fiduciary duty

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SEC wants you to confessSEC Chair Mary Jo White has indicated that the SEC will require that, in certain cases, admissions be made as a condition of settling rather than permitting the defendant to “neither admit nor deny” the allegations in the complaint of its enforcement action.  The move marks a departure from the typical practice at the SEC and many other civil federal regulatory agencies of allowing defendants to settle cases without admitting or denying the charges.  The policy of allowing defendants to neither admit nor deny the allegations has been increasingly criticized for its inherent lack of transparency regarding both the alleged wrongdoing and the corresponding disgorgement and forfeiture penalties.

According to White, the new policy will apply only in select cases, such as those where there is egregious conduct and/or wide spread public interest. While the precise parameters of the new policy have not been specified, White did note that the new policy would be applied on a case by case basis and that for most cases currently settling, the old policy would still apply.

Debate about the old policy began about two years ago, when Judge Jed S. Rakoff rejected a $285 million settlement that the SEC negotiated with Citigroup, in part because the deal included “neither admit nor deny” language.  The SEC has appealed, and the case is pending before a panel of the U.S. Second Circuit Court of Appeals. Since then, a handful of other judges have voiced their discomfort with allowing defendants to pay fines without admitting liability.

In previously defending the old policy, the SEC has argued that most defendants would refuse to settle if they had to admit wrongdoing.  Essentially, companies and executives would rather fight in court than admit liability and face additional liability in parallel civil lawsuits, as well as the added difficulty of losing director and officer indemnification coverage which often pays the legal fees for corporate officers (a benefit which can be lost if
Continue Reading It was me! SEC to toss “neither admit nor deny” policy in certain cases

SEC reminds you to have a disaster recovery planAlmost 10 months since Superstorm Sandy caused widespread destruction to the northeastern U.S., an area not known for frequent hurricane activity, the people and businesses affected have still not fully recovered. As we now reenter the peak of hurricane season, businesses along the eastern seaboard are probably taking a closer look now than in years past at their disaster preparedness in light of last year’s events. The impact of Hurricane Sandy was certainly not limited to the U.S. In reality, there were global implications as, for example, U.S. equity and options markets were closed for two full trading days following the storm. As a result, the SEC, FINRA and the CFTC undertook a joint review of their individual business continuity and disaster recovery planning. Last week, on August 16, these three regulatory agencies issued a joint release outlining some lessons learned and best practices noted in their investigations and review.

The release focused on a number of specific areas including:

  • Widespread disruption considerations;
  • Alternative locations considerations;
  • Vendor relationships;
  • Telecommunications services and technology considerations;
  • Communication plans;
  • Regulatory and compliance consideration; and
  • Review and testing.

The primary motif in the release was that
Continue Reading Hurricanes, flash freezes and other disasters – plan and disclose accordingly or you may be hearing from the SEC

Investment advisers vs broker-dealersWhen managing investments and strategies for personal financial goals, retail investors often seek guidance from their investment advisers, and on an increasing basis, from their broker-dealers.  Broker-dealers and investment advisers are regulated extensively, but the regulatory requirements differ.  Broker-dealers and investment advisers are also subject to different standards under federal law when providing investment advice about securities.

The Investment Advisers Act of 1940 regulates specified financial professions, including financial planners, money managers, and investment consultants.  Under the Advisers Act, an investment adviser is any person who, for compensation, is engaged in a business of providing advice to others or issuing reports or analyses regarding securities.  With regard to the required standard of care applied to investment advisers when providing advice to their clients, applicable case law requires a fiduciary standard which, essentially, requires that the advisor put the client’s interests first, ahead of his or her own interest.

The Securities Exchange Act of 1934 and its implementing rules comprise the most central regulatory apparatus for broker-dealers. The Exchange Act defines a broker as a “person engaged in the business of effecting transactions in securities for the account of others,” while a dealer is a “person engaged in the business of buying and selling securities for his own account.” In comparison to the fiduciary obligation of an investment advisor, broker-dealers currently have a less stringent “suitability standard” that requires that investment products they sell fit an investor’s financial needs and risk profile.

Under the Investment Advisers Act, registered broker-dealers are excluded from its terms so long as
Continue Reading Uniform fiduciary standard for broker-dealers and investment advisers? Proceed with caution!

Director Pay Practices

Since 2007, executive compensation practices of public companies have been at the forefront of activist shareholders’ and shareholder rights groups’ agendas. Mandatory say-on-pay proposals, enhanced executive compensation disclosure, compensation committee and compensation consultant independence rules are just a few of the recent significant changes to the laws and regulations applicable to public companies in the U.S. Moreover, as we reported in prior blogs, some countries have gone as far as making say-on-pay proposals binding on public companies. In fact, just this year, Switzerland amended its constitution to require binding shareholder say-on-pay votes and other executive compensation limitations for its public companies (also check out Broc Romanek’s blog for a collection of articles related to this topic). However, while public company executives have been in the crosshairs, little attention, if any, has been given to compensation of public company directors.

But that may change as a result of certain director pay practices highlighted by a recent NY Times Deal Book article by Steven Davidoff. The article focuses on two current proxy fights involving hedge funds attempting to get their proposed nominees elected to the boards of Hess Corporation and Agrium Inc. In the first case, the nominating hedge fund is proposing to pay a $30,000 bonus to any of its nominees who ultimately win a seat on the Hess board. Additionally, each such nominee would be eligible to earn a performance bonus based on share performance relative to its peer group. Based on the performance award formula, the maximum potential payout could be as much as $9 million if Hess outperforms its peer group by 300% over a three-year measuring period.

The second case is potentially even more lucrative for the director nominees. In addition to a $50,000 bonus each nominee would receive if elected,  they would also receive 2.6% of Jana Partners’ net profit based on the stock closing price on September 27, 2012. Director nominees not elected would still receive 1.8% of the net profit during that same period. Considering Jana’s total investment in Agrium is over $1 billion, the earning potential could be significant. However, based on the results of the Agrium annual meeting held on April 9, it appears that none of these Jana nominees were elected to the Agrium board this time around.

These arrangements pose some interesting questions from a corporate governance standpoint. Historically, directors
Continue Reading Will director compensation be the next target?

Say-on-pay lawsuitsWhy doesn’t the plaintiffs’ bar believe Congress means what it says? The Dodd-Frank Act could not have been more clear that the outcome of the mandatory say-on-pay advisory vote for public companies does not create or imply any change to the fiduciary duties of board members. However, as we have discussed in previous blog posts, this fact hasn’t stopped lawsuits in the wake of failed say-on-pay votes that allege, among other things, breaches of fiduciary duty by the boards of directors and management of public companies related to such failed votes. The vast majority of these cases have been dismissed at the early stages of proceedings, usually for failing to make a proper demand on the board of directors as required by most state corporate law statutes, but this has only lead to a shift in strategies. 

As the old saying goes, if you fail, try and try again. That is exactly what the plaintiffs’ bar is doing. The current tactic du jour seems to involve filing suits to enjoin the annual meeting. Most of these complaints seeking an injunction have typically alleged that directors and/or management breached their respective fiduciary duties by not providing adequate disclosure in the annual proxy statement to enable shareholders to make informed voting decisions, usually as it relates to proposals seeking to approve (i) executive compensation, (ii) a new or amended compensation plan, or (iii) an amendment to the charter to increase the number of authorize shares. Some of the most common allegations include: 

  • “The Proxy fails to disclose the fair summary of any expert’s analysis or any opinion obtain[ed] in connection with the [equity incentive plan]”; 
  • “The Proxy fails to disclose the criteria” used by the compensation committee “to implement the [stock purchase plan] and why the [equity incentive plan] would be in the best interest of shareholders”; 
  • “The Proxy fails to disclose the dilutive impact that issuing additional shares may have on existing shareholders”; and 
  • “The Proxy fails to disclose how the Board determined the number of additional shares requested to be authorized.” 

The timing of these lawsuits is less than ideal for companies as many are only a few weeks away from their scheduled meeting. This, of course, creates increased pressure to
Continue Reading Say-on-pay litigation: Round 2

Is ISS claiming pledging is the same as bribery?The answer: when ISS is evaluating a public company’s corporate governance under its revised policies for the 2013 proxy season. We previously blogged about the potential insider trading issues that could theoretically arise when insiders pledge company stock to secure loans. Now, with the implementation of the revised ISS governance standards, there are additional reasons for publicly traded companies to implement antipledging and antihedging policies.

ISS specifically addressed hedging and pledging activity in its 2013 U.S. corporate governance policy updates, which were posted in November of last year.  In these updates, ISS included a footnote to its policy on voting for director nominees in uncontested elections in circumstances where there are perceived corporate governance failures. Under the new policy, ISS will recommend “against” or “withhold” votes for directors (individually, committee members, or, in extreme cases, the entire board) due to “[m]aterial failures of governance, stewardship, risk oversight, or fiduciary responsibilities at the company”. The new footnote cites hedging and significant pledging of company stock as examples of activities that will be considered failures of risk oversight. Other cited examples of risk oversight failures include bribery, large or serial fines or sanctions from regulatory bodies, and significant adverse legal judgments or settlements. 

The rationale behind this new update seems to be based on ISS’s belief that pledging any amount of company stock by insiders for a loan is
Continue Reading When does hedging or pledging of company stock by insiders equate to bribery?

Proxy advisory firms' influence over proxy votingAs we say “goodbye” to 2012 we say “hello” to another proxy season full of angst caused by the self-appointed czars of corporate governance, the proxy advisory firms.  Although ISS and Glass Lewis have been making voting recommendations for more than a decade, over the past two years their power over voting outcomes has increased.  When the Dodd-Frank Act was enacted in 2010 Congress was very clear that the Say-on-Pay votes were merely advisory and that directors would not be subjected to increased liability over a company’s executive compensation practice; however, the unintended consequence of Dodd-Frank was to strengthen the unregulated proxy advisory firm industry by allowing these firms to be the near-final arbiters of whether executive compensation should be approved by shareholders.  Failure to comply with the arbitrary guidelines of ISS or the often unknowable guidelines of Glass Lewis can cause a company the potential embarrassment of a “failed” Say-on-Pay vote regardless of whether the independent directors at the company, who painstakingly analyzed various metrics in deciding what to pay the executive officers, determined the compensation to be in the best interests of the company and its shareholders.  In fact, Matteo Tonello of the Conference Board suggests there is substantial evidence demonstrating that the proxy advisory firms have significant influence over the design of executive compensation programs, but no evidence that they have contributed at all to improved governance quality or increased shareholder value.

The SEC clairvoyantly expected a growing conflict between issuers and the proxy advisory firms when it
Continue Reading Are investors’ interests served by proxy advisory firms?

Penn State Freeh reportMr. Lamm is Assistant General Counsel and Assistant Secretary at Pfizer Inc. and a Gunster alumnus.  The views expressed in this posting are Mr. Lamm’s personal views and should not be attributed to Pfizer Inc. or to Gunster.

While nothing good has come out of the Jerry Sandusky sexual abuse scandal at Penn State, I am not aware of anyone who has focused on the lessons learned, particularly the link between corporate governance and the scandal.  However, in my view, anyone who professes to be interested in corporate governance (or compliance) should read the report prepared by former FBI Director Louis Freeh and give it some thought.  It is comprehensive, well organized, well written and thoughtful; in short, it is an important document, notwithstanding the sordid subject matter and the massive human tragedy involved.

Of course, Penn State is an educational institution rather than a publicly traded company, and the facts of the Sandusky scandal are arguably not likely to be replicated in a public company setting.  However, many of the issues outlined in the Freeh Report apply equally to public companies – or to almost any form of organization – as much as to educational institutions, including the following (just to cover a few):

  • Boards of directors (or trustees, governors, etc.) tend to be blamed when bad things happen, even if they are not given the information they should be given and have no way of knowing that information.  Penn State’s trustees were excoriated in the press and other media for not dealing with the matter early on, despite the fact that they hadn’t been informed about the matter, didn’t even know of its existence and had no reason to know of its existence.  It’s really no different in the corporate world; the media tend to ask “where was the board?” even when the board could not possibly have known what was going on.  For example, was it really the board’s responsibility to review specific derivative trades that resulted in losses to financial institutions – particularly when the managements of the institutions provided information about the trades and assured their boards that the risks were minimal? If – as most corporate practitioners agree – the proper function of the board is to oversee management (rather than to supplant it), why should the board be blamed?
  • Of course, good directors understand that they have an obligation to ask questions, including tough questions, to test what they are being told and to ferret out more than what they’re being told.  Reading the Freeh Report, one gets the impression that
    Continue Reading GUEST BLOGGER: Lessons learned in corporate governance from the Jerry Sandusky tragedy

Imagine the following scenario. Your company is publicly traded. As such, senior management is keenly aware of the potential for executives and employees trading in the company’s securities on the basis of material nonpublic information in violation of Section 10(b) of the Exchange Act and the infamous Rule 10b-5 promulgated thereunder. To prevent improper trading, the company has instituted an insider trading policy which, among other things, requires certain high-level executives to pre-clear trades internally, prohibits directors and officers from trading during “blackout periods” (i.e., the period immediately prior to fiscal quarter and year ends), and requires periodic training for all employees on the scope of insider trading laws. As model corporate citizens, all of the company’s directors, officers, and employees follow the company’s policies precisely. No one would dare to take the risk of attempting to gain illicit profits by trading the company’s stock while in possession of material nonpublic information.

One day, just before the end of a quarter (and therefore during a blackout period), analysts covering your company reduce their estimates for the company’s quarterly results which in turn, causes the company’s share price to decline. The company’s officers know that the analysts’ revised estimates are accurate and that the company will report sub-par earnings results the following week but none of those officers initiated any trades to improperly take advantage of this material nonpublic information. However, as a result of the decline in share price alone, one of the company’s executive officers unknowingly violated Section 10(b) and Rule 10b-5 and both he and the company are now potentially on the hook for insider trading liability. 

How can this be if none of the officers executed any trades you ask? The problem arises from the fact that company policy does not prohibit margining company securities. When the share price declined, the value of the securities in the executive’s margin account dropped sufficiently to trigger a margin call requiring the executive to deposit additional collateral to make up the shortfall or risk having the broker sell a portion of the pledged securities (this is similar to what happened to the founder and chairman of Green Mountain Coffee Roasters, Inc. earlier this year). Regardless of which route is taken, the executive is in a problematic situation. 

If the executive does nothing and allows the broker to sell company stock, he’d be violating company policy by trading during the blackout
Continue Reading Margin calls: The insider trading trap

It is a basic tenant of corporate law that directors of a corporation are not liable for business decisions as long as the directors acted with a reasonable level of care in making these decisions. This is referred to as “the business judgment rule.” Because directors are not guarantors of corporate success, the business judgment rule specifies that a court will not review the business decisions of directors who performed their duties (1) in good faith; (2) with the care that an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner the directors reasonably believe to be in the best interests of the corporation. As part of their duty of care, directors have a duty not to waste corporate assets by overpaying for property (e.g., 100% of the stock of a target company in an acquisition) or employment services. The business judgment rule is very difficult to overcome and courts will not disregard it absent, among other things, a showing of fraud or misappropriation of corporate funds.

One of the landmark cases in this area of law was Smith v. Van Gorkam, which was decided by the Delaware Supreme Court in 1985. In that case, the board of directors of TransUnion approved a merger with Marmon Group without consulting outside experts as to the fairness of the price to be paid to TransUnion shareholders, rather, the board relied on the recommendations company’s CEO and CFO, neither of whom made any substantive attempt to determine the actual value of TransUnion. Additionally, the board did not inquire as to the process used by the CEO and CFO in determining the merger consideration. As a result, the Delaware Supreme Court found that the directors of TransUnion were grossly negligent in carrying out their fiduciary duties to the company. Because of this, the board was found not to have satisfied their duty of care and were therefore not entitled to the presumptions and protections of the business judgment rule. Ultimately, the TransUnion board agreed to pay $23.5 million in damages resulting from their fiduciary duty breaches.

The facts of Facebook’s recently announced acquisition of Instagram (as reported by the Wall Street Journal) are strikingly similar to the Van Gorkam case. Allegedly, Facebook’s CEO Mark Zuckerberg and Instagram’s CEO Kevin Systrom worked out the details of the acquisition privately over the course of 3 days at Mr. Zuckerberg’s home. Once the details were finalized for the $1 billion acquisition, the deal was presented, without notice, to the Facebook board of directors who approved the deal, likely without outside expert advice as to the fairness of the transaction. According to several reports, the board vote was largely symbolic because Zuckerberg has control of 57% of the voting power of the company. Facebook directors were likely put in a precarious
Continue Reading Could directors be personally liable if Facebook paid too much for Instagram?