Corporate Securities Law Blog

In a recent Securities & Exchange Commission (“SEC”) investigation, the SEC interviewed three persons who had proffer agreements with the SEC and United States Attorney. In a subsequent SEC enforcement action, a defendant served interrogatories asking the SEC to identify the factual information disclosed in those proffer sessions. The SEC objected, and the defendant moved to compel. The SEC opposed the motion to compel, arguing that defendant sought information protected by the attorney work product doctrine, had not shown substantial need and unavailability, and had not deposed any of the witnesses, despite their identification in Rule 26 disclosures more than a year before. The magistrate judge granted defendant’s motion to compel, and the United States District Court for the Northern District of California confirmed the ruling. SEC v. Sells, No. C 11-4941 CW, 2013 WL 1411247 (N.D. Cal. Apr. 8, 2013).

The California Revised Uniform Limited Liability Company Act (RULLCA) was signed into law by Governor Jerry Brown in September 2012. Intended to come into effect on January 1, 2014, RULLCA replaces the Beverly-Killea Limited Liability Company Act, and significantly revises the rules for formation and operation of Limited Liability Companies (LLCs) in the state of California. Most importantly, RULLCA applies retroactively to existing LLCs. There is no ability for existing California LLCs to “opt out” of RULLCA; it will apply and potentially “rewrite” substantive provisions of existing California LLC operating agreements. It, therefore, is important that the operating agreements of existing California LLCs now be reviewed with RULLCA in mind to identify provisions that will either be out of compliance with RULLCA or which may need revision prior to 2014 if RULLCA is not revised or repealed prior to its implementation.

In Gabelli v. Securities & Exchange Commission, No. 11-1274, 2013 WL 691002 (U.S. Feb. 27, 2013), the United States Supreme Court, in a unanimous opinion by Chief Justice Roberts, held that the five-year statute of limitations for the Securities & Exchange Commission (“SEC”) to bring a civil suit seeking penalties for securities fraud against investment advisers, codified in 28 U.S.C. § 2462 (“Section 2462”), begins to run when the alleged fraud occurs, not when it is discovered. In so holding, the Supreme Court refused to extend to Government civil penalty enforcement actions the “discovery rule,” which starts the clock on the statute of limitations for civil fraud actions when plaintiff should have reasonably discovered the fraud. The Supreme Court’s decision thus limits the authority of the SEC to seek civil penalties with respect to conduct that occurred more than five years before investigators took action.

At last!  We now have official guidance in one place from the United States Department of Justice and the Securities and Exchange Commission regarding the Foreign Corrupt Practices Act (“FCPA”).  A lengthy memorandum was released November 14, 2012, accompanied by a joint press conference.  Here is a link to the memo: http://www.sec.gov/spotlight/fcpa/fcpa-resource-guide.pdf

In SEC v. Apuzzo, 2012 WL 3194303 (2d Cir. Aug. 8, 2012), the United States Court of Appeals for the Second Circuit clarified the standard for finding liability for aiding and abetting under Section 20(e) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78t(e). Under Section 20(e), the Second Circuit held, the Securities and Exchange Commission (“SEC”) need not show that an aider and abettor “proximately caused” the harm on which the primary violation was predicated. Instead, the SEC need only show that the aider and abettor “in some sort associated himself with the venture, that he participated in it as in something he wished to bring about, and that he sought by his action to make it succeed.” In Appuzo, the Second Circuit has clarified that the SEC need only plead this level of participation — and not proximate causation — to adequately allege that an aider and abettor meets the “substantial assistance” prong of Section 20(e).

In Securities & Exchange Commission v. Goble, 2012 WL 1918819 (11th Cir. May 29, 2012), the United States Court of Appeals for the Eleventh Circuit held that the recording of a sham transaction in the corporate books did not constitute “securities fraud” in violation of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and Securities & Exchange Commission (“SEC”) Rule 10b-5, 17 C.F.R. § 240.10b-5, because “a misrepresentation that would only influence an individual’s choice of broker-dealers cannot form the basis for § 10(b) securities fraud liability.” In so holding, the Eleventh Circuit declined “the SEC’s invitation to expand [the] definition of materiality” to capture the misrepresentation.

On January 6, 2012, the Securities and Exchange Commission (“SEC”) announced that it has modified its settlement policy for enforcement actions that also involve a criminal conviction or admissions by a defendant of criminal violations. Under its new policy, the traditional “neither admit nor deny” language will be deleted from its settlement documents. Instead, the SEC will recite the facts and nature of the related criminal proceeding. Enforcement staff will have the discretion to incorporate into SEC settlement documents any relevant facts admitted by the defendant in the criminal proceedings.

In In re Washington Mutual, Inc., No. 08-12229 (MFW), 2011 WL 4090757 (Bankr. D. Del. Sept. 13, 2011), the United States Bankruptcy Court for the District of Delaware denied confirmation of debtor Washington Mutual, Inc.’s (“WaMu”) plan of reorganization.  Standing in the way of confirmation was the equity committee’s motion for leave to file an adversary proceeding against four noteholding hedge funds because of insider trading. The bankruptcy court, in granting the motion, provided guidance to participants in bankruptcy proceedings who might be inclined to purchase or sell stock on information gleaned through the bankruptcy process.
 

In City of Pontiac General Employees’ Retirement System v. MBIA, Inc., 2011 U.S. App. LEXIS 3813 (2d Cir. Feb. 28, 2011), the United States Court of Appeals for the Second Circuit delineated the standard needed to asses how much information a reasonably diligent investor must have about the facts constituting a securities fraud violation before those facts are deemed “discovered” for purposes of triggering the statute of limitations for a claim under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission (“SEC”) Rule 10b-5, 17 C.F.R. § 240.10b-5.In doing so, the Second Circuit addressed the gap left by the United States Supreme Court in Merck & Co. v. Reynolds, 130 S. Ct. 1784, 1796 (2010) [see blog article here], where the Supreme Court expressly declined to prescribe a list of the facts needed to constitute a securities law violation for purposes of triggering the statute of limitations.
 

On October 21, 2010, the Securities and Exchange Commission announced enforcement actions against Office Depot, Inc. and two executive officers for violating Regulation FD by selectively conveying to analysts and institutional investors that Office Depot would not meet analysts’ earnings estimates.

On August 13, 2010, New York State Governor David Paterson signed into law amendments to New York's Power of Attorney Law (A.8392-C/S.7288-A) (the "2010 Amendments"). The 2010 Amendments become effective September 12, 2010 and will be retroactive to September 1, 2009, the effective date of the prior amendments to the New York State Power of Attorney Law that caused uncertainty and debate among transactional attorneys due to its onerous requirements and absence of a carve out for certain commercial transactions.
 

With the increasing numbers of companies which were once thought to be giants of industry filing for bankruptcy, more opportunities to purchase major assets are becoming available to savvy buyers looking to expand their business or asset base. The Bankruptcy Code provides debtors with the ability to liquidate all or a part of their assets through court-supervised sales and buyers with the ability to obtain those assets at more favorable prices than they would pay if the sale were consummated outside of a bankruptcy.

The United States Securities and Exchange Commission (“SEC” or the “Commission”) recently made changes that could affect the speed and efficiency with which investigations are handled and enforcement actions are brought. Stung with allegations of investigative failures in the wake of revelations regarding the Bernard Madoff Ponzi scheme, the SEC is centralizing its intake of tips, complaints and referrals. It is adding specialized “units” within its Division of Enforcement. It also announced an “Enforcement Cooperation Initiative,” indicating that it will be more receptive to making deals with insiders in order to better understand potential securities violations.
 

1. Lower Thresholds For HSR Filings

On January 19, 2010, the Federal Trade Commission announced revised, lower thresholds for premerger filings under the Hart-Scott-Rodino Antitrust Improvements Act of 1976. The filing thresholds are revised annually, based on the change in gross national product. For the first time, the thresholds have been reduced. They will be effective thirty days after publication in the Federal Register. Publication is expected to occur this week. Thus the new thresholds will most likely become effective late February 2010. Acquisitions that have not closed by the effective date will be subject to the new thresholds. Filing persons must wait a designated period of time, usually 30 days, before completing their transactions. The HSR Act imposes premerger notification and waiting period obligations on transactions over a certain size, where the parties are over a certain size, before those transactions may be completed. Each "person" who is a party to an HSR-reportable deal must file an HSR notification with the Department of Justice Antitrust Division and the Federal Trade Commission.
 

In United States v. Berger, No. 08-50171, 2009 WL 4141478 (9th Cir. Nov. 30, 2009), a three-judge panel of the United States Court of Appeals for the Ninth Circuit declined to apply loss causation principles in civil securities fraud litigation established by the United States Supreme Court in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342-48 (2005), in connection with the sentencing of a defendant in a criminal securities fraud prosecution. Declining to follow two other circuits that had endorsed the application of Dura Pharmaceuticals to criminal sentencing, the Ninth Circuit held that the policies underlying the proper standard for pleading and proving a loss by investors in civil cases are not present in the criminal sentencing context and that applying Dura Pharmaceuticals’ civil rule to criminal sentencing would clash with Congress’ endorsement of that method. Notwithstanding that the split in circuit decisions may prompt Supreme Court review, this decision provides another instance where courts have applied policy distinctions between civil litigation and criminal/enforcement proceedings involving securities fraud.

On November 12, 2009, the SEC announced that it had settled charges against SafeNet, Inc. and some of its former officers, employees and accountants, in connection with earnings management and options backdating schemes. This case represents the SEC's first enforcement action brought under Regulation G, and it provides important reminders to issuers on financial reporting practices.

On October 2, 2009, the U.S. Securities and Exchange Commission, or the SEC, delayed the requirement for small reporting companies[1] to include in their annual reports an auditor attestation report on internal control over financial reporting.[2] Prior to this announcement, a smaller reporting company was required to include the auditor's attestation report in its annual report filed for fiscal years ending on or after December 15, 2009. Under the extension, a smaller reporting company is now required to begin to include the auditor's attestation report in its annual report filed for fiscal years ending on or after June 15, 2010. This extension gives calendar year-end smaller reporting companies an additional year to plan for the required auditor attestation report.
 

In Abu Dhabi Commercial Bank v. Morgan Stanley & Co., Inc., 2009 WL 2828018 (S.D.N.Y. Sept. 2, 2009), the United States District Court Southern District of New York (Scheindlin, J.) held recently that First Amendment free speech immunity does not protect credit rating agencies from claims by investors “where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large.” Although this is not the first decision to deny the rating agencies’ First Amendment defense when the opinion is not published to the “public at large,” it is one of the first decisions to reject the defense in the context of  ratings of mortgage backed securities.
 

In Dreiling v. America Online, Inc., 2009 WL 2516325 (9th Cir. May 5, 2009), the United States Court of Appeals for the Ninth Circuit held that Section 16(b) of the Securities Exchange Act of 1934 — which, broadly speaking is intended to “prevent corporate insiders from exploiting their access to information not generally available to others” by requiring disgorgement of short-swing profits from trading in securities — did not “provide a private litigant with another means of litigating securities fraud” that are prohibited under Section 10(b) and Rule 10b-5. The Court held further that a company and an individual acting on behalf of a different company who participated in “negotiations that result[ed] in the formation of a business agreement between two companies” was insufficient to create the sort of agreement necessary to establish that they were a group of “insiders” for the purpose of Section 16(b). The Ninth Circuit, therefore, rejected plaintiff’s novel attempt to expand the reach and scope of liability under Section 16(b).
 

Two recent cases have given members of an LLC greater ability to avoid the passive activity loss limitations. Under Garnett, decided by the Tax Court in June, and now Thompson, decided July 20 by the Court of Federal Claims, a member of an LLC cannot be automatically treated as a "limited partner" under the passive loss regulations.
 

The Securities and Exchange Commission (SEC) recently approved a New York Stock Exchange (NYSE) proposed amendment to NYSE Rule 452 to prohibit broker's from exercising "discretionary voting" in all director elections. The amendment will apply to shareholder meetings held on or after January 1, 2010. Importantly, the NYSE Rules apply to NYSE member brokers in all of their discretionary voting activities, including voting for publicly –traded companies whose shares are not listed on NYSE. The amendment does not apply to companies that are registered under the Investment Act of 1940.

In Comedy Club v. Improv West Associates the Ninth Circuit held that an in-term covenant not to compete (a covenant that continues during the term of a contract or relationship) in a Trademark License agreement was overbroad, but enforced a more limited version of the covenant.  The Court held that while there is no exception in California's law against non-competition agreements for in-term covenants not to compete, they may be valid, at least in the context of a "franchise like" agreement.

On June 13, 2008, the Department of Justice ("DOJ") issued Opinion Procedure Release 08-02 which allowed Halliburton Company ("Halliburton") to acquire Expro International Group, PLC ("Expro"), a foreign (U.K.) corporation with potential Foreign Corrupt Practices Act ("FCPA") violations, without exposing Halliburton to immediate FCPA liability.  Specifically, the DOJ agreed that it would forgo action against Halliburton for any FCPA violations committed by Expro both prior to the acquisition and in the first 180 days after the acquisition provided Halliburton followed a "post closing plan" consisting of FCPA due diligence and disclosure.

On September 15, 2008, a California Court of Appeal decided the case of Varisco v. Gateway Science and Engineering, Inc., holding that - where all other indicators point to a valid independent contractor relationship - a single clause in a contract allowing either party to terminate the relationship "at will" does not transform it into an employment relationship.

California has amended its corporations law to accommodate the SEC's e-proxy rules.  The amendment permits corporations to comply with the annual report delivery requirements under California law by complying with the federal rules permitting the electronic delivery of annual reports and proxy statements without prior shareholder consent.  The amendment eliminates a conflict between California and federal laws that had stymied certain corporations from taking full advantage of the technological improvements and cost savings afforded by the SEC's e-proxy rules.

California's Song-Beverly Credit Card Act prohibits the requesting and recording of personal information in connection with credit card transactions. The statute provides for civil penalties "not to exceed two hundred fifty dollars ($250) for the first violation and one thousand dollars ($1,000) for each subsequent violation . . ." Recently, two new trends in Song-Beverly litigation have emerged: (1) plaintiffs have filed suits against retailers over requests for zip codes; and (2) plaintiffs have sued retailers for requests for personal information during credit card return transactions.

In United States v. Stringer, 2008 WL 901563 (9th Cir. Apr. 4, 2008), the United States Court of Appeals for the Ninth Circuit vacated a final order of the United States District Court for the District of Oregon that had dismissed criminal indictments against three individual defendants.  Those defendants had argued successfully before the district court that their rights had been violated by the Securities & Exchange Commission (“SEC”) when they cooperated voluntarily with an SEC investigation allegedly without knowing that the SEC was working with federal prosecutors on a parallel criminal prosecution.  The Ninth Circuit also vacated the district court’s alternative order suppressing evidence obtained during an SEC civil investigation.  This decision paves the way for reinstatement of criminal charges against the defendants and likely will encourage further cooperation between prosecutors and SEC enforcement personnel to gain strategic and tactical advantages against investigation targets.

In Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 2008 WL 123801 (U.S. Jan. 15, 2008) (Kennedy, J.), the Supreme Court rejected an attempt by a class action plaintiff to assert securities fraud claims against suppliers and customers of an issuer in whose stock the plaintiff invested.  Those suppliers and customers, it was alleged, knowingly agreed to sham contracts with the issuer that the issuer improperly accounted for in its financial statements.  Because the suppliers and customers (as distinct from the issuer) made no public statements and owed no disclosure duties to the issuer’s investors, the investors could not state a claim against them on the ground that the plaintiff could not plead or prove reliance on the secondary actors’ conduct.  This decision reflects the Supreme Court’s intent to limit exposure to private securities fraud class action litigation to those who are directly responsible for making false or misleading statements to the investing public.

In Miller v. Thane Int’l, Inc., 2007 WL 4147327 (9th Cir. Nov. 26, 2007), the Ninth Circuit held that even “literally true” statements in a prospectus may be actionable under Section 12(a) of the Securities Act of 1933 and, for the first time in the Ninth Circuit, held that a representation by a company that it would be listed on NASDAQ is material to investors.  This decision serves to remind counsel advising companies on their public disclosures to investors that they cannot rely entirely upon the literal truth of the disclosures to protect them from liability under the federal securities laws.

In Ryan v. Gifford, C.A. No. 2213, 2007 WL 4259557 (Del. Ch. Nov. 30, 2007), the Delaware Chancery Court ruled that the presentation of a Special Committee report to the full Board of Directors of Maxim Integrated Products, Inc., including individual director defendants and their counsel, waived the attorney-client privilege as to all communications between the Special Committee and its lawyers.  This decision is significant because of its implications for special committee practice.  After Ryan, there is a considerable risk that the attorney-client privilege will not be available to a Special Committee and its counsel when conducting an internal investigation if the Special Committee chooses to give a report to the full board with named defendants in attendance.

In Ryan v. Gifford, C.A. No. 2213-CC (Del. Ch. Nov. 21, 2007), the Delaware Chancery Court ruled that it could not exercise personal jurisdiction over certain nonresident officers of a Delaware corporation pursuant to 10 Del. C. § 3114(b).  That statute authorizes the exercise of jurisdiction in Delaware over a nonresident officer of a Delaware corporation if the cause of action arises out of the allegedly wrongful conduct of that officer accrued after January 1, 2004 (Section 3114(b)’s effective date) and if the officer’s conduct was in his official capacity.  The decision is noteworthy because of the court’s fairly narrow reading of Section 3114(b).  Ryan stands for the proposition that passively receiving, holding and allowing to vest allegedly backdated stock options does not constitute a continuing wrong that might satisfy the post-January 1, 2004 conduct requirement of Section 3114(b).

As we reported in May 2006 (link), prosecutors in recent years have been pressuring corporations to “cooperate” with prosecutions and investigations by denying indemnification and ceasing payment of defense costs of targeted individual officers and directors.  The Department of Justice was particularly proactive in pressing corporations to cease advancement of defense costs, citing a memorandum issued in 2003 to United States Attorneys by Deputy Attorney General Larry D. Thompson.  In the Thompson Memorandum, the DoJ indicated that “the corporation’s . . . willingness to cooperate in the investigation of its agents” would hinge, at least in part, on “whether the corporation appears to be protecting its culpable employees and agents” by, inter alia, advancing attorney fees.

In In re CheckFree Corporation Shareholders Litigation, No. 3193-CC (Del. Ch. Nov. 1, 2007), Delaware Chancellor Chandler denied plaintiff shareholders’ motion to preliminarily enjoin a merger between CheckFree Corporation and Fiserv, Inc.  In his opinion, Chancellor Chandler held that while “directors have a duty to disclose all material information in their possession to shareholders when seeking shareholder approval for some corporate action,” that duty does not go so far as to require disclosure of all of the internal projections prepared by management of the target corporation that were shared with the acquirer and the target’s financial adviser.  In addition, Chancellor Chandler noted that “the public interest requires an especially strong showing” by a shareholder plaintiff of a likelihood of success on the merits and a threat of irreparable harm where the transaction sought to be enjoined is “a premium transaction in the absence of a competing bid.”  The CheckFree decision largely reaffirms settled Delaware law on these and other issues, while sending a strong signal to the plaintiffs’ bar that shareholder plaintiffs face a very high burden when challenging “a premium transaction in the absence of a competing bid.”

In In re Tyson Foods, C.A. No. 1106-CC (Del. Ch. Aug. 15, 2007), Chancellor Chandler held that granting “spring-loaded” stock options to key directors and executives without full disclosure of the practice is a breach of the directors’ fiduciary duties.  In rejecting defendants’ motion for judgment on the pleadings dismissing the consolidated class action and derivative complaints, Chandler stated that the defendants failed to rebut the pleading stage inference that they “intended to conceal a pattern of unfairly stocking up insiders’ larders” with option grants right before the announcement of events likely to increase the company’s stock price.  This decision would seem to support the notion, often dismissed by commentators, that the practice of granting “spring-loaded” stock options is improper per se, particularly in the absence of detailed disclosures.

In the latest of a series of chats with high-profile securities lawyers, Securities Law 360 conducted a Q&A session with Sheppard Mullin partner Robert D. Rose.

In Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007) (link) (Westlaw citation: 2007 WL 1773208), the Supreme Court for the first time addressed the heightened requirements for pleading scienter enacted in the Private Securities Litigation Reform Act of 1995 (the “Reform Act”).  Rejecting a relaxed “reasonable inference” approach adopted by the Seventh Circuit, the Supreme Court held that a securities fraud complaint will survive dismissal only if, based upon its factual allegations, the inference of defendant’s scienter is “cogent and at least as compelling as any opposing inference.”  In the majority opinion by Justice Ginsburg, the Court held that courts must consider at the pleadings stage plausible nonculpable explanations for the defendant’s conduct, as well as inferences favoring the plaintiff.  The inferences must be “cogent and compelling, and thus strong in light of other explanations.”

On June 8, 2006, the Delaware Supreme Court upheld the lower court’s decision in favor of the directors of The Walt Disney Company. Plaintiffs had claimed that the directors had breached their duty of care in approving an employment agreement with Michael Ovitz, which permitted Ovitz to receive a $140 million severance payment just 14 months after he joined the company. The lower court concluded that the defendant directors who had approved the terms of Ovitz’s employment agreement “did not act in bad faith, and were at most ordinarily negligent,” which was insufficient to constitute a breach of the duty of care. The Supreme Court held that the lower court’s “factual findings and legal rulings were correct and not erroneous in any respect.”

Material Adverse Effect or MAE Clauses ("MAE Clause")  that allow a buyer to terminate a transaction in the event of a material adverse change in the business being sold between signing and closing of a transaction are commonly used in acquisition agreements as a condition to closing.  Courts have recently made it more difficult for parties to rely on MAE Clauses as a means of abandoning a deal to which they have committed.

A recent Delaware Chancery Court ruling, ABRY Partners v. F&W, reflects the tension between promoting freedom of contract, and protecting parties from fraud.  The court reiterated the principle that a contract cannot insulate a seller who either deliberately lies or knows that the entity being sold has lied.  The court also found, however, that between sophisticated parties, a contract can be crafted to insulate a seller from a rescission claim based upon false statements made unintentionally.

Earlier this year, the SEC and DOJ settled parallel criminal and civil enforcement actions against Titan Corporation ("Titan") under the Foreign Corrupt Practices Act ("FCPA"). Titan agreed to pay the largest FCPA penalty to date of $28.5 million. This case is a reminder that companies need to adopt and enforce FCPA compliance policies before the discovery of FCPA problems leads to the unraveling of potential merger discussions and creates financial and reputational risk for the company, both of which occurred in Titan's case. The SEC's investigation of Titan also highlights future potential enforcement actions under the antifraud and proxy provisions of the federal securities laws for publication of false or misleading material disclosures regarding provisions in merger and other agreements filed with the SEC by an "issuer." See Related Resources

On May 31, 2005, the United States Supreme Court reversed Arthur Andersen's 2002 conviction for evidence tampering. That vindication does not alter the core lesson of the Andersen prosecution: a document retention policy must be drafted and implemented carefully to serve its purpose of protecting a company against a charge of evidence tampering. Prudent companies should adopt document retention policies that halt document destruction in the face of government investigations, train employees about document retention policies routinely rather than in response to crisis situations, and exercise caution in email content.