the pay ratio disclosure could harm investors.  Piwowar expressed his concern that investors using pay ratios to compare companies risked being distracted from material investment information and mislead by the conclusions offered by the ratios.  Additionally, he noted that investors may also be harmed if pressure to maintain a low pay ratio curtails expansion of business operations into regions with lower labor costs.  Second, he was troubled by his observation that the pay ratio rule could have a negative effect on compensation, efficiency, and capital formation because the competitive impacts of the disclosure would disproportionally fall on U.S. companies with large workforces and global operations and could influence how companies structure their business, leading to inefficiencies, higher cost of capital and fewer jobs. READ MORE →

“Something More” Than “But For” Required in the Ninth Circuit

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The Ninth Circuit recently reversed a ruling by the U.S. District Court of Nevada granting summary judgment in favor of the SEC in a case alleging violations of Section 5 of the Securities Act of 1933 in connection with the sale of unregistered securities.  The SEC’s complaint alleged that 1st Global Stock Transfer LLC (“Global”), a transfer agent, and Global’s owner, Helen Bagley (collectively “Defendants”), assisted in the sale of unregistered securities for CMKM Diamonds, Inc. (“CMKM”), a purported diamond and gold mining company.  The SEC’s complaint further alleged that CMKM had no legitimate business operations but instead the Company concocted false press releases and distributed fake maps and videos of mineral operations to its investors.  While CMKM was one of several defendants in the action, the SEC only moved for summary judgment against Global, Bagley, and CMKM’s attorney.  The District Court granted the SEC’s motion for summary judgment against the three defendants, but only Global and Bagley appealed that ruling.

In perpetrating the scheme, CMKM’s attorney was alleged to have provided hundreds of false opinion letters supporting the issuance of unregistered stock without restrictive legends to indicate that the stock was unregistered.  Relying on these opinion letters, Global and Bagley issued additional CMKM stock without restrictive legends, believing that the issuance was legal.  After a year and a half of this practice, Bagley became suspicious and asked a second law firm to confirm the opinion letters.  The second law firm, however, relied on the first attorney’s opinion letters and also issued an opinion letter stating that the issuance of additional CMKM stock was valid.  Based on the additional opinion letter, Global and Bagley continued to issue CMKM shares without restrictive legends. READ MORE →

The Auditor’s Report: Is “Pass/Fail’” Enough?

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Pen and Calculator

In August, the Public Company Accounting Oversight Board (“PCAOB”) issued a proposal that calls for enhanced communication from Auditors—in addition to the traditional Pass/Fail opinion—in Audit Reports (PCAOB Release No. 2013-005).  If this proposal is approved, it would be the first significant change to the audit report in more than 70 years, according to PCAOB Chairman James Doty.  The proposed changes are based on the premise that investors and financial statement users want more information from auditors, and these changes would represent a huge landscape change for the audit profession.

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Tell One, Tell All, The Risks of Selective Disclosure

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People at a Table

On September 6, 2013, the SEC charged the former head of investor relations at First Solar Inc., an Arizona-based solar company, with violating Regulation FD, which is designed to prevent issuers from selectively disclosing material nonpublic information to certain market participants before disclosing the information to the general public.  In this matter, the SEC determined that Lawrence D. Polizzotto violated Regulation FD when he indicated in “one-on-one” phone conversations with about 20 sell-side analysts and institutional investors that the company was unlikely to receive a much anticipated loan guarantee from the U.S. Department of Energy.  When First Solar disclosed the same information the following morning in a press release, the company’s stock dropped 6 percent.  In addition to a cease-and-desist order, Polizzotto agreed to pay $50,000 to settle the SEC’s charges.   The SEC determined not to bring an enforcement action against First Solar, due in part to the company’s “extraordinary cooperation” with the investigation.

The Polizzotto action is noteworthy for several reasons.  First, is the contrast between that action and the only Regulation FD case to go to litigation.  In June 2004, the SEC filed a civil action against Siebel Systems, Inc. for violating Regulation FD and an earlier SEC cease-and-desist order, and against two of the company’s senior executives for allegedly aiding and abetting Siebel’s violations.  The alleged violations were very similar to those alleged against Polizzotto:  in both cases, the SEC alleged that the company, through its executives, violated Regulation FD by selectively disclosing material nonpublic information to analysts and favored investors in one-on-one meetings before disclosing it publicly.  There were, however, several differences in the facts of the two matters.  In the Siebel matter, the U.S. District Court for the Southern District of New York held that the nonpublic statements made at the one-on-one meetings were not material because they did not add to, contradict, or significantly alter the information that the company had previously made available to the general public.  Although not literally the same as the public statements, the court found that the private statements generally conveyed the same material information.  On the other hand, the SEC deemed that Polizzotto’s statements provided new information about the status of the loan guarantees for one of company’s major projects, even though a letter from a Congressional committee to the Energy Department about the loan guarantee program and the status of conditional commitments, including three involving First Solar, had already caused concern within the solar industry about whether the Energy Department would be able to move forward with its conditional commitments.  The final blow to Polizzotto may have been First Solar’s recognition of the significance of private statements to analysts and particular investors about the loss of the loan guarantee.  For example, a company lawyer had specifically advised that, in discussing this development, the company would “be restricted by Regulation FD in any [sic] answering questions asked by analysts, investors, etc. until such time that we do issue a press release or post to our website….”  Thus, despite the fact that the court in the Siebel Systems action did not consider an 8 percent stock price movement following public disclosure to be material, the SEC here considered the 6 percent stock price movement to be material. READ MORE →

Extra, Extra! – Extraterritoriality And Criminal Actions As To Alleged Securities Fraud

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In its seminal decision in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010), regarding antifraud provisions of the U.S. securities laws, the Supreme Court held that “Section 10(b) [of the Securities Exchange Act of 1934] reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.”  Id. at 2888.  Although Morrison—which involved a private action by foreign plaintiffs—appeared to set down a bright-line rule, it spurred a number of questions, including whether its holding would apply beyond the private civil context, to SEC civil enforcement actions and criminal prosecutions as well.  A large number of courts have already applied Morrison to SEC actions.  In a recent significant development, the Court of Appeals for the Second Circuit concluded that Morrison also applies to criminal cases brought pursuant to Section 10(b) and Rule 10b–5.  United States v. Vilar, Case No. 10-521, at *3 (2d Cir. Aug. 30, 2013).  But the Dodd-Frank Act’s “extraterritorial jurisdiction” amendment to the Exchange Act for actions brought by the SEC and the DOJ—the immediate congressional response to Morrison—will presumably be invoked by the government for actions based on post-amendment conduct. READ MORE →

When Are Directors Liable for Failing to Exercise Proper Oversight?

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Recently we discussed whether directors of public companies face potential liability for not preventing cyber attacks.  As we discussed, the answer is generally no, because absent allegations to show a director had a “conscious disregard” for her responsibilities, directors do not breach their fiduciary duties by failing to properly manage and oversee the company.

That well-established rule was again affirmed last week by the Delaware Court of Chancery in In re China Automotive Systems Inc. Derivative Litigation,  a case that concerned an accounting restatement by a Chinese automotive parts company.  Plaintiffs there alleged that the company’s directors breached their fiduciary duties by failing to manage and oversee the company’s accounting practices and the company’s auditors, who improperly accounted for certain convertible notes from 2009 to 2012.  When the error was uncovered, the company restated its financials for two years and its stock price dropped by 15%. READ MORE →

A Ponzi of A Different Color

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Cuffed Hands

High profile schemes perpetrated by Bernie Madoff, Allen Stanford, Nevin Shapiro, and others have brought, or at least reinforced, a general understanding of the term “Ponzi scheme” into the public lexicon.  But what, legally, is a Ponzi scheme?  In SEC v. Management Solutions, Inc., 2013 WL 4501088 (D. Utah Aug. 22, 2013), Judge Bruce Jenkins endeavored to answer that question and, in the process, authored an encyclopedic account of the term and key court opinions, from seven federal circuits, that have construed it.

Management Solutions was an SEC enforcement action against a father-and-son team that had allegedly raised over $200 million through a “classic Ponzi scheme.”  According to the SEC’s complaint, investors in the scheme were sold “membership interests” in an apartment-flipping business and were guaranteed a return of five to eight percent.  In reality, the funds were allegedly deposited into a general account and were used to pay a variety of expenses, including returns to other investors.  Each of the defendants in the SEC case settled without admitting or denying the allegations.

A hearing was held in 2013 to determine whether, as argued by the court-appointed receiver, the scheme was properly classified as a “Ponzi scheme” and, if so, at what point that designation became applicable.  The receiver sought such a finding in order to obtain the so-called “Ponzi presumption,” which is sufficient to establish actual intent to defraud.  READ MORE →