In connection with the February 28 effective date of the
Securities and Exchange Commission's new executive compensation
disclosure rules, on March 1, the SEC's Division of Corporation
Finance updated related Compliance and Disclosure Interpretations
(C&DIs). The SEC's revised guidance on executive compensation
disclosures included the following revisions to previous
C&DIs: The SEC also added a C&DI addressing the year of reporting
in the SCT and Awards Table for an equity plan award over a
multi-year performance period where the compensation committee
retains negative discretion to reduce the award until the end of
the performance period. While Financial Accounting Standards Board
Accounting Standards Codification Topic 718 provides that negative
discretion may cause, in certain circumstances, the grant date of
the award to be deferred for financial statement reporting until
the date of the compensation committee's final decision, the
staff believes that the grant should be reported in the SCT and the
Awards Table in the year in which service begins in the multi-year
period because this better reflects the compensation
committee's decisions. The amount reported in both tables
should be the fair value of the award at the service inception
date, based upon the then-probable outcome of the performance
conditions. Click here
(sec.gov/divisions/corpfin/guidance/regs-kinterp.htm) to view the
C&DIs (Questions 119.16 and 119.24 and Interpretation 220.01)
under Regulation S-K. On February 26, the Delaware Chancery Court issued its
long-awaited opinion in the case of Selectica, Inc. v. Versata
Enterprises, Inc. The opinion is the culmination of a closely
watched legal battle between Selectica's directors, who sought
judicial validation of their use of a poison pill to protect
Selectica's tax assets, and defendants Versata Enterprises,
Inc. and Trilogy, Inc., who had deliberately triggered the pill and
sought to invalidate its provisions, reverse its effects and
recover damages. The court ultimately validated the poison pill,
upholding the Selectica directors' adoption and implementation
of a shareholder rights plan, and their subsequent decision to
dilute an acquiring person who deliberately crossed the pill's
triggering threshold to effect a takeover. In order to prevent a takeover by Trilogy, the Selectica
directors: (1) amended the company's poison pill to decrease
the beneficial ownership trigger from 15% to 4.99%; (2) implemented
an exchange feature in the poison pill that doubled the amount of
outstanding common stock held by each stockholder other than
Trilogy and Versata; and (3) "reloaded" the pill by
declaring a new dividend of purchase rights on similar terms that
would become exercisable after another triggering event.
Thereafter, Selectica sought a court order validating the
amendments to the pill, the exercise of the exchange feature and
the decision to "reload" the pill. Trilogy contended that
the same conduct was invalid and requested rescission, redemption
of the "reloaded" pill and money damages for breach of
fiduciary duty. The court applied the familiar two-pronged Unocal test
to determine the validity of the challenged conduct. Under the
first prong of the Unocal test, the "directors must
show that they had reasonable grounds for believing that a danger
to corporate policy and effectiveness existed." Under the
second prong, the board must demonstrate that "its defensive
response was reasonable in relation to the threat posed." A
defensive response will not survive Unocal scrutiny if it
is determined to be disproportionate, i.e., coercive or preclusive.
A measure is coercive if it is aimed at "cramming down"
on shareholders management's preferred course of action; a
measure is preclusive if it renders an alternative transaction
"mathematically impossible" or "realistically
unobtainable." Under the first prong of Unocal, the court found that
the board had reasonable grounds to conclude that Trilogy and
Versata presented a threat to a valid corporate
objective—the preservation of the company's net
operating loss carryforwards (NOLs). The court found that "a
board may properly conclude that the company's NOLs are worth
protecting where it does so reasonably and in reliance on expert
advice", notwithstanding the fact that there was no certainty,
or even a confirmed probability, that Selectica would ever be able
to realize the value of its NOLs. Central to the court's
analysis was the board's reliance on outside financial, tax and
legal advisors. Under the second prong of Unocal, the court found that
the amended 4.99% beneficial ownership trigger under the
shareholder rights plan was neither "preclusive" nor
"coercive," because the pill did not render a successful
proxy contest by Trilogy "a near impossibility or else utterly
moot." The court recognized that a pill triggered at 4.99% was
unusual (though not unprecedented), but determined that this low
threshold was permissible given the risk that additional share
purchases by Trilogy could lead to a "change in control"
under IRS regulations that would preclude any possibility of
Selectica ever realizing the value of its NOLs. Notably, the court
left open the possibility that a 4.99% trigger might be
inappropriate in other circumstances—"As a result of
its unique objective, a pill designed to protect NOLs necessitates
precluding a lesser accumulation of shares than might be
appropriate for a pill designed to prevent a hostile acquirer from
establishing a control position in the company." Finally, the court concluded that the use of the rights plan
fell within Unocal's "range of
reasonableness," finding the board's response reasonable
in response to the conduct of a "longtime competitor" who
"sought to employ the shareholder franchise intentionally to
impair corporate assets, or else to coerce the company into meeting
certain business demands under the threat of such impairment."
Significantly, the opinion indicates that the proportionality
analysis required by the second prong of the Unocal test
does not require a board's response to be perfect, or even
"narrowly tailored" to correspond to the identified
threat. Instead, the response need only be reasonable under the
circumstances. (Selectica, Inc. v. Versata Enters.,
Inc., C.A. No. 4241-VCN, 2010 WL 703062 (Del. Ch. Ct. February
26, 2010)) Plaintiff shareholders of NutraCea, a public corporation that
produces stabilized rice bran to sell as a nutritional supplement,
sued CEO Bradley Edson and CFO Todd Crow for violations of Section
10(b) of the Securities Exchange Act of 1934, and Securities and
Exchange Commission Rule 10b-5 promulgated thereunder, control
person liability under Section 20(a) of the Exchange Act, and
violations of the Arizona Securities Act. Both Mr. Edson and Mr.
Crow moved to dismiss the complaint; the court granted Mr.
Crow's motion as to the Rule 10b-5 claim, but denied the
motions in all other respects. Plaintiff shareholders alleged that defendants misled investors
concerning four corporate transactions by attesting to the
correctness of NutraCea's public financial statements, which
improperly recognized over $9.6 million in revenue from the
transactions. Plaintiffs claim that defendants knew, or were
deliberately reckless in not knowing, that NutraCea improperly
recognized revenue from four "sale" transactions that did
not satisfy the revenue recognition criteria under generally
accepted accounting principles. Under Section 10(b) and Rule 10b-5, plaintiffs must prove the
following elements: (1) a material misrepresentation or omission of
fact; (2) scienter; (3) a connection with the purchase or sale of a
security; (4) reliance; (5) economic loss; and (6) loss causation.
Defendants challenged these claims on the elements of scienter,
reliance and loss causation. The court reviewed the facts of the four transactions in
question and determined that the nature of the "sales"
were suspicious and helped support a scienter finding. One
transaction was actually a pure consignment sale, while another
involved a purchaser whose payment was financed by a consultant to,
and former officer of, the seller. The court found that the combination of Mr. Edson's
negotiation of one of the transactions at issue, his monitoring of
NutraCea's revenue recognition, and a personal profit motive
created a strong inference of scienter. The court was also
persuaded that plaintiffs had met their initial burden of alleging
an efficient market in which NutraCea's shares were traded,
providing the foundation for a presumption of reliance on the
efficiency of the market. Finally, plaintiffs' claim of a drop
in NutraCea's stock price after the company's announcement
that it had uncovered improper revenue recognition was sufficient
to suggest loss causation. Therefore, Mr. Edson's motion to
dismiss the claims under federal securities law was denied.
Similarly, plaintiff's claim for violation of Section 20(a) of
the Exchange Act survived Mr. Edson's motion to dismiss, as a
well pled Section 10(b) and Rule 10b-5 claim against a corporate
officer is sufficient to state a primary violation against the
corporate entity itself. Finally, the rationale for denying Mr.
Edson's motion to dismiss the federal securities law claims
applied with equal force to their state securities law
counterparts. With regard to Mr. Crow, the court granted his motion to dismiss
the Section 10(b) claim on the ground that plaintiffs failed to
allege, in contrast with their claim against Mr. Edson,
particularized facts raising a strong inference that Mr. Crow had
actual knowledge of the improper revenue recognition practices. The
court, however, denied Mr. Crow's motion to dismiss the Arizona
state law securities claim because, in the court's view, the
Arizona statute broadly authorized liability against any person who
potentially "induced" a securities purchase by
disseminating false information into the marketplace. (Burritt
v. NutraCea, No. CV-09-00406, 2010 WL 668806 (D. Ariz. Feb.
25, 2010)) A recent court ruling by U.S. Bankruptcy Judge Burton Lifland
clarifies the process for determining how much money investors may
be entitled to receive in connection with the Securities Investor
Protection Corporation (SIPC) proceeding involving the Madoff Ponzi
scheme. The new ruling specifically related to whether investors
could receive amounts equaling the totals appearing on their last
account statements. The judge sided with the SIPC-appointed
trustee, Irving Picard, who argued that investors could claim only
the amount they first invested with Madoff (minus any
withdrawals). Read
more (www.nysb.uscourts.gov/). The Financial Industry Regulatory Authority issued its 2010
annual examination priorities letter to highlight new and existing
areas of significance to FINRA's regulatory program for the
year. After describing a few key organizational developments,
including the newly constituted Office of Fraud Detection and
Market Intelligence and the new eFOCUS filing platform, the letter
begins with a number of "Regulatory and Business
Considerations" for firms, including, among others: direct
market access/sponsored access, member private offerings, new FINRA
financial and operational rules and liquidity issues. With respect
to 2010 examinations, FINRA listed a vast array of priorities
including: fraud detection, information barriers, variable
annuities, protection of customer information and
IT/Cyber-Security, anti-money laundering, pandemic
preparedness/business continuity planning, branch office
supervision, outsourcing, inventory and collateral valuation,
customer margin debts collateralized by nonmarketable securities,
accounting and spreadsheet controls, day-trading margin, fully paid
lending programs, market regulation options examination program,
short sales and Regulation SHO compliance, and algorithmic trading
controls. Read more (http://tinyurl.com/yhfdr5l). The Connecticut General Assembly has re-proposed a transparency
and disclosure bill, originally proposed in January 2009, after not
taking it to a vote last year. The bill, if enacted in its current
form, would require any investment adviser to a hedge fund with an
office in the state to disclose to investors and prospective
investors (not later than 30 days before any such investment) in
such fund when the investment adviser may have a conflict of
interest that could affect its duties and responsibilities to such
fund or its investors. The bill would become effective October 1.
go to Lou Mitchells To read the text of the bill, click here (http://tinyurl.com/ydzue2l). Click here (http://tinyurl.com/ycfr4go) for more
information on the original bill in the February 27, 2009, edition
of Corporate and Financial Weekly Digest. The Securities and Exchange Commission amendments to Rule
206(4)-2, the custody rule under the Investment Advisers Act of
1940, as amended, will become effective on March 12. Click here (http://tinyurl.com/ye7dcyj) to read
Katten's Client Advisory regarding the rule
changes. On March 5, the Financial Crimes Enforcement Network, the Board
of Governors of the Federal Reserve System, the Federal Deposit
Insurance Corporation, the National Credit Union Administration,
the Office of the Comptroller of the Currency, the Office of Thrift
Supervision, and the Securities and Exchange Commission released
guidance to clarify and consolidate existing regulatory
expectations for obtaining beneficial ownership information for
certain accounts and customer relationships (the Guidance). According to the Guidance, "Heightened risks can arise with
respect to beneficial owners of accounts because nominal account
holders can enable individuals and business entities to conceal the
identity of the true owner of assets or property derived from or
associated with criminal activity." The Guidance notes that the customer due diligence (CDD)
procedures used by a financial institution should be reasonably
designed to identify and verify the identity of beneficial owners,
as appropriate, based on the institution's evaluation of risk
pertaining to an account. The Guidance also describes certain CDD
procedures that may be used by a financial institution to verify
the beneficial owner of an account. For more information, click here
(www.fdic.gov/news/news/financial/2010/fil10008a.html). Treasury, IRS Issue Proposed Regulations and Guidance Addressing
FBAR Reporting Requirements for Retirement Plans At the end of February, the Financial Crimes Enforcement Network
(FinCEN) bureau of the U.S. Department of the Treasury issued
proposed amendments to the Bank Secrecy Act regulations governing
Reports of Foreign Bank and Financial Accounts, commonly referred
to as "FBAR." (Proposed Regulations). The Internal
Revenue Service (IRS) also issued Notice 2010-23 (the Notice),
providing relief on some plan-related FBAR filing requirements, and
Announcement 2010-16 (the Announcement), clarifying that the filing
requirement for 2009 and prior years relates only to U.S. citizens,
residents and domestic entities. These reporting requirements relate to foreign financial
accounts owned or controlled by U.S. persons and are aimed
primarily at money laundering and other evasion of U.S. law.
However, the broad scope of the FBAR requirements raised questions
about what compliance was necessary by U.S. retirement plans, many
of which utilize foreign-based accounts or investment vehicles. The
following are important points discussed in the Proposed
Regulations and Notice. Under the Consolidated Omnibus Budget Reconstruction Act
(COBRA), certain group health plan participants who lose their
coverage are permitted to continue coverage for a period of time by
electing continued coverage and paying the relevant premium
themselves. The American Recovery and Reinvestment Act of 2009, as
amended, provided a subsidy to certain eligible individuals that
allowed them a discount of up to 65% of their COBRA premiums for up
to 15 months. The COBRA subsidy expired on February 28. However,
Congress enacted a law that provides for a one-month extension of
the COBRA subsidy. Earlier this week, President Obama signed into
law the Temporary Extension Act of 2010 (the TEA), which extends
the COBRA subsidy through March, and clarifies certain features of
the COBRA subsidy. Under the most recent extension, employees will
generally be eligible for up to 15 months of reduced premiums if
they are involuntarily terminated from employment on or before
March 31 and they lose health plan coverage as a result of such
termination. In addition to extending the COBRA subsidy, the TEA
also created special COBRA rights for individuals who are
involuntarily terminated after incurring a reduction in hours, a
special notice obligation related thereto, as well as new civil
enforcement provisions. Various aspects of the COBRA subsidy have been changed since its
original enactment. For more information about the original subsidy, click
here (http://tinyurl.com/ataw3e). For information about several important changes to the original
subsidy, click
here (http://tinyurl.com/yfrl7ad). The text of the Temporary Extension Act of 2010 can be found here (http://tinyurl.com/y8h5aj7). On March 2, the Committee of European Securities Regulators
(CESR) published proposals for a pan-European short selling
disclosure regime. The proposals result from CESR's
consultation process, which began in July 2009 (see the July 10,
2009, edition of Corporate and Financial Weekly
Digest) (http://tinyurl.com/ya2vwad). CESR has proposed a two-tier model (private and public
disclosure) for short positions in shares admitted to trading on
any European Economic Area (EEA) regulated market or multilateral
trading facility (MTF). The regime will not apply to shares whose
primary listing is not on an EEA market or MTF. The measure of
whether disclosure is required will be based on economic exposure
(calculated on a net basis) which is the economic equivalent of a
short position. Positions in all financial instruments, including
derivatives and cash market positions, will be aggregated to
determine whether applicable thresholds are met. Market participants with short positions will be required to
make a non-public disclosure (to the national regulator of the
relevant issuer's primary market) of any position in an
issuer's share capital reaching 0.2%—an increase from
the originally proposed 0.1%. Further non-public disclosures will
be required as each successive 0.1% threshold is crossed after the
initial disclosure requirement has been triggered. If the higher
threshold of 0.5% is reached, a public disclosure will also be
required. Further public disclosures will be required for each 0.1%
change thereafter. Disclosure filings will be required on T+1.
Intra-day positions are not required to be disclosed. Market making
activities will be exempt. CESR has recommended that the new regime be implemented as soon
as possible. Its view is that there should be new European
legislation in this area, either (preferably) through the enactment
of a new directive or regulation or alternatively through
amendments to the Transparency Directive. It recommends that those
CESR members that already have powers to implement a permanent
disclosure regime should begin the process of implementing the
proposals, while those members not having the necessary legal
powers should aim at implementation on a best efforts basis. To read the proposals in full, click here (www.cesr.eu/popup2.php?id=6487). On February 25, the International Organization of Securities
Commissions (IOSCO) published a template for the global collection
of hedge fund data by regulators to facilitate international
cooperation in identifying and assessing systemic risks which might
arise from the hedge fund sector. The purpose of the template is to enable the collection and
exchange among regulators of consistent and comparable data from
hedge fund managers and advisors about their trading activities,
the markets they operate in, funding and counterparty information.
There are 11 proposed categories of information which incorporate
both supervisory and systemic data. The template is not intended to
be a comprehensive list of all of the types of information and data
which regulators might want to collect; therefore, regulators are
not restricted from requiring additional information at a domestic
level. IOSCO stated that it was publishing the template to help inform
any planned legislative changes being considered in various
jurisdictions, as well as to provide securities regulators with
examples of the type of information they could find useful to
collect. IOSCO recommends that the first data gathering exercise
should be carried out on a best efforts basis in September 2010. As
reported in the February 26 edition of
Corporate and Financial Weekly Digest
(http://tinyurl.com/y9f267r), the UK Financial Services Authority
has just released its own surveys of hedge fund activity which were
conducted in October 2009. To read the publication in full, click here.
SEC/CORPORATE
SEC Issues New Interpretations on Executive Compensation
LITIGATION
Delaware Chancery Court Rules on Use of Poison Pills
Shareholder Claims of Federal Securities Fraud Survive
CEO's Motion to Dismiss
BROKER DEALER
Bankruptcy Judge Makes Important Ruling Impacting Madoff
Investors
FINRA Issues Annual Exam Priorities Letter
PRIVATE INVESTMENT FUNDS
Connecticut General Assembly Re-proposes Transparency and
Disclosure Bill
INVESTMENT COMPANIES AND INVESTMENT ADVISERS
Custody Rule Changes to Become Effective
BANKING
Federal Agencies Issue Guidance Regarding the Bank Secrecy Act
and Beneficial Ownership
EXECUTIVE COMPENSATION AND ERISA
be in a better position to determine the existence of a foreign
financial account. Accordingly, a plan participant or IRA holder
with no other foreign financial accounts would not check any box on
his or her individual tax return indicating ownership or control
over such an account.
The Proposed Regulations, Notice and Announcement can be accessed
here
(www.irs.gov/taxpros/article/0,,id=219707,00.html).COBRA Subsidy Extended Through March
EU DEVELOPMENTS
CESR Publishes European Short Selling Disclosure Regime
INTERNATIONAL DEVELOPMENTS
IOSCO Publishes Template for Hedge Fund Data Collection
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.