A great deal has been written about the recent reversal of two insider trading convictions. Specifically, the U.S. Court of Appeals for the Second Circuit threw out the convictions of Todd Newman and Anthony Chiasson, hedge fund traders found guilty at the District Court level.
The press reports have treated the reversal as a major slap in the face for Preet Bharara, the U.S. Attorney for the Southern District of New York. Bharara has made a big name for himself on the backs of numerous alleged – and quite a few convicted – insider traders, including Raj Rajaratnam. While I’m sure Mr. Bharara isn’t happy about the reversal, he should take solace from the convoluted – no, byzantine – legal route by which insider trading convictions are achieved.
I suspect that most readers will not remember the SEC’s pursuit of Ray Dirks and a few others charged with insider trading many years ago. Dirks, a securities analyst, uncovered a massive fraud perpetrated by a company named Equity Funding. He alerted the SEC and some media about the matter, but neither did anything. When he couldn’t gain any traction, Dirks advised his clients to sell the company’s stock. For reasons that remain murky (including rumors of bad blood between the SEC and Dirks), the SEC decided to pursue insider trading charges against Dirks and a few other people who arguably should never have been prosecuted.
The courts have a way of dealing with cases that shouldn’t have been brought in the first place, and in this and some other prosecutions the outcome was the “misappropriation” theory of insider trading. Simplistically stated, insider trading is not insider trading unless the tipper owed some duty to the company whose information was misappropriated (though not necessarily the company about which information was leaked) and derived a personal benefit from leaking the information. Subsequent cases have generated many more wrinkles in what the theory really means. As for Messrs. Newman and Chiasson, their convictions were reversed because even though their tipper derived a personal benefit from giving the tip, they didn’t know that he was deriving that benefit.
So if you think that the point of insider trading prosecutions is to maintain a level playing field, think again. It’s not about what you know, or who you know; apparently, it’s about what you know about who you know. There ought to be a law, but this isn’t it.
I’d like to know what you think.
A few weeks ago - “From the same wonderful folks who brought you conflict minerals (among other things)” – I complained about Senator Blumenthal’s attempt to tell the SEC what to regulate and how to regulate it. I had an equal and opposite reaction to the recent news that Commissioner Gallagher and former Commissioner Grundfest had gone after the Harvard Shareholder Rights Project, in effect telling the Project (AKA Lucian Bebchuk) that its actions violate the federal securities laws.
I agree with some (though not all) of Commissioner Gallagher’s views. I’m also troubled by the notion of an esteemed academic institution taking aggressive, one-size-fits-all positions on corporate governance matters. However, in this case, I’m inclined to think that Commissioner Gallagher should have taken a higher road – encouraging discussion, maybe even holding an SEC Roundtable on the topic. And if he really thinks that there’s a violation here, perhaps he should have whispered in the ear of the Enforcement Division that it might want to look into this. Instead, he’s behaving somewhat like a bully – not that the Good Professor is likely to be quaking in his boots about it.
Also, it strikes me as downright inappropriate for a Commissioner to make a statement about a matter that the Commission could conceivably have to rule on if the matter ever does result in an enforcement action. At a minimum, he’d have to recuse himself on the matter, which could mean the difference between victory and defeat. And given recent criticisms of the SEC for (1) pursuing more matters as administrative proceedings than court cases and (2) unfairly touting its enforcement record, does Commissioner Gallagher think he's enhanced the stature of the SEC by doing this?
Photo by Seth M.
In recent years, the Financial Crimes Enforcement Network (“FinCEN”) and federal regulators of the financial services industry have more aggressively enforced the Bank Secrecy Act (“BSA”) and the economic sanctions imposed by the US Treasury’s Office of Foreign Assets Control (“OFAC”). While this should in of itself be a matter of particular attention to the directors and officers of those entities in the financial services industry, so too should the recent trend toward increased scrutiny for directors and officers failing to address alleged BSA or OFAC compliance shortfalls. An August 2014 agreement reached by FinCEN and a former casino official permanently barring the official from working in any financial institution drives the point home: When it comes to liability for BSA or OFAC violations, FinCEN and federal regulators might not limit penalties to the entity actually committing violations, and instead, may also penalize the individual directors and officers of those entities.
Even before FinCEN’s August 2014 bar of the casino official, a number of enforcement actions assessed personal monetary penalties against financial institution directors and officers over the past few years. In February 2009, the directors of Sykesville Federal Savings Association were collectively fined Continue Reading
In my first UpTick (“How about never? Does never work for you?”), I questioned statements by SEC Chair White that the remaining corporate governance rulemakings under Dodd-Frank would be out by year-end. Well, the SEC has now updated its regulatory rulemaking agenda and – lo and behold – final action on the pay ratio rule is now set for October 2015 (you can find the reference here). Assuming that a final rule is adopted in that time frame (which in turn assumes, among other things, that a Republican-controlled Congress won’t do something to the relevant provisions of Dodd-Frank – or to the Act in general), the pay ratio rule will first be in effect for the 2017 proxy season.
Further, based on the regulatory agenda, we shouldn’t expect rulemaking on the three other rules comprising the “four horsemen” (namely, hedging, clawbacks, and pay for performance) until October 2015 as well.
In other words, never may just work for us. Perhaps that’s another reason to give thanks?
Photo by Stuart Rankin
How to stop frivolous plaintiff lawsuits? Since 2010, when Vice Chancellor Laster of the Delaware Court of Chancery noted that “if boards of directors and stockholders believe that a particular forum would prove an efficient and value promoting locus for dispute resolution, then corporations are free to respond with charter provisions selecting an exclusive forum for intra-entity disputes,” many public companies have adopted bylaws provisions restricting frivolous derivative lawsuits. As the ABA notes, these so called “forum selection bylaws” are extensions of the forum selection clauses that have long been upheld in contracts.
As anyone who has ever worked on a public merger well knows, within hours after a merger is announced, several plaintiff firms will announce an “investigation” and then file a derivative lawsuit (presumably based on the findings of their thorough “investigation”). Of course, frivolous lawsuits aren’t limited to M&A transactions, but many of these lawsuits follow the same pattern. As a result, public companies have had continued interest in restricting such lawsuits. Forcing plaintiffs to sue in Delaware with a forum selection bylaw is one way to help restrict lawsuits. But, more recently, some companies have become even more creative. Here is a quick chronological summary of the movement to adopt restrictive bylaws:
- March 2010 – Vice Chancellor Laster of the Delaware Court of Chancery suggests Continue Reading
Connecticut Senator Richard Blumenthal has written to SEC Chair White urging that the SEC label so-called “fee-shifting” bylaws major risk factors and require companies to disclose them before any initial public offering. Moreover, Blumenthal believes the SEC should take the position that fee-shifting provisions are inconsistent with the federal securities laws and should refuse to permit registration statements to move forward for any company that has adopted these provisions.
I believe that Senator Blumenthal is a good and decent man, and I base this in part on some indirect personal knowledge of him. I also think that there are legitimate concerns with fee-shifting bylaws and that a debate on those and other provisions is perfectly appropriate. However, I find it seriously troubling that our legislators feel obliged to tell the SEC how to do its job, particularly at such a granular level. Are they trying to do away with the SEC? Do our senators and congressmen believe that they can do a better job regulating our capital markets and disclosure directly rather than through the SEC?
I happen to think that, in general, the SEC has done a superlative job in both areas. Of course, there have been errors of commission (no puns intended) and omission (e.g., can you say “Madoff”?), but over the 80+ years of its existence, the SEC has generally been an apolitical beacon of serious and legitimate regulation. And I suspect there’s a strong correlation between the SEC’s screw-ups and congressional interference (or lack of funding).
I don’t think for a nanosecond that Senator Blumenthal wants to do away with the SEC. So why is he trying to do so by more subtle means?
What do you think?
Institutional Shareholder Services and Glass Lewis have issued their voting policies for the 2015 annual meeting season. For the most part, both proxy advisory firms’ 2015 policies are refinements of those already in place. However, companies should carefully review their 2015 annual meeting agendas against the updated policies to anticipate possible issues. A summary of the new policies and some issues they raise follows. You can find the ISS policies here and the Glass Lewis policies here.
Unilateral Bylaw/Charter Amendments: Under its current policy, ISS treats the following as “governance failures”: material failures of governance, stewardship, risk oversight or fiduciary responsibilities; failure to replace management; and “egregious” actions relating to a director’s service on another board. In what ISS refers to as “extraordinary circumstances,” the occurrence of one or more of these failures will generally result in withhold or negative votes for individual directors, committee members or the full board.
Beginning in 2015, ISS will create a separate category of “governance failures” consisting of bylaw or charter amendments, adopted without shareholder approval, that “materially diminish shareholder rights” or that “could adversely impact shareholders.” ISS regards the creation of a separate category as little more than a codification of current policy. As is typical, these standards leave ISS lots of wiggle room in determining voting recommendations.
Last week I posted an UpTick about the rollout of ISS’s voting policies for 2015. This week saw what appears to be the completion of that rollout, and we were also blessed with the publication of Glass Lewis’s 2015 voting policies.
On a quick read, neither set of voting policies seems to contain anything shocking, but both sets continue the march towards what the proxy advisors see as shareholder democracy. To paraphrase Jules Feiffer, I sympathize with their aspirations, but in some ways it looks like shareholder tyranny. Both ISS and GL are adamant about two types of by-law amendments: those that make the loser pay in meritless lawsuits and those that arguably impact shareholder rights without getting shareholder approval. ISS also tinkers with shareholder proposals on CEO/board chair separation. GL is also concerned about by-law amendments and continues to rail against companies that don’t satisfactorily implement majority-approved shareholder proposals. GL also continues to focus “material” transactions with directors.
I really do sympathize with at least some of the aspirations of ISS and GL. However, their policies reinforce the notion – with which I’m not at all sympathetic – that shareholders have the right to second-guess each and every decision that the board makes. For example, why does ISS think that shareholders are in a better position than the board to determine the board’s leadership structure? And if the board has no business deciding on its own leadership structure, why give it the power to do anything at all?
We’ll be posting a more detailed analysis of the 2015 voting policies on The Securities Edge within the next few days. For the time being, let us know what you think of them (or of my views).
Britney Spears has nothing on Institutional Shareholder Services, better known as ISS. ISS is rolling out proposed new voting policies for the 2015 proxy season. ISS often uses more words to tout how transparent it is than to explain its voting policies clearly, and the draft policies being considered for 2015 are no different.
One new proposed policy addresses voting on shareholder proposals on independent board chairs. ISS proposes to expand the list of factors that will be considered in developing a voting recommendation and to look at these factors in a more “holistic” manner. (The current policy is to support the proposals unless the company meets all of the criteria.) So this seems like a good thing. However, ISS indicates that the new policy is not expected to change the percentage of independent chair proposals that it will support. The obvious question is, then, how will the new policy really work? Your guess is as good as mine (which frankly isn’t very good).
The other new proposed policy provides additional information regarding the “scorecard” that ISS will use to evaluate equity plans. Like the independent chair policy above, some more criteria are laid out, but it’s impossible to tell how the factors – or, indeed, the new scorecard, will be weighed or will work – thus assuring that companies seeking shareholder approval of equity plans will have to continue to use ISS’s consulting service to find out whether a new plan will pass muster.
I could just as easily have referred to Yogi Berra as to Britney Spears, because if this isn’t déjá vu all over again, I don’t know what is.
The SEC has approved new PCAOB auditing standards relating to related party transactions, significant unusual transactions, and financial relationships and transactions between a company and its executives, including executive compensation. You can find the SEC’s release on the new standards here.
When the PCAOB first proposed these standards, a number of us were concerned that the auditing profession might be getting into the business of second-guessing not only disclosures on related party transactions and executive compensation, but also the substance of transactions and compensation. For one thing, the proposal stated that auditors would need to assess the risks associated with these areas, which led the Society of Corporate Secretaries and Governance Professionals and others to politely suggest that the PCAOB should stay away from the area (you can find the Society’s comment letter here).
In response to these comments, the PCAOB tweaked its language a bit and gave some mild assurances that its intent was misunderstood and that it didn’t want to get into the weeds as feared. However, references to executive compensation stayed in the standards, and their wording doesn’t rule out the possibility that those weeds might be gotten into after all.
So when your auditors offer you this new piece of candy for Halloween, maybe you should ask for some reassurances before you bite into it.
What do you think?