Federal Securities Law Blog : Federal Securities Lawyer & Attorney : Porter Wright Law Firm : Securities Exchange Law : Serving Ohio, Washington DC, Florida

RiskMetrics Group—a significant source of proxy voting guidance for institutional investors—has published its Preliminary U.S. Postseason Report for the 2008 proxy season. The report indicates that before the most recent proxy season, analysts were predicting increases in “shareholder discontent.” Shareholders were expected to increasingly withhold votes for incumbent directors; however, this did not happen, and RiskMetrics blames the bear market.

It seems in times of capital market downturns, shareholders prefer to support management. RiskMetrics reports that most directors were elected with strong support in 2008, and there was only slightly increased support for say on pay proposals.

Certain “activist investors” as labeled by RiskMetrics, also chose not to pursue “vote no” campaigns against boards of struggling financial firms, and most boards received strong support in 2008 (based on voting percentages). These results could mean shareholders do not blame directors for the current market (with the exception of Washington Mutual where 9 directors received over 29% opposition).

If the current market is responsible for increased support for the company’s slate of directors, it could suggest that shareholders collectively understand there is some economic “cost” associated with installing new directors, even when the current directors are thought to be under-performing. One theory is that the costs of replacing poor-performing directors with new directors are higher in a struggling market.

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An emergency SEC rule that will go into effect on Monday prohibits naked short selling of 19 financial companies including Freddie Mac and Fannie Mae. The SEC expects the rule to curb illegal shorting practices that several financial firms claim are causing unnecessary panic and capital market dysfunction.

Short selling is the process of borrowing shares, selling the shares immediately, and then buying the shares back in the open market after the price has gone down (in order to return the shares to the lender). The borrower pays a fee to the lender and earns the difference between the sale price and the purchase price (minus transaction costs). Short selling is a prediction that a stock is overvalued and will decrease in value, and proponents argue that it is an important check on inflated stock prices.

Naked short selling occurs when short sellers and the entities loaning the shares (market makers and brokerages) do not identify whether shares are available to be borrowed. Because actual share certificates do not necessarily change hands, and transactions are settled days after the sale occurs, shares can be shorted without ever being borrowed in the first place. This practice creates opportunities for abuse, and there have been allegations of the same shares being lent to different short sellers resulting in shares being sold that do not exist and more shares shorted than are available in the public float.

Short selling does not work unless the stock price goes down, and the stock price (in theory) does not go down unless unfavorable information about a company is introduced into the market place. Fraud occurs when the unfavorable information is intentionally false, and fraud has been illegal long before short selling rules were in place.

The emergency rule will only last 8 days, but the SEC is considering a more permanent resolution and has the power to expand the emergency rule for a total of 30 days if necessary.

The complete list of firms for which there can be no naked short selling follows:

BNP Paribas Securities Corp.
Bank of America Corporation
Barclays PLC
Citigroup Inc.
Credit Suisse Group
Daiwa Securities Group Inc.
Deutsche Bank Group AG
Allianz SE
Goldman, Sachs Group Inc.
Royal Bank ADS
HSBC Holdings PLC ADS
J. P. Morgan Chase & Co.
Lehman Brothers Holdings Inc.
Merrill Lynch & Co., Inc.
Mizuho Financial Group, Inc.
Morgan Stanley
UBS AG
Freddie Mac
Fannie Mae

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As described in a recently-issued No Action Letter, the SEC has lessened the burden of reporting multiple stock sales of insider holdings. Section 16 reporting persons may now report multiple transactions with similar prices on an aggregate basis instead of listing each transaction at each price.

When a Section 16 insider sells a large block of stock, the sale is often accomplished by his or her broker selling smaller blocks of stock at different prices. For example, a sale of 50,000 shares might be accomplished by selling 50 blocks of 1,000 shares, each block priced within as little as one penny of the previous block. The previous SEC rules would have required 50 different line items on multiple Form 4s, which was time-consuming and tedious to file with the SEC. The new rules allow for reporting of same-day transactions on an aggregate basis (i.e., one line item), so long as the following requirements, among others, are met:

• Trades occur within a one dollar price range for each line item;
• The report specifies, in a footnote, the range of prices for the transaction reported;
• The reporting person undertakes to provide full information if requested; and
• The securities traded have the same type of ownership by the reporting person (all direct or indirect)

Not only was the old rule inefficient, but it actually made it more difficult for an investor to understand the insider transaction. The new rule should bring clarity to certain reports as well as save time and money.

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The SEC has released its 168-page proposed rule regarding nationally recognized statistical rating organizations (NRSROs). Recently, major rating agencies—Standard & Poor, Moody’s Investors and Fitch Ratings—have come under scrutiny for failing to identify risks in subprime mortgage investments that touched off the credit-market crisis. Seeking to avoid this problem in the future, the proposed rule amendments impose additional requirements on NRSROs, like Fitch Ratings and Standard & Poor, concerning the integrity of their credit rating procedures and methodologies.

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