Securities Mosaic® Blogwatch
May 3, 2012
Great Wolf Shows Shortcomings of Banker Valuation Opinions
by Broc Romanek

Great Wolf Shows Shortcomings of Banker Valuation Opinions

Last week, the WSJ Blog ran this interesting analysis entitled "Great Wolf Shows Shortcomings of Banker Valuation Opinions." Check it out!

May 2, 2012
Three More Companies Fail to Win Majority Support on Pay
by Ted Allen

Three more U.S.-listed companies - Cooper Industries, NRG Energy, and Ryland Homes - have reported that they failed to receive majority support for their executive compensation practices. At all three firms, it appears that investors had pay-for-performance concerns.

Cooper Industries earned just 29.4 percent approval at its April 23 annual meeting; this vote is the lowest support level during a say-on-pay vote this year, according to ISS data. The company's investors have expressed concern over pay in the past. Cooper, an Ireland-incorporated firm that is listed on the New York Stock Exchange and is part of the S&P 500, received just 50.4 percent support during its 2011 advisory vote.

NRG, a power generation firm in the S&P 500 index, received 45 percent approval during its April 25 advisory vote, one year after earning 59 percent support on compensation.

Ryland Group, a homebuilder in the S&P 600 small-cap index, had 41 percent support for its compensation policies at its April 25 meeting. Ryland also received significant opposition in 2011, earning just 62 percent approval.

These three votes suggest that some investors are taking a harder line this year at companies that had less than 70 percent support in 2011 but have not fully addressed shareholder concerns. At the same time, there are other firms that are receiving much greater support after suffering failed votes in 2011. One example is Stanley Black and Decker, which received more than 93 percent support this year after improving its pay practices. In addition, Umpqua Holdings earned 98 percent approval this year after getting just 36 percent support in 2011.

Overall, eight companies have reported failed votes this proxy season, according to ISS data. The other firms include Citigroup, International Game Technology, KB Home, FirstMerit Group, and Actuant Corp.

Notwithstanding these votes, investors have overwhelmingly endorsed the pay practices of most U.S. companies. As of May 1, the average support level was 90.6 percent, according to ISS data, which includes vote results from 345 issuers.

Governance Exchange members can obtain more data on say-on-pay results by clicking here.

May 3, 2012
SEC Wins In Eleventh Circuit Against Morgan Keegan
by Tom Gorman

The Commission prevailed on its appeal to the Eleventh Circuit Court of Appeals in an action against Morgan Keegan & Co. The case centers on claims that the firm defrauded its customers in connection with the purchase and sale of auction rate securities or ARS as the market crisis unfolded. SEC v. Morgan Keegan & Co., No. 11-13992 (11th Cir. May 2, 2012).

In the district court the Commission's complaint alleged violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(c). As the ARS market was collapsing in early 2008, according to the Commission, Morgan Keegan continued selling the securities. Four of its customers stated that they were told things such as ARS are as good as cash and that the securities were completely liquid. Those allegations were bolstered by internal records suggesting that the firm knew the ARS market was unraveling as the sales continued.

The firm argued on a motion for summary judgment that it fully informed investors about the risks of the auction rate securities market in a series of disclosure materials. In support of this claim Morgan Keegan pointed to a twenty-four page ARS Manual, its annual newsletter to customers and a brochure which fully informed customers about the risks of the market. In addition, customer trade confirmations gave buyers the right to rescind any transaction for ten days.

The district court agreed with Morgan Keegan and granted summary judgment in its favor. Characterizing this action as a "'hybrid case where the SEC claims that Morgan Keegan misled the public through the oral statements made to four individuals,'" the court concluded that the SEC must do more to withstand summary judgment than point to a few isolated instances of alleged broker misconduct to obtain the relief it seeks in the face of Morgan Keegan's disclosure documents.

The Eleventh Circuit reversed. The test for materiality has been well developed in a series of private damage cases, the Court noted, such as Matrixx Initiatives, Inc., v. Siracusano, 131 S.Ct. 1309 (2011) and Basic Inc. v. Levinson, 485 U.S. 224 (1988). The SEC and Morgan Keegan agreed that the test of materiality developed in these cases applies here.

In cases such as Matrixx and Basic the Supreme Court has repeatedly rejected the use of a bright line test for materiality as potentially over or under inclusive. Rather, the High Court has repeatedly opted for a standard utilizing the "total mix" of information important to an objective, reasonable investor test. Under this standard the representations made to the four clients of the firm cannot be disregarded in favor of the written materials relied on by the firm since it deprives them of context, the Court stated. It went on to note that "The problem for Morgan Keegan is the SEC enjoys the authority to seek relief for any violation fo the securities laws, no matter how small or inconsequential The SEC thus may seek a civil penalty against any defendant who has made a single misstatement or omission, if material and made with scienter and in connection with the purchase or sale of securities [thus] a rule excluding all individual broker-investor communications from the materiality inquiry is underinclusive. " (emphasis original). Since the brokers were acting within the scope of their authority the SEC may establish a violation as to each.

Finally, the Court rejected the conclusion of the district court that the written disclosures of the securities firm were sufficient as a matter of law to warrant summary judgment. Conceding that written disclosures may in some instances be sufficient to render an individual broker's misrepresentations immaterial, the Court concluded that here the "manner of distribution of its written disclosures was insufficient to warrant summary judgment." While it is clear that the written disclosures were given to some customers in some years, there is no evidence that in late 2007 and early 2008 the firm directly gave customers written disclosures before purchasing ARS. In fact the only documents they received were the written trade confirmations which say nothing about the liquidity risk of auction rate securities. Accordingly, the Court reversed the grant of summary judgment and remanded the case for trial.

May 3, 2012
Eleventh Circuit Reverses Summary Judgment for Morgan Keegan in ARS Action
by Barbara Black

In SEC v. Morgan Keegan & Co., Inc. (11th Cir. May 2, 2012), the appeals court reversed a summary judgment in favor of Morgan Keegan involving its sales of auction rate securities (ARS) between Jan. 2 and March 19, 2008. (Download SECv.MorganKeegan) The SEC alleged that MK's brokers and marketing materials misrepresented ARS as cash alternatives and omitted to disclose that ARS carried liquidity risk. MK based its summary judgment motion on the SEC's failure to meet the materiality requirement and argued that the SEC's evidence of oral misrepresentations made by four brokers to individual investors should not be included in the "total mix" of information available to the hypothetical reasonable investor. According to MK, the SEC must demonstrate that MK misled the public as a whole and not just a few individual investors.

The problem for Morgan Keegan is the SEC enjoys the authority to seek relief for any violation of the securities laws, no matter how small or inconsequential.

The court found no support for MK's argument that some minimum number of investors must be misled before finding its brokers' misrepresentations material in an SEC enforcement action.

MK also argued that its written disclosures rendered individual brokers' oral misrepresentations immaterial as a matter of law. The court, however, was not persuaded that MK's manner of distributing its written disclosures was adequate for purposes of granting summary judgment to the firm. The only written disclosures given directly to ARS purchasers during this time period were the trade confirmations, which did not provide any warning about liquidity risk and only referred the customers to the firm's website for "information regarding auction procedures," without providing a direct link to the ARS web page.

The court emphasized that its holding was narrow and limited to materiality.

May 3, 2012
An "S Corporation"? That's a Tax Status, Not an Entity
by Joel Beck

Often, I'll get calls or inquiries from folks looking to form a business who tell me that they want to form a S corporation.  I often know what they mean, even though there really is no such thing incorporating a S corporation here in Georgia.  Let me explain.

Some of the most common business types are sole proprietorship, partnerships, corporations, and limited liability companies (LLC).  There are several other entity types allowed here, but they are not as prevalent as these 4 types.  So, when most people (but not all) start a business, they choose one of these.  And, because of the limited liability protection offered by corporations and LLCs, one of these two entity types are often the right choice for folks.  But  the choice of which entity a person should form is based on the answers to many questions, including the type of business to be conducted, manner in which it will be conducted, number of owners and the involvement level of the owners, and plans for the future of the business.

What many people don't know is that they can effectively have a "S corporation" whether they form a corporation or an LLC.  That's because a "S corporation" is not a type of entity; rather, it is a election (a choice) of how the business will be taxed.  So, a client can form either a Georgia corporation or a Georgia LLC and have it treated the same way for tax purposes by filing an S corp. election.  But, because it is a tax matter, you should consult your CPA for additional guidance before making this decision.  Your legal counsel, together with your CPA can provide you with guidance to make the best decisions and help to position your new business for success.

Forming a corporation or LLC with the state is not difficult and people can do it themselves very easily. But knowing what to do after that is vitally important as well.  In addition to selling their goods or services, business owners need to be careful to ensure that they sign their contracts the proper way to avoid making themselves liable for the business's activities where appropriate, that they keep and maintain the appropriate business records, make the required annual filings, make tax elections and file appropriate tax returns and forms, obtain business licenses, and more. In future posts, I'll discuss more of these items.

May 3, 2012
The Other Kind of Merger-Related Litigation
by Kevin LaCroix

Much has been written recently (including on this blog) about the growing prevalence of M&A related litigation. These lawsuits, typically launched by the target company shareholders, are filed shortly after a merger announcement and usually object to some aspect of the proposed merger or of the merger-related disclosure. But the merger objection lawsuit is not the only kind of lawsuit that mergers can produce - there is also the kind of lawsuit that can arise post-merger when, it is alleged, the merger was not successful.

In a recent example of this second kind of merger lawsuit, on May 2, 2012, plaintiffs filed a shareholder class action lawsuit in the Northern District of Illinois against Allscripts Healthcare Solutions and two of its officers. Allscripts is, according to the complaint, the "corporate result" of the merger of Allscripts-Misys Healthcare Solutions and Eclipsys Corporation, which was announced on June 9, 2010.

The complaint references the company's April 26, 2012 filing on Form 8-K (here), in which the company "shocked the market" by reporting earnings sharply lower than guidance, as well as the termination of the Chairman of the company's board of directors; the resignations of three other directors; and the resignation of the company's CFO. According to the 8-K, the termination and resignations followed board discussions regarding the leadership of the company. The complaint alleges that in reaction to the news the company's share price dropped sharply.

According to plaintiff's counsel's May 2, 2012 press release (here), the complaint alleges that during the class period:

Allscripts concealed that: (a) the process of developing a unified product offering after the Merger had suffered debilitating setbacks, including major undisclosed schisms among the most senior levels of the Company, which ultimately resulted in the loss of key personnel and harmful upheaval in Company leadership; (b) a material portion of Allscripts' revenue and net income was predicated on the successful integration of these systems, and substantial business relationships had been destroyed by the Company's inability to make material progress in this area; and (c) as a result of the foregoing, Allscripts lacked a reasonable basis for its claims of progress in post-Merger integration, sound operations, profitable results, and continued growth.

This latest lawsuit exemplifies the second type of merger-related lawsuit, typically filed post-merger and typically alleging that the merger did not live up to expectations. Perhaps the highest profile example of this type of lawsuit is the litigation filed in July 2002 in the wake of the failed AOL Time Warner merger. That litigation ultimately resulted in a settlement of $2.5 billion (not to mention extensive additional opt-out settlements), which is the seventh largest securities class action lawsuit settlement of all time.

Another high-profile case of this same type is the lawsuit that was filed in 2000 following the December 1998 merger transaction that led to the formation of Daimler Chrysler. That case ultimately settled for $300 million.

Nor are high-profile mergers the only types of transactions that can produce this type of merger-related litigation. For example, in September 2011, shareholders filed a securities class action in the Northern District of California against Equinix and certain of its directors and officers, in which the plaintiffs disclosed that the company was having difficult with the integration of Switch & Data Facilities Company, which Equinix had acquired in April 2010. (To be sure, in March 2012, the court granted the defendants' motion to dismiss, albeit with leave to amend.)

My point here is that the merger objection cases are not the only type of litigation that mergers and acquisitions activity can generate. As these examples show, there is also the possibility that to the extent the merger does not live up to expectations (or rather - allegedly does not live up to expectations) there could be post-merger litigation as well. These post-merger suits may either allege (as was the case in the Daimler Chrysler litigation) that the merger related documents contained misrepresentations, or that the company made misrepresentations regarding its post-merger operations or merger-related integration (as was the case in the Equinix case and in the recently filed Allscropts case). At some level it is hardly surprising that litigation might arise post-merger from time to time, given that - depending on who you ask - "mergers have a failure rate of anywhere between 50 and 85 percent."

Indeed the possibility of a lawsuit alleging that the merger did not live up to expectations is itself not the only type of post-merger litigation that can arise. Another variant that can sometimes arise is the post-merger lawsuit alleging that the surviving company failed to properly account for the transaction or to properly present the financials of the combined companies. An example of this latter type is the July 2011 lawsuit filed against JBI, Inc. and certain of its directors and officers, in which the plaintiff alleged that the company did not properly account for certain media credits it had acquired in connection with an acquisition transaction.

All of which serves to underscore a point which has long been known to D&O underwriters - that is, the mergers and acquisitions transactions provide context out of which litigation sometimes (perhaps frequently) arises. The recent rise in merger objection litigation has certainly amplified this point. But as the examples in this blog post demonstrate, there are other types of lawsuits beyond the merger objection cases that can arise in connection with or following a merger transaction.

Are We There Yet?: One of the huge by-products of the July 2010 enactment of The Dodd-Frank Act is the huge rulemaking burden that the Act imposed on a variety of federal agencies. As I have noted in a prior post (here), the agencies have been laboring under the rulemaking burdens, and in many cases have fallen far beyond their rulemaking deadlines the Act required.

Although there obviously is no joy in the exercise, the Davis Polk law firm has been diligently tracking the agencies' rulemaking progress. In its May 2012 Dodd-Frank Progress Report (here) the law firm details the current status of the agencies' rulemaking efforts.

Among other things, the study shows that as of May 1, 2012, a total of 221 Dodd-Frank rulemaking requirement deadlines have passed. Of those 221, 148 (67%) have been missed and 73 (33%) have been met with finalized rules. Regulators have not yet released proposals for 21 of the 148 missed deadlines.

Of the total of 398 rulemakings that Dodd-Frank required, 108 (27.1%) have been met with finalized rules and 146 rules have been proposed that would meet the requirement (36.7% more). Rules have not been proposed to meet 144 (36.2%) rulemaking requirements.

The Dodd-Frank Act's rulemaking juggernaut grinds onward. Your government at work. At the direction of Congress.

May 3, 2012
Do Expert Agencies Outperform Generalist Judges?
by Josh Wright

My work (with GMU 3L Angela Diveley) featured on the University of Pennsylvania's RegBlog. An excerpt:

The comparison we conducted is one between institutions- the FTC and the federal judicial system- and not individual judges and commissioners. There is no doubt the antitrust and economic experts at the FTC are well equipped to analyze all modes of business dealings; in this sense, agencies certainly have greater economic expertise than courts as a general rule. However, like the FTC, courts incorporate economic expertise into their decision-making. While the FTC seeks to incorporate its staff's expertise, courts seek to incorporate the expertise of expert witnesses. Both institutions are organizations with complex internal structures with different modes of transmitting economic expertise into decision-making outputs and different constraints and incentives.

We sought to determine whether the FTC's institutional structure facilitates the transmission of economic inputs into its adjudicatory decisions more effectively than Article III judges in similar cases. The implicit assumption underlying the expertise hypothesis, and many of the calls for increased delegation to the agencies, is that they are better equipped to convert that expertise to litigation outcomes. If agencies do not hold such an advantage in converting expertise to outputs, interesting and important questions are raised concerning the optimal institutional design of the FTC and of administrative agencies generally. Our preliminary evidence suggests precisely this outcome as we find no advantage for administrative agencies.

Go read the whole thing. The current draft of the paper is available here.

May 3, 2012
Certified B Corporations v. Benefit Corporations
by Haskell Murray

Before jumping into the "corporate purpose" section of my benefit corporation posts, I want to make clear something that most of the readers probably already know, but that some in the popular media consistently fail to articulate. There is a difference between "certified B corporations" and "benefit corporations," even though both are sometimes referred to as "B Corps."

Certified B corporations are certified by the nonprofit organization B Lab. B Lab likens its certification of companies to the certification of coffee as "Fair Trade" or the certification of buildings as "LEED certified." A company can take the initial B Impact Assessment for free. Becoming a certified B corporation, however, is not free (though I have heard anecdotally that the benefits of being part of the certified B corporation community can exceed the cost of the certification fees because B Lab has negotiated significant discounts with various vendors). Interested readers can find details about the process of becoming a certified B corporation here.

Benefit corporations are formed under the state law of one of the seven states that have passed benefit corporation statutes (California, Hawaii, Maryland, New Jersey, New York, Vermont and my state of residence- Virginia.) (See my chart comparing the benefit corporation state statutes here.) Benefit corporations must be measured against a "third party standard" but the standard does not have to be B Lab's standard.

A company can be both a certified B corporation and a benefit corporation, but there are plenty of examples of companies that are one but not the other. Currently, there are 521 certified B corporations with total revenue of about $2.9 billion. I am trying to track down the exact number of benefit corporations, but everyone's best estimate seems to between 50 and 100 total benefit corporations. Remember, however, that all of the statutes are relatively new and that both the California and New York statutes just became effective a few months ago.

Unless otherwise noted, my posts will focus on "benefit corporations."

Bonus tip: It is "B Lab" not "B Labs."

May 3, 2012
The Crowdfunding Analysis Behind Kickstarter
by Broc Romanek

The Crowdfunding Analysis Behind Kickstarter

A few days ago, this NY Times article caught my eye about a three-year old site called "Kickstarter" that mainly had been used to raise funds for quirky projects but has now grown to help more serious entrepreneurs conduct fundraising for their innovative gadgets, etc. What blew me away is how a few guys raised a million bucks overnight for a digital watch they had invented- in particular, them going to the bar and coming back that evening to find out how much more they had raised in a few hours. They have now raised $7 million and counting.

Given that the JOBS Act was only recently enacted (but remember the SEC's warning that it needs to adopt rules to implement the new crowdfunding exemption before the floodgates open), I turned to Scott Miller of Ellenoff Grossman & Schole who knows more than me about crowdfunding for some analysis of how Kickstarter operates. Here's what Scott said:

Kickstarter, to date, has been operating based on the general belief that contributors are not purchasing securities (i.e. a profit interest in any of the companies in which they contribute funds) under the current methods used to raise funds on Kickstarter and similar funding sites. These fund sourcing sites do not purport to be an intermediary for a company's offer and sale of its securities, but instead companies only agree to provide contributors with something of value, in consideration for their contributions- in this case a Pebble wristwatch. Based on the assumption that such transactions do not constitute investments in securities, it does not appear to be regulated under U.S. securities laws.

Now that new crowdfunding laws are scheduled to go into effect sometime within the next 245 days, crowd sourcing sites like Kickstarter will need to be more aware of the methods used to raise funds on their sites to assure that they are not subject to regulation under the crowdfunding laws, or, if necessary, that the sites are properly registered and all transactions are conducted in compliance with applicable crowdfunding laws.

Interestingly, even though the article was written after the JOBS Act was signed into law by the President, there is no mention, in the article, of these new crowdfunding provisions. It is possible that the author of the article, as well as Kickstarter and similar crowd sourcing sites, are not yet convinced that crowdfunding, as provided under the provisions of the JOBS Act, will become a viable means of raising capital. For starters, it limits the total amount a company can raise during any 12-month period to $1 million, which is $6 million less than the amount of funds raised by the watch company through Kickstarter.

Also, if the digital watch company- Pebble- had been able to raise $1 million pursuant to the equity crowdfunding laws included in the JOBS Act, at the time these funds were raised, it would have been required to have audited financial statements and also be required to make certain disclosures to the SEC. Finally, Kickstarter, or any other funding portal through which the funds were raised, would be required to register with the SEC. It appears that those with an interest in providing services as funding portals under the new crowdfunding laws, including existing crowd sourcing sites like Kickstarter, are going to wait for a final determination of the registration requirements, before making any decisions on whether to register with the SEC as a funding portal.

We have posted memos regarding the crowdfunding provisions of the JOBS Act in our "JOBS Act" Practice Area.

The PCAOB's New Interactive Registered Auditor Database

A few days ago, the PCAOB updated its site to allow various sorting of registered auditors, such as firm location and type of audit firm practice.

Mailed: March-April Issue of "The Corporate Counsel"

We just mailed the March-April Issue of The Corporate Counsel and it includes pieces on:

- Analysis of the Jumpstart Our Business Startups Act
- Shareholder Proposal Eligibility Issues After Staff Legal Bulletin No. 14F
- Resignation or Retirement of Principal Officer and Appointment of Successor-Including Both Events in One Form 8-K
- Exclusive Forum Bylaws-Challenged in Delaware
- Hart-Scott-Rodino Act Developments-The DOJ and FTC Get Our Attention
- The SEC Staff (Again) Defends the Anti-Waiver Provisions of the 1933 and 1934 Acts
- The Latest on Regulation D
- SEC Backs "Primary Purpose" Test for Determining Whether Benefit is a Perquisite
- Confidential Treatment Requests-"Conditional" Issuer Consent to Release of Information
- More Staff Guidance on S-3 Waiver Requests

Act Now: Get this issue rushed to when you try a 2012 No-Risk Trial today.

- Broc Romanek

May 3, 2012
The Relationship between Bad Corporate Governance and Bad Corporate Performance
by J Robert Brown Jr.

One of the conundrums in the corporate governance world is the difficulty in showing a relationship between good corporate governance and performance. Increasing the number of independent directors from a majority to a super majority, for example, does not typically result in better performance. There are many reasons for this, not the least of which is that "independent" directors are often not really independent so the benefit to the company is questionable.

But can bad governance result in a decline in share prices? If Chesapeake Energy is any indication, the answer is yes. The company has engaged in any number of governance practices that have raised eyebrows, from purchasing the CEO's map collection to supporting the legislation in Oklahoma that would mandate staggered boards.

The board is almost entirely lacking in diversity and until recently combined chairman and CEO. Directors are lavishly paid, with total compensation for most of them exceeding $500,000 in 2011 and perqs that include the personal use of the corporate aircraft. See Proxy Statement, at 10. Perhaps unsurprisingly shareholder proposals calling for say on director pay have garnered considerable support (in 2010, the proposal received 192 million votes in favor; 222 million against; the proposal passed in 2009).

Concerns over governance, however, came to a head with the breaking of stories about loans by the CEO and outside investment activities. A Reuters report described the CEO's activities as running a hedge fund "that traded in the same commodities Chesapeake produces." Another report indicated that the CEO had "used his personal stake in Chesapeake wells as collateral for up to $1.1 billion in loans used mostly to pay his share of the costs of Chesapeake wells in which he had invested."

All of this suggests a board that has been passive with respect to the CEO and has displayed a tin ear when it comes to the governance interests of shareholders. So how has this been viewed in the market? Not favorably. Chesapeake share prices have taken a beating. While some of that is attributable to the failure to meet analyst expectations, the revelations about the CEO have played a role.

Adding an independent director or forming a risk committee of the board may not raise share prices. But suggestions that a board that does not pay sufficient attention to the activities of the CEO apparently does, at least if Chesapeake is any example.

View today's posts

5/3/2012 posts Blog: Great Wolf Shows Shortcomings of Banker Valuation Opinions
Insight: Three More Companies Fail to Win Majority Support on Pay
SEC Actions Blog: SEC Wins In Eleventh Circuit Against Morgan Keegan
Securities Law Prof Blog: Eleventh Circuit Reverses Summary Judgment for Morgan Keegan in ARS Action
The Beck Law Firm, LLC Blog: An "S Corporation"? That's a Tax Status, Not an Entity
D & O Diary: The Other Kind of Merger-Related Litigation
Truth on the Market: Do Expert Agencies Outperform Generalist Judges?
Conglomerate: Certified B Corporations v. Benefit Corporations Blog: The Crowdfunding Analysis Behind Kickstarter
Race to the Bottom: The Relationship between Bad Corporate Governance and Bad Corporate Performance

Blog posts are subject to copyrights held by the authors and are republished here with permission. Views expressed are those of the authors alone. Infringement Notification.