U.S. Department of Treasury Releases Plan for Regulatory Overhaul

On March 31, 2008 the U.S. Treasury Department released its Blueprint for an overhaul of the financial regulatory system. In his remarks regarding the Blueprint, the U.S. Secretary of the Treasury, Henry Paulson, stressed that the Treasury Department has proposed a move to an objectives-based regulatory structure, because “[the Treasury Department] believe[s] it provides a flexible framework that fosters and embraces innovation, helps ensure competitiveness and better manages risk.” A key component in this switch to an objectives-based system is the Blueprint’s proposed merger of the Securities Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). These two entities would merge into a single “business conduct regulator,” which would combine the regulatory philosophies of the two agencies and monitor business conduct regulation across all types of financial firms.

In his comments regarding the proposed regulatory changes, Paulson recognized that the objectives-based model proposed by the Treasury Department “is substantially different from our current system and, realistically, will not and could not be implemented any time soon.” Paulson’s Blueprint envisions an evolution to the model over time and is divided into discussions of short-term recommendations, intermediate-term recommendations and the final regulatory structure. As part of this evolution to the proposed new structure, the Treasury Department has recommended that the following changes be made in order to prepare the securities market for the merger of the SEC and the CFTC: (i) the adoption of core principles for exchanges and clearing agencies, (ii) an expedited self-regulatory organization rule approval process, (iii) general exemption under the Investment Company Act for already actively trading exempted products, such as exchange traded funds, to improve the new product approval process consistent with SEC investor protection standards, and (iv) new Congressional legislation to expand the Investment Company Act to permit a new global investment company.

In the weeks since its release, the Blueprint has received a great deal of attention, much of it negative. Some Democrats in Congress view Paulson’s efforts as a step in the right direction and a starting point for negotiations in Congress, but others worry that the plan, once executed, will not provide enough regulatory protections to investors. Paulson’s plan would curtail the SEC’s oversight of investment banks and allow registered investment advisers to be self-regulated. Not surprisingly, current and former SEC leaders have been some of the most vocal critics of Paulson’s plan, viewing the potential regulatory overhaul as weakening the agency and its ability to adequately regulate the securities market.

SEC Chairman Christopher Cox testified before a House appropriations subcommittee on April 16, 2008, and was asked his views on the Blueprint proposal for the SEC and CFTC to be combined into one agency. Cox was dismissive of the potential for that merger to occur and said the process for the development of the Blueprint was controlled by Treasury ”and Treasury was deliberately…not consultative” in the effort. Indeed, the SEC was “not a part of its preparation.”

Enron Plaintiff’s Lawyers Await Court Ruling on Largest Securities Fee Request in History

Plaintiff’s lawyers representing the Board of Regents of the University of California against various entities in connection with the downfall of Enron have submitted a fee request for nearly $700 million, the largest securities settlement fee request ever.

The Board of Regents filed suit in the Southern District of Texas in April 2002 and has settled the bulk of its claims against the main banks and other defendants for a total of $7.2 billion, the largest securities class action settlement in history. The fee agreement with the Regents reads in pertinent part as follows: “We have agreed upon the following fees as a percentage of the recovery for the class: 0-$1 billion, 8%; $1-2 billion, 9%; $2+ billion, 10%. The higher percentages apply only to the marginal amounts.” Based on this agreement, the plaintiffs’ counsel have sought $688 million in fees, representing a 9.52% fee request.

Plaintiff’s counsel urged the district court to award the full amount requested for litigation that has lasted six years and resulted in what they characterized as an unprecedented recovery. Plaintiff’s counsel pointed out that the litigation involved the review of 70 million documents, the taking of 370 depositions, the presenting of 18 expert witnesses by plaintiffs and defending against 40 expert reports submitted by defendants. Plaintiff’s counsel also argued that their fee was supported by the “lodestar” method for fee approval. In total, 12 law firms invested over 280,000 hours which, when multiplied against counsel's hourly billing rates, yielded a lodestar amount of $113.2 million. The fee request also involved a results multiple of 5.4, which plaintiff’s counsel argued was reasonable. The request was further supported by affidavits from former Third Circuit Judge H. Lee Sarokin, Chair of the Third Circuit’s Judicial Task Force on Court Awarded Fees, and by Harvard Law Professor Lucian A. Bebchuk, Director of the Program on Corporate Governance at Harvard. Both argued that the negotiated fee should be upheld.

On the other side, the Texas Attorney General and other objectors have lodged numerous objections to the fee request arguing it is “excessive on its face” and “shocks the conscience of the American civil justice system.” Urging the court to act as a fiduciary for the individual class members, the objectors believe a modified lodestar approach should be applied, reducing the hourly rates and decreasing the multiplier, among other suggestions for reducing the fee award.

On April 16, 2008 Judge Harmon issued a preliminary order on lead counsel’s fee application stating that “the Regents’ choice to enter into a contingent fee agreement is due deference provided that the result is reasonable” and that “the percentage fee award is an appropriate way to determine an award of fees from a common fund.” Nonetheless, the Court ordered plaintiff’s counsel to provide contemporaneous time records for the work done on the matter stating the Court will use those records in a lodestar calculation apparently as a “cross-check” against the negotiated percentage amount. A ruling on the amount of the fees is expected in a month’s time.

Mack Wins Morgan Stanley Election

At the company’s 2008 annual meeting of the shareholders, John J. Mack, Morgan Stanley chief executive officer and chairman, was re-elected to Morgan Stanley's board of directors despite efforts to unseat him led by CtW Investment Group, a shareholder rights group that advises several union-sponsored pension funds. CtW, displeased by Morgan Stanley's losses last year, mainly due to the company’s push into subprime mortgages, encouraged shareholders to withhold votes from the chairman and several other directors. Several large pension funds supported CtW’s proposal to withhold votes from Mack and elect an independent chairman. Despite this opposition, Mack was re-elected by an overwhelming 94.5 percent. Other directors also won re-election by substantial margins ranging from 90 percent to 97 percent. At the meeting, Mack informed the shareholders that he "acknowledged Morgan Stanley's disastrous experience trading subprime-related securities last year, which resulted in a $9.4 billion charge," and stated that he "take[s] full responsibility for the loss.”

The American Federation of State, County, and Municipal Employees submitted another shareholder proposal, which would have given shareholders an annual advisory vote on executive compensation. This proposal, which was supported by California Public Employees’ Retirement System, the California State Teachers’ Retirement System, and the State Universities Retirement System of Illinois, was defeated by a much narrower margin than efforts to thwart Mack’s re-election and received a 36.8 percent positive vote.

Colorado Initiative Would Make Top Executives Responsible for Business Violations

A labor and activist coalition in Colorado is proposing a statewide initiative for the November election that would amend state statutes to impose criminal and civil liability on “executive officials” who know of a business entity’s failure to perform any kind of specific legal duty even if they were not personally involved in the violation.

“Executive official” is defined in the initiative to mean “any natural person who is an officer, director, managing partner, managing member, or sole proprietor of a business entity.” The measure would apply to executive officials of any company doing business in Colorado whether or not the executives were located in the state.

Under the initiative, an executive official is absolved of all liability if, prior to being charged, he or she reported all facts of which he or she is aware concerning the business entity’s conduct to the state attorney general’s office.

The measure authorizes any Colorado resident to file a civil lawsuit against the business entity or its executive officials, but any compensatory or punitive damages are to be awarded to the governmental entity imposing the legal duty that was violated. The individual filing the lawsuit is entitled to recover reasonable attorney fees and costs for defending the interests of the state.

Supporters will need to gather signatures from 76,000 registered voters in order to place the initiative on the November ballot. Alternative versions of the initiative can be accessed on the Colorado Secretary of State’s website.

Sarbanes-Oxley Whistleblower Retaliation Claim Found Insufficient to Show Violation of Securities Laws

A sharply divided panel of the U.S. Court of Appeals for the Fourth Circuit in a 2-1 majority opinion affirmed summary judgment for the pharmaceutical company Wyeth, Inc., on the claim made by David Livingston, a former Associate Director of Training and Continuous Improvement at Wyeth’s Sanford, North Carolina facility, that one reason he had been fired was that he had complained repeatedly about deficiencies in the implementation of a training program for good manufacturing practices. Livingston v. Wyeth, Inc., No. 06-1939 (4^th Cir. March 24, 2008).

Wyeth terminated Livingston for insubordination in December 2002 after he threatened to have the Director of Human Resources forcibly removed from an off-site, company-funded holiday lunch for training department staff at which the Director of Human Resources had shown up uninvited. The majority opinion quoted Livingston as saying to the Human Resources Director: “What are you doing here? … You’re not invited. We have a gift exchange. You have no gift. We have limited food.”

Livingston contended that the incident at the party was simply the culmination of a series of run-ins with facility managers about his belief that the Sanford site was not ready for implementation of the training program and to state otherwise would provide false and misleading information to FDA and company shareholders (and thus allegedly constitute a form of securities fraud).

The whistleblower protection provisions of the Sarbanes-Oxley Act of 2002 prohibit publicly traded companies from retaliating against employees for providing information or cooperating in investigations related to conduct that the employee reasonably believes violates laws prohibiting securities fraud.

The majority opinion concluded: “[N]ot one link in Livingston’s imaginary chain of horribles was real or was in the process of becoming real. …Thus Livingston has failed to produce evidence that he provided information or made a complaint to Wyeth about conduct which a reasonable employee in his position could have believed at the time constituted a violation of the securities laws.”

The dissenting judge, sharply criticizing the majority for failing to review the facts in the light most favorable to Livingston, presented an alternative review of the facts and concluded that the evidence was sufficient to present an issue of material fact about whether Livingston’s complaints were protected under the whistleblower provisions.

Levitt Nominees Permitted to Stand for Election to Office Depot Board

On April 14, 2008 the Delaware Chancery Court (the Court) issued its opinion with respect to Levitt Corp. v. Office Depot, Inc., C.A. No. 3622-VCN (Del. Ch. Apr. 14, 2008), holding that Office Depot’s bylaws did not require Levitt Corporation (Levitt), a stockholder, to give notice of its intent to nominate directors where Office Depot had previously given notice with respect to the election of directors. This case is notable as the second of two recent Delaware Chancery Court decisions on advance notice provisions. The first case, JANA v. CNET, decided March 13, 2008, was discussed in the April 4, 2008 issue of Corporate Governance At A Glance.

On March 17, 2008 Levitt, which seeks to place nominees in two of the twelve seats on Office Depot’s board of directors, gave Office Depot notice of its intent to nominate these nominees for election as directors at the company’s 2008 annual meeting of stockholders to be held on April 23, 2008. In its decision, the Court interpreted a notice provision in Office Depot’s bylaws, which stated in relevant part: “At an annual meeting of stockholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, business must be (i) specified in the notice of the meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (ii) otherwise properly brought before the meeting by or at the direction of the Board of Directors or (iii) otherwise properly brought before the meeting by a stockholder of the corporation who was a stockholder of record at the time of giving of notice provided for in this Section, who is entitled to vote at the meeting and who complied with the notice procedures set forth in this Section.” The bylaws also provide that “To be timely, a stockholder’s notice shall be received at the company’s principal office…, not less than 120 calendar days before the date of Company’s proxy statement released to shareholders in connection with the previous year’s annual meeting.”

Office Depot argued that Levitt’s nominations were improper, because Levitt failed to give notice of its nominations within the appropriate time frame specified by the bylaws. Levitt asserted that it need not comply with the notice provisions of the bylaws, because Office Depot’s own notice of the annual meeting identified the election of directors as an item of business to be considered at the meeting. The Court held that Office Depot’s notice, which was properly given, satisfied the advance notice requirements of the bylaws and properly brought the business of electing directors before the meeting, including “the subsidiary business of nominating directors for election.” Since the requirements of notice regarding the business of electing and nominating directors had already been satisfied, the Court held that Levitt was not required to duplicate the notice and granted Levitt’s request for a declaration that it may nominate two directors for election at Office Depot’s 2008 annual meeting.