Securities Mosaic® Blogwatch
May 15, 2012
One Man's Trash is Another Man's...Affordable, Safe Form of Carbon-Free Energy
by Hester Serebrin

I listened to this podcast this morning on my way to work, and though it originally "aired" more than five months ago, the ideas were as fresh as ever.

Well, kind of fresh. Granted, TerraPower has been around for more than four years, and traveling-wave reactors were first proposed way back in the 1950s, but when issues of nuclear waste are piling up around the country, the energy surrounding the company certainly seem timely.

But let me back up. In this particular podcast, titled "Weird Recycling," our beloved host Stephen Dubner (of Freakonomics fame) takes us to meet mathematician, physicist, inventor, and food scientist Nathan Myrhvold, who joined forces with Bill Gates and others to found the aforementioned TerraPower- a company that "began as a series of explorations related to many energy technologies." Out of these explorations "came an advanced nuclear energy solution that presents a new path toward an affordable, safe form of carbon-free energy."

Specifically, that solution means using traveling wave reactor technology to turn depleted uranium (a waste byproduct of the production of enriched uranium for use in nuclear reactors) into an inexpensive, stable, zero-emissions, inexhaustible power source, according to TerraPower.

Could this make our "national nuclear garbage can" a moot issue? Potentially- though we'll have to wait a few years. A technical adviser for TerraPower is quoted in the New York Times:

"We've had conversations with the Chinese, the Russians, the Indians, the French, [where a pilot plant may be built]" Reynolds said in an interview. "We have an aggressive schedule where we think it is important to get something built and accumulate data so that we can eventually build them in the U.S. Breaking ground in 2015, with a startup in 2020, is more aggressive than our current [U.S.] regulatory structure can support."

May 16, 2012
The SEC Resolves A Reg FD Case
by Tom Gorman

The Commission resolved a Reg FD case with the former CEO of Presstek, Inc., Edward Marino. The case has been in litigation since March 2010. SEC v. Presstek, Inc., Civil Action No. 10-1058 (E.D.N.Y. Filed March 9, 2010).

Presstek is a company engaged in designing, manufacturing, selling and servicing high tech digital imaging equipment in the graphics arts industry. Mr. Marino formerly served as a member of the board of directors, the chairman of the audit committee and as CEO.

The allegations against Mr. Marino center on his conversations about company performance on September 28, 2006 with a registered investment adviser whose funds held a large block. Shortly before that conversation Mr. Marino received an e-mail from the company controller. It stated that company performance in North America and Europe for August was weak and had a negative impact on margin and operating income relative to plan. Several days later Mr. Marino told certain senior personnel about the difficult results in an e-mail. No announcement of financial performance was planned before early October.

On September 28, 2006, Mr. Marino received a telephone call from Michael Barone, a managing partner of Sidus, a registered investment adviser. The funds managed by the adviser owned almost half a million shares of Presstek. During the telephone call, Mr. Marino told the adviser that the summer had not been as vibrant as expected in North America and Europe, according to notes of the conversation prepared by Mr. Barone. The notes go on to record Mr. Marino as saying, in substance, that overall a mixed picture for the company emerged for the quarter.

Mr. Barone began selling Presstek shares immediately, sending an e-mail during the call. By the end of the day he liquidated most of the funds' holdings. The share price closed down about 19%.

The next day Presstek issued a preliminary announcement. It reported that quarterly financial performance was below prior estimates.

The Commission's complaint named Mr. Marino and the company as defendants. It alleges violations of Exchange Act Section 13(a) and Regulation FD. The prayer for relief requested an injunction against both defendants and a penalty.

The company settled at the time the complaint was filed, consenting to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. As part of the settlement the company agreed to pay a $400,000 civil penalty. In an unusual step the Commission, in its complaint, acknowledged the cooperation of the company citing its remedial measures. Those included revising its corporate communications policies and governance principles, replacing its management team, appointing new independent board members and creating a whistleblower's hotline.

This week Mr. Marino settled with the Commission. In the civil injunctive action he agreed to the entry of a final judgment which imposed a $50,000 civil penalty. The settlement did not include an injunction. Rather, a separate administrative proceeding was instituted based on the same allegations as the civil injunctive action. To resolve that action Mr. Marino consented to the entry of a cease and desist order based on Exchange Act Section 13(a). In the Matter of Edward J. Marino, Adm. Proc. File No. 3-14879 (May 15, 2012).

May 16, 2012
D&O Insurance: Officer Not Acting in Insured Capacity When Guaranteeing Company Debt
by Kevin LaCroix

A company's D&O insurance policy provides liability protection for the company's individual directors and officers, but only for their actions undertaken in their capacities as directors and officers. It does not protect them when they are acting in a personal capacity. So, when a company's CEO signs a loan guaranty for the company, is he acting in an official or personal capacity, and will the D&O insurance policy provide protection for liability under the guaranty? Those were the questions addressed in a May 14, 2012 decision of a three-judge panel of the Court of Appeals of the State of Washington. A copy of the opinion can be found here.


In March 2008, S-J Management LLC (SJM) obtained a $3.5 million line of credit from Commerce Bank. Michael Sauter, SJM's CEO and manager, signed the loan agreement and promissory note in his official capacity on behalf of SJM. In addition Sauter provided Commerce Bank a guaranty, which he signed as "Michael J. Sauter" and which was secured by seven deeds of trust on real property owned by Sauter and his wife.

In May 2009, SJM's line of credit matured and SJM failed to pay its indebtedness. Commerce Bank demanded that Sauter pay in full under his "personal guaranty of indebtedness" SJM's $2.8 million obligation. Sauter in turn demanded that SJM indemnify him for the amount he was obligated to pay, to which SJM's members (of which Sauter was one) agreed. However, SJM was financially unable to indemnify Sauter. After Commerce Bank threatened that Sauter's failure to cure the default could result in the sale of the six real properties securing the guaranty, SJM's counsel tendered the bank's demand to SJM's D&O insurer.

SJM's insurer denied coverage with respect to Sauter's obligation, and Sauter filed an action against the insurer seeking damages and a judicial declaration of coverage. The parties filed cross motions for summary judgment. The trial court denied Sauter's motion but granted the insurer's motion, holding that there was no coverage because no act by Sauter constituted a "Wrongful Act" under the policy and Sauter suffered no "Loss" as defined by the Policy. Sauter appealed.

The Appellate Court's May 14, 2012 Opinion

In an opinion written for the three-judge panel by Judge Stephen J. Dwyer and applying Washington law, the intermediate appellate court affirmed the trial court's ruling. The court noted that the policy provides that an act by an "Insured Person" constitutes a "Wrongful Act" only when that person commits the act "while acting in [his or her] capacity as... such on behalf of the Insured Organization." An "Insured Person" acts "in his capacity as... such on behalf of the Insured Organization" when that person commits the act in his or her official capacity as a "director, officer, general partner, manager or equivalent executive" of the insured company.

In recognition of this language, the court said that because the policy "explicitly provides coverage for the personal liability of the corporate officer incurred for acts performed in his or her capacity as such," the policy "does not insure against losses incurred where the officer acts in his or her personal capacity."

The court said that "the fact that Sauter is an officer of SJM is not dispositive of the question presented," which is - in what capacity did Sauter sign the guaranty, his capacity as an officer or his personal capacity? The Court noted that "a guaranty executed by a corporate officer that secures the indebtedness of the corporation is not executed in the officers' official capacity." Indeed, the execution of the guaranty in an official capacity "would result in the corporation itself guaranteeing its own indebtedness, thus negating the very purpose of the guaranty."

Because Sauter was acting in his personal capacity when he signed the guaranty, Sauter committed no "Wrongful Act" as defined in SJM's D&O insurance policy, and thus the court concluded that the policy does not provide coverage for Sauter's financial obligation to Commerce Bank.

The Court went on to note in addition that any purported "Loss" suffered by Sauter did not result from a "Claim" made against Sauter for a "Wrongful Act." Rather, the court noted, "Sauter incurred the obligation to pay SJM's indebtedness by executing the guaranty - not by failing to satisfy his obligation pursuant thereto." In other words, the court said, "his obligation to Commerce Bank was not the result of Commerce Bank's demand on the guaranty; instead his obligation was the result of the guaranty itself." Accordingly, because his obligation to pay was the result of his voluntary undertaking, "it is not a 'Loss' resulting from any Claim... for a Wrongful Act."


D&O insurance policies protect individual directors and officers. But that protection does not extend to everything those individuals might do. Rather, the protection only extends to their actions undertaken in their capacities as directors and officers, not to actions undertaking in the personal capacities.

There principles are easy to state, but the lines of demarcation between actions undertaken in an official capacity and actions undertaken in a personal capacity may not always be clear. This case illustrates how the lines can sometimes be difficult to discern. Here, it was SJM that wanted to borrow the money, and Sauter was clearly motivated by a desire to facilitate SJM's borrowing. What matters though is not his motivations but his actions. When he signed the loan agreement and the promissory note, he was clearly acting in his official capacity. But he separately signed a guaranty. Sauter's guaranty was designed to obligate Sauter not the corporation, and his undertaking was clearly a separate, personal undertaken, as evidence by the fact that the guaranty was secured by deeds of trust on property owned by Sauter and his wife.

There is a further reason why Sauter's guaranty should not be the responsibility of the insurance company. One cannot undertake an obligation to pay, default on that obligation, and send the bill to the insurance company. For that reason, many courts have held that as a matter of public policy repayment of a contractual obligation does not represent a Loss under a D&O insurance policy. As discussed here, many D&O policies incorporate express contractual liability exclusions.

Coverage disputes arising from the questions of whether or not an individual was or was not acting in an insured capacity are occur frequently, particularly in connection with smaller or closely held corporations, when an individual's roles may overlap or run together. It may sometimes be very difficult, for instance, in the context of a closely held company to distinguish when an individual is acting as an investor or shareholder and when the individual is acting as a director or officer.

Indeed, in many instances, individuals may have been acting in dual capacities or multiple capacities, which can make questions concerning coverage for related claims particularly challenging. One critical coverage issue that is sometimes overlooked in the dual capacity context is that to trigger coverage under most policies, an individual need only have been acting in an insured capacity - most policies do not require that the individual have been acting "solely" in an insured capacity. The problem then of course, if the individual is insured only to the extent he or she was acting in an insured capacity, is figuring out the extent of coverage. The fact that these kinds of disputes tend to be very fact-specific does not make them any easier to resolve.

Similar questions can also arise when a director or officer is also acting a director or officer of more than one entity or organization - for example, where an individual is serving at the request of a private equity or venture capital firm on the board of a portfolio company. These concerns are among the many issues that may arise as a result of the interplay between the investment firm's insurance and the portfolio company's insurance, as discussed here.

Many thanks to Aidan McCormick of DLA Piper for sending me a copy of the decision. DLA Piper represented the D&O insurer in this case.

May 16, 2012
Securities Suit Filed Against JP Morgan Chase Over Massive Trading Losses
by Kevin LaCroix

In the wake of JP Morgan Chase's startling news last week of its $2 billion trading loss, and of the equaling startling statements of Jamie Dimon, the bank's CEO, that the losing trades were, among other things, "flawed, complex, poorly reviewed, poorly executed, and poorly monitored," there has been speculation whether these disclosures would lead to litigation. In particular, commentators have asked whether Dimon's candid statements would hurt the company in any litigation that might arise.

Well, it looks like we will be finding out. On May 14, 2012, plaintiffs filed a securities class action in the Southern District of New York, against the bank; Dimon; Ina Drew, the bank's former Chief Investment Officer: and Douglas Bronstein, the bank's chief financial officer. A copy of the complaint can be found here.

According to the plaintiffs' lawyers' May 14, 2012 press release (here), the complaint alleges that during the class period of April 13, 2012 through May 11, 2012, the defendants issued "materially false and misleading statements regarding certain securities trading by the Company's Chief Investment Office ("CIO"). Specifically, Defendants misrepresented and/or failed to disclose that the CIO had engaged in extremely risky and speculative trades that exposed JPMorgan to significant losses." The complaint specifically references the defendants' reassuring statements made between the time the rumors about the trading activity first surfaced in April and the time of the disclosures of the trading losses, and blockbuster admissions about the trades.

The initial complaint is just 18 pages. Although the complaint quotes extensively from Dimon's statements in a May 10, 2012 conference call, it does not refer to many other highly publicized features involved with the trading losses, including for example, the April rumors of trading activities by a JP Morgan trader labeled the "London whale," whose trades had roiled the derivatives market (the complaint refers to the trades, just not to the "whale," at least not by that name) nor Dimon's statements to Meet the Press aired on Sunday May 13, 2012, that the bank had been "sloppy" and "stupid" and that he had been "dead wrong" when he characterized questions about the derivatives trades as a "tempest in a teapot."

The complaint's scienter allegations do not allege any motivations for alleged misrepresentations made during the relatively short class period. There are no allegations that any of the defendants' traded on basis of allegations or that the defendants otherwise personally benefited from the misrepresentations. The complaint does allege that the defendants did not believe their earlier statements about the bank's derivatives trading activities at the time the statements were made.

To be sure, it is not uncommon for an initial securities class action complaint to be skeletal, with more detailed allegations added in subsequent amended pleadings after lead counsel has been selected and the cases consolidated. Along those lines, there may well be other complaints filed on behalf of other prospective class representatives that may contain different or additional allegations. Subsequent complaints or amended complaints may well be more detailed. These complaints may also draw on subsequent news reports that JPMorgan's senior management allegedly had disregarded "red flags" regarding the bank's trading activities.

Even if they are able to add additional details, however, plaintiffs seeking to plead this case will be faced with the challenge of attempting to present scienter allegations sufficient to overcome the initial pleading hurdles. The defendants will argue that it is not enough for plaintiffs to rely on the magnitude of the losses or even on the fact that the losses resulted from a trading strategy that Dimon has now publicly acknowledges was flawed. In attempting to show that the early reassurances are not merely misleading but are actionable, the plaintiffs may find that they must allege more than the subsequent admissions about the trading activities.

How the securities class action plaintiffs will proceed and how they will fare remains to be seen. But in the meantime, there are now press reports circulating that the Department of Justice has "opened an inquiry" regarding the bank's trading losses. The news of the DoJ inquiry follows prior reports that the SEC had opened a review of the developments. President Obama, among many others, has seized upon the bank's trading losses as evidence of the need for greater bank regulation, including in particular the so-called "Volker Rule." Questions are also being raised whether the bank will or should seek to "claw back" compensation from the three trades who were released following the disclosure of the losses.

The fallout from the trading losses will continue to roil the markets and the media for some time to come, and could hound both Dimon and J.P. Morgan for some time as well. In the meantime, the private securities class action lawsuit will unfold, as these cases do, in the fullness of time. I will say that as interesting as it is that a securities class action complaint has been filed, it will be more interesting to see the plaintiffs' allegations as they appear in the consolidated, amended complaint that ultimately will be filed.

May 16, 2012
JPMorgan Outsource
by David Zaring

The $2 billion trading loss is different from your average financial catastrophe, particularly in journalist terms, because journalists were writing about the possibility two months ago. They called it! How often do they get to say that? I smell Loeb awards! Anyway, if you haven't seen them, here's three interesting takes on the trading loss:

May 16, 2012
How the JOBS Act Will Affect Certain International Issuers
by Kara OBrien

The JOBS Act loosens restrictions around capital raises, lessens both U.S. IPO and ongoing disclosure and other obligations for many issuers, including foreign issuers, and reduces the cost of being public in the United States. For those OTCQX International issuers, prospective issuers and other members of the OTCQX International community who are wondering what impact the JOBS Act will have on them, here is an article from Michael Littenberg and James Nicoll of Schulte Roth & Zabel which provides an overview of those portions of the JOBS Act of particular relevance to OTCQX International issuers. Here is an excerpt:

The most immediate benefit of the JOBS Act for most OTCQX International issuers will be the elimination of restrictions on general solicitations and general advertising in connection with most U.S. private placements. OTCQX International issuers typically are exempt from U.S. reporting pursuant to the U.S. Securities and Exchange Commission's Rule 12g3-2(b) exemption. Because this exemption is not available to foreign issuers that publicly raise capital in the United States, OTCQX International issuers that raise capital in the United States typically do so through private placements. Under current U.S. law, issuers and intermediaries are severely limited in their ability to promote a private placement. Among other things, they cannot engage in print, Internet or broadcast advertising and are limited in their ability to engage in other activities that may condition the market for the securities being offered, such as press releases, press conferences and interviews.

The JOBS Act shifts the focus away from how prospective purchasers of privately-placed securities are solicited. The JOBS Act requires the SEC to amend existing private placement rules to allow general solicitations and general advertising in connection with private placements conducted in accordance with Rule 506 of Regulation D and Rule 144A under the Securities Act, which are the two most common private placement exemptions relied on in connection with U.S. institutional placements.

The issuer in a Rule 506 offering will be permitted to engage in general solicitations and general advertising in connection with the offering so long as it takes reasonable steps to verify that all of the purchasers in the Rule 506 offering are accredited investors. In the case of Rule 144A, which is a resale exemption for privately placed securities, there must be a reasonable belief that all purchasers are qualified institutional buyers. In most respects, these requirements are consistent with existing Rule 506 and Rule 144A offering practice and do not meaningfully limit the purchaser universe. An accredited investor generally is a higher net worth individual with individual income exceeding US$ 200,000 or net worth exceeding US$ 1 million or an entity with more than US$ 5 million of assets. A qualified institutional buyer generally is an institutional investor with US$ 100 million or more in assets under management.

Over time, these changes are likely to affect how private placements are marketed in the United States and are likely to be especially beneficial to smaller companies that are not as well known among U.S. institutional investors. The SEC is required to adopt amendments to Rule 506 and Rule 144A giving effect to this portion of the JOBS Act within 90 days after its enactment, or by July 4, 2012. An open question that the SEC will need to address is the interplay between the amendments to Regulation D and Rule 144A and offshore offerings conducted under Regulation S, which is the exemption from U.S. registration for offshore public offerings that satisfy specified criteria.

Click here for the complete SR&Z publication which includes discussion of compliance costs and looks ahead to what is next for smaller companies.

Don't miss PLI's upcoming JOBS Act 2012: What You Need to Know Now on May 30th in NYC and live on the web!!

May 16, 2012
Glass Steagall, The Capital Markets and the Volker Rule
by J Robert Brown Jr.

Glass Steagall was adopted during the Great Depression. The effect of the legislation was to keep commercial banking (deposits and loans) separate from investment banking (underwriting and M&A activity). One consequence was that commercial banks were mostly kept out of the equity markets, reducing the amount of risk they could undertake. This was not to say that commercial banking was risk free. There were plenty of examples of banks failing because they found themselves over committed to a particular market segment, say energy, and collapsed with the market.

But Glass Steagall had another affect. As set out in The "Great Fall": The Consequences of Repealing the Glass-Steagall Act, Glass Steagall allowed for the rise of a world class, powerful set of investment banks. In effect, the law prevented commercial banks from absorbing and taking over the investment banking industry.

The takeover was inevitable because over time commercial banks have inherent advantages, including access to low cost funds (deposits) and access to the Federal Reserve window. Moreover, as the article pointed out, just before Glass Steagall was adopted, the commercial banks were in the process of taking over the industry. Indeed, Glass Steagall required some banks to separate their commercial and investment banking parts (JP Morgan & Morgan Stanley as one example).

The consequence of separating the two areas meant that investment banks focused not on lending relationships but on relationships that centered around the capital markets. They had an incentive to understand the capital markets and they had an incentive to encourage companies to rely on the capital markets. In short, they were a class of intermediaries that promoted active capital markets.

With the end of Glass Steagall, commercial banks have for the most part taken over the investment banking business, just as they were seeking to do in the 1930s, before Congress acted. Before the most recent financial crisis there were five world class investment banks: Goldman, Morgan Stanley, Merrill, Bear Sterns and Lehman. Bear is part of JP Morgan; Merrill is part of BofA. Lehman, of course, is gone. Only Morgan Stanley and Goldman remain (afer both converted to commercial banks).

Does it make a difference? First, as one can see from the latest problems at JP Morgan, commercial banks engaging in market activities take on enormous risk. But there is a deeper problem. First, commercial banks can offer companies both lending and underwriting services. In other words, they are not completely dedicated to the capital markets. Second, at least historically, commercial banks, because of more extensive regulatory oversight, were more conservative. They could be counted on not to push the capital markets envelope as hard as a traditional investment bank. Both are bad for the capital markets.

The Dodd-Frank Act added the Volker Rule, a provision that prohibits banks from engaging in proprietary trading and from sponsoring a hedge fund. This is not Glass Steagall. Banks can still engage in market activities with their client's money. Moreover, it does not guarantee a source of business for investment banks that do not want to engage in commercial banking activity. Those subject to the Volker Rule can farm out their proprietary trading activity to another commercial bank.

But this Blog will over time discuss the impact of the Volker Rule on the investment banking industry and the US capital markets.

View today's posts

5/16/2012 posts

The Green Mien: One Man's Trash is Another Man's...Affordable, Safe Form of Carbon-Free Energy
SEC Actions Blog: The SEC Resolves A Reg FD Case
D & O Diary: D&O Insurance: Officer Not Acting in Insured Capacity When Guaranteeing Company Debt
D & O Diary: Securities Suit Filed Against JP Morgan Chase Over Massive Trading Losses
Conglomerate: JPMorgan Outsource
Securities Law Practice Center: How the JOBS Act Will Affect Certain International Issuers
Race to the Bottom: Glass Steagall, The Capital Markets and the Volker Rule

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