Author: National Law Forum

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SEC Enforcement Actions: A Look at 2011 and What to Expect in the Next Year

A recent article by Matthew G. Nielsen and Crystal Jamison of Andrews Kurth LLP regarding SEC Enforcement recently appeared in The National Law Review:

In 2011, the U.S. Securities and Exchange Commission ushered in a new era of securities regulation, marked by a record-setting number of enforcement actions and a significant expansion of enforcement techniques and tools. This E-Alert focuses on key developments during 2011 and trends that will likely shape the SEC’s enforcement program in the next 12 to 18 months.

Key Developments in SEC Enforcement During 2011

Record-Setting Numbers

Over the last two years, the SEC has significantly reorganized its Division of Enforcement, most notably through the creation of special investigative units and multi-agency working groups dedicated to high-priority areas of enforcement. Also in this period, the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act gave the SEC new enforcement tools, including expanded enforcement authority, wider use of administrative proceedings, and broader scope of and expanded penalties for violations of securities laws. 2011 was the first full year of the SEC’s enforcement program under these new changes.

The organizational reforms and new tools culminated in the SEC filing a record 735 enforcement actions in 2011, an 8% increase from 2010.1 In 2011, the SEC filed 266 civil actions against 803 defendants, a slight increase from 2010, but substantially down from 2009. The SEC, however, continued the upswing in administrative proceedings, filing 469 cases against 1,058 individuals and companies in 2011, representing a 33% increase as compared to administrative cases brought in 2009. While the SEC sought about the same number of temporary restraining orders in 2011 versus 2010 (39 and 37, respectively), the agency requested much fewer asset freezes as compared to 2010, declining 26% from 57 to 42.

During 2011, the SEC obtained judgments and settlements for $2.806 billion in penalties and disgorgement, only slightly down from the 2010 record of $2.85 billion.2 But, the median settlement value with companies nearly doubled from $800,000 in 2010 to $1.47 million in 2011, near the post-Sarbanes-Oxley high of $1.5 million in 2006.3 And, the median settlement value for individuals was $275,000, a 35% increase from the previous post-SOX high of $130,000 in 2008.

Not all numbers were up, however. In 2011 the SEC both opened and closed fewer investigations. While the number of investigations opened was only slightly down from 2010, the number of investigations closed decreased by 36%.4 The SEC, however, saw an increase in formal investigations opened during 2011, rising nearly 9% from those opened in 2010 and 16.5% from 2009.

Major Enforcement Areas in 2011

Financial Crisis Cases — Enforcement actions against firms and individuals linked to the 2008 financial crisis remained a high priority for the SEC in 2011, continuing a three-year rise in the percentage of SEC settlements involving alleged misrepresentations or misappropriation by financial services firms. These types of settlements accounted for 41.6% of all SEC settlements in 2011, as compared to the average of 23.7% seen from 2003 to 2008.5 Since 2008, the SEC has filed 36 separate actions arising from the financial crisis against 81 defendants, nearly half of whom were individuals, meaning CEOs, CFOs and other senior corporate executives. Fifteen of these actions were filed in 2011, up from twelve filed in 2010. The majority of cases related to collateral debt obligations (“CDOs”) and mortgage-backed securities.

Notable 2011 financial-crisis cases include an SEC action brought against six executives at Brooke Corporation and three executives at mortgage lender IndyMac Bancorp for allegedly misleading investors about the deteriorating financial condition at their respective companies. The SEC also filed several actions alleging that firms concealed from investors the risks, terms, and improper pricing of CDOs. But, the most notable case of 2011 came in December, when the SEC filed suit against six former top executives at Fannie Mae and Freddie Mac for allegedly causing the companies to underreport the number of subprime mortgages they purchased during 2006 to 2008.6 

Investment Advisers and Broker-Dealers — In 2011, there was a substantial increase in the number of actions against SEC registrants, with 146 actions against investment advisers and investment companies, a 30% increase from 2010, and 112 broker-dealers actions, up 60% from 2010. Indeed, investment adviser, investment company, and broker-dealer actions constituted over 35% of the SEC’s total enforcement actions in 2011. The SEC focused on traditional areas of concern including inaccurate or inadequate disclosure, conflicts of interest, misappropriation of client assets and fraudulent trading schemes, misallocation of investment opportunities, false or misleading performance claims, and market manipulation. Another top priority that is likely to gain even more attention in the year to come is compliance programs, including the adoption and implementation of written compliance policies and procedures, as well as annual review of such programs.

Investment adviser and broker-dealer actions brought by the SEC in 2011 included charges against Charles Schwab entities and executives for allegedly making misleading statements to investors regarding a mutual fund heavily invested in mortgage-backed and other risky securities and AXA Rosenberg Group LLC and its founder for allegedly concealing a significant error in the computer code of the quantitative investment model that they used to manage client assets. The Schwab entities paid more than $118 million to settle the SEC’s charges, while AXA Rosenberg agreed to pay $217 million to cover investor losses and a $25 million penalty.

Insider Trading Cases — Protecting the integrity of the financial markets continued to be a major area of focus in the SEC’s enforcement program. In 2011, the SEC filed 57 insider trading cases (nearly an 8% increase over 2010’s total) against 126 defendants.7 Many insider trading cases also included parallel criminal charges by the Department of Justice (“DOJ”), including the highly-publicized Galleon hedge fund case discussed below. Among those charged in SEC insider trading cases in 2011 were various hedge funds managers and traders involved in an alleged $30 million expert network trading scheme, a former NASDAQ Managing Director, a former Major League Baseball player, and an FDA chemist. The SEC also brought insider trading charges against a Goldman Sachs employee and his father who allegedly traded on confidential information learned at work on the firm’s ETF desk, and a corporate board member of a major energy company and his son for allegedly trading on confidential information about the impending takeover of the company.

Executive Clawbacks — In 2011, the SEC became more aggressive in seeking executive compensation clawbacks. Section 304 of the Sarbanes-Oxley Act provides that if an issuer restates its financials because of misconduct, then the CEO and CFO “shall” reimburse any bonuses or other incentive-based compensation, or equity-based compensation, received during the year following the issuance of the incorrect financials. During 2011, the SEC sought clawbacks from executives even in instances where they were not personally involved in or aware of the alleged misconduct at the company, including a settlement to recover bonuses totaling more than $450,000 in cash and 160,000 options from the CEO of Koss Corp. for the CFO’s alleged wrongdoing. The SEC’s trend towards forcing innocent executives to pay the price for wrongdoing that happens under their watch will likely continue following the implementation of section 954 of Dodd-Frank early this year, which expands clawbacks to all executives, rather than just CEOs and CFOs, and is triggered even if the restatement did not occur because of “misconduct” by the issuer.

Chinese Reverse Mergers — Chinese companies who gain listing on a U.S. exchange through a reverse merger with a listed company have become a heavy focus of the SEC and other federal agencies. In 2011, the SEC unveiled new rules approved and adopted by each of the three major U.S. stock exchanges which impose more stringent listing requirements for foreign reverse merger companies. During the last 18 months, the SEC halted securities trading in several Chinese reverse merger companies, revoked the securities registration of several companies, and brought enforcement actions against executives and auditors of these types of companies.8 Moreover, the SEC is aggressively pushing to gain access to financial records for companies based in China. This led to the SEC’s suit against the Shanghai office of Deloitte Touche Tohmatsu CPA Ltd. to enforce an investigation subpoena compelling production of documents located in China.9 The Commission pursued this rarely used remedy when Deloitte refused to produce any documents, contesting the SEC’s ability to compel an audit firm to produce documents predating the Dodd-Frank Act and asserting that the production was prohibited under Chinese law. In resolving the tension between an entity’s competing obligations under U.S. and foreign law, the court recently granted the SEC’s show cause motion, thereby forcing Deloitte either to concede jurisdiction by appearing at the hearing, or to risk default judgment.

Breakdown of Major Categories of SEC Actions10


Changing the Structure of Enforcement Actions

New Cooperation Initiatives — In May 2011, the SEC entered into its first Deferred Prosecution Agreement (“DPA”), in which it agreed not to bring an enforcement action against Tenaris S.A. based on alleged violations of the FCPA, in exchange for Tenaris’ agreement to perform certain undertakings, to abide by a cooperation clause, and to pay about $5.4 million in disgorgement.11 The SEC introduced the DPA in 2010, along with the Cooperation Agreement and Non-Prosecution Agreement (“NPA”), as tools to encourage greater cooperation from individuals and companies. The SEC executed one NPA in 2010 and two more in 2012, one with Fannie Mae and one with Freddie Mac, in which the entities stipulated to certain facts and agreed to extensive cooperation clauses that make it clear the companies will be on the SEC’s side in the related litigation against individual targets.

Whistleblower Initiative — An additional initiative focused on rewarding cooperation is the SEC’s whistleblower program, another product of Dodd-Frank, that officially went into effect on August 12, 2011.12 The program is intended to incentivize whistleblowers to report potential securities violations to the SEC, with tipsters standing to earn bounty of 10 to 30% of any SEC recovery over $1 million. To qualify for the reward, the whistleblower must “voluntarily” provide “original information” that leads to successful enforcement proceedings. Within seven weeks of the SEC’s Office of the Whistleblower opening for business, it received 334 tips. So far, the most common complaint categories included market manipulation (16.2%), corporate disclosures and financial statements (15.3%), and offering fraud (15.6%).13

The SEC has yet to file a case based on a tip from the whistleblower programs, potentially because it is looking for the “perfect case” as the first few cases to come before the courts will likely be highly scrutinized given the huge potential bounties available to whistleblowers. Despite the apparent initial success of the program, the SEC’s limited resources and ability to follow up on tips may neutralize the impact of the initiative, giving companies a chance to investigate some of these complaints. Still, companies should refine compliance programs and training/awareness to encourage whistleblowers to approach internal investigators before going to the SEC directly.

Expanded Enforcement Tools — Through the Dodd-Frank Act, Congress increased the SEC’s enforcement power. The SEC is now allowed to seek civil monetary penalties and other relief in administrative proceedings, even those against entities that are not registered with the SEC, which were previously available only in federal court actions. The SEC flexed its new authority for the first time in March 2011 through a well-publicized administrative action in an insider trading case against Raj Rajaratnam, head of the Galleon Management hedge fund. Despite already receiving an 11-year prison sentence and being ordered to pay an $11 million fine and $53.8 million in restitution in the related DOJ action, the SEC imposed an additional $92.8 million civil penalty.14

Galleon highlights the convergence of SEC civil and DOJ criminal enforcement, and raises questions about double and excessive penalties in government enforcement actions. Other aspects of Galleon are also worth noting, including its potential to expand the SEC’s powers in conducting investigations. In Galleon, not only did the SEC use wiretaps in its investigation, the district court admitted the wiretaps into evidence – a decision that shocked many, especially Rajaratnam. This will play an important role in the upcoming year as wiretaps may become more routine in insider trading and other complex securities fraud cases.

Dodd-Frank also expanded SEC’s authority to bring aiding and abetting claims under the Securities Act of 1933 and to obtain civil penalties for aiding and abetting violations of the Investment Advisers Act of 1940. Congress also reduced the SEC’s burden to prove aiding and abetting liability to a “recklessness” standard. The SEC further obtained “collateral bar” authority — the ability to bar or suspend a registrant from the securities industry completely, although the registrant only committed a violation with regard to a particular segment. The effect of these new powers is not yet certain, but clearly give the SEC more tools in its enforcement program.

Key Securities Cases to Watch in 2012: Judiciary Pressuring the SEC to Re-Think Strategy

Janus and the Future of “Scheme Liability”

A Supreme Court opinion issued in June 2011 had an immediate impact on how the SEC pleads and attempts to prove its cases. In Janus, the Court considered whether separate legal entities within the Janus corporate group (adviser and parent) had exposure to primary liability for the statements of the entity issuing the securities and related disclosures.15 The Court ultimately interpreted the person who makes a statement very narrowly, finding that a defendant may be liable for making an alleged misstatement under section 10(b) of the Exchange Act only if he had “ultimate authority” or “control” over both the content and dissemination of the statement.

In the immediate wake of Janus, the SEC shifted the focus of its cases against non-speakers and non-signers from the “misstatements” prong of Rule 10b-(b) to the “scheme liability” provisions of Rules 10b-5(a) and (c) under the Exchange Act and to section 17 of the Securities Act. According to the SEC, Janus addressed only liability under Rule 10b-5(b), but “scheme liability” claims under subsections (a) and (c) of Rule 10b-5, as well as claims under section 17(a), survived Janus, because unlike Rule 10b-5(b) claims, these claims were not dependent on the word “make.”16 The lower courts are already grappling with how to apply Janus, with one court (and the SEC’s own Chief Administrative Law Judge) rejecting the SEC’s scheme liability and section 17(a) theories,17 while two others found Janusdid not apply to claims brought under section 17(a).18

SEC’s Pursuit of Negligence-Based Claims

In 2011, the SEC showed an increased willingness to proceed against alleged negligent or nonscienter-based conduct as opposed to scienter-based fraud, especially in the context of CDO-related cases. For example, the SEC charged Citigroup Global Markets, Inc. with misrepresenting to investors the quality of fund assets and with failing to disclose its short position against the assets.19Although the allegations appeared to be based on knowing and fraudulent intent, the SEC charged Citigroup only with negligence-based fraud under section l7(a)(2) and (3) of the Securities Act.

The negligence-based claims are easier to prove, thus the new focus should encourage companies to tighten their controls, deterring fraud before it happens, and leading to more stringent enforcement tactics. But, the penalties available for negligence-based misconduct are much lower than with scienter-based claims. Also, by focusing on negligent conduct, the SEC must divert its already scarce resources away from more flagrant, intentional conduct, running the risk of another “Madoff miss.”

Judicial Scrutiny of SEC’s “Neither Admit Nor Deny” Settlements

The use of negligence- and non-fraud-based settlements has already led to closer judicial scrutiny of the SEC’s standard settlement practices and language. In October 2011, the SEC reached a $285 million settlement with Citigroup relating to a mortgage-backed securities claim.20 In an unprecedented move, U.S. District Judge Jed S. Rakoff rejected the settlement as against the public interest because the SEC did not provide adequate factual support for the court’s approval and because Citigroup did not admit to any misconduct.21 Judge Rakoff sharply criticized the SEC’s longstanding practice of entering into settlements in which the defendant neither admits nor denies wrongdoing, finding that approving such settlements is “worse than mindless, it is inherently dangerous.” The SEC appealed the decision in December 2011.22

A second judge has followed suit, challenging similar language the SEC used in a settlement with Koss Corp. and its CEO.23 Both the defense bar and the SEC have expressed concerns about what will happen if this aggressive judicial scrutiny of settlements continues. If companies have to admit to violations to settle with the SEC, it will undoubtedly make it more difficult for the SEC and the defendants to reach settlements, meaning the number of settlements will go down and the amount of costly litigation will rise. Admitting guilt opens companies up to shareholder and other private litigation, and potentially even criminal liability. The SEC can only bring so many cases with its limited resources, as its Enforcement Director has repeatedly noted.

It is difficult to predict the result here. But, in the wake of Rakoff’s decision and the related media attention, the SEC announced on January 6, 2012, that parties will no longer be permitted to settle SEC charges on the basis of “neither admitting nor denying” wrongdoing when they admit to related criminal charges. This policy would also apply in situations in which a corporate defendant has entered into a DPA or NPA in the criminal matter.

Judicial Guidance on Key Issues Relating to the FCPA

In 2011, the courts also had the opportunity to weigh in on key issues relating to the FCPA, including the definition of “foreign official,” the knowledge requirement under the FCPA, and the jurisdictional scope of the Travel Act, which is often also charged in FCPA cases. An increased focus on pursuing individuals, who are generally more likely to litigate than companies, led to an unprecedented number of trials and related litigation that did not always bring favorable results for the government. Indeed, the government suffered a mistrial in the trial of the first group of SHOT Show Sting defendants and the convictions returned by the jury in the Lindsey Manufacturing case were vacated and the indictments dismissed.

Previously, judicial interpretations of the FCPA were limited and positions asserted by enforcement authorities often went unchallenged, especially in the context of settlements. Expect this year to bring even more opportunities for the judiciary to give guidance, as many of the 2011 decisions are the subject of appeals and more significant trial activity is poised to continue. The DOJ also announced that it will publish its own guidance on the FCPA in 2012.

Securities Enforcement in the Next Year

In 2011, the SEC soundly demonstrated its commitment to a vigorous securities enforcement program to address old and new priorities. All signs point to the SEC continuing to aggressively detect, prevent, and combat securities violations, especially in high-priority areas. Along with the progression of the key cases and areas identified above, here is what to expect in the next twelve to eighteen months:

  • More Dodd-Frank Initiatives: In addition to the continued development of the whistleblower program and other initiatives implemented this year, the SEC plans to conclude the voluminous rulemaking required by the Dodd-Frank Act, including finalizing rules on executive compensation.
  • More Financial Crisis Cases: While the SEC ramped up the number of cases stemming from the financial crisis, it will likely bring more such cases and name more individuals. Both Congress and the media have criticized the SEC for not holding more individuals accountable for wrongdoing that fueled the crisis.
  • Tougher Sentencing Guidelines: On January 19, 2012, in response to a Dodd-Frank directive to re-evaluate the sentencing guidelines for fraud offenses, the U.S. Sentencing Commission proposed amending the federal sentencing guidelines to include harsher penalties for senior leaders implicated in insider trading and increase the “offense level” and penalties for instances of “sophisticated insider trading.”24 These amendments, which could be approved later this year, would impact not only public companies, but also brokerage firms and investment advisers.

  • Shift to SEC Administrative Proceedings: The SEC will likely continue the trend of more enforcement actions through administrative proceedings, especially due to the SEC’s expanded remedies and claims in such proceedings coupled with the increased federal court scrutiny of settlements.

  • Continued Focus on High-Priority Areas: The SEC will continue to be active in its designated and traditional high-priority areas. Mostly notably, the SEC will likely focus on Asset Management (hedge funds, investment advisers, and private equity), Market Abuse (large-scale insider trading and other market manipulation schemes), FCPA, and insider trading cases. Also, with the SEC’s Whistleblower program underway, the SEC will likely institute more investigations and enforcement actions based on fraudulent financial reporting, which has waned over the last few years.

  • Increased Focus on Compliance Programs: The SEC will more heavily focus on the operations of compliance programs, both in examinations of registered advisers and broker-dealers and when making enforcement decisions as to SEC registrants where fraud has occurred. In addition to the right “tone at the top,” companies need to ensure that they have good policies covering key-risk areas (such as financial reporting, anti-corruption, business conduct and ethics, insider trading, and internal reporting channels for employees who suspect wrongdoing), appropriate training, and adequate oversight and testing.

1. SEC Press Release No. 2011-234 (Nov. 9, 2011), available athttp://www.sec.gov/news/press/2011/2011-234.htm. Note, the information provided by year in this E-Alert refers to the SEC’s fiscal-year data.

2. SEC Press Release No. 2011-214 (Oct. 19, 2011), available athttp://www.sec.gov/news/press/2011/2011-234.htm.

3. Year-by-Year SEC Enforcement Actions, available at http://www.sec.gov/news/newsroom/images/enfstats.pdf.

4. See Select SEC and Market Data Fiscal 2011, available athttp://www.sec.gov/about/secstats2011.pdf.

5. See NERA Releases 2011 Fiscal Year-End Settlement Trend Report (Jan. 23, 2012), available at http://www.nera.com/83_7590.htm.

6. See “SEC Enforcement Actions: Addressing Misconduct That Led to or Arose from the Financial Crisis,” available at http://www.sec.gov/spotlight/enf-actions-fc.shtml.

7. SEC Press Release No. 2011-234 (Nov. 9, 2011), available athttp://www.sec.gov/news/press/2011/2011-234.htm.

8. See April 27, 2011 letter from Mary Shapiro to Hon. Patrick McHenry, available athttp://s.wsj.net/public/resources/documents/BARRONS-SEC-050411.pdf.

9. SEC v. Deloitte Touche Tohmatsu CPA Ltd., No. 11-00512 (D.D.C.).

10. See http://www.sec.gov/news/newsroom/images/enfstats.pdf.

11. SEC Press Release No. 2011-112, “Tenaris to Pay $5.4 Million in SEC’s First-Ever Deferred Prosecution Agreement (May 17, 2011), available athttp://www.sec.gov/news/press/2011/2011-112.htm.

12. SEC Annual Report on the Dodd-Frank Whistleblower Program – Fiscal Year 2011 (Nov. 2011), available athttp://www.sec/gov/about/offices/owb/whistleblower-annual-report-2011.pdf.

13. Id.

14. U.S. v. Rajaratnam, et al., No. 09-01184 (S.D.N.Y.); SEC v. Galleon Mmgt, et al., No. 09-08811 (S.D.N.Y.).

15. Janus Capital Group, Inc. v. First Derivative Trader, 131 S. Ct. 2296 (2011).

16. SEC v. Kelly, 2011 WL 4431161 (S.D.N.Y. Sept. 22, 2011).

17. Id.

18. SEC v. Daifotis, 2011 WL 3295139 (N.D. Cal. Aug. 1, 2011); SEC v. Landberg, 2011 WL 5116512 (S.D.N.Y. Oct. 26, 2011).

19. SEC v. Citigroup Global Mkts., Inc., No. 11-07387 (S.D.N.Y.).

20. SEC Press Release No. 2011-214 (Oct. 19, 2011), available athttp://www.sec.gov/news/press/2011/2011-214.htm.

21. 2011 WL 5903733 (S.D.N.Y. Nov. 28, 2011).

22. See SEC Press Release No. 2011-265, SEC Enforcement Director’s Statement on Citigroup Case (Dec. 15, 2011), available athttp://sec.gov/news/press/2011/2011-265.htm.

23. SEC v. Koss Corp., et al., No. 11-CV-00991 (E.D. Wis.). On February 2, 2012, Wisconsin federal Judge Rudolph Randa issued an order directing the SEC to “provide a written factual predicate for why it believes the Court should find the proposed final judgments are fair, reasonable, adequate, and in the public interest.” Judge Randa cited Rakoff’s objections to the Citigroup settlement in his order.

24. See Carolina Bolado, US Proposes Tougher Sentences for Securities Fraud, Jan. 19, 2012, available at http://www.law360.com/topnews/articles/301721/us-proposes-tougher-sentences-for-securities-fraud.

© 2012 Andrews Kurth LLP

2012 Launching & Sustaining Accountable Care Organizations Conference

The National Law Review is pleased to bring you information on the Launching & Sustaining Accountable Care Organizations Conference will be a two-day, industry focused event specific to CEOs, COOs, CFOs, CMOs, Vice presidents and Directors with responsibilities in Accountable Care Organizations, Managed Care and Network Management from Hospitals, Physician Groups, Health Systems and Academic Medical Centers.

By attending this event, industry leaders will share best practices, strategies and tools on incorporating cost-sharing measures in a changing healthcare landscape to strengthen the business model and ensure long-term success.

Attending This Event Will Enable You to:
1. Understand the initial outcomes and lessons learned from launching ACOs, with a focus on how to sustain these partnerships in the future
2. Hear from the early adopters of ACOs or similar cost-reducing partnerships and understand their initial operational and implementation challenges.
3. Learn about the final regulations regarding ACOs and their impact on those who want to initiate the formation process
4. Gain a clear understanding of regulatory issues and accreditation processes
5. Conquering initial hurdles for establishing an ACO
6. Gain knowledge from newly-formed ACOs
7. Ensure longevity by establishing a robust long-term plan

Should Investors Buck the Status Quo with LLCs?

The National Law Review recently published an article by Jason B. Sims of Dinsmore & Shohl LLP regarding Investors and LLCs:

Sometimes change is good.

Too often investors and entrepreneurs just stick with the status quo, in terms of structuring a venture capital or private equity investment. One notable example is requiring that target portfolio companies formed as limited liability companies reincorporate into a “C” corporation because…well…that is just how it is always done.

Actually, the decision is a bit more thoughtful than that. One concern that investors have with LLCs is the typical pass-through tax election these entities make to provide economic benefits to the founders during the lean, loss years.That is a valid concern because funds investing in a pass-through vehicle will experience phantom losses and gains that flow to them as a result of the investment, which creates accounting nightmares. Many limited partnership or operating agreements for funds prohibit investments in pass-through vehicles for that reason.

Another reason that investors often prefer corporations, particularly in Delaware, is the generally corporation-friendly laws and the deep body of judicial opinions interpreting those laws create some level of predictability on how bad situations will play out. The laws governing LLCs and the related judicial opinions interpreting those laws are not nearly as robust in Delaware or any other state when compared to dealing with corporations.

Avoiding unnecessary tax issues and enjoying the protection of a wealth of well interpreted corporate laws are both relevant analytical points to consider, but they are not necessarily determinative of the choice of entity question.

Funds can eliminate the issue of phantom losses and gains in two ways. The most obvious is to have the LLC make an election to be taxed as a corporation. That sort of flexibility is one of many attractive features of an LLC. The other method to avoid phantom losses and gains is to set up a corporation, often referred to as a “blocker corp,” to serve as an intermediary between the fund and the LLC. This is something that private equity firms do more than traditional venture funds.

Delaware LLCs are not going to win the battle of legal precedent any time soon. But that doesn’t necessarily matter, because there is one step that the LLC can take that arguably trumps all the general predictability—at least, as far as the investors are concerned. That step, of course, is limiting, or even eliminating, fiduciary duties.

Venture capital or private equity investors often want to insert one (or more) of their own onto the boards of directors for their portfolio companies. That makes perfect sense because the investors have a vested interest in keeping abreast of the progress of their investment. The investors also typically have a wealth of experience that adds tremendous value to the development of the company, when they serve on the board. The rub is that serving on the board opens a Pandora’s Box for liability in the form of fiduciary duties.

In an earlier blog post, Mike DiSanto discussed the impact of fiduciary duties have on investor designees serving the board of directors of a portfolio when that portfolio company completes an inside round of bridge financing. But that isn’t the end of the analysis. Inside-led rounds of equity investment present the same issues, and investors wanting to truly double down on an investment shouldn’t be prevented from doing so from the fear that the valuation and other terms used to consummate the equity round will later be deemed to fall outside the inherent fairness test imposed by Delaware corporate law – remember, that standard is applied using 20/20 hindsight, making it ultra risky.

Of course, there is more. In the unfortunate event of a fire sale of a portfolio company, a board dominated by investor designees faces liability when the preferred holders consume all of the acquisition proceeds due to previously negotiated liquidation preference (full case here). Those same directors face potential liability when the board approves a reverse stock split that has ultimately forces a cash-out of minority stockholders (full case here).

There are lots of other examples, but you get the point. Fiduciary duties generally force investor designees serving on the board of a portfolio company to think about what is in the best interest of the stockholder base as a whole (or sometimes just the common holders), not what is best for the investment fund.

Delaware LLCs have a distinct advantage vis-à-vis corporations when it comes to mitigating potential damages for breaches of fiduciary duties. The Delaware Limited Liability Company Act allows for LLCs to expressly limit, or even eliminate, the fiduciary duties of managers or members by expressly stating that in the operating agreement.

Delaware takes this position because LLCs, unlike corporations, are a creature of contract. Not an organic form of entity that is regulated by well established corporate laws. Delaware has long encouraged the policy of freedom of contract, and that policy extends to the operating agreement of a LLC, even if that includes eliminating fiduciary duties.

It is also important to note that, as a creature of contract, Delaware LLCs have the freedom to establish all the various enhanced rights, preferences and privileges that typically go along with an investor acquiring preferred stock in a corporation. In fact, LLCs are often more flexible when it comes to the ability to tailor those rights into exactly what the parties want, rather than having to conform to existing corporate laws on liquidation or voting rights, for example.

All the pros combine to make Delaware LLCs a pretty attractive choice of entity from the perspective of a venture capital or private equity investor. I think it may be time for private equity funds and venture capital firms to reconsider investing directly into LLCs.

© 2012 Dinsmore & Shohl LLP.

2012 Young Professionals in Energy International Summit

The National Law Review is pleased to bring you information on the 2012 Young Professionals in Energy International Summit:

2012 YOUNG PROFESSIONALS IN ENERGY INTERNATIONAL SUMMIT

April 23-25, 2012
Planet Hollywood Resort & Casino
Las Vegas, Nevada

About the YPE:

Young Professionals in Energy (“YPE”) is the first and only interdisciplinary networking and volunteer organization for people in the global energy industry – a place where bankers can connect with engineers, accountants with geologists and so on. Our mission is to provide a forum for knowledge sharing and camaraderie among future leaders of the energy industry.

The event will feature panel discussions and presentations by YPE members from around the world on such vital energy issues as the world oil supply, shale, renewable energy, career issues and funding new energy projects.

Confirmed speakers include YPE members from the American Petroleum Institute, ExxonMobil, Fulbright & Jaworski L.L.P. the India Ministry of Petroleum and Natural Gas, the Nevada Institute for Renewable Energy Commercialization, Pemex, the University of Southern California and the U.S. Dept. of Commerce.

Highlighting the three-day conference is a keynote speech by Daniel Yergin, author of the best-selling “The Quest: Energy, Security and the Remaking of the Modern World (www.danielyergin.com).

One Individual and 20 Organizations Receive Inaugural Climate Leadership Awards

An article by U.S. Environmental Protection Agency recently was published in The National Law Review regarding Climate Leadership Awards:

WASHINGTON:  the U.S. Environmental Protection Agency (EPA), the Association of Climate Change Officers (ACCO),the Center for Climate and Energy Solutions (C2ES) (formerly the Pew Center on Global Climate Change), and The Climate Registry (TCR) named the winners of the inaugural Climate Leadership Awards. The awards recognize corporate, organizational, and individual leadership in addressing climate change and reducing carbon pollution. From setting and exceeding aggressive emissions reduction goals to reducing the emissions associated with shipping goods, these organizations are improving efficiency, identifying energy and cost saving opportunities, and reducing pollution.

“The inaugural winners of the Climate Leadership Award have demonstrated aggressive greenhouse gas (GHG) management actions and climate-related strategies,” said Daniel Kreeger, ACCO’s Executive Director. “The exemplary climate response exhibited by these organizations is a testament to the visionary leadership and innovation within their executive suite and workforce. The thought and action leadership of these award winners is a model for all companies, government entities, academic institutions and individuals for which to strive to achieve.”

“Corporate leadership is essential to meeting our climate and energy challenges,” said C2ES President Eileen Claussen. “We jo

in EPA in applauding the first winners of the Climate Leadership Award. These companies demonstrate every day that it’s possible to shrink your carbon footprint without compromising your bottom line. Their accomplishments will inspire other companies to act, and will contribute to strong, sensible policies benefiting both our economy and our climate.”

“The Climate Registry congratulates the inaugural Climate Leadership Award winners on their impressive achievements,” said David Rosenheim, the executive director of TCR. “As we transition in the next few years to a low carbon economy, these organizations will undoubtedly reap the benefits of taking aggressive action to reduce their carbon risk.”

Organizational Leadership: Recognizes organizations for exemplary leadership both in their internal response to climate change and through engagement of their peers, competitors, partners, and value chain:

  • IBM
  • San Diego Gas & Electric

Individual Leadership: Recognizes an individual for outstanding efforts in leading an organization’s response to climate change:

  • Gene Rodrigues, Director of Customer Energy Efficiency and Solar at Southern California Edison

Supply Chain Leadership: Recognizes organizations for actively addressing emissions outside their operations:

  • Port of Los Angeles
  • SAP
  • UPS

Excellence in GHG Management (Goal Achievement): Recognizes organizations for aggressively managing and reducing their GHG emissions:

  • Campbell Soup Company
  • Casella Waste Systems
  • Conservation Services Group
  • Cummins Inc.
  • Fairchild Semiconductor
  • Genzyme
  • Hasbro
  • Intel Corporation
  • International Paper
  • SC Johnson

Excellence in GHG Management (Goal Setting): Recognizes organizations for establishing aggressive GHG reduction goals:

  • Avaya
  • Bentley Prince Street
  • Campbell Soup Company
  • Ford Motor Company
  • Gap Inc.
  • Ingersoll Rand

The awards will be presented tonight at the inaugural Climate Leadership Conference in Fort Lauderdale, Fla. The conference will bring together leaders from business, government and academic institutions who are interested in exchanging best practices on how to address climate change while simultaneously running more competitive and sustainable operations.

More information about the Climate Leadership Awards and award winners:http://epa.gov/climateleadership/awards/2012winners.html

© Copyright 2012 United States Environmental Protection Agency

The ICC Rules of Arbitration training

ICC (International Chamber of Commerce) will run two-day practical trainings on the 2012 ICC Rules of Arbitration in Paris, for the first time since their publication

Through this training, you will:

  • acquire practical knowledge of the main changes in the 2012 ICC Rules of Arbitration on topics such as Emergency Arbitrator; Case Management and Joinder, Multi-party/Multi-contract Arbitration and Consolidation
  • apply the 2012 ICC Rules of Arbitration to mock cases, studying them in small working group sessions
  • be provided with valuable insights from some of the world’s leading experts in arbitration including persons involved in the drafting of the New ICC Rules.

The revised version of the ICC Rules of arbitration reflects the growing demand for a more holistic approach to dispute resolution techniques and serves the existing and future needs of businesses and governments engaged in international commerce and investment: The 2012 ICC Rules of Arbitration are the result of a two year revision process undertaken by 620 dispute resolution specialists from 90 countries.

Who should attend?

Arbitrators, legal practitioners and in-house counsel who wish to know more about the 2012 Rules of Arbitration.


Energy & Clean Tech Connections – Recent Washington D.C. Updates

Recently in The National Law Review an article regarding Energy & Clean Tech Federal Updates by Thomas R. Burton, III of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.:

On Capitol Hill, the administration promoted energy-related matters in the third week of February while Congress was in recess for the Presidents’ Day holiday. While speaking to college students in Miami February 23, President Obama criticized the pro-drilling approach of Republicans and the reluctance of the oil and gas industry to relinquish its rights to $4 billion a year in tax breaks, which the President has called for zeroing out in his fiscal year 2013 budget request.

Separately, the administration acknowledged that gas prices are rising faster and earlier this year than ever before and is using this issue to remind Americans that developing clean, alternative energy sources is critical. Also, after two years of speculation, Treasury Secretary Timothy Geithner last week unveiled the administration’s proposal for tax reform. Among other provisions, including reductions in the corporate and manufacturing tax rates, the proposal would make the tax credit for the production of renewable electricity permanent.

©1994-2012 Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.

RIMS 2012 Annual Conference & Exhibition

The National Law Review is pleased to bring you information about the

RIMS 2012 Annual Conference & Exhibition – REGISTRATION IS NOW OPEN!

Join us April 15-18 in Philadelphia


No Boundaries

If your organization is like most, risk is not confined to just one department. Everyone has risk management responsibilities. At RIMS 2012 Annual Conference & Exhibition, there are no limits to the information and resources available to help you and your organization innovatively minimize risks. You’ll find a wide array of educational sessions offering practical strategies, no matter what your business area. Sessions are offered at all experience levels—from beginner to advanced—so you can design an educational experience that fits your needs. And, the Exhibit Hall is jam-packed with solutions–everything you’ll need for the upcoming year.

RIMS ’12 will be held at the Pennsylvania Convention Center located on 1101 Arch Street, Philadelphia, PA 19107.

What’s New!

Continuing Education:  RIMS has partnered with the CEU Institute to administer CE/CEU/CPE credits at RIMS ‘12! Learn more.

Exhibit Hall Pass:  Available for Wednesday, April 18 only. Register now.

Strategic Risk Management (SRM):  New sessions offering concepts and analytic resources to enrich organizational strategic risk decisions. View sessions.

RIMS ’12 Mobile App: Get live event updates, interactive floor maps, exhibitor collateral and more. Coming soon! Check back for details.


The Expansion of the Jurisdiction of the DIFC Courts – United Arab Emirates

The National Law Review posted an article recently by Christopher R. Williams and Marc-Anthony Deeby of Bracewell & Giuliani LLP regarding the Jurisdiction of the DIFC Courts:

Historically, the Dubai International Financial Centre (DIFC) Courts which consist of a Small Claims Tribunal, Court of First Instance and Court of Appeal, have had limited jurisdiction to hear disputes and were initially intended to act solely as a forum to settle civil or commercial disputes between entities registered in the DIFC.  Specifically, parties not registered in the DIFC or who entered into contracts in the UAE without a nexus to the DIFC were not able to opt into the DIFC Courts jurisdiction and would typically be subject to the jurisdiction of the UAE Courts.

Before describing the significance of recent changes in respect of the jurisdiction of the DIFC Courts, it is important to consider the jurisdiction of the UAE courts.In general terms, the UAE Courts have a significant jurisdictional net.

Whilst parties are in theory free to choose (pursuant to the provisions of the UAE Civil Code) the law and governing jurisdiction of their commercial arrangements, in practice this is not the case.

The UAE Courts are incredibly guarded in respect of their jurisdiction. Consequently where commercial or civil disputes with a nexus (whether, for example, by virtue of place of contract performance or the identity of the contracting parties) to the UAE have been subject to foreign law and jurisdiction clauses, and overseas litigation, a party seeking to enforce an overseas judgment in such circumstances in the UAE has typically been frustrated. This is generally a result of the UAE Courts determining that the subject matter of such overseas judgment should have been within the confines of their jurisdiction. Consequently, in such cases, overseas judgments have not been automatically enforced but instead have been subject to an effective “retrial” by the UAE Courts, in effect defeating the purpose of the award of the overseas judgment.

For established international businesses well versed in litigation matters in developed common law jurisdictions such as the US and UK, the UAE court system can be a daunting prospect for the reasons detailed below:

  • The UAE Courts system is civil law based and does not have a developed principal of binding precedent. In turn this can give rise to inconsistent judgments;
  • The entire UAE court process is undertaken using the Arabic language. Importantly, this extends to all documentation related to the claim being translated and interpreted in the Arabic language. Consequently, it is our experience that this leads to issues of legal concepts and principals being “lost in translation”; and
  • From a practical perspective, restrictions on rights of audience in the UAE Courts prevents a significant proportion of international law firms from being able to represent their clients in the court process. As such, for many clients involved in contentious matters in the UAE Courts, there will be an additional cost and administrative burden of having two sets of counsel involved in a dispute.

In light of this context, the recently announced changes in respect of the jurisdiction of the DIFC Courts (as more particularly detailed below) have been broadly welcomed by Dubai’s international legal community.

The New Law – Expanding the Jurisdiction of the DIFC Courts

On 31 October 2011 Law No. 16 of 2011 amending law No. 12 of 2004 (the “Law”) was enacted.

Specifically the Law (under Article 5) grants exclusive jurisdiction to the DIFC Court of First Instance to hear and determine:

  • Civil or commercial claims and actions to which the DIFC or any DIFC Body, DIFC Establishment or Licensed DIFC Establishment is a party;
  • Civil or commercial claims and actions arising out of or relating to a contract or promised contract, whether partly or wholly concluded, finalised or performed within the DIFC or will be performed or is supposed to be performed within the DIFC or will be performed or is supposed to be performed within the DIFC pursuant to express or implied terms stipulated in the contract;
  • Civil or commercial claims and actions arising out of or relating to any incident or transaction which has been wholly or partly performed within the DIFC and is related to DIFC activities;
  • Appeals against decisions or procedures made by the DIFC Bodies where DIFC Laws and DIFC Regulations permit such appeals; and
  • Any claim or action over which the Courts have jurisdiction in accordance with DIFC Laws and DIFC Regulations.

In addition, the Court of First Instance may hear and determine any civil or commercial claims or actions where the parties agree in writing to file such claim or action with it whether before or after a dispute arises, provided always that such agreement is made pursuant to clear and express provisions.

DIFC Courts – The Litigation Benefits

The passing of the Law means that parties no longer require a nexus with the DIFC in order to utilise the DIFC Courts. Now parties can freely contract to have their civil and commercial disputes heard by the DIFC Courts, save where jurisdiction vests with an alternative competent authority. For example an attempt to circumvent the jurisdiction of the specially created Commercial Agency Committee and UAE Courts in respect of a dispute relating to a UAE commercial agency agreement registered pursuant to the UAE’s Commercial Agency Law would not be binding.

The principal benefits of the DIFC Courts are that:

  • The court system is based on common law, with binding precedent and procedures which borrow heavily from the English Civil Procedure Rules;
  • Court proceedings are undertaken in the English language;
  • International lawyers registered with the DIFC Courts can appear before the courts and local counsel are not required; and
  • The system allows a successful litigant to claim their legal fees from the losing party.  By comparison in the UAE Courts, it is very rare for legal fees to be awarded to a successful litigant by a judge.

On the binding precedent point, it is clear that as the DIFC Court’s system matures so will its body of case law. In the interim the DIFC Court’s judiciary has the ability to call on English common law precedent to help determine DIFC Law governed matters.

Enforcement of DIFC Judgments in the UAE

The Law clearly specifies that a DIFC Court judgment be automatically enforced in the Dubai Courts. Whilst there was initial concern in respect of whether a DIFC Court’s judgments would be enforced in neighbouring emirates, recent announcements seem to have quelled such concern.

Memoranda of understanding with respect to the recognition and enforcement of DIFC Court’s judgments have been signed with the courts in Ras Al Khaimah and the UAE Federal Ministry of Justice. We further understand that the DIFC Courts are in discussions with the Abu Dhabi Courts in respect of entering into a similar recognition and enforcement arrangement. With the same in mind, we will be keeping a “watching brief” on the progress of this issue and will provide additional updates as required.

Conclusion

From an international standpoint, the extension of the jurisdiction of the DIFC Courts particularly for international businesses contracting in the UAE is a welcome development, providing a common law alternative to the current civil law courts system.

In addition it is a desirable expansion of the international dispute resolution forums in the UAE and may prove an interesting alternative to the DIFC’s arbitration centre.

Notwithstanding the distinct positives flowing from the Law, it is our view that the success of the DIFC Courts from a pure UAE dispute resolution perspective, will very much be determined by the willingness of UAE nationals and Emirati controlled businesses consenting to the resolution of commercial and civil disputes other than through the UAE Courts. As such, only time will tell as to whether these changes will have a marked effect on the local dispute resolution market.

© 2012 Bracewell & Giuliani LLP

Labor & Employment Law Forum 2012

EVENT HAS BEEN POSTPONED – new dates soon!

 

 

 

The National Law Review is pleased to bring you information about the upcoming

Labor & Employment Law Forum

March 21-22, 2012
Hyatt Regency Washington on Capitol Hill
Washington, DC

The Labor & Employment Law Forum provides a unique opportunity for retail executives involved with labor and employment issues to come together to hear from legal experts, fellow retailers and government insiders on the critical employment issues you grapple with every day.

Ensuring compliance with case law and new regulations on employment and labor issues is increasingly difficult for retailers. Issues involving wage and hour, bargaining units, social media usage, and more are continuously changing the retail workplace and your relationship with and obligations to your employees. Through focused sessions and strategic networking, you will gain the tools to address the myriad workplace issues your company faces.