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See if you can guess why I think these two items are related.
» Business LawItem 1: "How to Get Attorneys to Read Something: E-Mail Them Telling Them Not to" Item 2: "Securities and Banking Industries Urge Senate to Retain Fed Regulatory Powers" SJP -
BLPB "Promotion"
» Business LawJosh Fershee has kindly accepted our offer to join us as one of our co-editors. The list of Blog Editors should be amended shortly. Onwards and upwards! SJP -
Comments will be moderated...now that I know where to find them.
» Business LawDear Readers, It turns out a number of you have been commenting on our posts. I was completely unaware of this till yesterday. (The secret is out, I actually don't read every word of every email / attachment / instruction... -
Heminway on the Financial Crisis
» Business LawJoan MacLeod Heminway has posted The Best of Times, the Worst of Times: Securities Regulation Scholarship and Teaching in the Global Financial Crisis on SSRN with the following abstract: This short piece is an annotated version of remarks that I... -
Going Canadian
» Business LawWhile Lions Gate is considering a move from Canada, a North Dakota pasta company is considering a merger with a Canadian suitor. Dakota Growers Pasta Co. is the third largest pasta company in the United States and has about 1000...
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13:09 Joint Venture Exception to the Usury Laws
» Corporate and Securities LawIn Junkin v. Golden West Foreclosure Service, Inc. (Jan. 5, 2010) 180 Cal.App.4th 1150, the First District Court of Appeal affirmed the trial court's finding that because the transaction involved was a joint venture, it was exempted from the usury laws.
In this case, Donald L. Junkin III filed a complaint against Golden West Foreclosure Service, Inc. and Garry Bennett to enjoin the threatened foreclosure of an office building in San Carlos under an allegedly usurious promissory note and deed of trust held by Bennett. Junkin, a licensed real estate agent, has owned and operated several real estate agencies and mortgage brokerage companies. "Bennett was a 'hard money' lender who specialized in providing money quickly at high rates" and Junkin had borrowed from Bennett and invested in property jointly with Bennett on numerous prior occasions.
In 2004, Junkin and Bennett purchased commercial property together and were jointly obligated on a loan from an institutional lender. In addition, Bennett loaned Junkin $856,000 to cover the remainder of the purchase price and in return received a promissory note, carrying an interest of 12%, secured by a deed of trust in favor of Bennett. Junkin and Bennett both held title to the property and considered themselves to be partners in the venture. Further, Junkin owned a 90% interest and Bennett owned a 10% interest in the property. After a sequence of failed payments by Junkin to Bennett, Bennett quitclaimed his 10% interest back to Junkin and later retained Golden West Foreclosure Service, Inc. to foreclose on the property.
Junkin filed a complaint against Golden West and Bennett, alleging that his promissory note was usurious and the foreclosure was unlawful. Bennett argued that "even if the interest rate on the loan could be characterized as usurious, there was no usury under the joint venture exception to the usury laws." The trial court found that the joint venture exception was applicable and entered judgment in favor of defendants.
The court of appeal affirmed the judgment. It began its analysis by examining the usury laws. Usury is defined as "the charging of interest for a loan or forbearance on money in excess of the legal maximum." 8 Miller & Starr, Cal. Real Estate (3d ed. 2001) § 21:1, p.4, fn. omitted. The maximum amount that may be charged in California is set forth in the Constitution. See Cal. Const., art XV, § 1. The court noted that while many exceptions to the usury law exist, only the joint venture exception was at issue in this case. Quoting a leading treatise, the court explained that, "where the relationship between the parties is a bona fide joint venture or partnership, the advance by the partners or joint venturers is an investment and not a loan, and the profit or return earned by the investor is not subject to the statutory maximum limitations of the Usury Law." 8 Miller & Starr, Cal. Real Estate, supra, § 21:1, p.48, fn. omitted.
Citing to Miller & Starr, the court identified several factors relevant to determining whether a transaction is a bona fide joint venture: (1) whether there is an absolute obligation of repayment (Junkin was obligated to repay the note in favor of Bennett), (2) whether the investor may suffer a risk of loss (Bennett assumed a risk of the loss of capital), (3) whether the investor has any right to participate in management (even though Bennett did not participate in the management, the court viewed this as his personal choice rather than anyone preventing him from doing so), (4) whether the subject property was purchased from a third party (as in this case), and (5) whether the parties considered themselves to be partners in the transaction (both Junkin and Bennett testified they considered themselves to be partners). Applying these factors, the court affirmed the judgment, holding that because a joint venture existed, the joint venture exception to the usury rules applied.
This case highlights the importance of carefully considering how loans involving a joint venture are structured as well as the entity that will be used to make the loan. For example, if Bennett had used a family trust or other entity to make the loan to Junkin, it is not clear if the court would have reached the same conclusion.
For further information, please contact Allison Berkley at (213) 617-5521.
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The Volcker Rule
» Business LawThe very name suggests a return to more stable economic times. The text condemns a practice that, for better or worse, has added liquidity to many domestic markets. To ban "proprietary trading" (transactions for a company's own trading book) among... -
Do Limits on Ownership Rights Eliminate Ownership?
» Business LawLast week, I wrote, “A shareholder move seeking a greater voice in corporate governance seems proper to me because it is about the exercise of ownership rights.” Professor Bainbridge disagreed (although he did concede that shareholders’ residual claim on the... -
"Fall of the Economy" Symposium at SJU
» Business LawThis past Friday, I was fortunate enough to take part in a full-day discussion of the government's responses to the continuing economic crisis. Hosted by The Journal of Civil Rights and Economic Development of the St. John's University School of...
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8:10
Proxy Season Heats Up as New Executive Compensation Rules are Effective and SEC Provides New Disclosure Guidance
» Corporate and Securities LawWith Spring just a few weeks away, it also means that the annual proxy statement season for calendar year public companies is in full swing. February 28th marked the effective date for the SEC's expanded executive compensation and corporate governance disclosure rules which we have previously reported on (see our December 18, 2009 blog).
In connection with the adoption of these new rules, the SEC's staff has regularly been updating its interpretive guidance (see for example our December 23, 2009 blog). Such guidance can be helpful to companies when questions arise regarding how to correctly comply with the SEC's regulations. Most recently, on March 1, 2010, the SEC's staff added/revised/withdrew various interpretations addressing proxy statement disclosure issues. The SEC's staff also previously added new executive compensation disclosure interpretations in January 2010 and February 2010.
Below is a brief overview of the SEC staff's recent updates to some of its interpretive guidance with respect to executive compensation and corporate governance disclosure requirements, which are relevant not only for purposes of annual proxy statements but in registered offerings of securities:
NEW INTERPRETATIONS
- Director Qualifications and Experience – The SEC issued new interpretations that reiterate its desire for companies to provide fuller disclosure regarding the specific attributes/qualifications of each individual director on a person by person basis. This information would also be required for those directors who are not up for re-election in the case of a classified board. However, the SEC also reiterated that this information need not be provided for directors whose term would not be continuing after the applicable meeting of shareholders.
- Equity Compensation –As we previously reported in our December 18, 2009 blog, the SEC changed the requirements with respect to reporting equity compensation values in the Summary Compensation Table (and Director Compensation Table). That is, the grant date value of the estimated dollar values of equity-based compensation awards (as determined under FASB ASC Topic 718) will now be utilized as compared to the prior requirement of using the annual financial accounting expense recognized for such equity awards. Therefore, a number of new interpretations were provided regarding the reporting of equity compensation awards. For example, an interpretation was issued covering involved how to report the amount of compensation when a named executive officer leaves the company and, in connection with such separation from employment, the company then decides to accelerate vesting of an option grant that had been granted earlier in the same fiscal year. In addition, guidance was issued covering the exclusion of estimated forfeitures in valuing time-based vesting equity awards along with clarifying that an equity award that is forfeited by an executive officer in the year of grant will nevertheless still be included in determining whether such officer is one of the top most compensated executive officers for such year. The SEC also clarified when to report the grant of a performance based equity compensation award if a company's compensation committee retains discretion to reduce the earned value of the award (as often is the case for awards that are seeking to qualify as performance-based compensation under Internal Revenue Code Section 162(m)). And, the SEC's new interpretations addressed the proper reporting of compensation in the proxy's Summary Compensation Table when the settlement of incentive compensation arrangements can or does occur with company stock rather than cash.
- Compensation Consultants - Depending on the underlying facts (see our December 18, 2009 blog), the expanded rules can require a company to disclose additional information regarding fees paid to a company's compensation consultant for other services rendered by the consultant to the company (depending on what the other services were and for what purpose they were performed). The SEC issued new interpretations covering the types of such other services provided by the consultant along with addressing situations where the consultant's services are not customized for a company or are limited to broad-based plans that do not favor executive officers.
- Risk Management - The new rules provide that if risks arising from a company’s compensation policies and practices are “reasonably likely to have a material adverse effect on the company”, then the company must provide disclosure about such policies and practices as they relate to risk management and risk-taking incentives that can affect the company’s risk and management of that risk. A new interpretation was issued stating that such disclosure should be presented together with a company's executive compensation disclosures.
- Reporting of Shareholder Votes - The new rules require accelerated reporting of shareholder votes on Form 8-K within four business days of the shareholder meeting. The SEC provided a new interpretation stating that the end of the shareholder meeting is the triggering event for starting the four day period (such that if the meeting ended on Tuesday, day one would be Wednesday, and the four-business day filing period would end on Monday).
- Disclosure Requirements in Registration Statements - The SEC issued interpretations reiterating that if a registration statement or post-effective amendment is filed after the end of an issuer's fiscal year end but before its Form 10-K is due:
- if filed on Form S-1, it must include Item 402 executive compensation disclosure prior to effectiveness
- if filed on Form S-3, it may forward incorporate by reference to a subsequently filed Form 10-K
- if filed on Form S-1, it must include Item 402 executive compensation disclosure prior to effectiveness
If a non-automatic shelf registration statement or post-effective amendment thereto is to be filed after the due date for the Form 10-K, the issuer must either file the definitive proxy statement before the Form S-3 is declared effective or include the officer and director information in the Form 10-K.
REVISED INTERPRETATIONS
- Equity Compensation – The SEC revised an interpretation covering the reporting of "re-load options" (i.e., where the optionee receives a new grant of options upon the exercise of an option) that were granted to a named executive officer. In such case, the grant date fair value of the additional options would need to be reported in the Summary Compensation Table in the aggregate amount. The SEC also has now stated that a company may provide the required valuation assumptions information for equity compensation awards (that would typically be incorporated by a reference to the company's financial statements) by reference to the Grants of Plan-Based Awards Table if the valuation assumptions are reported in such table.
WITHDRAWN INTERPRETATIONS
- Equity Compensation – As a result of the change in reporting equity compensation by switching to using grant date fair value, a number of the SEC's interpretations addressing the prior requirements of annual expense reporting became obsolete and therefore were withdrawn.
As we have mentioned in several of our prior blogs (see for example our December 18, 2009 blog), in addition to complying with the expanded disclosure rules, the SEC has clearly signaled that it will be expecting, and looking for, fuller compliance with its executive compensation reporting regulations along with clearer and more transparent company disclosures in annual proxy statements. Two primary areas that continue to receive greater SEC scrutiny are disclosure of performance targets and compensation benchmarking. Specific disclosure of performance targets which are a material element of compensation, and the actual achievement level against such targets, is required unless the company has a compelling explanation of why such disclosure would cause it competitive harm. And, the SEC has indicated that the competitive harm argument is unlikely to be successful after the company has disclosed the actual bonus amounts and particularly if the performance targets are tied to company-wide financial results that are publicly reported. Similarly, when a company refers to a peer group used for benchmarking purposes, the SEC expects to see disclosure of the names of the peer group companies, how they were selected, and where actual awards fell relative to the benchmark. Therefore, in conjunction with responding to the new disclosure requirements, reporting companies should avoid simply repeating last year's proxy disclosures. Rather, companies should consider re-examining the text and format of their prior /proxy disclosures from a fresh perspective with an objective of effecting improvements to the extent possible. Failure to do so could provoke comments from the SEC which could then force the company to have to amend its SEC filings.
If you have any questions regarding this information, please contact Greg Schick at (415) 774-2988. - Director Qualifications and Experience – The SEC issued new interpretations that reiterate its desire for companies to provide fuller disclosure regarding the specific attributes/qualifications of each individual director on a person by person basis. This information would also be required for those directors who are not up for re-election in the case of a classified board. However, the SEC also reiterated that this information need not be provided for directors whose term would not be continuing after the applicable meeting of shareholders.
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8:05
Tenth Circuit Holds Corporate Shareholders Do Not Have Standing Under Rico To Sue Derivatively For Alleged Injuries To Corporation
» Corporate and Securities LawIn Bixler v. Foster, No. 09-2138, 2010 WL 597477 (10th Cir. Feb. 22, 2010), the United States Court of Appeals for the Tenth Circuit affirmed the dismissal of a class action lawsuit brought by minority shareholders of Mineral Energy and Technology Corporation (“METCO”) against its directors and lawyers. Plaintiffs alleged that defendants violated the civil Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. §§ 1961-1968, for authorizing and facilitating the transfer of METCO’s assets to an Australian corporation. The Tenth Circuit held that, among other things, (1) plaintiffs lacked standing under RICO to assert shareholder derivative claims and (2) allegations of securities fraud did not establish predicate acts under RICO. This decision confirms that the civil RICO statutes generally are not available to shareholders and investors seeking redress for alleged ordinary corporate misconduct.
The action centered around the directors and majority shareholders of METCO, a New Mexico uranium mining company. The directors negotiated a trade of METCO’s uranium mining claims to subsidiaries of defendant Uranium King, Ltd. (“UKL”), an Australian corporation. UKL subsequently merged with another Australian corporation, Monaro Mining NL (“Monaro”). Plaintiffs alleged that the transfer of the mining claims provided for METCO to receive $6.5 million and stock in UKL in exchange for METCO’s uranium interests. The UKL stock was then to be distributed among the METCO shareholders on a pro rata basis. According to plaintiffs, after defendants transferred the METCO uranium claim deed to UKL, UKL abandoned the agreement and paid neither the money nor the UKL stock to METCO. Consequently, plaintiffs lost the value of their investment in METCO. Additionally, plaintiffs allege that the directors were “highly compensated” for arranging the transaction.
Based on this conduct, the plaintiffs alleged that defendants defrauded them of their share of the UKL stock and rendered their METCO investment virtually worthless. Plaintiffs also averred that the UKL-Monaro merger was a fraudulent means of transferring the mining claims to a third entity. Furthermore, plaintiffs claimed that the defendants conspired to deprive them of the value of their METCO shares by a series of predicate acts based on the above-described conduct, in violation of RICO. The United States District Court for the District of New Mexico granted the defendants’ motions to dismiss holding (among other things) that plaintiffs did not have standing to bring RICO claims on METCO’s behalf based on the diminution of the value of their shares and that the Private Securities Litigation Reform Act of 1995 (“Reform Act”) precluded RICO claims based on securities fraud. Plaintiffs appealed.
With regard to plaintiffs’ standing argument, the Tenth Circuit held that, as a general rule, conduct by corporate management which harms a corporation confers standing to sue on the corporation, not its shareholders. There are two exceptions to this rule, however. First, the shareholder standing rule allows shareholders to bring a claim where the corporation’s management has refused to pursue the same action for reasons other than good faith business judgment. Second, a shareholder with a direct, personal interest in a cause of action may bring suit even if the corporation’s rights are also implicated. Plaintiffs argued that their claim fell within this latter exception. Specifically, the plaintiffs alleged that the defendants’ actions caused their proportionate corporate ownership to be diluted, a direct personal injury.
To support their argument, plaintiffs asserted facts that showed that the majority shareholders received personal compensation for arranging the mining-claim transaction, while the minority shareholders did not. Thus, plaintiffs reasoned, the minority shareholders suffered a diminution in value of their corporate shares without receiving the same monetary compensation the majority shareholders received. The Tenth Circuit was not persuaded. The Court held that because plaintiffs made no showing that more shares were issued or that the value of the majority shareholders’ shares increased more than theirs, plaintiffs failed to show that their corporate ownership was diluted. Thus, there was no direct, personal interest to afford them standing. The Court’s conclusion accorded with the uniform holdings of all other Courts of Appeals that have considered the question and held, similarly, that corporate shareholders do not have standing to sue derivatively under the civil RICO statute for alleged injuries to the corporation.
Next, plaintiffs argued that the provision in the Reform Act stating that “no person may rely upon any conduct that would have been actionable as fraud in the purchase or sale of securities to establish a violation of [RICO],” Pub. L. No. 104-67, § 107, 109 Stat. 737, 758 (Dec. 22, 1995), amending 18 U.S.C. § 1964(c), did not apply because their claims did not involve the “purchase or sale of securities,” as required by the statute. The Court disagreed and held that although the minority shareholders did not “purchase” or “sell” their METCO shares as part of the alleged wrongdoing, their allegations that defendants defrauded them from receiving UKL stock as provided in the transaction, and the subsequent (allegedly fraudulent) merger of UKL and Monaro, adequately described a “purchase” and “sale” of securities to bar their claim under RICO. The Court also held that plaintiffs’ assertion that defendants transferred METCO’s uranium interests to UKL with the intent not to honor the corresponding agreement to issue UKL stock to METCO or its shareholders, also described a violation of the Securities and Exchange Commission’s (“SEC”) Rule 10b-5.
Plaintiffs also attempted to argue that the Reform Act exception does not apply because most of the alleged predicate acts did not describe securities fraud. They maintained that their allegations that defendants committed mail and wire fraud, bank fraud, extortion, obstruction of justice and interstate travel in support of racketeering described conduct not covered by the Reform Act. Again, the Court disagreed and held that although such conduct constituted illegal and fraudulent activity, it was also undertaken in connection with the purchase of a security. Thus, these activities could not support a civil RICO claim after the enactment of the Reform Act. The Court observed that “allowing plaintiffs to engage in surgical presentation of the cause of action would undermine the purpose of the RICO amendment.” Hence, the Court concluded that the plaintiffs’ claims fell within the Reform Act and thus could not form the basis of a civil RICO claim.
This decision further confirms the Circuits’ uniformity in holding that corporate shareholders do not have standing to sue under the civil RICO statute for alleged injuries to the corporation. It is also another instance in which the courts have strictly construed the Reform Act exception to RICO claims, barring claimants from seeking relief under the civil RICO statutes for claims that even remotely involve the purchase or sale of securities.
For further information, please contact John Stigi at (213) 617-5589 or Taraneh Fard at (213) 617-5492.
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Reuveni on Securities Regulation
» Business LawErez Reuveni has updated his draft of Extraterritoriality as Standing: A Standing Theory of the Extraterritorial Application of the Securities Laws on SSRN. The draft includes the following abstract: This Article contends that the current treatment of the extraterritorial scope... -
It's Official: We Exist (Bainbridge Just Linked to Us)
» Business LawProf. Bainbridge (responding to our own Josh Fershee) asserts shareholders don't own the corporation. While the post itself is relatively short, it provides links to a couple of his other posts that delve into the issue more deeply and are... -
Erickson on Corporate Governance
» Business LawJessica Erickson has posted Corporate Governance in the Courtroom: An Empirical Analysis on SSRN with the following abstract:Conventional wisdom is that shareholder derivative suits are dead. Yet this death knell is decidedly premature. The current conception of shareholder derivative suits... -
Escape from Icahn: The Road to Delaware
» Business LawBusinessWeek recently reported that Lions Gate Entertainment Corp. is seriously considering relocating to the United States in the face of Carl Icahn’s attempts to increase his stake in the company. Icahn is a well-known “shareholder activist” and apparently strikes such... -
Symposium Announcement - The Globalization of Securities Regulation: Competition or Coordination?
» Business LawOn March 5, 2010, the Corporate Law Center at the University of Cincinnati School of Law will host a symposium entitled: The Globalization of Securities Regulation: Competition or Coordination? The web page describes the event as follows: After the enactment... -
What's "worse than a yuppie upset with how their frappuccino turned out"?
» Business LawApparently, "a yuppie with a gun who's unhappy with how their frappuccino turned out." At least according to one barista who is quoted in this Wall Street Journal story about businesses confronting gun-toting customers. SJP -
Oh on Veil Piercing
» Business LawPeter B. Oh has posted Veil-Piercing on SSRN with the following abstract: From its inception veil-piercing has been a scourge on corporate law. Exactly when the veil of limited liability can and will be circumvented to reach into a shareholder’s... -
Complexity Does Not Necessarily Mean Evil
» Business LawAccording to Reuters (via the New York Times), the SEC is building up its New York City office this year, planning to expand by about eight percent with the goal of “catching cheaters” and aggressively going after Wall Street “bad... -
The Latest SEC Proposal on Short Selling
» Business LawThe short selling saga continues. In 2005, the Commission's Regulation SHO eschewed strong medicine in favor of record keeping and operational changes; meanwhile, reformers called for (at least) the end of "naked" short selling. Right before the financial crisis, the... -
Dear International Olympic Committee,
» Business LawWow! What fun were the games of Vancouver. Despite the fog, incessant medal counts, and a potpourri of sports seemingly created on a slow day at a railyard in MInsk, the spirit of sacrificial effort and noble competition somehow trudged... -
Who Knew There Were Net Winners in the Madoff Scheme?
» Business LawThe Wall Street Journal reports that U.S. Bankruptcy Judge Burton Lifland (New York City) today ruled that “net winners” (those who withdrew more funds than their initial investments and later deposits) in Bernard Madoff's ponzi scheme were not entitled to...
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8:52
Second Circuit Vacates Dismissal Of Securities Fraud Claims Holding That Mutual Funds' Alleged Misrepresentations Regarding Payment Of Transfer Agent Fees Were Material
» Corporate and Securities LawIn Operating Local 649 Annuity Trust Fund v. Smith Barney Fund Management LLC, No. 07-5125-cv, 2010 WL 520896 (2d Cir. Feb. 16, 2010), the United States Court of Appeals for the Second Circuit vacated an order dismissing a securities fraud class action brought on behalf of investors against the manager of a family of mutual funds. The Court held, among other things, that the defendants’ alleged misrepresentations regarding transfer agent fees paid by the funds were material under the “total mix” materiality test. This decision provides guidance regarding disclosures to be made by mutual funds concerning the details of transfer fee arrangements.
Plaintiff Operating Local 649 Annuity Trust Fund purchased shares in 105 mutual funds from the Smith Barney Family of Funds (“Funds”) between September 11, 2000 and May 31, 2005. Plaintiff alleged that Smith Barney negotiated a contract for transfer agent services that subjected the Funds to excessive and misleadingly disclosed fees and that a portion of these excessive fees were essentially a kick back to a Smith Barney affiliate. From 1994 through 1999, an outside contractor named First Data Investor Services Group (“First Data”), provided transfer services for the Funds. In accordance with industry practice, the Funds paid First Data’s fees through Fund assets, and this expense was publicly disclosed.
Plaintiff alleged that in 1997, with the contract between the Funds and First Data set to expire, Smith Barney asked Deloitte & Touche Consulting (“Deloitte”) to opine as to whether their subsidiary Citigroup Asset Management ("CAM") could take over the transfer agent function from First Data. To accomplish this, Deloitte recommended that CAM create a subsidiary to provide the transfer services to the Funds using technology purchased from a First Data competitor. CAM rejected this recommendation and, instead, the Funds rehired First Data to provide transfer agent services for substantially the same fees previously paid.
Around this time, CAM created a transfer agent subsidiary called Citigroup Trust Banks (“CTB”). The Funds then entered into a contract with CTB to provide transfer agent services, and CTB subcontracted with First Data to provide essentially the same transfer agent services that First Data had previously provided, but at a much lower rate. Plaintiff alleged that even though First Data reduced the rate it charged for its services, and despite the fact that CTB’s limited role as First Data’s subcontractor was to run a call center, CTB charged the Funds substantially more in transfer agent fees than it paid to First Data. In essence, a Smith Barney affiliate was allegedly “pocketing” savings on the cost of the transfer agent fees, rather than returning those savings to the Funds.
Finally, plaintiff alleged that CAM concealed this scheme from the Funds board of directors and from investors. Indeed, while the existence of the contracts between the Funds, First Data and CTB were disclosed, CAM allegedly did not disclose that First Data was still performing the same services it had previously performed at a substantially reduced rate. Nor did CAM disclose that CTB pocketed the difference between what it charged the Funds for its minimal services and what it paid First Data. Plaintiff alleged that the misrepresentations and omissions regarding the fees violated, among other things, Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder.
The United States District Court for the Southern District of New York dismissed plaintiff’s claims, holding that the mischaracterization of the fees paid to CTB as transfer agent were not, as a matter of law, a material misrepresentation because if an investment adviser discloses the total amount of fees paid by a fund for services, neither the allocation of the fees nor the profit margin of the transfer agent is material. Instead, the district court held, only the actual amount of fees is material because, when deciding to invest, an investor who knows the amount of fees a fund pays can compare the fees to those of its competitors. Since defendants disclosed the amount of the fees paid by the Funds, the district court concluded that “Plaintiffs were in possession of all material information; i.e., they knew the value of the Funds.” Plaintiff appealed.
On appeal, the Second Circuit reversed. In reaching its decision, the Court applied the well recognized “total mix” materiality test. When applying this test to determine whether a misrepresentation is material, courts look to whether there is a “substantial likelihood” that a reasonable investor would have viewed the disclosure of the omitted fact as having significantly altered the “total mix” of information made available to the investor. Put another way, a fact is deemed material if a reasonable person would consider that fact important when deciding whether to buy or sell shares of stock. Applying this “total mix” materiality test, the Second Circuit held that CAM’s alleged omissions were material. The Court reasoned that CAM, acting through investment adviser Smith Barney, owed a fiduciary duty to the Fund’s shareholders to negotiate the best possible arrangement for the Funds and, accordingly, a reasonable investor would be reluctant to deal with a fiduciary who allegedly “lined their pockets at the expense of investors whose interests they were obligated to protect.” The Court reasoned further that its holding also was supported by CAM’s alleged failure to follow the SEC’s disclosure requirements, which require mutual funds to detail the management fees payable to investment advisers. Accordingly, since CAM allegedly failed to disclose to investors its transfer agent service arrangement, and since a reasonable investor could find the arrangement important when deciding whether to buy or sell shares of stock, the Court concluded that CAM’s omissions were material.
In light of this ruling, investment advisers should be aware that in certain instances additional disclosures regarding the details of any transfer agent service arrangements, including amounts charged and amounts paid for transfer agent services, may need to be made in prospectuses and in SEC disclosures.
For further information, please contact Rob Friedman at (212) 634-3058 or Sean Kirby at (212) 634-3023. -
8:46
United States Supreme Court Clarifies Standard For Determining Corporate Citizenship For Purposes Of Federal Court Diversity Jurisdiction
» Corporate and Securities LawIn Hertz Corp. v. Friend, No. 08-1107, 2010 U.S. LEXIS 1897 (Feb. 23, 2010), the United States Supreme Court reversed the United States Court of Appeals for the Ninth Circuit’s holding that New Jersey-based Hertz Corporation (“Hertz”) was a citizen of the State of California for purposes of federal court diversity jurisdiction, rejecting the Ninth Circuit’s “business activities” test and instead adopting the corporate “nerve center” standard used by numerous other Circuits. In doing so, the Supreme Court established a single, uniform and clear interpretation of the phrase “principal place of business” for purposes of deciding a corporation’s citizenship status in disputes over whether diversity exists among parties to a lawsuit.
Hertz was sued in California state court by two California citizens. It filed a notice seeking removal the action to federal court based upon diversity of citizenship, arguing that the state in which it had its principal place of business (as the term is used in 28 U.S.C. § 1332(c)(1)) was New Jersey, not California. In support its argument, Hertz submitted a declaration attempting to demonstrate that the majority of its business occurred outside of California and that its leadership and headquarters were in New Jersey. The United States District Court for the Northern District of California applied the Ninth Circuit’s “business activities” test to determine Hertz’s citizenship. This test compared the amount of Hertz’s business activity on a state by state basis. It found that the plurality of Hertz’s business activities were in California, and thus its “principal place of business” was in that State. The Ninth Circuit affirmed.
The Supreme Court disagreed. It recognized that various Circuits have looked to numerous factors in attempting to determine the principal place of a corporation’s “business activities.” The factors considered by different courts, it observed, led to complicated, differing interpretations of the diversity statute. The Supreme Court addressed this by adopting the “nerve center” test, which was originally set forth in Scot Typewriter Co. v. Underwood Corp., 170 F. Supp. 862, 865 (S.D.N.Y. 1959). This test provides that a corporation’s “principal place of business” for purposes of diversity jurisdiction is “the place where a corporation’s officers direct, control, and coordinate the corporation’s activities. . . . [I]t should normally be the place where the corporation maintains its headquarters — provided that the headquarters is the actual center of direction, control, and coordination.”
Three reasons were set forth by the court for adoption of the nerve center test. First, the court looked to the statutory language of 28 U.S.C. § 1332(c)(1). In doing so, it recognized that the word “place” is singular and refers to a place within a state, not to an entire state. A corporation’s main headquarters is generally located in a single place. Conversely, it held, the business activities test was improper because it looks to a corporation’s activities within an entire state. Second, the nerve center test provides for much more simplicity and uniformity than the business activities test. Noting that the rule may sometimes lead to counterintuitive results, the court stated “accepting occasionally counterintuitive results is the price the legal system must pay to avoid overly complex jurisdictional administration while producing the benefits that accompany a more uniform legal system.” Third, the Court noted that legislative history indicated that the statute was aimed at providing a “simplicity-related interpretive benchmark” for determining the principal place of business of a corporation. While the “business activities” test often led to complex investigation into a corporation’s finances and activities, the “nerve center” test provides a simple, straightforward approach.
The significance of this holding for business entities operating in multiple states is significant, especially in the California. A test that focused on and compared the relative amount of business activity among various states state was inherently biased in favor of larger states. The nerve center approach removes that bias. It also provides for greater certainty, since it is not subject to shifts in business fortunes that can occur on a quarter-by-quarter basis. The Supreme Court’s decision promises not only to lessen the burden on entities with substantive operations in states where they do not have their executive offices, but also provides a simple solution for federal courts faced diversity disputes where individual, resident plaintiffs of a state may attempt to keep a dispute in state court.
For further information, please contact John Stigi at (213) 617-5589 or Amir Torkamani at (213) 617-4180.
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When 1st Amendment and Privacy Rights Collide
» Business LawA New York Times article from late last week described the criminal conviction (in absentia) by an Italian court of three current/former Google executives. The charges stemmed from Google Video's 2006 online display of students in Turin bullying an autistic... -
Dent on Shareholder Rights
» Business LawGeorge W. Dent Jr. has posted The Essential Unity of Shareholders and the Myth of Investor Short-Termism on SSRN with the following abstract: The separation of ownership and control publicized by Berle and Means in 1932 persists today. Domination of... -
Johnson on Securities Regulation
» Business LawJennifer J. Johnson has posted Private Placements: A Regulatory Black Hole on SSRN with the following abstract: Many investors, including vulnerable senior citizens, are victimized each year in dubious securities offerings yet governmental regulators can do little to intervene. Utilizing... -
Harris on Private Equity
» Business LawLee Harris has posted A Critical Theory of Private Equity on SSRN with the following abstract: In the private equity world, partnership agreements have received praise from many corners for reducing the agency costs arising between the interests of fund... -
Nees on Oversight Liability
» Business LawAnne Tucker Nees has posted Who's the Boss: Unmasking Oversight Liability within the Corporate Power Puzzle on SSRN with the following abstract: This article explores the competing interests between director authority and accountability within the doctrinal developments underpinning the arguments... -
Socrates knew that he did not know, but Todd Henderson knows that Roger Cohen is a moron.
» Business LawOver at Truth on the Market, Prof. Todd Henderson of Chicago takes on Roger Cohen of the New York Times. In what Larry Ribstein describes as a "great post", Henderson uses the following terms and phrases to describe Cohen and... -
Nelson on the Financial Crisis
» Business LawGrant Nelson has posted Confronting the Mortgage Meltdown: A Brief for the Federalization of State Mortgage Foreclosure Law on SSRN with the following abstract: This Article argues for federal preemption of state procedures governing the foreclosure of mortgages and security... -
Mitchell on Law and Economics
» Business LawLawrence E. Mitchell has posted Toward a New Law and Economics: The Case of the Stock Market on SSRN with the following abstract: Do the public equity markets play the macroeconomic role we believe them to play? What is the... -
Sticking with the Veil-Piercing Theme
» Business LawYesterday the United States Court of Appeals for the Eighth Circuit, in an ERISA action, issued an opinion that mirrors my response to at least a few exam questions on veil-piecing each year: finish your analysis. The court made clear... -
Online Poker as "Tax Fairness"
» Business LawPersonally, I don't care what you call it ... just legalize it. (We are reportedly talking about an extra $40-50 billion in tax revenue over the next 10 years.) SJP -
Are Republicans more likely than Democrats to support "fat bank profits, generous bonuses and stingy lending policies" during an economic recovery?
» Business LawApparently, some Wall Street lobbyists think so. SJP -
Symposium Announcement - The Fall of the Economy: How New York Can Rise to the Challenge
» Business LawOn March 5, 2010, The Journal of Civil Rights and Economic Development at St. John's University School of Law will host a symposium entitled: The Fall of the Economy: How New York Can Rise to the Challenge. The web page... -
A Veil Piercing Epidemic in the High Plains?
» Business LawFrom 1999 until 2007, the North Dakota Supreme Court did not hear single case seeking to “pierce the veil” of a limited liability entity. This is especially significant because there is not an intermediate court of appeals in the state;... -
Long live the painful mosaic...
» Business LawSecurities Regulation is undoubtedly a difficult patchwork of federal and state, civil and criminal, private and public authorities and actions. So it was conceived in 1933/34, and so it remains today. As we were all reminded by the written decision... -
Reform sliding backwards?
» Business LawA recent Bloomberg.com item noted that lobbyists were targeting the proposal to align rules for 'brokers' and 'investment advisers' through the creation of one, fiduciary standard of care. In addition to emphasizing the danger of stalled regulatory reform, the Bloomberg... -
Would Open Trading Trump Rational Apathy?
» Business LawIn a recent New York Times online opinion piece, William D. Cohen discusses the significant stock sales that many high-level Goldman Sachs executives made in their own company during the worst part of the 2008 stock market fall. Cohen states...
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16:40
Ninth Circuit Affirms Dismissal Of Section 14(a) Class Action Holding That A Share Dilution Theory For Pleading Economic Loss Is Unsupported By Case Law
» Corporate and Securities LawIn New York City Employees’ Retirement System v. Jobs, No. 08-16488, 2010 WL 309028 (9th Cir. Jan. 28, 2010), the United States Court of Appeals for the Ninth Circuit affirmed the dismissal of a class action lawsuit against Apple, Inc. (“Apple”) and fourteen of its officers and directors for the alleged false and misleading proxy solicitation of a stock option plan on the ground that plaintiff-appellant did not adequately plead economic loss in the form of “dilution to shareholder interests.” This decision provides yet another instance where courts have strictly applied the “loss causation” principles set forth in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342-48 (2005), in describing the contours of “loss” in private actions under the federal securities laws.
Plaintiff-appellant New York City Employees’ Retirement System (“NYCERS”) is a public pension fund that manages retirement assets for over 200,000 current and former employees of the City of New York. In its consolidated complaint, it alleged direct class claims under Sections 14(a) and 20(a) of the Securities Exchange Act of 1934. NYCERS claimed that Apple’s 2005 proxy statement was materially misleading based on allegations that Apple “backdated” 6,428 stock options between 1997 and 2002. Apple, it was alleged, compensated some employees by awarding stock options that were dated on a date earlier than when the stock options were actually issued, usually at a date when the stock price was lower. This benefited the recipients of the options, which were “in the money” from the time of receipt.
NYCERS alleged that the backdating of stock options rendered Apple’s 2005 proxy statement false and misleading for three reasons. First, NYCERS alleged that while the proxy statement explained that Apple’s compensation practices “aligned the interests of employees and stockholders” because stock options would have value only if Apple’s stock price increases, Apple’s issuance of “backdated” options could have value even if Apple’s stock price does not increase, thereby decoupling employee and shareholder interests. Second, the proxy statement reported that granted options did not make up for the below market cash compensation paid to executive officers. NYCERS alleged misrepresentation because backdating can surreptitiously increase compensation. Third, the proxy statement also indicated that in March 2003, Steve Jobs, Apple’s Chairman and CEO, canceled his outstanding options in exchange for ten million (split adjusted) shares of restricted stock. NYCERS alleged that this was misleading because some of the canceled options were backdated, improperly providing Jobs with 630,000 extra shares valued at over $50 million.
According to NYCERS, Apple shareholders suffered injury by reason of the allegedly false and misleading 2005 proxy statement through impairment of their right to a fully informed vote and the substantial dilution of their shares. NYCERS asserted that from 1996 to 2005, shareholders “unwittingly” authorized issuance of a total of 205 million shares, or 20% of Apple’s stock.
The United States District Court for the Northern District of California dismissed the Section 14(a) claim, holding (among other things) that the consolidated complaint failed to plead loss causation under the Private Securities Litigation Reform Act of 1995 (“Reform Act”). NYCERS appealed.
The Ninth Circuit held that to state a claim under Section 14(a) and Securities & Exchange Commission Rule 14a-9, private plaintiffs must plead that (1) a proxy statement contained a material misrepresentation or omission which (2) caused the plaintiff injury and (3) that the proxy solicitation itself, rather than the particular defect in the solicitation materials, was an essential link in the accomplishment of the transaction. In addition, private plaintiffs must meet the heightened pleading standards of the Reform Act, as well as its requirement to plead loss causation.
Relying upon Grace v. Rosenstock, 228 F.3d 40, 47 (2d Cir. 2000), the Ninth Circuit held that loss causation must be proven in the context of a private action under Section 14(a) and Rule 14a-9. As codified, loss causation requires a showing that the defendant “caused the loss for which the plaintiff seeks to recover damages.” 15 U.S.C. § 78u-4(b)(4). NYCERS sought to plead economic loss in the form of “dilution to shareholder interests.” In dismissing the claim, the district court held that “dilution is not necessarily accompanied by economic loss” and that the principles of Dura Pharmaceuticals bars any suit brought solely on the basis that a misrepresentation caused an inflated share price.
In Dura Pharmaceuticals, the Supreme Court considered whether investors successfully plead economic loss by alleging they paid artificially inflated prices for [the issuer’s] securities. 544 U.S. at 347. The Supreme Court held that the complaint was “legally insufficient” because an “‘artificially inflated purchase price’ is not itself a relevant economic loss.” Id.
NYCERS alleged economic loss only in the form of dilution of their shareholdings and, as such, purportedly did not seek to rely on Dura Pharmaceuticals. Instead, NYCERS argued that Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970), grants courts broad authority to fashion equitable remedies for Section 14(a) claims. The Ninth Circuit, however, discounted NYCERS’ argument, holding that the Reform Act does not differentiate between plaintiffs seeking legal and equitable remedies. Accordingly, pursuant to Dura Pharmaceuticals, without an allegation of economic loss no remedy, equitable or otherwise, is available.
NYCERS next argued that even if Dura Pharmaceuticals were to apply, it does not purport to establish a single method of proving loss causation. Nonetheless, the Ninth Circuit held that regardless of whether courts have recognized other showings of loss causation, Dura Pharmaceuticals still requires that the pleadings provide notice of what the relevant economic loss might be. Here, NYCERS stated that the dilution “reduce[d] a shareholder’s percentage of ownership” and that “this 20% transfer clearly ha[d] a highly significant economic consequence even though the Company’s share price may not have moved in response to the transfer.” The Court was not persuaded. In contrast, the Court held that NYCERS’ dilution theory of economic loss is unsupported by caselaw, and, as the district court recognized, economic loss does not necessarily accompany dilution. Thus, the court held that “such conclusory assertions of loss are insufficient” and the district court’s dismissal on that ground was proper.
The Ninth Circuit declined to expand the concept of “economic loss” required to state a Section 14(a) claim to include shareholder dilution. Instead, by applying Dura Pharmaceuticals and the Reform Act strictly, the Ninth Circuit limited the scope of potential Section 14(a) claims.
For further information, please contact John Stigi at (213) 617-5589 or Taraneh Fard at (213) 617-5492.
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Let's hope for sunlight on the Olympics...
» Business Law...and on the processes of its governing body. For while attention may presently be directed on its decisions addressing competitor safety, does anybody really understand how the International Olympic Committee determines the roster of "Olympic sports" ? It was July... -
Is it true that "most of the American people don’t begrudge people success or wealth”?
» Business LawThis quote from President Obama has popped up in a number of places recently, including DealBook. I have to admit that if this is true, it's news to me. First of all, that would mean we've vanquished Envy. Second, even... -
Sokol on Corporate Governance
» Business LawD. Daniel Sokol has posted Competition Policy and Comparative Corporate Governance of State-Owned Enterprises on SSRN with the following abstract: The legal origins literature overlooks a key area of corporate governance - the governance of state-owned enterprises (“SOEs”). There are... -
Khong on Law and Economics
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Fortney on Fiduciary Duties
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The Murky Rules of the Game After PUHCA
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"Capture" Still Matters
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You either have to be really wrong or really right (Get it?) to unite people against you like this.
» Business LawFollow this link to find out why some say that "Everyone Hates The Citizens United Ruling." Money quote: "The negativity cuts equally across party lines ...." SJP -
Citizens United: States
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