pomtalk

Pay to Play

Tamar Weinrib — 2009-11-04T17:26:12-05:00

Recently, Risk Metrics revisited an article published earlier this year called Is 'Pay-to-Play' Driving Public Pension Fund Activism in Securities Class Actions? An Empirical Study, written by David H. Webber, the Wagner Fellow in Law & Business at NYU's Law School and Stern School of Business earlier this year. The article analyzed whether elected officials acting as trustees for pension funds funnel business to law firms that provide campaign contributions to that official. Despite general sentiment that this is a widespread practice, Webber's article found that a negative correlation existed between the percentage of politicians on a fund's board and the lead-plaintiff appointments obtained by the fund. The general sentiment continues to hold popular opinion however as evidenced by legislation recently introduced in New York which would create a board of politically appointed trustees to oversee the state's pension fund, supposedly curtailing the ability of firms to engage in "pay to play" practices.

OTC Bill Clears Another Hurdle

Tamar Weinrib — 2009-10-26T17:17:09-04:00

Following the House Financial Services Committee’s approval of its version of proposed legislation to reform regulation of the OTC derivatives market on October 16, 2009, the House Agriculture Committee unanimously approved its own version of the bill on October 21, 2009. The two committees will now work together to reconcile any differences between the two versions before moving forward. Among other things, the bill would require standardized derivatives to be cleared through central clearinghouses and traded on an exchange or other regulated platform, subject to rules set by the Commodity Futures Trading Commission and the Securities and Exchange Commission. This is an important development on the road to increased transparency in a previously murky marketplace. Click here to view the House Financial Services Committee version of the bill. Click here to view the House Agriculture Committee version.

From the Pages of The Pomerantz Monitor: SEC Brings First Clawback Action

Carolyn Moskowitz — 2009-10-20T11:42:50-04:00

The September/October issue of The Pomerantz Monitor reports on the first “clawback” action brought by the SEC for violation of Section 304 of the Sarbanes-Oxley Act. Section 304 of SOX provides that if a company is required to restate its financial results because of “misconduct,” the CEO and the CFO “shall reimburse” the company for any bonus or other incentive-based compensation received during the year following the issuance of the erroneous financial statement. This provision was obviously designed to deprive the two principal officers of any benefit they derived from reporting inflated financial results, such as achieving a certain level of earnings or revenues. If those benchmarks were not really achieved, the two chief officers should not keep benefits that they received under false pretenses.

Frustratingly, courts have held that there is no private right of action for shareholders to “claw back” these overpayments. Because companies are typically loath to invoke this remedy and the SEC has done nothing to enforce it, Section 304 has been a right without a remedy. Making matters worse, without any caselaw, no one really knows whether the misconduct that must occur in order to trigger the clawback has to be committed personally by the CEO or CFO.

This issue may soon be clarified. On July 22, 2009 the SEC brought the first action under SOX’s clawback provision to recover compensation, and it does not even accuse the defendant of committing any misconduct. The SEC enforcement action charges Maynard L. Jenkins, the former CEO of CSK Auto, with receiving over $4 million in bonuses and profits on the sale of stock within one year of CSK’s issuance of false and misleading financial results for 2002-04. The SEC concedes that the actual accounting fraud was committed by other CSK officials, who were sued earlier.

There is no requirement in Section 304 that the CEO or the CFO from whom the reimbursement is sought have any involvement in the events that necessitated the restatement. Indeed, the statute doesn’t require any showing of wrongdoing or fault at all by these individuals.

On September 15, 2009, Jenkins filed a motion to dismiss the SEC’s high-profile case against him, stating that the SEC “is attempting to impose a Draconian penalty on an admittedly innocent person.”

To be continued . . .

The Bumpy Road to Recovery

Tamar Weinrib — 2009-10-19T17:00:00-04:00

During a high-profile White House event Friday, Obama slammed the Chamber’s multi-million advertising campaign against the consumer agency, calling the group’s spots “completely false.”

“We’ve made clear that only businesses that offer financial services would be affected by this agency. I don't know how many of your butchers are offering financial services,” Obama said to laughter.

During a high-profile White House event Friday, Obama slammed the Chamber’s multi-million advertising campaign against the consumer agency, calling the group’s spots “completely false.”

As our country is seeking to heal its economic wounds, we are constantly witnessing the reasons why we’ve arrived at this crisis in the first place. It is not only gargantuan bonuses and greedy CEOs that are frustrating the recovery, but also the $224 million spent by the financial industry in the first half of this year to lobby Congress to water down regulations aimed at preventing another financial meltdown. The need for reform is clear. What is unclear is who will win the battle over what shape reform should take. As Alan Blinder described in a recent New York Times op-ed, "The money at stake is mind-boggling, and one financial industry after another will go to the mat to fight any provision that might hurt it." Included on the anti-reform side of the playing field is the U.S. Chamber of Commerce. One crucial debate is over the proposed Consumer Financial Protection Agency (CFPA). The idea of the CFPA is to consolidate federal consumer regulation under one authority. To date, the Chamber of Commerce, which has consistently championed itself as a proponent of reform, has spent approximately $2 million on efforts to kill the agency.

The government has repeatedly asserted that regulatory overhaul is needed to protect us from another financial disaster. Most recently, President Obama attacked the Chamber of Commerce for its anti reform efforts and claimed that its ads attacking the CFPA are completely false. The Chamber of Commerce has claimed that the scope of the CFPA powers are too broad, extending well beyond companies that are principally engaged in financial services. According to Obama, the CFPA would only affect businesses that offer financial services and would have "just one mission: to look out for the financial interests of ordinary Americans."

SEC Delays Implementation of Proxy Access Rules

Jim Hodgson — 2009-10-15T11:20:43-04:00

SEC Chairwoman Mary Shapiro recently announced that the Commission's proposed changes to proxy access rules would not become final until sometime in 2010 – at the earliest. These rule changes, designed to give shareholders the ability to nominate their own board candidates, have been long awaited and are sorely needed. Chairwoman Shapiro reports that the delay has been caused by the overwhelming volume of comments to the proposed rules: "We have received hundreds of comments that we are reviewing to ensure that our rules are fair and appropriate."

Under the proposed rules, a public company would have to allow its shareholders the right to include their own board nominees in the company's proxy materials, assuming state law or the company's bylaws did not preclude this right. Shareholders would have to meet certain other criteria: they would have to meet minimum stock ownership requirements; they would have to have held the company's stock for a certain length of time and certify that they intend to remain holders; and they would have to guarantee that their nomination is not part of an effort to obtain corporate control. The typical institutional investor would meet this criteria easily, and we strongly favor the ability of such an investor to voice its preference for board nominees.

Unfortunately, the implementation delay eliminates any hope that proxy access rules will become final by the end of this year, as originally planned. Hopefully, the SEC will act quickly enough to have final rules in place by next spring's proxy season.

Key Pieces of Legislation to Empower Investors

Fei-Lu Qian — 2009-10-07T12:21:48-04:00

On October 1, 2009, Congressman Paul E. Kanjorski, Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises released discussion drafts of three pieces of legislation aimed at reforming needed areas in the U.S. financial services industry. The draft bills are the Investor Protection Act, the Private Fund Investment Advisers Registration Act, and the Federal Insurance Office Act.

According to Congressman Kanjorski’s press release, the Investor Protection Act will strengthen the SEC’s enforcement powers to “better protect investors, and efficiently and effectively regulate our securities markets.” The Private Fund Investment Advisers Registration Act will require private advisers to register in order for regulators to “better understand exactly how those entities operate and whether their actions pose a threat to the financial system as a whole.” The Federal Insurance Office Act will create a federal insurance office “will provide policymakers with access to the information and resources needed to respond to crises, mitigate systemic risks, and help ensure a well functioning financial system.”

From the Pages of The Pomerantz Monitor: Senator Specter Introduces Two Bills That Could Prove Very Important to Plaintiffs

Carolyn Moskowitz — 2009-10-05T15:15:51-04:00

As Susan Weiswasser reports in the current issue of The Pomerantz Monitor, two pieces of legislation recently introduced in the United States Senate, both sponsored by Arlen Specter of Pennsylvania, could, if passed, prove very important to plaintiffs. Both would effectively overrule Supreme Court decisions that made surviving motions to dismiss or getting relief for the acts of secondary actors in securities cases more difficult.

The Anti-Twombly Act. The first bill deals with the way plaintiffs have to present claims in their complaints to survive a motion to dismiss. Rule 8 of the Federal Rules of Civil Procedure requires, among other things, that a plaintiff make “a short and plain statement of the claim showing that the pleader is entitled to relief.” The standard for deciding whether a complaint satisfied Rule 8 was established in the 1957 Supreme Court case Conley v. Gibson. The Court held that the Federal Rules “do not require a claimant to set out in detail the facts upon which he bases his claim.” It stands to reason that plaintiffs very often will not have detailed facts available until after they have filed suit and obtained discovery from the defendants. The language the Conley Court used to describe this standard — that dismissal is improper “unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief” — would be quoted by courts reviewing motions to dismiss for the next 50 years.

Then, in 2007, the Court decided Bell Atlantic v. Twombly, and created a new standard — often referred to as the “plausibility standard” — which requires that, to survive a motion to dismiss, a plaintiff must provide “enough facts to state a claim to relief that is plausible on its face." Ashcroft v. Iqbal, decided earlier this year, reinforced Twombly’s message noting that “[t]he plausibility standard is not akin to a ‘probability requirement,’ but it asks for more than a sheer possibility that a defendant has acted unlawfully.” Since Twombly was decided, it is reported that motions to dismiss have been filed with much greater frequency.

Senator Specter’s bill would restore the pleading standard set forth in Conley v. Gibson. In his comments introducing the bill, Specter, a lawyer, made the point that “[n]ot until a plaintiff has had access to relevant information in the defendant’s possession during the discovery process . . . can the plaintiff normally offer evidence to support the complaint’s allegations.” Since the Federal Rules do not allow federal courts to pass on the merits of a case until plaintiffs have submitted evidence, either on summary judgment or at trial, Specter expressed the inappropriateness of requiring plaintiffs to do more than provide defendants with notice.

The Anti-Stoneridge Act. Second on Specter’s agenda is a bill that will restore securities fraud liability for aiders and abettors. While Congress had not specifically created a private right to sue aiders and abettors under the securities laws, until 1994 courts had allowed suits against accountants, lawyers, business associates and the like who assist primary violators in carrying out schemes to defraud investors.

In Central Bank of Denver v. First Interstate Bank of Denver, the Supreme Court dealt a serious blow to investors, holding that no private right of action for aiding and abetting could be had under the securities laws. Thus investors lost the ability to pursue wrongdoers who often played an indispensable role in perpetrating a fraud in spite of not being primary violators. Analyzing Congress’s intent as expressed in the text of the statute, the Court ruled that a cause of action against one who had not committed the manipulative or deceptive act could not be inferred. The majority discounted arguments that the availability of such a claim functioned as a deterrent to those who might provide behind-the-scenes assistance to actual violators of section 10(b).

Less than a year later, Congress introduced the Private Securities Litigation Reform Act (PSLRA). The SEC, which had filed a friend-of-the-court brief in Central Bank in support of maintaining the aiding and abetting cause of action, pressed Congress to overturn the Central Bank decision in the new law. Congress refused, delegating the right to bring an action for aiding and abetting to the SEC alone. The bill passed over President Clinton’s veto.

Recently, the Court had another look at who could be sued for securities fraud. In Stoneridge Investment Partners v. Scientific-Atlanta, where the Pomerantz firm represented plaintiffs, the Court considered whether the Central Bank decision barred a suit against a party who engaged in deceptive conduct but made no public statements about that conduct. The Court ruled that deceptive acts could create primary liability under the securities laws, as long as investors relied on those deceptive acts. Because the deceptions in Stoneridge were directed at the auditors, rather than the public, the Court held that investors could not have relied on them and thus could not prevail.

Senator Specter’s bill would recreate the private right of action for aiding and abetting, so that “any person that knowingly or recklessly provides substantial assistance” to a primary violator could be held liable for securities fraud. Specter is likely to have support for this bill beyond investors and the plaintiffs’ bar. As Specter pointed out in his introduction of the bill, Judge Gerald Lynch of the federal court in Manhattan recently wrote in an opinion that Congress’s choice to deny investors a private right of action against aiders and abettors:

“may be ripe for legislative reexamination. While the impulse to protect professionals and other marginal actors who may too easily be drawn into securities litigation may well be sound, a bright line between principals and accomplices may not be appropriate. There are accomplices and there are accomplices: after all, in the criminal context when the Godfather orders a hit, he is only an accomplice to murder – one who ‘counsels, commands, induces or procures’ but he is nonetheless liable as a principal for the commission of the crime. Likewise, some civil accomplices are deeply and indispensably implicated in wrongful conduct.”

SEC Chairwoman Shapiro Outlines the Commission’s Multi-Pronged Approach to Sweeping Financial Market Reforms

Jim Hodgson — 2009-09-24T12:06:42-04:00

In her speech earlier this month at the Transatlantic Corporate Governance Dialogue – 2009 Conference, SEC Chairwoman Mary Shapiro addressed a number of factors that precipitated the current financial crisis. For one thing, she identified a failure of corporate governance as being of central concern. “In particular,” she said, “boards of directors did not thoroughly question the decisions of senior management to take on risks. Of equal concern, boards often appeared to misunderstand the gravity of risks taken. Senior management took higher returns at face value, without questioning why such higher returns were possible for supposedly safe investments and strategies.”

Ms. Shapiro promised the conference that the SEC is committed to taking a more active role both in corporate governance and in financial industry oversight. With respect to the latter, she said, better policing of unfair trading practices, including abusive short selling, is of primary importance. Ms. Shapiro also stated that the SEC is in the process of implementing new regulations to govern credit rating agencies and investment advisers – two of the less visible players that contributed significantly to last year’s market collapse. Increasing board oversight of management, working to enhance the strength and integrity of investment products, and improving market transparency are other items at the top of the SEC’s agenda.

We applaud the Chairwoman’s ambition, and we hope that the Commission’s goals come to fruition. It seems like this sort of multi-pronged approach stands the greatest chance of curing what ails our financial markets.

To read all of Ms. Shapiro’s speech, please follow this link.

Report Recommends Establishing Clear Link Between Pay and Performance

Fei-Lu Qian — 2009-09-24T10:49:12-04:00

The Task Force on Executive Compensation convened by the Conference Board Governance Center to address the loss of public trust in the processes for oversight of executive compensation issued recommendations for corporations to restore credibility and public trust in pay practices and oversight. Some of the recommendations include asking companies to establish “a clear link between pay, strategy and performance” and to provide “compensation that is fair, affordable and clearly aligned with actual performance.”

Some supporters of the report include AFC Enterprises, Albemarle Corp., AT&T Inc., the California State Teachers’ Retirement System, Cisco Systems Inc., Hewlett-Packard CO., NASDAQ OMX Group Inc., Securities Industry and Financial Markets Association and Tyco International Ltd.

Robert E. Denham and Rajiv L. Gupta, co-chairs of the Task Force believe that shareholders “deserve to see executive compensation programs that serve shareholders’ interests and are explained to shareholders in thoughtful dialogue. Implementing the compensation principles we recommend is an important step in restoring the damaged trust in American companies.”

The SEC's Latest Blunder

Tamar Weinrib — 2009-09-21T17:00:00-04:00

The SEC alleged earlier this year that BofA had "materially lied" in shareholder communications prior to its takeover of Merrill Lynch, by failing to disclose bonuses owed to Merrill employees. So how does one properly punish the wrongdoer? By further victimizing the victims of course! In a remarkably deplorable attempt at rectifying BofA's breach of securities laws, the SEC's staff negotiated a settlement under which Bank of America paid a $33 million civil penalty, and no officer or employee paid anything or was otherwise disciplined. In other words, the shareholders continue to lose.

In a departure from the usual process of rubberstamping SEC settlements, as reported by John C. Coffee Jr. in a recent New York Law Journal article, Judge Rakoff issued a scathing opinion which detailed a "cynical relationship between the parties" under which "the S.E.C. gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger . . . [while] the Bank's management gets to claim that they have been coerced into an onerous settlement by overzealous regulators." Such a settlement, Judge Rakoff wrote, came not only at the expense of shareholders, "but also of the truth."

Especially vexing is that the SEC's actions in proposing such a settlement were in direct contravention to its own stated rule that, "Where the shareholders have been victimized by the violative conduct, or by the resulting negative effect on the entity following its discovery, the Commission is expected to seek penalties from culpable individual offenders acting for a corporation." The logic behind this policy is to punish the wrongdoers while protecting the shareholders from further injury. Did the SEC forget its own rule or decide to ignore it? In a feeble attempt at justifying its decision not pursue the individual wrongdoers at BofA, the SEC claimed that it could not charge the BofA officers because "key executives all stated that they delegated these decisions to counsel, who were aware of the relevant business terms of the transaction." The SEC never verified if this was in fact the case. In other words, the executives might have relied on counsel. Which of course begs the question: why didn't the SEC pursue the attorneys? With such defective logic, one can hardly wonder at the SEC's deplorable failure to detect Bernard Madoff's Ponzi scheme, arguably the largest fraud in history.

The burning question now is how the SEC will proceed. They can try to re-negotiate a new settlement or go to trial as Judge Rakoff ordered. Appealing Judge Rakoff's decision would be akin to pressing instant replay on the SEC's embarrassing fumble.

To view this is as an isolated error on the part of the SEC is to lose the forest for the trees. As the blunders start to add up, especially on the large scale of Madoff and Bank of America, the SEC needs to re-evaluate its methods of investigation and enforcement.