Securities Mosaic® Blogwatch
September 30, 2013
Reprieve From the Governor! The SEC Won't Shut Down (At Least Not Tomorrow)
by Broc Romanek

Reprieve From the Governor! The SEC Won't Shut Down (At Least Not Tomorrow)

On Friday, the SEC posted a notice saying that it "will remain open and operational in the event the federal government undergoes a lapse in appropriations on October 1. Any changes to the SEC's operational status after October 1 will be announced on this website." So the SEC's complete operations - including review and declaring registration statements effective - will continue until further notice (this is what happened during the pair of shutdowns in fiscal '96, which was the last time the government shut down - see this NY Times article about those). So maybe the answer to my poll about how many Corp Fin Staff are considered "essential" during a shut down is "all"?

It looks like some media outlets got confused and reported something different, perhaps because at the same time its "we're staying open" notice was posted, the SEC simultaneously posted its shutdown plan. What we don't know is how long the SEC can keep its doors open if the rest of the government is closed.

On Friday, the SEC extended the comment period for its latest Reg D proposals by 30 days...

Today's Spreecast: "PCAOB's Audit Report Proposals: A Big Sleeper?"

Come participate in the spreecast - "PCAOB's Audit Report Proposals: A Big Sleeper?" - at 1 pm eastern today! During it, Davis Polk's Joe Hall & re:theauditor's Francine McKenna will analyze the PCAOB's new audit report proposal that could come to rival Sarbanes-Oxley's Section 404 - internal controls - as a burden we all face. To access the spreecast, go here at 1 pm eastern. [Note the recent "More on Reg D Offerings Today" spreecast has had over 700 views; a new spreecast has been calendared for October 22nd: "Latest Corp Fin Comment Letter Trends"]

Here are FAQs about how spreecasts work - but the upshot is you have to register for Spreecast first (although it's possible to watch without registering if you close a prompt). Simply sign up by using an email address by clicking the "Or sign up via email" link in the upper right hand side of the site (it's in small print under the "Connect with Facebook" logo).

The Great Ellison and the America's Cup

Here's a note from Yahoo!'s Carrie Darling:

Last Wednesday, as I was flying back home from Broc's conference in D.C., I watched The Great Gatsby. Unfortunately, the timing of my flight was such that I was missing the America's Cup yacht race. When I got off the plane, I had a text from my husband saying that Oracle Team USA had won the America's Cup. All I could think of was "The Great Ellison." I kept saying it over and over to myself as I waited in baggage claim (baggage claim is really slow in San Jose). What is this America's Cup you ask? Why is Ellison so great? Well, let me tell you . . .

Larry Ellison is the CEO of Oracle Corp. and is the driving force behind/owner of Oracle Team USA. Last Wednesday, Oracle Team USA's victory marks one of the most improbable comebacks in the history of sports. His team won 11 races to score the 9 points required for victory, due to a penalty imposed by the International Jury of two points. Only a week before on September 18, Oracle Team USA trailed the series 8-1. They came back to win the series over Emirates Team New Zealand with eight consecutive victories. What an amazing day for sports and sailing.

So, what is the America's Cup? The America's Cup is the oldest international sporting trophy. The America's Cup, affectionately known as the "Auld Mug", is a trophy awarded to the winner of the America's Cup match races between two sailing yachts. One yacht, known as the defender, represents the yacht club that currently holds the America's Cup and the second yacht, known as the challenger, represents the yacht club that is trying to take the cup away from the defender. The timing of each match is determined by an agreement between the defender and the challenger.

The trophy was originally awarded in 1851 by the Royal Yacht Squadron for a race around the Isle of Wight in England, which was won by the schooner America. America finished 8 minutes ahead of her closest rival. Queen Victoria, who was watching at the finish line, was reported to have asked who was second, the famous answer being, "Ah, Your Majesty, there is no second." Thus, the trophy was renamed the America's Cup after the yacht (not after the country) and was donated to the New York Yacht Club (NYYC) under the terms of the Deed of Gift, which made the cup available for perpetual international competition.

Any yacht club that meets the requirements specified in the Deed of Gift has the right to challenge the yacht club that holds the Cup. If the challenging club wins the match, it gains control of the cup.

The trophy was held by the NYYC from 1857 until 1983 when the Cup was won by the Royal Perth Yacht Club, ending the longest winning streak in the history of the sport.
From the first defense of the Cup in 1870 through 1967, there was always only one challenger. In 1970, for the first time, there were multiple challengers. Louis Vuitton has sponsored the Louis Vuitton Cup as a prize for the winner of the challenger selection series since 1983.

Early matches for the Cup were raced between yachts that were between 65-90 ft. long. The 2010 America's Cup was raced in 90 ft. multi-hull yachts in Valencia, Spain. Challenger BMW Oracle Racing beat defender Alinghi 2-0 and won the Cup for the Golden Gate Yacht Club, bringing it back to San Francisco Bay. The 2013 America's Cup was raced in AC72 wing-sail catamarans, and was held in the San Francisco Bay.
It remains to be seen where Ellison will decide to hold the next America's Cup races. If not in San Francisco, I vote for Lanai!

- Broc Romanek

September 30, 2013
Objections to Conflict Minerals Rules Continue
by Celia Taylor

On September 11th a law firm filed a petition pursuant to Rule 192(a) of the Commission's Rules of Practice (which permits persons to seek, among other things, the amendment of a rule of general applicability) requesting the Commission to amend the rule governing the required Form SD (the form required to be submitted by issuers covered by the conflict minerals provision).  Currently, issuers subject to the conflict minerals rules must certify in the required reports (the first of which will be due in May 2014) that they had systems in place allowing them to demonstrate that they made a "good faith a reasonable country of origin inquiry" starting January 31, 2013.

Specifically, the request asks the Commission to permit alternative disclosure, for a temporary period, for issuers who cannot yet able to comply with the Conflict Minerals Rules.  The proposed amendment would grant:

A one-year deferral for filing Form SD to any registrant that, commencing with its first Exchange Act periodic report due on or after October 1, 2013, provides in that and subsequent periodic reports until it first files a report on Form SD, detailed status reports on the actions taken to-date and currently anticipated to be taken in order to yield compliance.

A two-year deferral with respect to coverage of foreign operations where the registrant complies with the requirements for the one-year deferral and thereafter continues to provide detailed status reports on foreign implementation consistent in scope with the status reports filed during the first year.

The status reports required to support the deferred filing would furnished under Exhibit 99 and would be required to include significant information about the issuers attempts to come into compliance with the Conflict Minerals Rules, including, among other information:

Confirmation that the registrant does not in good faith believe that it currently is able to comply fully with the Form SD requirements.

The title of the individual with day-to-day oversight responsibilities for compliance with Form SD.

The identity of each consulting firm retained by the registrant to assist in any material respect in facilitating compliance and a description of the scope of its engagement.

The status of the development of a conflict minerals policy and its expected date and location of publication.

The identity of the board (or similar) committee with ultimate oversight of registrant's compliance with Form SD and the date of management's most recent report to the committee.

The status of the registrant's review of its products to determine whether they contain conflict minerals, highlighting changes since the prior report.

The status of the registrant's reasonable country of origin inquiry and discussions with its suppliers as a whole regarding compliance.

The registrant's current timing expectations with respect to being able to file a complaint Form SD, highlighting key gating issues.

What justifies seeking such an amendment to the conflict minerals rules?  According to the law firm "based upon our experience over a broad range of registrants in a cross-section of industries, at this point in time we are unaware of any registrant with a significant number of products that include conflict minerals that has the ability to comply completely with the conflict minerals rules."  At heart, the claim is that it is simply too hard for issuers to come into compliance within the stated time frames.  The law firm claims that scope of the rules covers many issuers who did not believe they would be covered, that issuers' existing systems and structures are not suitable for compliance and deployment of additional resources to correct this problem will take time.  They note further that the hoped for "silver bullet" of recycled materials and conflict-free certified smelters are not "viable near term" alternatives for many issuers.  Additionally, they note that there is a shortage of experts who can assist issuers in bringing their activities into compliance with the rules. Therefore, based on these and other objections, the law firm suggests deferred disclosure.


What is the likelihood the SEC will grant the request? The SEC's course of action with respect to any particular issue is of course anyone's guess.  In favor of the SEC granting the request is the fact that the SEC didn't want to take on this issue in the first place and acknowledged at the time that it was complex and difficult. Further, refusing to grant the request may lead to "bad" disclosure - attempts to comply with the rules that fall far short of best practices.  Rather than rush the process and get inferior results the SEC may decide to slow things down and allow for more accurate and robust disclosure.

However, the arguments presented in seeking the amendment vary little from those received by the SEC during the notice and comment period preceding final adoption of the rule.  "It's too hard" is not an overly compelling reason to change a rule.  Further, the rule as drafted was upheld by the DC Circuit Court which certainly considered the objections posed by the request for amendment.

Regardless of the outcome of the request for admission, the appeal to the rules remains before the US Court of Appeals for the District of Columbia and the controversy over the rules will continue.


September 29, 2013
Slowing of Global Warming May Be Cold Comfort for the Oceans
by Peter Lohnes

Pity the planet's oceans. They have been doing more than their fair share in coping with humanity's profligate dumping of carbon into the atmosphere and the consequent rise in global temperatures. The oceans have been serving as a buffer, masking the full impact of our species' voracious need for energy. But their watery intervention seems to come at a tremendous cost.

The Intergovernmental Panel on Climate Change released its latest report on Friday. The big headline news is that the report (the summary of which required unanimous agreement from member nations) provides "unequivocal" evidence that the atmosphere and oceans have warmed since 1950, and that scientists are now "95 per cent certain" that humans are the "dominant cause".

Prior to the report's release, much had been made of the "pause" in global warming over the last fifteen years during which the earth's temperature has not increased as much as predicted. Climate change skeptics have been making hay with the discrepancy between climatologists' predictions of ever increasing temperatures and the apparent leveling off the earth's surface temperature over the last decade or so. An organized campaign by well-funded climate skeptics have seized on the apparent slowdown to try to discredit a theory supported by the overwhelming majority of climate scientists.

John Church, the IPCC scientist coordinating research on sea change dismissed any notion that the apparent hiatus in rising temperature indicated a slowdown in global warming itself. Rather, the cause is likely attributable - at least in part - to the oceans absorbing the ever increasing heat. "Oceans can trap huge amounts of heat," said Church. "But how much and for how long is unclear." As Church describes the process, heat is being absorbed at deeper levels of the ocean, effectively masking the overall heat load we are asking the planet to take.

The IPCC report is hardly the first time the pause in global warming has been attributed to the oceans acting as giant heat sumps. A recent study in the journal Nature posited that the oceans are absorbing atmospheric heat, pausing the increase in global temperatures even as arctic ice continues to melt at a record pace. That conclusion was echoed in a detailed report by Zeke Hausfather for the Yale Forum on Climate Change and the Media which attributes the slowdown in global surface temperatures at least in part on more heat going into the deep oceans.

But the heat load is not the only effect carbon is having on the oceans. The very chemistry of the seas is changing.

The Seattle Times, one of the last independent, family-owned major metropolitan newspapers, is running a remarkable series of investigative reports on ocean acidification. The profoundly unsettling articles describe ocean acidification as the lesser-known twin of climate change. Humanity is dumping 100 tons of carbon - the equivalent of a hopper car of coal - every second of the day, according to the Times report. The oceans are already 30% more acidic than they were just 30 years ago. All that carbon dioxide is scrambling marine life on a scale almost too big to fathom. The increasing acidity of the ocean waters can play havoc with crabs, squid, coral, oysters, and especially krill. Krill are the tiny crustaceans which form the base of the food chain in the world's oceans. If krill populations collapse, the consequences for the entire ecosystem would be dire.

The Times details the growing alarm in Alaska over the threat to the state's lucrative crab harvest. Experts warn that the entire fishery there could collapse in the coming decades barring a dramatic reduction in greenhouse gas emissions.

As Hausfather points out in his study, there is still much we don't understand about the many different factors impacting Earth's climate system. Nobody knows how much heat and carbon the oceans can safely absorb. But the effects of pouring carbon into them are already apparent. And warming water and increasing acidity are only the beginning. Perhaps the spookiest side effect I've seen discussed is the alarming growth in jellyfish populations around the globe. Yes, global climate change and ocean acidification are apparently causing massive increases in jellyfish populations, with decidedly unpleasant consequences for divers, beach combers, and other sea life. While acidification is killing off mollusks and krill, jellyfish, which have no hard shell, thrive in more acidic and warmer waters. They're taking over the oceans.

Jellyfish appear on the menu in some parts of the world. The Chinese, in particular, have long considered them a delectable treat.

We may all end up eating jellyfish, by necessity if not choice. Get used to it.

The Times has performed an invaluable service by publishing its series on acidification, and you owe yourself the the time to read it. The first installment is here.

September 28, 2013
Chancery Imposes Fees for Bad Faith Litigation Tactics
by Francis Pileggi

ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member LLC, C. A. No. 5483-VCL (Del. Ch. Sept. 16, 2013)

This Chancery decision, on remand from the Delaware Supreme Court, awarded attorneys' fees based on the bad faith exception to the American Rule. The Supreme Court had remanded because the award of fees was originally based on a fee-shifting provision in the contract, but the high court ruled that such was not a proper basis for a fee award because the prevailing party did not incur fees in light of their counsel providing free representation as a means of avoiding a malpractice claim.

This opinion provides a useful explanation of the types of litigation behavior that will support an award of fees. For example, in this case the court found that the scorched-earth tactics of filing three separate suits in three separate states was designed to drive up costs and to extract a settlement disproportionate to the merits.

Prior decisions in this case were highlighted on these pages here.

Postscript: Regular readers may notice that blogging has been light over the last few weeks, and it is expected to continue to be light for the next two weeks or so due to the press of business for paying clients - which for a practicing lawyer should be a good thing. Once my schedule returns to a "less frenetic pace" I hope to resume more regular updates.

September 27, 2013
Don't Get Caught In The Crosshairs When The SEC Deploys Its Full Enforcement Arsenal
by Jim Meyers

On September 26, SEC Chair Mary Jo White gave an important speech to the Council of Institutional Investors in Chicago. The speech, entitled "Deploying the Full Enforcement Arsenal," provides the first detailed roadmap to the Commission's enforcement priorities in the White administration. While some of the SEC's enforcement program going forward will involve a continuation and reinforcement of efforts begun during the administration of former Chair Mary Schapiro and former Enforcement Director Robert Khuzami, much of it will entail new initiatives. The bottom line is that - not surprisingly - Chair White, a former U.S. Attorney, is committed to a vigorous, prosecutorial-minded enforcement program.

Here are the key takeaways from the speech:
Individuals First. Perhaps most importantly, Chair White stated that the "core principle of any strong enforcement program is to pursue responsible individuals wherever possible." Accordingly, she has "made it clear that the staff should look hard to see whether a case against individuals can be brought. I want to be sure we are looking first at the individual conduct and working out to the entity, rather than starting with the entity as a whole and working in." She also indicated that the Commission is likely to seek more industry and officer-and-director bars against individuals. Chair White described this focus on individuals first as a "subtle" shift in approach, but it is one that, if followed in practice, will have significant consequences, particularly when paired with some of the other initiatives described below.

Areas of Enforcement Scrutiny. Chair White identified several substantive areas of enforcement focus during her administration. Many are familiar, but some are new or at least resurrected. She identified them in the following order:
misconduct by investment advisers at hedge funds, private equity funds, and mutual funds;
financial statement and accounting fraud - this is consistent with the Enforcement Division's recent creation of a task force devoted to proactively identifying ways in which companies can try to manipulate its financial statements and books and records;
insider trading;
microcap fraud, particularly in the context of social media;
violations of new rules implemented pursuant to the Dodd-Frank and JOBS Acts; and
actions relating to sophisticated trading strategies, dark pools, and other trading platforms.

Admissions of Wrongdoing. Chair White started by saying that in "most" cases, the SEC's longstanding approach of not requiring admissions of liability as a condition of settlement "makes very good sense." But she then noted that the Commission has expanded the circumstances in which the Enforcement Division and Commission will require admissions of wrongdoing or admissions of facts that might establish a violation of the securities laws, as follows:
"Cases where a large number of investors have been harmed or the conduct was otherwise egregious;"
"Cases where the conduct posed a significant risk to the market or investors;"
"Cases where admissions would aid investors deciding whether to deal with a particular party in the future;" and
"Cases where reciting unambiguous facts would send an important message to the market about a particular case."

Tougher Sanctions - Penalties. Chair White emphasized that the Commission "must make aggressive use of our existing penalty authority, recognizing that meaningful monetary penalties - whether against companies or individuals - play a very important role in a strong enforcement program." She stated that the Commission's January 2006 Corporate Penalties Statement provides a useful list of factors that the Enforcement staff and Commission will consider in deciding whether to impose corporate penalties and in what amount, but then pointedly added that the Statement "was not then, and is not now, binding policy for the Commission or the staff" and that "[t]oday, we have an entirely new Commission." The "bottom line" for Chair White "is that corporate penalties will be considered in all appropriate cases."

Tougher Sanctions - Undertakings. Chair White said that the market should "[e]xpect to see" more orders subjecting companies to "mandatory undertakings in future cases so that we are not just punishing past wrongs, but also acting to prevent future wrongs." She specifically cited training and reporting undertakings in FCPA settlements as an example. She added that "[w]hen we enter into a settlement with a company involving systems control failures... we should consider mandating new policies and procedures and other controls, and require that a compliance consultant test these controls."

Negligence theories of liability. Chair White stated toward the outset of her speech that the Commission will bring both "the tough cases" and the "smaller ones." She added that "[i]f we do not have the evidence to bring a case charging intentional wrongdoing, then bring the negligence case that does not require intent." This has been a hot-button topic within the Enforcement Division over the last few years, since Mr. Khuzami started pursuing negligence-based cases in a more concerted fashion. Some within the Enforcement Division have argued that such an approach is not the best use of the Commission's scarce resources, and some outside the Commission, such as members of Congress and the judiciary, have questioned why the agency is not devoting its resources to more vigorously pursuing fraud cases. Chair White's comment suggests that the SEC will continue on the current path of pursuing negligence as well as fraud cases.

September 27, 2013
How Much Latitude Do Directors Have In Setting Executive Compensation?
by Alex Talarides, Jennifer Lee and Robert Varian

Executive compensation decisions are core functions of a board of directors and, absent unusual circumstances, are protected by the business judgment rule. As Delaware courts have repeatedly recognized, the size and structure of executive compensation are inherently matters of business judgment, and so, appropriately, directors have broad discretion in their executive compensation decisions. In light of the broad deference given to directors' executive compensation decisions, courts rarely second-guess those decisions. That is particularly so when the board or committee setting executive compensation retains and relies on the advice of an independent compensation consultant.

Nevertheless, despite the high hurdle to challenging compensation packages, shareholder plaintiffs continue to aggressively challenge executive compensation decisions, in particular at companies that have performed poorly and received negative or low say-on-pay advisory votes.

As we've discussed on previous occasions, Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires most public companies to include a resolution in their proxy statements asking shareholders to approve the compensation of their executive officers, in a non-binding, "say-on-pay" shareholder vote. Despite the fact that Dodd-Frank explicitly provides that say-on-pay votes "may not be construed" as altering the fiduciary duties of boards or imposing any additional fiduciary duties, dozens of companies throughout the country have been the subject of shareholder derivative lawsuits following a negative say-on-pay vote. These lawsuits generally allege that the directors breached their fiduciary duties by failing to alter an executive compensation plan in response to its rejection by the shareholders. Notably, even though most of these lawsuits target Delaware corporations, none have been filed in Delaware.

In any event, most courts have rejected say-on-pay cases challenging executive compensation disapproved by shareholders, the most recent being the California Court of Appeal in Charter Township of Clinton Police and Fire Retirement System v. Martin. The complaint in that case alleged that the board of Jacobs Engineering Group, a Delaware corporation, breached its fiduciary duties by, among other things, adopting a compensation plan in the face of poor performance by the company, and failing to amend the plan after its rejection by a majority of Jacob's shareholders. The court dismissed the complaint, recognizing that matters of executive compensation are generally "left to the wide discretion of the directors." As the court held, under Delaware law, allegations that the directors "supported the [compensation] plan during the shareholder vote, and stuck with it after the negative vote, do not begin to approach the level of pleading necessary to overcome the presumption of the business judgment rule," since the "goal of retaining key executives during poor economic circumstances is entirely reasonable in order to attempt to minimize the effects of a major economic downturn on a company."

This case, along with other cases that have rejected similar "say-on-pay" claims, reinforce the principle of U.S. corporate law that directors, not shareholders, manage the business and affairs of the company. Absent extraordinary circumstances, directors of public companies have the power and discretion to decide what the level of executive compensation should be, taking into account a variety of factors other than financial performance and shareholder sentiment.

September 27, 2013
Baker & Hostetler discusses the Philip Falcone & Harbinger Capital Settlement
by Marc D. Powers

On August 19, 2013, the Securities and Exchange Commission (SEC) announced that New York-based hedge fund adviser Philip A. Falcone and his advisory firm Harbinger Capital Partners - which once boasted $26 billion under management - agreed to a settlement in which Falcone is barred from the securities industry for at least five years, Falcone and Harbinger must pay more than $18 million and, most notably, Falcone and Harbinger admit certain wrongdoing. The agreement comes several months after Falcone apparently jumped the gun by announcing to his investors that he and SEC staff had reached a more lenient settlement, which did not require any admission of wrongdoing. The new settlement reflects a more aggressive stance recently announced by the SEC and is a sea change from its long-standing policy of allowing defendants to "neither admit nor deny" wrongdoing. The rationale for this shift was articulated by Andrew Ceresney, new co-director of the SEC's enforcement division: "Falcone and Harbinger engaged in serious misconduct that harmed investors, and their admissions leave no doubt that they violated the federal securities laws." Time will tell if the Commission's interest in obtaining admissions of wrongdoing will enhance and advance a fair and effective enforcement program.


In June 2012, the SEC filed two civil lawsuits against Falcone and Harbinger.[1] The most serious charge was that Falcone borrowed $113 million from a Harbinger fund to pay his own personal taxes at a time when his investors were prohibited from withdrawing their own money from the fund. The first complaint also alleged that Falcone allowed some large investors to pull their money from his funds in return for their vote to approve a plan to restrict client redemptions from a different fund. According to the SEC, Harbinger concealed these preferred shareholder deals from the funds' independent directors and investors. The second complaint alleged that Falcone and Harbinger, as part of Falcone's retaliation efforts against Goldman Sachs, manipulated the bond market by conducting an illegal "short squeeze" of bonds issued by a Canadian manufacturing company.


In May, the SEC reached an initial deal with Falcone and Harbinger in which the defendants would be barred from the securities industry for two years and, most notably, in which neither defendant was required to admit any wrongdoing. The deal was rejected two months later by the Commission as being too lenient. In the new settlement, the defendants specifically admit to acting "recklessly" and admit to a long list of facts, including that Falcone improperly borrowed millions of dollars to pay personal tax obligations.[2] In addition, Falcone consents to the entry of a judgment barring him from the industry for five years.[3] Hedge fund managers and investment advisers are, from this settlement, on continued alert as to the SEC's enforcement focus on the areas of self-interested transactions and failure to disclose material information to investors, as well as preferring certain investor classes over others.


The revamped settlement agreement is the first to require a defendant to admit wrongdoing since the new policy of requiring admissions in some cases was announced in June by new SEC Chairman, Mary Jo White. For the life of the SEC Enforcement Division, spanning several generations, the SEC (and other Federal administrative and regulatory agencies, such as the FDA and EPA) agreed to settlements in which the targets of investigations were allowed to settle without admitting or denying guilt, a practice that has been criticized by some judges in recent years.

For example, in 2011, U.S. District Judge Rakoff for the Southern District of New York rejected a $285 million settlement between Citigroup Inc. and the SEC.[4] Judge Rakoff derided the amount of money that Citigroup had agreed to pay, calling it "pocket change" for the bank.[5] He also found that, in settling the case without requiring the bank to admit to wrongdoing (a practice he called "hallowed by history but not by reason"), the parties deprived the public "of ever knowing the truth in a matter of obvious public importance." [6] Both parties appealed the decision to the U.S. Court of Appeals for the Second Circuit, arguing that Judge Rakoff exceeded his authority in rejecting the settlement. [7] In March 2012, the Second Circuit granted a stay of the District Court proceeding while it reviewed the appeal. The three-judge panel of the Second Circuit, writing per curiam, found that the parties made a strong showing of likelihood of success on appeal, noting that Judge Rakoff did not "appear to have given deference to the S.E.C.'s judgment." [8] The appellate court also questioned the District Court's "apparent view that the public interest is disserved by an agency settlement that does not require the defendant's admission of liability." [9] Argument was heard on the merits of the case in February of this year and the issue remains sub judice.

In the wake of such criticism, and in response to public outrage at recent financial scandals, in 2012, then-SEC Enforcement Director Robert Khuzami announced a change to the "neither admit nor deny" policy in SEC enforcement actions involving defendants who had been convicted in parallel criminal cases. In such cases, the SEC would delete the "neither admit nor deny" language from its settlement documents, and instead recite the facts and nature of the criminal conviction. [10]

Following this trend, in June of this year, Chairman White sent a letter to staffers of the enforcement division, instructing them to assess their ongoing investigations and pending actions with an eye toward whether the conducts and circumstances might require a public admission of guilt. Later that month, Ms. White told an audience at a financial conference that the SEC was "going to, in certain cases, be seeking admissions going forward... Public accountability in particular kinds of cases can be quite important and if we don't get them, then we litigate them." The Falcone matter was found to be one of those particular kinds of cases.


The announcement by Ms. White, a former United States Attorney, is not without critics. Some argue that requiring admissions as part of a negotiated settlement is beyond the scope of the SEC's charge, which, as a civil administrative body, is to regulate the securities markets and promote the raising of capital. Requiring admissions, the argument goes, moves beyond deterring bad behavior and instead seeks to punish offenders, which is more properly within the province of the Department of Justice. Commentators also suggest that because of collateral consequences associated with parties being required to make admissions, the new policy may actually decrease the number of enforcement actions the SEC will be able to bring, and may result in disproportionately harsh treatment to individual defendants and those firms that lack the resources needed to litigate a case to trial in order to try and prove their innocence.

An admission of wrongdoing in an SEC settlement could also make a defendant more vulnerable to liability in investor class actions, as well as proceedings by criminal prosecutors and state regulators. Not only could the admissions embolden others to file suit, such admissions may be able to be used offensively and collaterally in future litigation. Admissions may also constitute events that will render a broker-dealer statutorily disqualified under federal law. [11] Because of these types of collateral consequences, defendants may be far less likely to settle if admissions of wrongdoing are required.

Protracted litigations could have negative consequences for all parties, as well as shareholders. Such cases could drain finite resources from the SEC's overall enforcement program, thereby reducing the number of enforcement actions the SEC could actually initiate. Moreover, the original deterrent objective behind an SEC lawsuit may be weakened if a case takes so long that, by the time a trial is over and appeals exhausted, the events from which the case arose are far in the past.

It will also be interesting to see if over time, small to mid-size defendants feel particularly squeezed or compelled to admit wrongdoing due to their own resource constraints, or whether, in the exercise of its discretion, the Commission will relax its admissions policy based on the resource sizes and constraints of such defendants.


Ms. White has stated that admissions will be sought only where the conduct alleged is particularly "egregious." Yet, the discretionary nature of determining what is "egregious" may prove difficult in practice and leave too much discretion in the hands of SEC staffers. In short, although it remains too early to tell if the Falcone settlement is indeed "a Harbinger of things to come," it should be clear to all regulated entities - including public companies, investment advisers and broker-dealers everywhere - that SEC enforcement actions come with even greater risk and potential for deeper and more far-reaching exposure.


[1] SEC v. Harbinger Capital Partners LLC,12-cv-¬5028 (PAC) (S.D.N.Y. June 27, 2012); SEC v. Philip A. Falcone, et al.,12-cv-5027 (PAC) (S.D.N.Y. June 27, 2012).
[2] There are, however, no direct admissions of liability for violating any specific rules or laws, nor does the settlement prohibit the defendants from taking a different position in other lawsuits in which the SEC is not a party.
[3] Falcone is barred from associating with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent or nationally recognized statistical rating organization for at least five years. He is, however, allowed to assist with the liquidation of his hedge funds under the supervision of an independent monitor.
[4] SEC v. Citigroup Global Markets Inc., 827 F. Supp. 2d 328 (S.D.N.Y. 2011). Likewise, in 2009, Judge Rakoff rejected the proposed settlement between the SEC and Bank of America Corp., which called for an injunction against future violations and a penalty of $33 million for the bank, but also contained a proposed "neither admit nor deny" stipulation. SEC v. Bank of America Corp., 653 F. Supp. 2d 507 (S.D.N.Y. 2009).
[5] Other judges have also questioned the SEC on settlements that do not require admissions of wrongdoing. A $602 million settlement with hedge fund SAC Capital Advisors LP, in which the defendant had been charged with insider trading, was briefly held up this year after U.S. District Judge Marrero, also of the Southern District of New York, said he needed more time to consider whether to approve the agreement without an admission of wrongdoing. The SAC settlement was ultimately approved; however, Judge Marrero stated that he was "troubled" by the settlement agreement's "neither admit nor deny" provision, and expressly conditioned his judgment on the outcome in Judge Rakoff's Citigroup appeal. SEC v. CR Intrinsic Investors, LLC, No. 12 Civ 8466, 2013 WL 1614999 (S.D.N.Y. Apr. 16, 2013).
[6] Judge Rakoff also noted the disparity in the SEC's treatment of Citigroup and Goldman Sachs, which, in a similar case, paid a $550 million penalty to settle civil charges and was forced to state that its disclosures "contained incomplete information" and that it made a "mistake" in how it marketed the securities. Citigroup, 827 F. Supp.2d at 334 n. 7
[7] SEC v. Citigroup Global Markets, Inc., 673 F.3d 158 (2d Cir. 2012).
[8] Id. at 163.
[9] Id. at 165.
[10] The policy is the same in cases in which the defendant admits or acknowledges criminal conduct in non-prosecution or deferred prosecution agreements with criminal prosecutors.
[11] Broker-dealers are required to register with the SEC. Section 15(b)(4) of the Exchange Act enumerates "disqualifying events," such as certain findings of wrongdoing, under which the SEC may suspend or revoke such registration.

The original memo was published by Baker & Hostetler LLP on September 3, 2013 and is available here.

September 27, 2013
Assessing U.S. Public Company Cyber Risk Disclosure Practices
by Kevin LaCroix

It has been nearly two years since the SEC Division of Corporate Finance issued its Disclosure Guidance on cybersecurity risks. During this period reporting companies have had the opportunity to incorporate disclosures in their reporting documents about the cybersecurity risks they face. To develop a picture of what companies are disclosing and what the disclosure suggests, the insurance brokerage firm Willis reviewed the cyber disclosures in the SEC filings of the Fortune 1000 companies. The August 2013 report based on that review can be found here.

As readers will recall, the SEC Division of Corporate Finance issued its Disclosure Guidance on cybersecurity in October 2011 (about which refer here). Among other things, the Guidance suggested that appropriate risk factor disclosures might include:

  • Discussion of aspects of the registrant's business or operations that give rise to material cybersecurity risks and the potential costs and consequences;
  • To the extent the registrant outsources functions that have material cybersecurity risks, description of those functions and how the registrant addresses those risks;
  • Description of cyber incidents experienced by the registrant that are individually, or in the aggregate, material, including a description of the costs and other consequences;
  • Risks related to cyber incidents that may remain undetected for an extended period; and
  • Description of relevant insurance coverage.

Willis reviewed the 10-Ks and annual reports of the Fortune 1000 companies in order to assess the extent of cyber risks and exposures identified and the steps being taken to reduce the risks and exposures. The firm also compared disclosure practices between the largest 500 companies with the Fortune 501-1000 companies.

Among many interesting things, the report notes that a large number of companies have chosen to remain silent in their filing documents about cybersecurity risks - the filings of 12% of the companies in the Fortune 500 contained no cyber disclosures and the filings of 22% of companies in the Fortune 501-1000 contained no cyber disclosure. On the other hand, the majority of companies in both groups reported either that cybersecurity risks could "impact" or "materially impact" their businesses, or that they could "materially harm" or "seriously harm" their businesses.

Though many companies are now disclosing their concerns about cybersecurity risks, few of the companies disclosed that they had in fact been the subject of an actual cyber event. Only 1% of the Fortune 1000 disclosed a cyber event in their reporting documents. As the Willis report notes, this is "a seemingly low number given the number of attacks that appear in the press on a regular basis." The report notes further that none of the companies that disclosed actual attacks included the associated cost, even though the SEC's Guidance requests the dollar costs of the attacks that have occurred.

The report groups the kinds of cybersecurity risks that reporting companies specifically identified, noting that the most frequently used terms to describe the cyber exposures facing companies include "privacy/use of confidential data" and "reputation risk." Interestingly, given recent prominent publicity, relatively few companies identified either cyber terrorism (less than 20% overall) or loss of intellectual property (less than 12% overall) as among the cybersecurity risks the companies face.

Even the SEC's disclosure guidance specifically references the availability of insurance for cyber security exposures as among the appropriate topics for companies to address, only about 6% of reporting companies referenced insurance in their disclosures. The Willis report notes that based on the firm's own informal survey of companies that many more companies purchase cyber insurance than the disclosure reports would suggest; for example, their survey of life and health insurance companies suggests that more that 60% of companies in that sector purchase cyber insurance, but only 1% of companies in that industry in the Fortune 1000 mentioned purchasing it in their SEC filings. The report observes that "many companies may be under-reporting insurance covering cyber-risks."

The report interestingly analyzes by industry how different companies have characterized their cybersecurity risks, as well as the number and type of different kinds of cyber exposures the company faces and the loss control measures the companies have taken.

The SEC has not just received the companies' filings, but, according to published accounts, the SEC has sent comment letters to approximately 50 companies asking them to supplement or amend their filings. As discussed here, the kinds of things on which the SEC has requested further elaboration include: that companies disclose whether data breaches have actually occurred and how the companies have responded to such breaches; that cybersecurity risks should be broken out separately and stand alone from disclosure of other types of risks because of the distinct differences between the risk of cybersecurity attacks and the risk of other types of disasters or attacks; and for companies that have suffered cyber breaches, additional information regarding why the public company does not believe the attack is sufficiently material to warrant disclosure.

By focusing only on the companies large enough to be included in the Fortune 1000, the report does not include any analysis of smaller companies' disclosure practices. Just the same, the report does note perceptible differences in reporting and disclosure between the companies in the Fortune 500 and the Fortune 501-1000, which suggests that a review of companies outside the Fortune 1000 would likely find that disclosures are even less robust.

However, regardless whether companies are larger or smaller, the SEC has made cyber disclosure remains a priority item for the SEC. Indeed, in May 2013, Mary Jo While, the SEC's new Chairman reported that she had asked her staff to evaluate the SEC's current guidance for cybersecurity exposures and to consider whether more stringent requirements are necessary.

The likelihood is that cybersecurity disclosures will remain a priority. The one area that seems likeliest to receive attention is the issue of disclosure of actual breaches. The low level of reported breaches that the Fortune 1000 disclosed: the focus on the issue in the SEC's comment letters; and the importance of the issue to shareholders and other constituencies all suggest that this will be an area of continued focus and scrutiny.

As always whenever there are disclosure requirements, there is always room for allegations that the disclosures are misleading or incomplete. Whether or not plaintiffs' attorneys target companies for their cybersecurity disclosures, there is the possibility that the SEC may target a company for its cybersecurity disclosures as a way to highlight the importance of the issue and as a way to encourage other companies to focus more on their cybersecurity risk disclosures.

While the way that all of this will play out remains to be seen, it seems likely that the issue of cybersecurity disclosure will only become more important in the months ahead.

Special thanks to Jim Devoe at Willis for sending me a copy of the report.

September 27, 2013
Activist Shareholder, More On
by David Zaring

Bainbridge has a take on the merits of activist shareholders for other investors here. His recommendation? He

"proposes managing shareholder interventions through changes to the federal proxy rules designed to make it more difficult for activists to effect operational changes, while encouraging shareholder efforts to hold directors and managers accountable."

It is the topic of the moment; in addition to the Bebchuk/Lipton debate, Penn just had in Dionysia Katelouzou, who had an interesting (and I think not yet published) paper arguing that, assuming shareholder activism is welfare-enhancing, it takes a shareholder-protective legal system for them to be able to perform their magic, meaning that campaigns were more likely to work in Japan, Canada, and the UK, than they might in continental Europe.

September 27, 2013
Last Week in Online Environmental Impact Statements: Clinker
by Hester Serebrin

While Federal agencies are required to prepare Environmental Impact Statements in accordance with 40 CFR Part 1502, and to file the EISs with the EPA as specified in 40 CFR 1506.9, the EPA doesn't yet provide a central repository for filing and viewing EISs electronically. Instead, each week they prepare a digest of the preceding week's filed EISs, which is published every Friday in the Federal Register under the title, "Notice of Availability" (NOA). However, starting October 1, 2012 all EIS submissions must be made through e-NEPA. An EPA source says that as EISs begin to come in electronically, they will appear alongside EPA comments here.

In the meantime, we've done the dirty work for you. Below, we've located and linked to the EISs referenced in last week's NOA. Please note that some of these documents can be very large, and may take a while to load.

You can read any available EPA comments on these EISs here.

* * *

EIS No. 20130278, Final EIS, EPA, LA, Designation of the Atchafalaya River Bar Channel Ocean Dredged Material Disposal Site, Review Period Ends: 10/28/2013, Contact: Jessica Franks 214–665–8335. Website.

EIS No. 20130279, Draft EIS (Not yet available online – check back here for updates.), BLM, ND, North Dakota Greater Sage-Grouse Draft Resource Management Plan Amendment, Comment Period Ends: 12/26/2013, Contact: Ruth Miller 406–896–5023. Website and website.

EIS No. 20130280, Draft EIS, BLM, NV, 3 Bars Ecosystem and Landscape Restoration Project, Comment Period Ends: 11/12/2013, Contact: Chad Lewis 775–635–4000. Website.

EIS No. 20130281, Final EIS, USFS, MT, Kootenai National Forest Land Management Plan Revision, Review Period Ends: 11/26/2013, Contact: Paul Bradford 406–293–6211. Website.

EIS No. 20130282, Final EIS, USFS, WY, Clinker Mining Addition Project, Medicine Bow-Routt National Forests and Thunder Basin National Grassland, Review Period Ends: 11/04/2013, Contact: Misty Hays 307–358–4690. The above project was inadvertently omitted from the Federal Register Notice published on 09/20/2013. Website.

EIS No. 20130283, Draft EIS, WAPA, USFS, 00, Reauthorization of Permits, Maintenance, and Vegetation Management on Western Area Power Administration Transmission Lines on Forest Service Lands, Comment Period Ends: 11/12/2013, Contact: Jim Hartman 720–962–7255. The U.S. Department of Energy's Western Area Power Administration and the U.S. Department of Agriculture's Forest Service are joint lead agencies for the above project. Website.

EIS No. 20130284, Draft Supplement (Not yet available online – check back here for updates.), GSA, CA, San Ysidro Land Port of Entry Improvements Project, Comment Period Ends: 11/12/2013, Contact: Osmahn Kadri 415–522–3617. Website.

EIS No. 20130285, Final EIS (Not yet available online – check back here for updates.), FHWA, FL, St. Johns River Crossing, Review Period Ends: 10/28/2013, Contact: Cathy Kendal 850–553–2225. Website.

EIS No. 20130286, Final EIS (Not yet available online – check back here for updates.), FHWA, FL, US 301 (SR 200) from CR 227 to CR 233, Review Period Ends: 10/29/2013, Contact: Joseph Sullivan 850–553–2248. Website.

Amended Notices

EIS No. 20130148, Draft Supplement, USACE, FL, Jacksonville Harbor Navigation, Comment Period Ends: 10/24/2013, Contact: Paul Stodola 904–232–3271 Revision to FR Notice Published 08/09/2013; Extending Comment Period from 09/30/2013 to 10/24/2013. Website.

EIS No. 20130252, Final EIS, USN, CA, Hawaii-Southern California Training and Testing, Review Period Ends: 10/28/2013, Contact: Cory Scott 808–472–1420 Revision to FR Notice Published 08/30/2013; Extending the Review Period from 09/30/2013 to 10/28/2013, due to pages inadvertently omitted from the original filing. Website.

EIS No. 20130259, Final EIS, FTA, MD, Purple Line Draft Section 4(f) Evaluation, Review Period Ends: 10/21/2013, Contact: Daniel Koenig 202–219–3528 Revision to FR Notice Published 09/06/2013; Extending Review Period from 10/07/2013 to 10/21/2013. Website.

View today's posts

9/30/2013 posts Blog: Reprieve From the Governor! The SEC Won't Shut Down (At Least Not Tomorrow)
Race to the Bottom: Objections to Conflict Minerals Rules Continue
The Green Mien: Slowing of Global Warming May Be Cold Comfort for the Oceans
Delaware Corporate and Commercial Litigation Blog: Chancery Imposes Fees for Bad Faith Litigation Tactics
Securities Litigation and Regulatory Enforcement Blog: Don't Get Caught In The Crosshairs When The SEC Deploys Its Full Enforcement Arsenal
Securities Litigation and Regulatory Enforcement Blog: How Much Latitude Do Directors Have In Setting Executive Compensation?
CLS Blue Sky Blog: Baker & Hostetler discusses the Philip Falcone & Harbinger Capital Settlement
D & O Diary: Assessing U.S. Public Company Cyber Risk Disclosure Practices
Conglomerate: Activist Shareholder, More On
The Green Mien: Last Week in Online Environmental Impact Statements: Clinker

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.