May 2009


From the editors of CCH Federal Securities Law Reporter, CCH Blue Sky Law Reporter and the securities publications of Aspen Publishers, this update describes important developments covered in these publications, as well as timely topics of interest generally to federal and state securities practitioners. Also included is a “Hot Topic of the Month,” with research tips and references to CCH and Aspen source material on point. Finally, this update includes a preview of IPO Vital Signs, an advanced IPO research analysis tool, for IPO professionals and pre-IPO companies.

To view past issues of the Securities Update, please visit http://business.cch.com/updates/securities

If you have questions or comments concerning the information provided below, please contact me at rodney.tonkovic@wolterskluwer.com.

 

CCH Federal Securities Law Reporter

SEC Seeks Comments on Short Sale Price Test and Circuit Breaker Restrictions
The SEC proposed amendments to Regulation SHO in the form of a short sale price test restriction. The Commission proposed two approaches to restrictions on short selling, one of which is a price test that would apply on a market wide and permanent basis (“short sale price test” or “short sale price test restriction”) and one that would apply only to a particular security during severe market declines in that security (“circuit breaker”). The SEC proposed two alternative short sale price tests for the market-wide approach: a proposed modified uptick rule based on the national best bid and a proposed uptick rule based on the last sale price. The Commission also proposed two alternatives regarding the circuit breaker approach: a rule that would temporarily prohibit short selling in a particular security when there is a severe decline in the price of that security, and a rule that would trigger a short sale price test rule based on either the national best bid for any security for which there has been a severe price decline or on the last sale price for any security for which there has been a severe price decline. Release No. 34-59748 will be published in an upcoming Report at ¶88,601.

Commission Adopts Technical Amendments
The SEC adopted technical amendments to various rules, forms and schedules the Securities and Exchange Acts. The SEC also made certain technical changes to the Codification of Financial Reporting Policies that conform those rules, forms, schedules and the Codification to two recently issued Statements of Financial Accounting Standards issued by the Financial Accounting Standards Board dealing with business combinations and noncontrolling interests. Release No. 33-9026 will be published in an upcoming Report at ¶88,603.

Allegations "Too Feeble" for Suit to Go Forward
A 7th Circuit panel affirmed the dismissal of a shareholder action for failure to state a claim. The claims arose from the sale of a company that owned and managed office buildings. During the bidding leading up to the sale, the company filed four proxy solicitations providing details of the transaction. The shareholder's complaint alleged that the proxy statements were misleading in violation of Exchange Act Section 14(a) and Rule 14a-9. The district court found that the complaint failed to meet the Private Securities Litigation Reform Act's pleading requirements for state of mind and dismissed the action for failure to state a claim.

The appeals panel stated that while the PSLRA is applicable to proxy claims, there is no required state of mind for a violation of Section 14(a). As Judge Posner stated, there "is no required state of mind for a violation of section 14(a); a proxy solicitation that contains a misleading misrepresentation or omission violates the section even if the issuer believed in perfect good faith that there was nothing misleading in the proxy materials." According to the panel, proxy claims require proof that the solicitation was misleading, which implies at most negligence. Judge Posner concluded that "negligence is not a state of mind; it is a failure, whether conscious or even unavoidable (by the particular defendant, who may be below average in his ability to exercise due care), to come up to the specified standard of care." Negligence is conduct rather than a state of mind, observed Judge Posner. Regarding the shareholders' argument that it was improper for the buyer to demand a high termination fee, the panel noted that this was not a misrepresentation or omission in the proxy statements. The panel also rejected the argument that the shareholders would have rejected the sale were it not for the misleading proxy solicitations because the difference between the competing offers was less than one percent.

Even if the complaint survived these criticisms, the court noted that "the plaintiff's allegations that the proxy solicitations contained misrepresentations or misleading omissions were too feeble" to allow the suit to go forward. There was no suggestion that any shareholder was misled, and there was no evidence of loss or materiality or that any required information was omitted. Also rejected was what the panel characterized as the shareholder's main argument: that the last proxy solicitation was mailed too soon before a shareholder meeting to allow an informed vote. The panel stated that it is not up to the courts to impose a rule requiring that proxy solicitations be mailed at least fourteen days before a shareholder meeting. Finally, the panel affirmed that it was within the district court's discretion to abstain from exercising jurisdiction over the shareholder's state law claims due to parallel proceedings pending in state courts whose law governed those issues. Beck v. Dobrowski (7thCir) is reported at ¶95,093 (ip access user).


8th Circuit Addresses Scope of Fiduciary Duty for Fund Advisers
A panel of the 8th Circuit Court of Appeals addressed the scope of the fiduciary duty imposed on advisers of mutual funds by Investment Company Act Section 36(b). The shareholders of 11 mutual funds had brought an action alleging that the funds' manager had breached its fiduciary duty by misleading the funds' board of directors during fee negotiations and demanding excessive fees. The district court granted summary judgment in favor of the manager based on an analysis of whether the fee was so large that it could not have been the product of arm's-length bargaining according to factors set forth in Gartenberg v. Merrill Lynch Asset Mgmt., Inc. (1982-83 CCH Dec. ¶99,001 (ip access user)).

On appeal, the panel focused on the fee discrepancies between the mutual funds and comparable services provided by the manager for institutional accounts. After a review of cases, legislative history, and academic work, the panel concluded that the Gartenberg factors were useful, but flawed in that they could be applied in such a way as to "be diluted to a simple and easily satisfiable requirement not to charge a fee that is egregiously out of line with industry norms." The panel found that the proper approach to Section 36(b) would look to both the advisers' conduct during negotiations and the end result. Consequently, the panel disagreed with the district court's holding that the manager's fee did not constitute a breach of fiduciary duty. According to the panel, the district court should have compared the fees charged to the manager's institutional clients with those charged to its mutual fund clients, particularly since the advice may have been the same for both accounts. The panel also noted that the district court should have broadened its scope of review to take into account other possible violations of Section 36(b) such as the omission or obfuscation of information. The panel reversed the judgment and remanded the case, concluding that "the district court construed too narrowly the extent of the defendants' duty under Section 36(b) and gave insufficient weight to contested issues of material fact." Gallus v. Ameriprise Financial, Inc. (3rdCir) is reported at ¶95,108 (ip access user).

Evidence Failed to Show Acceptance of Duty of Confidentiality
A district court (SD NY) denied cross-motions for summary judgment on insider trading and securities fraud claims. The SEC brought this action against seven hedge funds and related companies and the individual serving as their managing partner and chief investment officer. The action arose from the funds' involvement in a series of Private Investments in Public Equities (PIPE) and their contemporaneous trading in the stock of the issuing entities. According to the Commission, the funds committed insider trading and violated duties of confidentiality by shorting the stock of four companies based on confidential, nonpublic information that companies intended to issue PIPEs.

Both parties agreed that the funds had information regarding the offerings and the issuers, that the information included language relating to confidentiality and that the funds contemporaneously traded the stock of the issuing companies. The parties disagreed, however, about whether the funds had and accepted a duty of confidentiality to the issuers. The court concluded that summary judgment would be inappropriate because material facts remained in dispute. While the court found that the information possessed by the funds was both material and nonpublic, the evidence offered by the Commission was insufficient to establish conclusively that the funds accepted a duty of confidentiality. "A reasonable juror," stated the court, "could conclude defendants never saw or accepted the confidentiality language."

At the same time, the court found that the funds could not establish as a matter of law the absence of a duty of confidentiality because of evidence describing the companies' confidentiality procedures and the funds' course of conduct. Regarding whether trades were made on the basis of the material nonpublic information, the funds were unable to establish that the trading in question was part of a "pre-existing trading plan" under Rule 10b5-1 because they did not show any existing plan or strategy. Furthermore, the trades in question, which occurred over a two-week period, were "insufficient to establish a history or practice of regular trading that might provide an innocent explanation." Also, the fact that the funds held both short and long positions did not by itself establish that they received no financial benefit from the information. Finally, the court rejected the managing partner's claim that he had no personal knowledge of any duty of confidentiality. According to the court, the record contained direct and circumstantial evidence that the partner was aware of and breached duties owed to the issuers. SEC v. Lyon (SD NY) is reported at ¶95,099 (ip access user).

CCH Blue Sky Law Reporter

CALIFORNIA Clarifies Form D Filing Procedures After SEC's 3/16/2009 Electronic Form D Filing Mandate
Procedures for filing Form D to claim California's Rule 506 or Section 25102(f) exemptions were clarified by the Department of Corporations in light of the SEC's requirement, effective March 16, 2009, that Form D be filed electronically at the federal level. NOTES: (1) An electronic signature on a copy of electronic Form D is accepted in California; (2) California does not require amendments or annual renewals; and (3) Issuers filing electronically with the SEC are advised to allow adequate time to obtain an EDGAR access code before filing with the SEC, to meet the California 15-day filing requirement. ¶12,667 (ip access user).

KENTUCKY Adopts Prohibition Against Use of Senior Certifications, Requirement that BDs and IAs Apply to Have Their Control Changes Approved and Rules Listing BD/IA Unethical Practices
Rules prohibiting the use of senior-specific certifications or professional designations and listing other unethical practices for security industry persons were adopted by the Kentucky Department of Financial Institutions, along with a rule requiring broker-dealers and investment advisers to apply to have their changes of control approved by the Department. ¶27,404B (ip access user), ¶27,450 (ip access user), ¶27,460 (ip access user), ¶27,470 (ip access user).

OREGON Adopts Non-Profit Cooperative Membership Exemption
Certificates evidencing membership in non-profit cooperatives are exempt from registration by the Director of the Oregon Division of Finance and Corporate Securities, provided: (1) the issuing cooperative is formed under specified Oregon statutory provisions; (2) the issuing cooperative owns or leases land in Oregon on which manufactured dwelling are (or will be) located; (3) membership certificates would be issued only to natural persons who own or occupy a manufactured dwelling located on land owned or leased by the issuing cooperative; (4) only one membership certificate would be issued for each space lease in the cooperative no matter how many people occupy a manufactured dwelling located in the space; (5) the membership fee would be a reasonable amount not exceeding $1,000; and (6) each membership certificate would include a condition requiring the certificate to be returned to the cooperative at the time of terminating an individual's membership, in exchange for at least the same price originally paid by the purchasing individual. ¶47,551A (ip access user).

TENNESSEE Amends Broker-Dealer Financial Reporting Requirements
A requirement that Tennessee-registered broker-dealers file a report of their financial condition within 90 days after each fiscal year-end is eliminated, instead requiring the filing only when, i.e., for those years, the report is requested by the Tennessee Securities Division. ¶54,417 (ip access user).

"Group Pleading Doctrine" Did Not Apply on Summary Judgment Motion
The California Court of Appeals has held, in Bains v. Coles, that the "group pleading doctrine" did not apply in determining whether the plaintiff shareholders presented sufficient evidence to avoid summary judgment on their claims of fraud and market manipulation against the directors of the corporation. Alternatively known as the "group published information doctrine," the group pleading doctrine creates a judicial presumption that statements in group-published documents, such as annual reports and press releases, are attributable to officers and directors who have day-to-day control or involvement in regular company operations. The appellate court observed, however, that no California authority has applied the doctrine in the context of a motion for summary judgment, whereas several federal appellate courts have suggested that the rationale for the doctrine arises only in the context of determining the sufficiency of the plaintiff's pleadings. Accordingly, the trial court properly determined that the group pleading doctrine did not apply to create a disputed issue of material fact. Bains v. Coles is reported at ¶74,761.

Aspen Federal Securities Publications

Investment Management Law and Regulation, Second Edition, by Harvey E. Bines and Steve Thel. The 2009 Cumulative Supplement (ip access user) is now live on the IRN Investment Management Library. The update contains developments in the regulation of banks as brokers; the rejection of the SEC’s attempt to exempt broker-dealers offering nondiscretionary advice on an asset-based or fixed fee basis, and the SEC’s response, including safe harbor for principal trades and interpretative guidance on definition of investment advisers; the SEC’s response to judicial rejection of the requirement that hedge fund managers register as investment advisers; the regulation of variable annuities as securities under the Securities Act; reforms of mutual fund prospectus and advertising rules; ERISA liability for employers failing to follow employee instructions regarding investment of defined contribution plan assets; judicial review of mutual fund advisory fees; cherry picking of trades by investment managers; prospective federal regulation of hedge funds and best practices for hedge fund investors and sponsors; and non-ratable allocation of aggregated trades.

Hot Topic of the Month

This month's hot topic is the statutory safe harbor for forward-looking statements created by the Private Securities Litigation Reform Act. Congress intended the safe harbor provision to shield specified persons from liability relating to forward-looking disclosures in order to encourage greater disclosure by issuers so that investors could make more informed investment decisions.

The safe harbor provided by Exchange Act Section 21E is a bifurcated provision. One prong focuses on whether the person making a statement identified it as forward-looking and included meaningful cautionary statements. The other prong focuses on that person's state of mind. If and to the extent that one of these prongs has been satisfied, a covered person is protected from private action liability in connection with the forward-looking statement.

The safe harbor's first prong protects forward-looking statements that include certain cautionary language. Covered persons are not liable in connection with a written or oral forward-looking statement if the statement is identified as a forward-looking statement and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement. The second prong looks to the state of mind of the person making the statement. A person or business entity will not be liable for a written or oral forward-looking statement absent a showing of actual knowledge that the statement was false or misleading.

The safe harbor applies only to forward-looking statements made by issuers and certain persons retained or acting on behalf of an issuer. The definition of "forward-looking statement" includes: 1) certain financial items, including projections of revenue, income and earnings, capital expenditures, dividends, and capital structure; 2) management's statement of future business plans and objectives, including those relating to the issuer's products or services; 3) certain statements made in SEC required disclosures, including management's discussion, analysis, and results of operations; 4) any statement disclosing the assumptions underlying or relating to any of the preceding; 5) reports of an outside reviewer retained by an issuer, to the extent that the report assesses a forward-looking statement of the issuer; and 6) other projections or estimates as the SEC may prescribe.

We publish related information in a wide range of resources (e.g., Federal Securities Law Reporter, Insights – Amy L. Goodman, Securities Regulation – Loss, Seligman & Paredes, etc.), and document types (laws, regulations, releases, newsletter articles, treatise discussion). For example:

Federal Securities Law Reporter

Insights – Amy L. Goodman (e.g., “Giving Good Guidance --What Every Public Company Should Know” (March 2007) (ip access user)
Securities Regulation – Loss, Seligman & Paredes (e.g., Chapter 2.D.2.a (ip access user))
Corporate Finance and the Securities Laws – McLaughlin & Johnson (e.g., Chapter 3.04[D] (ip access user))
Jim Hamilton’s World of Securities Regulation (http://jimhamiltonblog.blogspot.com/)

IPO Vital Signs

IPO Vital Signs, an advanced IPO research analysis tool, assists IPO professionals and pre-IPO companies satisfy their most challenging research needs and answers hundreds of mission critical questions for all the players in the IPO process. IPO Vital Signs’ tabular data analyses focus on issues surrounding client advisement, deal negotiation, and prospectus disclosure.

IPO Week in Review, a weekly e-newsletter to keep professionals up to date with recent filing and going public activity, is an important element of the IPO Vital Signs system or is available by separate subscription. Coverage includes a monthly feature article on recent trends in going public in the U.S.

To see how an IPO Vital Sign works click on the Vital Sign title below:

#766 - IPO Issuer Legal Proceedings

An interactive table highlighting legal proceedings disclosures as they appear in final IPO prospectuses.

Use IPO Vital Sign #766 to...

  • Identify comparable IPO issuers based on type of legal proceedings, SIC code and issuer's law firm,
  • Determine if the legal proceedings in which your company or client company are involved should be disclosed,
  • Analyze the frequency of inclusion and content of corresponding risk factors.

Tip! Scroll down to the type of legal proceeding you are interested in researching and click any or all of the blank boxes in the column just left of the Legal Proceedings Disclosure column. Once you have checked the comparable disclosures you want to read in full, click the [COMPARE] button in the Legal Proceedings Disclosure column heading.