After the Rainbow: Impact of the DOMA Ruling on Public Companies

As has been widely publicized, on June 26, 2013, the U.S. Supreme Court in United States v. Windsor (PDF) struck down Section 3 of the federal Defense of Marriage Act (DOMA) under the Fifth Amendment and thus required federal recognition of same-sex marriage recognized under state law. After the decision, the reactions, the punditry and the parades, a moment of reflection causes one to realize that Windsor will impact a number of critical definitions and concepts that are important, if not critical, in public company regulation and other aspects of federal securities law.

For those who haven’t yet read the actual opinion, Section 3 of DOMA provided that, for purposes of federal law, the term “spouse” could only apply to different-sex couples legally married under state law (including common law).  As Justice Kennedy’s opinion states, that Section of DOMA “enacts a directive applicable to over 1,000 federal statutes and the whole realm of federal regulations.” As a result of Windsor, terms like “spouse” and other terms having a bearing on marriage will now be read to include same-sex spouses legally married under state law.

Many commentators have focused on the impact of DOMA on federal taxation.  But consider the number of SEC regulations affecting public companies and other fundamental SEC rules that will be affected by the immediate change in the definition of “spouse”:

  • Section 16 Beneficial Ownership — The presumption of indirect pecuniary interest of a shareholder under Rule 16a-1 under the Securities Exchange Act of 1934 (and therefore, the “beneficial interest” of such shareholder for purposes of reporting under Section 16 of that Act) includes holdings of a spouse.
  • Rule 144 — Under SEC Rule 144(a)(2)(i), the term “person” (i.e., the shareholder seeking to sell under Rule 144) includes a spouse and any relative of that spouse.
  • Related Party Disclosures —Spouses of public company directors, executive officers, director-nominees and greater-than-ten-percent beneficial owners are considered “related persons,” and transactions with such persons are subject to disclosure under Item 404(a) of Regulation S-K.
  • Form S-8 RegistrationForm S-8 (PDF) may be used to register the exercise of an option and resale of the underlying stock by an employee’s “family member” who has acquired the options from the employee through a gift or a domestic relations order.  The term “family member” includes a spouse or former spouse.
  • Accredited Investors — Under Rule 501(a) of Regulation D, both means by which most individual natural persons (other than corporate officers or directors of the entity offering securities) are eligible to participate in a private placement offering — by virtue of their net worth either alone or together with their spouse, or by virtue of their income either alone or together with their spouse — will change with the definition of “spouse.”
  • Qualified Purchasers and Qualified Clients — Like the “accredited investor” definition, these defined terms, important under the Investment Company Act of 1940 and the Investment Advisers Act of 1940, respectively, should now be read to include the net worth and income of same-sex spouses.  In addition, the “spouse” definition under the Investment Adviser Act regulations also impacts the definition of “client” used in that Act.

In addition to federal securities law, Windsor will also impact definitions and concepts important in the administration of most stock incentives, human resources and employee benefits.  For example:

  • Stock Incentives — Both stock incentive plans and non-plan incentives often, if not typically, permit the transfer to and exercise of incentives by a legal representative or transferee pursuant to a will or the laws of descent and distribution (which will now presumably include transfers to same-sex spouses who are legal heirs).  Some plans also permit distributions to “family members” (typically with a cross reference to the definition of that term contained in the General Instructions to Form S-8).  That term should now be understood to include same-sex spouses.
  • Qualified Retirement Plan — The administration of survivor benefits and the assignment of portions of qualified retirement plans pursuant to “qualified domestic relations orders” issued by courts during a marital dissolution will now presumably need to account for same-sex couples.
  • Health Plans — Health coverage for the same-sex spouse of an employee will no longer be subject to income or payroll taxes, and employers will have no reporting and withholding obligations for such coverage.

These changes will affect the practice of private and in-house securities and benefits lawyers as well as other related professionals.  Presently, only 11 states and the District of Columbia permit same-sex marriage. Nevertheless, it is likely that more states will follow suit.  How quickly remains to be seen.

It is unclear to what extent regulators like the SEC, the IRS and the Department of Labor  will undertake to make definitional changes in their regulations or provide official guidance.  Regardless of what steps those regulators take to connect all the dots for professionals, the main point and effect of the Windsor ruling seems plain enough—the question of who can be legally married is now reserved to the states by our federal system and constitution. As shown by the array of regulations and provisions above, the impact of the ruling will be wide-ranging and may not be fully understood in the near future.

Graphic: Wikimedia Commons

SEC Reverses Course on Rule 144 Holding Periods for Donees and Pledgees

The SEC’s Division of Corporation Finance issued 15 new Compliance and Disclosure Interpretations (C&DIs) last week. Two of the C&DIs I found noteworthy relate to the inapplicability of Rule 144 holding periods when a non-affiliate of the issuer acquires shares from an affiliate by gift or through foreclosure of a pledge, and the shares were control securities (not restricted securities) in the affiliate's hands. These new interpretations represent a welcome change.

It is well established that Rule 144 holding periods only apply to the sale of restricted securities and do not apply to an affiliate's sale of non-restricted control securities. However, prior to last week’s guidance, the SEC staff took the long-standing position that the Rule144 holding period did apply to a donee or pledgee that acquired control securities from an affiliate, even though the holding period didn't apply to the affiliate. This staff position was based on a technical reading of Rule 144, but it never struck us as being very logical. By putting donees and pledgees on even footing with the affiliates from whom they acquire control shares, the new C&DIs represent a well-reasoned change to the prior result in these situations. 

Well done, SEC!

New SEC "Lost Securityholder" and "Paying Agent" Rules May Add to Compliance Costs

On December 21, 2012, the SEC issued new rules requiring broker-dealers to search for holders of securities with whom they have lost contact. The new rules also require broker-dealers and other “paying agents” to provide notice to persons who have not negotiated checks received on account of securities they beneficially own. The new rules may make it easier as a practical matter for states to lay claim to “unclaimed property” held by broker-dealers and paying agents. In addition, the rules may make it more attractive (i.e., profitable) for states to focus their unclaimed property collection efforts on securities and securities-related property in general. As described below, this could drive up compliance costs for public companies and their service providers.

New SEC Rules. Broker-dealers will be required to comply with the revised “lost securityholder” rules (Rule 17Ad-17) in the next year or so. Similar to existing transfer agent requirements, broker-dealers will be now obligated to conduct at least two database searches (using at least one database service) for “lost securityholders” - securityholders whose mail is returned as undeliverable. The first search must be conducted between three and 12 months of a person first becoming a “lost securityholder,” and the second search must be conducted between six and 12 months after the first search. Exclusions will apply for a securityholder (i) for whom the broker-dealer (or transfer agent) has documentation indicating the securityholder is deceased, (ii) whose aggregate value of assets is less than $25, or (iii) who is not a natural person.

Also, “paying agents” (including certain issuers, broker-dealers, transfer agents, and other entities) will be required to notify each “unresponsive payee” within seven months of the date on which an unnegotiated check is sent. An “unresponsive payee” is someone to whom a check is sent by the paying agent and the check is not negotiated (i.e., cashed) before the earlier of the paying agent’s sending the next regularly scheduled check or the lapse of six months after the sending of the unnegotiated check. Here too, an exclusion applies if the value of the unnegotiated check is less than $25.

Effects on State Unclaimed Property Laws. Although the new SEC paying agent rules in particular contain a statement that those rules “shall have no effect on state escheatment laws,” the rules may nonetheless affect the collection of unclaimed property in significant ways. For example, the new and revised rules will make it easier for state inspectors to find and obtain evidence of a lack of “dominion and control” by securityholders over their investment property, a finding that can trigger unclaimed property proceedings. Furthermore, some state laws require a second finding, that the owner of property be “lost,” prior to the commencement of what is commonly referred to as the “dormancy period” (generally three to seven years for securities). In sum, the new and revised SEC rules will make lost or inactive accounts more easily indentifiable by state investigators, and the rules may offer additional evidence for state investigators to assert that the owner is “lost”, if relevant.

Unclaimed Property on the States’ Radar. While unclaimed property and escheat law is complex, the importance of escheatment and unclaimed property is not lost upon state legislators attempting to balance state books. As indicated in this comprehensive academic review of unclaimed property laws in the Michigan Law Review in 2011 (PDF), only approximately 30% of unclaimed property is eventually reclaimed by a rightful owner or heir. And state efforts have been effective. The Delaware Office of Economic and Advisory Council estimated Delaware’s 2012 revenue from unclaimed property at $475 million, a figure that approaches 50% of all revenue raised from personal income taxes in that state. According to the Minnesota Department of Commerce website, in 2011, Minnesota received nearly $57 million in unclaimed property.

The significance of revenue derived from unclaimed property is a major reason why states will continue to pursue the property aggressively. For example, as Broc Romanek recently reported in Blog, many states have shortened the statutorily defined “dormancy period” after which they can take possession of such property, and embarked upon various “voluntary reporting” programs practically designed to speed the process by which the state takes possession of property.

Comment. As described above, the SEC rules may help states track down unclaimed property and provide them with additional evidence. Therefore, the biggest beneficiaries of these new rules may in fact be the states and their balance sheets. Quite a nice holiday gift for the states. A thank-you note to the SEC may be in order. Broker-dealers, paying agents and ultimately issuers may not be so grateful if their compliance costs are increased by the SEC rules and the states’ increased activity.

It's Time to Review Procedures for Insiders' Rule 10b5-1 Trading Plans

Recent news reports make it clear that now is a good time for public company compliance officers to review their company’s procedures for approval of insiders’ Rule 10b5-1 trading plans. If you are not looking at your practices in this area, it’s possible that a regulatory authority or media reporter will soon be taking a close look.

Rule 10b5-1, adopted in 2000, provides insiders with an affirmative defense to charges of insider trading if the trades are made pursuant to a so-called 10b5-1 trading plan. The plan must be entered into at a time when the insider has no material nonpublic information about the company and must either provide specific instructions about the trades or must turn the decision making over to a third party who does not possess material non-public information. Since its adoption, the rule has facilitated countless trades by public company officers and directors.

Recently, the Wall Street Journal has led the charge in scrutinizing insiders’ transactions in their companies’ stock, either within 10b5-1 plans or outside of such plans:

On November 28, 2012, in Executives’ Good Luck in Trading Own Stock (subscription required), the Journal’s reporters Susan Pulliam and Rob Barry detailed numerous examples of executives making sales, generally under Rule 10b5-1 plans, shortly before corporate announcements of negative news. These trades thus permitted the insiders to take advantage of higher sale prices than would have been the case had they sold after the news was made public.

On December 11, in Insider-Trading Probe Widens, the Journal reported that the November 28 article had triggered a criminal investigation by the Manhattan U.S. Attorney’s office of trades by seven executives, and an SEC investigation of another. On December 12, in Big Sales by Big Lots Brass, the Journal gave more detail on the some of the trades. One of the problematic practices cited: insiders making trades outside of Rule 10b5-1 plans fairly close in time to trades within the plan. While there is no requirement that all trades be made under the Rule (which is only a safe harbor), frequent trades outside the plan can raise questions about whether the insider is acting in good faith.

On December 14, in Trading Plans Under Fire, the Journal reported that Congress is investigating whether Rule 10b5-1 provides adequate protections against insider trading, a development that could put pressure on the SEC to increase scrutiny on insider trades even further.

All of this attention means that companies should focus on making sure that their own insider trading policies are adequately enforced and prevent, not only illegal activity, but even the appearance of impropriety. In connection with 10b5-1 trading plans, companies should focus on the following areas:

  • Consider adopting or expanding a cooling off period between adoption or amendment of the 10b5-1 plan and the commencement of trading. This can make it easier to prove that the plan was actually adopted or amended before the insider learned of any material nonpublic information. In a September 2010 survey reported by Blog, respondents reported that their companies used the following cooling-off periods: two weeks or less-13%; one month-23%; two months-6%; a waiting period until the next open window-12%; none-37%. Such a cooling off period has become a best practice, even though it would not have prevented all of the problems outlined in the recent Journal articles.
  • Consider encouraging insiders to sell shares only pursuant to a 10b5-1 plan. In the 2010 survey cited above, 31% of the respondents said that their companies "strongly encouraged" insiders to sell only under a Rule 10b5-1 plan, and another 4% said their companies actually require that trades be made only under such a plan.
  • Examine other aspects of your process for approving 10b5-1 plans and amendments and make sure they are up to date and adequately enforced and documented. For example, make sure it is possible to document that all 10b5-1 plans and amendments were actually adopted or amended at a time when the insider was not in possession of material non-public information.
  • Avoid multiple trading plans by the same insider at the same time, which can permit the insider to exercise discretion by terminating one or more of the plans. This was the manipulative technique used by former Countrywide Financial CEO Angelo Mozilo, resulting in a record settlement of $67.5 million with the SEC in 2010.

Maslon’s Holiday E-Card – Send it On!

I wanted to share with all of you our Maslon Holiday E-Card with the theme, “Send it On.” Maslon attorneys and friends of the firm have shared “Words of Wisdom” from others that have guided each of us.

We invite you to participate by taking a couple of minutes to share words of wisdom that have meaning for each of you. You can help us reach our goal of 200 or more submissions. For each submission, Maslon is making a donation to Bolder Options, an innovative charity focused on promoting healthy development of youth through mentoring.

We wish you all a very happy holiday season.

What Should Public Companies Know About the JOBS Act?

On April 5, 2012, President Obama signed the Jumpstart Our Business Startups (JOBS) Act (PDF), which increases the ability of companies to access capital without registration under the Securities Act and encourages initial public offerings of "emerging growth companies." For those of you who have only received 500 law firm alerts about the JOBS Act and are anxious to read your 501st, you should review the Maslon Legal Alert, which is refreshingly short.

The JOBS Act focuses mainly on privately-held companies: early stage companies seeking investors through private placements, and companies preparing to file a registration statement for their initial public offering (IPO). However, officers and boards of directors of companies that are already publicly held might be interested to know the answer to this question: Will the JOBS Act will have any impact on public companies? (Note: Although this post may be the 502nd submission you will receive on the legislation, it may be the first on this particular topic.)

The answer: for most public companies, the impact is probably very limited. However, there are aspects of the new law that might become relevant to some public companies:

Impact on SEC Rulemaking. Practically speaking, the biggest impact might be on the SEC rulemaking timetable. In the JOBS Act, Congress followed its time-honored tradition of creating an impossible time frame for the SEC to adopt related rules. For example, within 90 days of enactment, the SEC is required to adopt new rules eliminating the prohibition of general solicitation in certain private placements to accredited investors. Within 270 days of enactment, the SEC is required to adopt rules creating the new “crowdfunding” exemption. Also, the SEC is scrambling to prepare FAQs regarding some of the requirements that went into effect immediately - see the SEC's Frequently Asked Questions page, including a set of FAQs posted today on the emerging growth company provisions described below. This blog post by Broc Romanek in Blog speculates that the JOBS Act requirements may set back the SEC’s existing rulemaking projects timetable under the Dodd-Frank Act.

Relaxed IPO Requirements. For companies going public that qualify as “emerging growth companies” (generally, companies with less than $1 billion in annual gross revenues), some of the SEC review requirements for going public are eased, and these companies are also relieved of some compliance requirements (e.g., Say-on-Pay votes) for up to five years, as long as the company continues to qualify as an emerging growth company. These new standards do not affect existing public companies.

However, sometimes, new public companies are created by existing public companies in a so-called minority IPO or equity carve-out, creating a new subsidiary and causing the subsidiary to go public. This method can create a vehicle to finance one of the business units of a public company. There is no apparent reason that these provisions cannot be used by a subsidiary of an existing public company. The new provisions may make this approach more popular. These subsidiaries have the additional advantage of relaxed governance requirements, as “controlled companies” under applicable rules of Nasdaq and the New York Stock Exchange.

Relaxed Private Placement Requirements. The JOBS Act, upon adoption of new SEC rules, will also permit issuers to engage in general solicitations in connection with private offerings under Rule 506 (one of the Regulation D exemptions) and Rule 144A of the Securities Act, as long as the issuer reasonably believes that the investors are exclusively accredited investors, or qualified institutional buyers, respectively. These requirements are intended to be useful to privately held companies seeking capital. However, the statutory provisions under the JOBS Act are not restricted to private companies. In limited circumstances, the relaxed requirements may be useful to public companies doing private placements of public equity (PIPE transactions) or Rule 144A offerings of certain securities to institutional investors. However, we will have to wait for the SEC rules to see how helpful these provisions will be.

Easier for Banks and Holding Companies to Go Private. The JOBS Act contains a provision that allows banks and bank holding companies to go private if their equity securities are held of record by fewer than 1,200 persons. The threshold was previously 300 shareholders, as with other public companies. In addition, all companies can now exclude employees who received their securities in connection with their employment. See the SEC's FAQs on these provisions of the JOBS Act.

Therefore, some public companies will have an interest in watching the SEC’s rulemaking process, to see whether any of the above developments will benefit them. Otherwise, you can just wait for the next 500 law firm alerts on the JOBS Act.

Thanks to my colleagues, Alan Gilbert and Brad Pederson, for their help with this post.

Not Just Whistling Dixie: The SEC Whistleblower Chief Speaks

Last Friday, the SEC’s whistleblower rules (PDF) went fully into effect, and the Office of the Whistleblower web page went live. The Office’s Chief, Sean McKessy, spoke forcefully about why companies should not be overly alarmed. But the proof will be in the results.

The SEC web page now includes links to the necessary forms for submitting tips or claiming bounty awards under the rules, as well as FAQs for tipsters. The page also includes a link to a speech by McKessy, explaining that the rules are still misunderstood and should in fact be considered a positive factor for companies. In particular, he tries to counter the perception that the rules will undermine internal compliance systems by giving whistleblowers incentives to go directly to the SEC:

. . . The rules specify that employees who report wrongdoing internally first and, within 120 days, then report the wrongdoing to the SEC, benefit in two significant ways. First, those employees will be deemed to have reported the information to the SEC on the date they reported internally. This preserves their place in line in terms of when information was provided to the SEC. Second, the employees who report internally first receive the benefit of all the information uncovered by the company in connection with its own internal investigation of the alleged wrongdoing. . . .

McKessy goes on to explain how this latter factor will allow the whistleblowers who first report internally to share in the potential for a percentage share in a much greater ultimate recovery. Further, a whistleblower who first reports internally will likely receive a higher percentage bounty within the 10% to 30% range established by the rules. The rules “. . . require that cooperation with internal compliance programs be considered as a positive factor that could increase a whistleblower award, and interference with such programs as a negative factor that could decrease an award.” He concludes that these incentives built into the SEC program will actually improve the strength and effectiveness of internal compliance programs.

These statements won’t alleviate fears that the rules will lead to a flood of whistleblower complaints that bypass internal compliance programs. For example, in “W-Day is Here: The SEC’s Whistleblower Rules Are Now Effective” in Blog, Broc Romanek points out that “The opportunities [for Foreign Corrupt Practices Act violations claims] are so great that U.S.-based plaintiffs' lawyers are ramping up their advertising throughout Europe, Asia and Africa in order to bring SEC whistleblowers out of the woodwork.” These sorts of reports don’t make corporate compliance personnel rest any easier.

However, according to a Reuters report, the SEC promises to make changes in the whistleblower program in the event of unintended consequences. In “US SEC says will fix whistleblower rule if any problems” by Andrea Shalal-Esa, McKessy is quoted as stating, “If our program is not doing what it’s intended to do, then we’ll look at it and figure out ways to fix it.”

In the meantime, McKessy, a former compliance officer with AOL and Altria, recognizes that siding with whistleblowers is not exactly going to win him any popularity contests in corporate America. The Reuters article quotes him as saying:

Look in a thesaurus under 'whistleblower' and see what kind of words you get out. I'm either the head of the office of the rats, or the rat finks, or rat bastards . . . .

[But] if even one fraud is stopped before it gets to a Madoff-type situation, then all the effort has been worth it.


Whistle While You Work (Part 2)! SEC Adopts Final Whistleblower Rules

The SEC today adopted its final whistleblower rules (302 page PDF) under Section 21F of the Securities Exchange Act of 1934 (Section 922 of the Dodd-Frank Act), which provides a bounty to whistleblowers who disclose securities law violations leading to large monetary sanctions. This SEC press release summarizes the new rules.

The whistleblower bounty can range from 10% to 30% of the amount of the sanctions. To qualify, a whistleblower must “voluntarily” provide the SEC with “original information” that “leads to” successful enforcement in which the SEC obtains monetary sanctions totaling more than $1 million. The final rules track the proposed rules fairly closely on these concepts. See this previous post for a description of the general nature of the rules and some commentary on corporate compliance. The post also describes the creative use of commercials by a whistleblower lawyer who directs viewers to go to his website,, to get information about whistleblower reporting and possible bounties.

The big news is that, after months of extensive lobbying by business groups and whistleblower advocates, the SEC declined to change the proposed rules to require that a whistleblower use the company’s internal reporting system as a condition to receiving the bounty. Large companies and the US Chamber of Commerce had pushed for this change, as described in the SEC release (pages 96-97). However, the SEC did alter its rule in several ways in an attempt to further encourage employees and other potential whistleblowers to use internal reporting systems, as described at the end of the press release. For example, the rules “. . . make a whistleblower eligible for an award if the whistleblower reports internally [consistent with the company’s internal policies] and the company informs the SEC about the violations. . . .”

Comment. In light of the bounty program, as I said in the previous post, public companies will need to continue to refine their whistleblower policies and training programs. This is only one of the aspects of Dodd-Frank in which we corporate lawyers will need to partner with our colleagues who specialize in employment law (i.e., clawbacks under Dodd-Frank are on their way!).

The Current Tally on Say When on Pay Votes

Semler Brossy Consulting Group recently published Say on Pay Results (PDF), a report of its a study of the Russell 3000 companies that had filed results of shareholder advisory votes under the Dodd-Frank Act as of May 11, 2011. The report indicates the following results, of the 628 companies in the Russell 3000 that had supported the various frequencies:

  • Shareholders supported an annual Say-on-Pay vote at a total of 82% of the companies.
  • Of the companies that recommended an annual Say-on-Pay vote, not surprisingly, shareholders supported an annual vote at more than 99% of these companies.
  • Of the companies that recommended a triennial vote, shareholders at 43% of these companies supported a triennial vote (the number fell to 22% out of the largest companies included in the S&P 500). In his Proxy Disclosure Blog on (subscription site), Mark Borges reports a similar number – of the companies that recommended a triennial vote, shareholders at around 48% of these companies followed the recommendation.

Comment. Certainly, shareholders supported annual Say-on-Pay votes at a large majority of companies, especially the larger companies. However, even among Fortune 500 companies, in a significant number of cases shareholders have been willing to go along with a triennial vote. Therefore, for companies that have not yet filed their proxy statements, if the board of directors believes a triennial vote is the best choice for the company and can articulate the reasons for that decision, it is certainly a supportable decision to make this recommendation. If the shareholders disagree, however, the board will then be in a position of evaluating whether to follow the preference of the shareholders despite its recommendation. See this previous post for steps to follow in dealing with this situation.

Animated Regulation FD Training Video is Informative and Entertaining

Melissa Gleespen, Senior Counsel, Securities and Corporate Law at Owens Corning has created this great computer-animated video as part of an internal training program on compliance with Regulation FD, the SEC’s prohibition against selective disclosure of material non-public information:

In a podcast interview with Broc Romanek on (content by subscription), Gleespen reported that the video was very easy and inexpensive to create on – she simply made some selections from a menu and typed in a script. This seems like an easy way to enhance a compliance training program, on Regulation FD or any other topic.

Compliance training is even more important now than ever, given the SEC’s expanded enforcement activity. In an article in, “Office Depot case highlights value of Reg FD policies,” Tim Human points out that Office Depot recently received a steep fine from the SEC for Regulation FD violations. The SEC cited Office Depot’s lack of a Regulation FD policy and failure to provide training on Regulation FD. By contrast, Human reports that the SEC let American Commercial Lines off the hook in a Regulation FD action against its CFO, with the SEC commending that the company had cultivated a culture of compliance through training.

With tools like the animated video above, you don’t have to be a Fortune 50 company to provide effective training.

Updated Scoreboard on the Frequency Vote (“Say When on Pay”)

In last week’s post, I provided a scoreboard of the proxy statements filed so far that include the shareholder advisory votes required under the Dodd-Frank Act, including the ‘Say When on Pay” frequency vote. Based on Mark Borges’ updated tally of 15 companies’ proxy statements in his Proxy Disclosure Blog on (subscription site), here’s the score:

Triennial Say-on-Pay vote recommendation: 9 companies
Biennial Say-on-Pay vote
recommendation: 1 company
Annual Say-on-Pay vote
recommendation: 4 companies
No recommendation: 1 company

I wouldn’t be surprised if the final score at the end of proxy season is in the same proportions shown above. Fortunately, this is one scoreboard we can keep watching from the safety of our offices, without the risk of an inflatable dome collapsing above our heads. . . .

Dodd-Frank Act Provision May Affect SEC Enforcement Settlements

The SEC has a new weapon in its enforcement proceedings, thanks to a provision in the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF). In an interesting article in DealBook, “Can the S.E.C. Avoid Scrutiny of its Settlements?” Professor Peter J. Henning points out that Section 929P of the Act “now allows the S.E.C. to impose a civil monetary penalty in an administrative proceeding ‘against any person’ who violates a provision of the federal securities laws.” Prior to enactment of the Act, the S.E.C. had to go to court to impose penalties against companies other than broker-dealers or investment advisors.

Professor Henning points out that this authority might have made a big difference in the SEC’s recently announced settlement of an enforcement proceeding against Citigroup over its disclosure of its exposure to subprime mortgages. Like the settlement in the Goldman Sachs proceeding, the Citigroup settlement is being delayed, as a federal district judge scrutinizes the settlement.

Under the new Dodd-Frank Act provision, Professor Henning says the SEC enforcement staff will be able to bypass the courts altogether on some types of proceedings by filing settled cases as administrative proceedings. This may allow the staff to act more quickly and impose sanctions on a greater number of companies more quickly. It’s hard to predict the impact of such a trend, however. The scrutiny of the judge in cases such as the Goldman Sachs settlement forced the SEC to get tougher in the final settlement, so the availability of administrative proceedings may make it easier for the SEC and its corporate targets to negotiate deals that are less tough than a federal judge would require. One way or another, however, the flurry of activity from the newly empowered SEC enforcement staff is sure to continue.

Show Me the Logo

Speaking of the empowered enforcement staff, the SEC obviously wants to showcase their toughness – I noticed the brand new logo that’s now prominently displayed at the upper right corner of the home page of the SEC’s website, just above a set of links to its latest high profile enforcement cases:





I’m not going to try to take any credit for the logo, but it does remind me a bit of the graphic I have used in this blog a few times:





I first used the "Busted" graphic in my post in September 2009, “’Busted’ - Don't Be Blindsided by the SEC's New Enforcement Posture,” in which I provided some tips for public companies to avoid problems with enforcement proceedings. I’ll provide an updated list of tips in an upcoming post.

Actually, one of my partners said the SEC’s new enforcement logo reminds him of another one – maybe the SEC is trying to show that its new “cops on the beat” are just as tough as the cops represented by this logo:


Whistleblower Bounty Provision is the Securities Law "Sleeper" in the Financial Reform Bill

As I have reported previously, Dodd Bill, the Restoring American Financial Stability Act of 2010 (1,600 page PDF), includes extensive governance and compensation reforms that apply to all public companies (or, in some cases, all listed companies), not just financial institutions. However, a lesser-known provision in the Dodd Bill could also have a significant impact on public companies: a program that would pay whistleblowers a bounty for reporting violations of securities law.

Under Section 922 of the Dodd Bill (starting on page 974), if a whistleblower provides information on a securities law violation that leads to monetary sanctions of more than $1 million, the SEC will be required to pay the whistleblower an amount ranging from ten percent to 30 percent of what has been collected. This bounty would apply to a wide range of securities law violations, including violations of the Foreign Corrupt Practices Act. The Frank Bill, which is being reconciled with the Dodd Bill in conference committee, contains a similar provision, without the ten percent minimum. Because the Senate and House versions are similar, it seems likely that the provision will be part of the final bill, expected to be passed this summer.

I view this provision as the “sleeper” in the Dodd Bill for public companies. It’s received less publicity than other provisions such as mandatory Say-on-Pay and a majority voting requirement for directors in listed companies. However, its impact on public companies could be even greater than those other provisions. The bounty provision may encourage employees to report perceived violations in a greater number of cases than before. Considering the recent increases in SEC enforcement staffing and activity, public companies will also be at greater risk of SEC investigations and enforcement proceedings.

In preparation for the likely passage of the bill, public companies should ensure that their whistleblower policies are up to date and that they are prepared to process a possible increase in whistleblower reports. The policies should provide clear procedures for employees to report possible violations within the company. Careful preparation may help reduce the chances of an expensive and time-consuming problem in the future.

Tips From the 2010 Bowne Conference: How to Avoid Disclosure Problems

The 2010 Bowne SEC Accounting, Compliance & Legal Issues Conference held in Minneapolis last week was a major success. More than 250 public company representatives and advisors attended to hear a day-long program featuring up-to-date information on disclosure, corporate governance, executive compensation and accounting issues.

I moderated a panel discussion on public company disclosure issues that also featured my partner, Paul Chestovich. Paul provided an update on the SEC’s new positions on climate change disclosures and non-GAAP financial measures, also the subject of a very handy article Paul wrote for the Small Public Company Forum called “Generation Non-GAAP”. We also participated in a discussion of tips for public companies to avoid disclosure problems. The SEC has beefed up its enforcement staff and enforcement activity, making compliance especially important these days, to avoid being “busted” by the SEC. Some of our disclosure and compliance tips were as follows:

  • When making tough disclosure calls, remember the current public skepticism and SEC activism (business as usual may not be enough).
  • Revisit forward looking disclaimers, risk factors and MD&A in light of current conditions.
  • Before you have a problem, check your D&O policy – does it cover SEC investigation expenses? (Many do not.)
  • Focus on process, process, process - in light of SEC scrutiny, it’s important to have consistency and proper oversight, and to be able to demonstrate that with good documentation.
  • Make sure disclosure controls are formalized (written and compiled), and that the internal disclosure committee keeps proper records.
  • Re-examine whistleblower policies, especially in relation to reporting of financial fraud. Note that, under the new financial reform bills, whistleblowers may receive a “bounty” for reporting financial fraud, which will encourage further activity by whistleblowers.
  • Consider a formal Communications Policy to control the flow of information to analysts, media, etc. This will reduce the risk of inconsistent or misleading statements and help promote compliance with Regulation FD (prohibiting selective disclosures to analysts).
  • Review the corporate website and make sure disclosures are consistent with public reports.
  • Focus on your insider trading policy - make sure the policy is up to date and policed. Even the appearance of insider trading gives plaintiffs and SEC additional basis for actions, where a disclosure issue alone might not trigger a proceeding.

Our complete presentation is available here (PDF).

If you were not there, hope you can make it to the Conference next year!

Securities Class Actions Continue to Fall; SEC Continues to Beef Up Enforcement Activity

In a post titled “Private Securities Litigation Continues to Fall”, Broc Romanek’s Blog recently summarized the results of a report by Cornerstone Research, “Securities Class Action Filings – 2009: A Year in Review” (PDF):

The latest report from Cornerstone Research shows a sharp drop-off in federal securities fraud class action filing activity in 2009. Continuing a trend that we have seen over the past few years, the 169 federal securities fraud class action filings in 2009 were off 24% from 2008, and were well below the historical average over the past ten years. Included in this big decline was a sharp retreat in credit-crisis filings, down nearly 47% from 2008 levels.

The chart on page 4 of the Cornerstone Research report shows an especially sharp decline when special cases, such as credit crisis filings and Ponzi schemes, are excluded.

Counterbalancing the drop-off in securities class action filings are the continued reports of the SEC’s efforts to beef up its enforcement efforts. In a Washington Post article, “SEC faces setbacks, skepticism in trying to reform its enforcement image”, Zachary A. Goldfarb outlines the SEC’s increased enforcement activity. He reports that SEC investigations more than doubled, from 233 in 2008 to 496 in 2009, and financial penalties increased from $1.03 billion in 2008 to $2.86 billion in 2009.

Comment: Goldfarb’s article focuses on the setbacks the SEC has encountered in beefing up its enforcement activities, which makes for interesting reading. However, the point remains that the SEC is more anxious than ever to bring enforcement proceedings. Compliance officers at public companies must continue to be vigilant to minimize exposure to disclosure-related liability. I included some tips in my previous post, “Don’t Get Caught Cheating”, and I will provide more tips in future posts.

Image: Wikimedia Commons

Busted Again: More SEC Enforcement Developments

BustedAs I reported previously, the SEC enforcement staff is "loaded for bear," stepping up its enforcement activities to go after violations of the securities laws. Some recent stories reinforce that it is more important than ever to guard against these violations: The Wall Street Journal reported on Wednesday that the SEC has greatly expanded its insider trading investigations of broker-dealers and hedge funds (subscription required to view complete article). According to the report, the staff has sent at least three dozen subpoenas in the past month, including investigating the role of Goldman Sachs bankers. The staff is using sophisticated technology to examine the webs of relationships among traders, investment bankers, attorneys and others.

    Comment: There is no reason to think that the current investigations are limited to broker-dealers and hedge funds, and the trail could easily lead the SEC staff to company personnel. It is more important than ever for companies to monitor and enforce their insider trading policies.

The SEC last month reported that it entered into a consent decree with former officers and accountants at SafeNet in the first enforcement action by the Commission under Regulation G. Reg G regulates the use (and abuse) of "non-GAAP financial measures" by reporting companies. The complaint accused the personnel of engaging in a scheme to meet or exceed quarterly EPS targets through improper accounting adjustments. The company represented that it was excluding "non-recurring" expenses from its results, when in fact it was excluding recurring operating expenses to make its earnings look better.

    Comment: SafeNet obviously was engaged in outright fraud, and Reg G gave the SEC staff another means to go after bad people. However, it's no coincidence that the first Reg G proceeding is in late 2009 - again, the enforcement staff is actively looking for perceived wrongdoing, in part to justify the agency's continued existence. Public companies should be more careful than ever in complying with Reg G - for example, be careful about characterizing any excluded expenses as "non-recurring," which is a real hot-button issue with the SEC staff.

Westlaw Business Currents reported last week that there has been a "noticeable uptick" in companies disclosing Wells Notices relating to enforcement proceedings.

    Comment: Be careful out there. And don't get caught cheating.

No News. I keep checking the SEC calendar to see whether the Commission has scheduled a meeting to consider adoption of the new proxy disclosure rules. Nothing posted yet. It's hard to predict whether anything will be adopted this year, or whether the new rules will be effective for the 2010 proxy season.

"I Am Not a Crook"

budkroghphoto1I attended a compelling legal education program this week, taught by Egil "Bud" Krogh. Political junkies know that Krogh was a young assistant White House counsel in the Nixon years. As a leader of the "Plumbers" unit, he authorized the 1971 break-in of the offices of Daniel Ellsberg's psychiatrist after the leak of the Pentagon Papers. After the break-in came to light in the Watergate hearings, Krogh pleaded guilty, served time in prison, was disbarred and later reinstated.

Bud now lectures on the topic of legal ethics, based on his recent book, Integrity: Good People, Bad Choices, and Life Lessons from the White House. His premise: in a pressure-filled environment such as the White House, intense loyalty to individuals can blind you to your higher principles. This is compounded by fear, inexperience, pride and other factors.

Krogh's description of an environment that can put pressure on decision-making is familiar to anyone called on to say yes or no to any proposal by a corporate officer. Whether the proponent is the client of an outside attorney or the boss of an in-house attorney, there is a lot of pressure just to nod approval, as Bud Krogh nodded to Howard Hunt when the Plumbers break-in was discussed. I think the situation is especially acute for in-house attorneys. Of course, most proposed actions are legal, and the advice is often about the level of risk involved in two alternatives. And most in-house attorneys do a great job of balancing the competing pressures of giving sound advice while also being part of the team. But how do some decisions, even decisions by good people, go astray?

A great example can be found in the options backdating scandals. An article in the Financial Times in November 2006 reported that the backdating scandals had resulted in at least twelve major US companies replacing their general counsel, and a March 2008 speech by the SEC's Director of Enforcement reported that at least seven former general counsel had been charged by the SEC in connection with the scandals. Backdating, even though not necessarily illegal in itself, in these cases represented falsification of documents and involved misleading accounting and tax fraud. I know many attorneys said "no" to the practice, but these counsel simply nodded as backdating was pushed by other corporate officers. It might not have seemed like such a big deal at the time.

I asked Krogh how to advise an attorney (maybe a younger in-house attorney) how to avoid the pitfalls of losing perspective in a pressure-filled situation. He steered me toward a Top Ten List provided by Hank Shea, a former Assistant U.S. Attorney in Minnesota who teaches ethical leadership at the University of St. Thomas Law School, including the following two lessons learned from the misconduct of others:

    When faced with a right versus a wrong decision, guard against that first intentional misstep.

    When faced with an ethical dilemma, seek advice and counsel from others.

After an interesting program, Bud entertained us with a great Nixon impression, including, at the request of one of my colleagues, the famous phrase "I am not a crook". Bud proved that we can all learn lessons about how to be able to make that statement, and mean it.

It's Just An IP Thriller - One More Comment

Bud Krogh also told a great story about Elvis, the King of Rock and Roll, who came to visit President Nixon in a meeting engineered by Bud. I just saw a great film about another King - the King of Pop. "This Is It" chronicles the rehearsals for Michael Jackson's planned comeback concert tour. I recommend it to anyone who wants to see the combination of pure genius and meticulous attention to detail shown by MJ. If you didn't see it before, it's worth reading my previous post, reporting that Jackson was actually one of the named inventors in an issued patent.

"Busted" - Don't Be Blindsided by the SEC's New Enforcement Posture

busted1I spoke this week at a Minnesota CLE Conference on the topic of how public companies can avoid liability for their disclosures. In preparing my remarks, it struck me that the SEC is "loaded for bear" in going after public companies and their officers with investigations and enforcement proceedings. The SEC has increased and reorganized its enforcement staff and is trying to raise its profile - really, an attempt to justify the agency's continued existence. Recent examples, just during July and August of 2009:

    A recent accounting fraud case against General Electric, where GE agreed to pay a $50 million fine.

    The SEC's $33 million settlement with Bank of America for failure to disclose the approval of Merrill Lynch bonus payments in the merger proxy statement. The District Court is considering rejecting the settlement as too lenient, which the SEC is disputing.

    The SEC's "clawback" action to recover $4 million in incentive compensation from the CEO of CSK Auto, reported here. It's not clear whether the SEC will be successful in this case. However, clearly, the SEC is trying to send a message to corporate officers that, if the officers are not vigilant to preventing accounting fraud and disclosure violations, their own compensation may be at risk.

This is all happening at a time when private lawsuits for securities fraud are getting more difficult for plaintiffs' attorneys to bring - a point of agreement for the plaintiffs' attorneys and defense attorneys on the panel. This does not mean company officials can relax, due to the increased scrutiny from the SEC and, probably, increased skepticism from judges and juries about public company practices. As I said in this prior post, this atmosphere should lead public companies to carefully consider their disclosure processes, including the disclosure controls and procedures required under SOX.

In other words, once again, "Don't Get Caught Cheating." Or, make sure you're not "BUSTED" by the SEC.

If you would like a copy of my PowerPoint presentation from this week, send me an e-mail. If you have any tips on disclosure procedures, or just want to weigh in on the SEC's newly found "mojo", post a comment below.

Have a great Labor Day weekend!