Eyes On Wall Street : Executive Compensation Lawyers & Attorneys : Labaton Sucharow Law Firm : Class Action Litigation, Shareholder Rights

The SEC has finally issued much-anticipated proposed rules regarding executive compensation.

On March 30, 2011, the SEC unanimously proposed rules directing the national securities exchanges to adopt certain listing standards related to the compensation committee of a company’s board of directors as well as its compensation advisers pursuant to the requirements set forth in the section 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The proposed rules require the exchanges to adopt listing standards that 1) require each member on a compensation committee be a member of the board of directors and be independent; and 2) provide that compensation committee has the authority to retain compensation advisers and is responsible for the appointment, compensation and work of any such adviser.

The proposed rules also require each company to disclose in its proxy material for an annual meeting of shareholders 1) whether its board’s compensation committee retained or obtained the advice of a compensation consultant, and 2) whether the work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how the conflict is being addressed. 

Once an exchange’s new listing standards are in effect, a listed company will be required to meet these standards in order for its shares to continue to be traded on the exchange. Comments to the proposed amendments are due on or before April 29, 2011.

Contributed by Yoko Goto.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Although the Wall Street Reform Bill has just been signed, the real battle over reform of the financial sector has only begun. In order to implement the sweeping changes outlined in the new statute, agencies such as the Securities and Exchange Commission and the Commodity Futures Trading Commission will be drafting more than 200 rules affecting nearly every area of the financial sector. It is these rules that will determine how the new legislation actually affects Americans.

Knowledgeable of this fact, companies intent on softening the coming blow have hired hundreds of lobbyists in an attempt to influence the final rules. Many of the lobbyists are themselves former regulators, who not only have long experience navigating Washington bureaucracies, but also know the pressure points and weaknesses of current regulators. As early as 2008, when the financial crisis was still new, lobbying firms anticipating reform began to prepare by interviewing former regulators.

Investors who want their voices to be heard have the opportunity to participate in this process. The S.E.C. is seeking public comments on numerous regulatory topics related to the new legislation. Such topics include regulation of advisers to hedge funds, Wall Street transparency and accountability, and improvements to the regulation of securities.

Contributed by James Jackson

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In a new Concept Paper, the Securities Exchange Commission has announced that it is investigating whether the U.S. proxy system needs to be drastically updated. It has been nearly 30 years since the Commission last conducted a comprehensive review of the proxy voting infrastructure, and there have been significant changes since then in shareholder demographics and technology.   The SEC’s inquiry focuses on, among other things, proxy voting by institutional securities lenders and the role of proxy advisory companies.

Institutional investors often lend their securities, and these lent shares lose their vote until recalled by the lender. Without sufficient advance notice of the issues to be voted on, lenders may not be able to recall shares in time to vote on key matters like executive compensation. Thus, the Commission is trying to find out whether shareholders would be helped by requiring the agenda items at shareholder meetings to be identified earlier, so that lenders can make a decision to recall their shares and vote on issues important to them.

The SEC is concerned that proxy advisory firms may be subject to conflicts of interest or may fail to conduct adequate research to support their recommendations. To remedy these problems, it is proposing improving disclosure of potential conflicts of interest, enhancing regulatory oversight over the formation of voting recommendations, and requiring eventual public disclosure by proxy advisory firms of their voting recommendations in SEC filings.

Interested investors should take the opportunity to send the SEC their comments.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

 On May 20, the Senate approved a bill that, if enacted, would represent the most sweeping regulatory overhaul since the Great Depression. Among other things, the Senate bill would:

• Establish a new council of “systemic” risk regulators to monitor growing risks in the financial system.
• Empower the Federal Reserve to supervise the largest, most complex financial companies to ensure that the government understands the risks and complexities of firms that could pose a systemic risk.
• Give the Securities Exchange Commission the authority to grant shareholders proxy access to nominate directors.
• Establish a new self-regulating organization for credit rating agencies designed to eliminate conflicts of interest in the issuer-pay model. The SEC would appoint members of the regulatory body which would assign rating agencies to provide initial credit ratings of financial instruments.

The Senate bill differs significantly in some ways from the House version of the Wall Street reform legislation. While both bills contain provisions calling for the creation of a new consumer protection agency, in the House version the agency would be substantially independent, while the Senate version would put the agency under the umbrella of the Federal Reserve, an institution not famous for its concern for consumer rights.

With respect to regulating the massive over-the-counter derivatives market, however, it is the Senate bill that calls for stricter rules—perhaps because it passed in the wake of the recent Goldman Sachs imbroglio   Both bills give regulators new powers to oversee the derivatives market and to force most derivative contracts to be traded through third party “clearing houses.” However, the Senate bill would make it more difficult for companies to seek exemption from the new rules.

Investors and taxpayers alike should stay tuned to what happens in the process of reconciling the two bills: the results may shape the U.S. markets for generations to come.

Contributed by Yoko Goto

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Goldman Sachs hosted its annual shareholder meeting on May 7, 2010, just ten days after the company’s CEO and chairman, Lloyd C. Blankfein, was put on the hot seat by the Senate committee at a hearing to discuss the bank’s suspect trading activities and a fraud suit by the SEC. While the meeting was widely seen as a potential referendum on investor confidence in Blankfein, there were surprisingly few questions about the investigations of Goldman’s past mortgage trading or the various lawsuits pending against the Company. 

Nevertheless, Goldman shareholders expressed their continued interest in paying a more active role in corporate decision making. Following the 2009 annual meeting, a majority of shareholders requested that the Board take steps to eliminate the supermajority voting provisions from the company’s Bylaws and Certificate of Incorporation.  In the 2010 annual meeting, the Board itself proposed a resolution to change the supermajority voting provision, which had required an 80% vote, to a majority provision, which requires a vote only above 50%. The proposal received support from an overwhelming 82.5% of outstanding shares and was approved. The passage of this proposal effectively increased shareholder power by decreasing the amount of votes needed to pass proposals at annual meetings.   

However, shareholders were much more ambivalent about a proposal to separate the Chairman and CEO roles at Goldman. The proposal emphasized that the “role of the Board of Directors is to provide independent oversight of management and the CEO” and addressed the “potential conflict of interest for a CEO to be his/her own overseer while managing the business.” It also referenced a 2009 report by Yale University’s Millstein Center for Corporate Governance and Reform that stated, “Having an independent chairman is a means to ensure that the CEO is accountable for managing the company in close alignment with the interests of shareowners, while recognizing that managing the board.” The Goldman board recommended that the resolution be voted “against,” and the resolution did, in fact, fail--with support from only 19.1% of the vote. In so voting, Goldman parted company with banks such as Morgan Stanley, Bank of America and Citigroup, which have all split the chairman and CEO roles.

Submitted by Carol Villegas

• Email This
• Print
• Comments
• Trackbacks
• Share Link

On Friday April 16th, the Securities and Exchange Commission (SEC) filed a civil complaint against Goldman Sachs and one of its vice-presidents, Fabrice Tourre, for allegedly defrauding investors by failing to disclose vital information about a financial product linked to subprime mortgages. Goldman’s shares tumbled, dragging the markets down with it.

The instrument in question, structured and marketed by Goldman, was a synthetic collateralized debt obligation (CDO), whose performance was tied to that of residential mortgage-backed securities. Goldman told its investors, who included some European banks, that the securities underlying the CDO had been selected by an independent third party, ACA Management. The SEC alleges that Goldman failed to disclose that another firm, Paulson & Co, a big hedge-fund manager, in fact had a hand in choosing what went into the CDO.

This was a crucial omission, since Paulson & Co—run by John Paulson, who made billions in 2007-08 betting against the housing market—had taken a short position against the CDO; in other words, the firm would profit if the instrument performed poorly. 

According to the SEC's complaint, Paulson shorted the portfolio it helped to select by purchasing insurance against the default of certain layers through derivatives called credit-default swaps (CDSs) it entered into with Goldman. The SEC argues that these derivatives gave the hedge fund an incentive to select mortgage securities that would bomb. And bomb they did. The deal closed in April 2007; by the end of January 2008, 99% of the portfolio had been downgraded by credit-rating agencies.

Goldman called the charges “completely unfounded in law and fact” and said it would contest them vigorously. Paulson & Co, which has not been charged, issued a statement saying that ACA, as the third-party collateral manager, had sole authority over the selection of securities in the CDO. In a more detailed response issued later, Goldman insisted that extensive information about the portfolio had been provided to the buyers, who were sophisticated investors aware of the risks.

It may seem surprising that Paulson is not named as a defendant in the SEC's complaint. However, the decision not to name Paulson as a defendant was likely influenced, at least in part, by the Supreme Court's recent landmark decision in Stoneridge Investment Partners, LLP v. Scientific-Atlanta, et al. (2008). The Stoneridge holding restricts plaintiffs from alleging 1934 Exchange Act fraud claims against "non-speaking" participants in schemes to defraud investors. Rather, investors may only sue those who issued statements or otherwise took direct action that the investors had relied upon in buying or selling stock. Thus, under Stoneridge, the SEC could not bring securities fraud allegations under Section 10(b) against Paulson without demonstrating that Goldman's investors directly relied on false statements or misleading conduct by Paulson.  

Given the public and official outrage over Paulson's involvement in the Tourre scandal, recent legislative efforts to overturn Stoneridge seem timely and well taken. 

Contributed by David Sack

• Email This
• Print
• Comments
• Trackbacks
• Share Link

On April 7, 2010, the Securities and Exchange Commission (SEC) began presenting its case against Jon-Paul Rorech, a Deutsche Bank bond salesman and Renato Negrin, a former trader at hedge fund Millennium Partners LP, for insider trading. However, this is not a run-of-the-mill insider trading case. This case is significant because it is the first case the SEC has brought to trial involving insider trading of credit default swaps (CDS), and its outcome could help clarify whether the securities laws reach the murky world of credit default swaps.

Credit default swaps are financial instruments that serve to protect against a default by a particular bond or security. They are essentially a form of insurance against defaults on a company’s debt. Unlike traditional insurance, however, the market for credit default swaps is largely unregulated. Many noted economists consider unregulated CDS trading to be one of the major contributing factors to the financial crisis.

The SEC alleges that Rorech illegally tipped off Negrin about a bond offering from Dutch media company VNU Group, which controls Nielsen Media, the television ratings service. Based on that information, Negrin bought credit default swaps that rose in value when the deal was made public, eventually earning him a $1.2 million profit. 

The defense argues that because credit default swaps are not defined as securities according to securities regulations and are not traded on any exchange, they are more like private contracts between financial players. Therefore, they are not subject to SEC enforcement under the insider trading provisions of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934.

The SEC in turn argues that credit default swaps, even though they are not considered securities in the traditional sense, clearly meet the definition of “security-based swap agreements” established by the Gramm-Leach-Bliley Act. Therefore credit default swaps fall within the purview of the SEC.

The decision in this case could very well determine whether credit default swaps, the derivatives blamed for much of the economic meltdown, are subject to the SEC’s anti-fraud actions.

Contributed by Vicky Ku

• Email This
• Print
• Comments
• Trackbacks
• Share Link

Last week, the SEC proposed new rules that would require issuers, instead of credit rating agencies, to vouch for the soundness of their asset-backed securities. The types of securities that would be affected by these regulations are bundles of loans that generate profits through regular payments, such as residential mortgages, student loans and commercial loans.

While current rules require that such asset-backed securities be rated “investment grade” by a nationally recognized statistical rating organization, the 667 page proposal would require asset-backed securities issuers to (1) certify that the assets will likely produce the type of return described in the prospectus; (2) keep at least a 5% stake in the asset backed securities; (3) provide investors with a way to confirm that the assets conform to the issuer’s representations and warranties; and (4) update the SEC with Exchange Act reports on an ongoing basis (as opposed to only updating the SEC with Exchange Act reports after the first year, as these issuers are currently allowed to do).

Credit rating agencies generated large fees in the years leading up to the recent financial crisis when they offered AAA ratings to catastrophically risky bundles of home loans made to unqualified buyers. These ratings failed to give investors sufficient notice of the true risk associated with many asset backed securities, a phenomenon that played a significant role in the financial sector collapse. The SEC has stated that the rule changes, which would also seek to regulate expedited “shelf offerings,” are intended to “eliminate the appearance of an imprimatur” that might result from a rating issued by a government-approved agency.

There is no question that proposed regulations' intent "to better protect investors in the securitization market" is a laudable one.  However, some might suggest that the proposed rules serve mainly to distance the government from the acts of the credit rating agencies, without addressing the conflicts of interest that give rise to flawed ratings in the first place.

Contributed by Carol Villegas

• Email This
• Print
• Comments
• Trackbacks
• Share Link

How much of an advantage is it to know about trades three hundredths of second before the investing public? Enough to warrant the concern of the SEC. The issue involves flash trading or high-frequency trading, which gives select traders the ability to see buy and sell orders a fraction of a second before the information becomes public. This tiny time advantage can be highly profitable, because high-speed super computers are able to process the flashed information to help investors capitalize on trading patterns that are not yet public information. Mary L. Schapiro, chairwoman of the SEC commented in a September 17, 2009 speech that, "[f]lash orders may create a two-tiered market by allowing only selected participants to access information about the best available prices for listed securities."

 Last month the SEC voted unanimously to propose regulations that would ban flash trading. If the regulations are adopted, they would effectively prohibit all markets, including equity exchanges, options exchanges and alternative trading systems, from displaying marketable flash orders. The Commission is seeking public comment and data on a broad range of issues relating to flash orders, including the costs and benefits associated with the proposal. It is also seeking comment on whether the use of flash orders in the options markets should be evaluated differently than their use in the equity markets.

The proposed ban on flash orders is just one part of a broader effort by the SEC to more effectively regulate the U.S. stock market in the wake of last year’s financial crisis.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In the autopsy of last year’s financial meltdown, one of the principal culprits to have emerged is the extraordinarily lax oversight that the boards of some public corporations have exercised over management. On September 17, 2009, Mary Schapiro, the new Chairman of the Securities Exchange Commission, gave a speech, "Address to Transatlantic Corporate Governance Dialogue--2009 Conference," announcing the SEC’s plan to ensure that this practice would come to an end.

Schapiro lambasted boards of directors for failing to reign in management decisions about risk, and suggested that many boards appear to have misunderstand the gravity of risks taken. The new Chairman stated that “[s]enior management took higher returns at face value without questioning why such higher returns were possible for supposedly safe investments and strategies.”

The new Chairman suggests that regulators should ensure that investors in publicly held companies have the opportunity to remove directors who turn a blind eye to irresponsible management. She outlined a proposal by the SEC to remove obstacles to shareholders' ability to nominate candidates for the boards of directors of the companies that they own.

Under the proposed rules, shareholders who otherwise are provided the opportunity to nominate directors at a shareholder meeting would be — subject to certain eligibility and procedural requirements — able to have their nominees included in the company proxy that is sent to all voters.

You can expect a fight. This comment letter (PDF)  in support of the proposal was filed by Labaton Sucharow and other firms representing institutional investors.

• Email This
• Print
• Comments
• Trackbacks
• Share Link