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New DOJ policies target corporate executives over companies

The U.S. Department of Justice (DOJ) issued new policies Sept. 9. One requires that companies disclose all facts relating to individual misconduct discovered during internal investigations or be considered uncooperative. This places pressure on corporations to turn over evidence against their own executives. The policy comes after ongoing criticism of the DOJ’s failure to prosecute individuals in the wake of the 2008 financial crisis.

The memorandum, issued by Deputy Attorney General Sally Q. Yates, marked the first major policy announcement of Attorney General Loretta Lynch since she took office in April. The Yates memorandum enumerates six key steps to strengthen prosecutions against individual defendants:…

SEC proposed rules for compensation clawback policies

The SEC has proposed rules that require the securities exchanges to adopt rules that in turn require listed companies to adopt, disclose and comply with a clawback policy for executive compensation based on erroneous financial statements. The new rules would apply to almost all companies listed on a securities exchange (such as NASDAQ and NYSE), including smaller reporting companies.

Many companies already have adopted interim clawback policies in an attempt to comply with the spirit of the law that requires the new rules, Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Until now, some key terms in the law have been undefined. The proposed rules are a good opportunity to think about whether existing policies sync with the proposed rules on the following key terms:

  • Are the correct “executive officers” included under the policy?
  • Is “incentive-based compensation” properly understood under the policy?
  • What types of, and how much, incentive-based compensation must be clawed back?
  • Are there any exceptions?
  • What types of clawback terms should be included in employment agreements?

SEC votes to propose executive compensation rules

On April 29, 2015, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the Securities and Exchange Commission (SEC) voted 3 to 2 to approve a proposed amendment to executive compensation rules in Item 402 of Regulation S-K. The proposed amendment directs the SEC to adopt rules requiring registrants to disclose in their proxy or information statements the relationship between executive compensation actually paid and the financial performance of the registrant.

Specifically, the SEC is proposing new Item 402(v) of Regulation S-K that would require “a registrant to provide a clear description of (1) the relationship between executive compensation actually paid to the registrant’s NEOs [(Named Executive Officers)] and the cumulative total shareholder return (TSR) of the registrant, and (2) the relationship between the registrant’s TSR and the TSR of a peer group chosen by the registrant, over each of the registrant’s five most recently completed fiscal years.” Such disclosure should be made taking into account any change in the value of the shares of stock and dividends of the registrant and any distributions.

The SEC is seeking comments to the proposed rules which can be made in the following manner:

Electronic comments:

Paper comments:

  • Send paper comments to: Brent J. Fields, Secretary, Securities and Exchange Commission 100 F St. NE

Recent Delaware case questions ability of common stockholders to prospectively waive appraisal rights; strictly enforces notice requirement to use drag along right

Drag along rights and an accompanying waiver by a minority stockholder of appraisal rights in connection with a change in control transaction approved by the majority stockholder are common features in stockholders agreements among majority stockholders and minority stockholders. The recent case of Michael C. Halpin, Et. Al. v. Riverstone National, Inc., No. 9796–VCG (Del. Ch. Feb. 26, 2015) highlighted the following issues that are important for M&A practitioners:

1. The court called into question, while refusing to answer, whether common stockholders can contractually commit to waive in advance their appraisal rights associated with a change in control transaction; and

2. Failure by a majority stockholder to strictly follow the notice procedure and timing requirements of a drag along right will prohibit the majority stockholder from exercising that drag along right.…

FINRA adopts rule to permit sharing of transaction based compensation to unregistered persons

The Securities and Exchange Commission (SEC) has approved the Financial Industry Regulatory Authority’s FINRA Rule 2040, which will permit the payment of compensation, fees, concessions, discounts, commissions or other allowances to unregistered persons if a member firm determines the activities of the unregistered person in question do not require registration as a broker-dealer. Support for the determination can be derived by, among other things, reasonably relying on previously published releases, no-action letters or SEC staff interpretations, seeking a no-action letter from the SEC or obtaining a legal opinion from an independent, reputable U.S. licensed counsel knowledgeable in the area.

A member firm’s determination must be reasonable under the circumstances and should be reviewed from time to time, suggested to be annually by FINRA, if payments to unregistered persons are ongoing. In addition, a member firm must maintain books and records that support the member firm’s determination.

FINRA Rule 2040 has an effective date of Aug. 24, 2015.…

Once again, House takes up bill governing M&A brokers

HR 686, The Small Business Mergers, Acquisitions, Sales & Brokerage Simplification Act, was introduced in the U.S. House of Representatives on Feb. 3, 2015. This bill is identical to HR 2274, which was passed unanimously in the U.S. House of Representatives in 2014, but was never acted upon in the U.S. Senate.

HR 686 would exempt an “M&A broker” from registration under the Securities Exchange Act of 1934 if the M&A broker is engaged in the business of effecting securities transactions solely in connection with the transfer of ownership of an eligible privately held company. The exemption is available to a broker if the broker reasonably believes that upon closing, any person acquiring the securities or assets of the eligible privately held company or business will control and will be active in the management of the eligible privately held company or business. In addition, if the any person is offered securities in exchange for securities or assets of the eligible privately held company, such person will, prior to becoming legally bound to close, receive or have reasonable access to the most recent year-end financial statements of the issuer of such securities.

For purposes of HR 686, the term “eligible privately held company” means a company that does not have any class of securities registered or is required to file periodic information or reports with the U.S. Securities and Exchange Commission, and in the fiscal year ending immediately before the fiscal year in which the M&A broker is initially …

Comment by Feb. 16 on proposed uniform state model rule for M&A brokers

The Broker-Dealer Section of the North American Securities Administrators Association is seeking comments no later than Feb. 16, 2015, on a proposed uniform state model rule exempting certain merger and acquisition brokers from registration as brokers, dealers, agents or broker-dealers under state securities laws. The proposed uniform model rule represents the evolution among regulators and Congress to exempt merger and acquisition brokers from some of the registration requirements in the federal securities laws.

The proposed state model rule would exempt from registration any broker or person associated with a broker engaged in the business of effecting securities transactions solely in connection with the transfer of ownership of an eligible privately held company, if the broker reasonably believes:…

Bill governing M&A brokers should resurface in 2015

During 2014, Congress has gained momentum toward creating an exemption from federal broker-dealer registration for “M&A brokers” who facilitate mergers, acquisitions, sales and similar transactions involving privately held companies.

H.R. 2274 unanimously passed the U.S. House of Representatives, but the U.S. Senate did act on the bill. If passed, the measure would have permitted M&A brokers to be involved with the sale of certain privately held companies without being registered as a broker-dealer. A number of limitations apply to the type of transaction addressed in the bill, including:

  • The size of the privately held company
  • Company leadership; the buyer would need to be actively involved, directly or indirectly, in operating the business after closing
  • Client funds; the bill forbids the M&A broker to have custody of client funds

Observers expect the bill to be reintroduced in 2015.

Shortly after H.R. 2274 passed the U.S. House, the Securities and Exchange Commission issued the M&A broker no-action letter, which concluded that the staff of the SEC Division of Trading and Markets would not recommend enforcement action if, without registering as a broker-dealer, an M&A broker engaged in M&A activities if all of the no-action letter’s conditions were satisfied. Among those conditions are that the target company must be an operating company that is a “going concern,” the buyer must be involved in operating the business after closing, and an M&A broker cannot bind a party to an M&A transaction or provide financing for an M&A transaction.

State regulators, in collaboration with …

Whistleblowers wanted; Holder seeks increased compensation for financial crime informants

In the first major public comment about white collar crime in more than a year, the Department of Justice (DOJ) called for an increase in compensation for whistleblowers under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). Senior DOJ officials, in three separate speeches, appealed to whistleblowers to come forward with information about crimes and suggested that compensation levels were too low to entice executives in the financial industry to report wrongdoing.

Attorney General Eric Holder, while speaking at New York University, suggested that Congress increase awards in cases involving banks and financial institutions. Under current law, FIRREA caps whistleblower awards at $1.6 million. Holder noted that under the False Claims Act (FCA), tipsters who provide information to law enforcement concerning wrongdoing can receive compensation at a level of 25 percent to 30 percent of the recovery received by the government.

Holder cited that in an industry that included a collective bonus pool of $26 billion and a median executive pay of $15 million, a “paltry” windfall of $1.6 million is “unlikely to induce an employee to risk his or her lucrative career in the financial sector.” Holder suggested that increased awards could improve the DOJ’s ability to gather evidence of wrongdoing “while complex financial crimes are still in progress — making it easier to complete investigations and to stop misconduct before it becomes so widespread that it foments into the next crisis.”…

Late Form 4s aren’t just embarrassing anymore

Yesterday, the SEC announced penalties totaling approximately $2.6 million against directors, officers, beneficial owners and issuers for failure to promptly report information about holdings and transactions in company stock.

The primary enforcement weapon for these types of failures historically has been public shaming: Rule 405 of Regulation S-K requires issuers to identify insiders who failed to file Section 16 reports on time during the previous year. But, apparently, based on yesterday’s announcement, the SEC also will levy fines against issuers and individual insiders for chronic filing failures.

Settled fines for individuals ranged from approximately $25,000 to $100,000. Six publicly-traded companies settled claims that they contributed to the filing delinquencies of their insiders and paid fines ranging from $75,000 to $150,000.…

Merging? Making an acquisition? Be careful out there.

Almost 40 years ago, Congress passed the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the “HSR Act”). The HSR Act provided a mechanism pursuant to which parties to an acquisition of assets or voting securities would be required, if certain thresholds were met, to file a notification form with the antitrust enforcement agencies — the Federal Trade Commission (the FTC”) and the Department of Justice, Antitrust Division (the DOJ) — and observe a waiting period before they consummated the transaction. The HSR Act empowered the FTC to promulgate rules and regulations governing the circumstances under which the parties would be required to submit an HSR Act filing.

The HSR Act rules and regulations are extensive and extremely complex; therefore, it is prudent for investors — both companies and individual — to have compliance procedures in place to ensure compliance with the HSR Act. Every so often, the FTC reminds us of this fact when it brings an enforcement action to penalize those who do not abide by their rules and regulations. That happened last week with an action, and consent decree, filed against Berkshire Hathaway.…

SEC issues statement on the recent Court of Appeals decision on the Conflict Minerals Rule

We reported previously on the ruling by the United States Court of Appeals for the District of Columbia Circuit striking down the part of the SEC’s conflict minerals rules that requires a registrant to describe its products as not “DRC conflict free” and upholding the remainder of the conflict minerals rules. Many observers have been eagerly awaiting the SEC’s response to this decision, including whether the SEC will delay the implementation of the conflict minerals rules.

On April 29, 2014, the SEC issued its response to the court’s decision in the conflict minerals rules challenge. In short, the SEC affirmed the June 2, 2014 deadline for registrants to file Form SD and their conflict minerals reports. Consistent with the court’s ruling, the SEC stated that registrants will not be required to describe their products as “DRC conflict free,” having “not been found to be ‘DRC conflict free,’” or “DRC conflict undeterminable.”

If a registrant voluntarily elects to describe any of its products as “DRC conflict free” in its conflict minerals report, it would be permitted to do so provided it had obtained an independent private sector audit (IPSA) as required by the conflict minerals rules. Pending further action from the SEC, an IPSA will not be required unless a registrant voluntarily elects to describe a product as “DRC conflict free” in its conflict minerals report.

Compliance with the conflict minerals rules can be a substantial undertaking. Registrants need to continue their compliance efforts and be prepared for the June 2, …

First conflict mineral report filed on Form SD

On April 24, 2014, Siliconware Precision Industries Co., Ltd. (Siliconware) earned the distinction of being the first registrant to file a conflict minerals report on Form SD. Here are links to Siliconware’s Form SD and its conflict minerals report. Although the filing deadline is not until June 2, 2014, this example gives registrants a glimpse of what conflict minerals disclosure might look like.

Siliconware reported that its due diligence efforts showed a portion of its products to be “DRC conflict undeterminable” and the remainder to be “DRC conflict free,” as those terms are defined in the Exchange Act. Siliconware chose to use these terms, which were prescribed in the conflict minerals rules, notwithstanding the fact that the requirement to use those specific terms was recently struck down by U.S. Court of Appeals on First Amendment grounds.

Registrants should continue to monitor conflict minerals reports of other registrants as they are filed in order to get a sense of market practice for the conflict minerals disclosure.…

U.S. Appeals Court Strikes Down Part of SEC Conflict Minerals Rules, Upholds Key Parts

On April 14, 2014, the United States Court of Appeals for the District of Columbia Circuit issued its ruling in the challenge to the SEC’s conflict minerals rules. The court struck down the requirement that an issuer describe its products as not “DRC conflict free” because it violates the First Amendment by compelling speech by the issuer. However, the Court upheld other key parts of the conflict minerals rules, including without limitation the lack of a de minimis exception, the country of origin due diligence requirement and the extension of the rules to issuers that “contract to manufacture” products.

The court concluded that compelling an issuer to describe their products as not “DRC conflict free,” is not narrowly tailored and, therefore, would not survive an immediate scrutiny review (although the court declined to state whether strict or immediate scrutiny would apply). However, the court did suggest that it would be permissible for the SEC to require an issuer to describe the conflict minerals status of its products using the issuer’s own language rather than the specific language required by the statute or the rules.…

Substantial risk of forfeiture guidance clarifies when Section 16 short-swing profit liability can defer taxation of equity compensation awards

Legend had it at my law school that one day, a lost student walked into a torts class and asked the professor if this class was wills, trusts, and estates. The torts professor replied, “We haven’t gotten that far yet.” A dry sense of humor on the professor’s part? Perhaps. His point, however, was that the law can be a seamless web, with one area of law often having an impact on another. This point often is true with respect to the tax and securities laws.

We blogged previously that the IRS and Treasury issued final regulations under Code Section 83 to “clarify” the definition of “substantial risk of forfeiture” with respect to restricted stock (and other property) grants. One of the clarifications was that transfer restrictions, in and of themselves, do not constitute a substantial risk of forfeiture. For taxation to be deferred on restricted stock grants, the stock must be both non-transferrable and subject to a substantial risk of forfeiture. An example might help illustrate this point. Suppose that a company grants its CEO restricted stock that vests on the fifth anniversary of the date of grant, provided that the CEO has been continuously employed through that date. Also suppose that the CEO satisfies this vesting condition, but on the vesting date, the company’s insider trading policy prohibits the CEO from selling the shares for several months. The CEO would be taxed on the value of the shares on the vesting date, despite the fact that the CEO …

Corporate law must reads — excerpts from the Federal Securities Law Blog

In the ever-changing world of corporate law, it’s important to have trusted resources that can keep an eye out for how the relentless evolution of regulation and legislation can affect business operations, governance, strategy and growth. Our goal is for the Federal Securities Law Blog, and the Porter Wright attorneys who contribute to it, to be one of those resources. We invite you to read our most recent e-book, which provides updates about recent federal rules changes that can have an impact on your business. Download the Corporate Must Reads e-book.…

Recent Delaware case reminds of importance of litigation expense advancement provisions in organizational documents

Much to the chagrin of corporate lawyers, there are still some companies that do not have provisions in their articles of incorporation, bylaws or operating agreements that provide for advancement of litigation expenses to directors and officers. The recent case of White v. Kern, No. 7872-VCG (Del. Ch. Jan. 24, 2014) (Transcript) illustrates that courts may prohibit the advancement of expenses to defendant directors and officers in the absence of these provisions.…

“Substantial risk of forfeiture” clarification impacts restricted property (stock) grants

As complex as the Internal Revenue Code is, many people still assume that the rules contain a great deal of specificity and precision, perhaps because of the mathematical nature of calculating taxes. They often are surprised to learn that the Code leaves a lot of room for discretion and subjectivity. A great example of this subjectivity is Code Section 83’s regulations governing the taxation of restricted stock (and other property). The underlying stock subject to these grants generally does not become taxable to the employee until the stock no longer is subject to a “substantial risk of forfeiture.” As you might guess, whether a risk is “substantial” can be quite a subjective determination.

In that backdrop, the IRS and Treasury recently issued final regulations that clarify the definition of substantial risk of forfeiture for purposes of Code Section 83. The final regulations will have the most direct impact on employers who have granted awards of restricted stock or other restricted property on or after Jan. 1, 2013. That is because the regulations stress the need for these agreements to contain a service or performance-based vesting condition that is not substantially certain to be satisfied. The retroactive effective date of may seem strange at first. It is the same effective date that the IRS provided in proposed regulations from May 2012. The good news is that the final regulations generally offer “clarifications” of the former regulations rather than new guidance. Still, it is important that affected employers review their restricted stock …

Appraisal actions in M&A transactions are increasing in frequency

Stephen M. Davidoff wrote an interesting article in the New York Times that notes the ten-fold increase in the value of appraisal rights actions over the last 10 years and describes the new trend of hedge funds purchasing shares in target companies following the announcement of an M&A transaction for the sole purpose of exercising appraisal rights with respect to the purchased shares.

The increase in frequency of appraisal rights actions and the presence of aggressive hedge funds as players in the appraisal process should serve as a reminder to both buyers and publicly traded target companies in M&A transactions that your transaction process and price are being watched carefully not only by your own shareholders, but also by other opportunistic investors looking to capitalize on a weak transaction process or price. This reinforces the importance for buyers and target companies to conduct a careful and conflict-free transaction process to deter the initiation of appraisal actions and to defend against any appraisal actions that may be brought by shareholders.…

FTC Revises HSR and Interlocking Directorate Thresholds

HSR Revisions

The Federal Trade Commission (FTC) recently announced the annual changes to the notification thresholds for filings under the Hart-Scott-Rodino Antitrust Improvements Act (HSR) as well as certain other values under the HSR rules.

As background, the HSR Act requires that acquisitions of voting securities or assets that exceed certain thresholds be disclosed to U.S. antitrust authorities for review before they can be completed. The “size-of-transaction threshold” requires that the transaction exceeds a certain value. Under certain circumstances, the parties involved also have to exceed “size-of-person thresholds.” This year’s values, which are adjusted annually based on changes in the GNP, take effect in mid-to-late February 2014. The FTC also adjusted the safe harbor thresholds that govern interlocking directorates in competing companies.

The most important change is that the minimum size-of-transaction threshold will increase from the current $70.9 million to $75.9 million. The size-of-person thresholds will also increase as follows.

  • For transactions valued between $75.9 million and $303.4 million, one party to the transaction must have $15.2 million in sales or assets and the other party must have $151.7 million in sales or assets, as reported on the last regularly prepared balance sheet or income statement.
  • For transactions valued at greater than $303.4 million, no size-of-person threshold must be met to require an HSR filing.

The filing fee thresholds have similarly increased as follows.

Filing FeeTransaction Value
$45,000$75.9 to $151.7 million
$125,000$151.7 to $758.6 million
$280,000$758.6 million or greater

Interlocking Directorates

Section 8 of the Clayton …

ISS 2014 U.S. Proxy Voting Guidelines

Yesterday, proxy advisory firm ISS released its 2014 proxy voting guidelines, effective for shareholder meetings held on or after Feb. 1, 2014. ISS positions on some topics continue to evolve. Below are some notable differences from the 2013 Guidelines:

When determining votes on director nominees, four fundamental principles continue to apply: (1) accountability; (2) responsiveness; (3) independence; and (4) composition (last year “composition” was referred to as “competence”). The description of “independence” is more robust than last year, including a statement that “the chair of the board should ideally be an independent director,” which is not surprising given that ISS has previously supported shareholder proposals requiring an independent chair.

In 2013, ISS recommended withholding votes for directors if the board failed to act on a shareholder proposal that received the support of a majority of the shares outstanding the previous year. For 2014, ISS will recommend voting case-by-case in that scenario and will consider various factors including the subject matter of the proposal and the rationale provided in the proxy statement for the level of implementation.

Finally, ISS has expanded on the factors it will consider in determining how to vote on proposals to recoup incentive cash or stock compensation made to senior executives when the calculations turn out to be based on erroneous figures. Such factors include consideration of the rigor of the policy and how and under what circumstances compensation is subject to the clawback.…

An Academic Perspective on Shareholder Activism as a Corrective Mechanism

The editors at the Corporate Governance & Social Responsibility blog brought our attention to a recent academic paper from The Ohio State University Moritz College of Law titled “Shareholder Activism as a Corrective Mechanism in Corporate Governance.” In the paper’s abstract, authors Paul Rose and Bernard Sharfman write:

Under an Arrowian framework, centralized authority and management provides for optimal decision making in large organizations. However, Arrow also recognized that other elements within the organization, outside the central authority, occasionally may have superior information or decision making skills. In such cases, such elements may act as a corrective mechanism within the organization. In the context of public companies, this article finds that such a corrective mechanism comes in the form of hedge fund activism, or more accurately, offensive shareholder activism.

Offensive shareholder activism exists in the market for corporate influence, not control. Consistent with a theoretical framework where the value of centralized authority must be protected and a legal framework in which fiduciary responsibility rests with the board, authority is not shifted to influential but unaccountable shareholders. Governance entrepreneurs in the market for corporate influence must first identify those instances in which authority-sharing may result in value-enhancing policy decisions, and then persuade the board and/or other shareholders of the wisdom of their policies so that they will be permitted to share the authority necessary for the policies to be implemented. Thus, boards often reward offensive shareholder activists that prove to have superior information and/or strategies by at least temporarily sharing authority …

Shareholder Approval of Equity Incentive Plan; Has It Been Five Years?

Most equity incentive plans have a number of different shareholder-approved business criteria for setting performance goals and allow the compensation committee to select the criteria each year. This practice generally requires re-approval of the goals by the shareholders under Internal Revenue Code Section 162(m) whenever the committee makes a material change to the criteria. If the committee has not made any material changes to the performance criteria but retains discretion to select the performance targets from year-to-year, shareholders generally will need to reapprove the criteria every five years under Code Section 162(m).

If shareholder approval last occurred in 2009, then it is time to prepare for re-approval in 2014. This is also a good time to consider if an amendment is needed to increase the authorized share pool.…