Saturday, June 23, 2007
On May 23, the SEC announced that it was proposing a series of measures to modernize and improve its capital raising and reporting requirements for smaller companies. This week it issued two releases setting forth some of the specifics. Release 33-8812 proposes modification of the eligibility requirements for use of Form S-3 so that companies with a public float below $75 million can use Form S-3 and can also take advantage of shelf registration. Release 33-8813 proposes revisions to Rule 144 to shorten the holding period for resales of restricted securities and revisions to Rule 145 to eliminate the presumptive underwriter doctrine.
When Form S-3 was revised in 1992, the SEC stated that the $75 million float requirement would limit use of Form S-3 principally to corporations traded on the NYSE or NASDSQ who were generally followed by at least three analysts. (In today's dollars, $75 million would be between $100-110 million). Indeed, the SEC's heavy reliance on the efficient markets hypothesis was the guiding principle behind the adoption of the tiered registration system, including Form S-3 and its incorporation by reference of 34 Act filings into the 33 Act registration statement. Today, the SEC believes that more companies should benefit from the greater flexibility and efficiency in accessing capital markets afforded by Form S-3. Citing the great advances in electronic dissemination and accessibility to company information since the last revisions to Form S-3, the SEC has dramatically expanded the use of Form S-3 and the periodic takedowns of securities permitted by shelf registration. The proposed rule would permit registrants (other than shell companies) to use Form S-3 for primary offerings, whether or not they satisfy the $75 million public float requirement, so long as they do not sell more than 20% of their public float over any twelve-month period and otherwise satisfy the Form S-3 requirements (i.e., the company must be a reporting company and must have timely filed all required 34 Act reports in the past 12 months). This would include companies quoted on the OTC Bulletin Board and the Pink Sheets quotation services. The cap of 20%, the SEC states, should be large enough to help issuers meet their financing needs but small enough to take into account the effect the issuances could have on the market for thinly traded securities. In the release the SEC emphasizes the advantages to smaller companies of shelf registrations. While it recognizes the concern that this would allow periodic takedowns without any further SEC staff review since the initial filing of the registration statement, it believes this risk is justified by the benefits for smaller companies. Comments are due August 27. The release contains a number of questions on which the SEC would like to receive comment. To me an important one, as stated by the SEC, is: in what way is market following an important criterion in light of technological changes?
There are two principal proposed revisions to Rule 144 to ease the restrictions of the Rule and to increase the liquidity of restricted securities and thus decrease the cost of capital. First, the Rule would reduce the holding period for restricted securities of 34 Act companies to six months (currently, it is one year), subject to increasing the holding period, for up to six months, if the holder engaged in hedging transactions during that time. The SEC believes that six months is a reasonable indication that an investor has assumed the economic risk of the investment and is therefore not an "underwriter." Second, the Rule would substantially reduce restrictions on resales by non-affiliates after they have satisfied the holding period. Non-affiliates of reporting companies would only be subject to the current public information requirement for one year after the acquisition of the securities. Non-affiliates of both reporting and non-reporting companies could resell their securities after one year without any other conditions. As is usual with Rule 144, there are plenty of technicalities, and the SEC has a two very useful charts (at p. 12 and p. 26 of the release) tracking the changes. The SEC has rewritten the Preliminary Note in "plain English," and it is startling in its brevity. As a securities law professor, I found the Preliminary Note's discussion of the principles behind the Rule and, in particular, its discussion of "when a person is deemed not to be engaged in a distribution" very helpful. I will be sorry to see it go.
Finally, the proposed changes to Rule 145 would, first, eliminate the presumptive underwriter position in paragraph (c), except for transactions involving shell companies. This is a long overdue change to my mind, since the presumptive underwriter doctrine did not make much sense in this context. Second, the resale provisions in paragraph (d) would be changed to conform with the changes in Rule 144.
If people thought the Dow Jones board's involvement in the negotiations with Murdoch would speed matters up, they must think again. The Dow Jones board has proposed to Rupert Murdoch a Special Committee on Editorial and Journalistic Independence and Integrity -- how pompous can you get? The proposal is apparently about the same as the one that the Bancroft family proposed in early June, and Murdoch's reaction was reported to be frustration. See NYTimes, Latest Plan From Dow Jones Is Said to Frustrate Murdoch; WSJ,Dow Jones Sends News Corp. Its Plan To Protect Editorial Independence.
Forget the ports deal -- I can't get used to the idea of the investment arm of Dubai owning Barneys! I remember when Barneys was a discount men's store owned by Barney Pressman and watched with bemusement as it transformed itself into a symbol of edgy, too-cool-for-most-of-us New York fashion. Now Jones Apparel, struggling to remain afloat, sold Barneys for $825 million to Istithmar -- a good deal considering Jones bought the stores in 2004 about half that amount. See WSJ, Jones Apparel to Sell Barneys To Dubai Firm for $825 Million.
Friday, June 22, 2007
Lear Corp. postponed its special meeting to vote on Carl Icahn's $36 per share buyout offer, for which it reaffirmed its support. Postponement seems to be a more common tactic these days, in face of shareholders' resistance. Both Proxy Governance and ISS recommend that shareholders vote against the deal. The new meeting date is July 12 (originally June 27). See WSJ, Lear Affirms Support for Buyout By Icahn, Delays Annual Meeting.
Fannie Mae plans to pay millions of dollars in incentive compensation to current and former officers and employees based on corporate performance since 2003, including the periods in which earnings were misstated and regulators say the company was mismanaged. The payments are subject to the approval of oversight agency OFHEO. The company did not disclose whether former CEO Franklin D. Raines would receive any payments. OFHEO and Raines are fighting over whether Raines has to return some of his previously paid compensation. See WPost, Fannie Proposes Releasing Executive Incentive Payments.
GE and Pearson announced that they have decided not to bid for Dow Jones, leaving Murdoch's $60 bid the only one out there. The Dow Jones board is reviewing the Bancroft family's proposal for an independent editorial board and is expected to begin its negotiations with Murdoch soon. See NYTimes, 2 Companies Drop Pursuit of Dow Jones; WSJ, Murdoch's Bid for Dow Jones Gets a Boost.
Despite calls this week from Congressmen to postpone its IPO because of tax and security concerns, Blackstone Group goes public today, having sold its shares at $31 per share, for a total of $4.3 billion. The speculatation is that rival Kohlberg Kravis Roberts will be next. See NYTimes, Blackstone Rival Plans Own I.P.O.; WSJ, Blackstone's Green Day.
Thursday, June 21, 2007
On June 20, the SEC settled enforcement proceedings against Cambrex Corporation (Cambrex) for violations of the recordkeeping and internal controls provisions of Section 13 of the Securities Exchange Act of 1934 (Exchange Act). Cambrex is a life sciences company whose common stock trades on the New York Stock Exchange. From at least 1997 through 2001, Cambrex failed to properly reconcile its intercompany accounts, thereby accruing an imbalance of approximately $17.1 million. Of that amount, approximately $3.5 million was erroneously reflected as income when in fact it should have been accounted for as an operating expense, and Cambrex could not ascertain whether another $2.6 million was also improperly booked as income. As a result, Cambrex issued erroneous periodic and annual reports, and, in January 2003, Cambrex restated its financial results for the five-year period, reducing net income after taxes by approximately $5 million. The complaint alleges that the officers were aware of the problem but failed to reconcile its intercompany accounts until its executives were faced with the new executive officer certification requirements under the Sarbanes-Oxley Act of 2002.
On June 20, the SEC issued interpretive guidance, unanimously approved on May 23, to help public companies strengthen their internal control over financial reporting while reducing unnecessary costs, particularly at smaller companies. The new guidance will enhance compliance under Section 404 of the Sarbanes-Oxley Act of 2002 by focusing company management on the internal controls that best protect against the risk of a material financial misstatement. The SEC also issued final rule amendments providing that a company that performs an evaluation of internal control in accordance with the interpretive guidance satisfies the annual evaluation required by Exchange Act Rules 13a-15(c) and 15d-15(c), defining the term "material weakness," and revising the requirements regarding the auditor's attestation report on the effectiveness of internal control over financial reporting. The Commission also issued a release requesting comment on a proposed definition of the term significant deficiency."
Chairman Cox and Commissioners Atkins, Campos, Nazareth, and Casey will appear before the House Committee on Financial Services on Tuesday, June 26, concerning a variety of SEC-related policy issues. The hearing will begin at 2:00 p.m. in Room 2128 of the Rayburn House Office Building.
The SEC adopted on June 20, 2007 amendments to strengthen Rule 105 of Regulation M. Rule 105 helps prevent abusive short selling and market manipulation. When a trader expects to receive shares in an offering, there is an incentive to sell short prior to pricing an offering and then cover that short position with shares bought at the reduced offering price. By doing so, the trader can cover the short sale with minimal risk, and generally lock in a guaranteed profit — to the detriment of the issuer and the other shareholders.
The amendments change the way the rule works to prevent this from happening. They replace the rule's current limitation on covering the short sales in the offering with a prohibition on purchasing in the offering after a short sale in the securities. This change was triggered by persistent non-compliance with the rule and a string of strategies to conceal the prohibited covering. Under the amended rule, if a person sells short during the restricted period prior to pricing, that person is prohibited from purchasing the offered security. See SEC Votes to Adopt Final Amendments to Rule 105 of Regulation M, Short Selling in Connection With a Public Offering.
NASD announced today that it has fined Wachovia Securities LLC of Richmond, VA, $2 million for failing to adequately supervise its fee-based brokerage business between 2001 through 2004. In addition, NASD ordered Wachovia to identify and pay restitution to approximately 1,300 customers who were inappropriately allowed to continue maintaining fee-based accounts, or who were inappropriately charged account fees on Class A mutual fund share holdings for which they had already paid a sales load. The firm also is required to retain an outside consultant to review its process of identifying and paying restitution to customers.
"Firms must have systems and procedures which are tailored to reasonably supervise their business activities," said NASD James Shorris, Executive Vice President and Head of Enforcement. "In the case of fee-based accounts, firms had an obligation to their customers to assess the appropriateness of such accounts both when the accounts were opened and periodically thereafter. Here, Wachovia failed to implement a system designed to ensure that an assessment of the appropriateness of the fee-based account occurred. This failure was compounded by the firm's failure to prevent certain fee-based customers from being charged both an account fee and a sales charge for the same mutual fund investments."
Abuses in fee-based accounts became prevalent in an era where competitive pressures reduced the profitability of commission-based accounts, so it's good to see the regulators bringing these actions. See NASD Fines Wachovia Securities $2 Million for Fee-Based Account Violations.
The Court's task, as framed by Justice Ginsburg in her majority opinion, was to resolve the disagreement among the Circuits on whether, and to what extent, a court must consider competing inferences in determining whether a securities fraud complaint gives rise to a "strong inference" of scienter, the PSLRA requirement. The "strong inference" requirement "unequivocally raise[d] the bar for pleading scienter" and signalled Congress' purpose to promote greater uniformity among the Circuits, according to Justice Ginsburg. Thus, the Court must set forth a "workable construction of the strong inference standard ... geared to the PSLRA's twin goals: to curb frivolous, lawyer-driven litigation, while preserving investors' ability to recover on meritorious claims."
Justice Ginsburg thus proceeds to set forth the roadmap. First, as with any motion to dismiss, the court must accept all factual allegations in the complaint as true. Second, the court must consider the complaint in its entirety, as well as other sources courts ordinarily consider when ruling on motions to dismiss -- documents incorporated by reference and other matters of which the court may take judicial notice. The inquiry is whether all of the alleged facts, taken collectively, give rise to a strong inference of scienter. Third, in determining whether the pleaded facts give rise to a "strong" inference of scienter, the court must take into account plausible opposing inferences. The inference of scienter must be cogent and compelling, thus strong in light of other explanations. In sum, the court must ask: when the allegations are accepted as true and taken collectively, would a reasonable person deem the inference of scienter at least as strong as any opposing inference?
Justice Scalia and Justice Alito each wrote concurring opinions, expressing the view that "strong inference" required that the test should be whether the inference of scienter is more plausible than the inference of innocence because this is the natural reading of the statute. Justice Stevens was the lone dissenter, arguing that the standard should be analogous to the probable-cause standard from criminal law.
In my view, the majority opinion was quite predictable and, indeed, inflicted probably the least amount of damage on plaintiffs, given the statute and the pro-business tendencies of this Court. Under the majority's test, the plaintiff "only" has to demonstrate that the inference of scienter was at least as likely as any plausible opposing inference. In contrast, if Justices Scalia and Alito had their way, the "strong inference" test would have constructed an even higher obstacle to private securities fraud cases, requiring that the inference of scienter be more plausible than the contrary inference. These days, the majority's rejection of that view can count as a victory.
To probably no one's surprise, the Supreme Court ruled (8-1) that plaintiffs in private securities fraud actions must meet a high standard for pleading scienter.
"To qualify as strong....we hold an inference of scienter must be more than merely plausible or reasonable," Justice Ginsburg wrote. "It must be cogent and at least as compelling as any opposing inference of nonfraudulent intent."
More to follow, after reading the opinion. For now, see WSJ, Court Sets Securities Suit Standard.
Treasury Secretary Paulson confirmed that he personally initiated the contact with the Justice Dept. to voice opposition to filing an amicus brief in support of plaintiffs in the "scheme liability" case pending before the Supreme Court. Testifying at a Senate Financial Services hearing, he said he was concerned about exposing to liability companies that "happened to do business" with a firm that committed securities fraud. See WPost, Paulson Behind Opposition to Third-Party Suits.
ISS recommends a no vote on Carl Icahn's proposed $2.75 billion takeover of Lear Corp, which management supports. ISS questions the strategic rationale for the takeover and says the $36 per share price is not much of a control premium. The shareholders' meeting is scheduled for June 27. See WSJ, ISS Recommends Lear Holders Reject Icahn Bid.
Today the Wall St. Journal has a long front page story on yesterday's announcement that the Dow Jones board was taking over the discussions with Rupert Murdoch about his offer for the company. What is fascinating about the WSJ articles on this subject is trying to figure out who within the company is talking, since the stories give us unusually detailed accounts of conversations within the boardroom. The WSJ reports that on Tuesday the five-member board committee heard an update from Michael Elefante, a director and the Bancroft family's trustee, who reported that the family would soon be sending a proposal to Murdoch. On Wednesday, when the full board heard the update, several independent directors raised questions about their liability if Murdoch withdrew his bid. See WSJ, Dow Jones Board Takes Over Talks On Firm's Future.
As the Blackstone Group's IPO approaches, Congress has been debating the tax treatment of private equity firms. Yesterday Senator Jim Webb (D. Va) raised another concern and asked the SEC to delay the IPO. citing national security concerns stemming from China's $3 billion investment. In a letter, he asked how the US "would prevent the transfer of sensitive national security information associated with the transaction." See WPost, Efforts Grow To Waylay Blackstone Stock Sale; WSJ, Proposed Higher Tax Rate Aimed At Buyout Shops May Get Sterner. The WSJ website has the letter.
Last week AIG sued its former CEO Maurice "Hank" Greenberg for $1 billion damages resulting from its regulatory difficulties with the New York Attorney General and the SEC. Yesterday Greenberg filed his own law suit against 16 current and former directors and officers of the company, saying that the company's financial restatement and $1.64 billion settlement were unnecessary. See NYTimes, In Suit, Ex-A.I.G. Chief Says Others Are Liable for Restatement; WSJ, Greenberg Says Directors Are 'Seriously Damaging' AIG.