Corp Law Blog

2003-06-05T08:25:00.000-07:00

WE'VE MOVED: Corp Law Blog has left blogspot for greener pastures. You can now find Corp Law Blog at http://www.corplawblog.com/. Please change your bookmarks and stop by and visit us soon. We look forward to seeing you there.

2003-06-04T15:47:00.000-07:00

DID MARTHA STEWART COVER UP LEGAL CONDUCT? As everyone knows by now, Martha Stewart was indicted today for allegedly engaging in both an illegal insider trading scheme by selling her shares of ImClone common stock while in possession of material nonpublic information and then seeking to cover it up. What makes this case so interesting to so many is that Stewart may lose her reputation, her career and hundreds of millions of dollars for the sake of a stock sale that saved her less than $45,673. What makes this case interesting to me, and potentially tragic for Stewart, is that if the SEC's complaint is accurate, Stewart went to a lot trouble to cover up a stock sale that was arguably legal. And by attempting to cover it up, she has made it easier for the SEC to prove that her stock sale was illegal. Today the SEC outlined its case against Stewart in this press release, this litigation release and this complaint. The SEC's complaint alleges both illegal insider trading and obstruction of justice against Stewart; the DOJ in a separate indictment also alleges obstruction of justice and perjury, but does not allege illegal insider trading. The SEC's key insider trading charge against Ms. Stewart boils down to

Stewart knew or acted in reckless disregard of the fact that information about the Waksals' efforts to sell their ImClone stock was nonpublic and that Bacanovic [her Merrill Lynch stockbroker] had communicated that information to her in breach of Bacanovic's duty of confidentiality to Merrill Lynch.

The SEC's charge is worded this way because it is not enough to simply say that Stewart traded on the basis of inside information. The SEC must also prove that Stewart knew (or was reckless in not knowing) that her stockbroker was breaking the rules by giving the inside information to her. I don't know whether Stewart did, in fact, know that her broker was breaking Merrill Lynch's internal rules. However, I do know that it is very difficult for the SEC to prove unlawful intent in cases like this. My guess is most investors accept investment advice (even hot tips) from their stockbrokers without ascertaining whether the broker is complying with his firm's internal policies. Unfortunately for Stewart, most investors do not subsequently attempt to cover up their reasons for acting on their stockbroker's investment advice. I am sure the SEC will offer Stewart's cover up as proof of her unlawful intent in selling the stock. If Stewart had not attempted to cover up her stock sale, the SEC would have had a much more difficult time proving the stock sale was illegal in the first place. By the way, the fact that Stewart used to be a stockbroker does not, in my mind, mean much in this case. According to the SEC's complaint, "in the late 1960's and early 1970's, Stewart was a registered representative for the broker-dealer, Pearlberg, Monness, Williams & Day." Almost everything we know today about insider trading law, especially as it relates to tippees, is based on Supreme Court court cases in the 1980s and 1990s, decades after Stewart worked as a stockbroker.

2003-06-03T12:26:00.000-07:00

SHOULD EMPLOYEE PLANS FILE A 906 CERTIFICATE WITH AN 11-K? The Sarbanes-Oxley Act of 2002 was cobbled together quickly by people who by and large did not know what they were doing and did not give themselves time to learn. Nowhere is this more evident than in the interplay of Sections 302 and 906, each of which requires CEOs and CFOs to deliver different certificates with most SEC filings. Section 302 appears to have been drafted with knowledgeable input from the SEC; Section 906 appears to have been drafted on the back of a used cocktail napkin. Among the many questions raised by Section 906 is whether employee plans must file 906 certificates with their annual reports on Form 11-K. This particular issue is very timely (see, for instance, the question posed yesterday by Janell Grenier of Benefitsblog) because most ERISA-qualified plans must file an 11-K within 180 days after the end of the plan's fiscal year. For plans with fiscal years ending on December 31, this means an 11-K will be due by the end of June. Section 906 of the Sarbanes-Oxley Act of 2002 provides that

Each periodic report containing financial statements filed by an issuer with the [SEC] pursuant to section 13(a) or 15(d) of the [1934 Act] shall be accompanied by a written statement by the chief executive officer and chief financial officer (or equivalent thereof) of the issuer.

The statement requires the CEO and CFO to certify that the periodic report complies with the 1934 Act and that the information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer. A Form 11-K is an annual report (a "periodic report") of an employee plan that typically contains audited financial statements of the employee plan ("containing financial statements") and is filed by the employee plan ("an issuer" [?]) under section 15(d) of the 1934 Act. While it would seem just from reading 906 that 11-Ks must include a 906 certificate, a few factors suggest that maybe they shouldn't. First, no one believes the Senate and House drafted 906 with the the intent to require plan administrators to certify audited plan financial statements. Plan administrators are already regulated under ERISA and have to certify similar but different stuff in plan form 5500s. Second, most employee plans have plan administrators (this is required under ERISA) but do not, I believe, have a CEO, CFO or any equivalent of a CEO or CFO. Third, the SEC in interpreting Section 302 has not required the very similar Section 302 certificates to be delivered in connection with Form 11-K filings. For this reason, some people feel that the SEC would not require 906s where it did not require 302s. However, the SEC does not have the authority to interpret 906, so we may never know. Fourth, the SEC believes it does have the authority to specify how a 906 certificate is delivered in or with an SEC report. When the SEC recently proposed rules specifying how a 906 certificate is to be delivered, the SEC tellingly did not list Form 11-K as one of the periodic reports that must include 906 certificates (see footnote 37):

[The 906] certification requirement applies to quarterly reports on Forms 10-Q and 10-QSB, annual reports on Forms 10-K, 10-KSB, 20-F and 40-F and semi-annual reports on Form N-CSR containing financial statements.

This silence by the SEC may not mean that the SEC agrees that 906s don't belong in 11-Ks. Commenters such as the ABA Section of Business Law and Cleary Gottlieb urged the SEC to clarify that its omission of 11-K meant that no 906 was required. The SEC recently announced that it had adopted final rules, but has yet to release the final rule release or the text of the final rule so we do not yet know whether the SEC will weigh in on this. On May 27, according to reports, Alan Beller, Director of the SEC's Division of Corporation Finance, stated at a public meeting of the SEC that he was "tending toward" an interpretation that 906 certificates are required with 11-Ks, but that the final interpretation would follow discussions between the SEC and the DOJ. Muddying things up even further, in April Senator Biden released a pseudo-legislative history that claimed, among other things, that 906 was intended to apply to Form 11-Ks. While Biden's "legislative history" is suspect both factually and precedentially, it certainly will not help those of us who do not think 906s should be attached to 11-Ks. So, what's an employee plan to do? Some companies, such as Amazon, have filed 906 certificates with an 11-K recently. Note that Amazon's 906s were delivered by Amazon's CEO and CFO, who do not appear from the certificates to be officers of the employee plan itself. Most other recent 11-Ks do not appear to be accompanied by 906s, although it is possible that the 906s were mailed separately and do not therefore appear in the pubicly-available EDGAR filings. For instance, see the most recent 11-Ks filed by employee plans of Goldman Sachs Group, Hughes Electronics and Dell Computer. The kernel of Atticus Finch still in me wants to fight the just fight and omit the 906 certificates from 11-Ks because they make little sense and really were not intended when 906 was crafted. However, the typically-conservative-securities-lawyer that I have become reasons instead that plan administrators already have to step up to the plate when filing Form 5500s and, in all likelihood, in delivering some kind of management letter to the accountants who audit the plan accounts, so I wonder whether it really would be that difficult for plan administrators to bite the bullet and deliver a 906 certificate as well. Most plan administrators already sign the 11-K, which has always subjected them to civil and potentially criminal exposure under the securities laws. If not filing a 906 increases, even slightly, the chances of a summons from the Department of Justice, I think it makes sense to assume you're going to file a 906 unless and until the SEC and DOJ tell us otherwise.

2003-06-02T23:11:00.000-07:00

NEW SITE SOON! Why hasn't the big-time corporate lawyer behind Corp Law Blog forked over $15 to get rid of the banner ads on this site? Why can't I get a decent RSS feed from this site? Why does this blog take 5 minutes to load on a good day? These questions and more will all be answered soon when Corp Law Blog unveils its new! design powered by its new! Movable Type personal publishing system, all located at its new! domain name hosted by its new! superduperfast web host. The ribbon cutting ceremony will be announced soon, so stay tuned!

2003-06-02T10:08:00.000-07:00

SOMETHING'S BREWING AT FARMER BROTHERS: Farmer Brothers (Nasdaq:FARM), an institutional coffee distributor, has some unhappy shareholders. These unhappy shareholders are so unhappy, they have set up this extraordinary website to share their unhappiness. While the unhappy shareholders have raised some interesting legal issues -- some of which I plan to discuss in later postings -- the initial reason for their unhappiness appears to be Farmer's insistence on holding onto a $288 million cash hoard while its coffee business declines. This cash hoard represents $150 per Farmer share (recently trading around $320 per share) or, looked at another way, it totals over 10 years of Farmer's earnings. These earnings, in turn, have been declining, which makes some of the stockholders wonder why their cash is being locked up in a company with few if any growth prospects.

2003-06-02T09:08:00.000-07:00

MCI FINE -- CONTRARY TO "ON THE CONTRARY": Today's New York Times contains an "On the Contrary" column (reg req'd) by Daniel Akst that argues that the $500 million MCI Worldcom settlement should be paid to the "chronically underfinanced" SEC instead of to MCI Worldcom's stockholders. In the column, Akst rightly asks "why are the creditors less worthy than the investors" and points out that

this action will transfer $500 million from one innocent party -- MCI's creditors in bankruptcy -- to another innocent party, investors affected by WorldCom's accounting practices. . . . [T]he creditors lent money to WorldCom with the understanding that they would be paid before the shareholders, a deal that this settlement turns on its head.

However, Akst then suggests that instead of giving the money to investors, we should give the money to the SEC. If it is unfair in the first place to take the $500 million from MCI's creditors and give it to MCI's stockholders, as Akst initially states, then I am not sure I understand why it is somehow fairer to take the $500 million from MCI's creditors and give it to the SEC. Either way, the creditors -- an "innocent party" in Akst's words -- are having to pay $500 million for the misdeeds of others.

2003-06-02T08:47:00.000-07:00

IPO MARKET -- ANYTHING IS BUSIER: This report in Reuters entited "IPO VIEW-Increase in filings points to busier times" suggests that the IPO market may be set for a rebound. The basis for the article's conclusion is an increase in IPO filings in May to 6 from 2 in April, 1 in March and 2 in February. I suppose having 6 IPO filings in one month is busier, but I don't think it necessarily means we are in for busier times. Keep in mind that according to this data compiled by Jay Ritter of the University of Florida, during the 1990s, we saw average of 384 IPOs price each year -- 32 per month and more than 1 per day. Even at a pace of 6 IPO filings per month (of which maybe 75% will price), we are significantly below the pace set during the 1990s.

2003-05-30T12:16:00.000-07:00

WHAT DOES 41% MEAN? Today's New York Times contains an article with the headline "Ingersoll Holders Support Return to U.S. From Tax Haven." Those of us who limit our reading to headlines would assume from this that a majority of the shares of Ingersoll-Rand Corp., which recently reincorporated in Bermuda, had been voted in favor of a resolution requesting IR to re-reincorporate in the U.S. But anyone reading the actual story would reach a different conclusion:

At Ingersoll-Rand's annual meeting, a proposal that the company reincorporate in the United States received 41 percent of the votes cast.

In other words, 59% of IR's shares were voted against the proposal to return to the U.S. While the number of IR shares supporting the proposal is higher than one typically sees with union-backed stockholder proposals, I don't think we can conclude from this that IR's stockholders as a group "support" the return to the U.S. The union proponents certainly did not interpret the vote as a loss:

Though a company spokesman called the 59 percent opposition a reaffirmation of the decision to incorporate in Bermuda, representatives of shareholders said it should cause the company's directors to reconsider the move. . . . The stronger support for the Ingersoll-Rand proposal encouraged shareholder advocates. It was presented at the meeting by Richard C. Ferlauto, director of pension investment policy at the American Federation of State, County and Municipal Employees. . . . "Clearly, the shareholders' voice has been sounded here, and the question is whether the company will listen," Mr. Ferlauto said.

Apart from the headline issue, the article raises an interesting fiduciary duty issue. It seems to me that the union proponents of the proposal are pushing it not because it will benefit stockholders but because it advances the unions' political agenda. IR believes that moving to Bermuda increased its profits by $55 million last year -- the unions countered that the move will potentially tarnish IR's brands and threaten $40-$60 million of IR government contracts. So long as IR's directors believe that saving $55 million or so per year is more valuable to IR and its stockholders than the potential problems raised by the unions, and so long as 59% or so of IR's stockholders oppose returning to the U.S., how could the IR directors justify a return to the U.S.? I am not familiar with Bermuda corporate law, but I doubt it permits directors to disregard their business judgment in favor of the political judgment of a minority of the stockholders.

2003-05-30T09:58:00.000-07:00

INTERESTING TIDBITS FROM THE IPO ADVISORY COMMITTEE'S REPORT: As noted below, yesterday the NYSE/NASD IPO Advisory Committee delivered a blue-ribbon report recommending changes to the IPO process. In addition to the widely reported platitudes regarding openness and fairness, the report contains some other interesting stuff (interesting to me, at least): Were IPO's during the bubble period over- or under-priced? On one hand, dramatic price increases immediately following an IPO pricing suggest that the IPO's was priced too low. On the other hand, the fact that many bubble IPOs soon traded near zero suggests they may have been over-priced even before their dramatic first day price increases. Although the committee doesn't decide this question, it does suggest making it easier to increase an IPO's price above its indicated pricing range. Currently issuers can increase the size or price of an IPO by 20% without giving the SEC a chance to delay the pricing; the committee suggests increasing this to 40%. The committee does not believe issuers should have the same ability to reduce the price or size of an IPO, as the committee believes a price increase is for some reason less material to an investor than a price decrease. Ban market orders on the first day of trading. The committee suggests banning market orders (those that require a broker to buy at any price) and also indicates that limit orders at prices substantially higher than the IPO price should be viewed with suspicion. Permit flipping penalties so long as everyone is subject to them. One way to keep an IPO price high is to prevent buyers from selling. This is often done by imposing flipping penalties on syndicate members whose buyers sell IPO shares too soon after the pricing. Instead of decrying flipping penalties as a manipulative device designed to artificially prop up IPO prices, the committee instead decries the selective enforcement of flipping penalties against retail customers. The committee's recommendations would therefore arguably lead to more IPO price manipulation. Limit "friends and family" programs. The committee believes friends and family programs -- the allocation of a portion of the IPO to employees, customers and others designated by the issuer -- can "compromise" the IPO process. The committee believes they should be limited to no more than 5% of the IPO and that buyers in the friends and families program should be subject to the same lock-up period that applies to officers and directors. It seems a little unfair to single out friends and families programs this way -- all IPO participants managed to find ways to compromise the IPO process during the bubble era. I also recall that underwriters generally did not like friends and family programs, as they took away shares that would otherwise have been allocated to clients of the underwriters. If an issuer feels strongly that its employees or suppliers should own a big chunk of its stock, then I don't think the issuer should necessarily be prohibited from structuring its IPO in a way that meets this goal so long as the issuer clearly discloses what it is doing. Will roadshows replace prospectuses? The committee believes IPO roadshows should be made available on the internet for all IPO investors to view. At one level, this sounds like a great idea as it will ensure that all investors, not just large institutional investors, have access to the same information. However, as the committee acknowledges, widespread availability of roadshows will only undermine the reliance investors place on the IPO prospectus. This may cause the SEC and others to re-examine the roadshow process and re-regulate it, which would likely limit the roadshow process for everyone. I think this will be one of the toughest committee recommendations to implement. Prohibit lock-up exemptions. "Lock-ups" are agreements in which officers and directors of an issuer (and, if the committee gets its way, friends and family program participants) agree not to sell their shares for 90 to 180 days following the IPO. These agreements always permit the lead underwriter to waive the restrictions. The committee suggests requiring underwriters and issuers to announce publicly any waivers before granting them. This, I suspect, will have the effect of killing any chance anyone might have to get a waiver. Reading the report made me nostalgic for the old days when we actually did IPOs.

2003-05-30T00:41:00.000-07:00

IPO ADVISORY COMMITTEE SUBMITS REPORT: Yesterday the NYSE/NASD IPO Advisory Committee submitted its report and recommendations on ways to improve the IPO process. A press release is available here and the report is available here. The committee was formed at the request of the SEC in October 2002.

2003-05-29T14:46:00.000-07:00

SUNSET FOR TRUST PREFERRED SECURITIES? Two recent developments may relegate trust preferred securities to the dustbin of history. A "trust preferred security" is a hybrid security that can be treated by the issuer as debt for tax purposes and equity for capital and accounting purposes. Issuers do this by issuing debentures to a grantor trust, which then sells preferred securities having the same terms as the debentures to investors. The grantor trust and its securities are disregarded for tax purposes, giving the issuer an interest deduction on the debenture payments. The debentures are disregarded for accounting and (generally) regulatory capital purposes, allowing the issuer to present the trust preferred securities as equity-like securities on its balance sheet. With these advantages trust preferred securities have all but replaced traditional preferred stock -- a person quoted in a Los Angeles Times article yesterday believes 95% of the currently outstanding supply of preferred stock and securities (estimated at $400 billion) is comprised of trust preferred securities. So what's the problem? Well, a few weeks ago the Financial Accounting Standards Board issued FAS 150 "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" (the FASB's press release is available here). Although I have not slogged through all of FAS 150's 77 pages, I have read enough to conclude that any security with a maturity date will be classified as debt on an issuer's balance sheet. Trust preferreds invariably have maturity dates of 30 years or so, so I expect issuers will no longer be able to classify trust preferreds as quasi-equity on their balance sheets. This change in presentation should not, by itself, be fatal to trust preferreds, but I wonder whether it will undermine the basis for the favorable equity-like capital treatment rating agencies and banking and insurance regulators have been giving to trust preferred securities. The tax cut bill (H.R. 2) signed by President Bush yesterday creates yet another problem for trust preferreds. The tax cut bill reduces an individual's tax rate on dividends to 15%. Unfortunately for trust preferreds, their distributions are not "dividends" for purposes of this tax cut. The trust preferred structure that permits the issuer to treat distributions as deductible interest payments requires the holder to treat the same distributions as interest income. This has always prevented corporate holders of trust preferred securities from taking advantage of the dividends-received deduction and it now prevents individual holders of trust preferred securities from taking advantage of the lower 15% dividend tax rate. Individuals have always been significant buyers of trust preferred securities because the distribution/dividend distinction was not meaningful to them. Now that it is, I think individuals and corporations will both clearly prefer dividends from preferred stock over distributions from trust preferred securities and will demand a higher yield before they buy any further trust preferred securities. All this makes me wonder whether the trust preferred's tax deductibility feature will be enough to overcome these disadvantages.

2003-05-29T13:02:00.000-07:00

A (TEMPORARY) DROP TO A BIG-3? According to this article in today's Washington Post, the SEC is seeking to prevent Ernst & Young LLP from accepting any new public company audit clients for 6 months. The SEC is claiming in an administrative proceeding that E&Y violated the SEC's auditor independence rules by both auditing the books of PeopleSoft Inc. and helping businesses install PeopleSoft's software -- the article notes that E&Y reaped $452 million in fees from 1995 through 1999 from its PeopleSoft consulting work. How far can the SEC go in disciplining the four remaining accounting firms? The Post article observes:

The case highlights the difficulty the SEC faces when determining appropriate sanctions for major audit firms. The agency does not want to disrupt the businesses that need auditors, an SEC official said. The collapse of Arthur Andersen in the Enron accounting scandal has made the balancing act even more complicated, leaving the majority of publicly traded companies dependent on only four big audit firms. The choices available to a company seeking a global audit firm may be even fewer, because some of the remaining firms may have business relationships or other conflicts of interest that prevent them from taking on a particular client.

2003-05-28T14:45:00.000-07:00

IS NEW YORK MISLEADING INVESTORS? According to this wire story picked up by the LA Times:

New York State may delete the word "tobacco" from future sales of tobacco-settlement bonds, to overcome investors' reluctance to buy the debt, some state legislators said. Underwriters said "it would be better, cheaper, if the underwriting did not contain the word 'tobacco' in it," said Assembly Speaker Sheldon Silver, a Democrat. The bonds still would primarily be backed by payments tobacco companies are expected to make to New York, as well as to other municipalities, over the next 25 years as part of a 1998 health-liability settlement. Investors have been balking at buying the bonds as court settlements stack up against the cigarette firms, raising the risk of missed payments.

Hmmm. Let me see if I understand this correctly. New York wants to sell tobacco bonds. Investors don't want to buy tobacco bonds. To solve the problem, New York will simply strike the word "tobacco" from its tobacco bonds. Does Eliot Spitzer know about this?

2003-05-28T13:14:00.000-07:00

HOUSE OFFERS SEC MORE ENFORCEMENT TOOLS: Last week Rep. Richard H. Baker (R-LA) introduced the Securities Fraud Deterrence and Investor Restitution Act of 2003 (H.R. 2179) in the House. If passed, the bill should make life in the SEC Division of Enforcement a bit easier. According to Rep. Baker's press release announcing the bill:

There are two purposes here. The first is to actually return money to harmed investors and make them whole to the greatest extent possible. The second is to strengthen the Securities and Exchange Commission to make it even more effective in deterring securities fraud and enforcing securities statutes.

A significant part of the bill is devoted to adding zeroes to many civil fines and making it easier for the SEC to levy them. Apart from those important provisions, I found the following provisions -- each of which has the effect of pre-empting state law -- most interesting: Section 2 would exclude settlements or judgments obtained by the SEC from state bankruptcy homestead laws. Normally, Section 522 of the Federal Bankruptcy Code permits debtors to exempt from the bankruptcy state property exempted under state laws. Perhaps the most famous of these laws is Florida's generous homestead law, which reportedly may be used by Scott Sullivan, former CFO at MCI Worldcom, to exempt his $15 million Boca Raton house from claims by the SEC and aggrieved investors. Section 4 would allow a person or entity to provide the SEC with documents that are privileged or protected under any work-product doctrine without waiving the privilege or protection under federal or state law. The bill is silent as to what happens to the privilege or protection if the information is subsequently disclosed or produced by the SEC to others. Section 8(b) would require states that obtain penalties or disgorgement from brokers or dealers to remit the amounts to the SEC for distribution through its Fair Fund for investors. I guess the SEC is still sore that Eliot Spitzer and other state attorneys general managed to snag a huge chunk of the recent $1.4 billion global settlement covering research analyst conflicts of interest. Not surprisingly, the North American Securities Administrators Association lost no time objecting to this provision of HR 2179:

First, we’re uncertain about its constitutionality . . . [the bill] could have the impact of undermining state regulators’ ability to determine the best course of action in a particular case and limit elected state officials’ determinations about how to appropriate and allocate fines imposed under state law. Second, depending on the exact language, it could serve to undermine the traditional role of the states as an early warning system for fraud . . . .

2003-05-28T11:48:00.000-07:00

SEC APPROVES "FURNISHING" 906 CERTIFICATIONS: At yesterday's meeting the SEC also announced that the Commissioners voted to adopt as final the proposed rule permitting companies to "furnish" rather than "file" Section 906 certificates. The SEC originally proposed this rule in March 2003 in Release 34-47551. At that time, the SEC took the unusual step of giving companies "interim guidance" to follow the rule even before it was adopted. The rule helpfully permits companies to include the Section 906 certificates in SEC reports without having the 906 certificates being considered part of the reports for securities liability purposes -- similar to the treatment of Regulation FD information furnished under Item 9 of a Form 8-K -- so my guess is most companies have already been following the new rule.

2003-05-28T08:38:00.000-07:00

SEC ADOPTS INTERNAL CONTROLS RULE: Yesterday the SEC announced that it had adopted the internal controls reporting rules originally proposed in Release 34-46701 last October. The SEC has not yet made the adopting release or the text of the final rule release available. The internal controls rules implement Section 404 of the Sarbanes-Oxley Act of 2002 and will require a company's management and auditors to attest each year to the company's internal control structure and procedures for financial reporting. In order to give this attestation, most companies will need to adopt new procedures and implement new internal control systems. In order to do this without running afoul of the new auditor independence rules, companies will probably not be able to do this with the assistance of their existing auditors. Many believe Section 404 will be the most costly Sarbanes-Oxley Act provision. For insight into the internal controls process, I suggest reviewing the materials available on the Committee of Sponsoring Organizations (COSO) website. COSO, also known as the "Treadway Commission" after its first chairman, is "a voluntary private sector organization dedicated to improving the quality of financial reporting through business ethics, effective internal controls, and corporate governance." As part of its mission to study financial fraud, COSO issued the Bible on internal controls: Internal Control -- Integrated Framework, available for $35 here on the AICPA's web site. Don't be surprised if Internal Control -- Integrated Framework displaces Who Moved My Cheese? at the top of the business bestseller lists.

2003-05-27T17:10:00.000-07:00

WILSON SONSINI PARTNER STARTS SECURITIES LITIGATION BLOG: I recommend The 10b-5 Daily, a blog devoted to

News and events related to securities class action litigation. Containing all facts, with particularity, and an occasional dose of commentary.

It's written by Lyle Roberts, a securities litigation partner at Wilson Sonsini in Reston, Virginia. I was going to refer to The 10b-5 Daily as a "new" blog, but it appears that Lyle started his blog a week before Corp Law Blog managed to get up and running.

2003-05-27T11:30:00.000-07:00

WITTGENSTEIN ON ENRON: This weekend The Guardian published "A philosophical investigation into Enron," an interesting essay by Donald MacKenzie, a sociology professor at the University of Edinburgh. Prof. MacKenzie traces the Enron debacle to "modernity's problem with trust." In the old days, we invested in a person only if we knew his character, reputation and virtue. MacKenzie points out that this is still the way top investors such as Warren Buffett and Silicon Valley venture capitalists invest -- "in a world in which technologies and economic circumstances change rapidly, personal virtues may be the most stable things around." For those of us who do not have personal access to CEOs of major companies, "trust in numbers" has taken the place of "trust in people." Awash in a sea of P/Es, ROEs and EBIDTAs, it is easy to forget that our trust in these numbers "works only if those who produce the numbers can be trusted: it displaces, rather than solves, modernity's problem with trust." It also places undue reliance on the accounting rules that produce these numbers. As Professor MacKenzie observes:

In the Philosophical Investigations, Wittgenstein pointed to the hidden complexity of the apparently simple notion of "following a rule". If we think of a rule as a set of words - written, for example, on the pages of GAAP - then following it seems to involve an act of interpretation of what the words "mean". Interpretations, however, are contestable - especially if you have expensive lawyers and sophisticated accountants bent on finding an interpretation that will permit a valued client to do what he or she wishes. Of course, one can write rules for interpretation, but these rules themselves need to be interpreted: we are at the start of a potentially endless regress. If rules are simply verbal formulae, then, as Wittgenstein put it, "no course of action could be determined by a rule, because every course of action can be made out to accord with the rule."

Even the anticipated move of US GAAP from a "rules-based" approach to a "principles-based" approach will not solve accounting's Wittgensgteinian problems:

Principles, however, are a species of meta-rule, and the Wittgensteinian analysis applies to them, too. It is easy to anticipate that, especially in the US legal system, a thicket of GAAP-like interpretation will come to surround them. . . .

This calls to mind the somewhat empty-headed slogan "you can't legislate morality" except that in this case I think the proper slogan would be "you can't legislate character." And I don't think that slogan is empty-headed.

2003-05-27T10:32:00.000-07:00

"BEATING A CORPSE" -- MORE ON THE MCI FINE: As discussed previously in this blog here and here, the $500 million fine levied by the SEC against MCI unfairly takes money from one victim of MCI's fraud (its creditors) to put it in the pocket of another victim (its stockholders). This theme is explored in "WorldCom Stockholders Owe SEC Thanks for Almost Nothing" in yesterday's Washington Post. Even though the $500 million fine will be returned by the SEC to the victims of the MCI Worldcom accounting fraud, the Post article figures that sum works out to

only about 17 cents a share for WorldCom stockholders -- if they were to get all of it. That's not much compensation for somebody who paid $60 a share for the stock four years ago when its value was inflated by phony accounting. . . . The $500 million is not only a pittance, it's also a pointless penalty that takes money out of the pockets of some MCI victims and puts it in the pockets of others. Along with doing next to nothing to compensate investors, it does nothing at all to deter other corporate crooks from the same kind of phony bookkeeping. The harder you look at the penalty imposed on MCI . . . the clearer it becomes that nobody in Washington has figured out the appropriate punishment for colossal corporate fraud.

Ethics experts interviewed by the Post agreed that the crooks should be punished, not the company:

"This is just a tragic situation, where there is no appropriate punishment other than prosecuting the perpetrators," said Edward Soule, assistant professor of managerial ethics at Georgetown University. "But the perpetrators are all out of WorldCom and they are being prosecuted." There is no point in fining MCI, Soule said. "It's like beating a corpse. It's hard to see what this is going to accomplish."

2003-05-27T09:00:00.000-07:00

EX-SKADDEN PARTNER DEMONIZES CORPORATIONS: A couple of weeks ago I wrote here about SB 917 -- a disturbingly bizarre bill before the California State Senate that, if passed, would establish a public and private right of action against a director of any California corporation that

violates any . . . law designed to protect the environment, violates human rights, adversely affects the public health or safety, damages the welfare of the communities in which the corporation operates, or violates the dignity of its employees. . . .

While checking on the status of this bill, I ran across this web site pushing a similar bill in Minnesota. The California and Minnesota bills, called the "Code for Corporate Responsibility" by supporters, were drafted by Robert Hinkley, who claims to have been a corporate partner for over 20 years at Skadden, Arps, Slate, Meagher & Flom LLP until he retired in 2000. Mr. Hinkley explains the basis for his Code for Corporate Responsibility in an interesting manifesto entitled "28 Words to Redefine Corporate Duties: The Proposal for a Code for Corporate Citizenship":

The cause of most corporate abuse is no secret. The thing that keeps greenhouse gases pouring out of smokestacks and tailpipes is the same thing that results in vendors of designer sneakers paying Third World children less than a dollar an hour. It's also the same thing that keeps tobacco companies marketing their products to children, fast food companies paying less than a living wage and meat packing companies maintaining dangerous working conditions. That thing is the dedication of the corporation to the pursuit of profit.

By ensuring that corporations elevate the public interest over profits, Mr. Hinkley reasons,

. . . companies will have to run their operations so they do not pollute . . . . No longer will they be able to engage in development or the harvesting or extraction of the earth's natural resources that is not sustainable. . . . companies will no longer be allowed to violate human rights in the Third World. Nor will they be allowed to put untested unsafe products in the marketplace. . . . the Code will guarantee a living wage, the right to collectively bargain and the right to work in a safe environment . . . . no longer will a major employer in a community be able to threaten to leave town unless the community accedes to the company's demands. Companies that create economic hardship will be responsible for compensating the community for the damage they cause.

I believe this elevation of public interest over profits has been tried before in the Soviet Union, the People's Republic of China and, most recently and perhaps most effectively, the Democratic People's Republic of Korea. Although I have not field-tested the results achieved by these early adherents to the Code for Corporate Responsibility, if Mr. Hinkley's reasoning is sound we should find that these countries have experienced no pollution, no unsustainable extraction of natural resources, no violations of human rights, no unsafe products, no unhappy workers and no economic hardships.

2003-05-26T15:12:00.000-07:00

MY FAVORITE RISK FACTOR: It's not often we corporate law-types find useful precedents in modern novels, so I had to share this model risk factor I ran into while reading Neal Stephenson's Cryptonomicon:

"EXTREMELY SERIOUS WARNING (printed on a separate page in red letters on a yellow background): Unless you are as smart as Johann Karl Friedrich Gauss, savvy as a half-blind Calcutta bootblack, tough as General William Tecumseh Sherman, rich as the Queen of England, emotionally resilient as a Red Sox fan, and as generally able to take care of yourself as the as the average nuclear submarine commander, you should never have been allowed near this document. Please dispose of it as you would any piece of high-level radioactive waste and then arrange with a qualified surgeon to amputate your arms at the elbows and gouge your eyes from their sockets. . . . If you ignore this warning, read on at your peril -- you are dead certain to lose everything you've got and live out your final decades beating back waves of termites in a Mississippi Delta leper colony."

Now that bespeaks caution!

2003-05-23T17:47:00.000-07:00

TWEEDY TAKES ON LORD BLACK: As previously reported here and here, relations between Hollinger International and its outside stockholders are less than harmonious. Earlier this week, days before Hollinger International's annual meeting, mutual fund manager Tweedy Browne, one of Hollinger International's largest stockholders, filed a Schedule 13D with the SEC detailing its concerns and demanding that Hollinger's independent directors investigate. As may be expected following this shot across the bow, the annual meeting was quite a show, with CEO Conrad Black (aka Lord Black of Crossharbour) defiantly deflecting efforts by the outside stockholders to question his management practices. According to this New York Times account, at one point Black

riled some in the audience by saying, "like all fads, corporate governance has its zealots" and that it was important to ensure that "corporate-governance crusaders don't throw the baby out with the bath water."

One of Tweedy Browne's main concerns is $73.7 million in non-competition payments paid to individual executives of Hollinger, including Black, in connection with sales of Hollinger newspapers since 2000. At the annual meeting, according to the NYT's account, Christopher Browne of Tweedy Browne

repeatedly pressed Lord Black and Mr. Thompson on details of the payments to the executives. He asked for another example of noncompetition fees going to executives rather than their companies, but Lord Black said he could not cite any.

Having reviewed Tweedy Browne's list of allegations, I think the following are the most interesting aspects of the non-competition payments (note that I have not independently verified any of Tweedy Browne's assertions): 1. Hollinger itself did not receive any non-competition payments, even though it seems to be the most likely party to compete. 2. Hollinger waited nearly 18 months to disclose the largest chunk of non-compete payments. 3. Black received non-compete payments even after he was prohibited by law from competing. When Conrad Black accepted his English title, he renounced his Canadian citizenship. Apparently, Canada does not permit non-Canadians to control media assets such as newspapers. 4. It's very difficult to compete with an established newspaper, so it's not clear why the buyers paid $73.7 million to protect themselves from a weak or non-existent threat of competition. As Warren Buffett observed in his 1995 letter to stockholders of Berkshire Hathaway:

[Newspaper] industry trends are not good. In the 1991 Annual Report, I explained that newspapers had lost a notch in their economic attractiveness from the days when they appeared to have a bullet-proof franchise. Today, the industry retains its excellent economics, but has lost still another notch. Over time, we expect the competitive strength of newspapers to gradually erode, though the industry should nevertheless remain a fine business for many years to come.

Despite this gradual erosion, most cities continue to have one dominant newspaper for a reason -- newspapers remain very difficult businesses to compete with. The main issue may come down to whether or not the non-compete payments improperly diverted a corporate opportunity or asset from Hollinger to its executives. The Hollinger board is apparently investigating the Tweedy Browne allegations -- it will be interesting to see what they find.

2003-05-22T23:19:00.000-07:00

MORE ON WORLDCOM FINE: In my previous discussions of the $500 million MCI settlement with the SEC here and here, I expressed a concern that the SEC was essentially penalizing MCI's creditors and remaining employees for misdeeds others perpetrated on them. According to an article in tomorrow's The Daily Deal (sub. req'd), "WorldCom makes tidy use of tax loophole," U.S. taxpayers will be paying a big part of MCI's fine because MCI will "possibly" be able to deduct the $500 million from its taxes. The Daily Deal reports that Senators Santorum and Grassley intend to introduce legislation this fall prohibiting firms from treating civil fines as tax deductions.

2003-05-22T20:18:00.000-07:00

CALIFORNIA ANTI-SPAM BILL PASSES SENATE: Thanks to So Cal Law Blog for the pointer to this newswire story available on the Sacramento Bee's website. According to the article, California's anti-spam bill (SB 12) was narrowly passed today by the California State Senate. In its most current form, the proposed anti-spam bill changes California from an "opt-out" state -- permitting spammers to send spam so long as they give Californians the right to opt-out (we all know how well that works) -- to an "opt-in" state, which prohibits any unsolicited email to be sent to any Californian who has not invited the email. An email would not be "unsolicited" if you "expressly consent" to receive it or if you have "made an inquiry, application, purchase or transaction regarding products or services offered by the sender." This goes beyond the proposed Federal CAN-SPAM Act of 2003, which only requires spammers to offer and honor opt-outs. The new bill would also make it illegal to send emails with false domain names or header information or with subject lines that have "the capacity or tendency to mislead the public about the contents of the advertisement." Also, it would be illegal for anyone to collect email addresses or sell them if the purpose is for someone to use them to send spam. If this California anti-spam bill passes, the optimist in me hopes that spam will finally stop filling up my inboxes, but the pessimist fears that the California law will have no more effect on the spammers than the federal law had on the junk faxers. Interestingly, the ACLU is listed as one of the few opponents of the anti-spam bill. I searched the web sites of both the ACLU of Southern California and the ACLU of Northern California could not find any calls to action opposing the California spam bill or press releases explaining the ACLU's position on the California spam bill. The California Senate analysis of the bill merely says the ACLU thinks a "do not email list" would be less burdensome on "protected speech" than California's "opt-in" approach. It also states that the ACLU believes there should be an exception for a "small business person trying to drum up business." The national ACLU's website lists some objections to the CAN SPAM Act of 2001, but like the newly proposed CAN SPAM Act of 2003, the 2001 version did not have an opt-in requirement. I wonder whether the ACLU believes an opt-in requirement is unconstitutional. I understand that restrictions on speech need to be narrowly tailored, but hasn't our experience with spam and junk faxes taught us that opt-outs don't work -- if anything, the act of opting-out verifies that your email address is "live" and will subject you to even more spam. I also wonder how far one can go in delivering "protected" speech against the will of the recipient. We already have opt-in procedures for speech delivered door-to-door -- no salesman or religious missionary has the right to barge into my house without first knocking at my door. Doesn't the same analogy apply to spammers who barge into my email box?

2003-05-22T16:00:00.000-07:00

MORE FROM HOLLINGER: According to this report from today's Hollinger stockholders' meeting:

[Hollinger CEO Conrad] Black said on Thursday the board would set up a committee of independent directors to study Tweedy [Browne]'s concerns, but was curt with shareholders who raised the issue. "You don't know what you are talking about but you are still welcome as a shareholder," Black told hedge fund manager Leon Cooperman, who stormed out of the room visibly angry.

This may be the first time someone has told Leon Cooperman, former Goldman Sachs partner and current head of the Omega Advisors hedge fund, that he did not know what he was doing. Of course, it was a nice gesture by Black to permit Cooperman to continue to be a shareholder. Still looking at the non-compete payments -- expect a post soon. I apologize if the suspense is killing you.

2003-05-22T10:08:00.000-07:00

MANY MEETINGS = LIGHT BLOGGING TODAY: But I plan to post more about claims being made by investment manager Tweedy Browne against Hollinger, as discussed in this New York Times article. Tweedy Browne, which owns 17.7% of Hollinger, alleges that several of its top executives have improperly taken $73.7 million from Hollinger since 2000 in the form of non-competition payments received from buyers of Hollinger assets. I am interested in exploring the corporate opportunity issue and in figuring out how buyers of Hollinger's newspaper assets -- assets which are usually insulated from direct competition -- concluded that it was worthwhile to pay $73.7 million to officers of Hollinger to keep them from competing.

2003-05-21T23:30:00.000-07:00

2ND CIRCUIT TO FITCH: "YOU'RE NO S&P" -- Yesterday the Court of Appeals for the Second Circuit decided in In re Fitch, Inc. that the Fitch ratings service is not entitled to the privilege of New York's press shield law (the decision is available on the Second Circuit's website and is discussed in this New York Times article). The Second Circuit reached this decision while acknowledging that Fitch's two main competitors -- S&P and Moody's -- are entitled to the press shield privilege. How, you may wonder, did the Second Circuit distinguish Fitch from S&P and Moody's? First, the Court found that Fitch only rates companies who pay for a rating. S&P and Moody's, on the other hand, routinely rate all public debt whether or not they are paid to do so. The Second Circuit apparently interpreted this to mean that Fitch rates for cash while S&P and Moody's rate for newsworthiness, making S&P and Moody's more like journalists and therefore more deserving of protection under New York's press shield. (Some would argue that the real reason S&P and Moody's rate everything in sight is to protect their near-duopoly in the ratings business from upstarts like Fitch.) Second, the Second Circuit found that "Fitch takes an active role in the planning of the transactions it analyzes, a role that is inconsistent with traditional journalism. . . . It is indisputable that Fitch has an extremely close relationship with the companies it rates." Despite Fitch's denials, the Second Circuit cited e-mails filed under seal (and therefore not specifically discussed) that indicated a "fairly active role on the part of the Fitch employee in commenting on proposed transactions and offering suggestions about how to model the transactions to reach the desired ratings." Such an active role, the Second Circuit held, "is not typical of the relationship between a journalist and the activities upon which the journalist reports." Although the Second Circuit does not address the larger implications of its findings, one wonders whether a rating agency that only rates for money and has extremely close relationships with the issuers who pay its fees may be more likely to place the interests of these issuers ahead of the interests of investors, who after all are the ones relying on the ratings.

2003-05-21T22:36:00.000-07:00

4% TO SEC, 96% TO CROOKS: According to this article from the Legal Times, during 2002 the SEC won orders requiring violators of securities laws to disgorge a total of $1.3 billion. Unfortunately, the SEC has so far collected only $57 million, or little more than 4% of these awards. What makes this pathetic collection rate particularly sad is that these disgorged funds are supposed to be returned to the victims of securities fraud. While some of the missing $1.24 billion was probably frittered away by the fraudsters long before the SEC came after them, I'm sure much of these uncollected funds remain in their pockets, reminding them that crime does pay.

2003-05-21T11:52:00.000-07:00

SEC RELEASES FINAL "IMPROPER INFLUENCE ON AUDITS" RULE: Yesterday the SEC adopted its final rule implementing SOX Section 303(a), which makes it unlawful for any officer or director to

take any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified accountant engaged in the performance of an audit of the financial statements of that issuer for the purpose of rendering such financial statements materially misleading.

I have yet to study this new rule in detail, so I may be missing something, but it appears to me that the conduct prohibited by the new rule is already prohibited by other rules, except for one activity rendered moot by another provision of SOX. According to the SEC, the new rule prohibits offering bribes, providing inaccurate information, threatening to fire the auditors or have an audit partner removed because of objections to the issuer's accounting, blackmailing and making physical threats. Bribery, blackmail and physical threats are already prohibited by other laws. Existing Rule 13b2-2 already prohibits officers and directors from providing misleading information to accountants. Section 301 of SOX has taken the power to hire and fire auditors out of the hands of companies and given it to their independent audit committees, so I think it is unlikely companies will be making empty threats and even less likely that accounting firms will be cowed by empty threats. Other types of fraud are presumably covered by existing rules such as Rule 10b-5, which already makes it unlawful for any person "to employ any device, scheme, or artifice to defraud." The SEC acknowledges that its new Rule 13b2-2(b) (say that three times fast) covers matters already dealt with elsewhere, but the SEC believes the new rule will

provide an additional means to address conduct to coerce, manipulate, mislead, or fraudulently influence an auditor during his or her examination or review of the issuer's financial statements, including conduct that did not succeed in affecting the audit or review.

2003-05-21T10:50:00.000-07:00

SHOULD HEALTHSOUTH ADVANCE SCRUSHY'S DEFENSE COSTS? As reported here in the New York Times, Richard M. Scrushy, former CEO of Healthsouth Corporation, is attempting to get Healthsouth to pay his legal bills. You may recall that 11 former Healthsouth employees have already pled guilty to a scheme to manifacture over $1.4 billion in earnings. Mr. Scrushy is facing civil and criminal charges, as well as private securities litigation, over his role in this fraudulent scheme. You may wonder what kind of chutzpah a guy like Scrushy must have to turn around and ask the victim of his alleged fraud to pay for his defense costs. Healthsouth is a Delaware corporation. Section 145 of the Delaware General Corporation Law (DGCL) permits (and in some cases requires) corporations to indemnify a current or former officer (such as Scrushy) for any actions (civil or criminal) brought "by reason of the fact that" the officer was an officer of the corporation. Indemnification may only be paid if the officer

acted in good faith and in a manner the [officer] reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe the person's conduct was unlawful.

In addition, the SEC believes agreements to indemnify officers for certain securities law violations is against public policy and therefore unenforceable. See Item 510 of Regulation S-K. Technically, therefore, indemnification payments can be made only after resolution of the action brought against the officer. This after-the-fact payment scheme does not do anything help officers actually defend themselves. No attorney worth hiring would agree to defend an officer if he could not pay anything to the attorney until the action was resolved and, if the action was resolved against the officer, may not ever be able to pay anything to the attorney at all. For this reason, Section 145(e) authorizes Delaware corporations to advance to the officer his defense expenses so long as the officer undertakes to repay the advances if it is ultimately determined that the officer is not entitled to indemnification. Corporations don't have to advance expenses, so when officers like Scrushy join a corporation they typically enter into indemnification agreements with the corporation that require the corporation to advance expenses in situations like this. Although I have not reviewed the Healthsouth indemnity agreement (it is an exhibit to a pre-EDGAR SEC filing), if it was well-drafted it will require advancement and it will require Healthsouth to pay any legal fees Scrushy incurs attempting to get Healthsouth to honor its contractual advancement obligation. If the Scrushy indemnification agreement was well-drafted, on what grounds is Healthsouth refusing to advance Scrushy's expenses? It may simply be a tactic to push Scrushy into an early plea. If this kind of tactic becomes standard operating procedure in situations like this, it will become reason #89 why no sane individual should agree to serve on a public corporation's board.

2003-05-19T15:46:00.000-07:00

UPDATE ON WORLDCOM: According to this SEC release, the actual Worldcom fine is $1.51 billion -- the SEC will accept $500 million because of Worldcom's bankruptcy. The SEC also confirms my speculation that the fine will be paid into its "Fair Funds for Investors" fund established under Section 308 of Sarbanes-Oxley, although the SEC's release does not describe who is eligible to claim amounts under this fund. Even when reduced to $500 million, this is the largest civil fine ever levied by the SEC. The question remains -- what purpose does it serve? The executives who engineered the fraud are already gone from the company, the stockholders have already been wiped out, thousands of employees have already lost their jobs, significant business units have already been sold, major customers have already defected, the company is already in bankruptcy. The remaining employees and creditors of MCI Worldcom have already suffered quite a bit for a fraud committed by others -- why punish them further?

2003-05-19T12:50:00.000-07:00

WHO PAYS THE WORLDCOM FINE? According to this report, MCI has agreed to pay $500 million in fines to settle securities fraud charges brought by the SEC. It is not clear to me what this fine is supposed to accomplish. The Worldcom executives who got MCI into this mess no longer work for MCI -- in fact, many face individual civil, criminal and private securities fraud suits. The Worldcom common stockholders, who (perhaps unwittingly) benefitted from any stock price inflation caused by the accounting shenanigans, have already been wiped out by MCI's bankruptcy. The only parties left with any kind of financial stake in MCI -- MCI's creditors -- were innocent victims of the fraud but will be required to "pay" this fine to the SEC. Section 308 of the Sarbanes-Oxley Act requires the SEC to establish a disgorgement fund for the victims of securities fraud. If this MCI penalty ends up being paid into that fund, it would seem that the parties who are in effect paying the fine -- the MCI creditors -- are also likely to be some of most compelling claimants to recover the fine from the disgorgement fund.

2003-05-19T11:06:00.000-07:00

DID OMNICARE JUST GET NARROWER? On Friday Delaware Governor Ruth Ann Minner announced that she would nominate Court of Chancery Vice Chancellor Jack B. Jacobs to the Delaware Supreme Court, where he would replace Justice Joseph T. Walsh, who retired on April 30, 2003. Just this April, Justice Walsh was one of 3 justices in the narrow 3-2 majority overturning the deal protection measures at issue in Omnicare v. NCS. With Justice Walsh off the court and Vice Chancellor Jacobs on, one wonders whether the troubling Omnicare decision will be interpreted narrowly -- perhaps even limited to its facts.

2003-05-19T08:32:00.000-07:00

HEDGE FUNDS FOR THE LITTLE GUY? This Jane Bryant Quinn column in Newsweek doesn't ring true to me. Ms. Quinn is concerned that Wall Street is cooking up a batch of "hedge funds" designed to lure Main Street back to Wall Street:

Hedge funds for the masses? Uh-oh. Until recently, these investments were strictly a hide-out for rich folk and institutions, such as college endowments and pension funds. Minimum investments ran to $1 million and up. But Main Street investors wary of stocks are poking around for something new—especially something like hedge funds, whose average price rose during the terrible 2002s. So, always obliging, Wall Street is tailoring funds for the “mass affluent”—those with $25,000 or $50,000 to invest. One fund lets you start with just $5,000.

The main legal difference between a hedge fund and a mutual fund is that a hedge fund is not required to register under, and comply with, the Investment Company Act of 1940. In order to do this, most hedge funds rely on the "qualified purchaser" exemption found in Section 3(c)(7) of the 1940 Act. The "qualified purchaser" exemption requires the fund to sell only to people or companies with at least $5 million in investments. Anyone can call their fund a "hedge fund" -- the term has no legal meaning. I think Ms. Quinn is either describing common mutual funds that are seeking the cache of hedge funds by borrowing the name, or efforts by Wall Street to market traditional hedge funds to people with at least $5 million in investments. Either way, this will not result in "hedge funds for the masses." If anything, after the SEC finishes scrutinizing the hedge fund industry, it will probably get even more difficult to market these funds to anyone in the vicinity of the masses.

2003-05-19T07:45:00.000-07:00

THE COST OF SOX: The regulatory burden of Sarbanes-Oxley has clearly made it more expensive to be a public company. This article from CFO Magazine discusses the growing trend of public companies going private in order to avoid these costs. According to the article, public companies with market caps of less than $500 million are all but invisible to securities analysts, mutual funds and investors. These micro-cap companies get almost none of the benefits of being public, but are expected to pay all the costs of being public.

2003-05-17T12:18:00.000-07:00

BLOG ROUND UP: A Taxing Blog links to a story describing a German "pleasure tax" assessed against brothels and other sex venues. A tax like this would certainly plug a few holes in California's budget. Ernie the Attorney is disenchanted with the Matrix Reloaded. How Appealing links to two Sunday New York Times articles discussing blogging. Overlawyered is all over the Oreos lawsuit. SCOTUSblog predicts a slew of Supreme Court opinions and orders on Monday. So Cal Law Blog finds a great new blog discussing corporate law matters. Oh wait, he's referring to Corp Law Blog....

2003-05-16T16:02:00.000-07:00

WINNING WITH 1% OF THE VOTE: At today's AOL Time Warner annual meeting stockholders registered their disapproval with some of the directors up for election. According to this Reuters report, while 96% of the voting shares were voted for Ted Turner, Steve Case managed only 78% and his associate Miles Gilburne's level fell to 65%. Of course, Case and Gilburne would have won re-election even if 99.9% of the shares had been withheld. This is because directors, like U.S. Presidents, can win an election with only a plurality of the votes. In addition, if the number of nominated directors equals the number of open seats, a director can lose only if no shares are voted for him. This explains why stockholder activists such as AFSCME are campaigning to force AOL and other companies to permit stockholders to nominate directly candidates for board seats, thereby creating competitive races. The prospect of competitive board races is reason #87 why no sane individual should join the board of a public company.

2003-05-16T08:56:00.000-07:00

CORPORATE GOVERNANCE BY LERACH: As discussed in this Business Week article, Hanover Compressor (NYSE:HC) recently settled a securities fraud suit led by Milberg Weiss, Bill Lerach's firm. In addition to paying the requisite $80 million to Lerach and his clients, Hanover Compressor was required as part of the settlement to abide by an extraordinary nine-page list of corporate governance provisions and management restrictions that go well beyond anything found in Sarbanes-Oxley or the upcoming NYSE or Nasdaq corporate goverance rules. HC's press release announcing the settlement is here, and a copy of the settlement agreement can be found as an exhibit to the Form 8-K filed by HC on May 14, 2003 which, for 10kwizard.com subscribers, can be found here. Some of the more interesting governance provisions: (1) 2/3 of the board must be independent, (2) the definition of "independence" is expanded beyond the NYSE's proposed definition, (3) an independent lead director schedules and runs board meetings, (4) only independent directors may serve on the nominating committee, (5) two directors are nominated by Lerach and the lead independent director, after consulting with each stockholder owning more than 1% but less than 10% of HC's shares, (6) HC must disclose in each quarterly report the amount by which income was benefitted by an adjustment of a reserve or contingency, if the adjustment is more than 1% of revenues, (7) HC must expense all stock option grants, (8) HC must rotate its auditing firm (not just its partner, as required by SOX) every five years, (9) directors and officers must hold at least 33% of shares acquired on option exercises for at least 12 months, and (10) any "change in control" definition in an executive compensation plan can only be triggered by the closing of an actual sale or merger, and cannot be triggered by a vote approving a sale or merger. HC is required to abide by these provisions for 5 years, and can amend them only with the approval of Lerach which, thankfully for HC, cannot be unreasonably withheld. By giving a non-security holder a veto over amendments to HC's bylaws and certificate of incorporation and a key role in the selection of directors, I think the HC settlement goes too far in disenfranchising stockholders and may, for that reason, be unenforceable. Delaware's General Corporation Law requires corporations to be run by directors elected by stockholders; nowhere does it provide a role for plaintiffs' attorneys. It's one thing for the SEC, NYSE and Nasdaq to usurp authority over corporate law issues from the states (see this article for a discussion of this phenomenon), it is quite another for plaintiffs' firms to be running the show. Although, now that Lerach will be a "control person" of HC, if HC continues to experience troubles, it would be interesting to see Lerach defend himself against future strike suits filed by his brethren.

2003-05-15T16:25:00.000-07:00

SUIT AGAINST U.S. SENATE: Judicial Watch, a conservative D.C.-based organization, filed suit against the U.S. Senate seeking to overturn the filibusters holding up the nominations of Miguel Estrada to the D.C. Circuit and Priscilla Owen to the 5th Circuit. How, you may wonder, does Judicial Watch assert standing in this suit? According to the complaint, (1) Judicial Watch is second only to the U.S. government in suits pending before the D.C. Circuit, (2) one-third of the D.C. Circuit's judgeships remain unfilled, (3) Judicial Watch has therefore experienced "substantial delays" in the cases it has filed before the D.C. Circuit, and (4) therefore Judicial Watch is being harmed by the continued failure of the Senate to confirm these judicial nominations. Despite the clever standing argument, the suit appears doomed to fail because, as discussed on the Volokh Conspiracy, it presents exactly the kind of political question courts hate to decide.

2003-05-15T11:35:00.000-07:00

GOODBYE TO LARGE (AND MEDIUM) "S" CORPS IN CALIFORNIA? As noted in this Tax Alert from O'Melveny & Myers, California's legislature appears to be heading towards approval of SB 516, a bill that would treat any California "S" corp with $20 million or more in annual revenues as a "C" corp. Overnight, this would increase the "S" corp's California tax rate from 1.5% to 8.84% and treat distributions to shareholders as ordinary income dividends. As the author of O'Melveny's Tax Alert so eloquently put it:

The law would add fuel to the already blazing fire surrounding the ability of California to attract and sustain business here. The business community (both locally and nationally) increasingly views California as a state in which it is becoming not economically viable to do business.

2003-05-15T01:24:00.000-07:00

SECTION 16 FILING FAQ: On Tuesday, the SEC's Division of Corporation Finance posted a helpful FAQ regarding the new rules requiring Forms 3, 4 and 5 under Section 16 to be filed electronically.

2003-05-15T01:14:00.000-07:00

WHAT'S GOOD FOR THE GOOSE: The SEC has asked the NYSE and Nasdaq Stock Market to report to the SEC by May 15 on their own governance procedures, and has reportedly already requested the exchanges to make certain changes in their governance procedures. According to this Reuters report, neither the NYSE nor the Nasdaq are ready to report today to the SEC, and each also is objecting to some of the SEC's governance requests. The New York Times has a more complete report here in today's edition. The new corporate governance guidelines being proposed by NYSE and Nasdaq for their listed companies will demand a lot of flexibility once implemented. I only hope the NYSE and Nasdaq are prepared to give to their listed companies the sort of flexibility they seem to be expecting from the SEC.

2003-05-14T20:02:00.000-07:00

A TRIP TO THE SAUSAGE FACTORY: The California Chamber of Commerce publishes a depressingly long Bad Bills List. In addition to SB 766 (discussed below), the list includes: SB 335 -- the "Corporate Three Strikes Act" would ban corporations and other entities (such as LLCs) convicted of three felonies from doing business in California. SB 335 applies to entities formed in California and may also apply to quasi-California corporations, entities qualified to do business in California and even entities with subsidiaries in California, if the subsidiaries are convicted of felonies. AB 664 -- a clumsy incorporation of a number of Sarbanes-Oxley Act provisions into California law, including a probably unworkable graft of the attorney responsibility provision from SOX Section 307. Nearly all the intrepretative issues worked out by the SEC over the past 9 months are ignored in AB 664, leaving open all sorts of questions we thought had been answered. SB 917 -- a disturbingly bizarre bill that would, on and after January 1, 2017, establish both a public and a private right of action against any director of a California corporation if the corporation "violates any . . . law designed to protect the environment, violates human rights, adversely affects the public health or safety, damages the welfare of the communities in which the corporation operates, or violates the dignity of its employees. . . . " The only defenses available to a director are to show either (1) he was not on the board at the time, (2) he voted against the bad action at a board meeting or (3) the corporation had annual revenues of less than $15 million. Otherwise, this bill appears to create strict liability for directors for exceedingly vague actions such as violating people's dignity or harming a community's welfare. Of course, if a plaintiff can show intent, the possibility of punitive damages as well. If SB 917 passes, I'll join the Consumer Attorneys of California and dream of making the following closing argument: "Ladies and gentlemen of the jury, not only did the defendant's corporation intentionally close a factory, harming a community, he also violated the dignity of its employees by putting them out of work. For these intentional actions, we demand actual damages of $48 quadrillion and punitives of $432 quadrillion." I wouldn't even have to know what I was doing to win big under this bill. It'd be like shooting fish in a barrel. Perhaps my (least) favorite, though, is SB 204. SB 204, which is being carried by no less than 4 authors and 3 co-authors, would require manufacturers of diapers to be responsible for the stewardship of their used products. "Stewardship" means Pampers and Huggies would somehow have to collect used diapers, separate out the human wastes and send them to sewage treatment and then recycle the used diapers into new ones. I only hope my two-year old figures out the potty before this one gets enacted.

2003-05-14T18:15:00.000-07:00

FOUR BILLS FOR LERACH: Bill Lerach must be very happy with California State Senator Dean Florez. Florez has introduced four bills in the current legislative session that would, if passed, make it much easier for Lerach to recover damages in securities fraud suits brought by individual Californians under California law. Although most securities class actions must be brought in federal court under federal law, suits by individual plaintiffs (such as the massive California pension funds CalPERS and CalSTRS) may be brought in California courts under California state law. Therefore, these bills could provide significant assistance to Lerach and others who are looking for ways around SLUSA and other federal laws limiting their practice. California Corporations Code Section 25500 imposes civil liability on people who “willfully participate” in an act that violates Section 25400 (Manipulation of Prices or Appearances of Trading). Section 25400, among other things, makes it unlawful for a “broker-dealer or other person selling or offering for sale or purchasing or offering for purchase the security” to induce others to trade by making false or misleading statements. Section 25401 of the Corporations Code is a 10b-5-like antifraud statute, but appears to be less attractive to plaintiffs because it limits damages and provides defenses not available under Section 25400. SB 766 would broaden what it means to “willfully participate” under Section 25500 by (1) specifying that a person does not need to actually buy or sell a security in order to willfully participate, overruling a key holding in a case decided against Lerach’s client -- Kamen v. Lindly (2001) (one must have been a “market participant” in order to be liable), and (2) lowering the culpable mental state from “knowing and intentional” to something else, probably reckless, overruling the holding in California Amplifier v. RLI Insurance. The result – investment bankers, accountants and corporate lawyers are going to have a harder time getting dismissed from California securities fraud suits. The other Florez bills offer other assistance to California plaintiffs and their lawyers – SB 325 would extend the statute of limitations for “fraud in connection with the sale or issuance of corporate securities” from three years to five years from the date of discovery; SB 355 would make aiders and abettors primarily liable under Section 25401 (California’s 10b-5 analogue), thereby expanding it beyond the federal version to include investment bankers, accountants and attorneys as potential primary violators; and SB 396 would makes insurers liable for willful violations by policyholders of Section 25500, carving out an exception to California’s general rule that insurers cannot insure for willful acts. Lest you think these bills are atypical in California, I will detail in later posts several other anti-business bills pending in this year's California legislative session. It all makes one wonder whether it is possible for a public company to prevent Californians from owning its shares....

2003-05-14T10:37:00.000-07:00

CHECKING OUT OF THE ROACH MOTEL: The Nasdaq Stock Market has petitioned the SEC to repeal the New York Stock Exchange's Rule 500. The petition is not yet available on the SEC's website, but you can view it and a press release here on the Nasdaq's web site. The version of NYSE Rule 500 in effect since 1999 prevents a NYSE-listed company from leaving the Big Board unless it issues a press release, sends a notice to its top 25 stockholders and obtains the approval of both the entire board and the board's audit committee. The prior version of Rule 500, in effect from the 1930s until 1999, made it so difficult to leave the NYSE that it was dubbed the "roach motel" -- companies go in but they can never leave. The NYSE changed the roach motel version of Rule 500 in 1999 in response to pressure from the SEC. At the time, Nasdaq pressed to eliminate Rule 500 in its entirety as an unnecessary barrier to competition. In its new petition, Nasdaq again presses this case. Is Nasdaq taking advantage of the NYSE's current travails to finish what was started in 1999?

2003-05-13T16:43:00.000-07:00

FROM LAWYER TO CONSULTANT: Former SEC Chair Harvey Pitt plans to start a "consultancy called Kalorama Partners LLC, a Washington-based firm that will specialize in corporate-governance and crisis-management issues and provide regulatory advice for companies in the United States and abroad," according to this article in today's Washington Post. Former Fried, Frank partner Pitt will no longer be a lawyer-giving-legal-advice, he will now be a consultant-giving-regulatory-advice. Not being a lawyer-giving-legal-advice has many advantages, such as having the freedom to share profits with non-lawyers and conduct business within a truly limited liability entity, as well as avoiding state bar dues. If this works for Pitt, I predict a lot of other corporate lawyers will follow his lead and declare themselves consultants-giving-regulatory-advice.

2003-05-13T15:19:00.000-07:00

LAWYERS AS LOUSY TARGETS: I sure hope this article from the New York Law Journal gets passed around by plaintiffs' counsel. According to the article, "[a]s the nation's major law firms wrestle with how to avoid massive liability in the post-Enron world, they can take some comfort in the thought that the lawyers suing them are not entirely thrilled at the prospect either. That is because supposedly deep-pocketed law firms are frustratingly small potatoes. . . ." None of the largest law firms carries more than $100 million in liability insurance, and most carry much less, the article states. I suppose less than $100 million counts as "small potatoes" these days. In addition, the article notes: "Lawyers have already become accustomed to a large degree of instability in a marketplace where partners switch firms with ease and firms merge, expand and, sometimes, collapse. Such developments are anathema to plaintiffs' lawyers, whose preferred corporate defendants are not only large and staggeringly wealthy but also fairly stable organizations with a high tolerance for litigation pain. By comparison, law firms are tiny, fragile enterprises with virtually no assets beyond their highly mobile professional talent." I guess working for a "tiny, fragile enterprise" has some advantages after all....

2003-05-13T12:41:00.000-07:00

LBO MARKET IN DECLINE? U.S. Bancorp Piper Jaffray has studied the LBO market and concluded, not surprisingly, that the number of LBOs peaked in the late 1980s. Piper Jaffray's study is available here. The study concludes on a gloomy note: "Currently, the leveraged buyout industry faces a challenging environment due to the availability of relatively low leverage, $120 billion in uninvested capital, hundreds of financial sponsors, and a difficult M&A environment. The current leveraged buyout industry is very competitive. We suspect that many of the current players in the private equity community will not survive this more competitive environment."

2003-05-13T12:16:00.000-07:00

VLG MERGER? This article from The Recorder (via Law.com) reports that Venture Law Group and Orrick, Herrington & Sutcliffe "are engaged in ongoing talks about a merger".

2003-05-13T10:20:00.000-07:00

Welcome to The Corporate Lawyer. I practice corporate law at a Los Angeles-based law firm. This blog is my virtual bulletin board -- as I locate practice-related items on the web, I will post them here for my use and for other corporate lawyers.