Thinking You’ll Do A Better Job Than The Other Guy Is Not Reason Enough For A Board Of Directors To Avoid “Approval” Of Dissident Board Nominees That Will Harm The Corporation

Withholding approval is a threat to the shareholder franchise when the incumbent board retains power to approve a dissident slate but refuses to entrench itself.

SandRidge Energy found itself in a proxy fight launched by hedge fund instigator, TPG-Axon. TPG launched a consent solicitation to de-stagger SandRidge’s board, amend the bylaws, remove all of the current directors and install its own slate. Let’s just say that SandRidge’s performance had been lacking at the time.

The SandRidge board resisted and warned stockholders that the election of TPG’s slate would be a change of control that would trigger a requirement for SandRidge to repurchase its outstanding notes, referred to colorfully as the “Proxy Put.” If a new board majority is not approved by an incumbent board, the Proxy Put was triggered for purposes of the notes.

A stockholder claimed breach of fiduciary duty because the sitting SandRidge board did not have a proper basis for failing to approve the TPG slate for the purposes of the Proxy Put.

The court said that a board deciding whether to approve directors for the purposes of the Proxy Put could not act consistently with its fiduciary duties by simply failing to approve any director candidates opposing the incumbents.

The duty of loyalty demanded that the incumbents may only refuse to grant approve if the dissidents posed such a material threat of harm to the corporation that it would constitute a breach of the duty of loyalty to pass control to them. For example, unless the dissidents lacked ethical integrity, were looters or proposed a program that would demonstrably be materially adverse to the company’s ability to meet its obligations to the creditors, then the incumbents should approve the dissidents and allow the stockholders to vote.

The incumbents noted that the dissidents did not have sufficient energy experience, although several members of their slate had substantial experience, even if not in the upstream oil and gas industry. However, that the incumbents believed that they were better suited to run the company is not a sufficient fiduciary basis to deny approval of the dissidents. The incumbents did not have reason to doubt the integrity of the dissident slate. As the court said:

“In other words, the incumbent board has simply made the same determination that all incumbents who seek to continue in office make: we are better than the new guys and gals, so keep us in office.”

The court went on to disparage a company that would enter into an agreement with a Proxy Put without hard negotiation and clear economic advantage given the obvious entrenching purposes of a Proxy Put as the court believes that the costs of resisting such a term would be insubstantial to non-existent.*

Update:
SandRidge and TPG settled, and SandRidge added four TPG nominees to the board.

Links:
Kallick v. SandRidge Energy
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*Ed. Note: Not really. Many lenders/noteholders/counterparties want to know exactly who they will be dealing with during the term of their agreement. The Proxy Put is probably more widely used and integral to many transactions than the court realizes.

SEC OK’s Social Media, Or Does It?

Cue dramatic music . . .

Last week, the SEC announced that companies can use social media to release key information. This had been described to me as a groundbreaking move for company disclosure. Then I read the release.

Background
Last year, the SEC sent a Wells Notice to Reed Hastings, CEO of Netflix, stating that he violated a bunch of 34 Act statutes and regulations, including Regulation FD, for making some statements on his Facebook page about Netflix’ user metrics.

New Stuff?
The SEC accepted the fact that it is a grey area about whether or how to use social media to release material nonpublic information. The SEC continued to say that you could do it without violating a bunch of laws and regs if you don’t restrict access and if you tell people where to look for it.

So, has the SEC finally discovered the Inter-tubes and embraced the future?

No. This is the same analysis they have been providing for years. As they said in their release about the use of company websites in 2008 [Ed.: I can’t believe it has been that long.]:

“Through the years, we have taken a number of steps to encourage the dissemination of information electronically via the Internet, as we believe that widespread access to company information is a key component of our integrated disclosure scheme, the efficient functioning of the markets, and investor protection.”

When doing the analysis of website posting for Reg FD purposes, the SEC has said that:

“Thus, in evaluating whether information is public for purposes of our guidance, companies must consider whether and when: (1) a company web site is a recognized channel of distribution, (2) posting of information on a company web site disseminates the information in a manner making it available to the securities marketplace in general, and (3) there has been a reasonable waiting period for investors and the market to react to the posted information.” [Ed.: Emphasis added.]

In other words, there is nothing new here. Would the market expect to see financial or performance metrics on a Facebook page? Is registration or subscription required? Are you effectively making a public or limited release of the information?

I interpret the new SEC release to be as much of a warning as it was “permission.”  Money quote:

“Personal social media sites of individuals employed by a public company would not ordinarily be assumed to be channels through which the company would disclose material corporate information.”

From one of the greatest movies of all time:

Fletch: Can’t do that, Frank. Fat Sam isn’t the story, there’s a source behind him.
Frank Walker: Who?
Fletch: Well, there we’re in kind of a grey area.
Frank Walker: How grey?
Fletch: Charcoal?

Cross-post: How to Get $1.2 Billion of Goldman Sachs Shares Without Really Trying (err, Paying). Goldman Sachs, Warren Buffett and Berkshire Hathaway Amend 2008 Financial Disaster Warrants.

Over at Underdisclosed.com is an analysis of how Goldman Sachs and Berkshire Hathaway reworked the warrants Goldman issued in the wake of the 2008 financial calamity.  Enjoy.

Be Your Own IT Dept. – Computer Update Edition

When I was outfitting the office, I got an HP Pavilion.  It was a fast, powerful machine at a great price.  I have spent more time with customer service and updates and system restores in the last 6 months than I had in the prior 14 years with Dells.

Once again the computer took it upon itself to update the BIOS.  I’m sure everything runs smoothly after the update other than the fact that the screen disappears.

I had client issues this morning and the need to produce documents, but I was turning my computer on and off while waiting to go back in time to restore points.  While the computer was running again and my display was working, my security systems had been deleted.  I had to uninstall/reinstall Norton360 and the fingerprint facility that stores passwords.  I guess I better remember them now.

Automatic updating has now been turned off.  The several hours I spent as IT guy were hours I did not spend billing clients and earning fees.  Next time, I’ll purchase my computer at Best Buy (if they’re still around) and get Geek Squad.  I have not found a comparable independent, but someone to call and fix things would take the pressure off.

A Couple of New Securities Litigation Cases from the Supreme Court

The Supreme Court issued a couple of securities litigation opinions today.  A snapshot:

Amgen Inc. v. Connecticut Retirement Plans and Trust Funds

Held:  Proof of materiality is not a prerequisite to certification of a securities-fraud class action seeking money damages for alleged violations of Securities Exchange Act of 1934 Section 10(b) and Rule 10b–5.

A quick reminder:  Elements of an implied Section 10(b) cause of action for securities fraud are:

  • a material misrepresentation or omission by the defendant;
  • scienter;
  • a connection between the misrepresentation or omission and the purchase or sale of a security;
  • reliance upon the misrepresentation or omission;
  • economic loss; and
  • loss causation.

Basic v. Levinson, an important case in the securities law area, provided, among other things, that fraud-on-the-market can establish the reliance element.

In addition, to certify a class, a plaintiff must also establish that the questions of law or fact common to class members predominate over any questions affecting only individual members.  They are fighting for the group, so to speak.

Considering whether to certify a class in a securities fraud case, the court looked at whether proof of materiality is needed to ensure that the common questions of law or fact predominate over individual questions as the litigation progresses.  The court said ‘no’ because:

  1. materiality is judged according to an objective standard, it can be proved through evidence common to the class; and
  2. a failure of proof on the common question of materiality would not result in individual questions predominating. Instead, it would end the case, for materiality is an essential element of a securities-fraud claim.

The second point was a focus of the dissenting justices, which said that the failure to establish materiality retrospectively confirms that:

  • fraud on the market was never established;
  • questions regarding the element of reliance were not common; and
  •  therefore, certification was never proper.

Therefore, the dissent said that the plaintiffs should not be excused at certification that questions of reliance are common merely because they might lose later on the merits element of materiality.  Because a securities-fraud plaintiff invoking fraud-on-the-market to satisfy the certification rules should be required to prove each element of the theory at certification in order to demonstrate that questions of reliance are common to the class.  However, they lost.

Gabelli v. Securities and Exchange Commission

The Investment Advisers Act makes it illegal for investment advisers to defraud their clients and authorizes the SEC to bring enforcement actions against fraudsters.  To do this, the SEC must file suit “within five years from the date when the claim first accrued.”

So, what does that time limit mean?

In this case, the SEC sought civil penalties in 2008 for fraud allegedly committed from 1999 until 2002.  The SEC argued that the statute of limitations did not begin to run until the SEC discovered or reasonably could have discovered the fraud.

Held:  The five-year clock in begins to tick when the fraud occurs, not when it is discovered.

The SEC argued that because of the fraud aspect, a plaintiff may not know it has been injured so the statute of limitations should begin at discovery.

The court said that it has never applied the discovery rule where the plaintiff is not a defrauded victim seeking compensation, but is instead the government bringing an enforcement action for civil penalties.  The government is a different kind of plaintiff whose purpose, in the case of the SEC, is to root out fraud.  The discovery rule helps to ensure that the injured get compensation, but civil penalties go beyond compensation, are intended to punish and label defendants wrongdoers.

In addition, deciding when the government knew or reasonably should have known of a fraud would also present particular challenges for the courts, such as determining who the relevant actor is in assessing government knowledge, whether and how to consider agency priorities and resource constraints in deciding when the government reasonably should have known of a fraud, and so on.

SEC Provides Guidance To Foreign Firms

The SEC released informal guidance to foreign private issuers, describing how to comply with U.S. securities laws and SEC regs.

It actually provides a decent overview of the securities laws for any issuer along with a discussion of what it takes to qualify as a foreign private issuer.

It also provides a decent discussion of a couple of topics that generally causes confusion:

  • Requirement of registration vs. exemptions from registration
  • Resales of restricted securities.

It is worth checking out.  See it here.

Facebook Hacked!

On Friday afternoon, Facebook announced that hackers had their way with some employee laptops.  It said none of its users’ data was compromised, and that the attack occurred after some employees visited a website that infected their machines with malware.

The writer said that “It was not immediately clear why Facebook waited until now to announce the incident.”  Why, oh why, would a company wait until Friday afternoon to release negative news?  You may also wonder why the government waits until Friday afternoon to release economic news.  So people can spend the weekend absorbing the information over the weekend free from the distractions of work, of course.

Facebook described these risks in its latest Form 10-K:

Computer malware, viruses, hacking and phishing attacks, and spamming could harm our business and results of operations.

Computer malware, viruses, and computer hacking and phishing attacks have become more prevalent in our industry, have occurred on our systems in the past, and may occur on our systems in the future. Because of our prominence, we believe that we are a particularly attractive target for such attacks. Though it is difficult to determine what, if any, harm may directly result from any specific interruption or attack, any failure to maintain performance, reliability, security, and availability of our products and technical infrastructure. Any such failure may harm our reputation and our ability to retain existing users and attract new users.

In addition, spammers attempt to use our products to send targeted and untargeted spam messages to users, which may embarrass or annoy users and make Facebook less user-friendly. We cannot be certain that the technologies and employees that we have to attempt to defeat spamming attacks will be able to eliminate all spam messages from being sent on our platform. As a result of spamming activities, our users may use Facebook less or stop using our products altogether.

The SEC has been focusing on disclosure of cybersecurity risks.  Here is the release, which is exactly as exciting as it sounds.

Be Your Own IT Dept. – Applying a Protective Screen Shield to Your Mobile Device

Due to very pressing professional needs that had nothing to do with Angry Birds, I bought an Asus Transformer tablet.  I wanted an Android tablet rather than an iPad since I do some Android development in my spare time.  See my apps here.  And buy them.  This blog ain’t paying for itself.

Since I intend to use it as a paper substitute with a stylus, I figured I needed a screen protector and settled on Armorsuit.  Unfortunately, the application method involves “washing hands” and “solutions” and squeegying.  The final product is streaky and bubbly, but from the comments I read this is to be expected while the solution dries.

I’m supposed to leave it off for 12 to 24 hours and the bubbles and streaks should eventually go away.  The website says it can be removed without residue, so I have that going for me.  I’ll let you know how it goes.

Here’s how YouTube says to do it:

Best comment:  “If I leave my phone off for 24 hours, my family and friends will most likely think I’m dead.”

The High Cost of Avoiding Higher Costs

I have a very long ‘to do’ list for setting up the new solo practice.  There is a ton of stuff that my old firm used to handle for me.  I never paid any mind to any of it.  And now I have to arrange for lots of stuff, including professional liability insurance.

Where to start?  I was going to go through the Texas bar program for insurance, but I read that they won’t write insurance if your securities practice is too large.  My may become too large, but its difficult to know since I won’t have any clients when I start.  I got a recommendation for a broker from a friend who had a solo practice a few years ago.

I await the estimates for the policy early next week, but the securities coverage is expensive.  The securities rider to the application was lengthy and was not particularly well suited to a new practice that is disconnected to the old practice.  For example, as a solo practitioner, it is unlikely that I’ll be representing underwriters in initial public offerings, but that had been a major part of my practice over the last few years.  And yet, the rider was focused on extrapolating the last year or so of my practice over the next year for coverage.  We’ll see how it turns out.