Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

Section 929P of the Dodd-Frank Act amended, among other things, Section 21B(a) of the Securities Exchange Act to permit the SEC to impose civil monetary penalties in administrative cease-and-desist proceedings before an administrative law judge.  The provision eliminates the need for the SEC to seek a court order imposing civil penalties following the entry of a cease-and-desist order.

The SEC recently brought a high profile administrative action against Rajat K. Gupta, alleging Mr. Gupta on a number of occasions disclosed material non-public information that he obtained in the course of his duties as a member of the Boards of Directors of Goldman Sachs and Procter & Gamble.  In the order commencing the action, the SEC requests a determination of whether Mr. Gupta should be ordered to pay disgorgement pursuant to 21C(e) of the Exchange Act and penalties pursuant to Section 21B(a)(2) of the Exchange Act.  Since the SEC is seeking civil penalties in this cease-and-desist administrative action, it appears to be a high profile use of this new tool in the SEC’s enforcement arsenal.

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The SEC has announced a settlement with the chief executive officer of an Atlanta-based homebuilder to recover several million dollars in bonus compensation and stock profits that he received while the company was committing accounting fraud.

According to the SEC’s complaint filed in federal court in Atlanta, CEO Ian J. McCarthy previously failed to reimburse Beazer Homes USA Inc. for bonuses, other incentive-based or equity-based compensation, and profits from Beazer stock sales that he received during the 12-month periods after his company filed fraudulent financial statements during fiscal year 2006.

The SEC brought previous enforcement actions against the company and its former chief accounting officer who perpetrated the fraud.  While not personally charged for the misconduct, McCarthy is still required under Section 304 of the Sarbanes-Oxley Act to reimburse the issuer for incentive-based compensation and stock sale profits received during that fraudulent period.  The settlement with McCarthy is subject to court approval.

Without admitting or denying the SEC’s allegations, McCarthy agreed to reimburse Beazer $6,479,281 in cash, 40,103 restricted stock units (or its equivalent), and 78,763 shares of restricted stock (or its equivalent). This reimbursement represents McCarthy’s entire fiscal year 2006 incentive bonus ($5,706,949 in cash and 40,103 in restricted stock units), $772,232 in stock sale profits, and 78,763 shares of restricted stock granted in 2006.

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In Pezza v. Investors Capital Corp., (D. Mass. Civ. Ac. No. 10-10113-DPW), the plaintiff claimed he was wrongfully retaliated against, in violation of the Sarbanes-Oxley Act, after having raised concerns regarding misconduct by the defendants in connection with securities transactions.  The defendants raised the obligation to arbitrate as an affirmative defense and moved to compel arbitration and either stay or dismiss the action.  On July 21, 2010, while defendants’ motion to compel arbitration was under advisement, the Dodd-Frank Act enacted a bar to pre-dispute arbitration agreements for whistleblower claims brought under the Sarbanes-Oxley Act.  The plaintiff then contended that Section 922 of the Dodd-Frank Act was dispositive of defendants’ demand for arbitration.  The defendants contended the Dodd-Frank Act bar on Sarbanes-Oxley whistleblower arbitration agreements was not retroactive.

The court then applied the test set forth in Fernandez-Vargas v. Gonzales, 548 U.S. 30, 37-38 (2006) to determine whether a statute should be applied retroactively.  The analysis in that case requires a court to “look to whether Congress has expressly prescribed the statute’s proper reach, and in the absence of language as helpful as that we try to draw a comparably firm conclusion about the temporal reach specifically intended by applying our normal rules of construction.  If that effort fails, we ask whether applying the statute to the person objecting would have a retroactive consequence in the disfavored sense of affecting substantive rights, liabilities, or duties on the basis of conduct arising before its enactment.  If the answer is yes, we then apply the presumption against retroactivity by construing the statute as inapplicable to the event or act in question owing to the absence of a clear indication from Congress that it intended such a result.”

The court then noted nothing in Section 922 of the Dodd-Frank Act provides an express congressional intent regarding retroactivity.  The court then examined other provisions of the Dodd-Frank Act that restrict the use of predispute arbitration.  Finding congressional intent unclear, the court next looked to whether Section 922 of the Dodd-Frank Act would produce any prejudicial “retroactive consequence.”  The court noted the parties did not claim that a different substantive result will obtain merely because Pezza’s claim will be heard by a court rather than by a FINRA arbitration panel.  Consequently, the court held that Section 922 of the Dodd-Frank Act should also be applied to conduct that arose prior to its enactment.

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Disney has reacted to ISS’ no vote on its say-on-pay vote by filing additional definitive proxy materials.  Styled as a letter to shareholders, Disney notes: 

 We write with respect to the ISS Proxy Report you may have seen regarding the proposals to be voted on at The Walt Disney Company annual shareholder meeting. We take serious issue with ISS’s recommendations against the Company’s position on the advisory vote on executive compensation and the shareholder proposal regarding performance tests for restricted stock units. We set forth below why we believe the two negative ISS recommendations are unwarranted.

1. ISS’s recommendation to vote “against” the advisory vote on executive compensation relates to a practice that no longer exists. The recommendation appears to be grounded on a concern that the Company “recently extended excise tax gross ups.” But, in point of fact, the Company’s Compensation Committee has adopted a policy, fully disclosed in the proxy statement, that prohibits excise tax gross ups in any future agreements with executive officers, or in any material amendments or extensions of existing agreements, unless the provision is submitted to approval by shareholders. The “recent” extension of a gross up that ISS refers to (which would not be permitted under the new policy) occurred over a year ago, was fully disclosed in a Company filing on January 8, 2010, well prior to last year’s annual meeting and prior to last year’s ISS proxy report, which made no mention of it. Subsequent to that time, the Compensation Committee, in response to feedback from shareholders, adopted a policy that would prohibit tax gross ups as outlined above. For that reason, we urge that you vote in favor of the advisory vote on executive compensation.

2. In its original recommendation to support the shareholder proposal regarding performance tests for restricted stock unit awards, ISS made frequent reference to what it argued was the short-term nature of a one-year earnings per share component of the Company’s current performance test. In point of fact, however, the EPS test is a three-year test. ISS acknowledged this mistake in the introduction to its update, but the body of the report (which relied on that error) and the rationale supporting the recommendation remained unchanged. Again, we believe that, on the basis of a corrected record, ISS’s rationale does not hold. The three year EPS measure is an integral component of a long-term performance test that was designed to tie vesting of RSU’s to the attainment of long-term performance metrics.

For the foregoing reasons, we believe ISS’s recommendations are unwarranted and urge you to vote “for” the advisory vote on executive compensation and “against” the shareholder proposal relating to performance tests for restricted stock units.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Federal Reserve Board and the Federal Trade Commission, or FTC, have  proposed regulations regarding the credit score disclosure requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The statute requires creditors to disclose credit scores and related information to consumers in risk-based pricing and adverse action notices under the Fair Credit Reporting Act, or FCRA, if a credit score was used in setting the credit terms or taking adverse action.

The Board, jointly with the FTC, proposes to amend Regulation V (Fair Credit Reporting) to revise the content requirements for risk-based pricing notices and to add related model forms to reflect the new credit score disclosure requirements.

 The Board also proposes to amend certain model notices in Regulation B (Equal Credit Opportunity), which combine the adverse action notice requirements for both Regulation B and the FCRA. The proposed amendments would revise the model notices to incorporate the new credit score disclosure requirements.

 Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

As required by the Dodd-Frank Act, the Board of the National Credit Union Administration, or NCUA, voted to approve a draft interagency proposed rule establishing general requirements for incentive-based compensation arrangements for “covered” financial institutions.  Dodd-Frank requires the NCUA, Federal Reserve, FDIC, Federal Housing Finance Agency, OCC, OTS, and SEC to jointly prescribe regulations or guidelines with respect to incentive-based compensation practices at financial institutions with total assets of $1 billion or more.

In another action required by the Dodd-Frank Act, the NCUA Board issued proposed rules to remove references to nationally recognized statistical rating organization, or NRSRO, credit ratings in NCUA regulations and to substitute other standards of credit worthiness.  The proposed amendments would replace NRSRO ratings with either narrative standards or a credit union’s own internal standard. Under the proposal, credit unions would be required to explain how the securities it purchases or counterparties with which it does business meet the applicable standards. Credit unions would be required to develop, maintain and apply criteria for assessing the creditworthiness of securities and counterparties.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Dodd-Frank Act requires municipal advisors to register with the SEC, and as a result, with the Municipal Securities Rule Making Board, or MSRB.  The question remained, once registered with the MSRB, how does an entity withdraw?

The MSRB has published a rule proposal and filed it with the SEC which requires notification to the MSRB when municipal advisors have terminated their advisory activities.  Since the MSRB categorized the rule filing as non-controversial, the proposal was effective on filing with the SEC.

The proposed rule change consists of amendments to Rule A-15 (on notice of termination of municipal securities activities) that extend the coverage of the rule to municipal advisors that have terminated their municipal advisory activities and expand the circumstances under which notification must be provided to the MSRB to include involuntary terminations and suspensions of regulated activities due to bar or suspension by regulatory agencies or judicial authorities or otherwise, and, with respect to brokers, dealers and municipal securities dealers, expulsion or suspension from membership or participation in a national securities exchange or registered securities association.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

Some issuers will learn in the upcoming proxy season that ISS is recommending a “No Vote” on their say-on-pay proposal.  An outline of a contingency plan is set forth below. 

STEP 1:  Understand the reason for the ISS recommendation and pinpoint any flaws or errors in their logic.

STEP 2:  Issuers, after consultation with legal counsel, should emphasize their position by filing addional solicitation materials like Tyco International.

STEP 3:  Contact your large shareholders personally and explain your position.  Consult with your legal counsel about what is permissible under the proxy rules.

STEP 4:  Prepare for the meeting.  The vote is likely to be close, so review your proxy materials to see what disclosures were made about when a vote passes.  Understand the treatment of abstentions and broker non-votes.

STEP 5:  Prepare for post-meeting public relations.  Perhaps consider drafting two press releases, one addressing a vote where a majority supports the executive compensation program and one where there is no majority support.

STEP 6:  It is still likely that even if a majority of shares voted support the executive compensation program, there will still be a significant “No Vote.”  After the meeting consider means to address and implement any perceived shortcomings and disclose those steps in the next CD&A.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Federal Reserve Board has issued a final rule and requested public comment on a proposed rule under Regulation Z to revise the escrow account requirements for certain home mortgage loans.  The revisions to the regulation, which implements the Truth in Lending Act, or TILA, are being made pursuant to the Dodd-Frank Act. 

The final rule implements a provision of the Dodd-Frank Act that increases the annual percentage rate, or APR, threshold used to determine whether a mortgage lender is required to establish an escrow account for property taxes and insurance for first-lien, “jumbo” mortgage loans.  Jumbo loans are loans exceeding the conforming loan-size limit for purchase by Freddie Mac, as specified by the legislation. 

The Federal Reserve Board is also proposing a rule that would expand the minimum period for mandatory escrow accounts for first-lien, higher-priced mortgage loans from one to five years, and longer under certain circumstances, such as when the loan is delinquent or in default.  The proposed rule would provide an exemption from the escrow requirement for certain creditors that operate in “rural or underserved” counties, as authorized by the legislation. 

The proposal also would implement new disclosure requirements contained in the Dodd-Frank Act.  Disclosures would be required at least three business days before consummation of a mortgage loan to explain, as applicable, how the escrow account works or the effects of not having an escrow account if one is not being established. The proposed rule also would require consumers to receive disclosures three days before an escrow account is closed. 

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

Tyco International has filed additional definitive proxy materials.  The filing states “Further, one of the larger proxy advisory firms, ISS Proxy Advisory Services, has recommended that its clients vote “against” Proposal 8a, while management, along with another large proxy advisory firm (Glass Lewis & Co.) has recommended that shareholders vote “for” this proposal.  We believe that ISS’s analysis of our executive compensation programs is flawed.  We outline below the reasons why we believe this and why we believe Tyco’s executive compensation programs pay for performance.”

This is not the first such filing this year (see Jacobs Engineering), nor will it be the last.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.