While Feds Increase Insider Trading Enforcement, Other Feds Increase Insider Trading Activity, Part 1

There has been much ink spilled about the SEC’s recent aggressive moves on insider trading allegations, from Rajat Gupta and Goldman Sachs to its pursuit of Steven Cohen of SAC Capital fame to calls for scrutiny of Rule 10b5-1 Plans.

However, lost in the shuffle to punish people who made more money than other people in the stock market is the recent news about federal employees engaging in conduct that is far worse.

The Washington Post (who hasn’t objected to the behavior of federal employees since January 20, 2009) today noted that hundreds of federal employees were told of important Medicare decisions weeks in advance of public release, which was also just before trading of shares in firms impacted by the decision spiked.  The public shouldn’t be alarmed because “agency officials said they take care to safeguard information and carefully vet which employees have access to it.  Employees are educated regularly about he need for confidentiality and CMS documents are often stamped with warnings about early disclosure.”

Sen. Charles Grassley said that this should sound an alarm and should result in better controls to avoid unfair access to information.

Great.  More rules that won’t be followed by people who will not be punished for engaging in behavior that will cause the government to destroy the lives of non-public sector employees.  So the answer is to talk about more rules for making illegal behavior super-illegal.  That should solve everything.

Exchange Offer Qualifies for Exemption From SEC Blackout Period Rules

In a no-action letter, the SEC stated its view that officers and directors may participate in an exchange offer during a blackout period. Pfizer’s request for SEC interpretive relief is here.


Pfizer owns a bunch of shares of Class B supervoting common stock of Zoetis, which recently went public.  The companies expect to convert these shares into plain vanilla shares of Class A common stock.  Pfizer wants to give its shareholders the chance to own Zoetis shares through an exchange offer without forcing them to take the Zoetis shares, such as through a spin-off.  To get the Zoetis shares, the shareholder would have to affirmatively participate in the exchange offer by giving up a certain number of Pfizer shares.

The Problem

Regulation BTR prohibits an officer or director from certain transactions with the company’s stock during a blackout period, a period when the ability to sell to engage in transactions in an individual account plan is suspended by the company or a fiduciary of the plan.  Pfizer said it looks like the exchange offer will run headlong into a blackout period.  This would prevent Pfizer officers and directors from participating.

Exemptions from Reg BTR include M&A deals and divestitures, but exchange offers are not necessarily included.  Pfizer thinks they should be saying that Reg BTR purpose to  equalize the treatment of corporate executives and rank-and-file employees and align the interests of directors and executive officers would be served through a transaction conducted pursuant to the SEC’s tender offer rules.

The Result

The SEC agreed, noting that:

  • the exchange offer is solely for the purpose of divesting Zoetis from Pfizer;
  • the exchange offer is subject to, and will comply with, Exchange Act Rule 13e-4 or Regulation 14D under the Exchange Act;
  • a suspension of activity in the plan participants’ accounts (as communicated by the administrators to Pfizer) is imposed by the administrators to enable them to allow participants and beneficiaries of the plans to elect to participate in the exchange offer while maintaining an accurate accounting of the account balances of such participants and beneficiaries; and
  • Pfizer directors and executive officers would continue to be permitted to tender into the exchange offer during a blackout period, but would not otherwise be permitted to directly or indirectly purchase, sell or otherwise acquire or transfer Pfizer common stock during the blackout period if the shares involved were or would be acquired in connection with service or employment as a director or executive officer.

When Termination Of A SERP To Avoid A Change Of Control Payment In An Acquisition Is Tortious Interference

Gardner v. Heartland Industrial Partners, LP

Most of it didn’t interest me, but the case dealt with whether the plaintiffs’ state-law claim for tortious interference of contract was preempted under ERISA.  The contract is a pension plan.  I was more interested in the interference claim than the ERISA or preemption issues.

The Set-Up

Investment firm Heartland Industrial Partners, L.P. held an ownership interest in Metaldyne Corporation and affiliates on Metaldyne’s directors and executive officers.

Heartland agreed to sell its interest to Ripplewood Holdings, another investment firm.  Metaldyne was a public company at the time and filed proxy and information statements related to the deal.  The filings failed to disclose that Metaldyne would be obligated to pay certain Metaldyne executives, the plaintiffs, $13 million as a result of the deal due to a change of control provision in Metaldyne’s SERP.*

Ripplewood threatened to back out when it found out about the payment obligation, so Heartland decided to declare the SERP invalid.  Problem solved.

The Problem Arises

The central question of this particular case is whether the plaintiff’s complaint can be removed to federal court.  After a lot of discussion of the type of civil procedure stuff I learned in law school and have since tried to forget, the more interesting question is whether there is a tortious interference claim**, which would involve Michigan law.

The Relevant Stuff To Me

Under Michigan law, one party’s complete repudiation of a contract is enough to establish breach.  Declaration of refusal to perform will amount to breach of contract.  The court here found the pleading of repudiation sufficient.

“ . . . without stating a reason, or giving plaintiffs any opportunity to be heard, [the Metaldyne Board] declared the Amended SERP invalid.”


*Supplemental Executive Retirement Plan
**In Michigan, a claim for tortious interference involved (1) a contract, (2), a breach of the contract, and (3) an unjustified instigation of the breach by the defendant.

Sarbanes-Oxley Lowered Standard to Remove Someone From Acting as an Officer or Director of a Public Company, Court Says

Then explains the standards, which really aren’t standards.

The Set-Up

Bankosky was a senior official of a pharmaceutical company.  He had inside information on potential deals, and he traded on them.

Aside:  As a music student in college, I told my primary professor that I was quitting my music degree and changing my major to pursue a law degree.  He replied, “It doesn’t surprise me that people sell out, but how cheaply they do.”

How is this relevant?  Bankosky’s illicit trades yielded $63,000.

Among other sanctions, the SEC moved to bar Bankosky permanently from serving as an officer or director of a public company.  The court said, “Yep.  Sounds good to me.”*

The Arguments

On appeal, the court noted the non-exclusive factors from U.S. v. Patel useful in making an assessment of the offender’s fitness to serve as an officer or director of a public company based on Exchange Act Section 21(d)(2).  However, this was before Sarbanes-Oxley, which lowered the standard from “substantial unfitness” to “unfitness.”  Results:  Fireworks.

Does this mean that Patel no longer applies, as the SEC asked as it was looking for what it considers a more stringent standard? Nope.  The court said:

“Moreover, the Patel factors are neither mandatory nor exclusive; a district court may determine that some of those factors are inapplicable in a particular case and it may take other relevant factors into account as it exercises its “substantial discretion” in deciding whether to impose the bar and, if so, the duration, so long as any bar imposed is accompanied with some indication of the factual support for each factor that is relied upon.”

In other words, the court may or may not look at a standard that may or may not apply based on something or other that may have six or seven elements that are probably substantially similar in substance.  The court has a lot of discretion when determining what factors to consider in barring someone from acting as a public company director or officer.

SEC v. Bankosky

*Not a direct quote.

The Cogent Shareholders Have Spoken. Executive Compensation Not Approved. The Results, Well, The Same, I Guess.

Dodd-Frank getting the results! Not many results as ink was spilled and money was spent soliciting a non-binding vote ignored by management, but those are still results.

At its 2011 Annual Meeting of Shareholders, the shareholders of Cogent Communications Group, Inc. did not approve the executive compensation. Did Cogent learn its lesson?

At its 2013 Annual Meeting of Shareholders, the shareholders of Cogent Communications Group, Inc. did not approve the executive compensation. Will Cogent learn its lesson?

In each of 2011 and 2012:

  • Base salary for the CEO, CFO, Chief Revenue Officer, Chief Legal Officer and highest paid VP increased;
  • Total compensation decreased from 2010 to 2011 but skyrocketed in 2012 over and above 2011 levels. In the case of the CEO, total comp went from about $4.0 million in 2010 to $8.8 million in 2012.

I guess we’ll see next year if this is what the shareholders had in mind.

Form 8-K – 2011 Annual Meeting Results
Form 8-K – 2013 Annual Meeting Results
Proxy Statement – 2013 Annual Meeting

After the SEC Seems to Grant Approval for the Use of Social Media to Release Material Nonpublic Information, Zynga Announces It Will Use Social Media to Release Material Nonpublic Information

Zynga tells where, but not what or when. Is this general disclosure enough?

After the SEC provided guidance on the use of social media, we may be starting to see companies embrace it.

In the Form 8-K for their latest earnings release, Zynga followed the guidance and let investors know that they would use a variety of channels to announce material information, including social media.  They also provided the URLs for their Facebook, Twitter and blog pages.

It will be interesting to see how the SEC views this strategy since their guidance was not exactly a groundbreaking open invitation to use any and all websites with an Internet connection.  The existing SEC guidance made clear that the SEC was not picky about how a company distributes information as long as the method gets the information to the general public.  Does the Facebook page, Twitter feed or blog have a following that is wide enough that a post will be considered public dissemination?  Even if you tell people that you will use those channels to make announcements?  That is the question.  As the SEC said in the latest release:

Regulation FD requires companies to distribute material information in a manner reasonably designed to get that information out to the general public broadly and non-exclusively. It is intended to ensure that all investors have the ability to gain access to material information at the same time. [emphasis added]


Companies should review the Commission’s existing guidance — it is flexible enough to address questions that arise for companies that choose to communicate through social media, and the guidance does so in a straightforward manner.

Here is how Zynga did it:

Our investors and others should note that we currently announce material information to our investors using SEC filings, press releases, public conference calls and webcasts. We use these channels as well as social media channels to announce information about the company, games, employees and other issues. Given the recent SEC guidance regarding the use of social media channels to announce material information to investors, we are notifying investors, the media, our players and others interested in the company that in the future, we might choose to communicate material information via social media channels and it is possible that the information we post on social media channels could be deemed to be material information. Therefore, in light of the SEC’s guidance, we encourage investors, the media, our players and others interested in our company to review the information we post on the U.S. social media channels listed below. . .

Any updates to the list of social media channels we will use to communicate material information will be posted on the Investor Relations page of the company’s website at http://investor.zynga.com.

Despite the hoopla around “SEC BLESSES SOCIAL MEDIA!!!!”, the big question is how the SEC will respond to this method when important information is released on some blog without a press release or Form 8-K announcing that the specific piece of information will be released at a particular time on that blog.  I still think it is an open question as to whether a Zynga-type notice will save the release of material nonpublic information on a lightly trafficked blog.

Zynga Form 8-K
SEC Release re: Use of Company Websites
SEC Guidance for Use of Social Media

When Introductions Go Bad. Be Wary of the Unregistered Broker-Dealer.

I frequently get questions along these lines:  “If we pay someone a commission to make introductions to investors, that’s okay, right?  I mean, people do it all the time.”

Then we get into discussions about broker-dealer vs. finder and the requirements for a finder under the Texas statutes.  However, if someone is getting paid a commission for introductions to investors, you can bet he or she is acting as broker and better have a license.

Another unregistered broker-dealer case came down from the SEC last month.  In this case, an investment fund retained Stephens as a “consultant” to find potential investors.  Stephens had not been registered with the SEC in any capacity since he was barred from association with investment advisers since 2002. However, due to connections with the fund and a long history in the industry, he still had contacts with potential investors.

Stephens’ consulting arrangement entitled him to a percentage of all capital commitments from investors he introduced, which was revised for other introductions. He earned about $3.8 million on commitments of $569 million, which is not too shabby.  He was also involved significantly in the investor solicitation process and provided services way beyond the “finder” function.

Fines, industry suspensions and cease-and-desist orders were delivered to the fund and the principals of the fund, proving that someone else’s improper conduct can hurt the issuer and the individuals involved (another thing I hear:  “If it is a problem, it isn’t my problem, right?”  Wrong.).  Although the facts of the case seem egregious, most situations seem to be closer calls.  However, the results are usually the same, and calling someone a “consultant” (a frequent suggestion) does not change the analysis.

For $3.8 million (or even a lot less), just get licensed or hire someone who is.

In re: Ranierei Partners LLC and Donald W. Phillips


Recent Case Shows How Little The SEC Appreciates The Beauty* Of A Reverse Merger

*Beauty Is in the eye of the stock promoter.
SEC v. Sierra Brokerage, et al.

Many of the arguments in the case are procedural, but the basis of the case involves Tsai, who created shell companies for reverse mergers.  As part of the process, Tsai would distribute the shares to his buddies to spread out the holdings in order to qualify for OTC trading.  Tsai also had stock powers from these people that allowed him to redistribute the shares in the reverse merger.

Tsai’s ability to reclaim the shares at a reduced price constituted “control” over the shareholders in addition to his control over the company and made them all “affiliates.”  According to the SEC and the court, this made him an underwriter and Rule 144 unavailable.  Thus, the distribution was a violation of the registration requirements of the 33 Act.

But wait, there’s more.  His failure to report the shares he controlled via the stock powers was a violation of Section 13(d) and Section 16(a) of the 34 Act (requirements to file Schedule 13Ds and Forms 3, 4 and 5).

If you want to draw broader lessons:

  • Spreading out securities holdings without an effective registration violates the 33 Act
  • The ability to repurchase shares demonstrates control
  • The ability to repurchase shares constitutes beneficial ownership and pecuniary interest for purposes of the Williams Act and Section 16 disclosure and short swing profit rules
  • The SEC still does not like reverse mergers