stockboardAlthough the IPO pace is off from last year’s sizzling levels, the number of companies completing IPOs on U.S. exchanges remains at heightened levels. In addition, the number of completed IPOs picked up as the year progressed, suggesting that IPO activity in the U.S. in the year’s second half will also be lively.

 

U.S.  IPO activity in 2014 was at the highest levels in more than a decade, when there were a total of 275 U.S. IPOs (as discussed here). According to Renaissance Capital (here), through the first six months of 2015, there have been a total of 104 completed IPOs, which is well below the 147 completed in the first half of 2014 (representing a decline of 29%). However, other than when compared with 2014, the number of U.S. IPOs completed in the first half of 2015 is the first half total since 2004.

 

The pace of completed IPOs has picked up as 2015 has progressed. The number of U.S. IPOs completed in June 2015 was the highest monthly total since July 2014, and the number of IPOs completed during the week ending on June 25, 2015 was the highest weekly total since October 2014, as discussed here. Moreover, the market for IPOs appears to be quite healthy as we head into the year’s second half. Seres Therapeutics, which debuted during the week ending June 25, 2015 soared 186% on its first day of trading, the highest post-IPO pop since January 2014. Continue Reading U.S. IPO Activity Remains at Heightened Levels in Year’s First Half

brazilIn an earlier post, I noted that a significant factor driving securities litigation filings so far this year has been the rising number of U.S. securities lawsuits involving non-U.S. companies. A number of different factors are contributing to the filing of these suits, but among the factors is the increasing numbers of U.S.-listed non-U.S. companies that have been caught up in corruption investigations in their home countries.

 

The highest profile company among the firms involved in corruption probes is the Brazilian petroleum company, Petrobras, which has been the target of growing Operação Lava Jato (Operation Car Wash) corruption investigation in Brazil. Petrobras, whose ADSs trade on the NYSE, was hit with a class action securities lawsuit in the U.S. in December 2014 (as discussed here).

 

The continuing Petrobras investigation has spread to a number of other Brazilian companies. Among other things, the investigation has led to the recent arrests of two high profile executives in the construction industry in Brazil, as discussed here. The leaders of the nation’s two largest engineering and construction companies, Marcelo Odebrecht, head of Odebrecht SA, and Otavio Marques Azevedo, head of Andrade Gutierrez, were taken into custody in raids linked to the Petrobras scandal.

 

The investigation has now led to yet another U.S. securities class action lawsuit against yet another Brazilian company. On July 1, 2015, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of New York against Braskem, S.A. and certain of its directors and officers. Braskem, which is based in Brazil, is Latin America’s largest petrochemical company. Continue Reading Another U.S. Securities Suit Arising from Overseas Corruption Investigation

seclogoOn July 1, 2015, a divided SEC voted 3-2 to propose rules directing the securities exchanges to adopt standards requiring listed companies to adopt policies requiring the companies’ executive officers to pay back incentive-based compensation in the event the company restates its financials for the year in which the compensation was awarded. The proposed rules, which Dodd Frank Act Section 954 required the agency to adopt, are now subject to a 60-day comment period, have already generated a great deal of discussion. If the final rules bear any resemblance to the currently proposed version, the rules could prove controversial and could lead to disputes and disruption.

 

The SEC’s 198-pages of proposed rules can be found here. The SEC’s July 1, 2015 press release (including a “fact sheet” summarizing the proposed rules) can be found here. A good summary of the proposed rules by the Dorsey & Whitney law firm can be found here. A summary from the Ropes & Gray law firm set up in a Q&A format can be found here.  Unusually, all five of the commissioners issued separate statements about the proposed rules, including two sharply worded dissents by Commissioners Michael S. Picower (here) and Daniel M. Gallagher (here).

 

Under the proposed rules, the national securities exchanges are required to develop listing standards requiring companies to develop and implement policies to “claw back” incentive-based compensation that “later is shown to have been awarded in error.” The proposed rules are designed to “improve the quality of financial reporting and benefit investors by providing enhanced accountability.”

 

Recovery would be required from current and former “executive officers” who received incentive-based compensation during the three fiscal years preceding the date on which the company is required to prepare an accounting restatement. The recovery is required on a “no fault” basis, without regard to whether any misconduct occurred or to an executive officer’s responsibility for the erroneous financial statements. The amount of recovery is to be measured by the amount of the compensation exceeds what the officer would have received had the compensation been based on the restated financials.

 

For purposes of these rules, the definition of “executive officer” is very broad, and includes not only a company’s president and principal financial officer, but also the principal accounting officer, any vice-president in charge of a principal business unit, division or function, and any other person who performs policy-making functions at the company.

 

Companies would have discretion not to recover the excess incentive-based compensation if the expenses of enforcing the recovery would exceed the amount of the recovery. In addition, foreign private issuers would not have to enforce the recovery if recovery would violate their home country law.

 

The proposed rules specify that each listed company would be required to file its compensation recovery policy as an exhibit to its Exchange Act annual report.

 

Of significant interest for readers of this blog, under the proposed rules issuers are not permitted to indemnify officers against any amounts recovered under its clawback policies or to pay premiums on an insurance policy covering an officer’s potential clawback obligations.

 

The proposal requires the exchanges to file their proposed listing rules no later than 90 days after the publication of the final rules that the agency ultimately adopts, and requires the listing rules to become effective no later than one year following the publication date.

 

Discussion

As required by the Dodd-Frank Act, these proposed rules are considerably broader than the existing executive compensation clawback requirements under the Sarbanes-Oxley Act. The SOX clawback rules applied only to the CEO and the CFO; these rules apply to a much broader range of executive officers. In his dissent, Commissioner Gallagher argued that the list of officers to whom the rules would apply is much broader than the Dodd-Frank Act required.

 

From my perspective, these rules continue a deeply troublesome trend in which our system of laws increasingly seeks to impose liability without culpability. As I have previously noted on this site (most recently here), there is an unfortunate willingness to impose penalties on those who neither engaged in wrongdoing nor were even aware that wrongdoing had even occurred, contrary to our legal system’s long-standing tradition that punishments were only administered on those who were somehow at fault or at least had a guilty mind.

 

The dissenting commissioners have numerous other criticisms of the proposed rules. Commissioner Gallagher (whom I learned from his recent speech at Stanford Law School Director’s College — which I attended — is a colorful speaker and writer), referred to the rules as the Commission’s “newest Goya, tortured and nightmarish.” Commissioner Picower criticized the rules as “likely to impose a substantial commitment of shareholder resources and, unintentionally, result in a further increase in executive compensation,” as companies move away from incentive-based compensation that would be subject to clawbacks. In a sign of the deep divisions with the agency, both dissenters also objected to the way that the final proposed rules were put forward and proposed. Commission Picower objected to that way that “at the very end, significant changes are agreed upon by the Chair’s office in ways that diverge from Congressional intent.”

 

The depth of division reflected in the dissents and the level of rancor at the commission that the tenor of the dissents reflects is frankly a little disturbing. The dysfunction these divisions suggest are arguably even more disturbing given the high-profile criticism the current SEC chair has faced – from within the same party as the President who nominated her – for not moving aggressively enough.

 

Setting aside the debate over the merits of the proposed rules, the rules as proposed could prove to be very difficult to administer as a practical matter. As discussed in at July 1, 2015 Law 360 article entitled “SEC Clawback Plan to Create Enforcement Nightmares” (here, subscription required), the implementation of the rules’ requirements in the event of a restatement could present a  host of challenges. Among other things calculating the difference between the compensation that was awarded and the compensation that should have been awarded based on the restate financials could produce some difficult calculations, particularly for types of compensation based on total shareholder return.

 

There is also the “open question about how companies will go about getting back money once they determined who owes what.” As one commentator quoted in the article states, the rules “create a potentially awkward dynamic.” In addition, companies who want to determine whether or not they fall into the rules’ exception which exempts clawbacks if recovery costs exceed potential recoveries could get caught up in preliminary calculations about likely recovery costs. Many companies, eyeing the rules’ complexity and challenges, may switch to forms of compensation that would not be subject to clawback, so that less of executives’ compensation is at risk.

 

There are two specific features of the proposed rules that D&O practitioners will want to note. The first is that given the requirement that the rules requirement that clawback could be imposed without respect to fault, the effort to enforce the clawback may not involve an actual or alleged Wrongful Act within the usual meaning of a D&O insurance policy. (This potential issue could be circumvented to the extent the definition of the term Wrongful Act also incorporates a provision including within the term any matter claimed against them as a result of their status as such as a director or officer of the company.).

 

Practitioners will also want to note that the under the proposed rules issuers would not be permitted to pay premiums on an insurance policy covering an officer’s potential clawback obligations. There have been various efforts over the past several years within the D&O insurance industry to try to come up with insurance solutions that would address corporate officials’ risk of compensation clawback. These provisions of the new rules would seem to suggest that these insurance measures are no longer feasible – except that the way the proposed rules are written, they would only prohibit the company from paying the premium for the insurance; they do not appear to prohibit an individual from paying the premium for the insurance.

 

In any event, the rules’ prohibition seems to extend only to the payment of premium for insurance protecting against the actual clawback itself, not for the payment of premium for insurance providing defense cost protection in the event a corporate official is hit with a claim for compensation clawback. (However, another potential problem for coverage of even just the defense costs is the fact that the clawback claim is likely to come from the company itself, and therefore potentially could be subject to the insured vs. insured exclusion.)

 

Coming Soon: Direct Sales to the Business Insurance Industry?: In case you didn’t see it over the holiday weekend, on July 3, 2015, the Wall Street Journal had an interesting article entitled “Buffett Re-Examines Reinsurance” (here) discussing how changes in the reinsurance industry and the amount of investment capital that has been drawn into the reinsurance space has made reinsurance a less attractive proposition for Berkshire Hathaway than it has been in the past. As a result of these changes, Berkshire has moved into the direct insurance business.

 

Of even greater potential interest to readers of this blog, the article mentioned that Berkshire’s new insurance strategy includes a direct sales model for business insurance, along the lines that Berkshire unit Geico uses for auto insurance. Among other things, the article stated that “By next year, Berkshire plans to sell insurance to small and medium-size businesses directly over the Internet, bypassing the industry’s middlemen.” The article also stated that “Berkshire’s other big initiative is a planned move into online insurance. To be called Berkshire Hathaway Direct, it will target small and midsize businesses. Traditionally, insurers have relied on agents and brokers to sell their products, but Mr. [Agit] Jain is taking a page out of the Geico direct-to-consumer playbook, convinced the industry is ripe for disruption from this effort.”

 

To say that there are big changes afoot in the insurance industry these days would be one of the understatements of the year.

gavelnewThe first half of 2015 was an active period for new securities class action lawsuit filings. The filings through the year’s first six months suggest we are on pace for the highest annual number of new filings since 2011. The heightened levels of lawsuits involving non-U.S. companies and IPO companies contributed to the uptick in securities suit filings in the year’s first half. Continue Reading An Active First Half for Securities Class Action Litigation

GaIn  a recent post in which I discussed the “basic value proposition” of D&O insurance, I noted that among the five indispensable elements required in order for coverage under a D&O insurance policy to exist is the requirement that a Claim for an alleged Wrongful Act against an Insured Person acting in an Insured Capacity. The prerequisite that the Insured Person must have been acting in an Insured Capacity at the time of the alleged Wrongful Act arises from the fact that individuals act in a number of different capacities; it is only conduct undertaken in their capacity as an officer or director of the insured company for which the insurance policy provides coverage.

 

A June 22, 2015 decision by the Eleventh Circuit, applying Georgia law, provides a good illustration of how an individual might be acting in multiple capacities, and underscores the fact that the insurance under a D&O policy is only available when the insured was acting in his or her capacity as a director or officer of the insured company. The case presents some interesting policy wording lessons. A copy of the Eleventh Circuit’s opinion can be found here. Continue Reading D&O Insurance: A Question of “Capacity”

nystateOne of the standard features of D&O insurance policy is the fraud exclusion, which these days typically provides that the exclusion is triggered only after a “final” judicial determination that the precluded conduct has occurred. But what is it that makes a determination “final”?

 

On June 23, 2015, in a decision that has a number of important implications, the New York (New York County) Supreme Court, Appellate Division, First Department, applying New York law, held that the imposition of a post-conviction criminal sentencing constitutes a “final judgment” that not only triggered the fraud exclusion in a D&O insurance policy but also required the convicted individual to reimburse the carrier for amounts it had already paid – even though the individual’s appeal of his criminal conviction was pending.

 

As discussed below, the court’s opinion has some important lessons for D&O insurance practitioners. A copy of the court’s opinion can be found here. Continue Reading D&O Insurance: A “Final” Analysis

Cohen photoAs I noted in a recent post (here), on June 11, 2015, the Delaware legislature passed legislation prohibiting fee-shifting bylaws for Delaware stock corporations. On June 24, 2015, Delaware’s governor signed the statute into law, as discussed here. As I noted in my blog post about the legislation, though the statute has been passed, a number of questions remain about fee-shifting bylaws, including in particular what the legislation’s impact might be for bylaws purporting to shift fees in connection with federal securities litigation. As discussed here, according to Columbia Law School Professor John Coffee, as a result of the statute’s wording, there may be unanswered questions whether the statute prohibits bylaws shifting fees in connection with securities litigation.

 

In the following guest post, Neil J. Cohen, Publisher, Bank and Corporate Governance Law Reporter, takes the position that there may be arguments that the new legislation is broad enough to preclude bylaws that purport to shift fees in connection with federal securities litigation. (Please note that Neil wrote and submitted his article before the Governor has sighed the statute into law.) The “Note” at the beginning of the guest post is part of Neil’s article.

 

I would like to thank Neil for his willingness to publish his article on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this site. Please contact me directly if you would like to submit an article. Here is Neil’s guest post.

 

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Note: The following article discusses a Delaware bill, passed by both the Senate and House, which prohibits a Board of Directors of a stock company from implementing fee-shifting provisions for “internal corporate claims.” The author asserts that securities fraud suits can fit within that category. The article is part of a Round Table on the Delaware legislation that includes Professors J. Robert Brown and John C. Coffee. The June, 2015 issue of the Bank and Corporate Governance Law Reporter containing the entire Round Table can be downloaded here.

The Governor of Delaware is expected to sign a bill, passed by the House and Senate, which prohibit fee-shifting provisions for “internal corporate claims”. The bill also contains a prohibition of bylaws or charter provisions that designate a forum other than Delaware as the exclusive forum. That provision would prevent corporations from choosing forums that allow fee-shifting provisions.

The legislators resisted a lobbing effort by the Chamber of Commerce’s Institute for Legal Reform to insert a provision expanding the Court of Chancery’s discretionary authority to shift to include cases that “plainly should not have been brought but that do not satisfy the extremely narrow ‘bad faith’ or ‘frivolousness’ exceptions”.

Assuming the Governor signs the bill, what is the outlook for fee-shifting provisions affecting securities fraud litigation?  Will plaintiffs file for a declaratory judgment in Chancery Court or in District Court to strike the fee-shifting provisions as facially invalid under the new Delaware law? If so, the specific questions are likely to be whether the general bylaw authority under Section 109 of the law allows such provisions and, if so, whether Section 115, dealing with “internal corporate claims,” exempts them. If they are not exempt plaintiffs will be forced to overcome a high standard of proof to demonstrate they are invalid as applied.  In the author’s opinion the best argument that the fee-shifting provisions are invalid is because they are exempt as “internal corporate claims” under Section 115 of the new law. Continue Reading Guest Post: Does Delaware Legislation Cover Fee Shifting in Securities Cases?

the dandodiaryWith this blog post, The D&O Diary is proud to launch its new look website. I hope  readers will find the cleaner, more open page design easier to read, and that the relocation of the search box and the alterations to other website functions will make the site easier for readers to use.

 

Though the website redesign represents a pretty significant change to The D&O Diary’s look, the bigger and more important changes to the site are actually behind the scenes.

 

The primary purpose for the redesign was to implement what is known as responsive web design, which should allow the website to be viewed across a wide range of devices without any loss of design integrity or functionality. In other words, the website should look about the same and function about the same regardless of whether you are viewing it on your phone, on your tablet, or on your computer.

 

The launch of this redesign is the culmination of several months of planning and implementation. I hope that readers like the changes, and in particular I hope that readers like being able to have the same experience when viewing the site, regardless of the device on which it is accessed. I welcome readers’ comments about the changes.

 

Along with the design changes, the feed URL for those who access the site using an RSS feed has been changed. Those readers who want to continue to subscribe via RSS should make sure to subscribe at the new feed URL https://www.dandodiary.com/feed

2015-06-22 18.45.28aThe D&O Diary was in Palo Alto, California this week for the annual Directors’ College at the Stanford Law School (depicted to the left). The keynote speaker on Tuesday morning was SEC Commissioner Daniel M. Gallagher, who recently announced that he will be stepping down from the Commission when his successor has been confirmed. As was the case with many of the panels at the conference, the focus of Gallagher’s speech was on the questions and concerns involving activist shareholders. The text of Gallagher’s June 23, 2015 speech can be found here.

 

Gallagher began his speech by rhetorically posing the question of whether shareholder activism is good or bad, a question that he contends is all too often answered based on a “binary view of the world” in which shareholder activism is viewed either as all good or all bad. For Gallagher, this view “is convenient, but it is also far too simplistic.” The question that needs to be answered in determining whether a specific instance of shareholder activism is either good or bad is whether or not it is aimed at creating long-term shareholder wealth and whether or not that effort is successful.

 

As for whether or not the SEC should be in the business of determining which activism is good and which is not, he said that “it doesn’t, and shouldn’t.” It is the SEC’s role to “create a level playing field, chiefly through disclosure”; it is up to the states to determine the substantive rights of shareholders. As for the SEC, while it has been a faithful groundskeeper over the years, the prudent division of responsibilities between the agency and the states has been eroded over the years as a result of marketplace changes and due to “our own overzealous implementation of legislative enactments.”

 

Shareholder activism is one of the areas where Gallagher sees the balance of responsibilities as having changed. In discussing this topic, Gallagher drew a distinction between shareholder proposal activism and hedge fund activism. With respect to shareholder proposal activism, Gallagher asserted that the current SEC process for administering the process is broken, both for shareholder activists and for the companies that they target. Specifically, Gallagher said, “the SEC’s shareholder proposal rule, Rule 14a-8, is being abused by special interest groups to advance idiosyncratic goals that may directly conflict with the interests of most shareholders.”

 

Gallagher would prefer to see the SEC get out of the business of policing shareholder proposals, and leave the entire issue to the respective states under their governing corporate laws. In the interim, which awaiting these types of changes, he would like to see the current Commission “no action” letter process, which is administered at the staff level,  to be “jettisoned” and converted into a process involving Commission advisory opinions, in which the Commission itself would issue opinions on major policy issues. The buck, Gallagher said, should stop with the political appointees at the Commission.

 

Hedge fund activism, by contrast to shareholder proposal activism, Gallagher said, is at least driven by profit motivation, but “the key question here is whether activist hedge funds drive long-term value creation, or whether short-term gains to activism are at the expense of long-term corporate growth.” Gallagher noted the debate within the academic and legal communities about the value of shareholder activism but expressed his doubt that answers to the value of activism can be found in econometrics.

 

The SEC’s role with respect to activist investors begins with its administration of the Section 13 reporting obligations that are triggered when an investor’s ownership share exceeds the 5% threshold. Gallagher observed that in the current trading environment an activist investor can quickly accumulate a 5% stake in a particular company, often using trading mechanisms and ownership structures.  However, even with a 5% stake, 95% of the ownership remains elsewhere and the activists are still subject to the requirements of the other investors.

 

The question then, according to Gallagher, is “how the other investors are conducting themselves vis-à-vis activists, and whether the SEC has done enough to ensure the integrity of this process.” In particular, Gallagher noted, institutional investors could make or break activist interventions, but they “paying insufficient attention to their fiduciary obligations to their clients when they determine whether to support a particular activist’s activity.” All too often the funds are simply deferring to the proxy advisory firms. The states and SEC are not doing enough to police the funds. The funds are “fiduciaries, they are in the markets we oversee, dealing with SEC registrants, and they should be held accountable for their activities.”

 

Gallagher said that better policing of advisors and funds is “hard, and it is controversial, ” but  it “falls to the SEC and the states to figure out how to empower the individuals and give them the information they need to hold their advisers to account, and to take action against the institutional scofflaws.”

 

Gallagher then turned to the topic of proxy advisory firms. He said that too many institutional investors simply rely on the proxy advisory firms. He said that the proxy advisory firms have done too little to address concerns about their sometimes shoddy research. The proxy advisory firms’ lack of progress could and probably should result in further action on the SEC’s part.

 

He then turned to corporate boards and management, which obviously have a critical role in the activist debate. In discussing the role of boards and management, Gallagher observed that there are two models of shareholder involvement, the first of which is based on a model of pure democracy in which the corporation is directly controlled by shareholder voting, by contrast to the republic model in which the shareholders elect the directors and the directors control the company. Which of these two models is to be preferred is a matter of state law. Gallagher said that the SEC action increasingly has disrespected that distinction and has become biased toward direct shareholder democracy. Gallagher said the SEC’s rules should be flexible enough to accommodate both approaches.

 

The pressure toward more shareholder democracy comes when boards are perceived as falling short. There may be, Gallagher noted, company boards that have become stale or too chummy with management, but a vigorous board that drives change “moots” the need for direct shareholder democracy.  Boards that are out in front and engaged with shareholders  by “communicating your company’s strategy and how the board is overseeing management’s execution of that strategy to investors, and in turn hearing what’s on your investors’ minds, can help demonstrate to the SEC that boards are a tool for investor protection, not an impediment to it.” This approach can also allow companies to get out in front of activist investors.

 

All of these constituencies can coexist on a level playing field, with activists putting pressure on companies that fall short. The problem, Gallagher said, is that the activist campaigns can involve short-term goals rather than a long-term focus. In the current low interest rate environment, activism has become popular, motivated by the desire for returns. In this environment, investors become focused on the short term, and so too are managers as they seek to stave off activists. The SEC, Gallagher said, has played a role, as its corporate governance rules are contributors to the short-termism. There is, Gallagher says, “enough blame to go around.”

 

Gallagher said that the pendulum may have started to shift as a bi-partisan view is emerging that the pervasive short-termism is destructive of long-term shareholder value. But as of yet there are no bi-partisan consensus on what to do about it. There are a number of ideas and proposals circulating. Gallagher referred approvingly to the proposals of Harvard Law School Professor Guhan Subramanian in his March 2015 Harvard Business Review article “Corporate Governance 2.0” (here), in which Subramanian suggested that using principles drawn from basic negotiation theory that concerned parties should engage in a process to re-conceptualize overall corporate governance, to develop an alternative to the activists’ incremental approach to corporate change.

 

Gallagher said that he hoped that the SEC “give life” to Professor Subramanian’s proposal and host a roundtable “where representatives from interested groups can sit down and try out this approach.” The agency is uniquely situated to provide a neutral forum could lead to the outline of a consensus. He noted that while it is this type of roundtable meeting unlikely to take place before his departure as Commissioner he hoped that his colleagues will “take up this banner and run with it if they so choose.”

……

I am grateful to have had the opportunity while at the conference to participate on a panel on the topic of Indemnification and D&O Insurance, with my good friends Priya Cherian Huskins of Woodruff-Sawyer and Jim Kramer of the Orrick law firm, as pictured below.

 

2015-06-23 15.32.39a

 

The conference overall was great. It is always interesting to hearing the perspective and questions of the directors themselves. Congratulations to Stanford Law Professors Joseph Grundfest and Joe Siciliano and to the Directors’ College staff for another successful conference.

 

More Pictures:

Stanford University is so beautiful, it is a pleasure just to be there (note the circle of students enjoying the tree shade): 

 

2015-06-22 18.49.39a

 

At Dinner in Palo Alto with my good friends Winnie Van (ABD) and Mike Hoy (Socius):

 

mike and winnie

 

Scenes from Glen Canyon Park, San Francisco:

 

GlenCanyonParkHillside

 

 

GlenCanyonParkGap

 

A view of the San Francisco Skyline, from Billy Goat Hill in Glen Park, San Francisco:

 

sanfranciscoskyline