Securities and Financial Sector Legal Review

Corporate Governance Update – October 2014

Posted in Corporate Governance

Associate Matthew Zucker co-authored this article.

1) Former CFO Sues Walgreens for Defamation Over Earnings Forecast Error

In this Chicago Tribune article, it’s reported that a former Walgreens CFO has sued the company for blaming him for an earnings forecast error – a $1 billion error for which he was terminated.

2) Six Federal Agencies Jointly Approve Final Risk Retention Rule

On October 22, 2014, six federal agencies approved a final rule requiring sponsors of securitization transactions to retain risk in those transactions. The final rule implements the risk retention requirements in the Dodd-Frank Wall Street Reform and Consumer Protection Act.  A copy of the final rule can be accessed here.

3) SEC Approves PCAOB’s Related Party Transaction Changes

On October 21, 2014, the SEC issued an order approving the Public Company Accounting Oversight Board’s (“PCAOB”) new related-party transaction standards. Notably, the SEC retained the PCAOB’s proposed effective date – so the new standards will become effective for audits for fiscal years beginning on and after December 15, 2014.

4) SEC Statistics

On October 16, 2014, the SEC released the statistics for the activities of its Enforcement Division for the agency’s 2014 fiscal year, noting a “record” number of enforcement actions in 2014 involving a “wide range of misconduct” and including a “number of first-ever cases.” An analysis of the information released by the SEC that was produced by Kevin LaCroix at RT ProExec can be found here.

5) SEC Staff Goes After “Unregistered Securities” Brokers

The Division of Trading & Markets issued this set of FAQs – and OCIE issued this Risk Alert – to remind brokers of their obligations when they sell unregistered securities on behalf of clients, such as when founders and employees sell their initial stakes in companies that have gone public or when investors sell securities in public companies that were acquired in private placements. This twin sets of Staff guidance was accompanied by the announcement of an enforcement action against E*Trade for improperly selling billions of shares of penny stocks through such unregistered offerings. Stan Keller notes that while this doesn’t deal with lawyers and no registration opinions, including resales, the guidance has relevance for lawyers.

6) SEC and FINRA Warn Investors About Penny Stock Scams Hyping Dormant Shell Companies

On October 30, 2014, The SEC’s Office of Investor Education and Advocacy and the Financial Industry Regulatory Authority (FINRA) issued an alert warning investors that some penny stocks being aggressively promoted as great investment opportunities may in fact be stocks of dormant shell companies with little to no business operations. A copy of the press release can be found here.

Corporate Governance Update – September 2014

Posted in Corporate Governance, Enforcement Actions and Investigations, False Claims Act and Whistleblower Litigation

Associate Michael A. Rueda co-authored this article.

1) SEC Launches Section 16 and Schedule 13D Enforcement Initiative

In early September, the SEC announced charges against 28 officers, directors, or major shareholders for violating federal securities laws requiring them to promptly report information about their holdings and transactions in company stock (Section 16(a) reports and Schedules 13D and 13G). Six publicly-traded companies were charged for contributing to filing failures by insiders or failing to report their insiders’ filing delinquencies. Those companies settled allegations that they failed to disclose their insiders’ Section 16(a) violations as required by Item 405 of Regulation S-K.

2) World’s Leading Institutional Investors Managing $24 Trillion Call for Carbon Pricing, Ambitious Global Climate Deal

Prior to the recent Climate Summit at the United Nations to spur climate action and facilitate a global climate agreement in 2015, nearly 350 global institutional investors representing over $24 trillion in assets issued a statement calling on government leaders to provide stable, reliable and economically meaningful carbon pricing that helps redirect investment commensurate with the scale of the climate change challenge, as well as develop plans to phase out subsidies for fossil fuels.

3) SEC Grants Bad Actor Waivers to Citigroup

The SEC granted Citigroup waivers from restrictions that would have restricted a range of the bank’s activities, including selling investments in hedge funds to individuals, following a recent securities-fraud settlement. In August, the SEC completed a $285 million settlement with Citigroup over the sale of certain collateralized debt obligations to clients in late 2006 and early 2007. Under the SEC’s bad actor rule, parties with a “a relevant criminal conviction, regulatory or court order, or other disqualifying event” are restricted from participating in a private offering. The rule, adopted last year, is part of the 2010 Dodd-Frank regulatory changes.

Citigroup told clients in August it was working with the SEC to resolve the restrictions over the bank’s sale of hedge funds. The SEC granted Citigroup its request for a waiver to resume selling so-called private fund investments, accepting the bank’s arguments that its $285 million settlement didn’t involve intentional misconduct or a large number of employees. The SEC grants waivers to let firms conduct normal business, as long as the waiver is seen as being in the public’s interest. The SEC also allowed Citigroup to retain its “WSKI” status, removing a restriction that applied to the bank given the SEC’s finding that Citigroup violated antifraud provisions of U.S. securities laws. Firms found to have violated those laws typically have their status revoked for three years but are granted the option of appealing the decision.

The waivers can be found here and here.

4) Council of Institutional Investors Wants Proxy Disclosure of Board Evaluation Process

In its report, “Best Disclosure: Board Evaluation,” surveyed CII members said they value detailed disclosure of the board evaluation process when deciding on director elections. CII makes clear that investors do not expect information about the results of the actual evaluations, but believe that the process discussion “…is an indication that a board is willing to think critically about its own performance on a regular basis and tackle any weaknesses.”

5) SEC Announces Largest-Ever Whistleblower Award

On September 22nd, the SEC announced an expected award of more than $30 million to a whistleblower who provided key original information that led to a successful SEC enforcement action. The award will be the largest made by the SEC’s whistleblower program to date and the fourth award to a whistleblower living in a foreign country, demonstrating the program’s international reach.


Corporate Governance Update – August 2014

Posted in Corporate Governance

Associate Michael A. Rueda co-authored this article.

SEC Fee Rate Advisory #1 for Fiscal Year 2015

The SEC announced that in fiscal year 2015 the fees that public companies and other issuers pay to register their securities will be set at $116.20 per million dollars, representing a 10% drop from the current filing fee rate of $128.80 per million dollars.  The SEC order can be reviewed here.

SEC Announces $300,000 Whistleblower Award to Audit and Compliance Professional Who Reported Company’s Wrongdoing

The SEC announced a whistleblower award of more than $300,000 to a company employee who performed audit and compliance functions and reported wrongdoing to the SEC after the company failed to take action when the employee reported it internally.  It’s the first award for a whistleblower with an audit or compliance function at a company.

SEC Adopts Asset-Backed Securities Reform Rules

The SEC announced that it has adopted new rules for asset-backed issuers governing the disclosure, reporting, and offering process for asset-backed securities (ABS) to enhance transparency, better protect investors, and facilitate capital formation in the securitization market.

SEC Adopts Credit Rating Agency Reform Rules

The SEC announced that it has adopted new requirements for credit rating agencies to enhance governance, protect against conflicts of interest, and increase transparency to improve the quality of credit ratings and increase credit rating agency accountability.  The new rules and amendments, which implement 14 rulemaking requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act, apply to credit rating agencies registered with the SEC as nationally recognized statistical rating organizations (NRSROs).

SEC Charges Bank of America with Fraud in RMBS Offering

The SEC charged Bank of America and two subsidiaries with defrauding investors in an offering of residential mortgage-backed securities (RMBS) by failing to disclose key risks and misrepresenting facts about the underlying mortgages. (Press release and complaint)

The SEC alleges that Bank of America failed to tell investors that more than 70 percent of the mortgages backing the offering originated through the bank’s “wholesale” channel of mortgage brokers unaffiliated with Bank of America entities.  Bank of America knew that such wholesale channel loans presented vastly greater risks of severe delinquencies, early defaults, underwriting defects, and prepayment.  Bank of America only selectively disclosed the percentage of wholesale channel loans to a limited group of institutional investors.  Bank of America never disclosed this material information to all investors and never filed it publicly as required under the federal securities laws.

SEC Announces Award for Whistleblower Who Reported Fraud to SEC After Company Failed to Address Issue Internally

The SEC announced an award of more than $400,000 for a whistleblower who reported fraud to the SEC after the company failed to address the issue internally.

SEC Investor Alert on Unregistered Offerings

The SEC’s Office of Investor Education and Advocacy published an alert regarding unregistered offerings, entitled “10 Red Flags That an Unregistered Offering May be a Scam.” When Rule 506(c) of Regulation D was adopted pursuant to Title II of the JOBS Act, many feared that the rule would facilitate scammers trying to use the lifting of the general solicitation ban as a way to reach more potential victims.  This new investor alert is directed at educating investors about scams involving private placements and unregistered offerings, not just those involving a general solicitation.

SEC Announces Settled Proceedings for CEO and CFO Violations of SOX Internal Control and Certification Provisions

The SEC announced partially settled administrative proceedings against the CEO and former CFO of a company for violating the SOX internal control and certification provisions. The SEC alleges that the CEO and former CFO represented in a management’s report on internal controls that the CEO participated in management’s assessment of the company’s internal controls, when he didn’t actually participate in the evaluation. Moreover, the CEO and former CFO were alleged to have each certified that they had disclosed all significant deficiencies in internal controls to the outside auditors, when they allegedly misled the auditors about their controls by withholding from the auditors information about inadequate inventory controls and improper accounting practices.  It is not often in the years since SOX was enacted that these sort of standalone internal control/certifications cases are brought. Typically charges on these points are incidental to a much larger case relating to accounting failure.

SEC Publishes Investor Alert Regarding False and Misleading Stock Information Spread via Social Media

The SEC’s Office of Investor Education and Advocacy published an Investor Alert warning that promoters may use social media channels to spread false and misleading information about stock, mostly penny stocks.  Use of social media enables promoters to reach larger numbers of individuals with minimum effort and at a relatively low cost.  The alert provides tips as to how to spot the red flags of a social media based investment fraud.

      I.        LEGAL UPDATES

Delaware Extends Inspection Rights to Privileged Internal Investigation Documents

The Delaware Supreme Court in Wal-Mart v. Indiana Electrical Workers Pension Trust Fund – approved granting shareholders the right to inspect privileged and confidential internal investigation materials upon showing “good cause.”

American Meat Institute and the Conflict Minerals Rules

The U.S. Court of Appeals for the District of Columbia Circuit issued an en banc opinion in the appeal of American Meat Institute vs. U.S. Department of Agriculture, upholding a Department of Agriculture rule requiring “country of origin” labeling for meat products.  The outcome of this case may give the SEC hope that the Court will reverse the three-judge panel’s holding that the Dodd-Frank Act conflict minerals disclosure rules violate the First Amendment in National Association of Manufacturers, et al., v. Securities and Exchange Commission.  This is because a central issue with regard to the standard for review in the National Association of Manufacturers case was also at issue in American Meat Institute.

    II.        OTHER

Broadridge Publishes 2014 Proxy Season Statistics

Broadridge released its 2014 proxy season statistics. Most were in line with recent years, except mobile voting grew to over 1.5 million shareholders, a 300% increase over since ’12 and 70% from ’13.

PwC and IRRC Report on Cybersecurity Disclosures

A report released by PwC and the Investor Responsibility Research Center Institute indicates that while companies must disclose significant cyber risks, “those disclosures rarely provide differentiated or actionable information.” The report goes on to examine key cybersecurity threats to corporations and provides information to investors for the purpose of evaluating investment risk, business mitigation strategies, and the quality of corporate board oversight.

Updated AICPA Comfort Letter Guidance

The American Institute of Certified Public Accountants issued SAS 129, which amends the guidance in SAS 122 on comfort letters. The amendment addresses the auditor’s responsibilities when engaged to issue comfort letters to requesting parties in connection with a nonissuer entity’s financial statements included in a registration statement or other securities offerings. Through this amendment, the AICPA is seeking to address unintended changes to previous practices as a result of its Clarity Project (not to be confused with the FASB Simplification Initiative). The amended comfort letter guidance is effective for comfort letters issued on or after December 15, 2014, but early implementation is encouraged

Corporate Governance Update – July 2014

Posted in Corporate Governance

Associate Raxak Mahat co-authored this article.

1. SEC Charges Company CEO and Former CFO With Hiding Internal Controls Deficiencies and Violating Sarbanes-Oxley Requirements

On July 30, 2014, the SEC announced charges against the CEO and former CFO of QSGI Inc., a Florida-based computer equipment company for misrepresenting to external auditors and the investing public the state of its internal controls over financial reporting. The SEC’s Enforcement Division alleges that CEO Marc Sherman and former CFO Edward L. Cummings (i) misrepresented in a management’s report accompanying the fiscal year 2008 annual report for QSGI Inc. that Sherman participated in management’s assessment of the internal controls, (ii) improperly certified that they had disclosed all significant deficiencies in internal controls to the outside auditors, and (iii) withheld from auditors and investors that Sherman and Cummings participated in a series of maneuvers to accelerate the recognition of certain inventory and accounts receivables in QSGI’s books and records by up to a week at a time.

2. Chamber Releases Disclosure Effectiveness Recommendations

On July 30, 2014, the U.S Chamber of Commerce’s Center for Capital Markets Competitiveness released a set of recommendations for the SEC as the agency considers how to make disclosure more effective. The report contains both near-term and long-term recommendations for improvement, and among the near-term recommendations are suggestions to address identified reporting requirements that are obsolete or duplicative of other disclosures (e.g., Item 101 of S-K disclosure of acquisitions, financial disclosure by geographic region, disclosure of where an investor can get copies of filings). Longer-term improvements suggested by the Center include addressing the problem of duplication among SEC filings, modernizing the presentation and delivery of public company reports, and reforming disclosures for CD&A and MD&A.

3. SEC Adopts Money Market Fund Reform Rules

On July 23, 2014, the SEC adopted amendments to the rules that govern money market mutual funds. The new rules require a floating net asset value (NAV) for institutional prime money market funds, which allows the daily share prices of these funds to fluctuate along with changes in the market-based value of fund assets and provide non-government money market fund boards new tools – liquidity fees and redemption gates – to address runs.

4. ISS Releases Survey for 2015 Policy Updates

On July 17, 2014, Institutional Shareholder Services Inc. (ISS), the most influential proxy advisory firm, opened its annual survey ahead of updating its policies. The survey closes on August 29th – and then the results are released a few weeks later. There is also an open 30-day comment period in October, with the final policy updates arriving sometime in November.

5. FASB Publishes Proposal to Eliminate Extraordinary Items from US GAAP

On July 15, 2014, the Financial Accounting Standards Board (FASB), issued an exposure draft of a proposed Accounting Standards Update (ASU) that would eliminate the concept of extraordinary items from US GAAP. The proposed ASU is part of a simplification initiative by the FASB to identify, evaluate and improve areas of US GAAP for which cost and complexity can be reduced, while maintaining or improving the usefulness of the information provided to users of financial statements.

6. SEC Charges Ernst & Young With Violating Auditor Independence Rules in Lobbying Activities

On July 14, 2014, the SEC charged Ernst & Young LLP with violations of auditor independence rules. The SEC’s order instituting a settled administrative proceeding found that an Ernst & Young subsidiary lobbied congressional staff on behalf of two audit clients. Such lobbying activities were impermissible under the SEC’s auditor independence rules because they put the firm in the position of being an advocate for those audit clients. Despite providing the prohibited legislative advisory services on behalf of the clients, Ernst & Young repeatedly represented that it was “independent” in audit reports issued on the clients’ financial statements. Ernst & Young agreed to pay more than $4 million to settle the charges.

7. FINRA Clarifies Filing Requirements under Rule 2210 for Certain Research Reports and FWPs

On July 11, 2014, FINRA issued Regulatory Notice 14-30, announcing that the SEC has approved amendments to FINRA Rule 2210 (Communications with the Public) that: (i) exclude from Rule 2210’s filing requirements research reports concerning only securities listed on a national securities exchange and (ii) clarify that free writing prospectuses that are exempt from filing with the SEC are not subject to Rule 2210’s filing or content standards, while the filing and content requirements of Rule 2210 do apply to free writing prospectuses required to be filed with the SEC pursuant to Securities Act Rule 433(d)(1)(ii). These amendments were effective immediately.

8. SEC Issues New C&DIs on Accredited Investor Definition and Rule 506(c) “Reasonable Steps” Verification Safe Harbors

On July 3, 2014, the SEC issued new compliance and disclosure interpretations (C&DIs) on the definition of accredited investor under Rule 501(a) and the safe harbors for taking “reasonable steps” to verify accredited investor status under Rule 506(c).

9. NASAA Proposes Model State Rule for Electronic Filing of Form D and Other Documents with State Securities Regulators

The North American Securities Administrators Association (NASAA) sought comment on a proposed model rule that would require issuers to electronically file SEC Form D and other state securities registration and notice filing materials with state securities administrators through a new multi-state electronic filing system currently being developed by NASAA.


Update: Judge Rakoff Approves Citigroup-SEC Settlement

Posted in Mortgage-Backed Securities, Notable Decisions

One final development in the Citigroup-SEC settlement saga.  Today, Judge Rakoff approved the $285 million proposed settlement of the SEC’s charges against Citigroup in connection with certain mortgage-backed securities transactions.  This follows the Second Circuit’s decision on June 4th to vacate Judge Rakoff’s decision that rejected the settlement.  In that 2011 decision, Judge Rakoff criticized the Citigroup-SEC settlement on a number of grounds, including that it allowed Citigroup to avoid admitting guilt.  He was no less critical of the Second Circuit in his opinion approving the settlement, stating that the Court of Appeals “has now fixed the menu, leaving this Court with nothing but sour grapes.”

The case is U.S. Securities and Exchange Commission v. Citigroup Global Markets Inc., U.S. District Court for the Southern District of New York, No. 11-cv-7387.  For additional commentary and analysis, see Judge Rakoff Says 2011 S.E.C. Deal With Citigroup Can Close, Approval of SEC-Citigroup Deal Leaves Rakoff With a Case of ‘Sour Grapes’, and U.S. Judge Reluctantly Approves SEC-Citigroup $285 Million Deal.

Corporate Governance Update – June 2014

Posted in Corporate Governance

Associate Michael Rueda co-authored this article.

1. SIFMA Guidance on Accredited Investor Verification

Last week, the Securities Industry and Financial Markets Association (SIFMA) issued guidance to registered broker-dealers and investment advisers on some accredited investor verification methods. The guidance includes a form of a Rule 506(c) accredited investor questionnaire as well as a form of written confirmation.

2. SEC Announces Fraud Charges Against Three Former Regions Bank Executives in Accounting Scheme

The Securities & Exchange Commission announced fraud charges against three former senior managers of Regions Bank for intentionally misclassifying loans that should have been recorded as impaired for accounting purposes. The SEC also entered into a deferred prosecution agreement with Regions Financial Corp., which substantially cooperated with the agency’s investigation and undertook extensive remedial actions. Regions will pay a total of $51 million to resolve parallel actions by the SEC, Federal Reserve Board, and Alabama Department of Banking.

3. SEC Charges Former Brokers with Trading Ahead of IBM-SPSS Acquisition

The SEC charged two additional brokers with trading on inside information ahead of the $1.2 billion acquisition of SPSS Inc. in 2009 by IBM Corporation. The SEC alleged that former brokers Benjamin Durant III and Daryl M. Payton illegally traded on a tip about the acquisition from Thomas C. Conradt, a friend and fellow broker in the New York office of a Connecticut-based broker-dealer. The SEC complaint, filed in federal court in Manhattan, seeks return of alleged ill-gotten trading gains of approximately $300,000, with interest, financial penalties, and permanent injunctions. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Durant and Payton. The SEC previously charged that Conradt and David J. Weishaus, another fellow broker and tippee, traded on confidential information that Conradt received from his roommate, Trent Martin, a research analyst who misappropriated it from an attorney working on the transaction. Martin, Conradt, and Weishaus settled with the SEC and pled guilty last year to related criminal charges in the matter.

4. SEC Adopts Cross-Border Security-Based Swap Rules

The SEC adopted the first of a series of rules and guidance on cross-border security-based swap activities for market participants. The new rules will be key to finalizing the remaining proposals. The rules will be effective 60 days after their publication in the Federal Register.

5. SEC Charges Hedge Fund Advisory Firm and Others in South Florida-Based Scheme to Misuse Investor Proceeds

The SEC charged a West Palm Beach, Fla.-based hedge fund advisory firm and its founder with fraudulently shifting money from one investment to another without informing investors. The firm’s founder and another individual later pocketed some of the transferred investor proceeds to enrich themselves.

6. SEC to Bring More Insider Trading Cases in Administrative Proceedings?

As noted in a recent Reuters article, the SEC is looking to bring more insider trading cases “as administrative proceedings in appropriate cases,” Andrew Ceresney, head of the SEC enforcement division, told the District of Columbia Bar. “We have in the past. It has been pretty rare. I think there will be more going forward.”

7. The SEC’s First Whistleblower Retaliation Case

The SEC has brought its first whistleblower retaliation case against Paradigm Capital Management, Inc. for engaging in prohibited principal transactions and then retaliating against the employee who reported the trading activity to the SEC. This is the first time the SEC has filed a case under its new authority to bring anti-retaliation enforcement actions. The SEC also charged the firm’s owner with causing the improper principal transactions.

8. PCAOB Adopts “Related Parties & Unusual Transactions” Auditing Standard

The PCAOB recently adopted Auditing Standard #18 that expands audit procedures required to be performed with respect to three important areas: (1) related party transactions; (2) significant unusual transactions; and (3) a company’s financial relationships and transactions with its executive officers. The standards also expand the required communications that an auditor must make to the audit committee related to these three areas. They also amend the standard governing representations that the auditor is required to periodically obtain from management. The standard and amendments require SEC approval. If approved, they will become effective for audits of financial statements for fiscal years beginning on or after December 15, 2014, including reviews of interim financial information and may be revised for small reporting companies.

9. SEC Charges Bitcoin Entrepreneur With Offering Unregistered Securities

The SEC announced that is has charged the co-owner of two Bitcoin-related websites for publicly offering shares in the two ventures without registering them. A SEC investigation found that Erik T. Voorhees published prospectuses on the Internet and actively solicited investors to buy shares in SatoshiDICE and FeedZeBirds. But he failed to register the offerings with the SEC as required under the federal securities laws. Investors paid for their shares using Bitcoin, a virtual currency that can be used to purchase real-world goods and services and exchanged for fiat currencies on certain online exchanges. The profits ultimately earned by Voorhees through the unregistered offerings totaled more than $15,000.


Update – The Middle Road Taken: The Supreme Court’s Halliburton II Decision

Posted in Securities Fraud and Class Actions

On June 23, 2014, the Supreme Court issued its Decision in Halliburton v. Erica P. John Fund (“Halliburton II”). The decision upholds the Court’s prior Basic v. Levinson decision allowing the fraud on the market theory that presumes reliance, however; the Court agreed with Halliburton that defendants could rebut the presumption pre-class certification with evidence that an alleged misrepresentation did not actually affect the stock price. According to Law360, the decision “will likely make it somewhat more difficult for plaintiffs to bring securities class actions, but it stopped short of closing a major door.”

Chief Justice Roberts delivered the opinion of the Court, joined by Justices Kennedy, Ginsburg, Breyer, Sotomayor and Kagan.  Justice Ginsburg filed a concurring opinion, in which Justices Breyer and Sotomayer joined.  Justice Thomas filed an opinion concurring in the judgment, which Justices Scalia and Alito joined.

By way of background, Plaintiffs alleged that Halliburton “made a serious of misrepresentations regarding its potential liability in asbestos litigation, its expected revenue from certain construction contracts, and the anticipated benefits of its merger with another company – all in an attempt to inflate the price of its stock,” which dropped after Halliburton made a series of corrective disclosures.  Plaintiffs filed a motion to certify a class, which the District Court denied.  This District Court (which was affirmed by the Fifth Circuit) found that Plaintiffs must prove “loss causation,” that is, a “causal connection between the defendants’ alleged misrepresentations and the plaintiffs’ economic losses in order to invoke Basic [v. Levinson]’s presumption of reliance and obtain class certification.”  In its 2011 opinion, the Supreme Court vacated the judgment, finding that nothing in Basic justified the Fifth Circuit’s requirement that Plaintiffs prove loss causation at the class certification stage.  On remand, Halliburton argued that it had presented the absence of any price impact caused by its misrepresentations, and thus, investors would have to prove reliance on an individual basis rather than take advantage of Basic, which should defeat certification of the class.  The District Court rejected this argument, and the Fifth Circuit affirmed, finding that Halliburton’s price impact evidence could be used at trial on the merits, but that Halliburton could not use such evidence at the class certification stage.

In its 2014 Decision, the Supreme Court considered Halliburton’s request to overrule Basic’s presumption of reliance and “to instead require every securities fraud plaintiff to prove that he actually relied on the defendant’s misrepresentation in deciding to buy or sell a company’s stock.”  Halliburton advanced several arguments that Basic should be overruled, principal among them the “efficient capital markets hypothesis.” Essentially, Halliburton argued that Basic’s view of the market efficiency (that prices of shares traded on developed markets reflect all publicly available information, including any material misrepresentations) is “no longer tenable.”  According to Halliburton, empirical evidence suggests capital markets are not fundamentally efficient. This evidence, citing to recent crashes, suggests that information affecting a stock price is not immediately incorporated into stock price. The Supreme Court declined to disturb Basic, finding it rested on a “modest” premise.  As the Court held, “[e]ven the foremost critics of the efficient-capital markets hypothesis acknowledge that public information generally affects stock prices.”

While the Supreme Court kept the Basic presumption alive, it did give defendants a weapon.  Overruling the Fifth Circuit, the Supreme Court held that defendants should be able to defeat the presumption at the class certification stage through evidence that the alleged misrepresentation did not affect the stock price – so-called “price impact evidence.”  The Court held:

The fact that a misrepresentation “was reflected in the market price at the time of [the] transaction” – that it had price impact – is “Basic’s fundamental premise.”  Halliburton I, 563 U.S. at __ (slip op., at 7).  It thus has everything to do with the issue of predominance at the class certification stage.  That is why, if reliance is to be shown through the Basic presumption, the publicity and market efficiency prerequisites must be proved before class certification.  Without proof of these prerequisites, the fraud-on-the-market theory underlying the presumption completely collapses, rendering class certification inappropriate.  But as explained, publicity and market efficiency are nothing more than prerequisites for an indirect showing of price impace. There is no dispute that at least such indirect proof of price impact “is needed to ensure that the questions of law or fact common to the class will ‘predominate.’”  Amgen, 568 U.S. at __ (slip op., at 10) (emphasis deleted); see id., at __ (slip op., at 16-17).  That is so even though such proof is also highly relevant at the merits stage

Accordingly, the Court held that Defendants may introduce either “direct” or “indirect” price impact evidence at the class certification stage. Practicallly speaking, this means both sides will rely on experts and price impact studies, which will likely increase costs, and potentially serve as a deterrent to plaintiffs.  As Justice Ginsburg wrote in her concurring opinion, “[t]he Court’s judgment, therefore, should impose no heavy toll on securities-fraud plaintiffs with tenable claims.”  It may, however, result in fewer cases brought by plaintiffs with weaker claims.

In the few days since the decision came out, there has been significant commentary on its reasoning and likely effects.

While the Supreme Court took a “middle road,” many wonder if this created more confusion.  Professor Charles Korsmo of Case Western Reserve University School of Law told the Volokh Conspiracy that the decision “renders an already confused area of the law even more convoluted…”  Among other things, he observed that “[t]he dispute is almost never over whether there actually was a stock drop; it is over whether the company fraudulently concealed the negative information.”

Law 360 noted that the decision leaves open what exactly must be proven to show price impact or the lack thereof:

Price impact studies ultimately will be a tool defendants use to try to defeat claims at the class certification stage, so questions about what exactly defendants need to prove will have to be answered, according to Boris Feldman, a partner at Wilson Sonsini Goodrich & Rosati PC. Is it enough for the defendant to show no price impact followed the false statement? Or will they also have to show there was no impact when the corrective disclosure was made?

The real winners here may be the experts.  Costs will likely increase on both the plaintiff and defendant side to reflect the costs of preparing “price impact studies” at the pre-certification stage.  Beyond the costs of an expert price impact study, commentators also raised the spectre of increased discovery costs. Reuters columnist Alison Frankel, spoke to David Boies, attorney for the Halliburton II plaintiffs. She reported,

Moreover, Boies pointed out, defendants who decide to raise price impact arguments to oppose class certification will have to face shareholders’ discovery demands on the merits of their defenses. That’s going to expose defendants to depositions and documents requests they won’t welcome, he said. “Plaintiffs are going to get a whole lot more information at the class certification stage,” Boies said.

In anticipating of the decision, D&O insurers already began taking action.  As Law 360 reported,

Anticipating a so-called middle-of-the-road ruling in Halliburton, American International Group Inc. had already offered D&O policyholders an “event study endorsement” that will apply a $0 retention toward the cost of class certification event studies — critical tools used in securities litigation to measure an isolated stock price movement.


A representative for AIG said the Halliburton ruling has not impacted the company’s new policy provision. The decision to provide full, upfront coverage for costs of a class certification event study can be seen as a bet on AIG’s part that the Supreme Court’s decision, though tempered, is likely to benefit at least a few defendants battling securities class actions, experts say.


Breaking: Supreme Court Decides Halliburton

Posted in Securities Fraud and Class Actions

Today, the Supreme Court issued its Decision in Halliburton v. Erica P. John Fund. The decision upholds the Court’s prior Basic v. Levinson holding allowing the fraud on the market theory that presumes reliance, however; the Court agreed with Halliburton that defendants could rebut the presumption pre-class certification with evidence that an alleged misrepresentation did not actually affect the stock price. According to Law360, the decision “will likely make it somewhat more difficult for plaintiffs to bring securities class actions, but it stopped short of closing a major door.”


We will update this post with more analysis.


Corporate Governance Update – May 2014

Posted in Corporate Governance




Recent studies indicate that over the past year companies have become more sensitive to environmental, social, and governance (ESG) concerns of shareholders. One article describes a study compiled by the Institutional Shareholder Services that relies on data from investor complaints lodged during recent proxy seasons and suggests that social responsibility investors (SRI) have been encouraged by company action.

Indeed, shareholder litigation after regulatory/enforcement action has increased and led to shareholder lawsuits in which directors have been named and claimants have sought damages for the environmental remediation costs the company incurred. Coupled with efforts this year by the United Nations Global Compact that encouraged investors to submit their sustainability desires to the World Federation of Exchanges, investors have been influencing companies’ attention to climate change and sustainability. Their actions may soon influence the ESG reporting standards required by the New York Stock Exchange.


On May 2nd 2014, the SEC issued an order staying the effective date for compliance with the portions of the Exchange Act Rule 13p-1 and Form SD that the Court of Appeals held would violate the First Amendment. However, with respect to portions not deemed to violate the First Amendment, companies were expected to file any report required under Rule 13p-1 on or before the due date.

The SEC order issuing stay can be found here.

The April 29th 2014 statement the order refers to can be found here.


On May 29th 2014, the SEC filed a petition seeking en banc rehearing of the conflict minerals decision. The original decision from April 14, 2014 found that the requirement that issuers report to the SEC and state on their website “that any of their products have not been found to be ‘DRC conflict free’” compelled speech and violated the First Amendment. Although en banc review is difficult to attain, the need for en banc review in the conflict minerals is heightened given that the appropriate level of scrutiny for deciding the First Amendment issue is already subject to en banc review in the American Meat Institute case.

The petition for the rehearing can be found here.


On May 22nd 2014, the SEC announced the latest in a series of cases against microcap companies, officers, and promoters arising out of a joint law enforcement investigation to unearth penny stock schemes with roots in South Florida. The SEC charged five penny stock promoters with conducting various manipulation schemes involving undisclosed payments to induce purchases of a microcap stock to generate the false appearance of market interest

An article elaborating upon these charges can be found here.


On May 16th 2014, in United States v. Joel Esquenazi and Carlos Rodriguez, the Eleventh Circuit Court of Appeals became the first court to address the definition of the term “instrumentality” (“entity controlled by the government of a foreign country that performs a function the controlling governments treats as its own”) as it appears in the Foreign Corrupt Practices Act (“FCPA”). The court, in addition to providing  a non-exhaustive list of factors to consider, also provided the following two-part test to determine whether an entity is an instrumentality of a foreign government: (1) whether a foreign government controls the entity in question and (2) whether an entity performs a function the foreign government treats as its own.

The DOJ and SEC view this decision as validating their broad interpretation of who qualifies as a “foreign official” under the FCPA. Esquenazi demonstrates that companies cannot rely on “public” or “private” labels to determine whether an entity is an instrumentality under the FCPA.

A more in-depth article on this topic can be found here.


On May 1st 2014, the SEC announced an enforcement action against the NYSE and two affiliated exchanges for their failure to comply with the responsibilities of self-regulatory organizations (SROs) to conduct their business operations in accordance with SEC-approved exchange rules and the federal securities law.

While the NYSE operates under the auspices of its own laws and the securities laws, as SROs, the NYSE exchanges must file all proposed rules and rule changes with the SEC. The SEC then publishes them for public comment before they take effect. The violations occurred over the period from 2008 to 2012 and breached Section 19 (b) and 19 (g) of the Securities Exchange Act.

More on this topic can be found here.


On May 19th 2014, at the NYC Bar Association’s Third Annual White Collar Crime Institute in New York, NY, Chair Mary Jo White presented a nuanced view of the following three key pressure points of some of the more significant issues in the current enforcement environment:

 1. the pressure of multiple regulators with overlapping mandates to pursue the same investigations and achieve coordination successes while avoiding unnecessary competition,

2. the decision of whether to charge individuals, entities, or both in order to both emphasize regulatory scrutiny for individuals and effectively hold corporations accountable for negligent and intentional wrongdoing, and

3. the range of remedies and ultimate resolutions, such as barring wrongdoers for periods of time, requiring admissions of wrongdoing in certain cases, and using monitors or independent compliance consultants to directly address root causes of misconduct.

The full transcript of Chair Mary Jo White’s speech can be found here.




On May 1st 2014, the SEC approved changes to FINRA’s rules to limit self-trading. FINRA Rule 5210 now requires firms to have policies and procedures in place that are reasonably designed to review their trading activity and prevent a pattern or practice of self-trades resulting from orders originating from a single algorithm or trading desk, as well as those related algorithms or trading desks.

FINRA stated that it will announce an effective date to reflect this change to FINRA Rule 5210 in a regulatory notice in the near future.


The SEC recently approved FINRA’s amendment to Rule 5110, commonly referred to as the “Corporate Financing Rule,” which addresses commercial fairness in underwriting and other arrangements for the distribution of securities. The amendment expands the circumstances in which termination fees and rights of first refusal are permissible, eliminates obligations of the issuer with respect to the payment of any termination fee, and eliminates the requirement to file offerings of certain types of ETF’s.

The SEC also approved FINRA’s amendment to Rule 5121, the Conflict of Interest Rule. The new amendment narrows the scope of the definition of “control.” Whereas “control” historically included being a holder of 10% or more of the debt of the issuer, the new rules narrows the scope of the definition to exclude holders of subordinated debt.




The 2014 proposed amendments to the General Corporation Law of the State of Delaware

(“DGCL”) would give corporations and their counsel increased flexibility in structuring transactions and in effecting various corporate acts.

These sections would provide the following changes:

1. Section 251(h) will clarify the requirements for accomplishing two-step takeovers without a back-end vote on the merger,

2. Section 141(f) will provide a means of enabling board and stockholder consents to be delivered in escrow,

3. Section 141(f) along with Section 228(c) will clarify the time frame that a person executing stockholder consent may provide consent,

4. Section 242 will simplify the process of implementing certain amendments to the certificate of incorporation,

5. Section 218 will relax the filing requirements in respect of voting trusts, and

6. Section 103(a)(1) will provide corporations a means of dealing with issues that arise when their incorporator has not duly completed the incorporation process and cannot be located to assist with any necessary corrective measures.

An in-depth discussion of the proposed amendments from Insights can be found here.


On May 2nd 2014, in Third Point LLC v. Ruprecht, et al. the Delaware Court of Chancery denied preliminary injunctive relief against Sotheby’s annual meeting, scheduled for May 6, 2014.

Plaintiffs claimed that the board had violated its fiduciary duties by (1) adopting a stockholder rights plan with a two-tiered trigger, capping stockholders who file Schedule 13Ds at 10% of the outstanding stock, but permitting passive investors who file Schedule 13Gs to acquire up to 20% of the outstanding stock; and (2) refusing to grant Third Point, the company’s largest stockholder, a waiver enabling it to acquire up to 20% of the outstanding stock.

On a preliminary basis, the Court held that Unocal, rather than Blasius, provides the appropriate framework of analysis. Under Unocal, the Court held that the majority-independent board showed that it acted reasonably in interpreting Third Point as a legally cognizable threat and responded reasonably

To read the full opinion, click here.




On May 2nd, 2014, the SEC announced that Chief Economist and Division of Economic Risk Analysis (DERA) Director Craig M. Lewis will leave the agency to return to his position as the Madison S. Wigginton Professor of Finance at Vanderbilt University’s Own Graduate School of Management.


On May 15th, 2014, the SEC announced that after a six-year tenure at the SEC, Chief Accountant Paul A. Beswick is leaving the agency to return to the private sector. During the transitional period, he will remain to help ensure continuity in the agency’s Office of the Chief Accountant (OCA).


On May 29th, 2014, the SEC announced that Stephanie Avakian has been named Deputy Director of its Division of Enforcement. She comes to the SEC from the law firm of Wilmer Cutler Pickering Hale and Dorr LLP, where she is a partner in the New York office and a vice chair of the firm’s securities practice.

Second Circuit Vacates Judge Rakoff’s Decision Rejecting Citigroup-SEC Settlement

Posted in Securities Fraud and Class Actions

Today, the Second Circuit Court of Appeals vacated Judge Rakoff’s November 28, 2011 Order, which criticized the Citigroup-SEC settlement on a number of grounds, including that it allowed Citigroup to avoid admitting guilt. We have covered this settlement extensively (see, here, here and here).

Circuit Judges Pooler, Lohier and Carney’s opinion found three specific errors by the District Court:

(i) the court found that the District Court had abused its discretion by requiring that the SEC “establish the ‘truth’ of the allegations against a settling party as a condition for approving the consent decrees.”

(ii) the court found that the District Court committed “legal error” when it “made no findings that the injunctive relief proposed in the consent decree would disserve the public interest, in part because it defined the public interests as ‘an overriding interest in knowing the truth.’” The court found that disagreement with the “SEC’s decisions on discretionary policy” — such as deciding to settle without admission of liability — was not a proper ground to find that the public interest was disserved.  However, the court also specifically found that the District Court did not “condition” approval of the settlement on an admission of liability.

(iii)  the court found that “to the extent the district court withheld approval of the consent decree on the ground that it believed the SEC failed to bring the proper charges against Citigroup, that constituted an abuse of discretion.”

Judge Lohier wrote a separate concurring opinion, observing that he would be inclined to reverse rather than vacate and remand, because it did not appear that any additional facts are necessary to determine that the proposed decree is “fair and reasonable” — however, Judge Lohier found no harm in  vacating and remanding to allow “the very able and distinguished District Judge to make that determination in the first instance.”

While the Second Circuit vacated the decision, in the almost 3 years since Judge Rakoff’s November 2011 order, there have been some changes in SEC policy.  In January 2012, as we reported, the SEC announced that it would require admissions in securities cases where defendants have been convicted of or admitted to criminal conduct in related proceedings.