Corporate law Archives - Page 30 of 32

Preparation for 2011 Fiscal Year SEC Filings and 2012 Annual Shareholder Meetings

Published recently in The National Law Review an article by Megan N. Gates and Pamela B. Greene of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. regarding Year End SEC Filings and Shareholder meetings for 2012:

As our clients and friends know, each year Mintz Levin provides an analysis of the regulatory developments that impact public companies as they prepare for their fiscal year-end filings with the Securities and Exchange Commission (SEC) and their annual shareholder meetings. This memorandum discusses key considerations to keep in mind as you embark upon the year-end reporting process in 2012.¹

Year 2 of Say-on-Pay.

As required by Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and related SEC rulemaking, public companies other than smaller reporting companies were required to include two new, non-binding resolutions in their proxy statements for their first shareholder meetings taking place on or after January 21, 2011. The first resolution, the “say-on-pay” vote, allows shareholders to vote whether to approve executive compensation as disclosed in the proxy statement pursuant to Item 402 of Regulation S-K. The second vote, referred to as the “say-on-frequency” vote, asks shareholders how often they want to conduct future say-on-pay votes: once a year, once every two years, or once every three years. For the 2011 proxy season, shareholders overwhelmingly voted in favor of annual votes on say-on-pay, as opposed to either of the other possible choices, making say-on-pay a yearly event for most companies. However, now that the first year is behind us, companies are not required and not expected to propose another say-on-frequency vote until their shareholder meetings taking place in 2017. Companies that qualify as “smaller reporting companies” will not be required to conduct the say-on-pay or say-on-frequency votes until the first annual or other meeting of shareholders at which directors are to be elected that occurs on or after January 21, 2013.²

For further detail on the final say-on-pay rules that were adopted last year, please review our client alert.

The advent of say-on-pay has caused companies to revisit how they write their compensation-related disclosure in their proxy statements, in particular the Compensation Discussion and Analysis (CD&A) section, with both advocacy and disclosure in mind. For the year ended December 31, 2011, 46 companies failed to receive a majority vote in favor of their executive compensation payments and practices, suggesting that executive compensation is more vulnerable than initially thought at some companies. While this percentage of failed votes is small compared to the number of companies conducting say-on-pay votes last year, it is still higher than most experts expected. In addition, say-on-pay has resulted in shareholder litigation against many of these companies and such suits name the board, compensation committee members, and executives in their suits.³ The allegations of several of the complaints filed generally claim that the directors breached their fiduciary duties in three different ways. The first alleged breach arises from allegations that the directors diverted corporate assets to the executives in a manner that put the executives’ interests ahead of those of the shareholders. The second alleged breach arises from allegations that the companies that have adopted “pay-for-performance” compensation policies failed to disclose in their proxy statements that the compensation awards were made notwithstanding or in contravention to the policies. Finally, the complaints also bring claims for corporate waste against the directors based on the alleged excessive size of the executive compensation awards. Given these claims, it is critical for companies to review their CD&A disclosure, especially with regard to a company’s pay-for-performance philosophy. Many companies have boilerplate compensation policy language that is vulnerable to being exploited by derivative plaintiffs and which is not necessary to provide an accurate and reasonable basis for a company’s compensation decisions. Companies should review the CD&A section of their proxy statements to ensure that it reflects the company’s actual executive compensation philosophy and accurately describes the rationale for payment of executive compensation.

The Dodd-Frank Act added a new requirement in the CD&A beginning this year relating to the say-on-pay vote taken last year. Item 402(b)(1) of Regulation S-K was amended to add section vii to the CD&A disclosure requirements to require a discussion as to whether and, if so, how the company has considered the results of the shareholder say-on-pay vote in determining compensation policies and decisions and, if so, how that consideration has affected the company’s executive compensation decisions and policies. In preparing for compensation committee meetings, companies should make sure the compensation committee is in a position to discuss and make recommendations on this new disclosure requirement, as the disclosure must specifically address what actions the company has taken to date. Companies should make sure their compensation committees have been provided with the following information well in advance of approving this year’s executive compensation:

the results of the shareholder vote on say-on-pay from the 2011 annual meeting and any information that the company has as to the specific shareholders that voted against say-on-pay; and
the 2011 Institutional Shareholder Services (ISS) Proxy Advisory Services report discussing its analysis of the company’s say-on-pay proposal.

In preparing for this year’s say-on-pay vote the compensation committee should consider:

how it defines “pay-for-performance” and whether the company has a good pay-for-performance story for 2011 backing up its executive compensation decisions;
whether the company should reach out to shareholders who voted against the company’s say-on-pay proposal last year (and who are still shareholders) to determine what issues they had with the company’s compensation as many institutional shareholders have expressed their desire to engage with companies regarding their executive compensation policies as long as the discussion is not at the eve of the voting decision and preferably before the proxy season begins in earnest;
whether the company has had any significant changes to its shareholder base that could change the say-on-pay results for this year; and
whether ISS changes in how it will be determining whether a company has a pay for performance disconnect this year will have any effect on its recommendations for the 2012 proxy season.

Lastly, as companies enter this proxy season they need to be aware of how ISS will evaluate their say-on-pay proposals this year. ISS expects companies which received the support of less than 70% of the votes cast last year on say-on-pay to take specific action to address the concerns expressed by shareholders and expects to see substantive disclosure regarding the company’s response to shareholders’ opposition. If ISS is not satisfied with the changes made by the company, they will recommend a vote against compensation committee members as well as a vote against this year’s say-on-pay proposal. As it did last year, ISS will continue to review say-on-pay proposals by making a quantitative assessment of the CEO’s pay as compared to the company’s financial performance to initially identify underperforming companies. However, ISS has revised its approach and will measure the degree of alignment between the company’s total shareholder return rank and the CEO’s rank within the peer group⁴ as measured over a one-year (40% weight) and three-year (60% weight) period as well as the multiple of the CEO’s total pay relative to the peer group median. It will also measure the absolute alignment between the trend in CEO pay and a company’s total shareholder return (TSR) over the prior five fiscal years. These quantitative measures are to identify outlier companies that have demonstrated significant misalignment between CEO pay and company performance over time. In cases where alignment appears to be weak, further in-depth analysis will determine causal or mitigating factors, such as the mix of performance- and non-performance-based pay, grant practices, the impact of a newly hired CEO, and the rigor of performance programs.⁵

SEC Rules on Mandatory Proxy Access Have Been Vacated by the Courts but “Private Ordering” Lives On.

Despite the mandate provided by Section 971 of the Dodd-Frank Act and subsequent rulemaking by the SEC, shareholders’ ability to require companies to include shareholder nominees in companies’ own proxy statements was vacated by the United States Court of Appeals for the District of Columbia Circuit in July 2011.⁶ However, the amendments to Rule 14a-8 of the Securities Exchange Act of 1934, as amended (the Exchange Act), the rule addressing when a company must include a shareholder’s proposal in its proxy statement, were not affected by the court decision and became effective on September 20, 2011. As a result of amendments to Rule 14a-8, shareholders will now be able to propose nominees for director in a company proxy statement provided that a company’s by-laws allow for such action. This is known as “private ordering.” As a result, proxy access may become a reality if shareholders are successful in requiring companies to add by-law amendments allowing for shareholders to nominate directors in a company’s proxy statement. If a company’s by-laws allow shareholder proxy access for director nominations, then the same procedures must be followed as those that would have been followed had mandatory SEC proxy access survived under the Exchange Act. These procedures include Rule 14a-18, providing for disclosure regarding nominating shareholders and nominees submitted for inclusion in a company’s proxy material pursuant to applicable law or a company’s governing documents; Regulation 14N, which requires filings by certain nominating shareholders on a Schedule 14N; and amendments to Rule 14a-2(b) to facilitate shareholder director nominations. As of December 21, 2011, ISS had reported a total of 16 proxy access proposals submitted to companies with varying procedural provisions. It remains to be seen whether any of these proposals for by-law amendments to require proxy access will be adopted by companies or whether any company may instead choose to adopt its own preemptive proxy access by-law amendment to provide procedures more stringent than would be set forth in a shareholder by-law amendment proposal. We expect that like majority voting for directors, the momentum for proxy access will begin with larger companies and will continue to gain traction over the next few years.

SEC Issues Additional Guidance with Respect to Proposals Brought by Shareholders.

The SEC staff issued Legal Bulletin No. 14F on October 18, 2011 providing new guidance on topics relating to shareholder proposals under Rule 14a-8 of the Exchange Act that to date had been unclear. The new guidance addresses issues on proof of share ownership for beneficial owners, submission of revised proposals, procedures for withdrawal of a no-action request for a proposal submitted by multiple proponents, and the use of e-mail to transmit information. This SEC Legal Bulletin, together with SEC Legal Bulletins 14-14E, contains important information for any company that receives a shareholder proposal.

Other Sections of the Dodd-Frank Act Are Still Subject to Rulemaking.

The Dodd-Frank Act contains several other sections that will impact companies’ proxy statements in coming years, including the requirements to provide disclosure on measuring pay for performance, the ratio between CEO compensation and other employees’ compensation, hedging of shares by employees and directors, clawback of “erroneously awarded compensation” and rules regarding compensation consultants and compensation committee independence.

However, these sections of the Dodd-Frank Act require that the SEC undertake rulemaking to implement them, and only the rules with respect to exchange listing standards regarding compensation committee independence and factors affecting compensation adviser independence and disclosure rules regarding compensation consultant conflicts have been proposed to date. The SEC does expect to finalize these proposed rules in the first half of the calendar year but it is unclear whether it will be in time for the 2012 proxy season. The SEC’s rulemaking calendar was recently revised to state that it expects to propose the rest of these corporate governance and disclosure rules required by the Dodd-Frank Act in the first half of the 2012 calendar year and adopt them in the July through December 2012 time frame, not within the time to take effect for the 2012 proxy season. We will update our clients and friends separately as these rules are proposed and issued.

Whistleblower Bounty System in Effect.

The SEC’s rules under Section 922 of the Dodd-Frank Act, relating to bounties to be paid to whistleblowers who report information to the SEC about violations of the securities laws, took effect on August 12, 2011. These rules, which were the subject of hundreds of comment letters, put in place a system under which whistleblowers may benefit financially from contacting the SEC directly with allegations of federal securities fraud and other violations.

A new Office of the Whistleblower has been set up within the SEC, which is charged with receiving and reviewing reports directly from individuals of violations or potential violations of the federal securities laws. These reports can be submitted through a form on the SEC’s website, by e-mail, or by telephone.

These regulations have the potential to impact any issuer that has issued a security, regardless of whether that issuer is public, private, foreign, or domestic, or whether the security is equity or debt. As long as the situation about which a whistleblower makes a report constitutes a violation or potential violation of the federal securities laws, a whistleblower may bring a claim to the SEC in an effort to obtain a reward. Companies have expressed serious concerns about these rules, primarily because they are worried that the rules create a financial incentive for employees to circumvent a company’s internal compliance procedures and reporting mechanisms and contact the SEC directly with respect to a potential violation.

In order to be entitled to a whistleblower bounty, an individual must provide information that leads to the successful enforcement by the SEC of a matter resulting in sanctions that exceed $1 million. The bounty, by statute, is required to be paid in an amount between 10% and 30% of the funds that are recovered by the SEC in the matter. As a result, a whistleblower complaint needs to involve a reasonably significant claim in order to have the potential to result in a recoverable bounty. Also, the bounty is only available to an individual, and not to an issuer or other entity. Further, some individuals are ineligible to obtain a whistleblower bounty, including those who have client relationships with an issuer, such as an independent public accountant or a lawyer. Interestingly, the SEC does not exclude individuals who are involved in the wrongdoing itself from receiving a bounty, although any participation in the wrongdoing would factor into the determination of the size of the bounty awarded.

Whistleblower information, in order to qualify for the payment of a bounty, has to be submitted on a voluntary basis. Consequently, a person is not eligible for a bounty if he or she produced information as the result of a subpoena or request for information by the SEC. The individual must come forward with the information of their own volition, and the information has to be “original,” meaning it (1) must be derived from the independent knowledge or analysis of the whistleblower, (2) is not known to the SEC from any other source, and (3) is not exclusively derived from another public source such as an administrative hearing or news report. Hearsay and other forms of indirect evidence are not acceptable forms of evidence and cannot be used to support a whistleblower’s claim.

Other factors besides the culpability of the whistleblower can increase or decrease a whistleblower award pursuant to these rules. First, the information must be significant and not just incremental to information that the SEC already possesses. In addition, the size of an award may be larger if the whistleblower reports the wrongdoing internally through an issuer’s own compliance procedures and mechanisms before going to the SEC. There is no requirement, however, for a whistleblower to report internally before reporting to the SEC. A whistleblower may also make an initial report anonymously, but if the SEC investigation does result in the payment of an award, the person who made the report must reveal his or her identity to the SEC in order to receive the payment.

To protect whistleblowers against retaliation, the regulations contain an express anti-retaliation provision which mandates that an issuer may not retaliate against an employee for coming forward with a whistleblower report. To date, purported whistleblowers have brought a number of anti-retaliation claims as a result of the whistleblower rules, and the number of those claims is likely to increase as whistleblowers become more aware of the existence of these regulations.

Companies should take steps now to ensure that their employees are aware of internal reporting systems and compliance procedures for addressing potential violations of the federal securities laws. Employees should not learn about the concept of whistleblowing for the first time when they hear about the potential to claim a bounty for making a report to the SEC. Rather, they should have their employer’s own internal reporting system at the top of their minds, and think of using that system to report a problem if they see one. As part of preparations for fiscal year-end reporting in 2012, companies should remind employees that management is committed to full compliance with the federal securities regulations, and educate them as to the systems in place at the company to report any issues with compliance.

“Proxy Plumbing”.

In July 2010, the SEC issued a concept release on the US proxy system.⁷ This release, which has come to be known as the “proxy plumbing” release, addresses three principal questions regarding the current proxy system in the United States: whether the SEC should take steps to enhance the accuracy, transparency, and efficiency of the voting process; whether the SEC’s rules should be revised to improve shareholder communications and encourage greater shareholder participation in the shareholder meeting process; and whether the voting power held by shareholders is aligned with the economic interest of such shares. No rulemaking has yet been issued by the SEC in response to this concept release, but we understand that the SEC is continuing to evaluate the issues it raised in that document. In addition the SEC is also looking at proxy advisory firms and the role they play in shaping shareholder votes. Although the SEC has no ability to regulate these firms, the SEC is concerned about the lack of competition and the sway they seem to have over the voting decisions made by many institutional investors.

SEC Cybersecurity Guidance.

On October 13, 2011, the staff of the SEC issued Corporation Finance (CF) Disclosure Guidance on Cybersecurity, a guidance document regarding disclosures of cybersecurity risks that may impact the issuers of securities.⁸ There has been an increase in cybersecurity attacks on issuers in many industries in recent years — attacks on an issuer’s networks, systems, computers, programs and data that can result in seizure or misappropriation of sensitive information about business partners, customers, and other parties. The Guidance provides direction to companies with regard to when the risks or consequences of those attacks must be disclosed to the public.

An issuer is generally required to disclose any material information related to its business that may impact an investor, including with regard to cybersecurity or cyber attacks. Information is considered to be material if there is a substantial likelihood that a reasonable investor would consider it important when contemplating an investment in a company. With respect to cybersecurity issues, there are certain scenarios in which disclosures may be material to an issuer and its investors. The Guidance notes that public companies are required to evaluate their cybersecurity risks and “consider the probability of cyber incidents occurring and the quantitative and qualitative magnitude of those risks, including the potential costs and other consequences resulting from misappropriation of assets or sensitive information, corruption of data or operational disruption.” Therefore, issuers who work with or have access to sensitive customer data or whose businesses would be seriously impacted by a computer security breach should consider disclosing the risk of cyber attacks and similar events in their disclosure documents.

The SEC also provided direction in the Guidance regarding disclosures which reference how an issuer should address potential cyber security risks, and the need to explain why the cost and consequences associated with doing so represents a material event. The SEC also addressed the need for disclosures if a cyber attack could materially affect the issuer’s products or services, customer relationships, and competitive conditions, as well as disclosure in the event of a pending legal proceeding regarding a cyber attack.

Where an issuer is required to incur substantial costs in order to protect against potential cybersecurity risks, the issuer may need to include references to those costs in the Management’s Discussion and Analysis (MD&A) section of its filings, as well as in footnotes to financial statements. Likewise, when a cyber attack occurs, litigation involving suppliers and customers could be costly; companies may need to disclose and explain these risks in addition to the consequences of the cyber attack itself. Finally, issuers are required to disclose the effectiveness of their disclosure controls and procedures in SEC filings; to the extent those controls and procedures are impacted by cyber attacks, an analysis of the consequences of those attacks for the controls and procedures may be required.

The Guidance does not impose any new disclosure requirements or make any changes to existing disclosure rules. The Guidance does, however, make it very clear that the SEC is strongly concerned about cybersecurity as a general concept. The purpose of the Guidance is to remind companies that they should be keeping this specific topic in mind when crafting disclosure within the existing framework of the SEC’s rules, especially when preparing disclosure in their Forms 10-K regarding risk factors, MD&A, the business description, financial statements, and legal proceedings.

Conflict Minerals Disclosure.

Conflict minerals-related disclosure is another highly controversial topic for which the SEC was required to issue rules under the Dodd-Frank Act. Section 1502 of the Dodd-Frank Act provides that the SEC shall require companies to disclose whether or not their products contain so-called “conflict minerals” — i.e., tin, gold, tantalum, or tungsten, from the Democratic Republic of Congo and neighboring countries. This provision was included in the Dodd-Frank Act at the request of legislators who believe that the process of mining for and producing these particular minerals in certain countries is contributing to a grave, ongoing humanitarian crisis in that region of Africa.

The SEC proposed rules on this topic in December 2010, and the Dodd-Frank Act had required the rules to be finalized by April 15, 2011. However, due to the strong resistance to the rules from a broad cross section of the business community, the rulemaking has been delayed and, as of January 2012, is still not yet final. The implementing rules as proposed provide that:

If “conflict minerals” are necessary to the functionality or production of a product manufactured, or contracted to be manufactured, by an issuer, the issuer would be required to disclose in its annual report whether the conflict minerals originated in the Democratic Republic of the Congo or an adjoining country.
If the answer is that they do originate in such countries, the issuer must furnish an exhibit to its annual report that includes, among other matters, a description of the measures taken by the issuer to exercise due diligence on the source and chain of custody of its conflict minerals.
These due diligence measures would include, but would not be limited to, an independent private sector audit of the issuer’s report conducted in accordance with standards established by the Comptroller General of the United States. Any issuer furnishing such a report would be required to certify that it obtained an independent private sector audit of its report, provide the audit report, and make its reports available to the public on its Internet website.

Of particular concern to the business community is the fact that there is no de minimis threshold for the disclosure, meaning that the presence of even trace amounts of the conflict minerals would need to be analyzed and reviewed for the purpose of this requirement. Further, from a practical standpoint, commenters have argued that companies with dozens or even hundreds of suppliers may find it unmanageably expensive and burdensome to gather this information from several steps back in the supply or production chain. The SEC convened a roundtable discussion on October 18, 2011 in order to obtain information from companies regarding this issue that could help the agency put some parameters around the rule to make it realistically manageable. However, as the final rules have not yet been released, we are still waiting to see what the SEC ultimately produces. In the meantime, companies engaged in manufacturing products in the electronics, medical device, aerospace, and computer industries, among others, should give some consideration to how they would address this requirement by reviewing supply contracts to determine the number and locations of suppliers they would need to contact for information in the event that the rules are passed essentially as written.

Internal Control over Financial Reporting.

One positive development for smaller reporting companies contained in the Dodd-Frank Act was the permanent elimination of the requirement for such companies to provide an attestation report of their auditors with respect to their internal control over financial reporting in their annual reports on Form 10-K. All other companies have been and are still required to include those reports, pursuant to Section 404 of the Sarbanes-Oxley Act. In addition, all issuers, including smaller reporting companies, are required to include reports of their management as to the effectiveness of internal control over financial reporting.

2012 Periodic Report Filing Deadlines

For companies that qualify as large accelerated filers and have fiscal years ending on December 31, annual reports on Form 10-K are due 60 days after fiscal year-end (Wednesday, February 29, 2012).⁹Form 10-K reports continue to be due 75 days following fiscal year-end for accelerated filers¹⁰(Wednesday, March 15, 2012 for December 31 year-end companies) and 90 days after fiscal year-end for non-accelerated filers (Friday, March 30, 2011 for December 31 year-end companies).

In addition, Form 10-Q reports filed by accelerated filers and large accelerated filers continue to be due 40 days after the close of the fiscal quarter. The deadline for Form 10-Q reports for non-accelerated filers continues to be 45 days after the close of the fiscal quarter

These changes do not affect the existing proxy statement filing deadline of 120 days after fiscal year-end for companies that choose to incorporate by reference from their definitive proxy statements the disclosure required by Part III of the Form 10-K.

Companies should also note the extra day in the first quarter as this year is a leap year with February 29th as an added date.

Board of Director and Committee Membership

Each year as part of the year-end reporting process, we recommend that companies carefully examine the membership profiles of their board and board committees. Sarbanes-Oxley, the SEC rules issued under Sarbanes-Oxley, and the listing requirements of Nasdaq, NYSE, and NYSE Amex relating to board and committee membership requirements all impact who may serve.¹¹ Mintz Levin has prepared a director independence and qualification checklist to assist with this analysis, and we encourage you to evaluate each director and director nominee to ensure continued compliance with these requirements.

Shareholder Approval of Equity Compensation Plans

Nasdaq, NYSE, and NYSE Amex all require shareholder approval for the adoption of equity compensation plans and arrangements for employees, directors, and consultants and for any material modification of such plans and arrangements, including the addition of new shares to a plan. Exemptions from the shareholder approval requirement continue to be available for inducement grants to new employees if such grants were approved by a compensation committee or a majority of the company’s independent directors, and if, promptly following each grant, a press release is issued specifying the material terms of the award, including the name of the recipient and the number of shares issued. In certain situations, exceptions to the requirement may also be available for a grant relating to an acquisition or merger. An exemption from the shareholder approval requirement is also available for certain tax-qualified, non-discriminatory employee benefit plans (such as plans that meet the requirements of Section 401(a) of the Internal Revenue Code and Employee Stock Purchase Plans meeting the requirements of Section 423 of the Internal Revenue Code), provided that such plans are approved by the issuer’s compensation committee or a majority of the issuer’s independent directors. Equity plans adopted prior to June 30, 2003 are unaffected under this rule, until a material modification is made to such a plan.

As noted above, companies considering option repricing programs in light of significant declines in their stock prices should note that such programs may require shareholder approval, depending on the terms of the equity compensation plan under which the options were granted. In the event that shareholder approval is required, the company will need to file a preliminary proxy statement with the SEC, which would not be required for approval of a new plan or an amendment to an existing plan.

Companies should review their existing equity compensation plans as part of their year-end reporting preparation in order to determine whether shareholder approval will need to be obtained for new plans or to determine increases in the numbers of shares available under old plans, option repricing programs, or material plan amendments. Since this is another area where ISS continues to weigh in heavily, both with respect to the number of shares to be authorized under the plan and with respect to some of the substantive disclosure within the plan itself, plenty of time should be allotted to drafting proposals on these matters.

Other Year-End Considerations

We also recommend that companies take the opportunity while planning their year-end reporting to consider what amendments may be necessary or desirable to their corporate documents over the coming year that may require shareholder approval. Some items to consider are:

Does the company have enough shares authorized under its certificate of incorporation to achieve all of its objectives for the year, including acquisitions for which it may want to use its stock as currency?
Does the company have adequate shares available under its equity compensation plans to last throughout the year?
Are there other material changes that should be made to the company’s equity compensation plans that would require shareholder approval?
Has the company reviewed its charter and by-laws to assess any anti-takeover measures in place?

To the extent that a company expects any proposal in its proxy statement to create controversy among its shareholder base, it may want to consider hiring a proxy solicitor to assist with the process of seeking the requisite shareholder vote.

In addition, in light of the say-on-pay, executive compensation, and governance rules described above, management and directors of public companies should annually consider the following questions, with a view to the disclosure that would flow from each answer.

Compensation Committe

Consider whether the company’s compensation policies and practices for all of the company’s employees, including non-executive officers, create risks that are reasonably likely to have a material adverse effect on the company.

Are there business units that carry a significant portion of the company’s risk profile?
Are there business units with compensation structured significantly differently from the other units within the company?
Are there business units that are significantly more profitable or risky than others within the company?
Are there business units where compensation expenses are a significant percentage of the unit’s overall expenses?
Does the company have compensation policies or practices that vary significantly from the overall risk and reward structure of the company and are not in alignment with the timing of the outcome on which the award was based?

Is the company using a compensation consultant for which disclosure would be required under these rules?

If the company is currently subject to the say-on-pay rules, is the CD&A written in a sufficiently compelling and persuasive manner?

Nominating Committee

» Consider, for each director and nominee, the particular experience, qualifications, attributes, or skills that led the board to conclude that the person should serve as a director for the company and how the directors’ skills and background enable them to function well together as a board, as of the time that a filing containing this disclosure will be made with the SEC. Review the company’s current requirements regarding minimum qualifications to serve as a director that are currently set forth in the company’s proxy statement to make sure that the disclosure works with the current nominating committee policy.

» Consider whether, and if so how, the nominating committee considers diversity in assessing director nominees. Consider whether to adopt a policy regarding the consideration of diversity in identifying nominees, how to implement the policy, and how to assess its effectiveness.

» Consider the current governing structure of the board. Is it still appropriate for the company? Are revisions necessary or appropriate?

» Revise the nominating committee charter, if necessary, based on the issues discussed above.

Full Board

Consider the board’s role in managing and overseeing the material risks facing a company. Has this role been effectively managed by the board? Should the role be delegated to a committee?

Endnotes

1 We invite you to review our memorandum from last year, which analyzed regulatory changes that were new for fiscal year 2010, and we would be happy to provide you with another copy upon request.

2 Smaller reporting companies are those that have less than $75 million in public float as of the last business day of their most recently completed second fiscal quarter.

3 For a further discussion regarding say-on pay litigation see our Client Advisory, dated July 18, 2011, entitled “Lessons Learned from Initial ‘Say-on-Pay’ Litigation, Plaintiffs’ Attorneys Start Utilizing ‘No’ Votes as a Basis for Claims Against Directors”.

4 The peer group is generally comprised of 14-24 companies that are selected by ISS using market cap, revenue (or assets for financial firms), and GICS industry group, via a process designed to select peers that are most similar to the company, and where the company is close to median in revenue/asset size.

5 The ISS 2012 policy in evaluating say-on-pay is available on the ISS website.

6 Specifically, Exchange Act Rule 14a-11, which sets forth the specific procedures and rules to be used to nominate a director, was vacated.

7 Concept Release on the U.S. Proxy System (Release No. 34-62495, July 14, 2010).

8 Securities and Exchange Commission, CF Disclosure Guidance: Topic No. 2, Cybersecurity (October 13, 2011).

9 Large accelerated filers are domestic companies that meet the following requirements as of their fiscal year-end:

· have a common equity public float of at least $700 million, measured as of the last business day of their most recently completed second fiscal quarter (i.e., for calendar fiscal year-end companies, this test would be applied as of June 30, 2011);

· have been subject to the reporting requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, for at least 12 months;

· have previously filed at least one Annual Report on Form 10-K; and

· do not qualify as smaller reporting companies under SEC rules.

10 Accelerated filers are those that meet all of the above tests but have a common equity public float of at least $75 million, but less than $700 million, measured as of the last business day of their most recently completed second fiscal quarter (i.e., for calendar fiscal year-end companies, this test would be applied as of June 30, 2011).

11 Please see our Client Advisory, dated November 2003, entitled “Changes to Corporate Governance Standards for Nasdaq-Listed Companies,” for a further description of these changes. We would be happy to provide you with a copy upon request.

California Appellate Court Issues a Decision That Mutual of Omaha Insurance Agents Qualify as Independent Contractors as a Matter of Law

From a recent posting in the National Law Review an article by attorney Thomas R. Kaufman of Sheppard Mullin Richter & Hampton LLP regarding the way insurance companies treat their independent agents:

December 31, 2011, as a final act for the year, the First Appellate District of the California Court of Appeal issued a good appellate decision for employers on the issue of independent contractor status, Arnold v. Mutual of Omaha. The case creates a veritable roadmap for insurance companies on how to treat agents so that they maintain their status as independent contractors rather than employees.

The Key Facts

Ms. Arnold worked as a non-exclusive insurance agent for Mutual of Omaha, which meant she was authorized to sell their products but was free to (and did) sell products of other insurance companies. Nonetheless, she claimed she was actually an employee rather than an independent contractor (IC), and that she therefore was entitled to recover for reimbursement of expenses and waiting time penalties for unpaid final wages on behalf of herself and a purported class of similarly situated agents. The factual record was very strong for the defense as to the limited control Mutual of Omaha exercised over Arnold (and its other agents):

The contract Arnold signed with Mutual of Omaha expressly stated that the parties understood it was an independent contractor agreement.
Her chief duties were to procure and submit insurance applications, collect money, and service clients.
She was compensated entirely on commissions for products sold, with a chargeback if money was uncollected or refunded.
She received no performance evaluations and nobody at Mutual of Omaha monitored or supervised her work schedule. Plaintiff decided when, where, and to whom she would market insurance.
Although Mutual of Omaha provided some training on its products and sales techniques, it was not mandatory for ICs to take the training. The only mandatory training was as to compliance with certain state insurance laws and regulations.
Mutual of Omaha provided some office space if agents wanted to use it, but it was optional, and agents had to pay for the “workspace and telephone service.” Mutual of Omaha also did not pay for business cards or any other business expenses, although it provided certain services for a fee if an IC wanted them.
Under the IC agreement in place, either party could terminate the relationship at any time with or without cause, or if Arnold failed to sell a Mutual of Omaha product for 180 days.

On this record, the trial court granted summary judgment to Mutual of Omaha that Arnold was an independent contractor rather than an employee. Arnold appealed.

What Makes the Case Noteworthy

The court of appeal affirmed, declaring that it was not even a close case. As a preliminary matter, the court held the common law test of employee v. IC applies to claims under Labor Code Section 2802. This is a multi-factor test (roughly 10 factors depending how you count them), codified in a decision called S.G. Borelli & Sons, Inc. v. DIR, 48 Cal. 3d 341 (1989). This holding is not exactly earth-shaking as the plaintiff’s argument of statutory interpretation was not particularly cogent. It is the summary judgment aspect of the case that makes it notable, because the case sets forth a pretty good roadmap of what an insurance company who wants to have independent contractor agents should follow to preclude a lawsuit that the agents are really employees. The court pointed to the existence of undisputed facts on several specific issues as justifying summary judgment:

“After a careful review of the opposing evidence, we find nothing that raises a material conflict with the supporting evidence summarized above. The salient evidentiary points established Arnold used her own judgment in determining whom she would solicit for applications for Mutual’s products, the time, place, and manner in which she would solicit, and the amount of time she spent soliciting for Mutual’s products. Her appointment with Mutual was nonexclusive, and she in fact solicited for other insurance companies during her appointment with Mutual. Her assistant general manager at Mutual’s Concord office did not evaluate her performance and did not monitor or supervise her work. Training offered by Mutual was voluntary for agents, except as required for compliance with state law. Agents who chose to use the Concord office were required to pay a fee for their workspace and telephone service. Arnold’s minimal performance requirement to avoid automatic termination of her appointment was to submit one application for Mutual’s products within each 180-day period. Thus, under the principal test for employment under common law principles, Mutual had no significant right to control the manner and means by which Arnold accomplished the results of the services she performed as one of Mutual’s soliciting agents.”

The court mentioned that several other factors further tilted in Mutual of Omaha’s favor, but it appears that establishing undisputed facts on the above items would generally be sufficient to support summary judgment. Furthermore, the court recognized that a plaintiff cannot avoid summary judgment simply by raising a triable issue of fact on one or two minor factors of IC status. Rather, the court held that if a reasonable factfinder considering all of the evidence together could not conclude that the agent was an employee, the employer is entitled to judgment:

“The existence and degree of each factor of the common law test for employment is a question of fact, while the legal conclusion to be drawn from those facts is a question of law. (Harris v. Vector Marketing Corp. (N.D. Cal. 2009) 656 F.Supp.2d 1128, 1136.) Even if one or two of the individual factors might suggest an employment relationship, summary judgment is nevertheless proper when, as here, all the factors weighed and considered as a whole establish that Arnold was an independent contractor and not an employee for purposes of Labor Code sections 202 and 2802. (SeeVarisco, supra, 166 Cal.App.4th at p. 1106.)”

10 Tips for Conducting an Internal Investigation

Recently posted in the National Law Review an article by Catherine Salmen Wright of Dinsmore & Shohl LLP regarding conducting an internal investigation:

The recent news involving Penn State highlights how high the stakes can be when conducting an internal investigation. In fact, Penn State has hired former FBI director Louis Freeh to lead its internal investigation into alleged criminal conduct by a former employee. But while most employers do not face circumstances this challenging, the reality is that employers are presented with circumstances on a regular basis that must be investigated effectively to avoid significant legal liability.

Of course, this begs the question of when an employer needs to investigate. The simplest answer is when the employer has knowledge of misconduct. Misconduct can include a breach of an employer policy, violation of a drug or alcohol policy, theft or other criminal activity, or even misuse of company property. Employers should not, however, too narrowly construe what constitutes “knowledge,” which can include formal and informal complaints, information obtained during exit interviews, anonymous tips and third-party information.

Employers should also keep in mind that an internal investigation may become your defense in any subsequent litigation and therefore may be subject to significant scrutiny by the plaintiff, the plaintiff’s lawyer and possibly a jury. For example, in a sexual harassment lawsuit, the employer’s investigation is what typically shows that the employer exercised reasonable care to prevent and correct any harassing behavior. Another defense used by employers in wrongful termination lawsuits is the “honest belief” rule. Specifically, if the employer can show that it reasonably relied on the particularized facts that were before it at the time the decision was made, it can potentially avoid liability over a challenged decision. The investigation does not need to be perfect, but the employer must make a reasonably informed decision before taking an adverse employment action.

As a result, conducting an effective internal investigation is critically important. Every investigation comes with a unique set of facts and challenges, but the following 10 principles serve as a guide for conducting an effective investigation.

1. Determine the objectives and strategy for the investigation.

At the outset, employers must establish the objectives of the investigation. Questions that should be addressed include:

Are you trying to develop a complete record to justify a decision?
Are you attempting to avoid litigation?
What are your legal obligations?
Do you need an attorney involved?

Evaluating the answers to these questions will allow you to tailor your investigation.

2. Maintain confidentiality.

A guiding principle in any investigation is confidentiality, which employers should maintain to the extent possible. However, don’t promise what you can’t deliver. Absolute confidentiality when employees will be interviewed is virtually impossible. Also, employers need to be vigilant when it comes to thoroughness and promptness. For example, if you had to answer questions one year later in a deposition, can you give a reasonable explanation of why it took the amount of time it did to complete the investigation?

3. Determine if immediate actions need to take place to protect the workforce.

Based on what you know at the time the investigation begins, you may need to take immediate steps to protect the complaining party, alleged victim or the workforce in general. For example, an accused harasser may be put on a paid or unpaid leave, supervisory responsibilities could be changed or an employee could be temporarily transferred pending an investigation, but in no case should an employer penalize the alleged victim.

4. Review company policies.

Take an inventory of employer policies that may impact the investigation process. For example, a collective bargaining agreement may provide an employee the right to have a representative present at any interview.

5. Conduct a preliminary search of available records.

This includes reviewing personnel files and any documents relating to the misconduct. Act quickly to retrieve what electronic information is still available, including emails and text messages.

6. Select the appropriate personnel to conduct the investigation.

Investigators should be unbiased and unprejudiced — and perceived as such. Good investigators are skilled at setting people at ease and drawing out reticent witnesses in order to collect facts. They also need knowledge of company policies and procedures, the ability to maintain confidentiality and a level of authority consistent with the significance of the matter being investigated.

7. Control the interview process.

Obtaining detailed statements from interviews with the complaining party and the accused are a critical part of any investigation. Documentation should include the facts, not legal conclusions, or your interpretations and assumptions. Give witnesses ground rules: No conclusion has been reached, no reprisal will be taken, and no discussions about the interview are allowed with anyone.

8. Communicate throughout the process.

Many employers launch an investigation, only to fail to keep the complainant reasonably informed during the process. Unfortunately, this results in the complaining party believing their complaint was ignored, which may prompt them to involve an attorney.

9. Close the investigation properly.

Having invested the time and cost associated with the investigation, protect your investment by properly closing out the investigation. Make a decision, communicate the decision and document the process.

10. Ensure against retaliation.

Employees who make complaints may be legally protected from experiencing an adverse employment action. This includes complaints involving discrimination, harassment, safety violations, wage and hour violations and more. Do ensure against retaliation by continuing to monitor the situation.

As seen in the December 9th issue of Business Lexington.

In Ninth Circuit, Whistleblowers Not Exempt From Confidentiality Agreements

Posted in the National Law Review an article by attorney Anthony Navid Moshirnia of Sheppard, Mullin, Richter & Hampton LLP about blowing the whistle on alleged fraud against the Government does not entitle an employee to loot:

Blowing the whistle on alleged fraud against the Government does not entitle an employee to loot and disclose her employer’s records in violation of a confidentiality agreement – at least not in the Ninth Circuit. In an opinion handed down in March of this year, the Ninth Circuit refused to adopt a so-called “public policy exception to confidentiality agreements to protect [qui tam plaintiffs]” who misappropriate documents from their employers ostensibly to buttress claims brought under the federal False Claims Act (“FCA”). U.S. ex rel. Cafasso v. Gen. Dynamics C4 Sys., Inc., 637 F.3d 1047, 1061-62 (9th Cir. 2011). Though this opinion has been on the books since Spring, it remains relevant, and worth keeping an eye on, as it provides powerful ammunition against FCA plaintiffs that continue to tout the “public policy” exception as though it were unassailable.

After learning that her job at General Dynamics C4 Systems, Inc. (“General Dynamics”) was going to be terminated, but before leaving her employment, Mary Cafasso “copied almost eleven gigabytes of data from [her employer’s] computers in anticipation of bringing a qui tam action” under the FCA. When it discovered what Ms. Cafasso had done, General Dynamics filed suit in Arizona state court, seeking return of its purloined documents through a temporary restraining order (“TRO”). Apparently to avoid complying with the TRO, which the state court granted, Ms. Cafasso filed “a conclusory six page complaint . . . alleg[ing] FCA violations and retaliation.” She then used the FCA action to persuade the Arizona court to vacate the TRO and stay General Dynamics’ lawsuit.

When Ms. Cafasso’s FCA complaint was unsealed, General Dynamics counterclaimed alleging, inter alia, breach of contract arising from Ms. Cafasso’s misappropriation of documents in violation of a confidentiality agreement. In opposition to General Dynamics’ motion for summary judgment, Ms. Cafasso argued that General Dynamics had failed to prove contract damages and that, even if it had, her conduct was permissible because “[p]ublic policy grants [a] Relator a privilege in gathering copies of documents as part of an investigation under the FCA and gives [a] Relator immunity from civil liability based on claims against her for so doing.” U.S. ex rel. Cafasso v. Gen. Dynamics C4 Sys., Inc., 2009 WL 1457036, *13 (D. Ariz. May 21, 2009).

The trial court dismissed both of Ms. Cafasso’s arguments. It found that damages were established by the stipulated damages clause in the General Dynamics confidentiality agreement. After reviewing the parties’ competing legal arguments, the trial court also found that “public policy does not immunize Cafasso, [who] confuses protecting whistleblowers from retaliation for lawfully reporting fraud with immunizing whistleblowers for wrongful acts made in the course of looking for evidence of fraud.” The court concluded that “[s]tatutory incentives encouraging investigation of possible fraud under the FCA do not establish a public policy in favor of violating an employer’s contractual confidentiality and nondisclosure rights.”

On appeal, Ms. Cafasso did not dispute that her actions violated her confidentiality agreement with General Dynamics, but nonetheless urged the Court to “adopt a public policy exception to enforcement of such contracts that would allow relators to disclose confidential information in furtherance of an FCA action.” While noting that Ms. Cafasso’s position was not frivolous, and might apply “in particular instances for particular documents,” the Ninth Circuit found that Ms. Cafasso’s data removal was not privileged.

The Ninth Circuit appears to have relied on two factors to reach this conclusion: the scope and volume of the documents Ms. Cafasso took. With respect to scope, the Ninth Circuit faulted Ms. Cafasso’s “indiscriminate appropriation of documents,” referring to it as an “unselective taking [that included] attorney client privileged communications, trade secrets belonging to [General Dynamics] and other contractors, internal research and development information, sensitive government information, and at least one patent application that the Patent Office had placed under a secrecy order.” The Court was also troubled by the fact that Ms. Cafasso had taken over 11 gigabytes of data, noting that “the need to facilitate valid claims does not justify the wholesale stripping of a company’s confidential documents.” In sum, the Ninth Circuit found that an “exception broad enough to protect the scope of Cafasso’s massive document gather in this case would make all confidentiality agreements unenforceable as long as the employee later files a qui tam action” – an unacceptable result.

While Cafasso stopped short of rejecting the public policy defense to data theft as a matter of law, it certainly provides a new avenue to FCA defendants attempting to prevent qui tam relators from benefitting from extrajudicial discovery.

Are Restrictive Covenants Enforceable in California? It Depends.

Recently posted in the National Law Review an article by attorneys Alice Y. Chu and Kurt A. Kappes of Greenberg Traurig, LLP regarding the enforeceability of non-competes in California:

In California, it is well established that non-compete provisions are unenforceable, subject to certain statutory exceptions. Nevertheless, some courts have also recognized that non-compete provisions are enforceable if necessary to protect confidential information or trade secrets.

But what about non-compete provisions that are ambiguous as to their protection of confidential information or trade secrets? Recently, when faced with such a provision, one California federal court narrowly construed the provision to find it enforceable.

The Facts in Richmond

In Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 (N.D. Cal. July 1, 2011), a California federal district court evaluated the following provisions included in the parties’ Confidentiality and Non-Disclosure Agreement (“NDA”):¹

Non–Solicitation. During the Term of this Employment (a[s] hereinafter defined), and for a period of one year thereafter, [defendant] [shall not] directly or indirectly, initiate any contact or communication with, solicit or attempt to solicit the employee of, or enter into any agreement with any employee, consultant, sales representative, or account manager of [plaintiff] unless such person has ceased its relationship with [plaintiff] for a period of not less than six months. Similarly [plaintiff] shall not solicit the employment of, or enter into any agreement with any employee, consultant or representative of [defendant].

Non–Interference. During the Term of this Employment, and for a period of one year thereafter, [defendant] will not initiate any contact or communication with, solicit or attempt to solicit, or enter into any agreement with, any account, acquiring bank, merchant, customer, client, or vendor of [plaintiff] in the products created and serviced by [plaintiff], unless (a) such person has ceased its relationship with [plaintiff] for a period of not less than six months, or (b) [defendant]’s relationship and association with such person both (i) pre-existed the date of this Agreement and (ii) does not directly or indirectly conflict with any of the current or reasonably anticipated future business of [plaintiff].

Non Compete and Non Circumvent. [Defendant] will not compete with [plaintiff] with similar product and or Service using its technology for a period of one year thereafter. [Defendant] will not use any of the [plaintiff]’s technical knowhow or Source Code for the personal benefit other than the employment and to meet the customer needs defined by [plaintiff].²

The NDA also contained a provision that barred the defendant from disclosing or using confidential information used in plaintiff’s business.³ Confidential information was defined to include “Proprietary Data,” such as “know-how,” contract terms and conditions with merchants, technical data, and source code; “Business and Financial Data;” “Marketing and Developing Operations;” and “Customers, Vendors, Contractors, and Employees,” including their names and identities, data provided by customers, and information on the products and services purchased by customers.⁴

The Richmond Court’s Analysis

In evaluating plaintiff’s motion for a temporary restraining order, the court assessed plaintiff’s claim that, by teaming up with plaintiff’s former employee to form a competing venture, the defendant had breached the non-compete provisions of the NDA.⁵ Defendants argued that the plaintiff was not likely to prevail on its contract claims because the non-compete provisions in the NDA are unenforceable under California Business and Professions Code § 16600.⁶

Within this context, the court first noted that the California Supreme Court had recently confirmed that “‘[t]oday in California, covenants not to compete are void, subject to several exceptions,” and that the California Supreme Court “‘generally condemns noncompetition agreements.’”⁷

Second, the court also observed that the California Supreme Court had rejected the “narrow-restraints” exception to Section 16600 applied in several Ninth Circuit cases, finding that “‘California courts have been clear in their expression that section 16600 represents a strong public policy of the state which should not be diluted by judicial fiat.’”⁸ As the court stated, “Section 16600 stands as a broad prohibition on ‘every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind.’”⁹

Third, the court rejected plaintiff’s argument that Section 16600 applies only to restrictions on employees, concluding that Section 16600 did apply to the facts of the case.¹⁰

Fourth, the court acknowledged that, even though Section 16600 applied, a number of California courts have also held that former employees may not misappropriate a former employer’s trade secrets to compete unfairly with the former employer.¹¹

Applying these principles, the court held that the non-solicitation and non-interference provisions of the NDA were likely unenforceable under California law because the provisions were more broadly drafted than necessary to protect plaintiff’s trade secrets and “would have the effect of restraining Defendants from pursuing their chosen business and professions if enforced.”¹²

In regards to the non-compete provision, the court reasoned that “the scope of the prohibitions on ‘compet[ing] with [plaintiff] with similar product and or Service using its technology” and using ‘technical knowhow’ is not entirely clear.”¹³ However, the court then concluded that “if the clause is construed to bar only the use of confidential source code, software, or techniques developed for [plaintiff’s] products or clients, it is likely enforceable as necessary to protect [plaintiff]’s trade secrets.”¹⁴

To support this construction, the court specifically cited the California Uniform Trade Secrets Act (“UTSA”)’s definition of a “trade secret,” even though plaintiff had not alleged a UTSA claim against the defendants and the UTSA was not briefed.¹⁵ The court also found that the provision prohibiting use of confidential information was likely enforceable to the extent that the claimed confidential information is protectable as a trade secret.¹⁶

Based on these conclusions regarding the enforceability of the provisions, and facts showing that plaintiff had established at least serious questions going to the merits of its claims, the court issued a narrow temporary restraining order.¹⁷

IMPLICATIONS

Richmond demonstrates that at least one California federal court may be willing to narrowly construe an ambiguous non-compete provision and find it enforceable to the extent necessary to protect a party’s trade secrets. In so doing, however, the court invites comparisons to California cases where courts have refused to narrowly construe broad non-compete provisions to be protections of trade secrets.¹⁸ For example, in D’sa v. Playhut, Inc., 85 Cal. App. 4th 927 (2000), a Court of Appeals refused to reform a non-compete provision that broadly prohibited employees from working in connection with a competing product.¹⁹ But D’sa was strictly in the employment context, where courts are more likely to look for over-reaching. Arguably, moreover, the provision at issue in D’Sa was broader than the provision considered inRichmond, which expressly referenced “technology,” “technical knowhow,” and “Source Code” in its language. Nevertheless, even with these references, the Richmond court conceded that the scope of the provision was “not entirely clear,” yet was willing to reform it to find it enforceable.

Furthermore, in enforcing the non-compete provision, the Richmond court also relied on the so-called “trade secret exception” to Section 16600²⁰ — an exception that the California Supreme Court noted but declined to address in Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 n.4 (2008). This is an exception that other courts, particularly state courts, have questioned.²¹ This reliance suggests that, in the absence of conclusive guidance from the California Supreme Court on the viability of this exception, federal courts may remain willing to apply this exception to non-compete provisions perhaps as a way to harmonize the two statutes. In doing so, it is possible that the same collision between federal jurisprudence and state jurisprudence that gave rise to the Edwards decision may lie ahead. The California Supreme Court will then have an opportunity to address a key issue that the Supreme Court left unaddressed in a footnote in Edwards.

Finally, even with the uncertainty over the viability of the “trade secret exception” and whether courts will narrowly construe a non-compete provision to find it enforceable, companies should ensure non-compete provisions are drafted to clearly and specifically protect trade secrets, thereby increasing the likelihood that such a provision will be enforced.

¹Plaintiff is a company that provides enterprise resource planning software for financial service companies that provide credit card terminals to merchants. Id. at *1. One of the defendants developed and maintained enterprise resource planning software for the plaintiff and, pursuant to this relationship, entered into this NDA with plaintiff’s predecessor-in-interest. Id. at *1-2.

²Id. at *16.
³Id. at *16.
⁴Id. at *16.
⁵Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *15-22 (N.D. Cal. July 1, 2011).
⁶Id. at *16.
⁷Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *16 (N.D. Cal. July 1, 2011)(quoting Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 945-46 (2008)).
⁸Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011)(quoting Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 949 (2008)).
⁹Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011)(quoting Cal. Bus. & Profs. Code § 16600).
¹⁰Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *17 (N.D. Cal. July 1, 2011).
¹¹Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 at *18 (N.D. Cal. July 1, 2011)(quoting Retirement Group v. Galante, 176 Cal. App. 4th 1226, 1237 (2009)(citing Morlife Inc. v. Perry, 56 Cal. App. 4th 1514, 1519-20 (1997); American Credit Indemnity Co. v. Sacks, 213 Cal. App. 3d 622, 634 (1989); Southern Cal. Disinfecting Co. v. Lomkin, 183 Cal. App. 2d 431, 442–448 (1960); Hollingsworth Solderless Terminal Co. v. Turley, 622 F.2d 1324, 1338 (9th Cir. 1980); Gordon v. Landau, 49 Cal. 2d 690 (1958); Gordon v. Schwartz, 147 Cal. App. 2d 213 (1956); Gordon v. Wasserman, 153 Cal. App. 2d 328 (1957)).
¹²Id. at *18.
¹³Id. at *19.
¹⁴Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)(citing Whyte v. Schlage Lock Co., 101 Cal. App. 4th 1443, 1456 (2002)). Interestingly, there is theoretically no temporal limit to a trade secret, so the one year limit of the non-compete provision actually undercut the plaintiff’s protection!
¹⁵See Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)(citing Cal. Civ.Code § 3426.1(defining “trade secret” to include programs, methods, and techniques that derive independent economic value from not being generally known to the public, provided they are subject to reasonable efforts to maintain their secrecy)).
¹⁶Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158, at *19 (N.D. Cal. July 1, 2011)
¹⁷Id. at *23.
¹⁸Perhaps this decision also signals a willingness among California federal courts to protect employer’s interests by reforming or severing provisions that may not comply with Section 16600. See also Thomas Weisel Partners LLC v. BNP Paribas, No. C 07–6198 MHP, 2010 WL 1267744 (N.D. Cal. Feb. 10, 2010)(holding that a former employee’s non-solicitation provision was void to the extent it restricted the former employee’s ability to hire the employer’s employees after the former employee transitioned to another company, but upholding the rest of the employment agreement). These decisions may renew forum shopping, the ill that the California Supreme Court’s decision in Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937 (2008) was implicitly designed to address.
¹⁹The provision stated: “Employee will not render services, directly or indirectly, for a period of one year after separation of employment with Playhut, Inc. to any person or entity in connection with any Competing Product. A ‘Competing Product’ shall mean any products, processes or services of any person or entity other than Playhut, Inc. in existence or under development, which are substantially the same, may be substituted for, or applied to substantially that same end use as the products, processes or services with which I work during the time of my employment with Playhut, Inc. or about which I work during the time of my employment with Playhut Inc. or about which I acquire Confidential Information through my work with Playhut, Inc. Employee agrees that, upon accepting employment with any organization in competition with the Company or its affiliates during a period of five year(s) following employment separation, Employee shall notify the Company in writing within thirty days of the name and address of such new employer.” D’sa v. Playhut, Inc., 85 Cal. App. 4th 927, 930 -31(2000).
²⁰Richmond Technologies, Inc. v. Aumtech Business Solutions, No. 11–CV–02460–LHK, 2011 WL 2607158 at *18 (N.D. Cal. July 1, 2011).
²¹As an example of the trend, see, e.g., Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564, 577 (2009)(“Although we doubt the continued viability of the common law trade secret exception to covenants not to compete, we need not resolve the issue here.”); Robinson v. U-Haul Co. of California, Nos. A124070, A124097, A124096, 2010 WL 4113578, at *10 (Cal. Ct. App. Oct. 20, 2010)(“the so-called ‘trade secrets’ exception to Business and Professions Code section 16600 . . .rests on shaky legal grounds”)(citing Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, 946 n.4 (2008); Dowell v. Biosense Webster, Inc., 179 Cal. App. 4th 564, 578 (2009);Retirement Group v. Galante, 176 Cal. App. 4th 1226, 1238 (2009)). When the apparent conflict in this area is addressed, perhaps the California Supreme Court will defuse it entirely, by agreeing with the way the court in Retirement Group v. Galante, 176 Cal. App. 4th 1226 (2009) reconciled it: “the conduct is enjoinable not because it falls within a judicially-created ‘exception’ to section 16600’s ban on contractual nonsolicitation clauses, but is instead enjoinable because it is wrongful independent of any contractual undertaking.” Retirement Group v. Galante, 176 Cal. App. 4th at 1238.

OSHA Seeking Comment on SOX Whistleblower Complaint Rules

Posted in the National Law Review an article by attorney Virginia E. Robinson of Greenberg Traurig regarding OSHA seeking public comment on interim final rules that revise its regulations on the filing and handling of Sarbanes-Oxley Act (SOX) whistleblower complaints

The U.S. Department of Labor’s Occupational Safety and Health Administration (OSHA) is seeking public comment on interim final rules that revise its regulations on the filing and handling of Sarbanes-Oxley Act (SOX) whistleblower complaints.

OSHA, the entity charged with receiving and investigating SOX whistleblower complaints, issued the interim rules in part to implement the amendments to SOX’s whistleblower protections that were included in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Those amendments include an extension of the statute of limitations period for filing a complaint from 90 to 180 days. They also clarify that nationally recognized statistical rating organizations and subsidiaries of publicly traded companies are covered employers under SOX.

In addition to implementing the Dodd-Frank amendments, the interim rules also seek to improve OSHA’s handling of SOX whistleblower complaints, and will permit the filing of oral complaints and complaints in any language.

The planned amendments to those regulations were published in the Nov. 3 Federal Register. Comments must be received by Jan. 3, 2012, and may be submitted online, by mail, or by fax. The Depatment of Labor’s recent news release provides additional details.

Department of Labor Revises Conflict Disclosure Requirements for Labor Union Officials

Barnes & Thornburg LLP‘s Labor and Employment Law Department recently posted in the National Law Review an article about the United States Department of Labor’s Office of Labor-Management Standards adopted a final rule revising the information that union officials must disclose on Form LM-30, the Labor Organization Office and Employee Report.:

On Oct. 26, 2011, the United States Department of Labor’s Office of Labor-Management Standards adopted a final rule revising the information that union officials must disclose on Form LM-30, the Labor Organization Office and Employee Report. The new rule reverses the rule published by the agency in 2007 that significantly expanded the financial disclosure requirements of union officials. Effective Nov. 25, 2011, union officials are now required to disclose only payments and interests that involve “actual or likely” conflicts between the official’s personal financial interests and his or her duties to the union. The DOL explains that such conflicts include “payments, interests and transactions involving the employers whose employees the union represents or actively seek to represent, vendors and service providers to such employers, the official’s union or the union’s trust and other employers from which a payment could create a conflict.” The new rule applies to reports required by union officials with fiscal years beginning on or after Jan. 1, 2012.

Use of Form LM-30 for reporting purposes began in 1963 pursuant to Section 202 of the Labor-Management Reporting and Disclosure Act. Although the reporting requirements for Form LM-30 were significantly expanded in 2007, the DOL had issued a non-enforcement policy in 2009 that allowed filers to use either the 2007 expanded version of Form LM-30 or the 1963 version of the Form to disclose potential conflicts.

Second Circuit's Citigroup Decision Endorses Presumption of Prudence, Upholds Dismissal of Disclosure Claims

Posted this week at the National Law Review by Morgan, Lewis & Bockius LLP regarding the decision that employer stock in a 401(k) plan is subject to a “presumption of prudence” that a plaintiff alleging fiduciary breach:

In a much-anticipated decision, the U.S. Court of Appeals for the Second Circuit joined five other circuits in ruling that employer stock in a 401(k) plan is subject to a “presumption of prudence” that a plaintiff alleging fiduciary breach can overcome only upon a showing that the employer was facing a “dire situation” that was objectively unforeseeable by the plan sponsor. In re Citigroup ERISA Litigation, No. 09-3804, 2011 WL 4950368 (2d Cir. Oct. 19, 2011). The appellate court found the plaintiffs had not rebutted the presumption of prudence and so upheld the dismissal of their “stock drop” claims.

BACKGROUND

The Citigroup plaintiffs were participants in two 401(k) plans that specifically required the offering of Citigroup stock as an investment option. The plaintiffs alleged that Citigroup’s large subprime mortgage exposure caused the share price of Citigroup stock to decline sharply between January 2007 and January 2008, and that plan fiduciaries breached their duties of prudence and loyalty by not divesting the plans of the stock in the face of the declines. The plaintiffs further alleged that the defendants breached their duty of disclosure by not providing complete and accurate information to plan participants regarding the risks associated with investing in Citigroup stock in light of the company’s exposure to the subprime market. On a motion to dismiss, the district court found no fiduciary breach because the defendants had “no discretion whatsoever” to eliminate Citigroup stock as an investment option (sometimes referred to as “hardwiring”). Alternatively, the lower court ruled that Citigroup stock was a presumptively prudent investment and the plaintiffs had not alleged sufficient facts to overcome the presumption.

SECOND CIRCUIT DECISION

Oral argument in the Citigroup case occurred nearly a year ago, and legal observers have been anxiously awaiting the court’s ruling. In a 2-1 decision, with Judge Chester J. Straub issuing a lengthy dissent, the Second Circuit rejected the “hardwiring” rationale but confirmed the application of the presumption of prudence, which was first articulated by the Third Circuit in Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995). The court also rejected claims that the defendants violated ERISA’s disclosure obligations by failing to provide plan participants with information about the expected future performance of Citigroup stock.

Prudence

Joining the Third, Fifth, Sixth, Seventh, and Ninth Circuits,[1] the court adopted the presumption of prudence as the “best accommodation between the competing ERISA values of protecting retirement assets and encouraging investment in employer stock.” Under the presumption of prudence, a fiduciary’s decision to continue to offer participants the opportunity to invest in employer stock is reviewed under an abuse of discretion standard of review, which provides that a fiduciary’s conduct will not be second-guessed so long as it is reasonable. The court also ruled that the presumption of prudence applies at the earliest stages of the litigation and is relevant to all defined contribution plans that offer employer stock (not just ESOPs, which are designed to invest primarily in employer securities).

Having announced the relevant legal standard, the court of appeals dispatched the plaintiffs’ prudence claim in relatively short order. The plaintiffs alleged that Citigroup made ill-advised investments in the subprime market and hid the extent of its exposure from plan participants and the public; consequently, Citigroup’s stock price was artificially inflated. These facts alone, the court held, were not enough to plead a breach of fiduciary duty: “[T]hat Citigroup made a bad business decision is insufficient to show that the company was in a ‘dire situation,’ much less that the Investment Committee or the Administrative Committee knew or should have known that the situation was dire.” Nor could the plaintiffs carry their burden by alleging in conclusory fashion that individual fiduciaries “knew or should have known” about Citigroup’s subprime exposure but failed to act. Relying on the Supreme Court’s decision in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), the court of appeals held these bald assertions were insufficient at the pleadings stage to suggest knowledge of imprudence or to support the inference that the fiduciaries could have foreseen Citigroup’s subprime losses.

Disclosure

The court’s treatment of the disclosure claims was equally instructive. Plaintiffs’ allegations rested on two theories of liability under ERISA: (1) failing to provide complete and accurate information to participants (the “nondisclosure” theory), and (2) conveying materially inaccurate information about Citigroup stock to participants (the “misrepresentation” theory).

As to the nondisclosure theory, the court found that Citigroup adequately disclosed in plan documents made available to participants the risks of investing in Citigroup stock, including the undiversified nature of the investment, its volatility, and the importance of diversification. The court also emphasized that ERISA does not impose an obligation on employers to disclose nonpublic information to participants regarding a specific plan investment option.

Turning to the misrepresentation theory, the court found plaintiffs’ allegations that the fiduciaries “knew or should have known” about Citigroup’s subprime losses, or that they failed to investigate the prudence of the stock, were too threadbare to support a claim for relief. Though plaintiffs claimed that false statements in SEC filings were incorporated by reference into summary plan descriptions (SPDs), the court found no basis to infer that the individual defendants knew the statements were false. It also concluded there were no facts which, if proved, would show (without the benefit of hindsight) that an investigation of Citigroup’s financial condition would have revealed the stock was no longer a prudent investment.

IMPLICATIONS

Coming from the influential Second Circuit, the Citigroup decision represents something of a tipping point in stock-drop jurisprudence, especially with respect to the dozens of companies (including many financial services companies) that have been sued in stock-drop cases based on events surrounding the 2007-08 global financial crisis. The Second Circuit opinion gives the presumption of prudence critical mass among appellate courts and signals a potential shift in how stock-drop claims will be evaluated, including at the motion to dismiss stage.[2]

Under the Citigroup analysis, fiduciaries should not override the plan terms regarding employer stock unless maintaining the stock investment would frustrate the purpose of the plan, such as when the company is facing imminent collapse or some other “dire situation” that threatens its viability. Like other circuits that have adopted the prudence presumption, the Citigroup court emphasized the long-term nature of retirement investing and the need to refrain from acting in response to “mere stock fluctuations, even those that trend downhill significantly.” It also sided with other courts in holding that the presumption of prudence should be applied at the motion to dismiss stage (i.e., not allowing plaintiffs to gather evidence through discovery to show the imprudence of the stock). Taken together, these rulings may make it harder for plaintiffs to survive a motion to dismiss, especially where their allegations of imprudence are based on relatively short-lived declines in stock price.

Some had predicted the Second Circuit would endorse the “hardwiring” argument and allow employers to remove fiduciary discretion by designating stock as a mandatory investment in the plan document. The Citigroup court was unwilling to go that far, but it did adopt a “sliding scale” under which judicial scrutiny will increase with the degree of discretion a plan gives its fiduciaries to offer company stock as an investment. This is similar to the approach taken by the Ninth Circuit inQuan and consistent with the heightened deference that courts generally give to fiduciaries when employer stock is hardwired into the plan. Thus, through careful plan drafting, employers should be able to secure the desired standard of review. Language in the plan document and trust agreement (as well as other documents) confirming that employer stock is a required investment option should result in the most deferential standard and provide fiduciaries the greatest protection.

Also noteworthy was the court’s treatment of the disclosure claims. Many stock-drop complaints piggyback on allegations of securities fraud, creating an inevitable tension between disclosure obligations under the federal securities laws and disclosure obligations under ERISA. The Second Circuit did not resolve this tension, but it construed ERISA fiduciary disclosure requirements narrowly and rejected the notion that fiduciaries have a general duty to tell participants about adverse corporate developments. The court made this ruling in the context of SPD disclosures under the 401(k) plan that identified specific risks of investing in Citigroup stock. Plan sponsors should review their SPDs and other participant communications to make sure company stock descriptions are sufficiently explicit about issues such as the volatility of a single-stock investment and the importance of diversification. These disclosures may go beyond what is already required under Department of Labor regulations.

[1]. See Howell v. Motorola, Inc., 633 F.3d 552, 568 (7th Cir.), cert.denied, 2011 WL 4530151 (2011); Quan v. Computer Sciences Corp., 623 F.3d 870, 881 (9th Cir. 2010); Kirschbaum v. Reliant Energy, Inc., 526 F.3d 243, 254 (5th Cir. 2008); Kuper v. Iovenko, 66 F.3d 1447, 1459-60 (6th Cir. 1995).

[2]. That said, plan sponsors and fiduciaries should continue to monitor future developments in Citigroup in light of Judge Straub’s dissenting opinion and the likelihood of a petition for rehearing (or rehearing en banc), which the Citigroup plaintiffs have indicated they intend to seek. In his dissent, Judge Straub rejected the Moench presumption in favor of plenary review of fiduciary decisions regarding employer stock. He also disagreed with the majority’s interpretation of ERISA disclosure duties.

The U.S. Has a New Patent Law

Posted in the National Law Review on October 27, 2011 an article regarding the Patent Reform Act of 2011 by Taylor P. Evans of Andrews Kurth LLP:

President Obama signed the Patent Reform Act of 2011 into law on September 16, 2011. Below is a summary of selected provisions of the Act.

First to File

Effective March 2013, the U.S. patent system will change from a first-to-invent to a first-to-file system. This means that if two people make the same invention and there has been no public disclosure of the invention, and both describe and claim that invention in separate patent applications, the inventor that filed his patent application first gets the patent. Thus, filing early will be more critical than ever before. Companies should consider filing a provisional application for an invention as early as possible, possibly followed by additional provisional applications as the technology of an invention develops, with a non-provisional application within a year of the first provisional application. The first-to-file provision will have no effect on existing patents or applications filed before March 2013.

Post-Grant Challenges

Effective September 2012, third parties will be able to challenge the validity of patents within nine months of issuance in the Patent Office in a Post-Grant Opposition Review proceeding. Any basis for a validity challenge will be entertained, including questions of novelty and obviousness, as well as challenges based on non-patentable subject matter or an improper written description or other formalities. After nine months, third parties may challenge patents through Inter Partes Review, which will replace existing Inter Partes Reexamination proceedings. In an Inter Partes Review, invalidity challenges must be based only on prior patents and printed publications.

In view of these changes, companies planning to initiate Inter Partes Reexamination proceedings should do so prior to September 2012. In addition, companies should arrange a monitoring program to identify patents that relate to the company’s product line for possible challenge in a Post-Grant Opposition Review proceeding upon issuance. Similarly, patentees should be aware that a significant challenge against their patents in the patent office may develop, and they should be prepared to defend against challenges from competitors when their own patents issue.

False Marking

The new Act severely limits false marking lawsuits. Only the federal government and direct competitors that have been damaged can sue for false marking. Furthermore, non-government litigants will no longer be able to collect five hundred dollars in damages per item. In addition, it is no longer actionable not to remove expired patent numbers from products. The new law also provides for “virtual marking,” by which a company marks its product with “Patent” or “Pat.,” followed by a web address. The corresponding website displays the patent marking information and must be available to the public at no charge. These changes apply retroactively to existing cases.

Disjoinder

The new law bars plaintiffs from suing multiple defendants in the same suit if the only thing that the defendants have in common is that they are alleged to infringe the same patent(s). Courts will also be barred from consolidating cases involving different defendants according to the same criteria, except that unrelated parties may still be joined for purposes of discovery. This provision applies to all suits filed on or after September 16, 2011.

Supplemental Examination

Supplemental examination is a new post-grant procedure that will allow a patentee to cure possible inequitable conduct by presenting previously withheld information to the Patent Office after issuance of a patent. After the previously withheld information is presented, and if the claims are allowed again, that information cannot be used in later court proceedings. Supplemental examination proceedings cannot be commenced or continue once an infringement action has been brought.

Assignee Filing

Under the new Act, a company can file a patent application on behalf of an inventor where the inventor is under obligation to assign its rights to the company and refuses to sign the oath or declaration. This provision will become effective in September 2012.

Fees

Effective September 26, 2011, all Patent Office fees will be subject to a 15% surcharge.

Other Changes

There are numerous other changes to the patent system under the Patent Reform Act of 2011, including, for example, elimination of the “best mode” requirement, and changes unique to specific types of inventions, such as business methods or computers. For additional information or to discuss all the new changes in more detail, please call us.

IRS Announces Retirement Plan Limitations for 2012 Tax Year – Most Limits Increased

Recently posted in the National Law Review an article written by Alyssa D. Dowse of von Briesen & Roper, S.C. regarding the cost of living adjustments for the 2012 tax year:

The Internal Revenue Service (“IRS”) has announced the cost of living adjustments for the 2012 tax year, which affect various dollar limitations for retirement plans. The IRS increased many of these limitations for the first time since 2009. Some limitations remain unchanged. The following chart highlights many of the noteworthy limitations for the 2012 tax year.

Plan Limit	2011	2012
Social Security Taxable Wage Base	$106,800	$110,100
Annual Compensation (Code Section 401(a)(17))	$245,000	$250,000
Elective Deferral (Contribution) Limit for Employees who Participate in 401(k), 403(b) and most 457(b) Plans (Code Sections 402(g), 457(e)(15))	$16,500	$17,000
Age 50 Catch-Up Contribution Limit (Code Section 414(v)(2)(B)(i))	$5,500	$5,500
Highly Compensated Employee Threshold (Code Section 414(q)(1)(B))	$110,000	$115,000
Defined Contribution Plan Limitation on Annual Additions (Code Section 415(c)(1)(A))	$49,000	$50,000
Defined Benefit Plan Limitation on Annual Benefit (Code Section 415(b)(1)(A))	$195,000	$200,000
ESOP Distribution Period Rules—Payouts in Excess of Five Years (Code Section 409(o)(1)(C))	$985,000 $195,000	$1,015,000 $200,000
Key Employee Compensation Threshold for Officers (Code Section (416(i)(1)(A)(i))	$160,000	$165,000

Plan sponsors should review employee communications and update such communications as appropriate based on the 2012 cost of living adjustments. Other cost of living adjustments can be found on the IRS website: http://www.irs.gov/retirement/article/0,,id=96461,00.html.

Year 2 of Say-on-Pay.

In preparing for this year’s say-on-pay vote the compensation committee should consider:

SEC Rules on Mandatory Proxy Access Have Been Vacated by the Courts but “Private Ordering” Lives On.

SEC Issues Additional Guidance with Respect to Proposals Brought by Shareholders.

Other Sections of the Dodd-Frank Act Are Still Subject to Rulemaking.

Whistleblower Bounty System in Effect.

“Proxy Plumbing”.

SEC Cybersecurity Guidance.

Conflict Minerals Disclosure.

Internal Control over Financial Reporting.

2012 Periodic Report Filing Deadlines

Board of Director and Committee Membership

Shareholder Approval of Equity Compensation Plans

Other Year-End Considerations

Compensation Committe

Nominating Committee

Full Board

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The Key Facts

What Makes the Case Noteworthy

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Recently posted in the National Law Review an article by Catherine Salmen Wright of Dinsmore & Shohl LLP regarding conducting an internal investigation:

1. Determine the objectives and strategy for the investigation.

2. Maintain confidentiality.

3. Determine if immediate actions need to take place to protect the workforce.

4. Review company policies.

5. Conduct a preliminary search of available records.

6. Select the appropriate personnel to conduct the investigation.

7. Control the interview process.

8. Communicate throughout the process.

9. Close the investigation properly.

10. Ensure against retaliation.

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The Facts in Richmond

The Richmond Court’s Analysis

IMPLICATIONS

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BACKGROUND

SECOND CIRCUIT DECISION

Prudence

Disclosure

IMPLICATIONS

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