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

The SEC has approved the listing standard changes relating to compensation committee independence and consultants for both Nasdaq and the NYSE.

The proposed listing standards implement Rule 10C-1 under the Securities Exchange Act of 1934, which was added by the Dodd-Frank Act.

With respect to the Nasdaq listing standard changes, most listed companies will be required to comply with the new rules, but Nasdaq has exempted "smaller reporting companies" from compliance.  First, by July 1, 2013, the listed company must have a formal written charter that provides:

• The compensation committee will review and reassess the adequacy of the charter on an annual basis;
• The scope of the committee's responsibilities and how it carries out those responsibilities, including structure, processes, and membership requirements;
• The committee's responsibility for determining or recommending to the board for determination, the compensation of the CEO and all other executive officers of the company, and provide that the CEO may not be present during voting or deliberations on his or her compensation; and
• The committee's responsibilities and authority with respect to retaining its own advisers; appointing, compensating, and overseeing such advisers; considering certain independence factors before selecting advisers; and receiving funding from the company to engage them.

The compensation committee may select, or receive advice from, a compensation consultant, legal counsel or other adviser, other than in-house legal counsel, only after taking into consideration the following factors:

• The provision of other services to the company by the person that employs the compensation consultant, legal counsel or other adviser;
• The amount of fees received from the company by the person that employs the compensation consultant, legal counsel or other adviser, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel or other adviser;
• The policies and procedures of the person that employs the compensation consultant, legal counsel or other adviser that are designed to prevent conflicts of interest;
• Any business or personal relationship of the compensation consultant, legal counsel or other adviser with a member of the compensation committee;
• Any stock of the company owned by the compensation consultant, legal counsel or other adviser; and
• Any business or personal relationship of the compensation consultant, legal counsel or other adviser or the person employing the adviser with an executive officer of the company.

The rule clarifies that nothing in the rule requires a compensation consultant, legal counsel or other adviser to be independent, only that the committee considered the enumerated independence factors before selecting, or receiving advice from, a compensation adviser.  Further, the committee is not required to conduct an independence assessment for a compensation adviser that acts in a role limited to the following activities for which no disclosure is required: (a) consulting on any broad-based plan that does not discriminate in scope, terms, or operation, in favor of executive officers or directors of the company, and that is available generally to all salaried employees; and/or (b) providing information that either is not customized for a particular company or that is customized based on parameters that are not developed by the adviser, and about which the adviser does not provide advice.

By the earlier of a listed company's first annual annual meeting after January 14, 2014, or October 14, 2014, the company's compensation committee must comply with the new director independence standards applicable to the compensation committee.  The listed company must have a compensation committee composed of at least two members, each of whom must be an independent director as defined in Nasdaq's rules, and not accept directly or indirectly any consulting, advisory or other compensatory fee from the listed company or any of its subsidiaries, not including (i) fees received as a member of the compensation committee, the board of directors, or any other board committee; or (ii) the receipt of fixed amounts of compensation under a retirement plan (including deferred compensation) for prior service with the company, provided that such compensation is not contingent in any way on continued service.  The board must also consider whether a director is affiliated with the company and whether such affiliation would impair the director's judgment as a member of the compensation committee.

A listed company must certify to Nasdaq, no later than 30 days after the final implementation deadline applicable to it, that it has complied with the committee charter and independence provisions.

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On October 22, 2012, the U.S. Chamber of Commerce, the National Manufacturers Association, and the Business Roundtable filed a lawsuit in the United States Court of Appeals for the DC Circuit seeking to modify or eliminate the Securities and Exchange Commission’s ("SEC") final rules governing conflict minerals. The SEC adopted the final rules on conflict minerals on August 22, 2012 pursuant to Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") requiring companies to publicly disclose their use of conflict minerals that originated in the Democratic Republic of the Congo ("DRC") or an adjoining country. See SEC Adopts Final Rules for Disclosing Use of Conflict Minerals (posted August 24, 2012). The lawsuit did not contain any legal arguments or explanations for the requested modification.

In a joint statement, the U.S. Chamber of Commerce and the National Manufacturers Association stated, “[t]he final conflict mineral rule imposes an unworkable, overly broad and burdensome system that will undermine jobs and growth and may not achieve Congress’s overall objectives.” According to a report in the Wall Street Journal, the SEC estimated that approximately U.S. and foreign companies would have to comply with the conflict-minerals rules with an upfront cost of $3 to $4 billion dollars and an additional $200 million annually.

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On October 17, 2012, the Securities and Exchange Commission ("SEC") issued its Third Report on the Implementation of SEC Organizational Reform Recommendations.  Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act"), the SEC was directed to engage an independent consultant to conduct a review of the SEC's operations, structure, funding, and the SEC's relationship with Self-Regulating Organizations.  This is the third of four reports that the SEC will provide to Congress under Section 967(c) of the Dodd-Frank Act.  The goal of this review process is to increase the SEC's effectiveness and efficiency.

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On August 30, 2012, the Securities and Exchange Commission ("SEC") released its findings of a staff study (the "Study"), as mandated by Section 917 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act"), identifying the existing level of financial literacy among retail investors as well as the methods and efforts to increase the financial literacy of investors.  The Study identifies investor preferences regarding a variety of investment disclosures, such as that investors prefer to receive investment disclosures prior to investing. The Study also identifies information that investors find useful and relevant in helping them make informed investment decisions, such as information about fees, investment objectives, performance, strategy, and risks of an investment product, as well as the professional background, disciplinary history, and conflicts of interest of a financial professional. The Study also shows that investors favor disclosure of investment information in a visual format, using bullets, charts, and graphs.

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On August 22, 2012, the Securities and Exchange Commission ("SEC") adopted a final rule pursuant to Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") requiring resource extraction issuers (companies engaged in the development of oil, natural gas, or minerals) to disclose in an annual report information relating to any payment made by the issuer, a subsidiary of the issuer, or an entity under the control of the issuer, to a foreign government or the U.S. government for the purpose of the commercial development of oil, natural gas, or minerals. Section 1504 added Section 13(q) to the Securities Exchange Act of 1934 (the "Exchange Act"), which requires the SEC to promulgate rules requiring disclosure to be made by resource extraction issuers annually by filing a Form SD with the SEC.

Section 13(q) of the Exchange Act requires a resource extraction issuer to provide disclosure on Form SD to be filed with the SEC that includes (1) information about the type and total amount of such payments made for each project related to the commercial development of oil, natural gas, or minerals, (2) information about the type and total amount of payments made to each government, and (3) information regarding those payments in an interactive data format.

A resource extraction issuer must comply with the new rules and form for fiscal years ending after September 30, 2013. The Form SD must be filed with the SEC no later than 150 days after the end of its fiscal year.

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On August 22, 2012, the Securities and Exchange Commission ("SEC") adopted a new form and final rule pursuant to Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") requiring companies to publicly disclose their use of conflict minerals that originated in the Democratic Republic of the Congo ("DRC") or an adjoining country. Section 1502 added Section 13(p) to the Securities Exchange Act of 1934 (the "Exchange Act"), which requires the SEC to promulgate rules requiring issuers to disclose their use of conflict minerals that include tantalum, tin, gold, or tungsten if those minerals are “necessary to the functionality or production of a product” manufactured by those companies and whether any of those minerals originated in the DRC or an adjoining country.

If an issuer’s conflict minerals originated in the DRC or an adjoining country, Section 13(p) of the Exchange Act requires the issuer to provide disclosure on a new Form SD to be filed with the SEC that includes (1) a description of the measures it took to exercise due diligence on the conflict minerals’ source and chain of custody (including an independent private sector audit of the report that is conducted in accordance with standards established by the U.S. Comptroller General), and (2) a description of the products manufactured or contracted to be manufactured that are not "DRC conflict free" the facilities used to process the conflict minerals, the country of origin of the conflict minerals, and the efforts to determine the mine or location of origin. Section 13(p) of the Exchange Act also requires the information disclosed by the issuer to be available to the public on its Internet website.

Issuers are required to file the Form SD for the calendar year beginning January 1, 2013 with the first reports due May 31, 2014 and annually on May 31 every year thereafter.

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In an Opinion and Order dated February 23, 2012, Judge Michael Mosman adopted the January 11, 2012 Findings and Recommendations of Magistrate Judge John Acosta to dismiss the derivative lawsuit against the Board of Directors of Umpqua Holdings Corporation ("Umpqua") for breach of fiduciary duty. Magistrate Judge Acosta recommendation to dismiss the say-on-pay" lawsuit was the first of its kind. Judge Mosman agreed that plaintiffs' failure to make a presuit demand was not excused under the arguments they raised regarding the Board members' exercise of the business judgment rule or their lack of independence or disinterest. Plaintiffs have until March 26, 2012 to amend their complaint.

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On January 11, 2012, Magistrate Judge John Acosta recommended the dismissal of the derivative lawsuit against the Board of Directors of Umpqua Holdings Corporation ("Umpqua") for breach of fiduciary duty. The lawsuit was filed after the shareholders, in an advisory vote, rejected the Board-approved executive compensation program. The Magistrate Judge found that the plaintiffs failed to make a presuit demand as required for a derivative suit and were not excused from doing so under the arguments they raised regarding the Board members' exercise of the business judgment rule or their lack of independence or disinterest. As Broc Romanek of theCorporateCounsel.Net Blog pointed out, "[t]his is the first federal court decision to dismiss such an action." Magistrate Judge Acosta has referred his Findings and Recommendations to District Judge Michael W. Mosman for review and final determination.

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Yesterday the SEC released its final rule regarding the exclusion of the value of a person’s primary residence when determining whether the person qualifies as an “accredited investor” on the basis of having a net worth in excess of $1 million. The accredited investor standards are used to determine certain exemptions from Securities Act registration for private offerings. Prior to Dodd-Frank, investors could include their primary residence in calculating a minimum net worth of more than $1,000,000. Section 413(a) of the Dodd-Frank Act changed the requirement to exclude the value of the primary residence, for which the SEC has now finalized rules.

But, expect more changes to the accredited investor concept. Section 415 of the Dodd-Frank Act requires the Comptroller General of the United States to conduct a “Study and Report on Accredited Investors” examining “the appropriate criteria for determining the financial thresholds or other criteria needed to qualify for accredited investor status and eligibility to invest in private funds.” The study is due by July 2013, and the SEC will likely use the study for future rule making.
 

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The SEC's Office of Whistleblower has released its first Annual Report on the Dodd-Frank Whistleblower Program for Fiscal Year 2011. The Report (available here) points out that because the Final Rules became effective August 12, 2011 (discussed here), there were only seven weeks of whistleblower tip data available for fiscal year 2011. The Report includes an Appendix, which list by subject matter and month, the 334 whistleblower tips received from August 12, 2011 through September 30, 2011. The most common complaint categories were market manipulation (16.2%), corporate disclosures and financial statements (15.3%), and offering fraud (15.6%).

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In a September 20, 2011 Opinion, Judge Timothy Black of the Southern District of Ohio ruled that a lawsuit brought against senior executives and directors of Cincinnati Bell, Inc. alleging a breach of fiduciary duty regarding compensation would be allowed to proceed. The lawsuit focuses on the "say-on-pay" provisions of the Dodd-Frank Act: specifically, attacking the Board's decision to increase 2010 executive compensation in light of the nonbinding vote by 66% of the voting shareholders to reject that increase. Although the defendants argued that they are entitled to rely upon the business judgment rule in proceeding with the increase in compensation, the Court held that the issue of whether defendants properly exercised that judgment or, as plaintiff claimed, acted with deliberate intent to injure the company (or reckless disregard for the company) would be an issue based on the evidence (at trial or summary judgment) and not decided at the pleading stage.

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There were two interesting news items this week regarding what the nation's regulators are doing to protect investors – one from the SEC and the other from the Department of Justice. The SEC announced that it "is in the process of re-establishing an Investor Advisory Committee," while Commissioner Luis A. Aguilar expressed disappointment that the Committee was not being re-established sooner. Meanwhile, the U.S. Department of Justice Office of the Inspector General issued an Audit Report criticizing the Complex Asset Team of the U.S. Marshals Service for its management of complex assets, including its handling of certain assets seized from Bernard Madoff.

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On Friday, September 9, the Office of the Chief Operating Officer of the SEC issued its Report on the Implementation of SEC Organizational Reform Recommendations, which was mandated by Section 967 of the Dodd-Frank Act. The 25-page report was prepared to address the recommendations made in March 2011 by the Boston Consulting Group ("BCG"), who submitted a Report to Congress examining the internal operations, structure and need for reform at the SEC (as discussed here). Friday's report noted the budgetary issues the SEC faces and reported on the largely organizational steps the agency has taken to begin the multi-year task of implementing the recommendations. In short, the SEC summarized that that "[w]hile the agency has made progress, the path forward is still long."

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On August 30, 2011, the SEC announced it had settled a case with James O'Leary, the former CFO of Beazer Homes USA under Section 304 of the Sarbanes-Oxley Act. Section 304's "clawback" provision requires the reimbursement of compensation from executives under certain circumstances when their companies were in material non-compliance of financial reporting requirements due to misconduct. In Mr. O'Leary's case, although he was not charged with any misconduct, he has agreed to reimburse $1.4 million he received after fraudulent financial statements were filed.

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Two recent posting in the blogosphere discuss the long-threatened Congressional efforts to roll back the impact of the Dodd–Frank Wall Street Reform and Consumer Protection Act. First, a post from Jim Hamilton's World of Securities Litigation discusses Congressional efforts to repeal specific regulations and pass fundamental and structural reform of the federal rulemaking system. Second, Broc Romanek of theCorporateCounsel.net Blog has a post which discusses the Whistleblower Improvement Act of 2011, which will require whistleblowers to report matters to his or her employer before reporting to the SEC.

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The Commodity Futures Trading Commission has adopted its Final Rules to implement a whistleblower program mandated by the Dodd-Frank Act. The CFTC stated that it sought to harmonize its rules with those recently adopted by the SEC.

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The SEC announced that its Whistleblower Rules, adopted on May 25, 2011 became effective today and the Commission launched its new web page (here) for that particular office.  In addition, in his first speech since being appointed as Chief of the Office of the Whistleblower, Sean McKessey addressed some misunderstanding about certain hotly debated issues related to the whistleblower program.

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The SEC and Rajat Gupta have agreed to settle their dispute regarding the forum in which they should litigate the allegations of insider trading by the former Goldman Sachs director by dismissing the pending actions against each other. Specifically, the SEC has dismissed its Administrative Proceeding against Mr. Gupta alleging insider trading and the parties have advised Judge Jed Rakoff (who is presiding over the lawsuit filed in federal court in New York by Mr. Gutpa against the Commission) that they will be entering a Joint Stipulation of Dismissal. In doing so, the parties agreed that, if the SEC elects to bring action against Mr. Gupta, it will do so in federal court in New York and designate it as related to the other Galleon cases pending before Judge Rakoff.

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On Thursday, July 21, 2011 (the first anniversary of the passage of the Dodd-Frank Act), SEC Chairman Mary Schapiro testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs regarding the Commission's efforts to fulfill its responsibilities under the Act. During her testimony, she advised the Committee that "the new responsibilities assigned to the agency under the Dodd-Frank Act are so significant that they cannot be achieved solely by wringing efficiencies out of the existing budget without also severely hampering our ability to meet our existing responsibilities." Her prepared remarks during the testimony are available here.

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On Monday, July 11, 2011, New York federal Judge Jed Rakoff denied the SEC's Motion to Dismiss in Gupta v. SEC, No. 11-cv-1900 (S.D.N.Y.). The Plaintiff, Rajat Gupta, a former director at Goldman Sachs, has been accused by the SEC of having provided material nonpublic information to Raj Rajaratnam of Galleon Management, who was recently convicted of insider trading (discussed here). Unlike the 28 other defendants named in lawsuits relating to Galleon, the SEC commenced an Administrative Proceeding against Mr. Gupta. Mr. Gupta's complaint in federal court (discussed here) alleged that the SEC unconstitutionally deprived him to a jury trial in federal court and that it was necessary to have the question of whether the Dodd-Frank Act provisions could be applied retroactively (which the SEC seeks to do in the Administrative Proceeding) decided in federal court. By denying the SEC's motion to dismiss, Judge Rakoff allowed Mr. Gupta's case to proceed, but ruled that "the theory of the Complaint is narrowed to one of equal protection."

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At an open meeting on Wednesday morning, the SEC adopted final rules to implement Section 922 of the Dodd-Frank Act regarding securities whistleblower incentives and protection. One of the significant highlights of the final rules is that the Commission has sought to struck a compromise between the importance of the corporation's compliance programs on the one hand, and the incentive for the whistleblower to report directly to the SEC (and by-pass the corporation) on the other hand. The SEC's Press Release announcing the adoption of the rules (and providing a brief summary) is here, while a copy of the SEC's Release and the rules themselves are available here.

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In March 2011, an individual accused of participating in an insider trading scheme filed a Complaint against the SEC in federal court in New York, arguing, among other things, that the SEC should be enjoined from retroactively applying the provisions of the Dodd-Frank Act in an administrative proceeding against him. On Friday April 1, 2011, the SEC filed a brief requesting that the Court dismiss that complaint for lack of subject matter jurisdiction, arguing, in part, that the retroactivity claim was not "ripe" and the individual had not exhausted his administrative remedies. In short, the Commission argued that the federal court cannot consider this issue until the administrative proceeding is completed and the SEC decides whether or not to impose civil penalties under the Act.

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On March 10, 2011, the Boston Consulting Group ("BCG") submitted a Report to Congress examining the internal operations, structure and need for reform at the SEC. As part of its work, BCG reviewed extensive documentation and conducted over 425 interviews. The Report (available here) recommended a series of initiatives designed to optimize the SEC's resources, but also recommended that Congress consider whether such improvements allow the Commission to meet congressional expectations. If not, Congress will either need to adjust the SEC's funding or change its role to fit available funding, the Report concluded. 

The Report, mandated by the Dodd-Frank Act, recommended that the SEC:

• reprioritize its regulatory activity, which would include focusing on activities that the Commission deems critical to commerce or to strengthen the SEC itself, scaling back or stopping activities, or delegating them to self-regulatory organizations ("SROs");

• reshape its organization by, among other things, taking into account the reprioritization described above and seeking flexibility on certain offices mandated by the Dodd-Frank Act;

• invest in enabling infrastructure, particularly in the area of information technology and human resources; and

• enhance its role as an overseer and co-regulator with SROs by strengthening its oversight of them and centralizing its contacts with them.

BCG noted however, that its recommendations would only take the Commission "so far," due to constraints its faces: notably civil service laws limit the ability of the agency to attract, retain and manage personnel. The Report noted that, even with these changes, the SEC may not be able execute upon all activities necessary. If so, Congress will need to either relax funding constraints or alter the SEC's role to fit its existing funding and rely more heavily upon the SROs to fill regulatory needs.

In recent congressional testimony, the SEC sought additional funding to be able to fulfill its role. SEC Chairman Mary Schapiro testified on Thursday (March 10) before a Senate Committee and today (March 15) before a House Subcommittee in support of the Administration's proposed budget for Fiscal Year 2012, which seeks $1.4 billion for the SEC (an increase over the $1.2 billion sought Fiscal Year 2011). In a separate statement, she welcomed the BCG report and was pleased that it recognized "the many initiatives we have taken over the past two years to increase the agency's efficiency and effectiveness." However, she acknowledged that "there is more work to be done."

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