Category: Corporate law

“Hello, Newman” Government Continues to Litigate Reversed Insider Trading Convictions

Barnes & Thornburg LLP Law Firm

The U.S. Attorney for the Southern District of New York, Preet Bharara, has decided not to go down without a fight. Following a Second Circuit panel’s reversal of Bharara’s signature achievement, the insider-trading convictions of former hedge fund managers Todd Newman and Anthony Chiasson, the U.S. Attorney’s office has petitioned the court for rehearing and rehearing en banc. The Securities and Exchange Commission has also weighed in on the U.S. Attorney’s side, arguing in an amicus brief that the panel seriously erred in its decision. Meanwhile, in other cases, particularly outside the Second Circuit, the Justice Department, and the SEC have argued strenuously that the Second Circuit’s panel decision should not be followed.

In the Second Circuit, the battle lines are being drawn. Bharara’s office has asked both the panel and the full Second Circuit to rehear the case. The US Attorney’s office has argued that the panel erred by imposing two requirements that are purportedly contrary to law– first, that a tipper act for a “personal benefit” of financial consideration, or something at least akin to monetary gain; and second, that the tippee know that the tipper supplying the inside information acted for such a benefit. The SEC has concurred with this assessment, elaborating on Newman’s conclusion that evidence of friendship between tipper and tippee is insufficient to prove the “personal benefit” necessary for tipping liability. The Commission contends that this contradicts Dirks v. SEC, the Supreme Court’s seminal insider trading decision. Both the U.S. Attorney and the SEC contend that, if Newmanremains the law, it will seriously threaten the integrity of the securities markets, and government regulators will be dramatically limited in their ability to prosecute “some of the most common, culpable, and market-threatening forms of insider trading.”

In opposition, Newman and Chiasson, along with various law professors, the criminal defense bar, and even Marc Cuban, have argued that the Second Circuit panel got it right when it imposed an important, objective outer bound to an otherwise amorphous illegal activity. The defendants even engaged in ad hominem criticism of Bharara, analogizing him to a “Chicken Little” complaining that the sky is falling, or more precisely, a “petulant rooster whose dominion has been disturbed.” Those supporting the opinion assert that any perceived difficulty created by the decision can, and should, be rectified by Congress.

Even as the Newman case continues forward, its repercussions are being felt within the Second Circuit and beyond. In the Southern District alone, at least a dozen defendants, who were convicted or pleaded guilty underpre-Newman law, have argued that their cases need to be revisited in light of Newman. No court yet has agreed with that argument, but most of these motions remain pending.

Outside the Second Circuit, the Government is looking to ring-fence the Newman decision and limit its applicability elsewhere. Federal prosecutors, for example in North Carolina, have argued that Newman is not the law in the Fourth Circuit and therefore should not be followed. Meanwhile, defendants in other jurisdictions are invokingNewman in pending, and even resolved, insider trading matters, both civil and criminal.

Defendants are even arguing Newman’s applicability within the SEC’s administrative courts – with success. In In re Peixoto, an SEC administrative proceeding related to Herbalife, the Commission voluntarily dropped its case against Peixoto after Newman. Other cases in the agency’s courts (including against SAC founder Steven Cohen) remain on holding pending final resolution of Newman. And in In re Ruggieri, the administrative law judge said that he would require the SEC to demonstrate the Newman standard of “personal benefit.”

Clearly, the Newman saga has not reached its conclusion, but the fall-out already demonstrates what a momentous decision the Second Circuit panel made.

ARTICLE BY

Brian E. Casey
OF
Barnes & Thornburg LLP

“Hello, Newman" Government Continues to Litigate Reversed Insider Trading Convictions

Barnes & Thornburg LLP Law Firm

The U.S. Attorney for the Southern District of New York, Preet Bharara, has decided not to go down without a fight. Following a Second Circuit panel’s reversal of Bharara’s signature achievement, the insider-trading convictions of former hedge fund managers Todd Newman and Anthony Chiasson, the U.S. Attorney’s office has petitioned the court for rehearing and rehearing en banc. The Securities and Exchange Commission has also weighed in on the U.S. Attorney’s side, arguing in an amicus brief that the panel seriously erred in its decision. Meanwhile, in other cases, particularly outside the Second Circuit, the Justice Department, and the SEC have argued strenuously that the Second Circuit’s panel decision should not be followed.

In the Second Circuit, the battle lines are being drawn. Bharara’s office has asked both the panel and the full Second Circuit to rehear the case. The US Attorney’s office has argued that the panel erred by imposing two requirements that are purportedly contrary to law– first, that a tipper act for a “personal benefit” of financial consideration, or something at least akin to monetary gain; and second, that the tippee know that the tipper supplying the inside information acted for such a benefit. The SEC has concurred with this assessment, elaborating on Newman’s conclusion that evidence of friendship between tipper and tippee is insufficient to prove the “personal benefit” necessary for tipping liability. The Commission contends that this contradicts Dirks v. SEC, the Supreme Court’s seminal insider trading decision. Both the U.S. Attorney and the SEC contend that, if Newmanremains the law, it will seriously threaten the integrity of the securities markets, and government regulators will be dramatically limited in their ability to prosecute “some of the most common, culpable, and market-threatening forms of insider trading.”

In opposition, Newman and Chiasson, along with various law professors, the criminal defense bar, and even Marc Cuban, have argued that the Second Circuit panel got it right when it imposed an important, objective outer bound to an otherwise amorphous illegal activity. The defendants even engaged in ad hominem criticism of Bharara, analogizing him to a “Chicken Little” complaining that the sky is falling, or more precisely, a “petulant rooster whose dominion has been disturbed.” Those supporting the opinion assert that any perceived difficulty created by the decision can, and should, be rectified by Congress.

Even as the Newman case continues forward, its repercussions are being felt within the Second Circuit and beyond. In the Southern District alone, at least a dozen defendants, who were convicted or pleaded guilty underpre-Newman law, have argued that their cases need to be revisited in light of Newman. No court yet has agreed with that argument, but most of these motions remain pending.

Outside the Second Circuit, the Government is looking to ring-fence the Newman decision and limit its applicability elsewhere. Federal prosecutors, for example in North Carolina, have argued that Newman is not the law in the Fourth Circuit and therefore should not be followed. Meanwhile, defendants in other jurisdictions are invokingNewman in pending, and even resolved, insider trading matters, both civil and criminal.

Defendants are even arguing Newman’s applicability within the SEC’s administrative courts – with success. In In re Peixoto, an SEC administrative proceeding related to Herbalife, the Commission voluntarily dropped its case against Peixoto after Newman. Other cases in the agency’s courts (including against SAC founder Steven Cohen) remain on holding pending final resolution of Newman. And in In re Ruggieri, the administrative law judge said that he would require the SEC to demonstrate the Newman standard of “personal benefit.”

Clearly, the Newman saga has not reached its conclusion, but the fall-out already demonstrates what a momentous decision the Second Circuit panel made.

ARTICLE BY

Brian E. Casey
OF
Barnes & Thornburg LLP

Affordable Care Act Issues for U.S. Expatriates

By now most employers are beginning to come to terms with the Affordable Care Act coverage mandates and reporting requirements that apply to the group health coverage of their U.S. workforce. For global businesses, though, the problems do not stop at the U.S. border. These companies must also determine how ACA affects U.S. citizens and lawful permanent residents working abroad.

Most companies face four major questions concerning health coverage for U.S. expatriates:

  • Must they provide group health coverage to employees working abroad in order to satisfy the employer mandate?

  • Must their employees working abroad maintain a minimum level of health coverage in order to satisfy the individual mandate?

  • If an individual is covered by a foreign group health plan or insurance policy, does that coverage qualify as minimum essential coverage that satisfies the employer and individual mandates?

  • If an employer provides group health coverage to U.S. citizens or residents working abroad, is that coverage subject to the same requirements that apply to employer health coverage in the U.S.?

When Are Expatriates Subject to the Employer Mandate?

An employer with at least 50 full-time employees must offer minimum essential health coverage to substantially all of its full-time employees (and their dependents) in order to avoid an excise tax. For 2015, “substantially all” means 70% of the employer’s full-time workforce; starting in 2016, it means 95% of the employer’s full-time workforce. An employee who works on average at least 30 hours a week is considered to be a full-time employee. (For more information on the employer mandate, see IRS Proposes Shared Responsibility Tax Rules for Employers and Top Ten Things to Know about the Final Shared Responsibility Regulations.)

Service Outside the U.S. When an employer determines which employees are “full-time employees” covered by the employer mandate, the employer disregards hours of service performed outside the U. S. to the extent that the related compensation is foreign-source income. The “source” of compensation ordinarily is the location where the work is performed. Accordingly, for example, if a U. S. company has a substantial foreign branch, the U. S. company generally is not required to offer health coverage to employees working at the foreign branch in order to satisfy the employer mandate. This rule applies regardless of whether the employees working outside the U.S. are U.S. citizens or foreign nationals.

International Transfers. Complications can arise when an employer transfers employees between U.S. and foreign positions. Many employers rely on a lookback rule to determine an employee’s status as a full-time employee: if the employee works full-time in the U. S. during a measurement period, the employee is considered to be a full-time employee throughout a subsequent stability period lasting up to 12 months. As a result, an employee who works full-time in the U. S. during the measurement period might retain his or her status as a full-time employee for up to 12 months after the employee is transferred to a foreign affiliate.

The regulations include special rules to address the problem of international transfers. The employer may treat an employee transferred abroad as having terminated employment (so that the employee is no longer a “full-time employee” covered by the employer mandate) if the transfer meets two conditions: the employee is expected to remain in the foreign position indefinitely or for at least 12 months, and substantially all of the employee’s compensation will be foreign-source income. (In the reverse situation, when an employee based outside the U.S. on an assignment expected to last indefinitely or for at least 12 months transfers back to the U.S., the employer generally may treat the employee as a new hire.)

When Are Expatriates Subject to the Individual Mandate? 

U.S. citizens and U.S. residents generally must maintain minimum essential health coverage for themselves and their dependent children each month or pay an excise tax. U.S. citizens and residents working outside the U.S. are deemed to have the requisite health coverage for a given month, however, if the month falls in a period during which the individual meets one of three conditions:

  • The individual is a U.S. citizen whose tax home is a foreign country, and the individual has been a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire taxable year; or

  • The individual is a U.S. citizen or resident whose tax home is a foreign country, and the individual is present in a foreign country for at least 330 full days during a 12-month period; or

  • The individual is a bona fide resident of a U.S. possession (Guam, American Samoa, the Northern Mariana Islands, Puerto Rico, or the Virgin Islands).

The exemption from the employer mandate and the exemption from the individual mandate do not completely overlap. As a result, the employer mandate might require an employer to offer minimum essential coverage to an expatriate employee who is already deemed to have minimum essential coverage for purposes of the individual mandate. Conversely, the employer mandate might not apply to an expatriate employee who is nevertheless required to maintain minimum essential coverage in order to satisfy the individual mandate. Employers will have to think through these issues carefully and communicate them accurately to their expatriate employees.

When Is Foreign Coverage Minimum Essential Coverage? 

A U.S. citizen or resident working abroad often will be covered by a health insurance arrangement maintained by the foreign office where he or she works. To the extent that the employee is subject to the employer mandate or the individual mandate, the question will arise whether this coverage constitutes “minimum essential coverage” that satisfies the mandates.

Self-Insured Arrangements. A self-insured group health plan offered by an employer to an employee qualifies as minimum essential coverage regardless of where the plan is located. Accordingly, if an expatriate is covered by a self-insured group health arrangement maintained by a foreign employer, the arrangement will satisfy both the employer mandate and the individual mandate.

Insured Arrangements. An insured employer group health plan also qualifies as minimum essential coverage if the insurance is offered in the group insurance market within one of the 50 states or the District of Columbia, even if the policy covers U. S. expatriates. In contrast, however, an employer group health plan that is insured by a policy issued outside the U. S. market must meet a complicated set of requirements in order to qualify as minimum essential coverage.

HHS issued informal guidance in 2013 stating that foreign group health insurance would qualify as minimum essential coverage with respect to a covered individual for a given month as long as the insurer was regulated by a foreign government and the covered individual either (1) was physically absent from the U.S. for at least one day in the month, or (2) if physically present in the U. S. for the entire month, was covered while in expatriate status. In 2014 the agency proposed to modify this rule and apply it to foreign self-insured plans as well as foreign insured plans; but the proposal was not included in the final regulation.

The informal guidance states that the employer must notify all covered U.S. citizens and U.S. nationals that the plan constitutes minimum essential coverage, and must satisfy IRS reporting requirements under Internal Revenue Code section 6055 for those individuals, even if they are not subject to the individual mandate. (The term “U.S. nationals” includes, in addition to U.S. citizens, certain persons born in outlying possessions of the U.S. and their descendants.) The notice and reporting requirements are easily overlooked by a foreign employer that is not otherwise subject to the Affordable Care Act.

New Legislation. The Expatriate Health Coverage Clarification Act of 2014 (the “Act”), enacted in December 2014 as Division M of the Consolidated and Further Continuing Appropriations Act (H.R. 83), states that any plan that qualifies as an “expatriate health plan” is deemed to provide minimum essential coverage. Like HHS’s informal guidance, the Act requires the sponsor of an expatriate health plan to meet the IRS reporting requirements for minimum essential coverage under Internal Revenue Code section 6055, and it also requires a large employer to satisfy the reporting requirements under Internal Revenue Code section 6056. The Act permits expatriate health plan sponsors to furnish participants with electronic versions of the section 6055 and 6056 statements as long as a participant has not explicitly refused electronic delivery.

In most cases, an employer group health plan will qualify as an “expatriate health plan” for purposes of the Act only if substantially all of the covered employees are either (1) employees who work outside the U.S. for at least 180 days in a 12-month period that overlaps the plan year, or (2) employees who are temporarily assigned to the U.S. for job-related reasons and who receive other multinational benefits (such as tax equalization or moving allowances). Foreign nationals who reside in their home country are ignored for purposes of applying the “substantially all” test. Accordingly, for example, a foreign employer that maintains a group health plan in its home country cannot satisfy the test solely by reason of the fact that its entire local workforce meets the 180-day condition. Instead, substantially all of the expatriates covered by the plan must satisfy the test without taking local citizens into account. If the plan meets the “substantially all” test with respect to covered expatriates, however, it can qualify as an “expatriate health plan” even though it also covers a large proportion of local citizens.

In addition to covering eligible expatriates, a group health plan must meet a number of substantive requirements in order to qualify as an expatriate group health plan under the Act. For example, the plan must:

  • provide significant health coverage (hospitalization, outpatient facility, physician, and emergency services) that is not limited to excepted benefits such as dental and vision coverage;

  • satisfy the applicable pre-ACA requirements for health plans, such as HIPAA nondiscrimination, genetic nondiscrimination, minimum maternity stay, and mental health parity requirements;

  • cover at least 60% of the costs covered under a typical large group health plan;

  • cover dependent children until they turn age 26 if the plan provides dependent coverage; and

  • be insured, or if self-insured be administered, by an insurer or administrator that is licensed to sell insurance in more than two countries and has a global presence prescribed by the Act (such as maintaining network agreements with providers in eight or more countries).

Under the Act, the term “expatriate health plan” applies both to a group health plan and to health insurance coverage issued in connection with a group health plan. Accordingly, U. S.-insured, foreign-insured, and self-insured plans can qualify as expatriate health plans if they meet the Act’s requirements.

Effective Date. The Act applies only to expatriate health plans issued or renewed on or after July 1, 2015. When the Act becomes applicable, it is not clear how it will coordinate with existing guidance concerning expatriate health plans. It is likely that the regulatory agencies will address this point in the coming months.

At present, it appears that all U.S.-based self-insured employer group health plans and insured plans covered by insurance issued in the U.S. group market will continue to qualify as minimum essential coverage whether or not they meet the definition of “expatriate health plans” under the Act. As explained in the next section, the bigger question for these plans is whether they can avoid some of ACA’s substantive requirements and fees by qualifying as expatriate health plans.

Which ACA Provisions Apply to Expatriate Plans?

Employers often provide health coverage to U.S. expatriates under a foreign health plan maintained by the local business where they work, or under a special group health policy for expatriates and third-country nationals issued outside the U.S. insurance market by a U. S. or foreign issuer. In either case, the plan or policy must comply with local rules governing group health coverage. In some cases, these rules are incompatible with ACA’s mandates; and foreign insurers often are not equipped to comply with ACA’s intricate reporting and participant disclosure requirements.

A plan maintained outside the U.S. for employees substantially all of whom are nonresident aliens is exempt from ERISA’s substantive requirements, including the group health plan mandates added by the Affordable Care Act. Accordingly, an employer that includes a few U. S. expatriates in a foreign group health plan that predominantly covers local nationals generally does not have to worry about compliance with ERISA. Unfortunately, however, the parallel group health plan mandates in the Internal Revenue Code do not include a similar exemption for foreign plans. As a result, an employer that is subject to tax in the U. S. might incur substantial excise taxes if it fails to comply with applicable group health plan mandates.

The regulatory agencies issued temporary guidance in FAQs XIII and FAQs XVIII exempting some expatriate plans from most of ACA’s mandates through the end of 2016. The exemption applies only to insured plans with enrollment limited to primary insureds who live outside their home country or outside the United States for at least 6 months during a 12-month period and their dependents. The temporary guidance provides no relief for self-insured plans. In order to qualify for the exemption, an insured plan must comply with a number of pre-ACA mandates, such as the mental health parity provisions, the HIPAA nondiscrimination requirements, the ERISA claims procedures, and ERISA reporting and disclosure obligations.

The Act expanded the definition of “expatriate health plans” to include self-insured plans, and it made the temporary relief permanent. If an insured or self-insured plan qualifies for relief under the Act, it is broadly exempt from most ACA mandates and fees.

The Act also modified the requirements that an insured or self-insured group health plan must meet in order to qualify for the relief, as described in the preceding section. For example, unlike the temporary guidance, the Act requires a group health plan to comply with certain ACA requirements—such as the requirement to provide minimum-value coverage, the requirement to cover dependents until age 26, and the reporting and disclosure obligations in Internal Revenue Code sections 6055 and 6056—in order to qualify for the relief. In addition, the Act provides that expatriate plans will be subject to the so-called Cadillac tax on high-cost health coverage (effective in 2018) with respect to employees assigned to work in the U.S.

Multinational employers will wish to evaluate the requirements for relief under the Act between now and July 1 and to consider whether to revise and re-issue plans covering U.S. expatriates so that they will qualify for relief under the Act.

ARTICLE BY

Amy N. Moore
OF
Covington & Burling LLP

Recent Trends in ESOP Litigation — Employee Stock Ownership Plan

There has been a lot of attention in the world of employee ownership plans to the 2014 Supreme Court Decision in Fifth Third Bancorp v. Dudenhoeffer. In that case, the Court ruled that “the law does not create a special presumption favoring ESOP (Employee Stock Ownership Plan) fiduciaries. Rather, the same standard of prudence applies to all ERISA fiduciaries, including ESOP fiduciaries, except that an ESOP fiduciary is under no duty to diversify the ESOP’s holdings.” This ruling overturns the so-called Moench rule that has been applied to plan fiduciaries for certain 401(k) plans investing in company stock and ESOPs. Moench gave a presumption of prudence to plan fiduciaries unless they knew or should have known the company was in dire financial circumstances.

As important as this ruling is, it actually has very little if any impact on the vast majority of ESOPs, over 95% of which are in closely held companies. The ruling is far more important for public companies with 401(k) plans or ESOPs that offer company stock as an investment choice.

First, it is important to distinguish between a statutory ESOP and what courts came, by a rather tortured logic, to call ESOPs—namely any defined contribution plan that had company stock in it. ESOPs were created as part of ERISA in 1974 and given not just the right but the requirement to invest primarily in employer securities. ESOPs were specifically created to encourage employers to share ownership with employees, and over the years Congress has given these plans a number of special tax benefits. Because fiduciaries are required to invest primarily in employer stock, standard fiduciary obligations concerning diversification in retirement plans would be impractical. The Moench presumption was created in a case involving a statutory ESOP.

The large majority of “stock drop” cases, however, have not involved statutory ESOPs, but 401(k) plans that either allowed employees to invest in company stock and/or matched in company stock. Some of these plans required fiduciaries to offer company stock; others made it optional. Defense attorneys argued that these plans were actually “ESOPs” too and were subject to the Moench presumption. Most district and circuit courts bought that argument, although some applied it only when company stock was required. That, I think, was unfortunate and inappropriate. 401(k) plans were never meant to be vehicles for sharing corporate ownership. They are intended to be safe, cost-effective retirement plans. ESOPs are a specific statutory creation with a specific set of rules and purposes.

When reading the Supreme Court decision, as well as the arguments made before the Court, it is also clear that the justices were thinking entirely of public companies. There is virtually no discussion of ESOPs in closely held companies, and the key tests that the Court now requires plaintiffs to meet in stock drop cases largely do not apply to privately held companies. Since the original Moench decision in 1995, we at the National Center for Employee Ownership have only found two cases in closely held companies that were decided even in part based on that presumption.

The Court’s decision in the Fifth Third case laid out three key hurdles for plaintiffs to overcome to prevail. The first states that it is insufficient to argue that fiduciaries should be able to outguess the market based on publicly available information. The second issue is whether decisions to sell company stock in light of inside information could be prudently taken in light of their potential impact on the prices of company stock. Fiduciaries are also not obligated to violate securities laws. Finally, the Court said plaintiffs must allege a reasonable alternative course of action.

In ESOPs in closely held companies, fiduciaries have few options that could form the basis for plaintiffs arguing a plausible course of action. First, the law requires that ESOPs be primarily invested in company stock. Second, the only liquidity options are a company buy-back of shares, which is probably impractical if the company is already in financial distress, or a sale of the company. But a fire sale like that would mean an even lower price for plan participants. As noted in more detail below, none of the presumption of prudence cases has concerned closely held companies, probably because of these issues. Also note that Dudenhoeffer distinguished between relying on inside information to sell company stock (which it classified as illegal insider trading and thus not required by the duty of prudence) and refraining from buying more company stock (which might be a fiduciary violation). The purchase of shares by an ESOP is already subject to substantial statutory and case law requirements, and this decision is unlikely to change the way these cases are contested.

As a result of all this, the prudence presumption has so far not been an issue for closely held ESOP companies in court, and it is likely to continue not to be as plaintiffs would have a hard time indicating what fiduciaries should have done. Instead, cases will continue to focus, as they have been before where there are alleged problems, on the initial sale price of the shares of the ESOP, which is determined by the trustee and relies on an outside appraiser. It is possible that the Dudenhoeffer decision may embolden the plaintiffs’ bar to initiate more lawsuits, but we would expect that to continue to be primarily in public companies.

Beyond Fifth Third—ESOPs Law for the 97%

Valuations

The 97% of ESOP companies that are closely held will not be much affected by the Supreme Court decision, but the last 25 years of litigation on ESOPs reveals some important trends that should be considered.

In an analysis by the NCEO of the 224 decisions courts have made on ESOPs in closely held companies between 1990 and 2014, we found that many of the suits involved plan management issues, such as failing to make distributions. The most significant issues, however, concerned valuation, indemnification, and fiduciary duties.

The valuation decisions are mixed. Courts have focused more on process than outcome. Some processes are clearly unacceptable, such as not hiring an independent appraiser or influencing an appraiser’s report. Several key best practices have emerged. A recent settlement between the Department of Labor and GreatBanc Trust in a valuation case (Perez v. GreatBanc Trust Co., 5:12-cv-01648-R-DTB (C.D. Cal., proposed settlement agreement filed June 2, 2014) set out terms for GreatBanc to follow in future engagements that does a good job of summarizing the trends in the courts.

Key points in the settlement included:

  • Trustees must be able to show that they vetted the independence and qualifications of appraisers carefully.
  • Trustees must show that they have assessed the reasonableness of financial projections given to the appraiser. Some valuation advisors include disclaimers in their engagement agreements that the DOL reads as too broad, in that read literally the valuation advisor can rely on any information it receives from the plan sponsor company without inquiring as to its reasonableness, no matter how unreasonable the information. The use of these disclaimers will not absolve the trustee of responsibility and the trustee should document how the appraisal firm has analyzed just how reliable projections are.
  • The trustee should consider how plan provisions, such as those relating to puts, diversification, and distribution policies, might affect the plan sponsor’s repurchase obligation.
  • The trustee should consider the company’s ability to service the debt if projections are not met.
  • Documentation should be detailed. While documentation of the valuation analysis may appear to be burdensome, making the effort to document the valuation review process at the time of the transaction can only benefit the valuation advisor and the trustee in later years.

Indemnification

The other significant legal development for closely held company ESOPs in recent years concerns indemnification, ironically also in the case involving Sierra Aluminum and GrratBanc. In Harris v. GreatBanc Trust Co., Sierra Aluminum Co., & Sierra Aluminum ESOP, No. 5:12-cv-01648-R (C.D. Cal. Mar. 15, 2013), a district court ruled that GreatBanc could be indemnified for its role as the ESOP fiduciary. The decision is significant in that it occurred in the one circuit (the Ninth) that has taken the position that indemnification should not be allowed, especially in a 100% ESOP.  In Johnson v. Couturier, 572 F.3d 1067 (9th Cir. 2009), the court ruled that ESOP plan assets were not distinguishable from company assets. If plaintiffs prevailed but the company’s indemnification had paid out millions in legal fees to defendants (as was the case here), the plaintiffs would have a very hollow victory. In that same circuit, in Fernandez et al. v. K-M Industries Holding Co., No. C 06-7339 CW (N.D. Cal. Aug. 21, 2009), a court that an indemnification agreement did not apply in the case of a 42% ESOP because if alleged ERISA violations concerning an improper valuation were sustained, the indemnification would harm the value of participant stock.

These decisions seemed to make indemnification largely moot, but in the GreatBanc case the court ruled that regulations (29 C.F.R. § 2510.3-101(h)(3)) of ERISA Section 410 state that in the case of an ESOP, the plan’s assets and the company assets are treated as separate.  In Couturier, the Harris court said, the company had already been liquidated and was thus no longer an operating company. The court also distinguished this case from Couturier in that in Couturier, plaintiffs had already shown likelihood to prevail on fiduciary charges, something that could not be said of this case. Finally, the Couturier case involved no exceptions for breaches of fiduciary duty, as was the case here, but only for “gross negligence” and “willful misconduct.”

Other courts in other circuits have not weighed in on this issue. Certainly a good argument can be made that if indemnification means that plaintiffs will lose a substantial amount of a settlement agreement because there is no money to pay, it seems compelling indemnification should not apply. That would not be the case if the company had other available assets. In any event, ESOP advisors now caution clients that indemnification may have limited value and that they should rely primarily on adequate fiduciary insurance.

Conclusion

In recent years, the Department of Labor has been more aggressive in pursuing what it perceives as valuation abuses in ESOP companies. While there have been a few more court cases and settlements per year than normal, a typical year finds only a handful of these out of the 6,500 or so ESOPs in closely held companies. A comprehensive study by the NCEO found that the default rate on leveraged ESOPs (those that borrow money to buy stock, which most do) is just .2% per year, way below other LBOs. If valuations really were routinely excessive, this number would be higher as the debt burden would be unrealistic.

Other ESOP litigation has been relatively mundane, focusing either on administrative errors or the occasional fraudulent behavior. Indemnification could become a more important issue, but companies can (and should) resolve that with proper fiduciary insurance.

The future for company stock in public company retirement plans, mostly 401(k) plan, is far less certain. There has been a steady decline in how many companies offer this and how much those that do rely on it.  Even for advocates of employee ownership, however, this is not necessarily a bad thing. Good ESOP companies have secondary diversified retirement plans—in fact, ESOP companies are more likely to have a diversified retirement plan than other companies are to have any plan. That is a best practice we strongly encourage.

ARTICLE BY

Corey Rosen
OF
The National Center for Employee Ownership

SEC Charges Chilean Citizens With Insider Trading Concerning Tender Offer for Chilean

Katten Muchin Law Firm

The Securities and Exchange Commission recently filed suit in the US District Court for the Southern District of New York, alleging that defendants, Juan Cruz Bilbao Hormaeche and Thomas Andres Hurtado Rourke, both Chilean citizens, illegally traded on material non-public information that Abbott Laboratories was interested in purchasing CFR Pharmaceuticals, S.A., a pharmaceutical company headquartered in Chile.

According to the complaint, on March 10, 2014, CFR’s Board of Directors met to consider Abbott’s offer to purchase CFR; Bilbao, then a member of the board, participated by telephone. After the meeting, between March 12, 2014 and May 7, 2014, Bilbao allegedly directed his business associate, Hurtado, to place trades purchasing more than $14 million in American Depository Shares (ADSs) of CFR in a US brokerage account maintained in the name of a British Virgin Islands company for the benefit of Bilbao. The SEC further alleges that based on knowledge of confidential information, Hurtado purchased 35,000 ADSs of CFR for $707,710. On May 16, 2014, Abbott announced a definitive agreement to acquire CFR, and on September 23, 2014, Abbott completed the tender offer. According to the SEC, Bilbao tendered his ADSs to Abbott on or before September 23, 2014, and saw a profit of more than $10.1 million. The SEC further alleges Hurtado tendered his ADSs to Abbott for a profit of about $495,000.

The SEC sued defendants for illegally trading on insider information. The SEC alleges that the nexus to the United States is the initial purchase of the ADSs through US-based brokerage accounts. The SEC seeks an order freezing defendants’ assets, an order requiring defendants to repatriate funds obtained from the alleged illegal activities, a final judgment that defendants violated the securities laws, and an order directing defendants to disgorge any illegal gains and to pay civil penalties.

Complaint, SEC v. Hormaeche, No. 14-cv-10036-RJS (S.D.N.Y. Dec. 22, 2014).

ARTICLE BY

Emily Stern
Zachary D. Denver
OF
Katten Muchin Rosenman LLP

GoPro Announces Plans to Sell Millions In Stock

McBrayer NEW logo 1-10-13

Stock sell-off, a term which our readers may have come across before, refers to the selling of securities by a company, whether stocks or bonds or other commodities. According to Investopedia.com, sell-offs can occur for a variety of reasons, such as after a less than satisfactory earnings report or when oil prices significantly increase. A sell-off can be a smart way for companies to deal with uncertainties in the stock market, depending on how they are handled.

Recently, GoPro—the company famous for designing and manufacturing high-definition personal cameras—announced that it would be selling off $100 million worth of stock in order to free up capital to expand its business. The company went public in June, and it is not uncommon for companies to sell stock after a successful initial public offering, particularly when there is still a need to raise capital to launch the company to greater success.

In addition to the $100 million sell-off, existing shareholders are going to sell off $700 million. In total, the sell-off could increase the company’s capital by over 40 percent. That money will reportedly be going toward investment in human capital, technology, as well as infrastructure and potential acquisitions.

There are a variety of ways companies can utilize sell-offs to better position themselves in the marketplace. Regardless of the approach used, it is critical that the sell-off is situated in the context of a long-term plan for the company’s success. Companies considering a sell-off should, naturally, work with an experienced legal team to ensure the success of their efforts.

Source: San Jose Mercury News, “GoPro plans $100 million cash boost with stock sale,” Heather Somerville, Nov. 10, 2014.

ARTICLE BY

Business and Corporate Law Practice Group
OF
McBrayer, McGinnis, Leslie and Kirkland, PLLC

United Kingdom: A Reminder About Careful Drafting of Confidentiality Clauses for Shareholders

Katten Muchin Law Firm

The recent decision by the High Court of England and Wales (Chancery Division) in Richmond Pharmacology Limited (Company) v. Chester Overseas Limited, et al. underscores the need to carefully draft confidentiality clauses and to incorporate specific exceptions where these exceptions are reasonably foreseeable in the future. The case involved a shareholders agreement which contained a standard confidentiality clause requiring the parties to treat as strictly confidential all commercially sensitive information concerning the company subject to certain prescribed exceptions. One of the exceptions allowed disclosure to a professional advisor provided that the advisor agrees to be bound by a similar confidentiality obligation. Unsurprisingly, however, there was no specific exception allowing disclosures to a potential third-party buyer. Under the terms of the clause as drafted, the shareholder was required to obtain consent to make the disclosures. 

Over time Chester Overseas Limited decided to sell its shares and engaged a corporate finance advisor (Advisor) to assist in facilitating the sale. After the initial discussions regarding a management buy-out fell through, the Advisor sought to generate interest from third parties. In doing so, the Advisor took care to obtain nondisclosure agreements from certain of these potential buyers prior to disclosing the sensitive information. 

In its decision, the High Court stated that while the shareholder was entitled to disclose the information to its Advisor pursuant to the professional advisor exception, it was not authorized to disclose the confidential information to third parties.   

While the High Court’s decision regarding the confidentiality clause may not come as a surprise, it does reinforce the need to carefully consider a client’s position in future transactions governed under English law.   

The High Court’s decision is available here.

ARTICLE BY

Neil Robson
 
OF 
Katten Muchin Rosenman LLP

The Real Tax Benefits of Inverting to Canada

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On August 26, Burger King announced that it entered into an agreement to acquire Tim Hortons, Inc., the Canadian coffee-and-doughnut chain, in a transaction that will be structured as an “inversion” (i.e., Burger King will become a subsidiary of a Canadian parent corporation).  The deal is expected to close in 2014 or 2015. The agreement values Tim Hortons at approximately $11 billion, which represents a 30 percent premium over Tim Hortons’ August 22 closing stock price.

Canadian Flag

Under the terms of the deal, Tim Hortons shareholders will receive a combination of cash and common shares in the new company. Each common share of Burger King will be converted into 0.99 of a share of the new parent company and 0.01 of a unit of a newly formed, Ontario-based limited partnership controlled by the new parent company. Holders of shares of Burger King common stock, however, will be given the right to elect to receive only partnership units in lieu of common shares of the new parent company, subject to a limit on the maximum number of partnership units issued.  Burger King shareholders who make this election will be able to defer paying tax on the built-in gain in their Burger King shares until the partnership units are sold. 3G Capital, Burger King’s principal shareholder, has elected to receive only partnership units. 3G will own approximately 51 percent of the new Burger King-Tim Hortons company, with current public shareholders of Burger King and Tim Hortons receiving 27 percent and 22 percent, respectively.

Inversions have gotten plenty of negative publicity during the past few years.  Most of the reported deals involve U.S. companies that have acquired smaller foreign companies in low tax jurisdictions such as Ireland, Switzerland, and the U.K.  As with any inversion transaction, the U.S. company will continue to be subject to U.S. federal income tax on its worldwide income.  The U.S. company will benefit, however, from the ability to: (i) reorganize its controlled foreign subsidiaries under a new foreign parent corporation (thereby removing those subsidiaries from the U.S. “controlled foreign corporation” regime and also allowing for the future repatriation of non-U.S. source profits to the foreign parent corporation and avoid U.S. corporate income tax); and (ii) “base erode” the U.S. company with intercompany debt and/or license arrangements with the new foreign parent or its non-U.S. subsidiaries.

It has been reported that Burger King’s effective tax rate was 27.5 percent in 2013 and Tim Hortons was 26.8 percent (15 percent federal rate plus 11.8 percent provincial rate), so “base eroding” Burger King with deductible interest and/or royalty payments to Canada will not provide a significant tax benefit to Burger King.  Where the use of a Canadian parent corporation, however, will benefit Burger King (and other U.S. companies that have inverted into Canada) from a tax perspective is the ability to take advantage of Canada’s (i) “exempt surplus” regime, which allows for the repatriation of dividends from foreign subsidiaries into Canada on a tax-free basis; and (ii) income tax treaties that contain tax sparing provisions, granting foreign tax credits at rates higher than the actual foreign taxes paid.  The United States does not provide either of these tax benefits under its corporate income tax system or treaty network. 

Canadian Exempt Surplus Regime

In general, under Canadian law, dividends received by a Canadian corporation out of the “exempt surplus” of a foreign subsidiary are not subject to corporate income tax in Canada.  Exempt surplus includes earnings of a foreign subsidiary that is resident in, and carrying on an active business in, a country with which Canada has concluded an income tax treaty or, more recently, a tax information exchange agreement (TIEA).  A TIEA is an agreement between two jurisdictions pursuant to which the jurisdictions may request and share certain information that is relevant to the determination, assessment and collection of taxes, the recovery and enforcement of tax claims, and the investigation or prosecution of tax matters.  The extension of the exempt surplus regime to jurisdictions that have signed TIEAs (but not income tax treaties) with Canada is significant because Canada has signed such agreements with low-tax jurisdictions, such as the Cayman Islands, Bermuda, and the Bahamas. Historically, the use of a Barbados IBC, which has a maximum corporate income tax rate of 2.5 percent, was the preferred jurisdiction for a Canadian parent company operating in a low-tax jurisdiction because of the long standing Canada-Barbados income tax treaty.

On the other hand, dividends received by a Canadian corporation out of the “taxable surplus” of a foreign subsidiary will be taxable in Canada (subject to a grossed-up deduction for foreign taxes) at regular corporate income tax rates. Taxable surplus includes most types of passive income, such as royalties, interest, etc., and active business income of a foreign subsidiary that is resident in, or carrying on business in, a country with which Canada has neither an income tax treaty nor a TIEA.  Special rules may deem certain passive income (such as interest or royalties) to be included in exempt surplus if received by a foreign subsidiary resident in a tax treaty or TIEA jurisdiction, if those amounts are deductible in computing the exempt earnings of another foreign subsidiary.  For example, interest and royalties paid from an active business of a U.K. subsidiary of a Canadian parent corporation to a Cayman Islands subsidiary of such Canadian parent will be eligible to be repatriated to Canada from the Cayman Islands under the exempt surplus regime on a tax-free basis.

It is interesting to note, however, that Burger King will not be able to repatriate most of its foreign-source income to Canada on a tax-free basis under the exempt surplus rules.  The majority of Burger King’s foreign-source income consists of royalties and franchise fees, which will be considered passive income for Canadian income tax purposes.  (Burger King, which operates in about 14,000 locations in nearly 100 countries, has become a franchiser that collects royalty fees from its franchisees, not an operator of restaurants).

Canada’s Tax Sparing Provisions

Another tax benefit offered by a Canadian parent corporation is the ability to utilize the “tax sparing” provisions contained in many Canadian income tax treaties. Canada currently has income tax treaties that contain tax sparing provisions with more than 30 countries, including Argentina, Brazil, China, Israel, Singapore, and Spain. In general, the purpose of a tax spari
ng provision is to preserve certain tax incentives granted by a developing jurisdiction by requiring the other jurisdiction to give a foreign tax credit for the taxes that would have been paid to the developing country had the tax incentive not been granted.  For example, under Article 22 of the Canada-Brazil income tax treaty, dividends paid by a Brazilian company to a Canadian parent corporation are deemed to have been subject to a 25 percent withholding tax in Brazil and therefore, eligible for a 25 percent foreign tax credit in Canada, even though the treaty limits the withholding tax to 15 percent (and in actuality, Brazil does not even impose withholding taxes on dividends under its local law).  A similar benefit is available for interest and royalties paid from Brazil to Canada (e.g., a deemed withholding tax, and therefore foreign tax credit, of 20 percent, even though the treaty caps the withholding tax at 15 percent).  As noted above, the United States does not currently have any income tax treaties that contain tax sparing provisions.

Conclusion

With Burger King’s effective corporate tax rate of 27.5 percent in the United States in 2013 and Tim Hortons 26.8 percent in Canada, the tax benefits of Burger King inverting to Canada are not readily apparent.  Notwithstanding the lack of a significant disparity in these tax rates, Canada does offer the ability to exclude from its corporate income tax dividends received from the earnings of a foreign subsidiary that is resident in, and carrying on an active business in, a jurisdiction that has concluded an income tax treaty or TIEA with Canada.  This key benefit, along with the Canadian income tax treaties that contain tax sparing provisions, provides one more example of why U.S. multinationals are operating at a competitive disadvantage when compared to other OECD countries around the world. 

ARTICLE BY

Jeffrey L. Rubinger
 
OF 
Bilzin Sumberg Baena Price & Axelrod LLP

What 2014’s Continued IPO Surge Means for Clean Tech and Renewable Energy Companies

Mintz Levin Law Firm

The year 2014 is on track to be the most active IPO marketin the United States since 2000, with the mid-year total number of IPOs topping last year’s mid-year total by more than 60%.[1] There were 222 US IPOs in 2013, with a total of $55 billion raised, and 2014 has already seen 151 US IPOs, for a total of $32 billion, completed by the mid-year mark. The year 2000 (over 400 IPOs) was the last year of a 10-year boom in US IPOs that reached its peak in 1996 (over 700 IPOs).

What does this mean for emerging energy technology andrenewables companies that might be looking to the capital markets? As of mid-year 2014, there have been six cleantech/renewables IPOs, while there were a total of seven in all of 2013. In both years, these deals have represented a relatively small percentage of total IPOs and still do not match the level of activity in the more traditional energy and oil & gas sector.  In 2014, IPOs were completed by a range of innovative companies, including Aspen Aerogels, TCP International and Opower.

Two unambiguously positive developments for clean energy in 2013 and the first half of 2014 have been the strong market for follow-on offerings and YieldCo IPOs. As was the case in 2013, several larger energy tech companies that are already public completed follow-on offerings to bolster cash for growth in 2014. Following in the footsteps of Tesla, SunEdison, First Solar, and other companies who completed secondary offerings in 2013, Jinko Solar (January 2014), Pattern NRG (May 2014), Plug Power (January and April 2014), Trina Solar (June 2014), and several other public companies capitalized on the continued receptiveness of clean-tech capital markets.

Following on successful YieldCo IPOs in 2013 (NRG Yield, Pattern Energy), there have already been three YieldCo IPOs in 2014: Abengoa Yield, NextEra Energy Partners, and, most recently, Terraform Power. The continued growth of YieldCo deals as well as the growing dollar amount of such offerings is an extremely encouraging sign for the energy and clean-tech sector as a whole, signaling a longer-term market acceptance of the ongoing changes in domestic and global energy consumption. The successful public market financings of these companies – whose strategy typically involves the purchase and operation of existing clean, energy-generating assets – should result in increased access to capital for renewable energy generation assets, as well as related technologies and services across the sector.

If the first half of this year is any indication, 2014 should prove to be a strong year for clean-tech and renewable energy companies opting to pursue the IPO path. The IPOs, follow-on offerings, and YieldCo successes that we’ve seen so far should improve the prospects for forthcoming clean-energy IPOs in the second half of 2014 and beyond.  I expect to see more renewable/clean energy companies follow the IPO route and make the most of the market’s continued receptiveness.

[1]  Please note that there will be some variance in the statistics for IPOs generally. This is because most data sets exclude extremely small initial public offerings and uniquely structured offerings that don’t match up with the more commonly understood public offering for operating companies. The data above is based on information from http://bear.warrington.ufl.edu/ritter/IPOs2012Statistics.pdf and Renaissance Capital www.renaissancecapital.com.

ARTICLE BY:

Sahir Surmeli
OF:
Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C

New Transportation Investment Center Boosts P3 (Public-Private Partnerships) Projects: “P3 or Not P3?” That is the Question. Obama Says: “P3.”

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President Obama last week formally embraced the expansion of Public-Private Partnerships (P3s) as a means to fill the gap in public sector transportation financing. Infrastructure developers and project sponsors should look to a planned September 9 summit on infrastructure investment hosted by the U.S. Treasury Department to learn more about how they may gain access to/benefit from expanded resources for P3s.

In an announcement culminating after a series of events aimed at cajoling Congress into addressing the looming deficit in the Highway Trust Fund, the President established the “Build America Transportation Investment Center,” a new office in the U.S. Department of Transportation (DOT) focused on encouraging P3s. Citing the potential for domestic and foreign investment in American infrastructure, the President moved to create this resource center within DOT to assist states and local governments find ways to expand the use of innovative financing to build needed projects.

For many years, the Office of Innovative Program Delivery Finance was housed within theFederal Highway Administration (FHWA). This latest move will centralize P3 resources at DOT for highway, transit and other crucial projects, particularly those considered to be of regional and national significance and “those that cross state boundaries,” according to the White House statement.

If those sorts of projects are truly the focus of this initiative, perhaps there could be new life (or added momentum) for long-planned, but delayed projects like the Columbia River Crossing in Washington State/Oregon or the New International Trade Crossing between Detroit and Windsor, Ontario or even a variety of high-speed rail proposals that fell victim to budgetary politics during President Obama’s first term.

The President’s announcement offers the promise of additional access to existing DOT credit programs, including the highly successful Transportation Infrastructure Finance and Innovation Act (TIFIA) program. According to government estimates, each dollar of TIFIA loans leverages an additional $10 in private loans, guarantees, and lines of credit. The new Investment Center will also offer technical assistance to states that wish to expand private infrastructure investment and the 20 states that have not yet entered the P3 market at all. The Center may offer case studies of successful projects, examples of deal structures, and analytical toolkits.

The White House also announced that the Treasury Department will host a summit on infrastructure investment in the U.S. on September 9, 2014 for state and local officials to meet with their federal counterparts.

Article By:

James M. Auslander
Brian C. Levey
Fred R. Wagner
Of:
Beveridge & Diamond PC