The International Law Firm of Fulbright & Jaworski - Corporate Governance
Paul Scott Conneely, Mark Thomas Oakes and Carlos Ray Rainer
February 19, 2010
- SEC Announces Enforcement Cooperation Initiative
- Fifth Circuit Reaffirms Strict Class Certification And Loss Causation Requirements For Securities Class Actions
- U.S. Supreme Court’s Recent Ruling in Citizens United v. Federal Election Commission Creates Potential New Corporate Governance Issues
- RiskMetrics Launches New Corporate Governance Rating Methodology
SEC Announces Enforcement Cooperation Initiative
In January, the Securities and Exchange Commission announced its “Enforcement Cooperation Initiative,” which is a series of measures intended to encourage greater cooperation by individuals and companies in SEC investigations and related enforcement actions. In connection with this initiative, the Division of Enforcement: (1) authorized its staff to use new tools, such as cooperation agreements, deferred prosecution agreements, and non-prosecution agreements, to encourage companies and individuals to provide assistance; (2) simplified the process for submitting witness immunity requests to the Department of Justice; and (3) issued a policy statement setting forth the framework to be utilized by the SEC in determining whether and to what extent to reward individuals who cooperate in SEC investigations, either by taking no enforcement action against the individual or by pursuing reduced charges or penalties.
Cooperation Tools and Immunity Requests
The SEC amended its Enforcement Manual to expressly provide for cooperation agreements, deferred prosecution agreements, and non-prosecution agreements. A cooperation agreement is a written agreement between the Division of Enforcement and a potential cooperating individual or company that is prepared to provide substantial assistance in the investigation. One of the key attributes of a cooperation agreement is that it can be utilized before the cooperation is provided, with stated benefits to the individual or entity if the individual or entity complies with the obligations set forth in the agreement. Deferred prosecution agreements and non-prosecution agreements, which are already utilized by the Department of Justice in criminal matters, provide mechanisms for the SEC to forego an enforcement action if the individual or entity complies with the obligations set forth in the agreement. Deferred prosecution agreements and non-prosecution agreements are often utilized as a settlement mechanism and usually include provisions for disgorgement and penalty payments.
In addition to adding new cooperation tools to its Enforcement Manual, the SEC also set forth express guidelines on the use and structure of proffer agreements—a tool long used by the SEC to gather information from otherwise reluctant witnesses. In addition, the SEC delegated authority to the Director of the Division of Enforcement to submit witness immunity requests to the Department of Justice. Under the former policy immunity requests required Commission approval.
Framework for Evaluating Cooperation by Individuals
Also in connection with the cooperation initiative, the SEC issued a “Policy Statement Concerning Cooperation by Individuals in its Investigations and Related Enforcement Actions,” which sets forth a framework to be utilized by the SEC in determining whether and to what extent to reward individuals who cooperate in SEC investigations. The policy statement (which is similar to the Seaboard Report that was issued in 2001 that details some of the factors the SEC considers when evaluating cooperation by companies) sets forth four categories to be considered in evaluating an individual’s cooperation: (1) the assistance provided by the individual in the investigation; (2) the importance of the underlying matter in which the individual cooperated; (3) the societal interest in ensuring that the cooperating individual is held accountable for his or her misconduct; and (4) the appropriateness of cooperation credit based upon the profile of the cooperating individual. Of note, the final category pertaining to “the profile of the cooperating individual,” suggests that the SEC will take a harder line with respect to individuals who are professionals or members of senior management. According to the policy statement, some of the factors the SEC will consider under this category include “[t]he degree to which the individual will have an opportunity to commit future violations of the federal securities laws in light of his or her occupation – including, but not limited to, whether he or she serves as: a licensed individual, such as an attorney or accountant; an associated person of a regulated entity, such as a broker or dealer; a fiduciary for other individuals or entities regarding financial matters; an officer or director of public companies; or a member of senior management – together with any existing or proposed safeguards based upon the individual’s particular circumstances.” top
Fifth Circuit Reaffirms Strict Class Certification And Loss Causation Requirements For Securities Class Actions
On February 12, 2010, in The Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton, No. 08-11195, the United States Court of Appeals for the Fifth Circuit upheld a decision denying class certification in a shareholder action. In doing so, the Fifth Circuit reaffirmed its decision in Oscar Private Equity Investments v. Allegiance Telecom, Inc., 487 F.3d 261, 269 (5th Cir. 2007), which held that in order to grant class certification in a securities fraud case, a plaintiff must first prove loss causation, i.e., “that the corrected truth of the former falsehoods actually caused the stock price to fall and resulted in losses.” The Court also explained that in order to meet this burden, “it is not enough merely to show that the market declined after a statement reporting negative news.” Instead, because “the main concern . . . is whether allegedly false statements actually inflated the company’s stock price,” the plaintiff must either (1) present evidence that the allegedly false statements caused a positive effect on the stock price, or (2) show that the alleged corrective disclosure causing the decrease in price was related to the allegedly false statement and that it is more probable than not that it was this corrective disclosure, and not other unrelated negative news, that caused the stock price decline.
This latest ruling by the Fifth Circuit maintains the high bar for class certification set in Allegiance Telecom. In support of any motion for class certification, Plaintiffs will be required to present expert testimony and empirical evidence demonstrating the link between any alleged misstatement and the alleged corrective disclosure, and will be required to show that the resulting stock drop was not the result of other information disclosed to the market. A mere decline in stock price following negative news, without more, will not support class certification. top
U.S. Supreme Court’s Recent Ruling in Citizens United v. Federal Election Commission Creates Potential New Corporate Governance Issues
On January 21, 2010, the U.S. Supreme Court issued a landmark decision in Citizens United v. Federal Election Commission, No. 08-205, which removed significant restrictions on corporate political speech and is likely to create new governance issues for U.S. corporations. In Citizens United, a sharply divided Court held 5-4 that certain restrictions on corporate independent expenditures amount to a prohibition on political speech in violation of the First Amendment. In its ruling, the Court expressly invalidated portions of the Bipartisan Campaign Finance Reform Act (also known as McCain-Feingold) banning certain “electioneering communications” during the period prior to an election and overruled Austin v. Michigan Chamber of Commerce (a 1990 decision which upheld restrictions on corporate spending to support or oppose political candidates) and part of its decision in McConnell v. Federal Election Commission (a 2003 decision that upheld parts of McCain-Feingold).
The case originated when Citizens United, a nonprofit corporation, released a documentary in January 2008 entitled “Hillary: The Movie” about former Senator Hillary Clinton, who was at the time a candidate for the Democratic Party’s presidential nomination. Citizens United desired to increase distribution of the movie through video-on-demand and promote the movie through television advertisements, but it was restricted from doing so by a federal law prohibiting corporations from using general treasury funds to make independent expenditures that expressly advocate a particular political candidate through any form of media. After the district court failed to grant Citizens United declaratory and injunctive relief that such prohibitions were unconstitutional, the Court granted review and eventually overturned the district court’s ruling. The Court departed from its prior view that the restrictions on political expenditures by corporations were justified in order to prevent corporations from having an unfair advantage in the political marketplace by using funds amassed in the economic marketplace, thereby eliminating a significant distinction between corporations and individuals with respect to political speech.
As a result of the Court’s decision, corporations generally may now use treasury funds to finance political communications and endorse candidates and political viewpoints before an election. However, Citizens United did not remove the prohibition on the ability of corporations to make treasury fund contributions directly to federal candidates, PACs, political committees and national political parties. It also did not eliminate applicable disclosure and disclaimer requirements under federal law.
Despite the removal of certain federal restrictions on political speech, corporations should continue to be mindful of other potential outside constraints on these expenditures. Corporations should expect closer scrutiny of political spending by shareholders, including the possibility of challenges to such spending through shareholder lawsuits or shareholder proposals to restrict political expenditures. Corporations should also be prepared for legislative responses to Citizens United, such as enhanced disclosure requirements regarding political spending by corporations or the institution of shareholder approval requirements. In fact, on February 11, 2010, Sen. Charles Schumer (NY) and Rep. Chris Van Hollen (MD) announced plans for new legislation in an effort to counter the effects of the Citizens United ruling. The proposed bill includes restrictions on political expenditures by corporations with a 20% or more foreign ownership interest or whose boards of directors are more than half composed of foreign principals and would require companies to disclose any political expenditures on their web sites within 24 hours and in their quarterly reports to shareholders. The lawmakers also announced that several representatives are considering language that would require publicly traded companies to receive shareholder approval prior to spending on political speech. Finally, in light of such potential litigation, new regulatory requirements or public scrutiny, corporations choosing to use treasury funds to advocate candidates or viewpoints should carefully consider the appropriate approval process for the deployment of such funds (i.e., is this a power that should be reserved by the board of directors or a committee thereof or delegated to management?). top
RiskMetrics Launches New Corporate Governance Rating Methodology
RiskMetrics Group has announced that it is introducing a new corporate governance rating methodology called “Governance Risk Indicators,” or “GRId.” GRId will replace RiskMetrics’ “Corporate Governance Quotient,” or “CGQ,” which has served as a benchmark or rating methodology for ranking corporate governance best practices followed by market participants for the past several years. GRId is expected to be launched in early March 2010 and proxy research reports published thereafter will include GRId for covered companies across various markets, including the United States, Canada, the U.K., France, Germany, Netherlands, and Sweden. CGQ scores will be frozen in early March 2010 and retired completely at the end of June 2010.
Under the GRId system, a company’s governance practices will be ranked on an absolute basis in four areas: Board Structure, Shareholder Rights, Compensation and Audit, with each area further divided into various subsections. The chief aim of GRId is to track and assess industry corporate governance best practices. Companies will be scored based on responses to a series of corporate governance questions (between 60 and 80 total). The scores will be weighted to provide a subsection score and each governance practice of the company receives a rating of either “increase concern,” “reduce concern” or “no impact on concern.” Subsection scores will then be weighted and tallied to provide an overall color-coded risk assessment (high, medium or low) for each category. In addition, RiskMetrics will no longer evaluate director education programs and GRId will not include director education as a variable for consideration.
RiskMetrics expects to disclose the GRId criteria and scoring methodology to companies in mid-February 2010 and plans on having a data verification site freely available to companies in early March 2010. GRId coverage will span across markets and include some 8000 global companies with U.S. issuers representing the majority of the companies included. While the GRId rating methodology functions as an investment management tool for the investing public, the rating program is not intended to be predictive of future performance, but rather is offered as one of many market resources available to investors to assess investment risks. Companies with annual meetings beginning in early April should carefully review their GRId data once available to ensure its accuracy and assess whether any changes to their corporate governance practices are advisable in light of this new methodology.
Paul Scott Conneely
Mark Thomas Oakes
Carlos Ray Rainer