May 2008


From the editors of CCH Federal Securities Law Reporter, CCH Blue Sky Law Reporter and the securities publications of Aspen Publishers, this update describes important developments covered in these publications, as well as timely topics of interest generally to federal and state securities practitioners.

To view past issues of the Securities Update, please visit http://business.cch.com/updates/securities

If you have questions or comments concerning the information provided below, please contact me at rodney.tonkovic@wolterskluwer.com.

 

CCH Federal Securities Law Reporter

Amendments to Form S-11 Expand Incorporation by Reference
The SEC adopted amendments to Form S-11, the registration statement used by real estate entities to register offerings under the Securities Act. The amendments permit an entity that has filed an annual report and that is current in its reporting obligations under the Exchange Act to incorporate by reference into Form S-11 information from its previously filed Exchange Act reports and documents. The amendments are identical to amendments to Form S-1 and Form F-1 previously adopted by the Commission in the 2005 offering reform rulemaking. Release No. 33-8809 at ¶88,092 (ip access user).

SEC Adopts Amendments to Implement Sudan Divestment Act
The SEC adopted form amendments that require disclosure by a registered investment company that divests, in accordance with the Sudan Accountability and Divestment Act of 2007, from securities of issuers that the investment company determines conduct or have direct investments in certain business operations in Sudan. Release No. 34-57711 at ¶88,104 (ip access user)

SEC Adopts Technical Amendments to “Broker” Exceptions for Banks
The SEC and the Federal Reserve board adopted technical amendments to Regulation R, which the agencies jointly adopted in September 2007. The technical amendments correct cross-references and other typographical errors in the regulation. Release No. 34 56501A at ¶88,097 (ip access user).

Fraud Claims Revived Under Tellabs Analysis: 1st Circuit
A securities fraud plaintiff pleaded "enough to give rise to inferences that are at least as strong as any competing inferences regarding scienter," wrote a 1st Circuit panel, as the court re-instituted one of four dismissed claims under a Tellabs analysis. The remand permitted the district court to allow a limited discovery period on the issues raised.

A plaintiff class sued Boston Scientific, a medical device manufacturer, for securities fraud under four distinct allegations of securities fraud. The investor class claimed inadequate and misleading disclosures regarding 1) a civil fraud and contract lawsuit with another manufacturer, 2) a Department of Justice investigation into a 1998 product recall, 3) the company's introduction of TAXUS stents to the market, and 4) FDA investigations and warnings regarding Boston Scientific's plants. Only the TAXUS stent issue was before the court on appeal following the dismissal of all claims. The class made several allegations concerning problems with the company's stent device. As alleged, the company knew of and did not reveal problems with the device from its use in Europe prior to its U.S. introduction, and the company's failure to disclose an FDA deficiency letter. The company also did not disclose a change in its manufacturing process, and according to the class complaint, the defendants misleadingly attributed any risks or problems to the unfamiliarity of doctors with the new device rather than to any functionality issues. This delay in addressing functionality evidenced scienter, according to the complaint, because of the desire of the defendants to build up inventory before announcing product recalls.

The district court dismissed all claims, finding in a pre-Tellabs decision that the allegations represented at most fraud by hindsight. "[N]o liability exists where a plaintiff's claim rests on the assumption that the defendants must have known of the severity of their problems earlier because conditions became so bad later on," wrote the trial court. The 1st Circuit rejected this conclusion, however, because the district court failed to consider other allegations that the lead plaintiff made in its supporting documents. The panel found, applying Tellabs, that "while there is support for defendants' inferences, we think, at this stage, that plaintiff's inferences are at least equally strong." In re Boston Scientific Corp. Securities Litigation (1stCir) is reported at ¶94,645.


Equity Fund Could Use Rule 16b-3 Exemption
A 2nd Circuit panel held that the Exchange Act Rule 16b-3(d) exemption applies to so-called "directors by deputization." In reaching this result, the appellate panel found persuasive the SEC's interpretation of Rule 16b-3(d) that such directors, even if they were also 10 percent holders, were protected by the rule. The court also found that the adoption of Rule 16b-3(d) was within the agency's exemptive authority under Section 16(b). In this case, Perseus, a private equity fund management firm and its affiliates acquired more than 10 percent of the common stock of Beacon Power Corp. Subsequently, two senior officers of Perseus were named to serve as Beacon directors. Perseus distributed 7.5 million Beacon shares to its members, pursuant to an investment agreement with Beacon which Beacon's board approved. The members, in turn, sold the shares. A Beacon shareholder filed a derivative action claiming that the acquisition of the Beacon shares by Perseus, allegedly a director by deputization, could be matched with the member sales for Section 16(b) purposes.

The U.S. Supreme Court recognized the doctrine of directors by deputization in the 1962 decision. The high court found that a shareholder, such as a partnership or corporation, could be a director for Section 16 purposes "if the investor actually functioned as a director" and "had been deputized to perform a director's duties not for himself" but for the firm.

The appeals court also rejected the plaintiff's contention that the Rule 16b-3(d) exemption is inapplicable to a director by deputization that is also a 10 percent holder. The court noted that "the Commission's adopting release, however, specifically addresses the rule's application to ten percent holders who are directors, and it does so without drawing a distinction between named directors and directors by deputization." In that release, the SEC stated that Rule 16b-3 does not provide an exemption for persons who are subject to section 16 solely because they beneficially own greater than ten percent of a class of an issuer's equity securities. Roth v. Perseus, L.L.C (2ndCir) is reported at ¶94,644.

Whistleblower’s Complaints Not Protected Under Sarbanes-Oxley
A former employee of a pharmaceutical company failed to establish a cause of action under the whistleblower protection provisions of the Sarbanes-Oxley Act. The employee alleged that the company unlawfully discharged him for complaining to management about the company's inability to implement a training program on schedule. The employee stated that he believed that the company's potential conduct in misrepresenting or covering up the deficiencies in timely implementation of the program would constitute violations of Exchange Act Section 10(b) and Rule 10b-5 and, therefore, that his conduct was protected under the Sarbanes-Oxley Act.

The district court (MD NC) entered summary judgment, concluding that the employee's complaints were not protected activity under the Sarbanes-Oxley Act because he could not reasonably have believed that the company was violating the securities laws. The court also concluded that the company had shown that the employee was discharged for insubordination and that the employee would have been discharged regardless of whether he had complained about the progress of the training program. A panel of the 4th Circuit Court of Appeals affirmed, based on the conclusion that no objectively reasonable basis existed for the employee to have believed that the company was violating the securities laws. The court noted that the employee did not complain that the company ever made any false statements to government agencies or stockholders, and the company in fact never did so. Furthermore, the training program was completed on schedule.

According to the court, the employee failed to produce evidence that he provided information or made a complaint to the company about conduct which a reasonable employee in his position could have believed at the time constituted a violation of the securities laws. The employee failed to show that the company misrepresented or concealed anything, violated a consent decree, had or intended to mislead shareholders, or that deficiencies in the training program schedule had a material impact on the company's finances. The court summed up by saying that "not one link in [the employee's] imaginary chain of horribles was real or was in the process of becoming real." Livingston v. Wyeth, Inc. (4thCir) is reported at ¶94,614 (ip access user)

CCH Blue Sky Law Reporter

California Amends Broker-Dealer Recordkeeping and BD/IA Financial Reporting Amendments
Broker-dealer books and records requirements that pertain to purchase and sale documents, customer records, associated person records and customer complaint records were amended by the California Department of Corporations to conform to SEC 2001 amendments to Rules 17a-3 and 17a-4 of the Securities Exchange Act of 1934 following adoption of the National Securities Market Improvement Act of 1996. In addition, financial statement requirements for broker-dealers and investment advisers were clarified. ¶12,222 (ip access user), ¶12,224 (ip access user)

Mississippi Clarifies Federal Covered Securities Rules and Adopts NASAA IA Recordkeeping and Custody Model Rules and NASAA Policy on Internet Advertising
Issuers filing SEC Form D to make a Rule 506 offering need to include Section E (state signature page) and the Appendix, under a rule change adopted by the Mississippi Secretary of State. Other amendments require that a notice of completion of the offering, sales report and $50 fee be filed for federal covered securities offerings under Section 18(b)(2) and 18(b)(4)(D) of the Securities Act of 1933. A sales report on Form NF or Form D and a $50 fee must be filed for a federal covered securities offering under Section 18(b)(2) or 18(b)(4)(D) that is not completed within 12 months of the date of initial notice filing. Also, NASAA Model Rules for investment advisers, 102(e)(1)-1 on custody of client funds/securities and 203(a)-2 on recordkeeping, were adopted. Lastly, NASAA's policy on Internet advertising by broker-dealers, agents, investment advisers and investment adviser representatives was adopted. ¶34,429H (ip access user), ¶34,430 (ip access user), ¶34,435 (ip access user), ¶34,516 (ip access user), ¶34,520D (ip access user), ¶34,542 (ip access user)

Washington Proposes Amendments to its Regulation D Rules
Washington is the first state to propose changes to its Regulation D rules to coordinate with the SEC's recent adoption of amendments to federal Regulation D authorizing electronic filing of Form D through EDGAR. As proposed, issuers would file with the Administrator or his or her designee an initial notice on Form D consisting of either: (1) a copy of the notice of sales on Form D filed electronically with the SEC through EDGAR in accordance with Regulation S-T in effect on September 15, 2008; or (2) a temporary Form D in effect from September 15, 2008 through March 15, 2009. Form D would be manually signed by the issuer's duly authorized person or contain a photocopy of a manually signed copy. Form D would be filed in the above manner until a system allowing electronic filing of Form D with the Administrator or his or her designee is implemented and approved by the Administrator. ¶61,751 (ip access user), ¶61,753 (ip access user), ¶61,754 (ip access user), ¶61,757 (ip access user)

Wisconsin Adopts Uniform Securities Act of 2002
The state has adopted Act 196, which can be cited as the “Wisconsin Uniform Securities Law.” This Act replaces the existing Wisconsin Securities Act, and is effective January 1, 2009. Although differences occur, this new Act adopts a large part of the Uniform Securities Act of 2002 (USA 2002) verbatim.

Agent Registration Required for Sellers of Covered Securities
In Myers v. OTR Media, Inc., a federal district court (W.D. Ky.) held that individuals who received commissions for effecting transactions in federal “covered securities” required registration as agents under the Kentucky and Michigan Blue Sky Laws. The evidence established that one of the defendants received “commissions,” as defined by state law, because he was paid for marketing the issuer's shares. Although the defendants contended that they did not fall within the definition of “agent” because the National Securities Markets Improvement Act of 1996 preempted state registration of the securities, the district court ruled that both the Kentucky and Michigan statutes required even those individuals selling only covered securities to be registered if they received commissions in connection with the transactions. The decision is reported at ¶74,694 (ip access user).

Aspen Federal Securities Publications

A Practical Guide to SEC Proxy and Compensation Rules, Fourth Edition, edited by Amy L. Goodman, John F. Olson, and Lisa A Fontenot
The 2008 Supplement (ip access user) to the Fourth Edition is now live on the IRN Corporate Governance Integrated Library. This analytical treatise includes comprehensive analysis of the SEC’s revised executive compensation disclosure rules and discusses the increase of shareholder activism. The 2008 Supplement continues to be written by a team of experts with a wealth of practical experience in counseling clients on these issues and includes: revised chapters regarding the Compensation Disclosure and Analysis section and the executive compensation disclosures tables reflecting SEC guidance and developing best practices in the first year of the new executive compensation disclosure rules; a revised chapter on executive compensation disclosure in light of 2007 IRS guidance regarding Section 162(m) of the Internal Revenue Code; an updated discussion of street name registration and the proxy solicitation process detailing the status of the proposed NYSE rule amendment regarding discretionary broker voting in director elections, the SEC’s new e-proxy rules, and the recent increase in separation of voting rights from economic interest with derivative securities; a revised chapter on director independence determinations reflecting current ISS Governance Services director independence standards; a revised chapter on shareholder communications discussing recent proxy proposal trends relating to election of directors and other governance matters and shareholder activism; and a completely rewritten chapter on electronic communications to reflect the new e-proxy rules.

Hot Topic of the Month

This month's hot topic is the Whistleblower Protection provisions of the Sarbanes Oxley Act. Sections 806 and 1107 of the Act created new federal protections designed to shield whistleblowers from retaliation. Section 806 prohibits certain retaliatory action against employees and Section 1107 establishes a criminal penalty for retaliation against a whistleblower.

Section 806 forbids public companies from taking retaliatory action against employees who provide information or assist in the investigation of conduct they reasonably believe is a securities violation or securities fraud, or who file or participate in proceedings related to fraud against shareholders. The protections only apply to investigations conducted by a federal regulator or law enforcement agency, a member of Congress or a congressional committee, or the employee's supervisor; employee complaints to the news media, by themselves, do not constitute whistleblowing under the Act. The aggrieved employee may bring a civil action for violations.

Criminal penalties are contained in Section 1107 of the statute and apply to a much broader set of whistleblowing transgressions than just those relating to securities fraud. A retaliatory action becomes a criminal matter under Section 1107 if the employee provides information to a law enforcement officer concerning the commission of any federal offense. Section 1107 states that whoever knowingly, with the intent to retaliate, takes any action harmful to any person for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any federal offense, must be fined or imprisoned for up to 10 years, or both.

Sarbanes-Oxley primarily placed enforcement of the whistleblower provision with the Department of Labor. If the Department of Labor does not resolve the matter within a specified period of time, the aggrieved whistleblower may bring an action in federal court. To date, the Commission has neither proposed rules concerning Section 806 nor filed an enforcement action under the statute. The SEC has relied on OSHA's efforts when it comes to the prosecution of stand-alone violations of the whistleblower protection provisions. The Chairman of the SEC has stated that to the extent that a company retaliates against an employee for blowing the whistle on practices that constitute violations of the securities laws, the SEC would investigate and bring an enforcement action against the company for any substantive violations.

We publish related information in a wide range of resources (e.g., Federal Securities Law Reporter, SEC Today, Insights – Amy L. Goodman, Securities Regulation – Loss, Seligman & Paredes, etc.), and document types (laws, regulations, releases, newsletter articles, treatise discussion). For example:

SEC Today

Federal Securities Law Reporter

Insights – Amy L. Goodman (e.g., “The Whistleblower Provisions of the Sarbanes-Oxley Act of 2002” (December 2002) (ip access user)
Sarbanes-Oxley Act: Law and Explanation (e.g. Chapter 9.08 (ip access user))
Sarbanes-Oxley Act: Planning and Compliance – Ambler, Massaro & Stewart (e.g., Chapter 2.05 (ip access user))
Securities Regulation – Loss, Seligman & Paredes (e.g., Chapter 12.B.6 (ip access user))
Jim Hamilton’s World of Securities Regulation (http://jimhamiltonblog.blogspot.com/) (e.g. 3-12-08 and 2-16-08)

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IPO Week in Review, a weekly e-newsletter to keep professionals up to date with recent filing and going public activity, is an important element of the IPO Vital Signs system or is available by separate subscription. Coverage includes a monthly feature article on recent trends in going public in the U.S.

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#770 – Officers and Directors

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