Friday, 28 February 2020

BakerHostetler attorneys examine SEC’s and FTC’s disgorgement powers as Liu Supreme Court argument nears

By Teresa Goody Guillen, Jeffrey D. Martino, Michelle N. Tanney and Baker Hostetler

Next week, the Supreme Court will hear arguments in SEC v. Liu, a case in which petitioners argue that because in Kokesh v. SEC the court held that disgorgement is a penalty, it cannot also be construed as an equitable remedy and is therefore a power that falls outside the scope of the SEC’s authority. According to attorneys at BakerHostetler, the importance of this challenge to the Commission’s ability to recover ill-gotten gains extends beyond the SEC, and could help upend the FTC’s consumer protection program and its authority to seek financial penalties in court. They look at the history of the SEC and FTC’s disgorgement powers, including the challenges those agencies have faced regarding those powers. They also consider the potential consequences if the Supreme Court ultimately rules in favor of the Liu petitioners.

To read the entire article, click here.

Thursday, 27 February 2020

Claims against insurance company directors re: merger negotiations may proceed

By Amy Leisinger, J.D.

The Delaware Chancery Court has declined to dismiss shareholder claims for breach of fiduciary duty made against the directors of an insurance company following a going-private merger. According to the court, the plaintiffs sufficiently pleaded facts demonstrating that the business judgment rule does not apply to the transaction because members of the special committee formed to negotiate and approve the merger had a material self-interest in the transaction given an earlier-filed lawsuit. The court did, however, dismiss the claims against one of the committee members who joined the company after the lawsuit, as well as the aiding and abetting claims against the other parties to the merger transaction (In re AmTrust Financial Services, Inc. Stockholder Litigation, February 26, 2020, Bouchard, A).

Merger. AmTrust, Inc., a family-controlled company engaged in the property and casualty insurance business, teamed up with a private equity firm to take AmTrust private through a merger. The buyout group conditioned the transaction on special committee approval and the approval of a majority of AmTrust’s minority stockholders. Following negotiations, the special committee voted to approve a $13.50 per share merger with the buyout group. However, the proposed merger terms drew criticism from major AmTrust stockholders, including Carl Icahn, who sued for breach of fiduciary duty and opposed the proposed share price.

Icahn later indicated willingness to support a transaction at $14.75 per share in discussions with certain AmTrust officials in which the special committee did not participate. Thereafter, the special committee and the company’s board approved an amended merger agreement with a price of $14.75 per share, and Icahn entered into a settlement agreement in which he agreed to drop his lawsuit, support the merger, and forego his appraisal rights. Thereafter, a majority of unaffiliated AmTrust stockholders approved the amended merger proposal.

The plaintiffs filed a complaint alleging that the final transaction did not comply with the framework set forth in Kahn v. M & F Worldwide Corp. for subjecting a squeeze-out merger by a controlling stockholder (the family owners of AmTrust) to business judgment review rather than the entire fairness standard. The special committee had a material self-interest in the transaction because it was expected to extinguish viable derivative claims against the members made in the settled pre-merger lawsuit, they alleged.

Material interest. In MFW, the Delaware Supreme Court held that the business judgment rule is the appropriate standard of review for a challenge to a merger when the merger is conditioned on both the approval of an independent special committee and the uncoerced vote of a majority of minority stockholders. The plaintiffs alleged that the special committee’s work yielded a proposed transaction that was ultimately rejected and that the final approved transaction for $14.75 per share was negotiated between Icahn and the family owners of AmTrust without any involvement by the special committee. The court found that the plaintiffs adequately alleged that at least one of the conditions of the MFW standard had not been satisfied. The second MFW condition considers the "independence" of members of a special committee, and the plaintiffs have pleaded a reasonably conceivable set of facts showing that three of the four members of the special committee had a material self-interest in the transaction in terms of the merger extinguishing potential liability in the Icahn’s earlier action, according to the court. The conditions necessary to apply the MFW framework to subject the transaction to business judgment review have not been satisfied, and the plaintiffs’ claims for breach of fiduciary duty may proceed, the court found.

Other claims dismissed. The court did, however, dismiss the fiduciary duty claim against one special committee member, noting that he was not named in the earlier action and that the plaintiffs did not allege facts to demonstrate that he had a material self-interest in the transaction or acted in bad faith. The court also dismissed a separate fiduciary claim against another director in his capacity of an AmTrust officer for failure to allege specific actions taken or statements made by him in that position.

As to the aiding and abetting claims against the other parties to the merger, the court found that the plaintiffs failed to plead facts demonstrating that these parties knew that their conduct assisted in a breach of fiduciary duty. The allegations do not support an inference that they must have known that members of the special committee were interested in the transaction, the court concluded.

The case is C.A. No. 2018-0396-AGB.

Wednesday, 26 February 2020

CII: SEC proxy advisor proposal aggravates already compressed proxy season

By Amanda Maine, J.D.

The Council of Constitutional Investors (CII) has again expressed criticism of the SEC’s proposed amendments regarding proxy advisory firms. In its latest letter, CII criticized the proposal for shortening the already limited time frame of the proxy season by requiring proxy advisory firms to clear their research reports with the company that is the subject of their proxy voting advice.

Incentive to file proxies earlier? CII has already submitted comment letters critical of the Commission’s proposals on proxy voting advice and shareholder proposal submissions. In its latest letter, CII focused its criticism on the proxy advice proposal’s requirement that issuers be given an opportunity to review and provide feedback on proxy voting advice before it is issued.

According to CII, one justification cited by the Commission for this proposed requirement is that companies would have an incentive to file their proxy materials at an earlier date. CII rejected this notion, noting that proxy firms face the same or even more difficult challenges during the spring proxy season as companies do. CII cited research stating that the benefits of expert proxy research and analysis are greater when proxy advisors have more time and fewer distractions to complete their work, undermining the SEC’s "weak" justification for the requirement.

CII pointed out that, as stated in its earlier communication with the Commission, claims of errors in proxy advisory firms’ analysis and reports have been unsubstantiated and overstated. Rather than encouraging companies to file their proxies earlier, the proposed amendments would aggravate the problem of the compressed proxy season by forcing proxy advisors to clear their research with the subject companies.

Research and lack of evidence. The proposal would give companies the "review and feedback" privilege only if they file proxy statements at least 25 days before the shareholder meeting. According to CII, nearly all companies already file their proxy materials at least 25 days before the shareholder meeting, so the proposal, if implemented, would not affect companies’ behavior in any significant way. In addition, CII asserted, the SEC provides no evidence that the purported incentive to file proxy materials earlier would change company behavior.

Citing data from Broadridge, CII advised that 2,900 companies (or 75.8 percent) filed their 2018 proxy materials between 40 and 48 days before the annual shareholder meeting. Only 95 companies (2.5 percent) filed their proxy materials 25 days or less before the annual meeting.

While CII opposes the proposed amendments in their entirety, the letter states that if the SEC does proceed with a review and feedback right for companies, it should be for a maximum of two days and be limited to factual information and data only. This right should only be provided to a company that files its proxy materials at least 50 days before the shareholder meeting, CII recommended.

Because the proposal as written would require that a proxy advisory firm’s report be furnished to the company two business days before it can be provided to the firm’s own paying customers, the proxy advisor will be under pressure to consider comments from company management. Between that and the minimum five business-day review period, the actual delay for investors receiving the proxy advisory firm’s report would be at least eight and as many as 11 calendar days, according to CII. This would reduce the time for investors to evaluate the reports and consider their proxy voting choices, CII advised.

Tuesday, 25 February 2020

Texas adopts cybersecurity incident procedures for dealers and investment advisers

By Jay Fishman, J.D.

The Texas State Securities Board has adopted certain notification procedures that dealers and investment advisers must undertake when a cybersecurity incident is triggered, effective February 27, 2020.

Cybersecurity incident procedures. Definitions. A "cybersecurity incident" is defined as the unauthorized acquisition of computerized or electronic data that: (1) compromises the security, confidentiality, or integrity of sensitive personal information being maintained; (2) jeopardizes the security of the information system or the information the system processes, stores or transmits; or (3) violates the information system owner’s security policies, security procedures or acceptable use policies to the extent the occurrence results from unauthorized or malicious activity.

An "information system" is a set of applications, services, information technology assets or other information-handling components organized for collecting, processing, maintaining, using, sharing, disseminating or disposing of electronic information, which is maintained by the dealer, investment adviser, an affiliate, or a third party at the dealer’s or investment adviser’s direction.

A "triggering event" is a cybersecurity incident pertaining to the information system a dealer or investment adviser maintains (or that is maintained on the dealer’s or investment adviser’s behalf). The triggering event requires the dealer or investment adviser to either submit a notice to a state or federal agency, law enforcement or self-regulatory body, or send a data breach notification to the dealer’s customers or to the investment adviser’s clients under applicable state or federal law, including Texas Business and Commerce Code Section 521.053 (or a similar law of another state).

Notice filing. A dealer or investment adviser must file a notice with the Texas Securities Commissioner when a triggering event occurs that does or may affect the dealer’s Texas-located customers or that does or may affect the investment adviser’s Texas-located clients. The dealer or investment adviser must specifically forward to the Securities Commissioner a copy of the above-mentioned "triggering event notice or notification" or a substantially similar document containing the same information. The dealer or investment adviser must include with the "notice document" the number of Texas-located customers or clients affected by the triggering event (if this information is available).

Monday, 24 February 2020

Wells Fargo to pay $3B to settle charges over fake accounts

By Anne Sherry, J.D.

The SEC and DOJ announced that Wells Fargo will pay $3 billion to settle claims relating to its "fake accounts" scandal. The payment resolves a criminal investigation into false bank records and identity theft, the government’s civil claims under FIRREA, and a newly filed SEC action for securities fraud. The latter accounts for $500 million of the total settlement. The Justice Department and Wells Fargo entered into a three-year deferred prosecution agreement on the criminal charges. Wells Fargo also asked the SEC to waive bad actor disqualification.

The charges center around Wells Fargo’s longstanding former practice of pressuring employees to cross-sell financial products. To meet quotas of up to eight accounts per customer, employees resorted to creating 3.5 million new deposit and credit accounts without the authorization of the customer, an internal investigation found.

SEC action. According to the SEC’s order instituting proceedings, Wells Fargo violated the antifraud provisions of the Exchange Act by touting its cross-selling strategy even though sales were inflated by the bogus accounts. The sales practices were also inconsistent with Wells Fargo’s public disclosures, which told investors that its selling model was grounded in customers’ needs. The SEC alleges that senior leadership within the Community Bank segment, which contributed the majority of Wells Fargo’s revenue, were aware of "gaming" practices among employees resulting from management pressure to meet onerous sales goals. However, leaders not only failed to relieve the pressure, they also promoted or praised managers who tolerated and encouraged gaming. Wells Fargo admitted these facts as part of its deferred prosecution agreement with the federal prosecutors.

DOJ claims. The government’s civil claims under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) are predicated on Wells Fargo’s maintenance of false bank records. The criminal charges arise out of the improper sales practices themselves. U.S. Attorney Nick Hanna characterized the scandal as "a complete failure of leadership at multiple levels within the bank." According to the Department’s press release, the global settlement "appropriately addresses the severity of the defendants’ conduct while avoiding the imposition of fines and penalties that are unnecessarily duplicative."

Prior settlements. In 2018 Wells Fargo agreed to pay $480 million to settle a private class action and another $575 million in a 50-state settlement of actions brought by state prosecutors. Previously, the Office of the Comptroller of the Currency, Consumer Financial Protection Bureau, and City of Los Angeles coordinated and settled charges against the bank. More recently, OCC announced that former CEO John Stumpf had agreed to pay a $17.5 million civil penalty and that OCC was taking action against other individuals, including seeking a $25 million penalty against former Community Bank head Carrie Tolstedt.

House FSC schedule. The House Financial Services Committee also announced its March schedule, to include a series of hearings entitled "Holding Wells Fargo Accountable." The full Committee will conduct hearings on March 10 and March 11 subtitled "CEO Perspectives on Next Steps for the Bank that Broke America’s Trust" and "Examining the Role of the Board of Directors in the Bank’s Egregious Pattern of Consumer Abuses." On March 25, the Subcommittee on Oversight and Investigations will convene for a hearing subtitled "Examining the Impact of the Bank’s Toxic Culture on Its Employees."

Friday, 21 February 2020

Comments highlight social, competitive effects of SEC proxy proposals

By Anne Sherry, J.D.

The SEC heard from the U.S. Department of Justice and from Sen. Tammy Baldwin (D-Wis) on its two November 2019 proposals affecting shareholder proposals and proxy advisors. Commenting on the proposal to raise the thresholds for submitting shareholder proposals, Baldwin said that the proposed rule would hinder progress against workplace discrimination affecting LGBTQ employees. The DOJ wrote that the proposal to regulate aspects of the proxy advisory business would improve transparency but could increase costs, resulting in a mixed effect on competition.

The SEC’s twin proxy proposals take aim at two related issues. One of the proposals would institute a tiered threshold such that larger investors could make proposals sooner than smaller investors, who would not have to hold as much stock but who would have to abide by a longer holding period. That proposal also would increase the resubmission thresholds that govern the amount of support required and the time frame for keeping a shareholder proposal alive. The second proxy proposal would subject proxy advisers to requirements on conflicts of interest and transparency that would allow companies reviewed by these firms to raise objections to proxy recommendations.

Shareholder proposals and LGBTQ rights. Baldwin’s comment letter observes that shareholder proposals led to a high adoption rate of workplace non-discrimination policies that include sexual orientation and gender identity. Fewer companies would have such policies under the proposed rule, damaging not only LGBTQ employees but also the companies and shareholders that would be deprived of their contributions. Baldwin cites a 2016 Credit Suisse report finding that companies with LGBTQ-friendly policies outperformed both a global index and a basket of peer companies. She adds that exposure to LGBTQ individuals, often in the workplace, greatly increases support for their equal rights.

The senator also criticizes the SEC’s analysis of previous shareholder proposals for going back only to 2011, by which time the LGBTQ rights movement was already underway. The analysis also overlooks changes that were driven by shareholder proposals but adopted through negotiation rather than majority votes on the proposal. Finally, and most concerning to Baldwin, the analysis uses probability to justify the likelihood that a proposal would be excluded based on the new thresholds. "I am disappointed that the Commission seems to believe the values of democracy can be done away with in lieu of probabilities," she writes.

Competition among proxy advisors. Commenting on the proxy advisory proposal, the DOJ approached the issue from its standpoint as the agency primarily responsible for promoting and protecting competition. The Department said it is aware of concerns that the proxy advisory industry is a duopoly, with two firms maintaining 97 percent of advisory services. DOJ also is aware that economies of scale create high barriers to entering the industry or to performing the same functions in-house.

The Department believes the proposal could create a foundation for greater competition by promoting accuracy and transparency in proxy voting advice and thus increasing demand for such advice. Furthermore, if clients had access to higher quality advice, their other compliance costs could decrease.

However, the proposal would also increase costs on proxy advisors themselves, which could decrease competition by causing some firms to exit the industry (or deter others from entering). The costs would be more significant to smaller businesses, which would be less able to absorb cost increases than larger, wealthier firms. DOJ also emphasized that care needs to be taken when increasing regulatory costs because these costs tend to be stable or increase over time. Ultimately, the comment letter defers to the SEC to strike the right balance if it concludes that the rules risk diminishing competition.

Thursday, 20 February 2020

CFTC defers to securities laws in Telegram matter

By Anne Sherry, J.D.

By invitation of the judge overseeing the SEC’s lawsuit against Telegram, the CFTC expressed its view that the "Gram" digital currency, while a commodity, may be subject to the registration requirements of the Securities Act. Telegram, which raised $1.7 billion via agreements for the purchase of Grams, argues that it was not required to register the offering because Grams "will constitute a currency and/or commodity—not securities under the federal securities laws."

The CFTC’s letter to the court denies that "commodity" and "security" are mutually exclusive categories. According to the agency, digital currency is indeed a commodity—but this classification does not equal a carve-out from the Securities Act registration requirements. The Commodity Exchange Act provides that many securities are also commodities to which the securities laws apply.

While the CFTC has exclusive jurisdiction over transactions involving commodity derivatives, its jurisdiction over the commodities themselves is generally limited to policing those markets against manipulation and fraud. The Commodity Exchange Act contains other provisions that preserve the SEC’s jurisdiction over securities. In the CFTC’s view, this includes certain commodities in the category of services, rights, and interests, which may also be securities. It is also possible that a given commodity may qualify as a security at certain points in time and not others.

Whether a digital asset is subject to the securities laws does not depend on whether the asset is a commodity, but rather whether the asset is a security within the meaning of the Securities Act, the CFTC writes, citing SEC v. W.J. Howey Co. (U.S. 1946). The Commission added that it expresses no view on the question of whether the Securities Act applies to Gram.

Wednesday, 19 February 2020

Commission, academia mourn the passing of former Chairman David Ruder

By Mark S. Nelson, J.D.

Northwestern University announced the passing of former Pritzker School of Law dean and one-time SEC chairman David Ruder. A Pritzker School of Law tweet linked to a Northwestern Now article that characterized Ruder as a "brilliant leader" who also was the William W. Gurley Memorial Professor of Law Emeritus, having served the school since 1961. Ruder was appointed chairman of the SEC during the latter years of the Reagan Administration and served in that role from August 1987 to September 1989. Ruder passed over the weekend at age 90.

As a newly confirmed SEC chairman, Ruder would deal with the market crash of October 19, 1987, which has been variously blamed on program trading. Under Ruder, the SEC would implement circuit breakers to reduce the risk from certain trading practices that could sap markets of needed liquidity in times of crisis.

Members of the current Commission issued a public statement reflecting on Ruder’s work at the SEC: "Notably, those who served with him often remark on his intelligence, candor and love for the Commission. More importantly, as Chairman Ruder would have wanted, and as he so often did, they have focused on instilling those characteristics and values in others. David set a fair and effective path for future generations that has stood the test of time."

In the years after Ruder left the Commission, he would testify before Congress many times, including on the need for targeted accounting reforms following the collapse of Enron. For example, Ruder began his testimony before the Senate Banking Committee in February 2002 by observing that despite the actions of a few regarding Enron and other companies, the U.S. accounting system was generally "strong and reliable." The February 2002 panel included other former SEC chairmen Arthur Levitt, Richard Breeden, Harold Williams, and Roderick Hills, collectively representing a 26-year period in the SEC’s history spanning five presidential administrations from President Ford to President Clinton. Testimony from this and other panels would lead to the creation of the Sarbanes-Oxley Act of 2002.

With respect to what would become the Public Company Accounting Oversight Board, Ruder told the Senate Banking Committee that an independent audit regulator could be designed to take advantage or some of the work already done at that time by the American Institute of Certified Public Accountants’ Public Oversight Board. More specifically, Ruder said: "A new, separate audit supervisory board should be modeled on the private sector Financial Accounting Standards Board—FASB—and perhaps on the self-regulatory system of the NASD. The Board should be subject to oversight by the SEC, which in turn should cooperate with the Board in the investigative area. The Board should be composed entirely of public members, not associated with the profession." Ruder added that such a board should be independently funded so that the persons it would regulate could not withdraw financial support if they disagreed with the standards to be imposed on them by the board.

Upon leaving the Commission, Ruder returned to Northwestern where he led efforts to provide continuing legal education through the Corporate Counsel Institute and the Ray Garrett Jr. Corporate and Securities Law Institute, both of which are held annually in Chicago, and the Securities Regulation Institute held annually in San Diego typically during late January. Anyone who has attended these events will recall Ruder’s nearly constant presence at the many panel discussions.

Ruder was originally from Wausau, Wisconsin. He completed his undergraduate work at Williams College before obtaining a law degree from the University of Wisconsin.

Tuesday, 18 February 2020

NASAA proposes continuing ed program for adviser representatives

By John M. Jascob, J.D., LL.M.

NASAA has requested public comment on a proposed investment adviser representative continuing education program, including a proposed state model rule for adopting jurisdictions to implement the framework. The stated goal of the program is to ensure that investment adviser representatives can better serve their clients by keeping their skills sharp and staying abreast of current regulatory requirements and best practices

"Investment adviser representatives play an important role in the financial lives of millions of Americans, yet unlike most financial services professions they are not required to meet a continuing education requirement to maintain their licenses to work with investors. We are proposing a program to close this education and investor protection gap," said Indiana Securities Commissioner Alex Glass, chair of NASAA’s Investment Adviser Section, in a news release.

Survey results. In 2017, NASAA’s Investment Adviser Continuing Education Committee worked with a leading education and testing vendor to develop a detailed survey to collect data from NASAA members and industry participants about an investment adviser representative continuing education program (IAR CE program). The survey included questions regarding, among other things, the need for IAR CE, whether a CE program would be supported by regulators and the industry, and potential topics to be included in any future program.

Given the strong support among state securities regulators, NASAA launched an industry-focused survey in early 2018 and met with industry and regulatory stakeholders to discuss IAR CE. Based in part on the findings from these surveys, NASAA’s IAR CE Committee developed a framework for an IAR CE program and drafted a proposed implementing model rule.

Proposed IAR CE framework. The proposed framework is structured around NASAA serving as the centralized body under which IAR CE flows. Similar to NASAA’s development and maintenance of the Series 63, 65, and 66 examinations, NASAA will develop and implement standardized criteria under which it will review potential IAR CE content providers and individual courses for approval. The proposed model rule in turn requires IARs in jurisdictions adopting it to take NASAA-approved IAR CE courses/content from NASAA-approved providers in order to satisfy the requirements in the proposed model rule.

General IAR CE requirements. The proposal envisions an annual IAR CE requirement under which adviser representatives would need to complete 12 total hours of CE. Six of the 12 hours would focus on a "Products and Practice" component designed to ensure ongoing knowledge and competency related to investment products, strategies, standards, and compliance practices relevant to the investment advisory industry. The remaining six hours would focus on an "Ethics and Professional Responsibility" component designed to ensure ongoing knowledge and competency related to a representative’s duties and obligations to his or her clients, including issues related to the fiduciary duty owed to each client.

Reporting and tracking. Reporting and tracking for IAR CE would be done by the course providers, though the reporting obligation would ultimately fall on the individual investment adviser representative. To facilitate reporting and tracking, NASAA-approved course providers would be given access to IARD either directly or via an intermediate system through which they would be required to report when a representative has completed an approved course or program. A small fee would be charged to the content providers to report IAR CE completion on a per hour and per individual basis.

Comments on the proposed continuing education program and accompanying model rule are due by March 30, 2020.

Friday, 14 February 2020

Deja vu all over again: CFTC and Kraft tell judge they have agreed to settle

By Brad Rosen, J.D.

At a scheduled status hearing, lawyers for the CFTC and Kraft Foods Group and Mondolez Global told District Court Judge John Robert Blakey that they had reached a preliminary agreement to settle what has been a bitterly contested enforcement action initially brought in April 2015 under the Dodd-Frank Act’s expanded anti-manipulation authority. In August 2019, the parties entered into their ill-fated settlement which involved a "gag" provision and no findings by the commission. That settlement was set aside in the wake of post-settlement statements by the CFTC and two of its commissioners, the defendants’ motion for contempt and sanctions, and a subsequent appeal to the Seventh Circuit (CFTC v. Kraft Foods Group, Inc. February 13, 2020, Blakey, J.).

Another attempt to settle this contentious litigation. CFTC Division of Enforcement Attorney Doug Snodgrass and J. Kevin McCall, on behalf of the defendants, advised the court of the following in connection with their preliminary settlement agreement:
  • The CFTC will provide the defendants with advance notice of the text of any press release announcing the settlement.
  • The parties will not be limited to issuing comments about the settlement.
  • The defendants will withdraw their motion for contempt, sanctions, and other relief.
  • The terms of any settlement agreement will be subject to the approval of the full CFTC. DOE attorneys noted that approval process could take up to 60 days.
Judge Blakey weighs in. While welcoming the news of the proposed settlement, Judge Blakey observed that the court itself might have an interest in the outstanding issue concerning the CFTC’s contempt in connection with the agency’s conduct regarding the court’s August 14, 2019 order. Additionally, at the request of the parties, the judge agreed to stay matters related to discovery and dipositive motions so that parties do not have to expend additional resources. Judge Blakey also invited the parties to submit their proposed agreement to him for his review as it is contemplated that the court will have injunctive authority with regard the enforcement of subsequent agreement.

The August 2019 settlement revisited. While the parties did not disclose material terms of the new proposed settlement, it’s worth noting that the failed August 2019 settlement provided for the defendants to pay $16 million to resolve claims that they manipulated wheat futures markets. Notably, Kraft, Mondelez, and the CFTC agreed to a "gag" provision in the consent order that limited its ability to speak publicly about the case. Moreover, the consent order did not contain any factual findings or conclusions of law. Commissioners Rostin Behnam and Dan Berkovitz described these two provisions as "unusual" in their joint statement.

The next status hearing in this matter is set for March 26, 2020 at 9:45 a.m.

The case is No. 15-cv-2881.

Editor’s Note: Brad Rosen, the author of this story, will be moderating a panel discussion at the Chicago Bar Association titled CFTC v. Kraft: Administrative Enforcement and the Public’s Right to Know. The event is scheduled at a joint meeting of the CBA’s Futures & Derivatives and Media & Entertainment Law Committees on February 27, 2020 at noon.

Thursday, 13 February 2020

ESMA lays out strategy on ESG factors

By Lene Powell, J.D.

The European Securities and Markets Authority (ESMA), the EU’s securities markets regulator, has published a new strategy describing how ESMA will place sustainability at the core of its activities by embedding Environmental, Social, and Governance (ESG) factors in its work. The Strategy on Sustainable Finance focuses on transparency obligations, risk analysis of green bonds, ESG investing, convergence of national supervisory practices on ESG factors, taxonomy, and supervision.

"The financial markets are at a point of change with investor preferences shifting towards green and socially responsible products, and with sustainability factors increasingly affecting the risks, returns and value of investments," said ESMA Chair Stephen Maijoor. "ESMA, with its overview of the entire investment chain, is in a unique position to support the growth of sustainable finance while contributing to investor protection, orderly and stable financial markets."

Underpinnings. In March 2018, the European Commission unveiled its Action Plan on Financing Sustainable Growth as a step in implementing the Paris Agreement on climate change and the EU's agenda for sustainable development. The Action Plan has three main objectives:
  • Reorient capital flows towards sustainable investment, in order to achieve sustainable and inclusive growth.
  • Manage financial risks stemming from climate change, environmental degradation and social issues.
  • Foster transparency and long-termism in financial and economic activity.
To further the Action Plan and respond to the increasing importance of ESG factors in the financial markets, ESMA drafted a strategy to take ESG factors into account across the range of its activities and monitor and assess ESG-related market developments and risks.

Growing sustainable finance. ESMA outlined six key priorities:
  • Completing the regulatory framework on transparency obligations via the Disclosures Regulation. ESMA will work with the EBA and EIOPA to produce joint technical standards.
  • Reporting on trends, risks, and vulnerabilities (TRV) of sustainable finance by including a dedicated chapter in its TRV Report, including indicators related to green bonds, ESG investing, and emission allowance trading.
  • Using the data at its disposal to analyze financial risks from climate change, including potentially climate-related stress testing in different market segments.
  • Pursuing convergence of national supervisory practices on ESG factors with a focus on mitigating the risk of greenwashing, preventing mis-selling practices, and fostering transparency and reliability in the reporting of non-financial information.
  • Participating in the EU Platform on Sustainable Finance that will develop and maintain the EU taxonomy and monitor capital flows to sustainable finance.
  • Ensuring ESG guidelines are adhered to in the entities that ESMA supervises directly, while being ready to accept any new supervisory mandates related to sustainable finance.
Next steps. The strategy document includes a timeline for achieving key priority goals. Overseeing the work is the Coordination Network on Sustainability, composed of experts from national competent authorities and ESMA staff. The network will be supported by a consultative working group of stakeholders that will be established in the coming months.

Wednesday, 12 February 2020

Hearing examines ‘astroturfing’ of agency comment letter process

By Amanda Maine, J.D.

The Subcommittee on Oversight and Investigations of the House Financial Services Committee heard from witnesses on alleged "astroturfing" of the Administrative Procedure Act (APA) process for submitting comment letters on agency rulemaking. Astroturfing, according to the subcommittee, can involve special interest groups using invented or stolen identities to submit comments about proposed rules under the guise of a spontaneous grassroots movement. In particular, the subcommittee hearing memorandum cited reports of astroturfing relating to proposals by the SEC and the CFPB, as well as a proposed bank merger under the Office of the Comptroller of the Currency (OCC).

"Fake letters" from Main Street investors. In December, SEC Chairman Jay Clayton came under fire from Sen. Chris Van Hollen (D-Md), who said that the chairman had been "duped" into issuing a statement citing letters from purported Main Street investors in support of reforming the proxy process. A Bloomberg article cited by Sen. Van Hollen found that the letters referenced by Chairman Clayton were not actually authored by the people that signed them or were authored by relatives of the chairman of a corporate interest group.

Subcommittee Chairman Al Green (D-Tex), cited Clayton’s statement and the subsequent controversy over the "fake letters" as a reason for holding the hearing, noting that public trust in the rulemaking process must be restored. Ranking Member Andy Barr (R-Ky), scoffed that the hearing was a "thinly veiled attempt to slow the regulatory process" because the majority party does not like "the regulators who are writing the rules."

Mass comments and false comments. Professor Beth Simone Noveck of New York University testified that the notice and comment period on proposed federal regulations is sometimes referred to as the "notice and spam" period due to the volume of duplicate comment letters agencies receive. For example, the FCC’s 2017 net neutrality proposal had 22 million comments, she said. She recommended that the agencies use readily available tools to address voluminous, duplicative, and fake comments. These include machine learning to summarize voluminous comments, "de-duplication" software to remove identical comments, and filtering software to sift out "the real and the relevant."

Paulina Gonzalez-Brito, executive director of the California Reinvestment Coalition (CRC), said that her organization uncovered facts during the merger of OneWest Bank and CIT in 2014 and 2015 that confirmed that the public comment process had been compromised and that fabricated comment letters were submitted in support of the bank merger. She noted that Joseph Otting, then CEO of OneWest Bank and currently the Comptroller of the Currency, urged his Wall Street contacts and business partners to submit comment letters in favor of the merger. Upon investigation, the CRC found that nearly all letters in support of the merger were sent from Yahoo email accounts with questionable addresses such as "" Other letters used fake names or real names without the individual’s permission. According to Gonzalez-Brito, OneWest benefited from the "fake support" because the letters were cited in the approval of the merger.

Professor Steven Balla of George Washington University cited the EPA as an example of how agencies can handle mass comment campaigns. According to Balla, about 75 percent of EPA comment letters come from environmental advocacy groups, labor groups, and progressive policy groups, with the rest coming from groups representing areas such as the agriculture industry and the energy sector. The EPA has dealt with mass comment letter campaigns by identifying and posting the campaigns to and informing the public about the organization that sponsored the campaign and the number of comments contained in the campaign. Instead of placing restrictions on mass comment letter campaigns, agencies should follow the EPA’s lead to separate mass comment letters from individual substantive letters, Balla recommended. Congress should focus its attention on the dangers presented by fake letters instead, he added.

Further action needed? Ranking Member Barr agreed that the problem is false comments and not mass comments. He asked Seto Bagdoyan of the GAO whether he thought that the APA should be amended to standardize the process. Bagdoyan noted that the APA does allow discretion to the agencies on how they collect and post comment letters. A 2019 GAO study recommended that certain agencies should clearly disclose how they post public comments and associated identity information, including the SEC and the CFPB. According to Bagdoyan, the SEC has implemented its recommendations by issuing a memorandum that reflects SEC’s internal policies for posting duplicate comments and associated identity information. The SEC has also communicated these policies to public users on the website by adding a disclaimer on the main comment posting page that describes how the agency posts comments.

Representative Katie Porter (D-Calif), asked Bartlett Naylor of Public Citizen about a letter his group wrote to the SEC’s inspector general about Chairman Clayton highlighting letters by "Main Street investors" who were in favor of restricting shareholder rights. Naylor called it a "Frank Capra moment" where Clayton referenced retired veterans and teachers with "ceremony and reverence." According to Naylor, Clayton had represented that he did a random sample across hundreds of comments and just happened to select the letters that were against shareholder rights.

Porter asked if it would be possible to pursue the lobbyists behind the fake comment letters. Naylor said it should be explored, as it involved corporate lobbyists using actual people as "stooges and pawns." In his written testimony, Naylor remarked that for the most egregious cases of comment fabrication, current law already provides penalties for fraud. It is a federal crime to "knowingly and willfully" make "any materially false, fictitious, or fraudulent statement or representation" to the federal government, punishable by a fine or up to five years in prison, or both. Naylor called on Congress to question why law enforcement has not penalized those who knowingly made such representations to the government in the form of these false comment letters. The committee should also commission a study on the utility of publicly listing of those who file fake comments, especially those who organize the effort, Naylor recommended.

Tuesday, 11 February 2020

Minority stockholder may yet have wielded control

By Anne Sherry, J.D.

With over a third of the voting power in NCI Building Systems, along with a proportionate number of insiders on the board and contractual veto rights, private equity firm Clayton, Dubilier & Rice may have controlled the company sufficient to cast doubt on its 2018 acquisition of Ply Gem. The Delaware Court of Chancery denied motions to dismiss a challenge to the merger, except as to four individuals who were effectively exculpated (Voigt v. Metcalf, February 10, 2020, Laster, J.).

In 2018 CD&R completed a leveraged buyout of Ply Gem Holdings, Inc., and combined it with another company, becoming a 70 percent owner of the resulting entity. Three months later, NCI acquired that new Ply Gem entity. An NCI stockholder challenged the merger on the basis that CD&R controlled both sides of the acquisition, requiring the defendants to establish that the transaction was entirely fair. The plaintiff alleged that CD&R had valued the Ply Gem entity at $638 million during the first transaction but insisted on a $1.2 billion valuation in the second.

Largely denying the defendants’ motions to dismiss, the court spent the bulk of its decision determining that there were multiple factors creating a reasonable inference of CD&R’s control over NCI. First, CD&R had the right to nominate four directors out of twelve, and it filled those seats with individuals it controlled. The private equity firm also had relationships with four other directors that contributed to a reasonable inference of actual control over the company.

Another factor contributing to control was the fact that CD&R held 34.8 percent of the voting power in NCI. Although this falls short of a majority, the court noted that stockholders who oppose a significant minority shareholder must vote at supermajority rates. Assuming 80 percent voter turnout, a 35-percent blockholder will win unless 90 percent of unaffiliated shares vote in opposition. The court also viewed CD&R’s voting power in the context of a stockholders agreement that allowed it to block actions the board could otherwise take unilaterally. While the stockholders agreement also contained measures that limited CD&R’s ability to retaliate against directors, CD&R did not give up its ability to vote its shares other than reelection or compensation or its contractual rights. Still other indicia of control included CD&R’s actual influence at the board level and its relationship with management and the company’s advisors.

Having inferred control at the pleadings stage, the court determined not to dismiss the breach of fiduciary duty claim against CD&R in its capacity of controller. Control implicated the entire fairness standard of review, requiring the defendants to demonstrate a fair price and a fair process. The valuation gap between the two transactions involving Ply Gem, occurring just three months apart, supported an inference of unfair price at the pleading stage. The complaint also called into question the fairness of the sale process, particularly undisclosed conflicts and inadequate disclosures in the proxy statement.

Furthermore, although four directors were effectively shielded by an exculpatory clause, the court declined to dismiss the breach-of-duty claims against several other directors with ties to CD&R. It would also be premature to rule on the four CD&R directors’ defense that they could not be liable because they recused themselves and abstained from voting. They did not withdraw from the process entirely, and given that they were dual fiduciaries to both the company and its stockholders, it was unlikely that they could have participated in the process while also obtaining dismissal under an abstention theory. The matter of their compliance with their fiduciary duties would require fact-specific analysis.

The case is No. 2018-0828-JTL.

Monday, 10 February 2020

High court receives another petition asking about disgorgement post-Kokesh

By Rodney F. Tonkovic, J.D.

A petition for certiorari involves a question already pending before the Court: whether the SEC may seek disgorgement in the courts as an equitable remedy. After Kokesh, the petition argues, lower courts are no longer free to rely on precedent to approve SEC requests for disgorgement. The petitioners recognize that the Court has granted a petition in Liu v. SEC asking the same question, and request that their petition be held pending the decision in Liu (Team Resources Inc. v. SEC, February 3, 2020).

Disgorgement ordered. In 2015, the SEC brought an enforcement action against Team Resources, Inc., alleging that the company raised millions from investors in oil and gas limited partnerships while knowing all along that the leases were not commercially viable. The defendants settled immediately, agreeing to the entry of permanent injunctions. In early 2017, the Commission moved for final judgment, asking for the disgorgement reflecting the defendants' alleged gross pecuniary gain.

While the SEC's motion was pending, the Supreme Court handed down its decision in Kokesh v. SEC, holding that disgorgement is a "penalty" subject to the five-year limitations period. The Commission amended its motion to reflect the five-year limit, and Team Resources pivoted to the argument that post-Kokesh, district courts no longer have authority to order disgorgement in SEC proceedings. The district court granted the requested disgorgement.

The Fifth Circuit affirmed, stating that since Kokesh expressly declined to address the issue of whether disgorgement is an equitable remedy that courts may impose, Fifth Circuit precedent upholding the authority of the district courts to order disgorgement controls. The court explained that Kokesh only decided the Section 2462 issue and did not decide that disgorgement can never be classified as equitable in any context. Absent an intervening change in the law, which Kokesh is not, in this context, the panel concluded that it was bound to follow a line of Fifth Circuit precedent extending back at least 40 years.

Is disgorgement available? The petition notes that the court has granted the Liu petition, which addresses the same issue, and makes many of the same arguments, as in this case: whether the SEC may obtain disgorgement from a federal court as an equitable remedy for securities violations despite the Supreme Court's determination that disgorgement is a penalty. The petitioners ask the Court to hold the petition pending the decision in Liu, which is set for argument on March 3, 2020, and to dispose of the case in a manner consistent with Liu.

Having granted Liu, the petition says that the Court has at least implicitly acknowledged the conflict between Kokesh and the lower courts application of disgorgement as a remedy in equity. Disgorgement, the petition's argument begins, is not among the forms of relief identified by Congress as available to the SEC in civil cases. And, since disgorgement as applied in the enforcement context was created by judicial fiat and functions as a punishment, it does not fit within the three enumerated categories of available remedies (injunctions, equitable relief, and civil penalties). After Kokesh, the petition says, "SEC disgorgement can hardly be regarded as anything other than a 'penalty' assessment."

Next, the petitioners assert that the courts have failed to apply Kokesh consistently and still treat disgorgement as an equitable remedy. The petition notes that the Fifth Circuit's decision here was issued after Liu was granted, a circumstance highlighting the need for further guidance. Lower courts have continued to adhere to pre-Kokesh precedent in affirming SEC disgorgement orders, frequently noting the statute of limitations context of that case, which ignores how disgorgement operates in practice, the petition says. In addition, the petition observes that the SEC, and other agencies, continue to collect billions in "unauthorized" disgorgement. In this case, the petition points out, the disgorgement order effectively doubled the defendants' liability from $15million to $30 million.

Finally, clarifying Kokesh's holding will have an impact beyond disgorgement and beyond the SEC. The petition argues that then-Judge Kavanaugh's concurrence in Saad v. SEC indicated that the reasoning behind Kokesh may apply to other types of equitable relief. For example, the Third Circuit has considered the application of Kokesh to SEC injunctions, and the Ninth has looked at remedies under the FTCA. The petitioners agree here with Liu's statement that with almost 100 statutes empowering the courts to fashion equitable relief, defining the scope of that authority is critical.

The petition is No. 19-978.

Thursday, 6 February 2020

CII voices concerns about SEC data on factual error frequency in proxy recommendations

By Mark S. Nelson, J.D.

The sheer number of public comments submitted to the SEC on its twin proxy proposals necessitates a closer look at a few of the more targeted comments. For example, the Council of Institutional Investors (CII) submitted a supplemental comment letter questioning whether SEC data said to justify giving companies more leeway to object to proxy advisors’ recommendations demonstrated the true scope of the problem. The CII focused on Table 2 in the proxy adviser proposal, which depicts research conducted by the SEC showing companies noting in their DEFA14A’s on EDGAR when they found factual and other types of errors in proxy advisor recommendations.

Table 2 in the proposal shows three years of data on 260 total filings along with the number of references in those filings to factual errors, analytical errors, general policy disputes, amended or modified proposals, and issues falling into a catch-all category titled "Other." Most categories show a downward trend over the three years the SEC surveyed, except for general policy disputes, which remained about the same over the surveyed period. Factual errors, for example, totaled 54 within this time frame; the SEC’s proposal suggested that factual errors for 2016, 2017, and 2018 numbered 24, 13, and 17, respectively (See 84 F.R. 66518, 66546 (December 4, 2019).

The CII said it still had questions about the SEC’s data even after the SEC’s Division of Economic and Risk Analysis (DERA) published a memorandum explaining its methodology in the weeks before the public comment deadline elapsed. For example, CII noted that DERA conceded that its classification of an error as factual or as another type of error was inherently subjective. CII itself, however, approached certain categories differently than did the SEC; for example, CII generally did not count an item as "Other" if it also fell into another category, and the CII added a category to capture "Additional disclosure."

The CII focused on 2018 and obtained results that were broadly consistent with the SEC’s results for that year, except that the CII found fewer instances of factual and analytical errors than did the SEC. The CII also concluded that most claimed errors concerned general policy disputes or the errors were related to companies’ decisions to modify proposals or to provide additional or clarified information (See, "Table: Summary of Analysis on Table 2 Data for 2018" on page 9 of the CII’s supplemental comment letter). The CII had submitted numerous other comments on the SEC’s proxy proposals, including a lengthy comment on January 30, 2020, that also noted potential issues with the SEC’s data in Table 2 regarding factual errors (See the main text of the comment letter on page 2 and the further explanation contained in footnote 4).

Wednesday, 5 February 2020

Main Street, gadflies, and corporate democracy: a first look at comments on the SEC’s proxy proposal

By Mark S. Nelson, J.D.

The deadline for submitting public comments on the SEC’s recently issued twin proxy system proposals expired February 3, 2020. Thus far, the many comments received on the proposals have overwhelmingly come from individuals, academics, and religious and eleemosynary groups. The largest number of comments, however, appear to be submitted in two form letters. Comments from securities industry groups are noticeably absent, at least in name, from the proposal on shareholder proposals, while some industry groups did weigh in on the proxy advisers proposal.

The proxy proposals in brief. The SEC in November 2019 proposed to reform the proxy system by raising the thresholds for submitting shareholder proposals and to regulate aspects of the proxy advisory business (Amendments to Exemptions From the Proxy Rules for Proxy Voting Advice, Release No. 34–87457, November 5, 2019; Procedural Requirements and Resubmission Thresholds Under Exchange Act Rule 14a–8, Release No. 34–87458, November 5, 2019).

The SEC’s twin proxy proposals take aim at two related issues. First, one of the proposals would increase the eligibility requirements for making shareholder proposals by instituting a tiered threshold such that larger investors could make proposals sooner than smaller investors, who would not have to hold as much stock but who would have to abide by a longer holding period. That proposal also would increase the resubmission thresholds that govern the amount of support required and the time frame for keeping a shareholder proposal alive. The proposed resubmission thresholds are close to the thresholds proposed in the defunct Republican-led Financial CHOICE Act (Section 844) in the 115th Congress and in a defunct SEC proposal from the 1990s (related concurrence).

A second proxy proposal would bring proxy advisory firms more firmly within the SEC’s grasp. Currently, only a few proxy advisers register with the Commission and they typically do so as pension consultants under the Adviser Act’s rules. The proposal would, among other things, subject proxy advisers to requirements on conflicts of interest and transparency that would allow companies reviewed by these firms to raise objections to proxy recommendations. The SEC already had partially co-opted prior Congressional proposals to regulate proxy advisers by withdrawing two no-action letters dealing with the use of proxy advisory recommendations. Commenters on this second SEC proposal can judge whether it aligns more nearly with the highly restrictive House bill or the more modest Senate bill (See H.R. 4015—reintroduced in the 116th Congress as H.R. 5116—and S. 3614). The main point here is that, as of the last Congress, there was bipartisan agreement on at least the need for proxy adviser regulation, but not necessarily on the scope of such regulation.

Many companies believe that the proxy system is badly broken and that proxy advisers, in particular, exert disproportionate influence over proxy voting. SEC Commissioner Elad Roisman, the SEC’s point person for proxy system reforms, recently gave a speech in which he sought to counter "myths" about the SEC’s proxy proposals. Specifically, he said the proposals are not the product of corporate lobbying and they do not enshrine a supposed SEC goal of marginalizing smaller shareholders.

As an example, Roisman explained the proposal to increase the eligibility thresholds for making shareholder proposals thus: "for those who hold $2,000 worth of shares in a company, our proposal would not raise the monetary threshold at all. Instead, it would require that such an investor hold this amount of stock for longer than is currently required—three years, instead of one year—before submitting a proposal" (emphasis in original).

A preliminary comment by Scott Stringer, New York City Comptroller, had attempted to preempt arguments like those made later by Commissioner Roisman, by asserting instead that the SEC’s proxy proposals were driven by corporate interests that seek to "radically tilt" the proxy system in favor of corporate managers.

Targeting the gadflies? James McRitchie, publisher of Corporate Governance ( and a frequent submitter of shareholder proposals, seems to think so. McRitchie’s was one of the first to comment on the proposals and his somewhat later comment submitted January 27, 2020 opens by reciting SEC Chairman Jay Clayton’s statement at the open meeting where the proxy proposals were approved in which Clayton suggested that the proposals could aid Main Street Investors by curbing the influence of a small number of corporate shareholders who account for a large percentage of shareholder proposals.

According to Clayton: "it is clear to me that a system in which five individuals accounted for 78 percent of all the proposals submitted by individual shareholders would benefit from greater alignment of interest between the proposing shareholders and the other shareholders—who hold more than 99 percent of the shares."

In reply, McRitchie said the shareholder proposals that he (and others) have submitted to companies often generate wide support. "It is time to set the record straight that my proposals, like the proposals of Chevedden and Steiner, are often widely supported," said McRitchie. "The argument from those who want to reduce democratic corporate governance seems to be that low thresholds for submitting and resubmitting shareholder proposals allow a few shareholders to impose their personal policy priorities on companies, with costs borne by all shareholders, most of whom do not support those proposals."

McRitchie also suggested that Clayton offered no evidence that a small number of active shareholders distort the shareholder proposal process (he asked rhetorically if baseball players and fans would complain if only a few players accounted more most home runs).

McRitchie also claims that his shareholder proposals in the current proxy season have received 52.3 percent support. McRitchie, however, acknowledges that some proposals on newer issues (e.g., share buy backs and cybersecurity) received little support (McRitchie also suggested that new proposals take time to catch on because funds may not yet have a relevant voting policy). But McRitchie said many older proposals received much greater support (e.g., annual director elections, majority vote for directors, proxy access, eliminating supermajority voting, special meetings, and political spending).

More recently, McRitchie posted a supplemental comment on his website (the comment does not yet appear on that provides a more detailed analysis of the specifics of the proxy proposals. For example, McRitchie notes that the SEC could make an inflation adjustment to the shareholder proposal eligibility requirement that would raise the monetary threshold from $2,000 to $2,500.

For comparison, Neuberger Berman also voiced opposition to both proxy proposals. The firm said the costs to companies under the current proxy system are not that great when viewed in light of the benefits derived from shareholder proposals. "We strongly believe minority shareholders deserve a voice, and that it is not only appropriate but advisable that companies balance perspectives from across their shareholder base," said the firm.

Academics and lawmakers. Senator Tammy Duckworth (D-Ill) submitted a comment critical of both the proxy adviser and shareholder threshold proposals. With respect to proxy advisers, Sen. Duckworth said the requirement that proxy advisory firms be subjected to comments from the companies they review could undermine the independence of proxy advisory recommendations.

Senator Duckworth also cited data from outgoing SEC Commissioner Robert Jackson suggesting that proposals on shareholder director nominations and limits on executive stock sales would have failed the third and higher resubmission threshold described in one of the SEC’s proposals, something she said would create a proxy system based on short-term interests that would potentially deny worthy shareholder ideas of the time needed to gain support.

John C. Coates, the John F. Cogan Professor of Law and Economics at Harvard Law School, and Barbara Roper, director of investor protection at Consumer Federation of America, commented that the SEC should "revis[e] and re-propos[e] a more reasoned and defensible set of changes to improve the proxy system for all investors." Both Coates and Roper are also members of the SEC’s Investor Advisory Committee, whose Investor-as-Owner Subcommittee recently recommended that the SEC reconsider the twin proposals on proxy advisers and shareholder proposals.

According to Coates and Roper, the SEC’s emphasis on proxy advisers is misplaced because the small number of large fund complexes present an equal or bigger problem. Coates and Roper said that Investment Company Act rules applicable to large fund complexes are insufficient because they do not squarely address how these funds operate at the "complex" level. As compared to proxy advisers, Coates and Roper stated: "But the SEC’s focus is not justifiable from a policy or cost-benefit perspective, and is also politically risky for the agency, as it will leave the SEC embarrassingly behind the curve when the influence of large fund complexes becomes too politically and financially obvious to ignore."

Other writers on the subject have likewise noted the influence of the big four fund complexes. For example, retired Delaware Chief Justice Leo Strine recently wrote that the biggest fund complexes exercise outsized influence over corporate elections and shareholder proposals.

However, Paul Mahoney, David and Mary Harrison Distinguished Professor of Law University of Virginia School of Law, and J.W. Verret, associate law professor at the Antonin Scalia Law School, George Mason University and a senior scholar at the Mercatus Center, wrote in support of the SEC’s proposals. Both Mahoney and Verret are also members of the SEC's Investor Advisory Committee and they submitted a comment explaining their dissent from the IAC’s recommendation that the SEC reconsider its proxy proposals. They emphasized the outsized influence of the two dominant proxy advisers.

Similarly, Tom Quaadman, executive vice president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, commented that proxy advisers present conflicts of interest, lack transparency, and are prone to errors. "Such disruptive behavior of an unregulated capital markets participant should not continue, and lack of regulatory action has allowed these issues to persist over time. The proxy advisory industry should not be permitted special exemptions to laws generally applicable to other business enterprises," said Quaadman.

Provenance of proxy comments. The SEC’s website noted that two form letters received by the agency account for many of the comments opposing the proposed changes to the eligibility requirements and resubmission thresholds for shareholder proposals. The SEC posted a note on the public comments webpage for the proposal indicating that the agency had been contacted by some of the owners of email addresses that sent one of the form letter types indicating that those persons had not submitted the comment letters. These letters total more than 13,000 in number and potentially present issues similar to those that arose when SEC Chairman Jay Clayton cited letters he said came from ordinary investors supporting the proposed changes. Subsequent investigations by news organizations found that those letters may have been submitted by dark money interest groups and that the letters’ signatories often did not authorize the letters.

Tuesday, 4 February 2020

No refund for Panera after paying dissenters more than fair value

By Anne Sherry, J.D.

The Delaware Court of Chancery appraised Panera Bread Company below the price at which it sold itself to JAB Holdings B.V. in 2017. The deal price of $315 per share was the best indicator of fair value in this case, minus cost and tax synergies of $11.56 per share. However, to reduce its potential interest liability pending the appraisal case, Panera had prepaid the full deal price to dissenting shareholders, but it did not negotiate for a clawback in case the company appraised below the deal price. The vice chancellor declined to read a refund requirement into the appraisal statute (In re Appraisal of Panera Bread Company, January 31, 2020, Zurn, M.).

Prior to striking a deal with JAB, Panera also had discussions with Starbucks, but those negotiations were unfruitful. JAB initially offered $286 per share, a 21.7 percent premium over Panera’s then-stock price. After Panera received JAB’s second offer of $296.50 per share, and while JAB was conducting due diligence, Morgan Stanley, Panera’s financial advisor, presented seven different valuation metrics to the board and identified other potential purchasers. The board agreed with CEO Ronald Shaich that none of these companies, nor anyone else, was likely to be interested. News of a possible sale leaked to the press, and Panera’s stock price jumped to $282. JAB made a final offer of $315 per share with a 3 percent termination fee. The board approved the merger, as did 97 percent of the shareholder votes cast at a special meeting, representing 80 percent of the outstanding shares. The merger closed in July 2017 with no other potential bidders having come forward.

Thirty dissenting stockholders, representing over 1.8 million shares, filed appraisal petitions in August and September 2017. Between December 2017 and May 2018, Panera prepaid 29 of these stockholders the full $315 per share of merger consideration plus statutory interest through the date of payment. Several of the petitioners withdrew their demands and dropped out of the consolidated appraisal action; the rest contended that the fair value of their shares was $361 per share. This analysis gave no weight to the deal price, instead basing their figure on analyses by their expert: 60 percent weight to his discounted cash flow analysis, 30 percent weight to his comparable companies analysis, and 10 percent to his precedent transaction analysis.

The court, however, looked at “indicia of fairness” of a transaction that suggest that the deal price is persuasive—but not presumptive—evidence of fair value following the Delaware Supreme Court’s appraisal decisions in Dell, DFC, and Aruba Networks. Here, it was more or less undisputed that Panera’s stock traded in an efficient market. The parties negotiated at arm’s length, and the board was independent and unburdened by conflicts of interest. JAB assessed Panera’s value using public information and due diligence into confidential information. After reviewing the specific nonpublic information that Shaich thought would lead to a greater value, JAB internally raised its offer and ultimately struck a deal price well above what it had said was its ceiling. The court also considered the fact that no other potential bidders emerged after the negotiations leaked to the press or after the parties announced the merger, even though the deal protections were not preclusive.

The court also dismissed the argument that weaknesses in the sale process undermined the deal price’s reliability as an indicator of fair value. While Shaich led the negotiations, the board negotiated the terms of the merger and unanimously approved the final merger agreement. It worked with Morgan Stanley to value the company and focused on getting JAB to raise its offer ceiling. JAB’s focus on confidentiality and speed benefited Panera, and the board negotiated for less restrictive deal protections, successfully bargaining down to a 3 percent termination fee from JAB’s offer of 4 percent. There was also no evidence that Shaich was conflicted due to his desire to retire; on the contrary, the court saw him as motivated to place the company he had founded in the hands of the right buyer at the best price.

Not only did the appraisal petitioners fail to secure an upwards price revision, but Panera proved $11.56 per share in synergies (based on combined cost and tax synergies at $37.29 per share, 31 percent of which was built into the deal price). Nevertheless, the petitioners received the full deal price as a prepayment by Panera, and the court denied the company’s request for a refund of the difference. The parties did not negotiate a clawback, the statute does not explicitly contemplate a refund, and it was logical that the General Assembly intended to omit a refund mechanism when it enacted the prepayment scheme in the shadow of the Model Business Corporation Act. Although the court did not break down the amount that Panera overpaid the dissenting stockholders, it should approximate $20 million, plus interest, based on the number of shares at stake and the difference between the deal price and fair value.

The case is No. 2017-0593-MTZ.

Monday, 3 February 2020

CFTC proposed rule on position limits approved on a 3-2 vote along party lines

By Brad Rosen, J.D.

At its recent open meeting, the CFTC approved a proposed rule on speculative position limits to conform with the Dodd-Frank amendments of the Commodity Exchange Act (CEA), as well as a proposed rule amending certain swap execution facility (SEF) and real-time reporting requirements. The long awaited and controversial proposed position limit rule passed on 3-2 vote along party lines. This proposal represents the fourth attempt over the past 10 years that the Commission has addressed this thorny issue. Meanwhile, the noncontroversial proposed rule for SEFs and related reporting requirements passed unanimously.

The battle over position limits continues. Speculative position limits have long been the source of political fights and court battles. This time around is no different. Chairman Heath Tarbert, together with Republican Commissioners Brian Quintenz and Dawn Stump are strong proponents for the proposal, while Democratic Commissioners Dan Berkovitz and Rostin Behnam have dissented and stand in opposition to its adoption.

According to Chairman Tarbert, the proposal will help ensure that futures markets in agricultural, energy, and metals commodities work for American households and businesses. He claimed that the proposal will protect Americans from some of the most nefarious machinations in our derivatives markets by capping speculative positions in the covered derivatives, which will thereby help prevent cornering and squeezing.

Meanwhile in his dissent, Commissioner Berkovitz asserted that the proposal would create an uncertain and unwieldy process "with the Commission demoted from head coach over the hedge exemption process to Monday-morning quarterback for exchange determinations." He also noted the proposal would abruptly increase position limits in many physical delivery agricultural, metals, and energy commodities, in some instances to multiples of their current levels.

Summary of the proposed position limit rule. Some of the main features of the proposed rule include the following:
  • The 2020 proposal applies federal position limits to a universe of 25 physically-settled futures contracts and their linked cash-settled futures, options on futures, and "economically equivalent" swaps. Nine of these contracts are currently subject to federal position limits. The other 16 contracts would be newly subject to federal position limits and include seven additional agricultural contracts, four energy contracts, and five metals contracts.
  • The 2020 proposal applies federal position limits on certain swaps. Specifically, swaps that meet the definition of an "economically equivalent swap" would be subject to federal limits as a referenced contract.
  • Federal spot month limits would apply to referenced contracts on all 25 core referenced futures contracts. The proposed spot month limit levels are set at or below 25 percent of deliverable supply, as estimated using recent data provided by the DCM listing the core referenced futures contract, and verified by the CFTC.
  • The 2020 proposal would generally include exemptions for (1) bona fide hedging transactions and positions; (2) spread positions; (3) certain financial distress positions; (4) certain natural gas positions held during the spot month; and (5) pre-enactment and transition period swaps, also as those terms are defined in the proposal.
The proposal also includes an expanded list of enumerated bona fide hedges to cover additional hedging practices. In addition, the proposal establishes a new process that would streamline requests for bona fide hedge exemptions for both exchange-set and federal position limit requirements.

A 90-day comment period for the proposed rule will end on April 29, 2020. Ordinarily, the comment period commences once a rule is published in the Federal Register. In this case, the open meeting itself apparently triggered the comment period commencement.

Summary of the proposed rule on SEF and real-time reporting requirements. The Commission also unanimously approved a proposed rule to amend certain rules in Parts 36, 37, and 43 of CFTC regulations relating to the execution of package transactions on SEFs; the execution of block trades on SEFs; and the resolution of error trades on SEFs. These matters are currently the subject of relief in certain no-action letters from Commission staff. As a result of the proposed rule, these no-action letters will in effect be codified.

In support of the proposed rule, Chairman Tarbert stated, "I expect the proposal, if finalized, will provide certainty and clarity to SEFs and their participants. CFTC staff has provided important relief over the last six years. There is great value in memorializing their no-action positions in a Commission rule." Commissioners Behnam, Berkovitz, and Quintenz also issued statements in support of the proposed rule.

This proposed rule has a 60-day comment period following publication in the Federal Register.