The RR Donnelley Securities Newsletter contains the latest developments and practical guidance for corporate & securities law practitioners. The content is provided by TheCorporateCounsel.net.
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Corp Fin Updates its CDIs
In mid-March, Corp Fin updated its guidance on Securities Act Forms with a new set of Compliance and Disclosure Interpretations. This now makes a complete set of Compliance and Disclosure Interpretations on Securities Act Sections, Rules and Forms. Included among the interpretations are no less than 55 interpretations dealing with Form S-8, which is a form that never ceases to generate a lot of questions in my experience. The latest Securities Act Forms guidance includes interpretations that were previously published in the Manual of Publicly Available Telephone Interpretations and in other guidance, as well as new interpretations.
Later in March, the Corp Fin Staff updated the Exchange Act Rules CDIs to include interpretations of Exchange Act Rule 10b5-1. Rule 10b5-1 interpretations had not been included in the Exchange Act Rules CDIs back when they were first published in September 2008, and were last addressed in the Fourth Supplement to the Manual of Publicly Available Interpretations from May 2001.
The new Exchange Act Rules CDIs largely repeat the Rule 10b5-1 interpretations from the Fourth Supplement without substantive change. There are, however, a few revised or new interpretations of note. In CDI 120.19 - which deals with the question of whether cancelling one or more plan transactions affects the availability of the affirmative defense in Rule 10b5-1(c) - the Staff notes that if a new contract, instruction or plan is put in place after the termination of a prior plan, then you would have to look at all of the facts and circumstances, including the period of time between termination of the old plan and establishment of the new plan, to determine whether a plan was established "in good faith and not as part of a plan or scheme to evade." In order to address this concern, it has become relatively common to impose a significant waiting period before a new plan can be adopted (i.e., six months), as well as a cooling off period (i.e., 30 days) before any sales are made following a plan termination.
In CDI 120.20, the Staff notes that the Rule 10b5-1(c) affirmative defense is not available when a person establishes a 10b5-1 plan while aware of material nonpublic information but delays any plan transactions until after the material nonpublic information is made public. Further, CDI 220.01 provides guidance on how a 10b5-1 plan can be transferred to a new broker when the original broker goes out of business (something to think about these days), while CDI 220.02 indicates that an issuer contemplating a repurchase plan relying on Rule 10b5-1 and 10b-18 could not structure the plan so that the amount to be repurchased by the broker under the plan could be automatically reduced by publicly disclosed block purchases, given the potential for the issuer to effectively modify the plan through the block purchases.
Even though the Rule 10b5-1 CDIs don't necessarily break new ground, it is a good time now to go back and review Rule 10b5-1 policies (or adopt such policies if none are in place). Some very useful resources are posted in our Rule 10b5-1 Practice Area. To date, we have not heard of any significant Rule 10b5-1 developments from the Division of Enforcement, but it is likely some of the cases that the Division began looking at a couple of years ago remain ongoing.
Treasury Finally Fleshes Out Its Financial Stability Plan
In mid-March, the Treasury Department provided more details about its plans to bailout banks and handle their toxic assets by providing a fact sheet and white paper about its new "Public-Private Partnership Investment Program."
Boiling down the PPIP, it will use a combination of public and private capital, managed by private sector managers to purchase toxic (now known as "legacy") assets from banks and investors. The PPIP proposes to use $75-100 billion of TARP funding along with private investor capital and FDIC-guaranteed debt to generate an initial $500 billion in purchasing power, which could grow to $1 trillion over time.
The PPIP has multiple components, including a Legacy Loans Program and a Legacy Securities Program. Since more details are needed, the government will need to create regulations to get these programs off the ground. We are posting memos in our "Credit Crunch" Practice Area.
Regulatory Reform Kick-Off
March 26th marked what we think was the big kick-off of several months of debate about the future shape of financial regulation. Treasury Secretary Geithner outlined the Administration's framework in testimony before the House Committee on Financial Services and, as noted in this Treasury Department outline, his remarks focused particularly on addressing systemic risk.
Not surprisingly, the Administration's proposals echo much of the conceptual framework that has been floated over the last several months by some legislators, academics and groups such as the Group of Thirty. In particular, the four focal points of the regulatory reform are: (1) addressing systemic risk; (2) protecting investors and consumers; (3) eliminating regulatory gaps; and (4) fostering international coordination. The Administration's systemic risk proposals contemplate one "independent" regulator who is responsible for overseeing "systemically important firms" (i.e., too big to fail firms) as well as the payment and settlement systems. Systemically important firms would be subject to heightened capital requirements, strict liquidity, counterparty and credit risk management requirements and would be subject to an FDIC-like "corrective action regime." These special firms could be any type of financial business: banks, brokers, insurance companies, etc.
The SEC figures prominently in the proposed systemic risk efforts, not as the systemic risk regulator of course but rather as the regulator of hedge funds and money market funds. The Administration envisions that advisers of hedge funds meeting as yet unspecified size requirements would be compelled to register with the SEC, and the funds would be subject to mandatory disclosure and reporting requirements, with the details of their reports to be shared with the systemic risk regulator. The proposals also call on the SEC to "strengthen the regulatory framework" around money market funds to make them less susceptible to a run on the funds and to reduce the credit risk and liquidity risk profile.
It is not clear from the proposals what role the SEC would play in a proposed new regulation of credit default swaps and OTC derivatives. The Administration calls for a "strong regulatory and supervisory regime" over OTC derivative markets, focused on central clearing of standardized OTC derivatives, encouragement of more exchange traded instruments, mandated standards for non-standardized contracts, transparency around trading volumes and positions, and robust eligibility requirements for market participants.
At the same time the Treasury Secretary was outlining the regulatory reform proposals in the House committee room on March 26th, SEC Chairman Schapiro was at a hearing before the Senate Committee on Banking, Housing and Urban Affairs focused on the regulation of the securities markets. In her testimony, Chairman Schapiro called for maintaining the independence of a capital markets regulator, consistent with preserving the Commission's role as the investor's advocate. The Chairman noted that, as an independent capital markets regulator, the SEC would be integral to dealing with the overarching concerns about systemic risks and serve to help the systemic risk regulator in evaluating risks. It seems clear from this testimony that, as the battle lines are being drawn, the SEC is going to fight to preserve its independence within the overall financial regulatory structure.
Rolling In: Rule 452 Comments
With comments due March 27th on the NYSE's broker non-vote proposal as noted in this blog, below are links to comment letters submitted by notable groups so far (here is a link to all the comment letters):
There are a surprising number of comment letters submitted by companies, including one from GM's now-former CEO Wagoner. We guess they realize the significance of this proposal and have overcome their traditional reluctance to voice an opinion directly (as opposed to through an industry group).
In terms of analysis of voting returns, this comment letter from Broadridge covers how broker non-votes impacted shareholder meetings during 2007.
Nasdaq Extends Suspension of the Bid Price and Market Value Requirements
In mid-March, Nasdaq filed an extension of the ongoing suspension of the bid price/market value of publicly held shares requirements until July 19, 2009. In support of the continued suspension, Nasdaq notes that market conditions have not improved since the suspension began last October, and that both the number of securities trading below $1 and the number of securities trading between $1 and $2 on Nasdaq has increased since the initial suspension. This is the second extension of the suspension, which would have otherwise expired on April 19, 2009. The NYSE recently filed with the SEC, on an immediately effective basis, a suspension of its $1 price requirement and an extension of the lowering of the market capitalization requirement, lasting until June 30, 2009.
Nasdaq also recently re-filed its new listing rule book, which is now scheduled to become effective on April 13, 2009. In this project, the Nasdaq has sought to make the listed company rules more transparent and clear, without making substantive changes to the requirements.
Another New E-Proxy Notice from Broadridge
Back in January, we blogged about Broadridge's new e-proxy notice for beneficial owners. It looks like they have gone back to the drawing board and improved their Notice some more in an effort to better educate shareholders and boost their willingness to vote. [We think this process would have gone smoother had Broadridge posted a draft Notice for public comment, both last year - and this year. And we don't mean to single Broadridge out here. All the providers with Notices should post drafts for comment - so they can get input into enhancing usability.]
Although there has been no statement from the SEC Staff, Broadridge informs us that the Staff has reviewed these changes in this Notice. This is important to know since the new notice fails to satisfy a few of the requirements of Rule 14a-16(d). For example, the new notice doesn't seem to have a place for directions to the meeting (Rule 14a-16(d)(8)). And although the requisite text for the legend required by Rule 14a-16(d)(1) seems to be included in one form or another, it doesn't track the exact wording from the Rule.
We have heard from a number of members that they feel uncomfortable about departing from the new rules without the Staff putting out formal guidance - and they have asked Broadridge to use the old form that squarely follows the Rule's text. This is too bad because better usability for investors is lost in the shuffle - but we can understand their hesitance.
These members may have a valid concern - even if the SEC has given oral indications that they will turn a blind eye if people use the new, non-compliant form - that a shareholder could conceivably challenge the adequacy of the notice (and thus the legitimacy of the annual meeting of a company that uses it) since anything can happen in the current environment. We hope the SEC Staff steps up and issues some written guidance soon...
First Whistleblower Action Over Executive Compensation Disclosures
On March 31st, the Chicago Tribune ran this article about a lawsuit brought against McDonald's by a former Senior Director of Compensation who balked against signing a subcertification related to the company's disclosure of executive compensation. The company denies the allegations. We're pretty sure this is the first whistleblower suit related to executive compensation disclosure.
The complaint was filed in US District Court for Northern Illinois - and includes allegations of (as noted in this blog):
- Setting up a reimbursement/repayment scheme to avoid disclosing golf club memberships for the regional President stationed in Hong Kong;
- Mislabeling the outgoing CEO as a "transitional officer" so he could keep his health and other benefits, and so the millions paid to him after his last day of work for McDonald's could be called salary and incentive pay, rather than severance; and
- Implementing a shareholder-mandated 2.99X cap on executive severance agreements with loopholes large enough to render the cap meaningless.
We'll be closely following this development since the topic is "near and dear" to many of our members.
BofA's Dueling "Say-on-Pay" Proposals
Recently, Bank of America filed preliminary proxy statement that includes BOTH a management proposal on say-on-pay and a shareholder proposal on say-on-pay (from Kenneth Steiner, whose agent is John Chevedden). The management proposal is an actual vote, while the shareholder proposal is merely a non-binding vote regarding whether the company should have a policy requiring an annual pay vote.
BofA had tried to exclude this proposal through the no-action letter process, arguing that it (1) conflicts with management's proposal and (2) the company has substantially implemented the shareholder proposal by including the management proposal. The proponent won the day with his argument that the two proposals are not the same because management's proposal is limited to the period of time that the company is in TARP, while his proposal is unlimited as to duration. Corp Fin has posted its response, not permitting BofA to exclude the proposal on either ground (they did waive the 80-day advance requirement).
We think dueling "say-on-pay" proposals will be confusing to shareholders - and we certainly hope this won't be a new trend. Over the past month, most proponents withdrew their "say-on-pay" proposals once management included their own; this position by the Staff may cause them to reconsider going forward...
Delaware Dismisses Caremark Claims Against Citigroup: CEO Pay "Waste" Claim Survives
From Travis Laster of Abrams & Laster: Delaware Chancellor Chandler's opinion in In re Citigroup Inc. Shareholder Litigation came out February 24th. The complaint alleged Caremark claims against the Citigroup directors based on Citi's subprime losses. The Chancellor dismissed all but one aspect of the case - a waste claim based on former Citi CEO Charles Prince's exit compensation agreement. [We have posted memos regarding this case in our "Risk Management" Practice Area.]
The opinion confirms that existing principles of Delaware law apply even in the midst of an unprecedented financial crisis, and that the Delaware courts will not go looking to hold directors up as examples for the economy's current difficulties. It provides a good summary of existing Delaware law principles governing Caremark claims, which I won't repeat.
Here are a few nuances worth highlighting:
- The Chancellor distinguishes between (i) a Caremark monitoring system designed to protect against financial fraud and criminal wrongdoing and (ii) the identification of and protection against business risk. He holds that Citi's problems fell squarely under the heading of unanticipated business risk. This will be a helpful distinction for other companies faced with similar problems brought on by the current financial crisis.
- The Chancellor makes clear that "Directors with special expertise are not held to a higher standard of care in the oversight context." (n.63). Likewise, for directors who sit on committees with oversight responsibility, "such responsibility does not change the standard of director liability under Caremark and its progeny." (Id.)
- Prior experience with scandals at other companies is not sufficient to make a director "sensitive to similar circumstances" and hence susceptible to a Caremark claim. (37).
- In a point of interest to those who litigate in Delaware and face competing litigation in other fora, the Chancellor questions whether a lower standard should apply to a motion to stay in favor of a prior pending action versus a motion to dismiss, noting correctly that both have the same practical effect. (n.16).
- In what I view as the most noteworthy section of the opinion, the Chancellor holds that the plaintiffs stated a claim for waste based on former CEO Prince's $68M exit package. He explains: "[T]he discretion of directors in setting executive compensation is not unlimited. Indeed, the Delaware Supreme Court was clear when it stated that 'there is an outer limit' to the board's discretion to set executive compensation, 'at which point a decision of the directors on executive compensation is so disproportionately large as to be unconscionable and constitute waste.'" (55-56). The Chancellor held that there was a reasonable doubt as to whether the exit package awarded compensation that is beyond the "outer limit." (56).
It used to be said that waste claims were easy to plead - but difficult to prove. Then for a long time they were also hard to plead. This one survived. It's too early to say whether the Delaware courts will now be more receptive to compensation challenges based on waste theories, but I feel safe predicting that this aspect of the decision will not go unnoticed by members of the plaintiffs' bar. Look for more waste claims to come based on big exit comp numbers.
A Few (Negative) Words about Naked Short Selling
When the market surged 6% on March 10th, it was allegedly due to the rumor that the SEC would bring back the "uptick" rule (the SEC had announced it will hold an April 8th Commission meeting to propose a new uptick rule). The use of short selling by hedges to move markets for their own gain was discussed during the recent conversation between Jon Stewart and Jim Cramer. Add us to the chorus that something has to be done about short-selling. And something different than the SEC's emergency short-selling restrictions implemented last Fall, which some argue had no impact.
We've always believed that naked short selling is a form of manipulation, particularly when it occurs near the market's opening and close (even if it is part of a hedging strategy, it's often still manipulative). There now have been a number of stories revealing what short sellers have been doing over the past few years and it's clear that this is destructive behavior.
It's time that the SEC and other regulators step up. Otherwise, this is one more aspect of "deregulation" that will continue to allow some to artificially manipulate stock prices - and feed the widespread belief that the markets aren't safe.
And right after we weighed in on the problems caused by naked short selling, the SEC's Inspector General issued a report noting that the SEC received 5,000 complaints over a year and a half period about aggressive short selling (of which, 2.5% of those were investigated) and the SEC's failure to bring any enforcement cases in this area (and Congress may consider legislation restricting short selling ahead of the SEC adopting a new uptick rule). Here is a Bloomberg article.
According to this WSJ article: "In a written response, the SEC's enforcement staff played down the likelihood of naked short-selling abuses. It noted that most trades settle on time. The SEC staff said the agency needs to "intelligently leverage" its resources and a large number of complaints provide "no support for the allegations." The SEC said it is looking to improve its handling of tips."
While we agree that a large number of complaints doesn't prove anything - and the Staff certainly needs more resources to do its job - we sure hope the SEC is taking the problems caused by naked shorts seriously and realize that adopting an uptick rule alone doesn't do the trick. We strongly urge folks to read Carl Hagberg's clear explanation of how naked short selling damages the markets and his suggestion for an easy fix.
Are Credit Default Swaps Enforceable?
In a recent presentation, Brink Dickerson of Troutman Sanders questioned whether credit default swaps are enforceable, at least in certain circumstances. Hedge funds, large banks and other financial institutions routinely control, either as a result of holding the underlying security or under contractual arrangements, the voting rights with respect to bonds and other indebtedness. At the same time, however, these institutions have hedged their economic interest in the CDS market, in some cases so much so that they are "over-hedged" and would benefit more from the failure of the underlying business than they do from its survival.
This in turn can lead to their opposing - if not blocking - otherwise rational consent solicitations, exchange offers and other restructurings. Brink speculated that to the extent that an institution has an over-hedged position that leads to an irrational action as a holder (or former holder) of indebtedness, the underlying CDS may be void (or, if misused, voidable) as a matter of public policy (see Restatement Second of Contracts § 178). He also speculated on whether the misuse of an over hedged position might lead to liability.
The law is not there yet on this issue, but the extremeness of the facts in some of the current restructurings - where in one case the CDS positions were a substantial multiple of the outstanding indebtedness - could lead to the courts striking out in a new direction. Professors Henry Hu and Bernard Black have written widely on this and related issues - which they call "debt decoupling" and "equity decoupling" - and this clearly is a topic that would get significant focus should a major company fail just because of irrational actions by a holder (or former holder).
The Latest Proxy Season Developments
If you haven't signed up to get our new "Proxy Season Blog" pushed out to you, here are a few of the recent items that you've missed:
- Draft E-Proxy Standards: NIRI Seeks Comment
- More on "Another New E-Proxy Notice from Broadridge"
- Proxy Disclosure of Compensation Practices in a Volatile Equity Market
- Intel First to Offer Live Internet Voting
- The Growth of "Poor Economy" Disclosure
- Re-Thinking D&O Questionnaires
Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog.
On the Way: Romeo & Dye Section 16 Deskbook
Peter Romeo and Alan Dye just completed the 2009 edition of the Section 16 Deskbook and it's now at the printers. In addition, they are in the process of wrapping up their latest version of the popular "Forms & Filings Handbook," with numerous new - and critical - sample forms included. To receive these critical Section 16 resources, try a '09 no-risk trial to the "Section 16 Annual Service" (or renew).
March-April Issue: Deal Lawyers Print Newsletter
The March-April issue of the Deal Lawyers print newsletter includes articles on:
- Lessons from the Meltdown: Remedies
- Poison in a Pen: Recent Trends in Drafting Shareholder Rights Plans
- The Ultimate Takeover Defense? RiskMetrics' New View on Net Operating Loss Poison Pills
- Delaware Upholds Private Equity Deal Structures
- Recent Developments under the Delaware Short-Form Merger Statute
- Section 13(d): The Challenges of "Group Membership"
If you're not yet a subscriber, try a 2009 no-risk trial to get a non-blurred version of this issue for free.
People: Who's Doing What and Where
At the SEC, Division of Trading and Markets Director Erik Sirri announced he is leaving the SEC at the end of April to return to academia. Jamie Brigagliano was promoted as Deputy Director of that Division.
Leaving her post as Staff Director for the U.S. Senate Banking Subcommittee, Didem Nisanci joined the SEC as the Chief of Staff. Didem also used to work for the Treasury Department.
The Office of General Counsel is filling its ranks: Mark Cahn was named as Deputy General Counsel and Jeffrey Singdahlsen was named as Associate General Counsel.
In Corp Fin, Felicia Kung was named as the new head of the Office of Rulemaking. She takes over for Betsy Murphy, who recently became the SEC's Secretary. Felicia has been on the Staff for many years, toiling in Corp Fin's Office of International Corporation Finance as Senior Special Counsel (ie. #2) to Paul Dudek for the past seven years.
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(c) 2009 Executive Press.
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