Securities Mosaic® Blogwatch
July 22, 2016
Commonsense Principles of Corporate Governance
by Margaret Popper, Sard Verbinnen
Editor's Note:

The Commonsense Principles of Corporate Governance were developed, and are posted on behalf of, a group of executives leading prominent public corporations and investors in the U.S. The Open Letter and key facts about the principles are also available here and here.

The following is a series of corporate governance principles for public companies, their boards of directors and their shareholders. These principles are intended to provide a basic framework for sound, long-term-oriented governance. But given the differences among our many public companies—including their size, their products and services, their history and their leadership—not every principle (or every part of every principle) will work for every company, and not every principle will be applied in the same fashion by all companies.

I. Board of Directors—Composition and Internal Governance a. Composition
  • Directors’ loyalty should be to the shareholders and the company. A board must not be beholden to the CEO or management. A significant majority of the board should be independent under the New York Stock Exchange rules or similar standards.
  • All directors must have high integrity and the appropriate competence to represent the interests of all shareholders in achieving the long-term success of their company. Ideally, in order to facilitate engaged and informed oversight of the company and the performance of its management, a subset of directors will have professional experiences directly related to the company’s business. At the same time, however, it is important to recognize that some of the best ideas, insights and contributions can come from directors whose professional experiences are not directly related to the company’s business.
  • Directors should be strong and steadfast, independent of mind and willing to challenge constructively but not be divisive or self-serving. Collaboration and collegiality also are critical for a healthy, functioning board.
  • Directors should be business savvy, be shareholder oriented and have a genuine passion for their company.
  • Directors should have complementary and diverse skill sets, backgrounds and experiences. Diversity along multiple dimensions is critical to a high-functioning board. Director candidates should be drawn from a rigorously diverse pool.
  • While no one size fits all—boards need to be large enough to allow for a variety of perspectives, as well as to manage required board processes—they generally should be as small as practicable so as to promote an open dialogue among directors.
  • Directors need to commit substantial time and energy to the role. Therefore, a board should assess the ability of its members to maintain appropriate focus and not be distracted by competing responsibilities. In so doing, the board should carefully consider a director’s service on multiple boards and other commitments.
b. Election of directors
  • Directors should be elected by a majority of the votes cast “for” and “against/withhold” (i.e., abstentions and non-votes should not be counted for this purpose).
c. Nominating directors
  • Long-term shareholders should recommend potential directors if they know the individuals well and believe they would be additive to the board.
  • A company is more likely to attract and retain strong directors if the board focuses on big-picture issues and can delegate other matters to management (see below at II.b., “Board of Directors’ Responsibilities/Critical activities of the board; setting the agenda”).
d. Director compensation and stock ownership
  • A company’s independent directors should be fairly and equally compensated for board service, although (i) lead independent directors and committee chairs may receive additional compensation and (ii) committee service fees may vary. If directors receive any additional compensation from the company that is not related to their service as a board member, such activity should be disclosed and explained.
  • Companies should consider paying a substantial portion (e.g., for some companies, as much as 50% or more) of director compensation in stock, performance stock units or similar equity-like instruments. Companies also should consider requiring directors to retain a significant portion of their equity compensation for the duration of their tenure to further directors’ economic alignment with the long-term performance of the company.
e. Board committee structure and service
  • Companies should conduct a thorough and robust orientation program for their new directors, including background on the industry and the competitive landscape in which the company operates, the company’s business, its operations, and important legal and regulatory issues, etc.
  • A board should have a well-developed committee structure with clearly understood responsibilities. Disclosures to shareholders should describe the structure and function of each board committee.
  • Boards should consider periodic rotation of board leadership roles (i.e., committee chairs and the lead independent director), balancing the benefits of rotation against the benefits of continuity, experience and expertise.
f. Director tenure and retirement age
  • It is essential that a company attract and retain strong, experienced and knowledgeable board members.
  • Some boards have rules around maximum length of service and mandatory retirement age for directors; others have such rules but permit exceptions; and still others have no such rules at all. Whatever the case, companies should clearly articulate their approach on term limits and retirement age. And insofar as a board permits exceptions, the board should explain (ordinarily in the company’s proxy statement) why a particular exception was warranted in the context of the board’s assessment of its performance and composition.
  • Board refreshment should always be considered in order to ensure that the board’s skill set and perspectives remain sufficiently current and broad in dealing with fast-changing business dynamics. But the importance of fresh thinking and new perspectives should be tempered with the understanding that age and experience often bring wisdom, judgment and knowledge.
g. Director effectiveness
  • Boards should have a robust process to evaluate themselves on a regular basis, led by the non-executive chair, lead independent director or appropriate committee chair. The board should have the fortitude to replace ineffective directors.
II. Board of Directors’ Responsibilities a. Director communication with third parties
  • Robust communication of a board’s thinking to the company’s shareholders is important. There are multiple ways of going about it. For example, companies may wish to designate certain directors—as and when appropriate and in coordination with management—to communicate directly with shareholders on governance and key shareholder issues, such as CEO compensation. Directors who communicate directly with shareholders ideally will be experienced in such matters.
  • Directors should speak with the media about the company only if authorized by the board and in accordance with company policy.
  • In addition, the CEO should actively engage on corporate governance and key shareholder issues (other than the CEO’s own compensation) when meeting with shareholders.
b. Critical activities of the board; setting the agenda
  • The full board (including, where appropriate, through the non-executive chair or lead independent director) should have input into the setting of the board agenda.
  • Over the course of the year, the agenda should include and focus on the following items, among others:
    • A robust, forward-looking discussion of the business.
    • The performance of the current CEO and other key members of management and succession planning for each of them. One of the board’s most important jobs is making sure the company has the right CEO. If the company does not have the appropriate CEO, the board should act promptly to address the issue.
    • Creation of shareholder value, with a focus on the long term. This means encouraging the sort of long-term thinking owners of a private company might bring to their strategic discussions, including investments that may not pay off in the short run.
    • Major strategic issues (including material mergers and acquisitions and major capital commitments) and long-term strategy, including thorough consideration of operational and financial plans, quantitative and qualitative key performance indicators, and assessment of organic and inorganic growth, among others.
    • The board should receive a balanced assessment on strategic fit, risks and valuation in connection with material mergers and acquisitions. The board should consider establishing an ad hoc Transaction Committee if significant board time is otherwise required to consider a material merger or acquisition. If the company’s stock is to be used in such a transaction, the board should carefully assess the company’s valuation relative to the valuation implied in the acquisition. The objective is to properly evaluate the value of what you are giving vs. the value of what you are getting.
    • Significant risks, including reputational risks. The board should not be reflexively risk averse; it should seek the proper calibration of risk and reward as it focuses on the long-term interests of the company’s shareholders.
    • Standards of performance, including the maintaining and strengthening of the company’s culture and values.
    • Material corporate responsibility matters.
    • Shareholder proposals and key shareholder concerns.
    • The board (or appropriate board committee) should determine the best approach to compensate management, taking into account all the factors it deems appropriate, including corporate and individual performance and other qualitative and quantitative factors (see below at VII., “Compensation of Management”).
  • A board should be continually educated on the company and its industry. If a Board feels it would be productive, outside experts and advisors should be brought in to inform directors on issues and events affecting the company.
  • The board should minimize the amount of time it spends on frivolous or non-essential matters—the goal is to provide perspective and make decisions to build real value for the company and its shareholders.
  • As authorized and coordinated by the board, directors should have unfettered access to management, including those below the CEO’s direct reports.
  • At each meeting, to ensure open and free discussion, the board should meet in executive session without the CEO or other members of management. The independent directors should ensure that they have enough time to do this properly.
  • The board (or appropriate board committee) should discuss and approve the CEO’s compensation.
  • In addition to its other responsibilities, the Audit Committee should focus on whether the company’s financial statements would be prepared or disclosed in a materially different manner if the external auditor itself were solely responsible for their preparation.
III. Shareholder Rights
  1. Many public companies and asset managers have recently reviewed their approach to proxy access. Others have not yet undertaken such a review or may have one under way. Among the larger market capitalization companies that have adopted proxy access provisions, generally a shareholder (or group of up to 20 shareholders) who has continuously held a minimum of 3% of the company’s outstanding shares for three years is eligible to include on the company’s proxy statement nominees for a minimum of 20% (and, in some cases, 25%) of the company’s board seats. Generally, only shares in which the shareholder has full, unhedged economic interest count toward satisfaction of the ownership/holding period requirements. A higher threshold of ownership (e.g., 5%) often has been adopted for smaller market capitalization companies (e.g., less than $2 billion).
  2. Dual-class voting is not a best practice. If a company has dual-class voting, which sometimes is intended to protect the company from short-term behavior, the company should consider having specific sunset provisions based upon time or a triggering event, which eliminate dual-class voting. In addition, all shareholders should be treated equally in any corporate transaction.
  3. Written consent and special meeting provisions can be important mechanisms for shareholder action. Where they are adopted, there should be a reasonable minimum amount of outstanding shares required in order to prevent a small minority of shareholders from being able to abuse the rights or waste corporate time and resources.
IV. Public Reporting
  1. Transparency around quarterly financial results is important.
  2. Companies should frame their required quarterly reporting in the broader context of their articulated strategy and provide an outlook, as appropriate, for trends and metrics that reflect progress (or not) on long-term goals. A company should not feel obligated to provide earnings guidance—and should determine whether providing earnings guidance for the company’s shareholders does more harm than good. If a company does provide earnings guidance, the company should be realistic and avoid inflated projections. Making short-term decisions to beat guidance (or any performance benchmark) is likely to be value destructive in the long run.
  3. As appropriate, long-term goals should be disclosed and explained in a specific and measurable way.
  4. A company should take a long-term strategic view, as though the company were private, and explain clearly to shareholders how material decisions and actions are consistent with that view.
  5. Companies should explain when and why they are undertaking material mergers or acquisitions or major capital commitments.
  6. Companies are required to report their results in accordance with Generally Accepted Accounting Principles (“GAAP”). While it is acceptable in certain instances to use non-GAAP measures to explain and clarify results for shareholders, such measures should be sensible and should not be used to obscure GAAP results. In this regard, it is important to note that all compensation, including equity compensation, is plainly a cost of doing business and should be reflected in any non-GAAP measurement of earnings in precisely the same manner it is reflected in GAAP earnings.
V. Board Leadership (Including the Lead Independent Director’s Role)
  1. The board’s independent directors should decide, based upon the circumstances at the time, whether it is appropriate for the company to have separate or combined chair and CEO roles. The board should explain clearly (ordinarily in the company’s proxy statement) to shareholders why it has separated or combined the roles.
  2. If a board decides to combine the chair and CEO roles, it is critical that the board has in place a strong designated lead independent director and governance structure.
  3. Depending on the circumstances, a lead independent director’s responsibilities may include:
    • Serving as liaison between the chair and the independent directors
    • Presiding over meetings of the board at which the chair is not present, including executive sessions of the independent directors
    • Ensuring that the board has proper input into meeting agendas for, and information sent to, the board
    • Having the authority to call meetings of the independent directors
    • Insofar as the company’s board wishes to communicate directly with shareholders, engaging (or overseeing the board’s process for engaging) with those shareholders
    • Guiding the annual board self-assessment
    • Guiding the board’s consideration of CEO compensation
    • Guiding the CEO succession planning process
VI. Management Succession Planning
  1. Senior management bench strength can be evaluated by the board and shareholders through an assessment of key company employees; direct exposure to those employees is helpful in making that assessment.
  2. Companies should inform shareholders of the process the board has for succession planning and also should have an appropriate plan if an unexpected, emergency succession is necessary.
VII. Compensation of Management
  1. To be successful, companies must attract and retain the best people—and competitive compensation of management is critical in this regard. To this end, compensation plans should be appropriately tailored to the nature of the company’s business and the industry in which it competes. Varied forms of compensation may be necessary for different types of businesses and different types of employees. While a company’s compensation plans will evolve over time, they should have continuity over multiple years and ensure alignment with long-term performance.
  2. Compensation should have both a current component and a long-term component.
  3. Benchmarks and performance measurements ordinarily should be disclosed to enable shareholders to evaluate the rigor of the company’s goals and the goal-setting process. That said, compensation should not be entirely formula based, and companies should retain discretion (appropriately disclosed) to consider qualitative factors, such as integrity, work ethic, effectiveness, openness, etc. Those matters are essential to a company’s long-term health and ordinarily should be part of how compensation is determined.
  4. Companies should consider paying a substantial portion (e.g., for some companies, as much as 50% or more) of compensation for senior management in the form of stock, performance stock units or similar equity-like instruments. The vesting or holding period for such equity compensation should be appropriate for the business to further senior management’s economic alignment with the long-term performance of the company. With properly designed performance hurdles, stock options may be one element of effective compensation plans, particularly for the CEO. All equity grants (whether stock or options) should be made at fair market value, or higher, at the time of the grant, with particular attention given to any dilutive effect of such grants on existing shareholders.
  5. Companies should clearly articulate their compensation plans to shareholders. While companies should not, in the design of their compensation plans, feel constrained by the preferences of their competitors or the models of proxy advisors, they should be prepared to articulate how their approach links compensation to performance and aligns the interests of management and shareholders over the long term. If a company has well-designed compensation plans and clearly explains its rationale for those plans, shareholders should consider giving the company latitude in connection with individual annual compensation decisions.
  6. If large special compensation awards (not normally recurring annual or biannual awards but those considered special awards or special retention awards) are given to management, they should be carefully evaluated and—in the case of the CEO and other “Named Executive Officers” whose compensation is set forth in the company’s proxy statement—clearly explained.
  7. Companies should maintain clawback policies for both cash and equity compensation.
VIII. Asset Managers’ Role in Corporate Governance

Asset managers, on behalf of their clients, are significant owners of public companies, and, therefore, often are in a position to influence the corporate governance practices of those companies. Asset managers should exercise their voting rights thoughtfully and act in what they believe to be the long-term economic interests of their clients.

  1. Asset managers should devote sufficient time and resources to evaluate matters presented for shareholder vote in the context of long-term value creation. Asset managers should actively engage, as appropriate, based on the issues, with the management and/or board of the company, both to convey the asset manager’s point of view and to understand the company’s perspective. Asset managers should give due consideration to the company’s rationale for its positions, including its perspective on certain governance issues where the company might take a novel or unconventional approach.
  2. Given their importance to long-term investment success, proxy voting and corporate governance activities should receive appropriate senior-level oversight by the asset manager.
  3. Asset managers, on behalf of their clients, should evaluate the performance of boards of directors, including thorough consideration of the following:
    • To the extent directors are speaking directly with shareholders, the directors’ (i) knowledge of their company’s corporate governance and policies and (ii) interest in understanding the key concerns of the company’s shareholders
    • The board’s focus on a thoughtful, long-term strategic plan and on performance against that plan
  4. An asset manager’s ultimate decision makers on proxy issues important to long-term value creation should have access to the company, its management and, in some circumstances, the company’s board. Similarly, a company, its management and board should have access to an asset manager’s ultimate decision makers on those issues.
  5. Asset managers should raise critical issues to companies (and vice versa) as early as possible in a constructive and proactive way. Building trust between the shareholders and the company is a healthy objective.
  6. Asset managers may rely on a variety of information sources to support their evaluation and decision-making processes. While data and recommendations from proxy advisors may form pieces of the information mosaic on which asset managers rely in their analysis, ultimately, their votes should be based on independent application of their own voting guidelines and policies.
  7. Asset managers should make public their proxy voting process and voting guidelines and have clear engagement protocols and procedures.
  8. Asset managers should consider sharing their issues and concerns (including, as appropriate, voting intentions and rationales therefor) with the company (especially where they oppose the board’s recommendations) in order to facilitate a robust dialogue if they believe that doing so is in the best interests of their clients.

 * * *

The Open Letter from the authors of these principles, and key facts about the principles, are available here and here.

July 22, 2016
Bail-in and Market Stabilization
by Wolf-Georg Ringe
Editor's Note:

Wolf-Georg Ringe is Professor of International Commercial Law at Copenhagen Business School and at the University of Oxford. This post is based on recent paper authored by Professor Ringe.

The concept of “bailing in” a distressed bank’s creditors to avoid a taxpayer-financed public rescue is commonly accepted as one of the most significant regulatory achievements in the post-crisis efforts to end the problem of “Too Big To Fail”. Yet behind the political slogan, surprising uncertainties remain as to the precise regulatory objective of bail-in, as well as its trigger and the requirements for applying bail-in powers. Further, broad scepticism is voiced as to decisiveness of regulators to make use of their bail-in powers. In short, serious doubts persist as to the credibility of the concept, in particular relating to the fear that regulators may shy away from taking bail-in action in the decisive moment of rescue operations. Regulatory frameworks are ambivalent about the precise trigger requirements and substantial conditions for applying it. At the bottom of this vagueness is a surprising uncertainty about the policy purpose of bail-in.

In a recent paper, Bail-In between Liquidity and Solvency, I trace the development of the bail-in concept since it was first conceived in 2010 and demonstrate that it has undergone an important conceptual metamorphosis over the past few years. I argue that the objective of bail-in has changed over time, developing from a purely redistributory goal (to avoid taxpayer liability) to a market stabilization purpose (to stem panic by avoiding value-destroying runs). Whilst this trend is to be welcomed, it requires a number of changes to the present legal frameworks that are in place in many jurisdictions around the world.

From this insight, the paper derives a number of regulatory implications. Issues to be addressed include, inter alia, to formulate appropriate criteria to trigger bail-in measures and to overcome a natural reluctance by resolution authorities to intervene and apply bail-in powers. Chiefly, I argue that bail-in can and should be applied to both insolvent and illiquid financial institutions, and that the regulatory framework should encourage making use of bail-in powers probably even earlier than that. Further, I make the case for providing liquidity to a resolved financial institution by a robust lender of last resort, as bail-in in itself only addresses the recapitalization of an institution, but fails to make provision for ensuring its liquidity.

Overall, the paper seeks to place the bail-in idea into the broader debate around the different operational tools that regulators and central banks have when dealing with a troubled global financial institution. Measured against Bagehot’s classic toolkit, bail-in appears as the “third way” to handle a failing institution by seeking to self-insure banks so that a rescue with public money becomes unnecessary. Over the past several years, this concept has won over a startling number of supporters across the world. Crucially, however, the success of bail-in will depend on how credible the legal framework is.

The full paper is available here.

July 22, 2016
This Week In Securities Litigation (Week ending July 22, 2016)
by Tom Gorman

Investment advisers were at the center of a number of actions brought by the Commission this week . Two proceedings involved a registered adviser and its COO that were involved in an unregistered and fraudulent offering; two other actions centered on undisclosed conflicts related to loans extended to the adviser through a new broker arrangement that were forgiven in whole or part; another was based on preferences given in redemption rights. The Commission also filed a settled action centered on extensive accounting errors.

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 2 civil injunctive action and 6 administrative proceeding, excluding 12j and tag-along proceedings.

Offering fraud: In the Matter of Concert Global Group Limited, Adm. Proc. File No. 3-17354 (July 21, 2016) names as Respondents Concert Global, the parent company of Respondent and registered investment adviser Concert Wealth Management, Inc. and Felipe Luna, the CEO and Chairman of Concert Global. The proceeding centers on the sale of about $2.2 million of unregistered Concert Global shares. The shares were sold from 2010 through 2013 to advisory clients of Concert Wealth and others to support a growth plan. Investors were solicited using materials that were materially inaccurate since they overstated the AUM of Concert Global as well as its financial results and either misrepresented or failed to disclose conflicts arising from the potential use of the offering proceeds to pay several affiliated entities. The Order alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Advisers Act Sections 206(2) and 206(4). Respondents took a series of remedial steps including sending corrective updates to investors and engaging a compliance consultant to address concerns identified by the inspection staff. The firm also agreed to a number of undertakings. To resolve the matter Concert Global consented to the entry of a cease and desist order based on the Securities Act Sections cited in the Order. Concert Wealth consented to the entry of a cease and desist order based on the Advisers Act Sections cited in the Order and to a censure. Mr. Luna consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. Concert Global and Concert Wealth will, jointly and severally, pay a civil penalty of $120,000. Mr. Luna will pay a penalty of $60,000. See also In the Matter of Dennis Navarra, Adm. Proc. File No. 3-17355 (July 21, 2016)(proceeding against Mr. Navarra who was the CFO, COO and Chief Strategy Officer of Concert Wealth; resolved with a cease and desist order based on Securities Act Sections 5(a), 5(c) and 17(a) and Advisers Act Section 206(2), the entry of a censure but no penalty based on financial condition).

Offering fraud: SEC v. Williams, Civil Action No. 2:14cv00519 (D. Utah) is a previously filed action against Stanley Parrish and Tyson Williams. The complaint alleged that the two men raised about $1.5 million from investors by selling them interest in ST Ventures, LLC. The funds were supposed to be invested in collateralized mortgage obligations that would be leveraged to achieve large returns in a short period. In fact investor funds were used to pay other investors. This week the court entered permanent injunctions against each defendant based on Securities Act Sections 5 and 17(a) and Exchange Act Section 10(b). The two defendants will pay, on a joint and several basis, disgorgement in the amount of $3,111,484.89 along with prejudgment interest and a civil penalty of $130,000. See Lit. Rel. No. 23598 (July 20, 2016).

Improper registration: In the Matter of Saving2Retire, LLC, Adm. Proc. File No. 3-17352 (July 19, 2016) is an action which names as Respondents the adviser and its sole owner. In 2011 Saving2Retire registered with the Commission. It claimed to be eligible under Advisers Act Rule 203A-2(e) which exempts certain advisers from the prohibition on registration in Section 203A if the adviser provides advice to all clients through an interactive website. The rule also provides that an adviser claiming the exemption may give advice through other means if certain limitations are met. Save2Retire did not qualify under 203A-2(e) because it did not have internet clients. In addition, for at least one period the firm gave advice to more clients than permitted. And, it failed to produce documents during an inspection. The Order alleges violations of Advisers Act Sections 203A and 204. The proceeding will be set for hearing.

Undisclosed conflicts: In the Matter of Washington Wealth Management, LLC, Adm. Proc. File No. 3-17349 (July 18, 2016). Respondent is a registered investment adviser. The firm engaged a broker-dealer and registered investment adviser to provide client services. The adviser received over $1.8 million in loans from the broker, most of which were intended to be forgiven. The adviser failed to inform clients of this arrangement. The Order alleges violations of Advisers Act Sections 206(2) and 207. To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. In addition, the firm will pay a penalty of $50,000.

Undisclosed conflicts: In the Matter of Advantage Investment Management, LLC, Adm. Proc. File No. 3-17348 (July 18, 2016) is a proceeding which names as a Respondent the registered investment adviser. The adviser entered into an arrangement with a broker-dealer and registered investment adviser for client services. It received a $3 million, five year, forgivable loan. The adviser failed to disclose this arrangement to clients in violation of Advisers Act Section 207 and 206(2). To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. In addition, the firm agreed to pay a penalty of $60,000.

Conflicts: SEC v. Conrad, Civil Action No. 1:16-cv-02572 (N.D. Ga. Filed July 15, 2016). Thomas Conrad and his son Stuart were named as defendants in the action along with Financial Management Corporation and Financial Management Corporation, S.R.L. Thomas had been barred from association with any broker or dealer and the registration of his then broker-dealer firm revoked in a 1971 administrative proceeding. Financial Management acted as the general partner and unregistered investment adviser for the hedge funds operated by Mr. Conrad under the World Opportunity Fund name, including its successor, World Fund II. Financial Management Corp. assumed Financial Management’s role as the general partner and adviser to the World Opportunity feeder funds. Mr. Conrad created at least four hedge funds, WOF, WOF Master, World Fund II and BVI. A master – feeder structure was used. Investors in the feeder funds received limited partnership interests in those funds. In January 2013 Mr. Conrad appointed himself a sub-adviser to WOF Master. His fees were not disclosed. Mr. Conrad also did not fully disclose his background to investors, failing to tell investors he had been barred by the Commission. In addition, investors were not told about the transactions involving his family and their use of investor funds for personal items. Finally, in 2008 when investors were precluded from redeeming their interests, Mr. Conrad and his son effected redemptions for their accounts and obtained other cash from the funds. The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section (b) and Advisers Act Sections 206(1), 206(2) and 206(4). The action is pending. See Lit. Rel. No. 23597 (July 18, 2016).

Accounting errors: In the Matter of The Phoenix Companies, Inc., Adm. Proc. File No. 3-17345 (July 15, 2016). Phoenix was a holding company for three insurance subsidiaries. On November 8, 2012 the firm announced that its previously issued audited financial statements, including those in its Forms 10K for the years ended December 31, 2011, 2010 and 2009 could no longer be relied on and would have to be restated. That included the unaudited financial statements for quarterly periods in Forms 10-Q going back to March 31, 2011. On April 1, 2014 the firm filed a Form 10-K for the year ended December 31, 2012. In the filing Phoenix restated and amended its consolidated financial statements for the years ended December 31, 2011 and 2010. The filing identified several errors as well as material weaknesses in internal controls. Overall income before taxes decreased by 92% for fiscal 2011 and 20% for fiscal 2010. Certain errors discovered involved the firm’s universal life insurance products. Others involved the fixed indexed annuity product of Phoenix. Phoenix also found errors in its accounting for reinsurance contracts. Finally, Phoenix made errors regarding the accounting for certain derivatives. The Order alleges violations of Exchange Act Section 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceeding Phoenix consented to the entry of a cease and desist order based on the Sections cited in the Order. The firm will also pay a civil penalty of $600,000.

Offering fraud: SEC v. Roberts, Civil Action No. 2:16-cv-1664 (D. Nev. Filed July 14 2016). Defendant Zachary Roberts is an inactive member of the bar of California. He controlled Encore Acceptance I, LLC, a Nevada limited liability company. In 2010 Mr. Roberts was introduced to the Chippewa Cree Tribe of the Rocky Boy’s Reservation, Montana. Eventually an agreement was stuck between Encore Service Corporation LLC, another Encore entity ostensibly operated by a Roberts associate, and an entity controlled by the Tribe. Under the terms of that agreement Encore would advise and mange the Tribe’s then nascent entry into the online payday lending business through a wholly owned subsidiary. The management agreement contained a number of provisions precluding interference with the business of the Tribe. Those included making payments to members of the Tribe and restricting Tribe members’ ability to have financial interests in certain controlled entities related to the on-line business. Subsequently, Encore, through another affiliate, sought to, and did, expand its management agreement to increase its business with the Tribe and the fees paid to it. The new agreement was initially rejected by the Tribe but later approved after arrangements were made to pay certain members of, and officials of, the Tribe (collectively "Tribe Affiliate"). Between December 2011 and July 2012 Encore offered and sold about $1.72 million of notes with an interest rate of 24% to 18 persons using a private placement memorandum. That memorandum did not disclose that from September 2011 to July 2013 over $1.1 million was paid by the Encore affiliate to Tribe Affiliate; the agreements under which the payments were made; and the fact that under the terms of the management agreement those arrangements and payments could be deemed an act which might result in the termination of the agreement and thus jeopardize the value of the investors’ interests. The Tribe eventually discovered the undisclosed agreements. The relationship with Defendant was terminated. Mr. Roberts tried to convince investors that the interruption resulted from a change in Tribe leadership. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is in litigation. See Lit. Rel. No. 23595 (July 15, 2016).

Criminal cases

Manipulation: U.S. v. Galanis, No. 1:15-cr-00643 (S.D.N.Y.). The case centers on a microcap fraud and the manipulation of shares of publicly traded Gerova Financial Group. To execute his scheme John Galanis, with the assistance of another, caused the firm to issue 5 million shares. That represented nearly half of the public float for the company. It was then placed in an account under the name of Shahina. This disguised his ownership of the stock. A series of accounts under the Shahina name were then opened. Mr. Galanis induced investment advisers and others to purchase shares of Gerova stock for their clients by paying bribes. These arrangements permitted him to control the timing of the market transactions. That activity was coordinated with wash sales and matched trades that manipulated the share price. As this market activity unfolded Mr. Galanis and his conspirators sold their stock. The manipulation yielded about $20 million in profits. Mr. Galanis pleaded guilty to one count of conspiracy to commit securities fraud and one count of securities fraud. The date for sentencing has not been set.


Misappropriation: The regulator fined Prudential Annuities Distributors, Inc. $950,000 for failing to detect and prevent a scheme that resulted in the theft of about $1.3 million from an elderly customer. Beginning in July 2010 account executive Travis Wetzel made withdrawals from a customer annuity and diverted the payments to his own use. Despite repeated red flags Prudential honored each request for a withdrawal.

July 22, 2016
The High-Level "Commonsense Corporate Governance Principles"
by Broc Romanek

The effort by 13 prominent business leaders – including Warren Buffett & Jamie Dimon – and large institutional investors to draw up a set of "Commonsense Corporate Governance Principles" is complete. Not an easy thing to do; getting folks to agree on anything these days. Some participants in the process dropped out along the way, including Fidelity and Walden Asset Management.

As could be expected, most of the principles are high level – and address topics that have been commonsense (and mainstream) for quite some time (although a few of them are emerging ideas, like rotating committee chairs and lead directors – and some are controversial, like limiting dual-class voting). So the real news probably is what is missing from them – as those are the items that shareholders & management seem to still disagree about.

This Gibson Dunn memo summarizes the principles. Here’s a statement from CII that welcomes the principles – but then goes on to note that they should have gone further on shareholder rights. See this DealBook piece…and then there is the "Idiot’s Guide to Mocking ‘Common Sense’"...

SEC Amends ALJ Rules

As noted in these memos posted in our "SEC Enforcement" Practice Area, with the SCOTUS portion of the ALJs saga behind us regarding the SEC’s use of administrative law judges for its enforcement proceedings, the SEC has adopted changes to its rules of practice for administrative proceedings last week. Here’s the intro from this blog by Steve Quinlivan:

The SEC has approved a final rule amending its rules of practice for administrative proceedings. The changes make incremental improvements but fall short of what is necessary to make the proceedings more fair. Among other things, the final rules would adjust the timing of administrative proceedings and give parties additional opportunities to take depositions of witnesses.

Davis Polk’s New Podcast Series! Linda Thomsen on "Directors as SEC Enforcement Targets"

I’m very excited to report that Davis Polk has joined my "Big Legal Minds" with their very own podcast series devoted to governance topics! Their series is called "Before the Board" and available on iTunes or by RSS feed. Or it can be accessed on the firm’s site – the 1st episode is a 20-minute interview conducted by Joe Hall with Linda Chatman Thomsen (now with Davis Polk & former SEC Enforcement Chief) about recent trends in SEC enforcement actions involving directors. Awesome!

Broc Romanek

July 21, 2016
Cahill discusses SEC's Amendments to Rules of Practice for Administrative Proceedings
by Bradley J. Bondi, Sara E. Ortiz and Michael Wheatley

On July 13, 2016, the Securities and Exchange Commission ("SEC") adopted important amendments updating its rules of practice governing its administrative proceedings.[1] These changes concern, among other things, the timing of hearings in administrative proceedings, depositions, summary disposition, the contents of an answer, admissibility of evidence and expert disclosures and the procedure for appeals.[2] The amendments are intended to update the rules and introduce additional flexibility into administrative proceedings, while continuing to provide for the timely and efficient resolution of the proceedings. The amendments will become effective sixty days after publication in the Federal Register and will apply to all proceedings initiated on or after that date.[3]

These amendments are long-awaited changes to administrative proceedings. They come at a time when the SEC’s administrative process faces a perception in the media that it is unfair for defendants. Last year, The Wall Street Journal reported that from October 2010 through March 2015, the SEC won 90% of its administrative proceedings, while in the same period the SEC prevailed in only 69% of the cases it brought in federal district court.[4] This brief memorandum provides an overview of some of the key changes.

Timing of Hearings

The SEC made three amendments to Rule 360,[5] which governs the filing of an initial decision by the hearing officer and the timing for the initial stages of an administrative proceeding. First, the "trigger date" for the time to file an initial decision is changed from the date of service of the order instituting proceeding ("OIP") to 30, 75 or 120 days from the date of completion of post-hearing or dispositive motion briefing, or a finding of a default.[6] Second, the amendments extend the length of the prehearing period from the current four months to a maximum of ten months for cases designated as 120-day proceedings, to a maximum of six months for 75-day cases, and to a maximum of four months for 30-day cases.[7] Third, the hearing officer can be granted an additional thirty days to issue an initial decision by certifying at least 30 days before deadline that extra time is needed.[8]


Perhaps most importantly, amended Rule 233 now permits parties in 120-day proceedings the right to notice three depositions per side in single-respondent cases and five depositions per side in multi-respondent cases.[9] It also permits each side to request two additional depositions under an expedited procedure.[10] Depositions are limited to seven hours in length.[11] Depositions are not permitted in 30-day or 75-day proceedings.

Summary Disposition

Rule 250[12] currently provides that a party may move for summary disposition after a respondent’s answer is filed and documents have been made available to the respondent. The amended rule provides that three types of dispositive motions may be filed at different stages of an administrative proceeding and sets forth the standards and procedures governing each type of motion. First, a party may make a motion for a ruling on the pleadings on one or more claims or defenses, no later than 14 days after a respondent’s answer has been filed.[13] Second, any party may move for summary disposition on one or more claims or defenses after a respondent’s answer has been filed.[14] Leave of the hearing officer is not required to file such a motion in 30-day and 75-day proceedings, but is required for 120-day proceedings. Third, following the division’s presentation of its case in chief, any party may make a motion, asserting that it is entitled to a ruling as a matter of law on one or more claims or defenses.[15] Leave of the hearing officer is not required to file such a motion for any type of proceeding.

Contents of an Answer

Rule 220[16] sets forth the requirements for filing answers to allegations in an OIP. The amended rule requires respondents to state in their answer whether they intend to assert any "reliance" defense and whether the respondent relied on the advice of counsel, accountants, auditors, or other professionals (e.g, compliance officers) in connection with any claim, violation alleged, or remedy sought. Failure to do so may be deemed a waiver.

Admissibility of Evidence

Rule 320[17] provides the standards for admissibility of evidence. Under the current rule, the Commission or hearing officer may receive relevant evidence and shall exclude all evidence that is irrelevant, immaterial, or unduly repetitious. The amended rule adds "unreliable" to the list of evidence that will be excluded. Hearsay evidence will continue to be evaluated on a case-by-case basis, and may be admitted if it is relevant, material and reliable.

Rule 235[18] was amended to allow parties, upon a motion, to introduce into evidence depositions taken pursuant to Rules 233 or 234, investigative testimony, and certain sworn declarations. The standard for granting such a motion focuses on the admissibility and relevance of the statement, the availability of the witness for the hearing, and the presumption favoring oral testimony of witnesses in an open hearing. This amendment, that might allow the SEC to introduce into evidence investigative testimony which has not been subject to cross examination, could be detrimental to respondents.

Expert Disclosures

Rule 222(b)[19] provides that a party who intends to call an expert witness shall disclose information related to the expert’s background, including qualifications, prior testimony, and publications. The amended rule requires each party who intends to call an expert witness to submit a statement of the expert’s qualifications, a listing of other proceedings in which the expert has given expert testimony during the previous four years, and a list of publications authored or coauthored by the expert in the previous ten years.[20] Importantly, draft reports and disclosures and most communications between a party’s attorney and the party’s expert are protected from disclosure.[21]


Rule 410(b)[22] currently requires petitioners to set forth all the specific findings and conclusions of the initial decision to which exception is taken, and provides that an exception that is not stated in the notice may be deemed to have been waived by the petitioner. The amended rule requires petitioners to set forth only a summary statement of the issues presented for review and limits petitions to a mere three pages.


While the new amendments provide additional safeguards to respondents, they still fall short of the procedural safeguards afforded defendants in federal district court. It remains to be seen whether these amendments will impact the statistical disparity described above, but the new amendments represent meaningful developments for respondents in SEC administrative proceedings.


[1] See Amendments to the Commission’s Rules of Practice, Release No. 34-78319; File No. S7-18-15 (July 13, 2016) ("Amendments"), available at In September 2015, the Commission proposed for comment amendments to its rules governing its administrative proceedings.

[2] Id.

[3] Id.

[4] Jean Eaglesham, SEC Wins With In-House Judges, WALL ST. J., May 6, 2015, available at

[5] 17 CFR 201.360.

[6] Rule 360(a)(2)(i). The OPI designates whether the proceeding is a 30-day, 75-day, or 120-day proceeding. Proceedings in the 30- day category are typically is reserved for proceedings under Section 12(j) of the Exchange Act. Proceedings in the 75-day category typically involve "follow-on" proceedings following certain injunctions or criminal convictions. Proceedings in the 120-day category range from routine matters involving a single violation of the securities laws to matters involving, for example, multiple and distinct alleged violations, a particularly voluminous investigative record, or a complex set of factual allegations. See the Amendments, supra n. 1, at n.18, 13.

[7] Rule 360(a)(2)(ii).

[8] Rule 360(a)(3).

[9] Rule 233(a)(1)-(2).

[10] Rule 233(a)(3).

[11] Rule 233(j)(1).

[12] 17 CFR 201.250.

[13] Rule 250(a). This is analogous to Rules 12(b)(6) and 12(c) of the Federal Rules of Civil Procedure. See Fed.R.Civ.P. 12(b)(6) (failure to state a claim upon which relief can be granted); 12(c) (judgment on the pleadings).

[14] Rule 250(b)-(c). This is analogous to Federal Rule of Civil Procedure 56 (summary judgment).

[15] Rule 250(d). This is analogous to Federal Rule of Civil Procedure 50(a) (judgment as a matter of law).

[16] 17 CFR 201.220.

[17] 17 CFR 201.320.

[18] 17 CFR 201.235.

[19] 17 CFR 201.222.

[20] Rule 222(b)(2).

[21] Communications relating to compensation for the expert’s study or testimony, identifying facts or data that the party’s attorney provided and that the expert considered in forming the opinions to be expressed, or identifying assumptions that the party’s attorney provided and that the expert relied on in forming the opinions to be expressed are not protected from disclosure.

[22] 17 CFR 201.410.

This post comes to us from Cahill Gordon & Reindel LLP. It is based on their memorandum, published July 15, 2016 and available here.




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CLS Blue Sky Blog: Cahill discusses SEC's Amendments to Rules of Practice for Administrative Proceedings

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