Securities Mosaic® Blogwatch
April 28, 2016
Intertemporal Variation in the Externalities of Peer-Firm Disclosures
by Nemit Shroff, Rodrigo S. Verdi and Benjamin P. Yost

One of the primary rationales in favor of regulating disclosure is that more information may create positive externalities, or spillover effects, by helping investors learn about industry- or economy-wide trends and growth opportunities. In this way, a firm's public disclosures informs investors not only about that specific firm's prospects, but also about the prospects of related, peer firms. Thus, the more firms within an industry disclosing regular, publicly available information, the less uncertainty exists among investors regarding the value of all firms in that industry. Although the idea is intuitive, it has been difficult to empirically examine the existence of disclosure externalities. In a recent paper, we examine whether peer-firm disclosures affect the cost of capital of related firms in an industry and when such effects (if any) are most important.

We propose that disclosure externalities are time-varying in nature. That is, peer-firm disclosure is important when firm-specific disclosure is scarce. But as firm-specific disclosure increases, peer-firm disclosure becomes less important. One way to think about our argument is that peer-firm disclosures provide a signal about a related firm’s value, but this signal is noisy. Thus, the value of the signal obtained from peer-firm disclosures depends on investors’ other sources of information. Our intuition is that investors are more likely to rely on the signal generated by peer-firm disclosures when there is relatively less disclosure provided directly by a firm (either because the firm is newly public or because of regulatory constraints on its disclosures). However, investors valuing firms that disclose more information themselves and that have a longer time series of public disclosure are likely to put lesser weight on the signal generated from peer-firm disclosures.

We focus on the effect of peer-firm disclosures on related firms’ cost of capital to test our prediction. In particular, we use our insight to investigate how peer-firm disclosures affect a firm’s cost of capital the first time it accesses public debt and equity markets. Since private firms are not subject to SEC reporting requirements until they raise public capital, there is relatively little firm-specific information available about them in the public domain prior to their capital raising event. But once the firm has issued publicly traded securities, it is required to generate significant firm-specific information. Thus, there a significant change in the amount of firm-specific information available to investors from the time a firm initially raises capital to the subsequent years, making it a particularly powerful setting to examine the time-varying nature of disclosure externalities.

We begin by examining private firms that issue public bonds for the first time. We find that in industries with greater peer-firm disclosures, the initial bond yields for these newly public firms are substantially lower than yields for firms in industries with lower peer-firm disclosures. We then track bond yields over time as the securities are traded on the secondary market, and we find that over the three years following registration with the SEC, the effect of peer-firm disclosures on the yield fades away into insignificance. Specifically, we find that peer-firm disclosures lower bond yields by 15% for first-time capital raisers in the year of issuance but this effect declines to 2% by the third year post issuance. This result is consistent with peer-firm disclosures reducing investor uncertainty when there is relatively little firm-specific information available, but becoming less important as more firm-specific information is produced.

We show a similar effect in the equity market, where firms transition from private to public via an initial public offering of equity (IPO). In the first year after going public, IPO firms in industries with greater peer-firm disclosure have significantly lower bid-ask spreads than their counterparts in industries with less peer-firm disclosure. But this effect fades away during the three years following the IPO date. This is exactly the same pattern we observe in the bond market setting.

Finally, we test whether the effect of peer-firm disclosure increases when firm-specific information decreases due to exogenously imposed disclosure restrictions. We examine the period surrounding seasoned equity offerings (SEOs), during which firms are restricted from freely disclosing information due to gun-jumping laws (before 2005). Prior research finds that investor uncertainty increases during this SEO "quiet period," which manifests in higher bid-ask spreads. We find that peer-firm disclosure becomes more important during the quiet period, substantially mitigating the rise in the bid-ask spread. Further, we find that the effect of peer-firm disclosure during the quiet period disappears following the enactment of the Securities Offering Reform in 2005, which relaxed the quiet period disclosure restrictions.

Our findings are important because they provide evidence that peer-firm disclosures have externalities and because they highlight a novel feature of disclosure externalities – i.e., their time-varying nature. Our evidence points to specific times when peer-firm disclosure is most valuable to investors, and we are able to better identify the existence of disclosure externalities with respect to the cost of capital.

The preceding post comes to us from Nemit Shroff, Associate Professor of Accounting at MIT Sloan School of Management, Rodrigo S. Verdi, Associate Professor of Accounting at the MIT Sloan School of Management and Benjamin P. Yost, PhD candidate at the MIT Sloan School of Management. The post is based on their article, which is entitled "Inter-Temporal Variation in the Externalities of Peer-Firm Disclosures" and available here.

April 28, 2016
In Praise of Preferential Treatment in Private Equity
by William Clayton

William Clayton is an Associate Research Scholar in Law and John R. Raben/Sullivan & Cromwell Executive Director of the Yale Law School Center for the Study of Corporate Law. This post is based on his recent article In Praise of Preferential Treatment in Private Equity: How the Rise of Individualized Investing Has Grown the Private Equity Pie.

Preferential treatment of investors is more common than ever in today’s private equity industry, thanks to new structures that make it easier to grant different terms to different investors. For decades, private equity managers raised almost all of their capital through “pooled” funds whereby their investors’ capital was aggregated into a single vehicle, but recent years have seen a dramatic increase in what I refer to in my paper as “individualized investing”—private equity investing through separate accounts and co-investments. Separate accounts and co-investment vehicles are entities that exist outside and independent of pooled funds, enabling managers to provide highly customized treatment to the investors in them. Estimates are that upwards of 20% of all investment in private equity went through these channels in 2015. Some anecdotal accounts suggest much higher levels.

Many of the largest and most influential investors in private equity have been using these customized vehicles to negotiate for significantly better terms and more robust rights than are available to pooled fund investors. This raises a question that is both economic and philosophical: is preferential treatment a good thing for private equity? Should policymakers be restricting and regulating these trends, or should they be left alone, or even encouraged?

For many people, the idea of preferential treatment runs counter to a deeply ingrained sense of fairness. My paper makes the case that, while instincts favoring egalitarianism may be entirely appropriate-even virtuous-in many contexts, they should not inform private equity policy. When managers have free rein to bestow preferential treatment as they see fit, the outcome is generally a more efficient marketplace for private equity investment, with greater surplus available for investors.

A bedrock principle of the corporate governance literature is that when conflicts of interest exist, they are only problematic insofar as they lead to an appropriation of value from investors. The core contention of my paper is that most forms of preferential treatment enabled by individualized investing in private equity create new value for the preferred investors who receive the favored treatment, rather than appropriate value from non-preferred investors. This logic applies to the following forms of preferential treatment: superior customization of investment strategies and vehicle structuring, superior rights to monitor and control the manager’s activities, and superior fees. Individualized investing makes it much easier for private equity managers to grant these kinds of preferential treatment—indeed, these are the very reasons why so many private equity investors have been seeking to form separate accounts and make co-investments in recent years.

Importantly, a darker possibility must also be considered. In addition to the efficiency-enhancing forms of preferential treatment noted above, the rise of individualized investing also makes possible a problematic form of preferential treatment in private equity-one that does involve an appropriation of value from non-preferred investors to preferred investors. This form of preferential treatment—which I call “inequitable allocation” in my paper-occurs when managers allocate superior investment opportunities and other finite resources disproportionately to separate accounts and co-investors and away from pooled funds. Fortunately, as set forth in my paper, a close examination of the incentives of private equity managers and investors in today’s individualized industry reveals little risk of systematic inequitable allocation when the market is competitive.

The most important policy lesson from my paper’s analysis is one of regulatory restraint. Even though preferential treatment has reached unprecedented levels in private equity, and even though much of this activity is taking place behind closed doors, policymakers should avoid the temptation to over-regulate the practice. However, as the shift toward individualized investing continues apace, an interesting side effect emerges: the incentive for broad coordinated action among private equity investors will grow weaker as their interests become more individualized, making it more challenging for investors to advocate for industry-wide standards and best practices. Information disclosure is one example of an area where standardization can sometimes be beneficial, raising issues in private equity that resemble the classic debate in the securities literature over mandatory disclosure by public companies.

The full paper is available for download here.

April 28, 2016
Proxy Access: Developments in Market Practice
by Glen Schleyer, Sullivan & Cromwell
Editor's Note:

This post is based on a Sullivan & Cromwell LLP publication authored by Glen T. Schleyer. The complete publication, including Annex, is available here. Related research from the Program on Corporate Governance includes Lucian Bebchuk’s The Case for Shareholder Access to the Ballot and The Myth of the Shareholder Franchise (discussed on the Forum here), and Private Ordering and the Proxy Access Debate by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

Looking back at the proxy access provisions adopted by U.S. companies over the past year, it is clear that there is convergence around most key terms and conditions, including exceptions and details that are not contemplated by most shareholder proposals. While this convergence does not mean that market practice will stop developing or that governance advocates will cease fighting terms that they find objectionable, companies considering whether to adopt a proxy access provision now have the benefit of significant precedents.

In addition, no-action letters issued by the staff of the Securities and Exchange Commission in February have confirmed that a company that receives a typical 3%/3-year shareholder proposal should be able to adopt a proxy access bylaw with market-standard terms and conditions and then exclude the shareholder proposal as “substantially implemented.” While governance activists have submitted, and will likely continue to submit, shareholder proposals requesting that companies modify their bylaws to remove some of these terms and conditions, the only proposal that has come to a vote to date has failed, receiving 40% of votes cast at Whole Foods.

We have attached as an annex (available in the complete publication here) a sample form of proxy access bylaw that companies can use as a starting point in crafting their own. This has been updated to reflect developments in market practice and ongoing discussions with clients.

Key Terms of Adopted Proxy Access Bylaws

Since the 2015 proxy season, 200 public companies have adopted some form of proxy access, compared to a total of only 15 companies before 2015.[1] At this point, consistency has emerged in most of the key terms of these proxy access provisions. In particular, of the proxy access bylaws adopted by U.S. companies from April 2015 through March 2016:

  • 97% have a 3% ownership threshold
  • 100% have a 3-year holding period
  • 100% require full voting and economic ownership
  • 91% allow aggregation by groups of up to 20 holders
  • 92% count funds under common management as a single holder for aggregation purposes
  • 87% limit the number of access nominees to 20% of the board, most of which (71%) provide a minimum of two access nominees
  • 79% count incumbent access nominees against the current-year maximum
  • 73% provide a nomination window of 120 to 150 days before the prior year’s proxy mailing date
  • 93% prohibit or limit the availability of proxy access in the event of a concurrent proxy contest
  • 82% prevent resubmission of a failed candidate who received less than a specified vote percentage (usually 25%) in the past few years

Many companies considering proxy access may, of course, determine that provisions that differ from the above make the most sense for their situation—this may particularly be the case for smaller and regulated companies—and market practice will likely continue to develop in these and other regards.

For some ancillary terms and conditions, practice continues to vary from company to company, and these will likely be the subject of ongoing discussion and focus. For example:

  • Loaned Stock. Bylaws vary in their treatment of stock that the nominating shareholder has loaned out. A slight majority of companies (54%) require that the shareholder actually recall the stock at some specified time, such as the annual meeting date, or the period from the record date or the nomination date through the meeting date. A significant number of companies (34%) do not require that the stock actually be recalled, but require that it can be recalled within five days (21%) or three days (13%). The latter provision is intended to exclude term stock loans, which can be viewed as more akin to a disposition of the loaned shares rather than a short-term loan.
  • Statement of Post-Meeting Intent to Hold Stock. Another developing area is whether the nominating shareholder must provide a statement of its intent to hold stock after the annual meeting. Most bylaws (69%) do not have any particular requirement in this regard. However, a significant number require either a representation that the shareholder intends to hold the stock for one year after the meeting (13%) or, consistent with the requirement of vacated SEC Rule 14a-11, a statement that describes the shareholders’ intent to hold stock after the meeting (19%).

The attached sample form of proxy access bylaw contains language that could be used to implement each of the key provisions and alternatives discussed above.

SEC Staff “Substantial Implementation” Letters

One question that has arisen in the proxy access context is whether a company’s adoption of a proxy access bylaw would permit the company to exclude the typical form of shareholder proposal on the basis that the proposal has been “substantially implemented” under Rule 14a-8(i)(10). The application of this exclusion became more important after the SEC staff narrowed the scope of Rule 14a-8(i)(9) such that a company may no longer exclude a shareholder proposal by putting forward a “conflicting” management proposal providing for similar rights but with different terms.[2]

On February 12, 2016, the SEC staff answered this question through the issuance of a number of no-action letters applying the “substantial implementation” exclusion in the proxy access context. In particular, with respect to the typical shareholder proposal (that is, 3%/3-years, nominee cap of 25% of the board or two nominees), the SEC staff permitted exclusion where the issuer’s bylaws had the same

3%/3-year threshold, but contained other conditions and limitations contrary to, or not contemplated by, the shareholder proposal.[3] Most notably, this included bylaw provisions that capped the number of nominees at 20% of the board (or two nominees, if greater), rather than 25%, and that limited the shareholder group size to 20 holders, even where the shareholder proposal specifically called for no limit on group size. In addition, the companies’ bylaw provisions contained a number of the other terms and conditions described in the prior section, including a “net long” definition of ownership, various qualification requirements for nominees, counting of incumbent access nominees against the nominee cap, restrictions on repeat nominees, and requirements to provide additional information along with the nomination notice. The staff did not permit exclusion in the case of a company that had adopted a 5% threshold, which suggests that the ownership threshold is viewed by the staff as one of the most important elements of the “essential objective” of these proposals.[4]

To some extent, this takes pressure off companies to adopt a proxy access bylaw prior to the Rule 14a-8 deadline for the 2017 annual meeting, rather than waiting to see if the company receives a 3%/3-year proxy access proposal. If the company does receive such a proposal, the company should be able to adopt a 3%/3-year bylaw that has terms and conditions consistent with market practice, and thereby exclude the shareholder proposal as substantially implemented. Of course, the application of the “substantial implementation” exclusion depends on the specifics of the shareholder proposal and the company bylaw, and the outcome may be different if shareholder proponents revise the form of their proposals in an attempt to give companies less flexibility in how they can “substantially implement” the proposal.

If a company decides not to wait and instead adopts a proxy access bylaw proactively during 2016, there is a risk that it will receive a shareholder proposal to amend the proxy access bylaw rather than a proposal to adopt one. For at least the next year or two, we expect that at least some companies with a proxy access bylaw with market-standard terms and conditions will receive a shareholder proposal to amend the bylaw to remove or modify some of those terms and conditions. Two of the more active submitters of proxy access proposals—the New York State Comptroller and James McRitchie—have in fact submitted proposals for 2016 meetings that seek such modifications, including removing the limit on shareholder groups, modifying the calculation of ownership and raising the 20% cap on nominees. So far in 2016, this shareholder proposal failed at Whole Foods, receiving the support of 40% of votes cast. The outcome of these votes in the 2016 proxy season will provide insight into whether the terms and conditions that have developed as market-standard may need to be re-examined in the future.

We expect that some companies that receive a proposal to amend an existing proxy access bylaw to modify terms other than the percent ownership threshold will seek to exclude the proposal under Rule 14a-8(i)(10) or, if the company’s bylaw is up for a shareholder vote, Rule 14a-8(i)(9). It is unclear at this point how the SEC staff may view such exclusion requests, as none of the handful of issuers who have received such proposals have sought such relief to date.[5]

The complete publication, including Annex, is available here.


[1] For a more detailed discussion of proxy access proposals during the 2015 proxy season, see our post Proxy Access Bylaw Developments and Trends. Any client that would like to receive a copy of the updated sample form marked to show changes from our prior sample form should contact any of the lawyers listed at the end of this publication or any other Sullivan & Cromwell lawyer you have dealt with.

For a comprehensive discussion of proxy access and other shareholder proposals, as well as public company governance, compensation and disclosure more generally, see the Public Company Deskbook: Complying with Federal Governance and Disclosure Requirements (Practising Law Institute) by our partners Bob Buckholz, Marc Trevino and Glen Schleyer, available at 1-800-260-4754 (1-212-824-5700 from outside the United States) or
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[2] For a further discussion of this SEC staff position, which was announced in October 2015 through Staff Legal Bulletin No. 14H, see our publication, dated October 23, 2015, entitled SEC Staff Issues Guidance on Excluding Shareholder Proposals.
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[3] See, e.g., Alaska Air Group, Inc. (Feb. 12, 2016); Baxter Int’l Inc. (Feb. 12, 2016); Capital One Financial Corp. (Feb. 12, 2016); Cognizant Tech. Solutions Corp. (Feb. 12, 2016), The Dun & Bradstreet Corp. (Feb. 12, 2016).
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[4] See SBA Communications Corp. (Feb. 12, 2016).
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[5] The SEC staff has allowed a company to exclude a shareholder proposal seeking to modify the company’s proxy access bylaw to (i) lower the threshold from 5% to 3%, (ii) lengthen the stock loan recall provision from 3 days to 5 days, (iii) remove the 20-holder group limit, and (iv) remove the requirement for an intent to own the stock for one year post-meeting, on the basis that it was substantially implemented by the company’s amendments to its bylaw that implemented only the modifications in clauses (i) and (ii) above. See NVR, Inc. (reconsideration, Mar. 25, 2016).
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April 28, 2016
Reporting "Up" Obligations
by Eugene Goldman, Kelsey Leingang, Michael Peregrine, William Schuman, McDermott Will & Emery
Editor's Note:

Michael W. Peregrine and William P. Schuman are partners at McDermott Will & Emery LLP. This post is based on a McDermott Will & Emery publication authored by Mr. Peregrine, Mr. Schuman, Eugene I. Goldman, and Kelsey J. Leingang. The views expressed herein do not necessarily reflect the views of McDermott Will & Emery LLP or its clients.

A recent decision of a state bar disciplinary commission has important implications for the risk oversight obligations of the governing board. According to various media reports, the Michigan Attorney Grievance Commission declined to pursue six former General Motors Co. in-house counsel for failing to disclose to consumers the safety risks of an alleged defective automotive product.[1] The reporting practices (or lack thereof) by members of the GM in-house counsel department were a major part of that company’s broader ignition switch controversy. As such, the circumstances surrounding the Commission's action are a useful reminder on how in-house counsel can support the flow of material information to the board, and enable the board to discharge its oversight responsibilities more effectively.

The Grievance Commission’s decision involved critical issues relating to the application of Section 1.13(b) (Organization as a Client) and Section 1.6 (Confidentiality of Information) under the Model Rules of Professional Conduct—ethical standards with significant relevance to in-house counsel of companies in highly regulated industries. In general, these Rules place certain reporting and confidentiality obligations on counsel once becoming aware that a corporate agent is engaged in action, intends to act or refuses to act in a manner that is a violation of a legal obligation to the organization, or a violation of law that reasonably might be imputed to the organization, and that is likely to result in substantial injury to the organization.

Such knowledge may require counsel to refer the matter to higher (and sometimes the highest) authority in the corporation—or, if referral has been futile, may allow counsel to reveal confidential client information to external sources (but in tightly prescribed circumstances). Note, however, that these reporting “up” and “out” obligations vary from state to state. For example, some states permit external reporting if necessary to prevent the risk of death or bodily harm. Other states (e.g., California) strictly proscribe “reporting out” (except in extremely limited circumstances).

The Securities and Exchange Commission has promulgated similar rules for attorneys appearing and practicing before the Commission.[2] For these attorneys, the Rules: (a) require them to report evidence of a material violation of the securities laws—or a breach of fiduciary duty—to the chief legal officer of the issuer and, in certain circumstances, to the governing board; and (b) permit them—in certain circumstances—to disclose outside the organization confidential information relating to the lawyer’s appearance before the Commission, without issuer authorization.[3] Such disclosure would typically be appropriate only in the most extreme circumstances.

Clarity on internal management-to-board reporting is critical to positioning corporate governance to exercise compliance and risk oversight, among its other major responsibilities. The ability of board and committee members to be responsive and attentive fiduciaries depends in large part on their ability to receive key risk and compliance information in a manner, context and time frame that are meaningful to the board/committee. A fulsome understanding of counsel’s professional “reporting up” and “out” obligations will serve not only to sharpen expectations of counsel’s duties, but also to support the board’s critical oversight role.

According to media reports, the Michigan issue arose in the context of a complaint filed by the father of an alleged ignition switch victim. The basic allegation was that certain GM inside counsel violated their professional obligations by failing to make a public disclosure of the ignition switch issues of which they were purportedly aware. (GM’s internal investigation, conducted by former U.S. Attorney Anton Valukas, concluded that the GM general counsel was not informed by the subordinates of the ignition switch issues until very shortly before the problems became public.)[4] According to media reports, the Michigan Grievance Commission declined to pursue the complaint. Likely critical to this determination was the fact that Michigan professional rules do not require counsel to disclose confidential information necessary to warn consumers at risk of death or bodily harm.[5]

It is uncertain whether the Grievance Commission was also called upon to consider sanctions for subordinate counsel’s failure to report switch issues to the GM general counsel. As one leading ethics observer noted, it may have been that GM did not file a separate complaint with the Commission in connection with the reporting lapse.[6]

This Michigan decision underscores the important confluence of corporate governance and professional responsibility. The application of Rules 1.13(b) and 1.6 has been of particular significance since the advent of Sarbanes-Oxley. Following the recommendation of the American Bar Association, many state rules of professional responsibility were amended to clarify and expand these Rules to embrace heightened corporate responsibility.

The amendments to Rule 1.13(b) and 1.6 served to (a) refine the role of lawyers in supporting the flow of information and analysis on legal compliance matters within the corporation they represent; and (b) clarify the limitations placed on the lawyer’s ability to disclose to third parties confidential information with respect to the client’s potential criminal or fraudulent conduct. The expectation was that the new rules would help prevent the types of internal oversight, reporting and disclosure failures which contributed so heavily to the notorious pre-Sarbanes corporate scandals.[7]

The Michigan decision provides a useful opportunity to remind the board about the relationship between its risk oversight responsibilities and in-house counsel’s professional responsibilities regarding “reporting up” and “reporting out.” Greater board awareness of the circumstances in which the company’s lawyers are required to make internal (and external) reporting of major risks serves at least four key purposes: first, it confirms the critical role that in-house counsel are expected to perform in support of the board’s oversight responsibilities; second, it impels the board to remove any perceived barriers to counsel’s ability to report to the board; third, it allows the board to set clear expectations with counsel regarding the exercise of these reporting obligations; and fourth, it may prompt the board to supplement these professional obligations with additional, corporation-specific reporting and notification protocols.

The decision may also serve as a valuable reminder to in-house counsel to confirm their understanding of the requirements of Model Rules 1.13(b) and 1.6 in the states in which members of the in-house counsel department are licensed and practice. It is particularly important to understand the steps that serve as a predicate to reporting to higher organizational authority, and whether the applicable Rule contemplates “reporting out” or “noisy withdrawal.” Also important is an understanding of the proper interpretation of key Rule 1.13(b) “trigger events,” e.g., what constitutes “known”; “likely to result in substantial injury to the organization”; “as is reasonably necessary in the best interest of the organization”; and “if warranted by the circumstances.”

These requirements may differ from both the Model Rules, and from each other, depending upon the relevant jurisdiction. California’s strict limitations on the “reporting out” option is a good example (i.e., permitting disclosure of a client’s confidential information only to prevent a criminal act that the attorney reasonably believes would result in the death of, or substantial bodily harm to, an individual).[8] In addition, there is also the potential for conflict between the interpretation of the state rules, and the SEC’s Section 205 Rules (particularly with respect to the “reporting out” option”). Risk oversight principles should prompt institution of corporate governance procedures that seek to assure counsel’s familiarity with the applicable rules.

The nexus of the Michigan decision to the GM controversy also commends two additional reporting refinements. First, an organization’s general counsel should be encouraged to adopt specific guidelines on the types of issues that should be elevated to the general counsel’s attention from associate general counsel and the entire in-house legal group. Similarly, the associate general counsel should be instructed to request the general counsel’s guidance when legal and risk processes are not operating in a timely and effective manner.


Board oversight of risk and other key matters will be enhanced when there is a shared governance/management understanding of the in-house lawyer’s upstream reporting obligations. These obligations support effective governance practices by supplementing existing risk reporting mechanisms, and by providing a “safety valve” in the extraordinary instance of leadership inattention.

The recent decision of the Michigan Attorney Grievance Commission in the GM matter provides a current and compelling platform from which the board and senior management can discuss the “reporting up” and “out” obligations of in-house counsel, and how those obligations can best be brought to bear in support of effective risk oversight practices.


[1] Sue Reisinger, Fired GM Lawyers Won’t Face State Discipline, Corp. Counsel (Mar. 29, 2016),; Mike Spector, Michigan Won’t Discipline Lawyers in GM Ignition Case, Wall St. J. (Mar. 27, 2016),
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[2] Standards of Professional Conduct for Attorneys, 17 C.F.R. Part 205.
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[3] 17 C.F.R. § 205.3(d)(2).
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[4] Anton R. Valukas, Report to Board of Directors of General Motors Company Regarding Ignition Switch Recalls (May 29, 2014), available at
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[5] MI Rules of Prof’l Conduct R. 1.6.
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[6] See Spector, supra note 1.
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[7] Am. Bar Ass’n Task Force on Corp. Responsibility, Report of the American Bar Association Task Force on Corporate Responsibility, 59 Bus. Law. 145 (Nov. 2003).
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[8] CA Rules of Prof’l Conduct R. 3-100.
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April 28, 2016
SEC Complaint: How To Create A Manipulation Vehicle
by Tom Gorman

Microcap fraud has long been a focus of SEC enforcement. Many of the cases start with a public shell followed by a reverse merger in which the promoters end up with large portions of the stock. The transaction culminated with a pump-and-dump market manipulation. An Israeli resident with dual citizenship in that country and the U.K. took a different path, however, beginning with the formation of the company. SEC v. Zwebner, Civil Action No. 16 CV 1013 (S.D. Cal. Filed April 26, 2016).

The action against Asher Zwebner, along with a companion case, details a series of steps to a manipulation, beginning with the formation of a shell company through a pump-and-dump market manipulation. At each stage Mr. Zwebner, who has implemented similar schemes in the past, secretly controlled the company — up to the point of the manipulation. The key steps were:

Formation: In June 2010 Crown Dynamics Corporation was incorporated in Delaware, supposedly by Amir Rehavi, in fact a Zwebner nominee.

S-1 Registration: In September of the same year Crown filed a Form S- 1 Registration Statement with the SEC. Although Mr. Zwebner controlled the entire process – even having the comments sent to him under another identity – his name never appeared. That is contrary to Items 401(a) and 404(c) of Regulation S-K which require the disclosure of officers, directors, promoters and control persons and related transactions conducted by them. In September 2011 the registration statement became effect – Crown could conduct an IPO.

The IPO: The final amendment to the S-1 described the procedures for the IPO. Investors, according to the amendment, would be required to submit a subscription agreement and deliver funds to Crown for purchase. In reality the offering was an "elaborate charade," charges the complaint. Defendant Zwebner and his sons arranged for local friends to serve as supposed purchasers – shills. A shareholder list of 40 IPO subscribers was created. The transfer agent issued the shares. Most of those on the IPO list never new about the issuance of the shares. Control and the shares remained with the Defendant.

Trading: To initiate trading on the OTCBB, Form 211 had to be submitted to FINRA by a market maker who demonstrated compliance with Exchange Act Rule 15c2-11. The rule requires the market maker to have a reasonable basis to believe the information about the firm is accurate and from a reliable source. Mr. Zwebner arranged for a broker-dealer to file a Form 211 in September 2011 regarding Crown’s securities so that quotations could be published on OTCBB. Amir Rehavi was the firm CEO; Crown would license a toothbrush for its manufacturer, according to the papers. The statements were false. Following amendments which also included false information, FINRA cleared the Form 211. The broker-dealer was permitted to enter quotes on the OTCBB. Mr. Zwebner had 2.5 million free-trading shares.

Sale: Mr. Zwebner sold the Crown shell to stock promoter Christopher Larson. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23526 (April 26, 2016).

The scheme concluded with the manipulation of Crown’s shares. SEC v. Zouvas, Civil Action No. 3:16-cv-998 (S.D. Cal. Filed April 25, 2016). Named as defendants are Luke Zouvas, and attorney; Cameron Robb, a business associate of defendant Larson; Christopher Larson, a CPA; James Schiprett, a nominee for defendant Larson; and Robert Jorgenson, also a nominee for defendant Larson.

Although Mr. Larson acquired control of Crown, his name never appeared in any filings made with the SEC. Crown’s shares were transferred to nominees for Mr. Larson, including defendants Schiprett and Jorgenson. A call center was paid $400,000 by Mr. Larson to promote the shares and create the appearance of market interest. As the share price became inflated defendant Larson’s nominees dumped their shares. Most of the proceeds which totaled at least $850,000 were wired to nominee accounts controlled by defendant Larson. The complaint alleges violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Section 10(b). The case is pending.

April 28, 2016
Survey Results: Auditing Standard #18: D&O Questionnaires
by Broc Romanek

Here's the survey results from this survey about how Auditing Standard #18 is impacting D&O questionnaires:

1. Did you update your D&O questionnaire in response to the PCAOB’s new Audit Standard #18 regarding related-party transactions?
– Yes – 66%
– No – 34%
– It hasn’t come up yet – 0%

2. Did your independent auditors ask for a list of immediate family members of directors and officers?
– Yes – 65%
– No – 31%
– It hasn’t come up yet – 4%

3. Did your auditors also ask for information regarding entities over which your directors, officers & their immediate family members control or have significant influence?
– Yes – 65%
– No – 30%
– It hasn’t come up yet – 6%

4. If you did update your D&O questionnaire, did your auditor ask you to do so?
– Yes – 44%
– No – 31%
– Not applicable because we didn’t update our questionnaire – 24%

5. If you did update your D&O questionnaire, will you also be seeking quarterly certifications or updates from your directors and officers?
– Yes – 16%
– No – 59%
– Not applicable because we didn’t update our questionnaire – 26%

Please take a moment to participate anonymously in this "Quick Survey on Registration Statement Due Diligence" – and this "Quick Survey on Proxy Mailing Practices."

Class Actions: Accounting-Related Suits Increase

As noted in this Cornerstone Research study, the number of securities class action lawsuit filings raising accounting-related allegations rose in 2015, as did the number and value of accounting-related securities suit settlements. In addition to the increase in the number of accounted-related lawsuit filings, the market capitalization losses associated with those new filings increased as well.

Governance 360 Evaluations

In this podcast, Dave Bobker of Rivel Research Group discusses research into how your shareholders are receiving your engagement messaging:

– Where did you grow-up?
– How did you get into the proxy solicitation business?
– What was it like at Georgeson back in the early days?
– You are now with Rivel Research, what do they do?
– What is a "perception study"?
– What is the "Corporate Governance Intelligence Council"?
– How can shareholders – both portfolio managers & proxy voters – provide anonymous input to companies about their governance engagement efforts?

Broc Romanek

4/28/2016 posts

CLS Blue Sky Blog: Intertemporal Variation in the Externalities of Peer-Firm Disclosures
The Harvard Law School Forum on Corporate Governance and Financial Regulation: In Praise of Preferential Treatment in Private Equity
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Proxy Access: Developments in Market Practice
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Reporting "Up" Obligations
SEC Actions Blog: SEC Complaint: How To Create A Manipulation Vehicle Blog: Survey Results: Auditing Standard #18: D&O Questionnaires

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