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• March 08, 2010
• 18:02

  Do Limits on Ownership Rights Eliminate Ownership?

   » ‎ Business Law
  Last week, I wrote, “A shareholder move seeking a greater voice in corporate governance seems proper to me because it is about the exercise of ownership rights.” Professor Bainbridge disagreed (although he did concede that shareholders’ residual claim on the...
• 10:57

  "Fall of the Economy" Symposium at SJU

   » ‎ Business Law
  This past Friday, I was fortunate enough to take part in a full-day discussion of the government's responses to the continuing economic crisis. Hosted by The Journal of Civil Rights and Economic Development of the St. John's University School of...

• 8:10

  Proxy Season Heats Up as New Executive Compensation Rules are Effective and SEC Provides New Disclosure Guidance

   » ‎ Corporate and Securities Law

  With Spring just a few weeks away, it also means that the annual proxy statement season for calendar year public companies is in full swing. February 28th marked the effective date for the SEC's expanded executive compensation and corporate governance disclosure rules which we have previously reported on (see our December 18, 2009 blog).
   

  In connection with the adoption of these new rules, the SEC's staff has regularly been updating its interpretive guidance (see for example our December 23, 2009 blog). Such guidance can be helpful to companies when questions arise regarding how to correctly comply with the SEC's regulations. Most recently, on March 1, 2010, the SEC's staff added/revised/withdrew various interpretations addressing proxy statement disclosure issues. The SEC's staff also previously added new executive compensation disclosure interpretations in January 2010 and February 2010.
  
  Below is a brief overview of the SEC staff's recent updates to some of its interpretive guidance with respect to executive compensation and corporate governance disclosure requirements, which are relevant not only for purposes of annual proxy statements but in registered offerings of securities:
  
  NEW INTERPRETATIONS
  

  • Director Qualifications and Experience – The SEC issued new interpretations that reiterate its desire for companies to provide fuller disclosure regarding the specific attributes/qualifications of each individual director on a person by person basis. This information would also be required for those directors who are not up for re-election in the case of a classified board. However, the SEC also reiterated that this information need not be provided for directors whose term would not be continuing after the applicable meeting of shareholders.
     
  • Equity Compensation –As we previously reported in our December 18, 2009 blog, the SEC changed the requirements with respect to reporting equity compensation values in the Summary Compensation Table (and Director Compensation Table). That is, the grant date value of the estimated dollar values of equity-based compensation awards (as determined under FASB ASC Topic 718) will now be utilized as compared to the prior requirement of using the annual financial accounting expense recognized for such equity awards. Therefore, a number of new interpretations were provided regarding the reporting of equity compensation awards. For example, an interpretation was issued covering involved how to report the amount of compensation when a named executive officer leaves the company and, in connection with such separation from employment, the company then decides to accelerate vesting of an option grant that had been granted earlier in the same fiscal year. In addition, guidance was issued covering the exclusion of estimated forfeitures in valuing time-based vesting equity awards along with clarifying that an equity award that is forfeited by an executive officer in the year of grant will nevertheless still be included in determining whether such officer is one of the top most compensated executive officers for such year. The SEC also clarified when to report the grant of a performance based equity compensation award if a company's compensation committee retains discretion to reduce the earned value of the award (as often is the case for awards that are seeking to qualify as performance-based compensation under Internal Revenue Code Section 162(m)). And, the SEC's new interpretations addressed the proper reporting of compensation in the proxy's Summary Compensation Table when the settlement of incentive compensation arrangements can or does occur with company stock rather than cash.
     
  • Compensation Consultants - Depending on the underlying facts (see our December 18, 2009 blog), the expanded rules can require a company to disclose additional information regarding fees paid to a company's compensation consultant for other services rendered by the consultant to the company (depending on what the other services were and for what purpose they were performed). The SEC issued new interpretations covering the types of such other services provided by the consultant along with addressing situations where the consultant's services are not customized for a company or are limited to broad-based plans that do not favor executive officers.
     
  • Risk Management - The new rules provide that if risks arising from a company’s compensation policies and practices are “reasonably likely to have a material adverse effect on the company”, then the company must provide disclosure about such policies and practices as they relate to risk management and risk-taking incentives that can affect the company’s risk and management of that risk. A new interpretation was issued stating that such disclosure should be presented together with a company's executive compensation disclosures.
     
  • Reporting of Shareholder Votes - The new rules require accelerated reporting of shareholder votes on Form 8-K within four business days of the shareholder meeting. The SEC provided a new interpretation stating that the end of the shareholder meeting is the triggering event for starting the four day period (such that if the meeting ended on Tuesday, day one would be Wednesday, and the four-business day filing period would end on Monday).
     
  • Disclosure Requirements in Registration Statements - The SEC issued interpretations reiterating that if a registration statement or post-effective amendment is filed after the end of an issuer's fiscal year end but before its Form 10-K is due:
    
    
    • if filed on Form S-1, it must include Item 402 executive compensation disclosure prior to effectiveness
       
    • if filed on Form S-3, it may forward incorporate by reference to a subsequently filed Form 10-K

  
  If a non-automatic shelf registration statement or post-effective amendment thereto is to be filed after the due date for the Form 10-K, the issuer must either file the definitive proxy statement before the Form S-3 is declared effective or include the officer and director information in the Form 10-K.
  
  REVISED INTERPRETATIONS
  

  • Equity Compensation – The SEC revised an interpretation covering the reporting of "re-load options" (i.e., where the optionee receives a new grant of options upon the exercise of an option) that were granted to a named executive officer. In such case, the grant date fair value of the additional options would need to be reported in the Summary Compensation Table in the aggregate amount. The SEC also has now stated that a company may provide the required valuation assumptions information for equity compensation awards (that would typically be incorporated by a reference to the company's financial statements) by reference to the Grants of Plan-Based Awards Table if the valuation assumptions are reported in such table.
     

  WITHDRAWN INTERPRETATIONS
  

  • Equity Compensation – As a result of the change in reporting equity compensation by switching to using grant date fair value, a number of the SEC's interpretations addressing the prior requirements of annual expense reporting became obsolete and therefore were withdrawn.
     

  As we have mentioned in several of our prior blogs (see for example our December 18, 2009 blog), in addition to complying with the expanded disclosure rules, the SEC has clearly signaled that it will be expecting, and looking for, fuller compliance with its executive compensation reporting regulations along with clearer and more transparent company disclosures in annual proxy statements. Two primary areas that continue to receive greater SEC scrutiny are disclosure of performance targets and compensation benchmarking. Specific disclosure of performance targets which are a material element of compensation, and the actual achievement level against such targets, is required unless the company has a compelling explanation of why such disclosure would cause it competitive harm. And, the SEC has indicated that the competitive harm argument is unlikely to be successful after the company has disclosed the actual bonus amounts and particularly if the performance targets are tied to company-wide financial results that are publicly reported. Similarly, when a company refers to a peer group used for benchmarking purposes, the SEC expects to see disclosure of the names of the peer group companies, how they were selected, and where actual awards fell relative to the benchmark. Therefore, in conjunction with responding to the new disclosure requirements, reporting companies should avoid simply repeating last year's proxy disclosures. Rather, companies should consider re-examining the text and format of their prior /proxy disclosures from a fresh perspective with an objective of effecting improvements to the extent possible. Failure to do so could provoke comments from the SEC which could then force the company to have to amend its SEC filings.
  
  If you have any questions regarding this information, please contact Greg Schick at (415) 774-2988.

• 8:05

  Tenth Circuit Holds Corporate Shareholders Do Not Have Standing Under Rico To Sue Derivatively For Alleged Injuries To Corporation

   » ‎ Corporate and Securities Law

  In Bixler v. Foster, No. 09-2138, 2010 WL 597477 (10th Cir. Feb. 22, 2010), the United States Court of Appeals for the Tenth Circuit affirmed the dismissal of a class action lawsuit brought by minority shareholders of Mineral Energy and Technology Corporation (“METCO”) against its directors and lawyers. Plaintiffs alleged that defendants violated the civil Racketeer Influenced and Corrupt Organizations Act (“RICO”), 18 U.S.C. §§ 1961-1968, for authorizing and facilitating the transfer of METCO’s assets to an Australian corporation. The Tenth Circuit held that, among other things, (1) plaintiffs lacked standing under RICO to assert shareholder derivative claims and (2) allegations of securities fraud did not establish predicate acts under RICO. This decision confirms that the civil RICO statutes generally are not available to shareholders and investors seeking redress for alleged ordinary corporate misconduct.
   

  The action centered around the directors and majority shareholders of METCO, a New Mexico uranium mining company. The directors negotiated a trade of METCO’s uranium mining claims to subsidiaries of defendant Uranium King, Ltd. (“UKL”), an Australian corporation. UKL subsequently merged with another Australian corporation, Monaro Mining NL (“Monaro”). Plaintiffs alleged that the transfer of the mining claims provided for METCO to receive $6.5 million and stock in UKL in exchange for METCO’s uranium interests. The UKL stock was then to be distributed among the METCO shareholders on a pro rata basis. According to plaintiffs, after defendants transferred the METCO uranium claim deed to UKL, UKL abandoned the agreement and paid neither the money nor the UKL stock to METCO. Consequently, plaintiffs lost the value of their investment in METCO. Additionally, plaintiffs allege that the directors were “highly compensated” for arranging the transaction.
  
  Based on this conduct, the plaintiffs alleged that defendants defrauded them of their share of the UKL stock and rendered their METCO investment virtually worthless. Plaintiffs also averred that the UKL-Monaro merger was a fraudulent means of transferring the mining claims to a third entity. Furthermore, plaintiffs claimed that the defendants conspired to deprive them of the value of their METCO shares by a series of predicate acts based on the above-described conduct, in violation of RICO. The United States District Court for the District of New Mexico granted the defendants’ motions to dismiss holding (among other things) that plaintiffs did not have standing to bring RICO claims on METCO’s behalf based on the diminution of the value of their shares and that the Private Securities Litigation Reform Act of 1995 (“Reform Act”) precluded RICO claims based on securities fraud. Plaintiffs appealed.
  
  With regard to plaintiffs’ standing argument, the Tenth Circuit held that, as a general rule, conduct by corporate management which harms a corporation confers standing to sue on the corporation, not its shareholders. There are two exceptions to this rule, however. First, the shareholder standing rule allows shareholders to bring a claim where the corporation’s management has refused to pursue the same action for reasons other than good faith business judgment. Second, a shareholder with a direct, personal interest in a cause of action may bring suit even if the corporation’s rights are also implicated. Plaintiffs argued that their claim fell within this latter exception. Specifically, the plaintiffs alleged that the defendants’ actions caused their proportionate corporate ownership to be diluted, a direct personal injury.
  
  To support their argument, plaintiffs asserted facts that showed that the majority shareholders received personal compensation for arranging the mining-claim transaction, while the minority shareholders did not. Thus, plaintiffs reasoned, the minority shareholders suffered a diminution in value of their corporate shares without receiving the same monetary compensation the majority shareholders received. The Tenth Circuit was not persuaded. The Court held that because plaintiffs made no showing that more shares were issued or that the value of the majority shareholders’ shares increased more than theirs, plaintiffs failed to show that their corporate ownership was diluted.  Thus, there was no direct, personal interest to afford them standing. The Court’s conclusion accorded with the uniform holdings of all other Courts of Appeals that have considered the question and held, similarly, that corporate shareholders do not have standing to sue derivatively under the civil RICO statute for alleged injuries to the corporation.
  
  Next, plaintiffs argued that the provision in the Reform Act stating that “no person may rely upon any conduct that would have been actionable as fraud in the purchase or sale of securities to establish a violation of [RICO],” Pub. L. No. 104-67, § 107, 109 Stat. 737, 758 (Dec. 22, 1995), amending 18 U.S.C. § 1964(c), did not apply because their claims did not involve the “purchase or sale of securities,” as required by the statute. The Court disagreed and held that although the minority shareholders did not “purchase” or “sell” their METCO shares as part of the alleged wrongdoing, their allegations that defendants defrauded them from receiving UKL stock as provided in the transaction, and the subsequent (allegedly fraudulent) merger of UKL and Monaro, adequately described a “purchase” and “sale” of securities to bar their claim under RICO. The Court also held that plaintiffs’ assertion that defendants transferred METCO’s uranium interests to UKL with the intent not to honor the corresponding agreement to issue UKL stock to METCO or its shareholders, also described a violation of the Securities and Exchange Commission’s (“SEC”) Rule 10b-5.
  
  Plaintiffs also attempted to argue that the Reform Act exception does not apply because most of the alleged predicate acts did not describe securities fraud. They maintained that their allegations that defendants committed mail and wire fraud, bank fraud, extortion, obstruction of justice and interstate travel in support of racketeering described conduct not covered by the Reform Act. Again, the Court disagreed and held that although such conduct constituted illegal and fraudulent activity, it was also undertaken in connection with the purchase of a security. Thus, these activities could not support a civil RICO claim after the enactment of the Reform Act. The Court observed that “allowing plaintiffs to engage in surgical presentation of the cause of action would undermine the purpose of the RICO amendment.” Hence, the Court concluded that the plaintiffs’ claims fell within the Reform Act and thus could not form the basis of a civil RICO claim.
  
  This decision further confirms the Circuits’ uniformity in holding that corporate shareholders do not have standing to sue under the civil RICO statute for alleged injuries to the corporation. It is also another instance in which the courts have strictly construed the Reform Act exception to RICO claims, barring claimants from seeking relief under the civil RICO statutes for claims that even remotely involve the purchase or sale of securities.
  
  For further information, please contact John Stigi at (213) 617-5589 or Taraneh Fard at (213) 617-5492.