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• September 03, 2010
• 15:42

  Proxy Access: The Added Wrinkle of the North Dakota Corporations Law

   » ‎ Business Law
  Back in 2007, North Dakota passed the North Dakota Publicly Traded Corporations Act (ND Act), which became Chapter 10-35 (Publicly Traded Corporations) of the North Dakota Century Code. The ND Act provided a shareholder friendly alternative to the state's Business...

• 13:39

  DODD-FRANK: WHAT NON-FINANCIAL FOREIGN PRIVATE ISSUERS NEED TO KNOW

   » ‎ Corporate and Securities Law

  While the Dodd-Frank Wall Street Reform and Consumer Protection Act generally focuses on regulation of financial institutions and U.S. companies, this summary focuses on what foreign private issuers that are not financial institutions need to know about the potential impact of Dodd-Frank.
   

  Background
  
  A “foreign private issuer”, or FPI, is a company that is incorporated outside the United States and which meets the following conditions: (i) U.S. residents do not hold a majority of the shares; and (ii) any of the following: (a) a majority of its directors and officers are not U.S. citizens or residents; (b) its business is administered from outside the United States; or (c) a majority of its assets are located outside the United States. A foreign private issuer benefits from less-restrictive rules under many of the federal securities laws and listing standards of U.S. national securities exchanges, including:

  • the ability to follow certain corporate governance practices that conform to its home-country requirements rather than those of the U.S. securities exchanges on which its securities are listed,
     
  • exemptions from certain rules applicable to audit committees of U.S.-domestic registrants,
  • exemptions from the proxy rules,
     
  • exemptions from Section 16 trading restrictions applicable to insiders of U.S.-domestic registrants, and
     
  • extended phase-in periods for compliance with certain existing and new rules.

  What changes now?
  
  Several provisions of Dodd-Frank apply to FPIs, including the following:

  • Exemption from Sarbanes-Oxley Section 404. Section 989G of Dodd-Frank exempts non-accelerated filers and smaller reporting companies from the requirement to provide an auditor attestation report on internal controls pursuant to Section 404(b) of the Sarbanes Oxley Act of 2002. The SEC will conduct a study focused on reducing the burden of complying with the auditor attestation requirement in Section 404(b) for companies whose market capitalization is between $75 million and $250 million and whether a reduction in this burden would encourage companies to list on U.S. exchanges. This relief applies to FPIs who qualify as either non-accelerated reporting companies or smaller reporting companies.

  • Beneficial Ownership Reporting. Section 929R of Dodd-Frank amends Section 13 of the Exchange Act to empower the SEC to accelerate the current 10-day deadline for initial reports on Schedule 13D (or, as applicable, Schedule 13G). Additionally, FPIs, like U.S.-domestic issuers, are no longer required to send these reports to the company or the exchange on which the applicable securities are traded.

  • Whistleblower Protection. Section 922 of Dodd-Frank provides new incentives to whistleblowers, including a payment of between 10% and 30% of amounts collected in proceedings where the SEC collects more than $1,000,000. Section 922 also provides whistleblowers a new express private right of action against employers who retaliate against them. The SEC must issue final rules implementing Section 922 within 270 days of Dodd-Frank’s enactment. Section 929A of Dodd-Frank extends the whistleblower provisions to employees of subsidiaries of publicly traded companies, effective immediately. 

  • Broker Discretionary Voting. Section 957 ofDodd-Frank codifies in the Securities Act of 1933 the prohibition on broker discretionary voting for director elections. The New York Stock Exchange's amended Rule 452, effective for the 2010 proxy season, had already achieved effectively the same result. Dodd-Frank also enables the SEC to determine other matters where brokers cannot exercise discretionary voting. 

  • Private Placement Exemption.For the purpose of determining qualification of an accredited investor, Dodd-Frank excludes the value of a primary residence from the calculation of the net worth of a natural person. This provision was effective on enactment. Issuers, including FPIs, should amend the definition of “accredited investor” in their subscription documentation accordingly. For more information on the change to the “accredited investor” definition, see our blog postings entitled Dodd-Frank Redefines “Accredited Investor (July 23, 2010) and SEC Provides New Guidance (September 3, 2010).

  • New Required Disclosures by Manufacturers and Extraction Issuers. Sections 1502, 1503 and 1504 of Dodd-Frank require certain new disclosures for reporting companies if any of the following apply: (i) specified minerals determined by the Secretary of State to be funding conflict in the Democratic Republic of the Congo, known as conflict minerals, are necessary to the manufacturing of the reporting company’s products, (ii) the reporting company is an operator of a coal or other mine, or (iii) the reporting company is a resource extractor. 

  • Credit Rating Agency Reforms. Various provisions of Dodd-Frank impose new governance and compliance requirements, penalties and liability on nationally recognized statistical rating organizations, or NRSROs. The full extent of the impact on NRSRO's business and customer relationships is not yet known. Among other things, Dodd-Frank increases internal controls, requires greater transparency of rating procedures and methodologies, provides investors with a private right of action, and provides the SEC with greater enforcement and examination tools. Section 939G repeals Rule 436(g) under the Securities Act and in so doing removes the exemption that issuers and ratings agencies relied upon to avoid the need for NRSRO consent to use of ratings information in a prospectus. For more information on the repeal of Rule 436(g) under the Securities Act, see our blog posting entitled Registered Public Offerings Of Debt Securities And The Use Of Credit Ratings Information In SEC Filings After Dodd-Frank(August 17, 2010).

  The following corporate governance reforms in Dodd-Frank may or may not apply to FPI's, depending on the results of future rulemaking:

  • Independent Compensation Committee. Section 952 of Dodd-Frank directs the SEC to require U.S. securities exchanges to incorporate into their rules higher thresholds of independence for compensation committees, with certain exceptions. Section 952 states that the SEC does not need to make thisrequirement applicable to FPIs that disclose annually the reasons why they do not have an independent compensation committee in place. Section 952 also requires certain disclosures relating to compensation consultants and other advisors. It is unclear whether these requirements will apply to FPIs.
  • Executive Compensation and Clawback. Section 954 of Dodd-Frank directs the SEC to require U.S. securities exchanges to incorporate into their rules clawback policies enabling the recovery of incentive-based compensation from current or former executive officers following a restatement of financial results. The trigger would be based on material noncompliance with any financial reporting requirements that led to a restatement, during the three-year period preceding the date on which a company is required to prepare the restatement. Wrongdoing is not required. The amount to be clawed back is the amount in excess of what would have been paid under the restated results.

  Provisions of Dodd-Frank requiring say-on-pay, new executive compensation disclosures and disclosure of CEO/Chairman structure are not expected to apply to FPIs. This is because FPIs have not historically been subject to proxy rules or to Regulation S-K, Item 402 rules concerning executive compensation, and Dodd-Frank does not require that FPIs be subject to these new rules.
  
  How will Dodd-Frank affect the jurisdiction of United States courts over FPIs?
  
  In addition to new regulations, Dodd-Frank clarified the jurisdictional reach of the antifraud provisions of the U.S. federal securities laws. 
  
  As described in our previous blog post entitled United States Supreme Court Limits Extraterritorial Reach Of Private Federal Securities Claims (July 30, 2010), the U.S. Supreme Court in Morrison v. National Australia Bank Ltd., U.S., No. 08-1191 (decided June 24, 2010) held that the principal antifraud provisions of the U.S. securities laws, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, apply only to transactions in securities that take place in the United States or transactions in securities listed on a U.S. securities exchange. The Court stated that these key provisions do not have extraterritorial application since Section 10(b) lacks an explicit statement of extraterritorial effect.The decision, written by Justice Scalia on behalf of a five justice majority, departed from decades of precedent from the United States Courts of Appeals that allowed such claims to be brought when substantial aspects of the misconduct occurred in the United States or when the misconduct had a substantial effect on U.S. investors. 
  
  In response to this ruling, Dodd-Frank explicitly extends the reach of the jurisdiction of the antifraud provisions of the securities laws with respect to actions brought by the SEC or the United States in connection with “conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or conduct occurring outside the United States that has a foreseeable substantial effect within the United States.” Dodd-Frank directs the SEC to study whether this right should extend to private rights of action.
  
  When are the new laws effective?
  
  Some provisions are effective immediately, as noted above; others will become effective over the next 18 months through rulemaking by the SEC and/or the U.S. securities exchanges. Future rulemaking should provide more clarity with respect to the application of Dodd-Frank to FPIs.
  
  What should you do now?
  
  FPIs should review their corporate governance practices to determine whether the potential Dodd-Frank changes will affect them. FPIs should also monitor the SEC’s rulemaking and the national exchanges closely for updated information regarding amendments that expressly or potentially impact FPIs. FPIs might consider commenting on the new rulemaking through the SEC’s website at [www.sec.gov] . 
  
  What if you have questions?
  
  For any questions or more information on these or any related matters, please contact any attorney in the firm’s corporate and securities practice group.
  
  Disclaimer
  
  This update has been prepared by Sheppard, Mullin, Richter & Hampton LLP for informational purposes only and does not constitute advertising, a solicitation, or legal advice, is not promised or guaranteed to be correct or complete and may or may not reflect the most current legal developments. Sheppard, Mullin, Richter & Hampton LLP expressly disclaims all liability in respect to actions taken or not taken based on the contents of this update.

• 11:50

  Legal Update: Dodd-Frank Redefines "Accredited Investor" and the SEC Provides New Guidance

   » ‎ Corporate and Securities Law

  This blog posting is an update to our blog posting entitled Legal Update: Dodd-Frank Redefines "Accredited Investor", in which we explained that Section 413(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act amended the definition of "accredited investor" under Rule 215 of the Securities Act of 1933 and Rule 501 of Regulation D to exclude the value of an investor's primary residence from the $1 million net worth calculation.
   

  Update
  
  The SEC released further guidance regarding the definition of the term "value" in the form of Division of Corporation Finance, Compliance and Disclosure Interpretations, Q. 179.01. Section 413(a) of Dodd-Frank does not define the term "value," and it does not address the treatment of mortgage and other indebtedness secured by the person’s primary residence for purposes of the net worth calculation. The SEC’s guidance states that, pending implementation of SEC rule changes mandated by Dodd-Frank, the amount of indebtedness secured by the primary residence up to its fair market value may also be excluded together with the value of the person's primary residence. The guidance also states that where the indebtedness secured by the residence exceeds the value of the home, the excess should be considered a liability and deducted from the investor's net worth.
  
  As noted in our previous blog posting, despite the instruction to the SEC to adopt rules implementing Section 413, the alteration to the definition of "accredited investor" pursuant to Dodd-Frank was effective on enactment of Dodd-Frank. Accordingly, issuers relying on Section 4(6) of the Securities Act or Rule 505 or 506 of Regulation D should ensure their disclosure and subscription documents reflect the new definition.
  
  What if you have questions?
  
  For any questions or more information on these or any related matters, please contact any attorney in the firm’s corporate and securities practice group.
  
  Disclaimer
  
  This update has been prepared by Sheppard, Mullin, Richter & Hampton LLP for informational purposes only and does not constitute advertising, a solicitation, or legal advice, is not promised or guaranteed to be correct or complete and may or may not reflect the most current legal developments. Sheppard, Mullin, Richter & Hampton LLP expressly disclaims all liability in respect to actions taken or not taken based on the contents of this update.

• September 02, 2010
• 12:18

  Federal Court Rules Ohio's Suit Against BofA Can Proceed

   » ‎ Business Law
  Kevin LaCroix has an excellent review of the decision here. As he notes, there is much to discuss. But what jumped out at me in the course of reading reviews of the opinion (I have not read the 140-page opinion...
• 11:40

  Help Make the BLPB One of the Top 25 Business Law Blogs for 2010

   » ‎ Business Law
  We here at the BLPB are pleased to announce that the blog has been nominated as one of the Top 25 Business Law Blogs for 2010 by LexisNexis. Now, we need your help. If you enjoy this blog, please post...

• 8:12

  New York State Amends Power of Attorney Law

   » ‎ Corporate and Securities Law

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

  2009 Amendments
  
  On September 1, 2009, amendments to New York General Obligations Law ("NY-GOL") Section 5-1501 (the "2009 Amendments") went into effect regarding the statutory requirements of powers of attorney executed by individuals within the State of New York. Shortly thereafter, it became clear that significant problems and unintended consequences were created by many of its provisions. The 2009 Amendments imposed new disclosure and execution requirements aimed at reducing the risks of abuse and fraud in elderly care and the financial planning process.  They required, among other things, the use of longer, more comprehensive power of attorney forms.  However, the 2009 Amendments provided no exceptions for certain commercial transactions that often rely upon or involve the granting of a power of attorney, particularly powers of attorney executed in connection with shareholder proxies, real estate transactions, brokerage arrangements, Securities and Exchange Commission filings, state blue sky filings and tax forms. As a result, the New York State Bar Association created a Power of Attorney Working Group to study and report on the impact of the 2009 Amendments. The NYSBA Power of Attorney Working Group worked alongside the New York State legislature and its committees to craft the 2010 Amendments.
  
  2010 Amendments
  
  The 2010 Amendments clarify the ambiguities in the 2009 Amendments and alleviate certain onerous provisions, including:

  • amending the definition of “principal” so that it only applies to individuals “acting for himself or herself, and not as a fiduciary or as an official of any legal, governmental or commercial entity, who executes a power of attorney;"
     
  • eliminating the provision of the 2009 Amendments that created a presumption that the execution of a power of attorney revokes any prior powers of attorney executed by the principal;
     
  • expressly providing that the execution of a power of attorney does not revoke any power of attorney previously executed by the principal;
     
  • adding a provision that a power of attorney that complies with NY-GOL 5-1501 and is executed in another state or jurisdiction by a domiciliary of the State of New York is valid in the State of New York, and a power of attorney executed in the State of New York by a domiciliary of another state or jurisdiction in compliance with the law of that state or jurisdiction or the laws of the State of New York is valid in the State of New York.

  In addition, the 2010 Amendments added NY-GOL Section 5-1501(c) which provided that the following powers are not "powers of attorney" under this law:
   

  1. a power of attorney given primarily for a business or commercial purpose, including without limitation:
   

  (a) a power to the extent it is coupled with an interest in the subject of the power;

  (b) a power given to or for the benefit of a creditor in connection with a loan or other credit transaction;

  (c) a power given to facilitate transfer or disposition of one or more specific stocks, bonds or other assets, whether real, personal, tangible or intangible;
   

  2. a proxy or other delegation to exercise voting rights or management rights with respect to an entity;
   

  3. a power created on a form prescribed by a government or governmental subdivision, agency or instrumentality for a governmental purpose;
   

  4. a power authorizing a third party to prepare, execute, deliver, submit and/or file a document or instrument with a government or governmental subdivision, agency or instrumentality or other third party;
   

  5. a power authorizing a financial institution or employee of a financial institution to take action relating to an account in which the financial institution holds cash, securities, commodities or other financial assets on behalf of the person giving the power;
   

  6. a power given by an individual who is or is seeking to become a director, officer, shareholder, employee, partner, limited partner, member, unit owner or manager of a corporation, partnership, limited liability company, condominium or other legal or commercial entity in his or her capacity as such;
   

  7. a power contained in a partnership agreement, limited liability company operating agreement, declaration of trust, declaration of condominium, condominium bylaws, condominium offering plan or other agreement or instrument governing the internal affairs of an entity authorizing a director, officer, shareholder, employee, partner, limited partner, member, unit owner, manager or other person to take lawful action relating to such entity;
   

  8. a power given to a condominium managing agent to take action in connection with the use, management and operation of a condominium unit;
   

  9. a power given to a licensed real estate broker to take action in connection with a listing of real property, mortgage loan, lease or management agreement;
   

  10. a power authorizing acceptance of service of process on behalf of the principal; and
   

  11. a power created pursuant to authorization provided by a federal or state statute, other than this title, that specifically contemplates creation of the power, including without limitation a power to make health care decisions or decisions involving the disposition of remains.

  
  The 2010 Amendments address the primary concerns of transactional attorneys advising clients in the shareholder proxy process, SEC filings, state blue sky filings and other commercial transactions by including the general exception for powers of attorney executed "primarily for a business or commercial purpose," as well as the more transaction-specific exceptions listed above. The retroactive effect of the 2010 Amendments means that so long as a power of attorney complies with the 2010 Amendments, it will be deemed valid and will not need to be re-executed even if it was improperly executed under the 2009 Amendments. Nevertheless, persons relying on a power of attorney in the State of New York should carefully review the amended New York State Power of Attorney Law to ensure that it complies with, or falls within a stated exception from, its provisions.
  
  For further information, please contact Gabriel G. Matus at (212) 634-3055. Mr. Matus is a member of the Corporate Practice Group in the firm's New York office.

• September 01, 2010
• 17:48

  Questioning the Quest for "Shareholder Engagement" -- European Edition

   » ‎ Business Law
  The European Federation for Retirement Provision (EFRP) weighed in today on the potential value of shareholder engagement in response to the European Commission's Green Paper on Corporate Governance in Financial Institutions and Remuneration Policies. The EFRP concluded that voluntary shareholder...
• August 31, 2010
• 13:48

  The SEC and the Foreign Freeze

   » ‎ Business Law
  Late last week, the SEC obtained a court Order authorizing "emergency action" against two Spanish nationals (a research analyst and a brokerage customer) who allegedly engaged in insider trading in Potash Corporation (an NYSE stock) through purchases of options on...

• 10:29

  Department Of Labor Attempts To Extend The "Christian Doctrine" To Subcontracts

   » ‎ Corporate and Securities Law

  This article was authored by members of the Firm's Government Contracts & Regulated Industries Practice Group. For additional articles and postings concerning this and related topics, please refer to Sheppard Mullin's Government Contracts Blog, which can be found at www.governmentcontractslawblog.com.
  
  It has long been questioned whether the “Christian Doctrine,” pursuant to which mandatory contract clauses reflecting core procurement policy are incorporated into government prime contracts by operation of law, can be used to incorporate such clauses into subcontracts. That question may now have an answer. In a non-CDA decision issued last year that has flown somewhat “under the radar,” the Department of Labor’s Administrative Review Board (“ARB”) held that at least some such clauses are incorporated into subcontracts by operation of law. OFCCP v. UPMC-Braddock, ARB Case No. 08-048 (“UPMC-Braddock”).
   

  While the ARB does not have jurisdiction under the Contracts Disputes Act (“CDA”), it has jurisdiction over a significant number of disputes arising under many of the socio-economic government contract clauses, such as the various equal opportunity clauses mandated by Executive Order 11246 and certain ameliorative statutes that address the needs of the disabled and veterans. Moreover, the reasoning of the ARB might also appeal to tribunals with jurisdiction over CDA disputes when considering whether a given clause is incorporated into a subcontract by operation of law.
  
  Given the number of contract clauses that the FAR mandates must be flowed down to contractors it would seem that a decision addressing this issue is long overdue. But in fact it has been some 47 years since the Court of Claims, in G. L. Christian & Associates v. United States, 312 F.2d 418, 426 (Ct. Cl. 1963), established the principle that contract clauses addressing “a deeply ingrained strand of public procurement policy” are “incorporated, as a matter of law, into [the] contract….”  This holding, commonly referred to as the “Christian Doctrine,” was quickly accepted by other tribunals because the policy underlying it makes sense: if Congress has directed that contractors are to comply with a given set of requirements, then neither they nor the contracting agency should be able to evade that direction simply by physically excluding the implementing clause from the contract document. The sensibility of the underlying policy, however, should not be confused with the sensibility of the Christian Doctrine itself. The Court of Claims could easily have held, consistent with that policy, that the contract itself was illegal, an unauthorized act for which the contracting officer had no actual authority, a decision that would have been consistent with the oft-cited case of Federal Crop Insurance v. Merrill. That, then, would have left the parties to their rights under a quantum meruit theory, with recovery based on a standard legal theory customarily used by the courts when there is no contract.
  
  It is not the purpose of this posting to revisit the wisdom of, or necessity for, the Christian Doctrine. It has been around too long and its principles are too settled to make that dialogue worth the effort. It has long been the law – for prime contracts. That policy that underlies the doctrine might arguably be thought to extend with equal felicity to subcontracts under government prime contracts, but – until UPMC-Braddock – we were aware of no Board of Contract Appeals or court that has so held. Perhaps this persistent silence reflected some vestigial respect for the concept of privity. If the Government is not a party to a contract, should it – a stranger to the bargain that owes no duty to and has no contractual liability to the subcontractor – be able to impose under that contract an obligation that the parties have excluded? Some might think the answer to that question would be a resounding “No.” But the ARB apparently believes otherwise.
  
  In UPMC-Braddock, the ARB, a tribunal with authority to decide disputes between the Office of Federal Contract Compliance Policy (“OFCCP”) and contractors, decided that the equal opportunity requirements of Executive Order 11426, the Rehabilitation Act, and the Vietnam Era Veterans’ Readjustment Act each express a significant or “deeply ingrained strand of public procurement policy” that is incorporated by operation of law into any subcontract under a federal prime contract – regardless of whether the parties to that subcontract included the clauses. In this regard, the two statutes in question explicitly require the inclusion of their implementing clauses in subcontracts. The Executive Order does not, stating, rather that “each [covered] contractor…shall file, and shall cause each of his subcontractors to file, Compliance Reports….”  (Emphasis added).
  
  The UPMC-Braddock decision arises from OFCCP policy of initiating enforcement proceedings directly against subcontractors at any tier and its determination that three hospitals holding HMO contracts with the University of Pittsburgh Medical Center (“UPMC”), which, in turn, had a prime contract with the Office of Personnel Management (“OPM”) to provide medical services and supplies to federal government employees, were
   

  (a)       subcontractors under a federal prime contract and
   

  (b)       bound by the provisions of the three equal opportunity clauses because the clauses were incorporated into the subcontracts by operation of law.

  
  By way of background, prior to this decision, health care providers never believed they were, nor had they ever been treated as, subcontractors under OPM’s Federal Employees Health Benefits Acquisition Regulation (“FEHBAR”), 48 CFR 1600 et. seq. This belief stemmed from the FEHBAR definition of “subcontractor” as “any supplier, distributor, vendor, or firm that furnishes supplies or services to or for a prime contractor or another subcontractor, except for providers of direct medical services or supplies pursuant to the Carrier’s health benefits plan ….” (Emphasis added). This definition was incorporated directly into the hospital HMO’s (“hospitals”) contracts with UPMC. As the HMOs in question were, in their view, something other than subcontractors, they never considered themselves covered by the requirements of the three Equal Opportunity laws, all of which (i) mandate that non-exempt subcontracts whose values exceed various specified thresholds incorporate the applicable equal opportunity clause and (ii) are implemented by the Secretary of Labor and his delegee the OFCCP. When the three hospitals first received letters from the OFCCP advising them that their contracts were covered under the three laws and scheduling compliance reviews of their operations, their managements politely declined either to provide the documents requested or to allow the agency to conduct onsite reviews of the HMOs’ compliance with the three equal opportunity clauses.
  
  The OFCCP sought injunctive relief that was granted by the ARB, which reasoned as follows:
   

  (a)        Pursuant to the Executive Order and the two statutes in question, UPMC’s contract with OPM “explicitly required” that UPMC include the applicable equal opportunity clause in every subcontract.
   

  (b)        The FEHBAR (which the decision characterizes as a “FAR regulation”) and contract provisions excluding “providers of direct medical services or supplies” from the definition of subcontractor was in direct conflict with the DOL regulations implementing the Executive Order and the two statutes, which collectively express “a significant or deeply ingrained strand of public procurement policy.” The exclusion was, therefore, “invalid or void.”

  
  Just where does this holding take us? Well, maybe nowhere. UPMC-Braddock and its sister hospitals have appealed the ARB’s decision to the U.S. District Court for the District of Columbia, arguing, among other things, that “[t]he affirmative action requirements that OFCCP seeks to impose . . . are not enforceable against a party which had never agreed to such requirements and which had never agreed to do business with the federal government.”  UPMC-Braddock v. Solis, D.D.C., Civ. A. No. 1:09-121-PLP (Complaint filed June 30, 2009). It would, of course, be refreshing if the court were to sustain the appeal and enforce the subcontracts as written, particularly since one might think that the HMOs had a justifiable basis for relying on the FEHBAR’s explicit declaration that their agreements were not “subcontracts.” The HMOs, it would seem, have both the language of their agreements and the language the FEHBAR on their side. One would hope that is enough.
  
  But if it is not, again, where does that take us?
  
  It is of course possible that its impact will be limited to those clauses over which the ARB has enforcement authority and that CDA tribunals will decline to extend it to every FAR clause that has ever been shoehorned into a prime contract via the Christian Doctrine. After all, four decades of silence on the issue suggests that the CDA tribunals have hardly been chomping at the bit to extend Christian. Moreover, the Government has a direct right of action against the prime contractor and can seek redress against the prime contractor for its failure to have discharged its contractual duty to flow the missing clause down into its subcontract and it would be extraordinary for a tribunal now to hold that Christian dispenses with the rule of privity in regard to Government claims against subcontractors. That is a slippery slope down which the Government may not wish to slalom if, at the bottom, it eventuates in the collateral elimination of privity as a bar to subcontractor claims against Uncle Sam.
  
  What about prime contractor claims against subcontractors seeking to impose duties under absentee clauses via the Christian Doctrine? Well, absent the litigation of the issue under an indirect, sponsored appeal agreement, those claims will not be heard by a CDA tribunal.  State and local courts, and even federal district courts, do not live and breathe the federal common law and we would hazard a guess that the judges in those tribunals will not find the Christian Doctrine as easy a pill to swallow as do those that work every day in the sometimes arcane world of government contracts. They may well be reluctant – if not loath – to modify subcontracts for the benefit of a prime contractor that simply failed to have included certain clauses in the subcontracts in the first instance. 
  
  All of which means – we live in a world of uncertain legal obligations. Root for the appellants.
  
  For further information concerning our Government Contracts Practice, contact our Practice Group Leaders, Bryan Daly in Los Angeles at (213) 617-5466 and Anne Perry in Washington, D.C. at (202) 218-6875.
  
  Authored By:
  
  W. Bruce Shirk
  202) 741-8426
  bshirk@sheppardmullin.com
  
  and
  
  Anne B. Perry
  202)218-6875
  aperry@sheppardmullin.com

• August 30, 2010
• 12:56

  Explaining Court Ordered Dissolution

   » ‎ Business Law
  The Delaware Court of Chancery issued an opinion on August 2 in Lola Cars International, Ltd. v. Krohn Racing, LLC (pdf) that provides a detailed example of how things can go wrong in a joint venture. The eighty-four page opinion...
• August 28, 2010
• 18:46

  Work-Life Balance: The Best House Music Podcast of the Year

   » ‎ Business Law
  If your thing is business law, then you've likely been quite busy recently. Please allow me to remind you that it is important to maintain a healthy balance in your life, including spending time with loved ones, getting plenty of...

• August 27, 2010
• 14:50

  SEC Adopts Mandatory Proxy Access Rule for Shareholder Director Nominations -- Applicable for 2011 Proxy Season

   » ‎ Corporate and Securities Law

  On August 25, 2010, the Securities and Exchange Commission voted 3-to-2 along party lines to adopt a controversial proxy access regime to facilitate shareholders’ ability to nominate a limited number of candidates for election as directors. The new rules, which are primarily contained in new Rule 14a-11 promulgated under the Securities Exchange Act of 1934, will permit a single shareholder or group of shareholders owning at least 3% of the shares entitled to vote for directors to nominate, in accordance with applicable state corporate law, a number of directors up to 25% of the number of authorized directors and have such nominees included in the company’s proxy statement.
   

  Although legal challenges are expected, the rules are intended to be effective for the 2011 proxy season, and we advise all public companies (other than foreign private issuers, who are exempt, and smaller reporting companies, who are exempt for the first three years) to consider immediately the impact of proxy access on the upcoming 2011 proxy season.
  
  Background
  
  The SEC has been exploring means of facilitating shareholder nominees of directors for decades. In the aftermath of the corporate scandals of the early 2000s, the SEC proposed in October 2003 a right for shareholders to force companies to include shareholder nominees in the company’s proxy statement if certain “triggers” occurred, such as a director candidate receiving a set percentage of withhold votes in an election. The 2003 proposal generated significant comments and controversy and the Commission did not adopt it. With another set of financial scandals occurring later in the decade, the SEC took up the issue again.
  
  The proxy access rules adopted on August 25, 2010 were proposed on June 10, 2009. The June 2009 proposal prompted hundreds of comment letters from concerned corporations and other interested parties. Activist shareholders, labor unions and pensions supported the proposed rules.
  
  Proxy access rules have been adopted in a different environment than when first seriously proposed in October 2003. Most larger public companies have now adopted a majority voting requirement for the election of directors, which provides shareholders an opportunity to show opposition to the board’s candidates.  Under most majority voting regimes, a candidate who fails to receive a majority of the votes cast must tender his/her resignation and the board or a committee will decide whether or not to accept the resignation. In 2009, the New York Stock Exchange amended its Rule 452 to prohibit brokers who trade on the New York Stock Exchange from exercising discretionary authority to vote shares held in street name in favor of director candidates in uncontested elections. The amendment to Rule 452 eliminated a reliable “head start” companies had toward achieving the majority voting requirement. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) also prohibits broker discretionary voting on the election of directors.
  
  In the years following the aborted 2003 proxy access proposal, proxy contests to elect a minority of directors saw a dramatic increase. Despite the cost of these campaigns, hedge funds began aggressively targeting underperforming companies, deliberately accumulating positions in such companies and then launching campaigns to unseat a minority of the directors and replace them with directors with an agenda to improve shareholder value, generally in the short term. While the financial meltdown may have temporarily reduced the growth pace of this industry, hedge fund activism is alive and well and several high profile campaigns are underway at the date of this article.
  
  Finally, the Dodd-Frank Act has mandated say-on-pay and say-on-golden parachutes shareholder votes (see our prior blog articles Senate Passes Dodd-Frank Wall Street Reform and Consumer Protection Act and The Regulatory March to Reform Executive Compensation Practices Takes Another Step Forward). Most commentators believe that such votes will provide a significant opportunity for shareholders to express their views on the performance of company management and discipline boards to give greater consideration in advance to the likely reaction of shareholders to compensation-related decisions. Such decisions are often at the heart of shareholder concerns over management.
  
  Despite all of these changes favoring the shareholder franchise, a majority of the Commissioners determined that direct access to a company’s proxy statement for shareholder nominees is in the best interests of the investing public. The rules adopted make a number of important changes to the June 2009 proposed rules, many of which are summarized below.
  
  While new SEC rules do not change any state or foreign corporate law rules governing the nomination and election of directors, they do provide for the inclusion of nominees properly nominated in accordance with state law in the company’s proxy statement, and in so doing, they reduce substantially the costs for shareholders to have nominees considered for election.
  
  Together with other recent rulemaking, institutional shareholders and special interests will be newly empowered in the 2011 proxy season to directly influence issuers through director elections, while issuers, incumbent directors and management will likely be forced to redirect significant time and resources to the process.
  
  What Changes Now
  
  Rule 14a-11
  
  New Rule 14a-11 will apply to companies reporting under the Exchange Act, including companies subject to the Investment Company Act of 1940.  However, as with other proxy rules, Rule 14a-11 will not apply to foreign private issuers.   Large accelerated filers and accelerated filers will be required to comply in time for the 2011 proxy season (see discussion of effective date below). Rule 14a-11 will eventually apply to smaller reporting companies, but not until three years after the effective date.
  
  Subject to the phase-in rule for smaller reporting companies, Rule 14a-11 is mandatory for all subject companies. A company may not opt out of or increase the thresholds for proxy access, even with the approval of its shareholders.  As discussed further below, companies may adopt proxy access rules that are more permissive of proxy access than Rule 14a-11.
  
  Rule 14a-11 requires a company to include in its proxy statement director candidates nominated by a shareholder or a group of shareholders holding in the aggregate at least 3% of a company's outstanding shares entitled to vote on the election of directors, who have held such number of shares continuously for at least three years. The maximum number of candidates a company must include is 25% of the number of directors (and always at least one director).

  • These ownership and holding period thresholds represent a departure from the June 2009 proposal, which called for scaled ownership requirements of 1%, 3% and 5% based on company size and a 1-year holding period. The number of directors is consistent with the June 2009 proposal.
     
  • In calculating the 3% ownership requirement of the Rule, ownership is reduced by any shares that a nominating shareholder has sold in a short sale.  Shares borrowed by a nominating shareholder are excluded from the calculation but shares loaned to others count towards the total, provided that the lender has the right to recall such shares and will do so upon being notified that its shareholder nominee(s) will be included in the company’s proxy statement. 
     
  • The three-year holding period is measured from the date the shareholder files notification of its intent to use the proxy access rules on Schedule 14N (discussed below) with the SEC. The shareholder must continue to own the shares through the date of the meeting at which directors are elected, and must state its intent to continue to hold such shares after the election. If a shareholder group files, the rules are applicable to each member of the group.
     
  • If 25% of the number of authorized directors is not a whole number, the number of nominees that must be included is rounded down to the nearest whole number. 
     
  • The number of directors that shareholders may nominate is not reduced for a classified board election of a subset of directors. However, where any continuing directors who are not up for election in a given year were elected as a shareholder nominee pursuant to Rule 14a-11, such continuing directors will count toward the 25% maximum.

  If multiple shareholders or groups propose candidates, the nominees of the nominating shareholder or group with the highest qualifying voting power percentage will be included. If that number of nominees is less than the maximum number that must be included, the nominee(s) of the next largest shareholder or group must be included, and so on until the maximum number of nominees is included. If, prior to the printing of proxy materials, a director candidate is disqualified or becomes unavailable, the same order of priority must be used to put a replacement candidate in the proxy. Once a company has begun printing its proxy materials, it does not need to include replacement nominees.

  • Priority based on holdings represents a departure from the "first-in" standard in the June 2009 proposal, which would have given priority to the first shareholder or group that filed its notice of intent.

  Nominee Eligibility
  
  No intent to influence control
  
  A nominating shareholder or member of a group may not use Rule 14a-11 if it holds any of the company’s securities with the purpose or the effect of changing control of the company or to gain a number of seats on the board that exceeds the maximum number of nominees permitted under Rule 14a-11. Each nominating shareholder or group member must certify to the absence of such intent in the Schedule 14N. The SEC clarified in the final rule that the absence of an intent to change control of the company is a condition for use of Rule 14a-11. Accordingly, a company that believes that a nominating shareholder or group member has an intent to change control or to pursue further nominees, has the opportunity to exclude the nominees using the SEC’s informal process (discussed below) or litigation.
  
  No agreements with the company
  
  In addition, a nominating shareholder or member of a group may not have an agreement with the company regarding director nominations prior to filing a Schedule 14N.  This rule is designed to prevent collusion among the company and friendly shareholders to nominate candidates that the board approves. This rule does not prohibit negotiations among the nominee, the nominating shareholder or group and the nominating committee or board of directors of the company regarding the nominee’s inclusion in the company’s proxy statement as a company supported nominee, where those negotiations are unsuccessful, or negotiations that are limited to whether the company is required to include the shareholder nominee in the company’s proxy statement in accordance with Rule 14a-11.  
  
  Independence requirement and violations of applicable law
  
  Companies whose securities trade on a national securities exchange or a trading system subject to national securities association rules need only include a shareholder nominee in the proxy statement if the nominee meets the exchange’s objective criteria for independence. NYSE and Nasdaq also have subjective criteria for independence, and heightened independence requirements for audit committee members,[1] but nominees do not need to meet these criteria as a condition to inclusion in the company’s proxy statement.
  
  A company may also exclude a nominee if it believes the nominee's inclusion on the board of directors would violate federal, state or foreign law, or the rules of the applicable national securities exchange, other than rules related to independence (which are addressed as described above).
  
  Companies may not exclude nominees that do not meet director qualification requirements set forth in the company’s organizational documents. If a nominee does not meet such requirements, the company can include that fact or belief in the proxy statement, which presumably would influence the vote on that nominee. If a nominee who does not meet qualification requirements is nonetheless elected, then under state law, the nominee would not in fact take a board seat, and applicable state law would govern what happens with respect to that seat. Although governing document qualifications cannot disqualify a nominee from being named in the company’s proxy statement, governing document qualifications may still be a powerful tool for companies to ensure that directors meet minimum standards important to the company.
  
  Exclusion Procedure
  
  The SEC will have an informal procedure for companies to use when they believe a purported Rule 14a-11 nominee may be excluded. No later than 14 calendar days after the close of the nomination window period, an issuer must notify the nominating shareholder(s) of a determination not to include one or more nominees. The nominating shareholder(s) will have 14 days after receipt of such notice to respond and, where applicable, cure any defects in the nomination. No later than 80 calendar days before filing its definitive proxy statement with the SEC, the company must notify the SEC of its intent to exclude a Rule 14a-11 nominee and the basis for its determination. The company may (but is not required to) seek a no-action letter from the SEC staff to support its determination. Nominating shareholder(s) will have 14 days after receipt of the company’s notice to the SEC to submit a response to the SEC staff. If requested by the Company, the SEC staff may at its discretion and as soon as practicable provide an informal statement of its views to the company and the nominating shareholder(s). Promptly following receipt of the SEC staff’s views (if provided), the company must provide notice to the nominating shareholder(s) whether it will include or exclude the nominee.
  
  Schedule 14N
  
  Nominating shareholders and groups will be required to provide a notice on Schedule 14N to the company of an intent to exercise nomination rights under the Rule. 

  • The Schedule 14N must be delivered to the company and to applicable securities exchanges and concurrently filed with the SEC.
     
  • Disclosure required by Schedule 14N includes information evidencing that the nominating shareholder(s) and the nominee(s) satisfy the eligibility requirements of Rule 14a-11, the extent and nature of relationships between the nominating shareholder(s) and the nominee(s) and the beliefs of the nominating shareholder(s) as to whether the nominee(s) satisfy any board qualification requirements in the company’s governing documents.  There are no restrictions on relationships between the shareholder(s) and the nominee(s). However, we would expect that shareholders who wish to avoid restrictions on trading in the company’s securities would avoid proposing a nominee who would make the shareholder subject to the company’s insider trading policy or to reporting and short-swing liability under Section 16 of the Exchange Act.
     
  • Schedule 14N may include a supporting statement not longer than 500 words per nominee, which the company must include in its proxy statement. A company will not be subject to any liability under the securities laws for incorrect information contained in the supporting shareholder statement.
     
  • The Schedule 14N must be filed with the SEC no earlier than 150 calendar days, and no later than 120 calendar days, before the anniversary of the date that the company mailed its proxy materials for the prior year’s annual meeting. If the company did not hold an annual meeting during the prior year, or if the date of the meeting has changed by more than 30 calendar days from the prior year, the company will be required to disclose the filing date, which must be reasonable, in a Form 8-K filed pursuant to new Item 5.08 within four business days after the company determines the anticipated meeting date.

  Amendments to Rule 14a-8 (Shareholder Proposals)
  
  Prior to the adoption of these new rules, the so called 'election exclusion' provided by Rule 14a-8 permitted companies to exclude shareholder proposals to amend the company's organizational documents to establish procedures for the inclusion of shareholder director nominees in the company proxy materials proposals. Rule 14a-8 will be amended to remove that basis for exclusion.  Accordingly, a shareholder may propose amendments to charter documents providing for more liberal rules of proxy access, such as reduced ownership thresholds, reduced holding periods, and the like. If the proposed amendments are to the bylaws, under Delaware and other state laws, the action may be direct rather than advisory.
  
  Amendments to Rule 14a-2 (Proxy Solicitation Rules)
  
  The SEC also amended Rule 14a-2 to permit shareholders to solicit other shareholders to form a nominating group for Rule 14a-11 purposes and to campaign for shareholder nominees without running afoul of the proxy rules.
  
  Rule 14a-2(b)(7) provides an exception from proxy solicitation prohibitions for oral and written communications solicitations by or on behalf of any shareholder in connection with the formation of a nominating shareholder group. To be eligible to use this exemption, a shareholder cannot be holding the company’s securities with the purpose, or with the effect, of changing control of the company or to gain a number of seats on the board of directors that exceeds the maximum number of nominees that the company could be required to include under Rule 14a-11.
  
  Written communications may include no more than a statement of the shareholder’s intent to form a nominating shareholder group, identification of and a brief statement regarding the potential nominee(s) (or, where no nominee(s) have been identified, the characteristics of the nominee(s) that the shareholder intends to nominate, if any), the percentage of voting securities that each soliciting shareholder holds or the aggregate percentage held by any group to which the shareholder belongs, and contact information. Such written information must be filed with the SEC under cover of Schedule 14N on the day first used.
  
  The exception also covers oral solicitations, which are not limited in content. In order to rely on the exception for oral solicitations, the shareholder must file a notice of commencement of oral solicitations on Schedule 14N.
  
  Rule 14a-2(b)(8) provides an exception from proxy solicitation prohibitions for solicitations by or on behalf of a nominating shareholder or group in support of its nominee(s). The exception may be used only when the speaker is not seeking proxy authority. Written solicitations must include specified disclosures, including the identity of the nominating shareholder or group, a description of his/her/its direct or indirect interests, by security holdings or otherwise, and a specified legend. These written communications must be filed with the SEC under cover of Schedule 14N on the day first used. There is no filing requirement for oral communications in support of nominees. A shareholder may begin these communications immediately upon being notified that such shareholder’s nominee(s) will be included in the company’s proxy statement.
  
  Neither rule discussed above provides an exemption for communications in connection with non-Rule 14a-11 proxy contests, such as those that occur under the director nomination provisions of a company’s governance documents. Moreover, both rules provide the exemption will be lost retroactively if the shareholder or group subsequently engages in a non-Rule 14a-11 nomination or solicitation in connection with the subject election of directors. The retroactive loss of the exemptions is designed to prevent exempt Rule 14a-11 solicitations from being used as a first stage in a more aggressive proxy contest.
  
  No Preliminary Proxy Statement for 14a-11 Nominees
  
  The inclusion of shareholder nominees in a proxy statement pursuant to Rule 14a-11 will not, on its own, require the filing of a preliminary proxy statement.
  
  Additional Deadline Disclosure under Rule 14a-5
  
  In addition to the shareholder proposal and advance notice bylaw deadlines already required to be disclosed under Rule 14a-5, companies must disclose the deadline for submitting nominees for inclusion in the company’s proxy materials for the company’s next annual meeting.
  
  Continuation of Use of Schedule 13G
  
  A shareholder eligible to report beneficial ownership on Schedule 13G rather than the longer form Schedule 13D will not be precluded from using Schedule 13G merely because a holder engages in a Rule 14a-11 process to nominate a director for inclusion in the company’s proxy statement.
  
  No Effect on Section 16 or Affiliate Status
  
  The standards for determining whether a shareholder is subject to reporting under Section 16 of the Exchange Act by virtue of being the beneficial owner of 10% or more of a class of voting securities registered under the Exchange Act will not change as a result of the new rules. Accordingly, joining a Rule 14a-11 nominating group may be considered for purposes of determining whether a holder is part of a “group” (as defined under Section 13(d) of the Exchange Act) that is a 10% or greater beneficial owner.
  
  Similarly, there is no “safe harbor” associated with Rule 14a-11 activities for determination of whether a shareholder is an “affiliate” for purposes of the securities laws. Accordingly, Rule 14a-11 activities may be taken into account in the facts and circumstances determination of whether a shareholder is an affiliate. The lack of a safe harbor from the affiliate definition is a departure from the June 2009 proposal.
  
  No Limitation on Repeated Nominations
  
  The new rules contain no limitations on the ability of shareholders to nominate previously unsuccessful candidates. A 3% or greater shareholder is free to nominate the same candidates every year despite unsuccessful prior elections, provided the conditions of Rule 14a-11 are satisfied each year.
  
  What will be the effect of the Rule?
  
  The ramifications of the proxy access rules are likely to be significant.
  
  It is unclear the extent to which institutional investors that have not previously pursued proxy contests will avail themselves of Rule 14a-11. It is also unclear whether individual investors will be able to organize groups large enough to meet the 3% ownership threshold, and if they do, whether larger investors will step in and propose nominees that “trump” the nominees of smaller investors for the limited Rule 14a-11 space on the proxy statement.
  
  Most majority voting provisions provide that they do not apply in contested elections for directors. Accordingly, one effect of Rule 14a-11 will be to restore plurality voting for directors in most elections where shareholders avail themselves of Rule 14a-11.
  
  It is clear that proxy access presents a significant change to the prevailing order of the board nomination process. Where a Rule 14a-11 candidate is elected, board communications will likely be affected, at least at the outset. The traditional board nomination process allows management and the continuing directors significant opportunity to get to know a new board member. That process usually involves the existing directors and the new director getting comfortable that they will operate harmoniously together. Rule 14a-11 directors that were opposed by the current board will lack the trust built through the traditional nomination process, and depending on the nature of the campaign, may be affirmatively distrusted and even disliked by the other directors. Of course, this kind of disruption is not new - boards that have seen successful activist shareholder campaigns have been through it. Rule 14a-11 has the potential to expand the universe of boards that experience such a shift to include more companies and particularly companies that in the past were not at significant risk of activist shareholder attack.
  
  The risk of shareholder nominees could affect future management decisions. That is, management at some companies might find incentive to make decisions to satisfy the concerns of small constituencies of shareholders who might otherwise disrupt the proxy process by nominating dissident directors. It remains to be seen whether directors hostile to management or otherwise unwelcome by other board members will improve corporate governance, accountability and performance, as the SEC hopes. In any case, incumbent boards and company management will likely be required to spend significant additional time and resources on the director nomination and election process. Some, including dissenting Commissioner Kathleen L. Casey, argue that this new proxy access regime may reduce the competitiveness of U.S. corporations.
  
  When is the New Rule Effective?
  
  The new rules will become effective 60 days after publication in the Federal Register. The publication date is uncertain, but the new rules should be in effect approximately November 1, 2010. Smaller reporting companies will be exempt from the Rule until three years after the effective date. 
  
  To determine whether the new rules will affect a company’s 2011 proxy season, subtract 120 days from the anniversary of the date the 2010 proxy materials were mailed to shareholders. If the resulting date is on or after the effective date of the new rules, the new rules will be in effect for the company’s 2011 proxy season. For example, if a company released its proxy statement to shareholders on March 1, 2010, the new rules will apply to the company’s 2011 annual meeting if the new rules become effective by November 1, 2010.
  
  What should you do now?
  
  We recommend that companies subject to the new rules quickly evaluate the impact of the new rules, considering the following:

  • Who are the company’s 3% or greater shareholders and which might be interested in nominating a director?
     
  • Which shareholders below 3% might be expected to solicit for formation of a 14a-11 group to nominate directors?
     
  • Are the company’s advance notice bylaws compatible with Rule 14a-11, including its notice provisions and information requirements?[2] 
     
  • Does the company have director qualification requirements in its charter or bylaws, and are such requirements sufficient to prevent persons unsuitable to serve from joining the board?
     
  • Will majority voting provisions cease to apply in a Rule 14a-11 contested election of directors, and if not, are the procedures for majority voting in a contested election workable?

  What if you have questions?
  
  For any questions or more information on these or any related matters, please contact any attorney in the firm’s corporate and securities practice group.
  
  Disclaimer
  
  This update has been prepared by Sheppard, Mullin, Richter & Hampton LLP for informational purposes only and does not constitute advertising, a solicitation, or legal advice, is not promised or guaranteed to be correct or complete and may or may not reflect the most current legal developments. Sheppard, Mullin, Richter & Hampton LLP expressly disclaims all liability in respect to actions taken or not taken based on the contents of this update.
  

  [1] The Dodd-Frank Act requires the SEC to require that the national securities exchanges and national securities associations determine rules relating to independence of compensation committee members. Because the definition of independent is not specified in the statute and requires SEC rulemaking, it is unknown whether compensation committee members will also need to meet heightened independence requirements.   The instructions to Rule 14a-11 state that the heightened requirements for audit committee members are not to be considered but does not address heightened requirements for other committee members.

  [2] The adopting release indicates that where provisions of a company’s governing documents are more restrictive than the requirements of Rule 14a-11, the company must still include nominees that are submitted in accordance with the requirements of Rule 14a-11. 

   

   

• 14:08

  Merging Skills and Doctrine in the Classroom: One Professor's Modest Beginning

   » ‎ Business Law
  The AALS Annual Meeting bulletin arrived in my mailbox today, reconfirming that curricular reform, new forms of assessment, and the need to bring skills into the class are hardly new topics of conversation for most faculties. From the Carnegie Report...

• 12:46

  Third Circuit Holds That Mixed Present/Future Statements Are Protected By Reform Act Safe Harbor

   » ‎ Corporate and Securities Law

  In In re Aetna, Inc. Securities Litigation, No. 09-2970, 2010 WL 3156560 (3d Cir. Aug. 11, 2010), the United States Court of Appeals for the Third Circuit held that certain allegedly misleading statements regarding the pricing of insurance premiums by a large health insurance company were protected under the safe harbor provision of the Private Securities Litigation Reform Act of 1995 (“Reform Act”), 15 U.S.C. § 78u-5(c)(1). The Court reasoned that the statements warranted protection because they were not only forward-looking — despite containing both present and future elements — but also immaterial. This decision further clarifies the Court’s analysis of mixed present/future statements for purposes of protection under the Reform Act’s safe harbor for forward-looking statements.
   

  Plaintiffs were investors who had purchased Aetna securities between October 27, 2005 and July 27, 2006, who initiated a class action against Aetna and four of its officers for violations of, inter alia, Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a). Plaintiffs alleged that Aetna secretly relaxed its underwriting criteria in an effort to under price competitors and gain market share, while publicly characterizing Aetna’s insurance premium pricing as “disciplined.” Plaintiffs also alleged that a statement appearing in Aetna’s April 27, 2006 SEC Form 10-Q report that “a percentage increase in per member medical costs . . . outpaced the percentage increase in per member premiums, due to higher medical cost trends for inpatient and outpatient facility and physician services,” misleadingly blamed the increase in MCR on higher medical costs rather than lower premium pricing.
  
  Aetna released its second quarter report for 2006 on July 27, 2006, announcing a 2% quarterly increase in MCR. That same day, Aetna’s stock price fell by 17%, causing a market capitalization loss of $3.58 billion. During the class period, the price of Aetna’s stock ultimately fell from $52.48 to $33.25. Plaintiffs claimed that, contrary to the officer’s characterization of the increase in MCR as “slight,” the 2% increase was in fact substantial, as evidenced by the sharp decrease in Aetna’s stock price.
  
  Defendants moved to dismiss, arguing that the “disciplined” pricing statements were “classic forward-looking statements” because Aetna could not confirm whether it had succeeded in ‘achieving premium yields in line with [its] medical cost trend’ until future actual medical costs incurred on policies were known. Defendants thus invoked the Reform Act safe harbor for forward-looking statements, which protects from liability statements that are (1) identified as forward-looking and accompanied by meaningful cautionary statements; or (2) immaterial; or (3) made without actual knowledge that the statement was false or misleading. Defendants also claimed the Form 10-Q was not misleading because it explicitly stated the fact that Aetna had underpriced some of its policies.
  
  The United States District Court for the Eastern District of Pennsylvania dismissed plaintiffs’ claims under Sections 10(b) and 20(a), holding all statements which formed the basis of plaintiffs’ claims expressed expectations about Aetna’s medical cost trend, which the court called “a specific measure of future performance.” The statements, characterized as “statement[s] of the plans and objectives of management for future operations” and “statement[s] of future economic performance,” were thus well within Reform Act’s definition of “forward-looking.” Plaintiffs appealed dismissal of their Section 10(b) and 20(a) claims.
  
  The Third Circuit observed that statements plaintiffs identified here were akin to those at issue in Institutional Investors Group v. Avaya, Inc., 564 F.3d 242 (3d Cir. 2009) [blog article here]. Avaya addressed protection of “mixed present/future” statements under the safe-harbor provision.   Avaya held that while mixed present/future statements are “not entitled to the safe harbor with respect to the part of the statement that refers to the present,” when the present-tense statements can not “meaningfully be distinguished from the future projection of which they are a part,” to the extent that those statements contained assertions about the present, “the assertions of current fact are too vague to be actionable.”
  
  The Third Circuit in Aetna, applying Avaya, found that despite that certain elements of defendants’ statements were partly historical and partly present-tense, those elements could not be distinguished from the statements’ assertions about the future. Specifically, “whether Aetna’s pricing was, in fact, disciplined could not have been determined at the time defendants made the statements,” because “[a]t the time the statements were made, the medical costs had not yet been incurred and could not be ascertained until later. Thus, to the extent that ‘disciplined’ pricing said anything about the current price of premiums, it did so in the form of a projection.” Further, while the statement in Aetna’s Form10-Q report was historical and not forward-looking, it was not misleading because it did not hide the fact that the increase in medical costs exceeded any increase in Aetna’s premium revenue.
  
  Having determined that the statements were “forward-looking” the Court went on to analyze the statements’ materiality and whether they were accompanied by any meaningful cautionary language. Plaintiffs argued that the language in Aetna’s financial reports filed with the SEC — that “[t]here can be no assurance regarding the accuracy of medical cost projections assumed for pricing purposes, and if the rate of increase in medical costs in 2006 were to exceed the levels projected for pricing purposes, our results would be materially adversely affected” — was insufficiently cautionary because it only addressed risks related to medical cost projections and failed to disclose Aetna’s alleged practice of underpricing premiums.
  
  The Court found this language provided “adequate” precautions under the Reform Act because it gave investors clear warning that “the accuracy of medical costs [could] be assured, actual medical costs [could] exceed projections assumed for purposes of setting premiums, medical costs in excess of projections [could not] be recovered through higher premiums, and inaccurate medical cost projections [could] have a materially negative effect on profitability.”
  
  Furthermore, the Third Circuit held that the statements were immaterial as a matter of law. Comparing the defendants’ statements to those at issue in In re Advanta Corp. Securities Litigation, 180 F.3d 525, 537 (3d Cir. 1999), the Court held that “oblique references to Aetna’s pricing policy” and “[g]eneral statements about the company’s dedication to ‘disciplined’ pricing and commitment to ‘discipline and rigor’” were “too vague to ascertain anything on which a reasonable investors would might rely,” and “could not have meaningfully altered the total mix of information available to the investing public.”
  
  Investors claiming statements containing both present and future elements are “misleading” must now be able to show the present components are clear and distinct from any future components, lest the entire statement be regarded as forward-looking and fall under Reform Act’s safe harbor protection. This case demonstrates the high bar investors must clear before a court will refuse to interpret such mixed statements as forward-looking.
  
  For further information, please contact John Stigi at (310) 228-3717 or Sarah Aberg at (212) 634-3091.

• 8:34

  Ninth Circuit Rejects Private Right Of Action To Enforce Section 13(a) Of The Investment Company Act Of 1940

   » ‎ Corporate and Securities Law

  In Northstar Financial Advisors, Inc. v. Schwab Investments, No. 09-16347, 2010 WL 3169400 (9th Cir. Aug. 12, 2010), the United States Court of Appeals for the Ninth Circuit held that nothing in Section 13(a) of the Investment Company Act of 1940 (“ICA”), as originally enacted or as subsequently amended, either created a private right of action or implied that such a right exists with the clarity and specificity required under United States Supreme Court precedent. In so holding, the Ninth Circuit followed the Second Circuit and the recent trend of federal courts to reject implied private rights of action under the ICA.
   

  The action centered around claims by investors that a large American investment trust operating a series of mutual funds unlawfully deviated from the investment policies set forth in its registration statement, to the detriment of the fund’s shareholders and in violation of Section 13(a) of the ICA. That provision generally requires an investment company to obtain shareholder approval before deviating from the investment policies contained in the company’s registration statement filed with the Securities and Exchange Commission (“SEC”). Defendant-Appellant Schwab Investments is an investment trust organized under Massachusetts law that consists of a series of mutual funds. In 1993, Schwab Investments initiated the Schwab Long-Term Government Bond Fund. By vote of that fund’s shareholders in 1997, Schwab Investments converted the fund into the Schwab Total Bond Market Fund (“Fund”), a fixed-income mutual fund that sought to track the Lehman Brothers U.S. Aggregate Bond Index (“Lehman Index”).  The Fund hired Defendant-Appellant Charles Schwab Investment Management, Inc. (“Charles Schwab”) as its investment advisor.
  
  Plaintiff-Appellee Northstar Financial Advisors, Inc. (“Northstar”) is a registered investment advisory and financial planning firm that manages discretionary and nondiscretionary accounts on behalf of investors and had over 200,000 shares of the Fund under its management. In August 2008, Northstar filed this shareholder class action in United States District Court for the Northern District of California against Schwab Investments and Charles Schwab (collectively, “Schwab”) for violations of Section 13(a) of the ICA.  Northstar sought to represent a class of investors who owned shares of the Fund from August 31, 2007, to the present. Northstar’s primary claim was that Schwab violated Section 13(a) when it allegedly deviated from the Fund’s fundamental investment policies. Northstar alleged that the deviations exposed the Fund and its shareholders to tens of millions of dollars in losses stemming from a sustained decline in the value of non-agency mortgage-backed securities. Schwab moved to dismiss for failure to state a claim under Section 13(a) of the ICA, asserting that there was no private right of action to enforce that section’s terms.  The district court denied the motion, upholding an implied private right of action under Section 13(a). Recognizing, however, that the question was not free from doubt, the district court certified its decision for interlocutory appeal. The Ninth Circuit accepted the appeal, and reversed and remanded.
  
  The Ninth Circuit reasoned that whether there exists a private right to enforce Section 13(a) of the ICA is a question of statutory construction, and, hence, the statute must either explicitly create a private right of action or implicitly contain one. Since both parties in the appeal agreed that Section 13(a) did not expresslycreate a private right of action, the Ninth Circuit held that if a private right to enforce existed, it must be implied from the statute’s language, structure, context and legislative history. The Ninth Circuit first analyzed the language and structure of the statute itself.
  
  In looking at the language of Section 13(a) and the structure of the ICA, generally, the Ninth Circuit looked for the presence of any “rights-creating language” that may have implied that Congress intended to confer upon shareholders the right to sue an investment company for violating the statute’s requirements. The Ninth Circuit held that the language of Section 13(a) and the structure of the ICA, generally, granted the SEC broad authority to investigate suspected violations, initiate actions in federal court for injunctive relief or civil penalties, and create exemptions from compliance with any ICA provision. The Ninth Circuit held that this thorough delegation of authority to the SEC to enforce the ICA strongly suggested that Congress intended to preclude othermethods of enforcement, including private rights of action. The Supreme Court had also cautioned that “where a statute expressly provides a particular remedy or remedies, a court must be chary of reading others into it.” Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 19 (1979).  Hence, because the statutory scheme of the ICA provides for thorough SEC enforcement of the ICA’s provisions, including Section 13(a), the Ninth Circuit followed the United States Supreme Court and held that “it is highly improbable that Congress absentmindedly forgot to mention an intended private action.”
  
  Furthermore, the Ninth Circuit held that it is evident from the text of the ICA that Congress knew how to create a private right of action to enforce a particular section of the Act if it wished to do so. Indeed, the Ninth Circuit pointed to two provisions in the ICA wherein Congress expressly authorized private suits for damages. First, in Section 30(f) of the original ICA, Congress expressly authorized private suits for damages against insiders of closed-end investment companies who make short-swing profits. Congress created a second express private right of action in 1970 when it added Section 36(b) to the ICA, which allows shareholders to sue an investment company’s advisor and its affiliates for breach of certain fiduciary duties relating to management fees.  The Ninth Circuit held that Congress’s enactment of these two express private rights of action elsewhere in the ICA, without the enactment of a corresponding express private right of action to enforce Section 13(a), indicates that Congress did not, by its silence, intend a private right of action to enforce Section 13(a).
  
  The Ninth Circuit then analyzed the legislative history of the ICA. Northstar argued that even if the ICA’s language did not imply a private right to sue, the statute’s legislative history, specifically the amendments to Sections 8 and 13 enacted in 1970 and 2007, demonstrated that Congress intended there to be an implied private right of action to enforce Section 13(a). The Ninth Circuit disagreed, holding instead that “nothing in the language or context of those amendments demonstrat[ed] a clear congressional intent to allow private lawsuits to enforce the statute’s provisions” (emphasis added).
  
  In concluding, the Ninth Circuit held that neither the language of Section 13(a), the structure of the ICA, nor the statute’s legislative history, including the amendments in 1970 and 2007, reflected any congressional intent to create, or recognize a previously established, private right of action to enforce Section 13(a). Thus, “the job of enforcement remains exclusively with the SEC.” Prior to this case, the Ninth Circuit had not decided the issue, but the Second Circuit had held that that there was no private right to enforce five other sections of the ICA, reasoning, in relevant part, that the purpose and structure of the entire ICA is grounded upon enforcement by the SEC, not on private enforcement. In holding with the Second Circuit, the Ninth Circuit’s decision highlights that federal courts have come to require increasingly specific congressional direction for the allowance of private suits to enforce public laws, and unless such direction is present in the statute, federal courts are reluctant to imply such a right.
  
  For further information, please contact John Stigi at (310) 228-3717 or Taraneh Fard at (213) 617-5492.

• August 26, 2010
• 13:30

  New Proxy Access Rules

   » ‎ Business Law
  Lisa Fairfax has a nice summary here. She highlights what I think has to be one of the money quotes from the release:[C]orporate governance is not merely a matter of private ordering. Rights, including shareholder rights, are artifacts of law,...
• 11:01

  Replacing Casebooks With Study Guides

   » ‎ Business Law
  I've been toying with the idea of replacing casebooks with the popular "Examples & Explanations" study guides in at least a few of my classes. Why? Because the study guides are significantly less expensive and more likely to be used...
• August 25, 2010
• 12:19

  Video Games, Best Efforts, and the Plight of the Long Snapper

   » ‎ Business Law
  Yesterday, I taught Business Associations I for the first time this semester, and today I begin Labor and Employment Law. Despite the name, that latter course is primarily an employment law course that provides an introduction to the NLRA and...
• August 24, 2010
• 10:08

  The SEC Sues New Jersey

   » ‎ Business Law
  This is no doubt the regulatory season for broad strokes. Emphasis has been placed on entities so large as to be "systemically significant;" a whole nation has seen its sovereign debt downgraded. And, as was recently publicized, the State of...
• August 23, 2010
• 12:50

  Investors Skeptical of Stock Market and Housing and . . .

   » ‎ Business Law
  This weekend brought news that many small investors are exiting the stock markets at a rate similar to that of the 1980s. Similarly, people are (for the most part) not thinking of homes as long-term growth investments in the way...

• 8:48

  D.C. Circuit Vacates Proposed Fee For NYSE Arca "Depth-Of-Book" Data And Remands To SEC For Further Review

   » ‎ Corporate and Securities Law

  In NetCoalition v. Securities & Exchange Commission, No. 09-1042 (D.C. Cir. Aug. 6, 2010), the United States Court of Appeals for the District of Columbia Circuit held that the Securities & Exchange Commission (“SEC” or “Commission”) failed adequately to explain the basis of, and failed to provide adequate support for, its approval of a proposed fee by NYSE Arca for access by investors to its proprietary “depth-of-book” product, Arcabook.  The Court vacated the approval order and remanded the matter to the SEC for further consideration of whether the proposed fee is consistent with the requirements and purposes of the Securities Exchange Act of 1934 (“Exchange Act”).
   

  NYSE Arca is an all-electronic U.S. trading platform that provides fast execution with open, direct and anonymous market access. It is registered with the SEC as a national securities exchange and, as a registered “self-regulatory organization,” is subject to the Commission’s oversight. Like all other national securities exchanges, NYSE Arca is required to file its governing rules (which include fees charged to investors) with the SEC, which are subject to approval by the Commission if they are consistent with the requirements of the Exchange Act. Commission orders are subject to direct appellate review by the D.C. Circuit.
  
  In May 2006, NYSE Arca filed a proposed rule change with the SEC that would allow it to charge a fee for its depth-of-book data, which previously was available at no cost. Depth-of-book data consists of outstanding limit orders to buy stocks at prices higher or lower than the best prices on the exchange.
  
  NYSE Arca took the position that its proposed fees conformed to the Exchange Act and regulatory requirements because (1) “the proposed market data fees would reflect an equitable allocation of its overall costs to users of its facilities,” and (2) its fees were “fair and reasonable because they compare favorably to fees that other markets charge for similar products.” After public comment, the SEC approved the proposal in an order dated December 2, 2008. The SEC made its decision utilizing a “market-based approach.” Based upon that methodology, the SEC concluded that NYSE Arca was subject to at least two types of significant competitive forces and there was no countervailing basis under the Exchange Act to disapprove the proposal.
  
  Petitioners NetCoalition and the Securities Industry and Financial Markets Association sought review of the SEC Order on three grounds. First, petitioners contended that the SEC’s market-based approach to evaluating the Arcabook fees conflicted with the Exchange Act. The Court, which evaluated the Commission’s interpretation of the Exchange Act under the two-step analysis enumerated by the Supreme Court in Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 827 (1984), disagreed. The Court held that the SEC’s construction of the statute was permissible. Under Chevron, if “Congress has directly spoken to the precise question at issue” the Court will “give effect to the unambiguously expressed intent of Congress.” If the statute is silent regarding the issue, the Court will “accept the agency’s interpretation of the statute as long as it is reasonable.” In this case, because the Exchange Act is silent regarding utilizing a market-based approach, the Court evaluated the reasonableness of the SEC’s interpretation. In examining the legislative history of the statute, the Court concluded that “Congress did not intend to take away the SEC’s authority to rely, at least in some circumstances, on the market.” Accordingly, the Court held that using “a market-based approach to evaluating whether NYSE Arca’s non-core data fees are ‘fair and reasonable’” was a permissible interpretation of the statute.
  
  Second, petitioners contended that the SEC arbitrarily rejected its prior cost-based approach in approving NYSE Arca’s proposed fees. They cited two examples of alleged departures from the cost-based approach, which the Court held did not fit the petitioner’s characterization. Neither example showed that the SEC intended to require that fees be cost-based for an exchange’s proprietary non-core data. The Court further determined that recent SEC pronouncements demonstrated that the Commission’s market-based approach was not an unexplained shift, and that the market-based approach did not arbitrarily depart from prior practice.
  
  Finally, petitioners argued that the SEC’s conclusion that NYSE Arca was subject to significant competitive forces that constrained its ability to set fees for market data was not supported by substantial evidence. The Court agreed. Although the Court upheld the SEC’s market-based approach, it did not conclude that a cost analysis was irrelevant. Indeed, pricing can be evidence of monopoly or market power. NYSE Arca’s proposal even recognized that costs are relevant in determining the reasonableness of its fees. Moreover, NYSE is one of the larges exchanges in the nation, and it is the exclusive provider of the Arcabook data.
  
  The SEC had concluded that NYSE Arca could not exercise market pricing power for Arcabook, but the Commission did not require NYSE Arca to substantiate its market data costs. Instead, the Commission recognized “the difficulty of cost calculation in determining whether a fee is fair and reasonable.” Petitioners argued that the SEC’s failure to consider NYSE Acra’s costs was arbitrary and capricious because such a cost analysis is not difficult. In reaching its decision, the SEC had concluded that a consideration of costs was not necessary because NYSE Arca is subject to “[a]t least two broad types of significant competitive forces” in pricing Arcabook. Namely, “(1) [its] compelling need to attract order flow from market participants[] and (2) the availability to market participant of alternatives to purchasing the ArcaBook data.”
  
  In examining the record, the Court found that the Commission’s determination failed the reasoned decision-making standard of the Administrative Procedures Act (“APA”), which provides that an agency’s result must not only “be within the scope of its lawful authority, but the process by which it reaches that result must be logical and rational.” First, the Court found that the SEC’s conclusion that order flow competition constrains the pricing of Arcabook was at odds with the Commission’s own statements that depth-of-book data was not important to most traders. There also was a lack of support in the record to support the SEC’s conclusion that order flow competition constrains market data prices.
  
  Second, the Court also found that the SEC’s conclusion that alternatives to Arcabook exist does not necessarily preclude market power. An analysis of market competitiveness focuses on the customer’s price sensitivity. The SEC’s Order did not include any analysis regarding the number of potential users of the data or how they might react to price changes. Without evidence regarding trader behavior, the Commission did not adequately support its determination.
  
  Because it found the record insufficient to perform an APA review of the SEC’s Order, the Court vacated the Order and remanded the matter back to the Commission for further proceedings. The Circuit Circuit’s ruling in NetCoalition continues the Court’s recent trend of thoroughly examining the SEC’s rulemaking process to ensure that the Commission fully and completely evaluates each proposed rule change for compliance with the Exchange Act.
  
  For further information, please contact John Stigi at (310) 228-3717 or Christopher Loveland at (202) 772-5313.

• August 21, 2010
• 12:47

  Web Resources: PLI's Securities Law Practice Center

   » ‎ Business Law
  I'm not sure exactly how new this is, but I was just recently made aware of this site. SJP
• August 20, 2010
• 17:44

  North Dakota Law Review Symposium Issue: Energy Derivatives and More

   » ‎ Business Law
  The North Dakota Law Review held an energy law symposium back in Apri, and a while back, I promised to follow-up on a discussion of energy derivatives. Well, at long last, the the symposium issue is out, and the issue...
• August 19, 2010
• 11:26

  Neurotic Courts?

   » ‎ Business Law
  Earlier this week, my co-blogger J. Scott Colesanti asked whether there was a "New Scrutiny of Settlements" coming from the bench. This made me think of an earlier post by J. Robert Brown Jr. over at the Race to the...
• 11:04

  The Increasing Role of State Securities Regulators

   » ‎ Business Law
  The Wall Street Journal has an article today about the increased role of state securities regulators in the oversight of hedge funds. The article notes a difference of opinion as to whether the state regulators are up to the task....
• August 18, 2010
• 23:17

  GM Warns of Anti-Takeover Provisions, But Are They a Risk?

   » ‎ Business Law
  General Motors today filed its SEC Form S-1 for its Initial Public Offering (IPO) (here). The Wall Street Journal has already noted a couple "surprising" risk factors listed in the filing (article here). I was hardly surprised by the listing...
• 8:31

  The New Scrutiny of Settlements?

   » ‎ Business Law
  This week - and for at least the third time this year - a federal judge has refused to rubber stamp a monetary settlement between a bank and a U.S. regulator. Specifically, a Washington court will later today scrutinize a...

• August 17, 2010
• 14:50

  Registered Public Offerings Of Debt Securities And The Use Of Credit Ratings Information In SEC Filings After Dodd-Frank

   » ‎ Corporate and Securities Law

  The practice of marketing registered public offerings of debt securities with credit ratings information and related disclosure of issuer credit ratings in SEC filings will change with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank").
   

  One of the many reforms of Dodd-Frank was aimed at credit rating agencies. Dodd-Frank Section 939G repealed SEC Rule 436(g) promulgated under the Securities Act of 1933. Rule 436(g) stated that in general, credit ratings were not deemed "expertized" portions of registration statements. As non-expertized content, issuers did not need consent from credit rating agencies to use their ratings in registration statements, and credit rating agencies were not subject to strict liability under Section 11 of the Securities Act for the opinion reflected in their ratings. The sudden repeal of Rule 436(g) left uncertainty in the capital markets, and the SEC quickly stepped in with interpretations that enabled public debt and asset-backed offerings to continue while the SEC develops additional rulemaking to address the role of credit ratings and credit rating agencies in registered public offerings.
  
  We discuss in this article the use of credit ratings in registered offerings of debt securities, the SEC’s recent interpretations, and their potential impacts on disclosure practices and future debt offerings.
  
  Background
  
  Section 7 of the Securities Act and Rule 436(a) promulgated thereunder generally require an issuer to obtain written consent from an expert for use of its report or opinion in the issuer’s registration statement. Section 11 of the Securities Act provides that the persons who sign a registration statement, the directors of the issuer, the underwriters and the experts who consent to be named in the registration statement are liable to purchasers of the securities sold under a registration statement for omissions and misstatements in the registration statement, subject to certain defenses. The standard for liability for the non-experts (i.e., the directors and underwriters) is lower for so-called "expertized" portions of a registration statement, where the experts themselves have the higher standard for liability. 
  
  Prior to the enactment of Dodd-Frank on July 21, 2010, Rule 436(g) provided that the credit rating assigned to debt securities, convertible debt securities, or preferred stock by a nationally registered statistical rating organization (NRSRO[1]) would not be considered a part of the registration statement prepared or certified by an expert within the meaning of Sections 7 and 11 of the Securities Act. Thus, Rule 436(g) permitted issuers to include credit ratings information in a registration statement, prospectus or prospectus supplement without obtaining the consent of NRSROs and without subjecting NRSROs to potential liability under Section 11.
  
  The Section 7 consent requirement does not apply to free writing prospectuses in compliance with Securities Act Rule 433 or in a term sheet or press release issued in compliance with Securities Act Rule 134.[2]
  
  Historically, issuers of debt securities have included credit ratings in registration statements, prospectuses, term sheets and Rule 134-compliant press releases to market offerings and raise capital with debt. Corporate debt issuers often disclose their credit ratings in SEC filings that are subsequently incorporated by reference into registration statements and prospectuses. Underwriters of debt securities and broker-dealers typically disseminate credit ratings information with final pricing terms to purchasers through Bloomberg screens. Credit ratings affect the pricing of debt securities and also the ability of certain investors to purchase and hold the securities.
  
  What changes now?
  
  The Dodd-Frank Act repealed Rule 436(g) under the Securities Act. As a result, credit ratings generally may not be included in a registration statement or a prospectus without consent of the NRSROs that issued the ratings. Providing such consents would subject NRSROs to liability under Section 11 of the Securities Act, and the NRSROs all announced immediately that they would not give consent for use of their ratings in registration statements or prospectuses.
  
  What are the potential impacts of the change?
  
  The intent of repealing Rule 436(g) was to make NRSROs more accountable for the quality of their ratings. However, with NRSROs refusing to provide their consents, the potential consequences were (i) inability to include credit ratings information in registrations statements and related prospectuses for issuers, including information incorporated by reference from reports under the Securities Exchange Act of 1934 (e.g., Forms 10-K, 10-Q and 8-K), (ii) the need to amend Exchange Act reports to remove credit ratings information previously included, and  (iii) a catch-22 for registered offerings of asset-backed securities, which are required to include credit ratings information in the prospectus. 
  
  What did the SEC do?
  
  The staff of the SEC Division of Corporation Finance issued a number of Compliance and Disclosure Interpretations related to the repeal of Rule 436(g) and also issued a no-action letter allowing registered offerings to continue. Specifically:

  • The SEC staff clarified that for non-asset-backed issuers, NRSRO consent is not required if credit ratings information is included in a registration statement or a statutory prospectus only for the purpose of satisfying disclosure requirements. This means that issuers may use credit ratings without obtaining NRSRO consent when the disclosure of the credit rating is related only to changes to an issuer's credit rating, the issuer's liquidity, the issuer's cost of funds or the terms of agreements that refer to credit ratings, which information is classified by the SEC as "issuer disclosure-related information."  Specific examples of "issuer disclosure-related ratings information" include ratings information disclosed: (i) in the context of a risk factor discussion regarding the risk of failure to maintain a certain rating and the potential impact a change in credit rating would have on the issuer; (ii) when an issuer refers to or describes its credit ratings in the context of its liquidity discussion in the MD&A section of its periodic SEC reports; and (iii) when an issuer discusses credit ratings in its description of debt covenants, interest or dividends that are tied to credit ratings or potential support to variable interest entities.[3]
     
  • The SEC staff indicated that issuers not subject to Regulation AB (for asset-backed securities) may rely upon Rule 401(a) under the Securities Act to allow continued use, for the limited period permitted under Rule 401(a), of a registration statement declared effective before July 22, 2010 that contains or incorporates by reference credit rating information beyond "issuer disclosure-related information," without NRSRO consent. This relief applies only to information and reports filed before July 22, 2010, and only until the next post-effective amendment to such registration statement. Reports incorporated by reference after July 22, 2010 should not contain credit ratings information other than "issuer disclosure-related information." The filing of the issuer’s next annual report on Forms 10-K, 20-F or 40-F is deemed to be a post-effective amendment of any registration statement on Form S-3 or F-3. Upon such filing, prior periodic reports and Form 8-Ks filed prior the beginning of the issuer’s fiscal year then in progress will no longer be incorporated by reference.[4]
     
  • The SEC issued a no-action letter to Ford Motor Credit Company on July 22, 2010 stating that it would not recommend enforcement action against an issuer that omitted credit ratings disclosure otherwise required in a prospectus that is part of a registration statement relating to an offering of asset-backed securities.[5] This no-action position expires with respect to any registered offerings of asset-backed securities commencing with an initial bona fide offer on or after January 24, 2011.

  What should you do now?
  
  For non-asset-backed issuers:

  1.  No action is needed if credit ratings information included or incorporated by reference in an already effective registration statement is "issuer disclosure-related ratings information."
      
  2.  If a registration statement includes or incorporates by reference any credit rating information beyond what is considered "issuer disclosure-related ratings information" in an SEC filing before July 22, 2010, no amendment is required until the next post-effective amendment to such registration statement. However, this position applies only if no subsequently incorporated periodic or current report contains credit ratings information other than "issuer disclosure-related ratings information." Thus, assuming consent from the NRSRO is not available, an issuer will have until the filing of the next post-effective amendment or annual report on Form 10-K, 20-F or 40-F to amend the registration statement to remove the consent. In many cases, such amendment will occur merely by filing the Form 10-K, 20-F or 40-F with no credit ratings information other than “issuer disclosure-related ratings information.”
      
  3. Make certain that any registration statements and Exchange Act reports filed in the future limit references to credit ratings to "issuer disclosure-related ratings information."  
      
  4. For takedowns of rated securities, if disclosure of credit ratings information is desired, disclose the credit rating for the particular issue in a free writing prospectus, which would generally be a term sheet or Bloomberg screen, or in a Rule 134-compliant press release, rather than in the prospectus supplement.

  For asset-backed issuers subject to Regulation AB:

  1. The SEC no-action letter to Ford Motor Credit Corporation was written for application to all asset-backed issuers, and until January 24, 2011, issuers of registered asset-backed securities may rely on it to omit credit ratings disclosure otherwise required in prospectus or prospectus supplement.
      
  2. For offerings to be commenced on or after January 24, 2011, watch for SEC rulemaking or further Congressional action.
      
  3. If your offering may not commence until January 24, 2011 or thereafter, consider structuring your offering of asset-backed securities as a private placement under Rule 144A or offshore under Regulation S as an alternative to a registered offering.
      
  4. Follow the guidance in paragraphs 3 and 4 above for non-asset-backed issuers.

  How will this impact the market for bond issuances?
  
  While it is too early to draw conclusions as to how the market will react to the repeal of Rule 436(g), a potential consequence may be that more issuers elect to issue securities in private placements pursuant to Rule 144A or offshore pursuant to Regulation S, particularly issuers of asset-backed securities.  For issuers of non-asset-backed securities in registered offerings, the result may simply be that credit ratings information is moved from the registration statement to a free writing prospectus that complies with Securities Act Rule 433, which would generally be a term sheet or Bloomberg screen, or to a Rule 134-compliant press release.
  
  When is the new law effective?
  
  The repeal of Rule 436(g) by Dodd-Frank Section 939G is effective now.
  
  Are additional changes to be expected?
  
  Further Congressional action or SEC rulemaking should be expected to clarify the use of credit ratings, particularly in registered offerings of asset-backed securities after January 24, 2011.
  
  What if you have questions?
  
  For any questions or more information on these or any related matters, please contact Louis Lehot, John Tishler, Camille Formosa or any attorney in the firm’s corporate and securities practice group.
  
  Disclaimer
  
  This update has been prepared by Sheppard, Mullin, Richter & Hampton LLP for informational purposes only and does not constitute advertising, a solicitation, or legal advice, is not promised or guaranteed to be correct or complete and may or may not reflect the most current legal developments. Sheppard, Mullin, Richter & Hampton LLP expressly disclaims all liability in respect to actions taken or not taken based on the contents of this update.
  

  [1] At the time of this article, NRSROs include credit rating agencies such as Standard & Poor's, Moody's Investor Service and Fitch Ratings, among others.

  [2]Division of Corporation Finance, Compliance and Disclosure Interpretations, Securities Act Rules, Q. 233.06.

  [3]Division of Corporation Finance, Compliance and Disclosure Interpretations, Securities Act Rules, Q. 233.04.

  [4]Division of Corporation Finance, Compliance and Disclosure Interpretations, Securities Act Rules, Q. 198.08, 233.07, 233.08.

  [5] Ford Motor Credit Company LLC, SEC No-Action Letter (July 22, 2010).

   

• August 16, 2010
• 20:15

  Dodd-Frank and Bounty Hunters...

   » ‎ Business Law
  ...or "Dodd-Frank and Whistleblowers," depending on your point of view. As previously noted here and elsewhere, the mammoth financial reform legislation touches, in part, upon the bounties paid by the SEC to individuals providing information leading to charges of fraud....
• 7:56

  Peak Oil, Peak Stocks

   » ‎ Business Law
  The Wall Street Journal reports that the correlation between stock prices and oil prices is near 70%, which more than doubles the rate in 2008 (article here). There are a variety of theories posed as to why this might be...
• August 14, 2010
• 17:32

  Is the continued vitality of technical stock analysis an affront to the efficient market hypothesis?

   » ‎ Business Law
  Technical stock analysis (predicting future stock prices on the basis of past price movement) remains alive and well. Just today, a Wall Street Journal headline referenced the "Hindenburg Omen"--a confluence of stock price data points that portend bad news ahead....

• August 13, 2010
• 14:09

  Treatment of Accrued But Unused Vacation in Asset Deals

   » ‎ Corporate and Securities Law

  The treatment of accrued but unused vacation pay (hereinafter, referred to as "Vacation Benefits") in the context of selling a business has arisen in recent transactions involving clients advised by the firm's Corporate Practice Group. This gives us an opportunity to remind business owners operating in California of the landscape of the rules associated with the payment of Vacation Benefits and the practice of transferring those liabilities to the new employer in the sale of a business.
   

  Under California law, when an employee terminates employment with his/her employer, the employer is required to pay the employee all wages owed at the time of such termination, which includes any Vacation Benefits. Furthermore, when employees of a business are transferred to a new employer upon a sale of all or substantially all of a company's assets to a third party, the sale results in the business employees terminating employment with the company, and thus, they must generally be paid out their Vacation Benefits along with wages.  The unfortunate impact of this rule is that the transferred employees must start from zero in accruing vacation pay during their employment with the new employer since their Vacation Benefits were paid out upon the sale. This result is disfavored by transferred employees since they typically report to work at the same location following the sale of the business and perform the same job with the expectation of the same or comparable pay and benefits.
  
  By way of background, the California Division of Labor Standards Enforcement (the "DLSE") is the state agency that has the authority to adjudicate wage claims, investigate discrimination and public works complaints, and enforce labor law and the Industrial Welfare Commission wage orders. According to the DLSE's Enforcement Policies and Interpretations Manual, it is permissible from a labor law perspective for an employer selling its business to substitute the new employer in its place with respect to the obligation for Vacation Benefits earned by transferred employees before the sale, as long as the substitution occurs with the express written consent of the transferred employees. Thus, to comply with the DLSE's  position, transferred employees must be given a choice between being paid out their Vacation Benefits upon the sale, or consenting to the new employer assuming the obligation such that the Vacation Benefits are available during employment with the new employer following the sale. 
  
  Although the practice of substituting the new employer as the obligor for Vacation Benefits with the transferred employees' consent is permissible under the purview of the DLSE, employers should be aware that the constructive receipt rules from an income tax perspective apply when an employee is given the choice between receiving cash now or a future benefit. In other words, the Internal Revenue Service would take the position that the constructive receipt rule applies when the transferred employees are given the choice between being paid their Vacation Benefits upon the sale or delaying the payment of the Vacation Benefits when the transferred employees actually takes vacation time off during employment with the new employer. The unintended result is that the Vacation Benefits are includible in the gross income of the transferred employees that consented to the "rollover" of the Vacation Benefits in the current tax year, even though the Vacation Benefits may not actually be paid until a later tax year.
  
  In order to avoid the constructive receipt issue, it is common for the new employer of the transferred employees to obtain the express written consent of the employees by way of an acknowledgement of the "rollover" contained in the employees' offer letters. For those employees that commence employment with the new employer, they are viewed as having consented to the rollover of their Vacation Benefits. Any employees that do not accept employment with the new employer are paid out their Vacation Benefits. Employers should be aware that although this practice avoids the constructive receipt issue, it may be challenged from a labor law perspective by the DLSE because the transferred employees are technically not given the choice of having their Vacation Benefits paid out upon the sale (i.e., the rollover of Vacation Benefits is a condition of employment with the new employer). 
  
  To summarize, paying out Vacation Benefits to transferred employees in the context of a sale of a business structured as an asset deal avoids raising any issues from both a labor law and tax law perspective. If employers wish to reduce the disruption cause by a company sale by rolling over Vacation Benefits to the new employer, they should proceed knowing that there are risks involved depending on how the consent of the transferred employees is structured and obtained.
  
  For further information, please contact one of the following members of the firm's Employee Benefits Practice Group with any questions:
  
  Martin J. Smith          (213) 617-5490
  
  Michael Chan            (213) 617-5537

• 12:59

  What Happened to Summer?

   » ‎ Business Law
  On Monday, the University of North Dakota School of Law welcomes its Class of 2013 to campus (orientation begins Tuesday). Regularly scheduled classes begin the following week, on Tuesday, August 24. I can hardly believe it. It's been a productive...

• 9:14

  Ninth Circuit Holds That Scienter May Be Established Through An Objective Evaluation Of A Defendant's Deliberate Recklessness

   » ‎ Corporate and Securities Law

  In Securities & Exchange Commission v. Platforms Wireless Int’l Corp., No. 07-56542, 2010 U.S. App. LEXIS 15328 (9th Cir. July 27, 2010), the United States Court of Appeals for the Ninth Circuit held that under Section 10(b) of Securities Exchange Act of 1934 (“1934 Act”), 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, a showing that a statement is so obviously misleading to a reasonable person that the defendant who made the statement must have known of its misleading nature is sufficient on summary judgment to prove defendant’s scienter. The Court held further that a defendant cannot defeat summary judgment merely by denying subjective knowledge of the risk that a statement could be misleading. This decision clarifies two points of law in the Ninth Circuit: first, that the Private Securities Litigation Reform Act of 1995, 15 U.S.C. § 78u-4 (“Reform Act”), did not alter the substantive requirement for pleading scienter for claims under Section 10(b) and Rule 10b-5, and second, that deliberate recklessness, for purposes of demonstrating scienter, may be proved by an objective, not subjective, evaluation of a defendant’s mental state.
   

  Between 1998 and January 2000, William Martin provided consulting services to Platforms Wireless International Corporation (“Platforms”) as an employee of Intermedia Video Marketing Company (“Intermedia”). In exchange for those services, Intermedia earned at least 17.45 million unregistered shares of Platforms stock. In March 2000, Martin became the Chairman and CEO of Platforms. Subsequently, in August 2000, Platforms issued a press release purportedly unveiling new airborne wireless communications technology despite the fact that at that time, Platforms had only a description of how the technology would operate and did not have prototypes built or the money to build them. Later in 2000 and 2001, Platforms issued Intermedia’s stocks to entities and individuals associated with Intermedia, who then sold those shares to the public.
  
  In October 2004, the Securities and Exchange Commission (“SEC” filed a civil enforcement action against Platforms, Martin and several other Platforms officers and directors alleging, among other things, that Martin and Platforms violated various federal statutes by selling unregistered securities to the public and issuing a fraudulent press release in August 2000. The United States District Court for the Southern District of California granted summary judgment in favor of the SEC on its claim under Section 5 of the 1934 Act for selling unregistered securities and on its Section 10(b) claim based on the August 2000 press release. The district court ordered Platforms and Martin jointly and severally to disgorge about $1.75 million in proceeds and pay almost $1 million in prejudgment interest. Defendants appealed.
  
  The Ninth Circuit affirmed the district court’s decision. The import of the Ninth Circuit’s holding derives from its discussion regarding the Section 10(b) violation in connection with Platforms’ August 2007 press release. A violation of Section 10(b) and Rule 10b-5 requires, among other things, a showing of the defendant’s mental state or scienter, which can be established by the defendant’s intent, knowledge or deliberate recklessness in connection with the making of a materially misleading statement.
  
  The Ninth Circuit focused first on the substantive level of scienter required for liability under Section 10(b) and the Reform Act. In In re Silicon Graphics, Inc. Securities Litigation, 183 F.3d 970 (9th Cir. 1999), the Court held that a securities fraud plaintiff must at a minimum plead and prove “deliberate recklessness” to support liability under Section 10(b) and Rule 10b-5. In defining “deliberate recklessness,” the Silicon Graphics Court relied upon pre-Reform Act decision in Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990) (en banc), which in turn quoted from Sundstrand Corp. v. Sun Chem. Corp., 533 F.2d 1033 (7th Cir. 1977). The Platforms Court confirmed that under Ninth Circuit precedent the Reform Act did not require a higher level of recklessness than existed previously, affirming what was previously only dicta from Howard v. Everex Systems, Inc., 228 F.3d 1057, 1064 (9th Cir. 2000).
  
  The Court then turned to the SEC’s arguement that scienter could be established conclusively through an objective showing that a reasonable person would see the statement as so obviously misleading that the defendant must have known it was so, rather than only through a showing that the defendant subjectively appreciated that the statement was misleading. The Ninth Circuit agreed, explaining that in Hollinger a showing of scienter can be satisfied if a statement is so objectively misleading that any reasonable person must have known of its misleading nature.
  
  The Court held further that a defendant cannot defeat summary judgment by merely denying subjective knowledge of the risk that a statement could be misleading. Rather, the standards adopted by Hollinger and Gebhart v. SEC, 595 F.3d 1034 (9th Cir. 2010), establish that “if no reasonable person could deny that the statement was materially misleading, a defendant with knowledge of the relevant facts cannot manufacture a genuine issue of material fact merely by denying (or intentionally disregarding) what any reasonable person would have known.” Essentially, the standard requires the defendant to show that the statement was objectively not misleading. As applied to the facts of the case, the court held the scienter requirement was satisfied primarily because the August 2007 press release “only permits the conclusion that Platforms was announcing it had actually developed a viable ARC system,” but in actuality the system had only been designed without a prototype and lacked sufficient financing. Based on these facts, the Ninth Circuit held Platforms could not reasonably deny that the statement was materially misleading, and the scienter requirement was established.
  
  For further information, please contact John Stigi at (310) 228-3717 or Amir Torkamani at (213) 617-4180.

• August 12, 2010
• 11:47

  Cleveland Rocks!

   » ‎ Business Law
  Cleveland has been taking a bit of a beating lately. So, since I'm showing someone around town this week I thought I'd post my top five spots to see when next you visit: 1. The Rock & Roll Hall of...
• 11:16

  (Not) Educating Students for Profit?

   » ‎ Business Law
  It is a question heard repeatedly across the country at law schools, graduate schools, and in employer offices: “How did you, Mr./Ms. College Graduate, get here without the ability to write a coherent paragraph?” One answer, provided by Craig Brandon...
• August 11, 2010
• 13:51

  GM to Buy AmeriCredit: Subprime, Bailout, and Other Mildly Relevant Buzzwords

   » ‎ Business Law
  The New York Times (among other sources) reports that General Motors is considering buying AmeriCredit, a subprime financing company that provides auto loans to those unable to find credit from banks, credit unions, and other more traditional sources. In his...

• 8:10

  2010 Mid-Year Securities Litigation Reports Repot That New Federal Securities Class Action Filings Continue To Decline, Returning To Pre-Recession Levels

   » ‎ Corporate and Securities Law

  NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for the first six months of 2010. (Their findings and analyses are summarized in press releases here: NERA, Cornerstone.) Both report that new federal securities class action filings continued to decline from 2009, as litigation following the 2008 credit crisis winds down. (We previously reported on trends for 2009 here.) If new filings continue at the same pace through the rest of the year, we could see the lowest level of filings since 2006 and the second lowest since 1997.
  
  For further information, please contact John Stigi at (310) 228-3717.

• 8:10

  2010 Mid-Year Securities Litigation Reports Indicate That New Federal Securities Class Action Filings Continue To Decline, Returning To Pre-Recession Levels

   » ‎ Corporate and Securities Law

  NERA and Cornerstone Research (in cooperation with Stanford Law School’s Securities Class Action Clearinghouse) recently issued their respective assessments of securities litigation for the first six months of 2010. (Their findings and analyses are summarized in press releases here: NERA, Cornerstone.) Both report that new federal securities class action filings continued to decline from 2009, as litigation following the 2008 credit crisis winds down. (We previously reported on trends for 2009 here.) If new filings continue at the same pace through the rest of the year, we could see the lowest level of filings since 2006 and the second lowest since 1997.
  
  For further information, please contact John Stigi at (310) 228-3717.

• August 10, 2010
• 21:54

  The SEC's Rarely Publicized Bounty Program...

   » ‎ Business Law
  ...should grow under Dodd-Frank, which authorizes the Commission to pay for tips leading to "impositions of penalty" in a wider range of cases. For a description of how lucrative the program can be, see [www.sec.gov] --JSC, 8/10/10
• August 09, 2010
• 22:46

  A Whole New Set of Random Numbers to Enjoy...

   » ‎ Business Law
  One of the most enjoyable parts of regulatory reform is having a whole new set of capricious numeric thresholds thrust upon us. The Dodd-Frank Act of last month is no exception. $50 billion in assets connotes "systemically important" bank holding...
• 12:53

  Financial "Hail Marys" Unlikely to Fix It

   » ‎ Business Law
  Over at the Wall Street Journal, an article today (here) discusses a variety of "Hail Mary" programs designed to jump start the economy, including plans from the current administration and advisors from both the Clinton and Reagan administrations. The article...
• August 07, 2010
• 13:18

  Behavior and Business Law Conference

   » ‎ Business Law
  The University of Tennessee School of Law's James L. Clayton Center for Entrepreneurial Law will be hosting a Behavior and Business Law Conference on October 2, 2010. The multi-disciplinary event features a number of terrific scholars. The full schedule is...
• August 06, 2010
• 17:31

  More on Markets and the Impact of Energy Subsidies

   » ‎ Business Law
  A little while back I discussed energy incentives (see here) and noted that people often forget that the incentives for traditional, non-renewable fuel energy “far outweigh renewable industry incentives.” A thoughtful comment to that post noted that, “Your point that...
• August 05, 2010
• 23:02

  Things that can make a lefty like me lean right.

   » ‎ Business Law
  Wasteful government spending. Taliban mutilations. SJP
• 22:38

  Citizens United in Action

   » ‎ Business Law
  Target makes newly-available political contribution. There is an outcry. Target apologizes. SJP
• August 04, 2010
• 15:15

  Exploring Corporate Personhood Through Citi-SEC Settlement

   » ‎ Business Law
  Over at the New York Times Dealbook, Andrew Ross Sorkin questions whether the SEC's $75 million fine as part of a settlement with Citigroup (for failing to tell shareholders about some $40 billion of subprime mortgage exposure) is punishment to...
• 11:11

  Kudos to the SEC...

   » ‎ Business Law
  Given the size and breadth of our behemoth stock market, perhaps the best any regulatory agency can do is to ensure adequate disclosure of the deal and/or circumstances. As FDR said upon presenting the first securities law to Congress in...
• August 02, 2010
• 21:11

  All Eyes on Basel...

   » ‎ Business Law
  The Financial Reform recently signed by the President eschewed net capital limits in favor of product limits and enhanced federal power to wind down/intervene with behemoth failures. Such approach leaves the possibility of enhanced capital restrictions to the representatives of...
• 20:54

  Hedge Fund Win In UK Should Make for Good Appeal

   » ‎ Business Law
  A U.K. court just ruled in favor of some hedge funds who lost their money in the Lehman Bros. investment bank failure, the Wall Street Journal reports. Good news for those funds whose money was not properly "ring-fenced"; not great...