Liability for inside bridge rounds?

The National Law Review recently published an article by Michael D. DiSanto of Dinsmore & Shohl LLP regarding Inside Bridge rounds and their liability:

Imagine for a moment that you are the CEO of a venture-backed technology or services startup. The company is in the midst of a round of funding, and it is taking longer than anticipated for whatever reason. The cash coffers are unnervingly low, with payroll or other normal monthly expenses right around the corner.

Or maybe the situation is something different. Maybe the company isn’t a technology or services company at all. Maybe it is a manufacturing company and the first big order has just arrived. The company needs to lay out a pile of cash to scale up its team or otherwise secure the necessary raw materials to fulfill the order.

Whatever the case may be, who is the first person the CEO typically calls to alleviate the temporary cash crisis? That is an easy one. The CEO almost always reaches out to the member of the board of directors that represents the private equity fund that typically demonstrates the most support for the company. The conversation typically lasts a few minutes, as the pair hammer out standard (or maybe not so standard) terms for a bridge loan, and the cash coffers are reloaded a few short days later.

Problem solved, right? Not necessarily.

The company’s short-term cash flow problem is solved. Yet, in at least one part of the country, the venture capital funds funding the bridge loans and the director designees approving the transaction could face liability for a breach of the duty of loyalty, if the transaction does not pass the “entire fairness” test.

Did that grab your attention? It certainly grabbed mine.

The Seventh Circuit issued an opinion that, if adopted by California and Delaware, could turn the common practice of inside bridge loans on its head.

The facts of the case probably sound all too familiar to anyone involved with technology startups during the so-called “bubble burst” in 2000 and the global economic crisis that kicked into high gear in late 2008. Cadant was a technology startup incorporated under the laws of Delaware and backed by an investor syndicate lead by two well known venture funds —Venrock and J.P. Morgan. Cadant was facing dire straits in the fall of 2000. Unable to complete a round of preferred stock financing, Cadant sought a bridge loan from an outside investor group, as well as an inside proposal from Venrock and J.P. Morgan.

In late January 2001, the VCs funded an $11 million bridge loan at 10 percent interest and 90-day maturity. Cadant burned through those funds in no time, so the company went back to the deep pockets of its investor syndicate and raised another $9 million bridge from the VCs. This time, however, the bridge included a two-times liquidation preference and the published court opinion makes no mention about seeking a competing proposal.

The Cadant board at the time of both transactions consisted of seven directors. Four were designees of the VCs. The other three were “engineers without financial acumen” who were basically “at the mercy of the financial advice” they received from the four VC designees. The board reportedly relied on Eric Copeland, one of its directors and a Venrock principal, to negotiate the terms of the two bridge loans, despite the fact that Copeland had a clear conflict of interest.

The rest of the story isn’t difficult to predict. Cadant ultimately defaulted on both bridge loans and agreed to sell all of its assets for stock then valued at approximately $55 million. That amount was completely consumed by the liquidation preference of the preferred stockholders and the company’s outstanding debt. The common holders received nothing. Bankruptcy ensued and a liquidating trust brought suit against the VC funds and their director designees.

The Seventh Circuit held that a decision by VC representatives on a board to approve a loan was essentially self-dealing that could not be cured by a vote of majority of the disinterested directors where the interested directors set the terms of the deal. The deal, therefore, had to be evaluated under the entire fairness doctrine, which could raise liability questions when distressed companies do not go out and shop the offer to get a market check as to the fairness of the terms. Note also that the VC funds, while not owing a fiduciary to shareholders directly, faced liability under an aiding and abetting theory.

This opinion seems to be at odds with Delaware law that appears on its face to allow a majority of disinterested directors to approve the deal so long as it was fully and fairly disclosed. Note that the court applied Delaware law due to the internal affairs doctrine, since the company was incorporated in Delaware.

Courts outside of the Seventh Circuit are obviously not bound by this decision. But Judge Posner, the man who authored the opinion, is one of the most well respected and widely cited members of any judiciary. If the Delaware Chancery Court adopts a similar position on the issue, it could result in a dramatically change in the appetite for VCs to fund quick inside bridge rounds for distressed portfolio companies hoping to create some breathing room ahead of an equity round or exit.

What’s the BIG deal?

Judge Posner’s opinion won’t likely have a chilling effect on inside bridge rounds for Delaware corporations, nor should it. Instead, it should serve as a bit of a wakeup call companies and investors shooting from the hip when it comes to inside bridge rounds.

Two practice points jump off the pages of the opinion. First, directors should think twice before sitting on both sides of the negotiation table when a CEO comes asking for a bridge loan. Had one of the non-VC designees negotiated the terms with the VCs in this case, the case might not have survived a motion to dismiss.

Second, boards should be prepared to defend inside bridges under the “entire fairness” test. Performing some semblance of a market check, if possible, is one way to help avoid liability. You know what they say – the more the merrier when it comes to competing proposals.

It will be interesting to see if Delaware and other jurisdictions ultimately decide to adopt Judge Posner’s approach to dealing with inside bridge rounds.

RIMS 2012 Annual Conference & Exhibition

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

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

Join us April 15-18 in Philadelphia

No Boundaries

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

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

What’s New!

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

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Increasing Offshore Wind Projects: A Focus on Regulatory Authority

The National Law Review announced the Winner–March 2012 Law Student Writing Competition: Kiboni Ann Yarling of the Florida Coastal School of Law we are pleased to bring you her article here:

I. Introduction: The Rise of Offshore Wind Projects

Meeting the challenges of environmental sustainability and climate control will require unprecedented advances in the global energy market through regulatory consistency, policy incentives, and economic integration. Energy conservation and environmental preservation are important to all human welfare. The current energy structure, on a global level, has contributed significantly to the drastic climate fluctuations as well as environmental destruction. Now that the impacts of fossil fuel consumption have become significant, a diversified energy structure is needed to ensure sustainability.[i] The United States needs to become more invested in alternative renewable energy sources in order to curb the impacts caused from fossil fuel consumption which include: environmental degradation, pollution, death, exhaustion, depletion, etc.

The energy demand in the United States as well as the rest of the world will continue to increase with industrialization, advancements in technology and population growth. While energy consumption rates skyrocket to never-before-seen heights, access to fossil fuels becomes more difficult and more expensive. Global development and energy demands will continue as newly industrialized countries become competitive with developed countries, and yet the global arena lacks an authoritative body to manage our precious fossil fuels. The United States should not hesitate in decreasing its dependency on fossil fuels and increasing renewable energy development.

As a result of rising concerns about energy prices, supply uncertainties, and adverse environmental impacts, the United States has taken a new approach to its energy structure by working towards developing renewable energies and generating more energy from domestic sources, while trying to lessen the environmental impacts.[ii] This approach calls for a cohesive system of agency regulation and management to streamline the permitting process for alternative renewable energy resources, especially offshore wind projects.

The potential energy generation from offshore, renewable resources is substantial and implementation is essential for environmental sustainability and responsible environmental resource management.[iii] For example, an offshore turbine is capable of producing fifty percent more electricity than an onshore turbine of the same size because offshore winds are stronger and more constant. [iv] The potential for U.S. offshore wind electricity is estimated to be more than 900,000 megawatts, a figure equal to the United States’ current production capacity.[v] The public needs to become educated on environmental impacts caused by fossil fuel consumption and the potential for renewable resources to mitigate those impacts. In turn, the public needs to pressure those agencies responsible for energy production to promote consistent and dependable methods for permitting renewable energy resource development.

In April 2010, the BP oil spill, the largest accidental oil spill in American history, caused irreparable damage to the water supply, marine wildlife and the entire ecosystem of the Gulf of Mexico. The actual damage caused by exploiting fossil fuel resources, in addition to the potential risks and unpredictable long-term impacts, provides sufficient motivation to move in the direction of promoting renewable energy resources, which pose relatively zero risks.[vi] However the current national energy structure is exactly the opposite. Renewable energy projects coming online are sadly minimal and the United States and other nations continue to pursue fossil fuel projects.

Part II discusses how the United States has delegated jurisdiction over the ocean to various agencies and provides an overview of the conflicts that exist among agencies with regard to jurisdiction over the ocean. Part III provides a case specific analysis of the permitting process for an offshore wind project and the difficulty of satisfying the requirements of the environmental review process. This section also suggests that the federal government should create new legislation for managing offshore wind projects, as well as for other renewable energy resources. Finally, Part IV offers recommendations that the federal government and the public should pursue initiatives and existing practices in the fossil fuel arena to be applied to the renewable energy arena, as to protect the health and economic stability of the United States.

II. Regulatory Background of Offshore Management – Jurisdictional Conflict Among Agencies

In 1945, President Truman proclaimed that the United States had jurisdiction and control over the U.S. Continental Shelf and the natural resources on the shelf and of the subsoil.[vii] Enacted in 1953, the SLA gave coastal states jurisdiction and control over the sea and the submerged lands, extending three nautical miles seaward from the coastline.[viii] However, SLA reserved the federal rights to “commerce, navigation, national defense, and international affairs.”[ix] OCSLA, enacted shortly after SLA, codified the Truman Proclamation and delegated to the Secretary of the Interior authority over exploration and development on the Outer Continental Shelf (OCS), submerged lands seaward from each states’ territory.[x] It is now established law that the seabed of the ocean beyond three miles from the shore and on the OCS is within U.S. territorial water and under exclusive federal jurisdiction.[xi] The OCSLA, delegated authority to the Department of the Interior to issue oil and gas leases, but it did not delegate authority over renewable energy development on the OCS.[xii]

Over the last decade, the delegation of federal authority to manage environmental regulations and oversee the development of offshore projects has created confusion among several agencies. Prior to 2005, the Army Corps of Engineers (Corps) was responsible for permitting offshore wind projects pursuant to the Rivers and Harbors Act.[xiii] However, under the Energy Policy Act of 2005, the Secretary of the Interior was given the power to grant leases, easements, and rights-of-way on the Outer Continental Shelf (OCS) for renewable energies.[xiv] In 2006, the Secretary of the Interior delegated its authority to the DOI’s Mineral Management Service (MMS).[xv] The Corps, however, retained its authority over permitting offshore projects.[xvi]

In response to confusion between MMS and the Corps as to who had exclusive authority over offshore renewable energy projects, the DOI and the Federal Energy Regulatory Commission (FERC) signed a Memorandum of Understanding (MOU) that gave MMS exclusive jurisdiction over offshore wind energy projects on the OCS.[xvii] The MOU charged MMS with conducting environmental reviews and ensuring that offshore wind projects comply with other federal agency requirements, including requirements under NEPA.[xviii]

The CEQ is charged with specific duties to carry out NEPA’s standards, including the duty to suggest, “national policies to foster…environmental quality to meet…goals of the Nation.”[xix] Under NEPA, federal agencies such as MMS are required to submit to CEQ a statement detailing any potential environmental impacts of any “major Federal actions significantly affecting the quality of the human environment.”[xx]

The Energy Policy Act of 2005 authorized the Department of the Interior (DOI) to issue leases, easements, or right-of-ways for alternative energy projects on the OCS. Prior to 2005, MMS had been responsible for managing oil, natural gas, and other resource activities on OCS lands. Under the Energy Policy Act of 2005, MMS became responsible for managing alternative energy-related activities, including renewable resources, on OCS lands.[xxi] MMS became the lead agency to coordinate the permitting process, and to monitor and regulate alternative energy production.[xxii] MMS is charged with ensuring that projects are in conformity with NEPA before permits are issued. Therefore MMS and its predecessors must comply with NEPA when considering applications, such as the Cape Wind application discussed below.[xxiii]

The statement detailing environmental impacts, required by the CEQ, can take the form of an environmental impact statement (EIS),[xxiv]a thorough assessment of the environmental impacts, or an environmental assessment (EA),[xxv]which is more conciseimpact statement. The EIS must include: (1) the environmental impacts of the proposed action, (2) alternatives to the proposed action; and (3) “any irreversible and irretrievable commitments of resources which would be involved in the proposed action should it be implemented.”[xxvi] MMS recognizes that offshore wind projects will significantly affect the human environment, therefore requiring an EIS instead of an EA.[xxvii]

MMS published the Renewable Energy and Alternative Uses of Existing Facilities on the Outer Continental Shelf (Rules),[xxviii]which requires two additional environmental reviews before MMS issues a commercial lease for an offshore wind project.[xxix] Under the Rules, a lessee is required to submit a Site Assessment Plan (SAP) before conducting a site assessment and then was required to submit a Construction and Operations Plan (COP) before beginning construction.[xxx] Both the SAP and the COP must undergo a NEPA review.[xxxi] After the SAP is approved, a five-year site assessment term begins, during which the lessee assesses the potential impacts of the project’s activities and prepares the COP.[xxxii]

However to reduce the review time, MMS decided that the SAP and COP could be submitted simultaneously.[xxxiii] If the SAP introduces additional information not included in the initial EIS, a second environmental review is required.[xxxiv] Another environmental review is required when the COP is submitted.[xxxv] MMS, initiated an interim policy to make the environmental review more efficient, under which resource data collection facilities “could be considered and authorized for installation and operation on the OCS before promulgation of final rules.”[xxxvi]

The Rules for permitting offshore wind projects were unsurprisingly similar to the regulatory process for oil and gas leasing since MMS was the lead agency for both.[xxxvii] The Rules allowed for leasing of commercial development on the OCS, and allowed for the issance of right-of-ways and right-of-use easements necessary to support renewable energy projects.[xxxviii] Commercial leases enable the lessee to deliver power by including the right to a project easement, allowing the lessee to install transmission cables.[xxxix] The Rules also require environmental reviews to be consistent with the CZMA.[xl] The CZMA was enacted, “to preserve, protect, develop, and where possible, to restore or enhance, the resources of the Nation’s coastal zone.”[xli] Congress gave states the authority to establish management programs, in accordance with CZMA, to oversee the development of offshore projects in and adjacent to the state’s territorial lands.[xlii] However a project may be exempt from the state’s program if it serves national interests and is consistent with the CZMA.[xliii]

In an effort to streamline the environmental review process, that has substantially prolonged, or completely stopped, some energy development programs, on June 18, 2010, MMS was reorganized and renamed the Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE).[xliv] BOEMRE met with the same challenges of the environmental review process as MMS, and its response yielded similar deficiencies. As a result, the federal agency was reorganized again. On October 1, 2011, BOEMRE was replaced by the Bureau of Ocean Energy Management (BOEM) and the Bureau of Safety and Environmental Enforcement (BSEE).[xlv] BOEM is now responsible for the environmental review process and for managing responsible development of offshore resources other than oil and gas.[xlvi] BSEE is responsible for the oversight of offshore oil and gas operations.[xlvii] BOEM consolidates all relevant information that developers of offshore wind projects must consider when applying for lease permits and complying with the steps necessary to begin construction.[xlviii]

III. Cape Wind

Cape Wind Associates, LLC (Cape) began its consistently-obstacle-ridden journey to develop a wind energy plant on Horseshoe Shoal in Nantucket Sound, Massachusetts, in November 2001. Cape filed a permit application with the Corps to construct a scientific measurement device station (SMDS) to monitor and assess the potential impacts of the wind farm.[xlix] The U.S. Court of Appeals for the First Circuit upheld the Corps’ regulatory authority to permit Cape’s construction of the SMDS, which would collect data for five years.[l] The Corps issued a permit to Cape under section 10 of the Rivers and Harbors Act of 1899, 33 U.S.C. § 401, for the construction of the SMDS after determining that the project posed no threat to marine and avian life and that it would aid navigation.[li]

In addition to the permit, the Corps issued an EA and a Finding of No Significant Impact (“FONSI”) pursuant to NEPA requirements.[lii] The United States Court of Appeals for the First Circuit affirmed the district court’s decision that the Corps’ did not violate its authority in issuing the permit for the SMDS.[liii] Once Cape tackled the hurdle of getting the first permit, the State of Massachusetts added more challenges, prolonging the project and risking Cape Wind’s financial stability.

After the Corps granted the permit, Massachusetts, represented by Ten Taxpayers Citizen Group, et al., challenged the issuance of the permit claiming the state rather than the federal government had jurisdiction over the project.[liv] However, the United States Court of Appeals for the First Circuit affirmed the district court’s dismissal of the complaint on the basis that the project fell under federal jurisdiction and Massachusetts statutes were therefore inapplicable to the Cape’s project.[lv] The court recognized the general rule that rights to offshore seabeds are reserved to the federal government as an incident of national sovereignty.[lvi]

On November 21, 2002 Cape submitted a separate application to the Corps for a permit to construct and operate an offshore wind energy plant. Cape planned to install and operate of 170 offshore wind turbine generators (WTGs) to generate up to 420 megawatts (MW) of renewable energy.[lvii] The Corps determined that an EIS was required for the project, the first proposal of its kind in the United States at the time. Subsequent to the EIS, construction of the project was intended to start in 2004.[lviii] The EIS was to include an assessment of alternatives to the project, including: the no action alternative; alternative wind park locations, including offshore versus upland; submerged cable route alternatives; alternative landfall and overland cable route locations, and alternative connections to a transmission line.[lix]

Also included in the EIS were “analyses of impacts associated with construction, operation, maintenance and decommissioning of the WTGs on resources.”[lx] The Corps recognized that the EIS should also include analyses of the projects with regards to the Endangered Species Act of 1973, the Magnuson-Stevens Fishery Conservation and Management Act, the National Historic Preservation Act of 1966, the Fish and Wildlife Coordination Act of 1958, CZMA, CWA, the Rivers and Harbors Act of 1899, the OCSLS, and applicable Executive Orders.[lxi]

However, when MMS became responsible for the environmental review process in 2005, it assumed authority over the Cape project. Therefore Cape became subject to a new review under MMS that was practically governed by the same principles as the review undertaken by the Corps. MMS assumed lead federal responsibility and initiated its own independent environmental review pursuant to NEPA. Therefore that which was accomplished in the first four years of the permitting process became practically irrelevant and Cape was pushed back to where it started in 2001. It was not until May 2006 that MMS announced its Notice of Intent (NOI) to prepare an EIS for the Cape project.[lxii] The EIS was to include all that which was required under the Corps review well as analyses of avian species, marine mammals, shellfish resources, essential fish habitat, commercial and recreational fisheries, air and water quality, visual impact, noise assessment, alternative sites, marine archeological and cultural resources, air and sea navigation, local meteorological conditions, sediment transport patterns, local geological conditions, and economic impacts.[lxiii]

In addition to requiring the EIS, MMS invited participation by cooperative agencies and commenced a 45-day comment period, pursuant to NEPA, to allow “Federal, State, tribal, and local governments and other interested parties to aid the MMS in determining the significant issues, potential alternatives, and mitigating measures to be analyzed in the EIS and the possible need for additional information.”[lxiv] MMS invited qualified government entities to inquire about cooperating agency status for the Cape Wind EIS.[lxv] However those cooperating agencies’ input neither enlarges nor diminishes the final decision-making authority of any other agency involved in the NEPA process.[lxvi] Unqualified agencies could still comment during the normal public input phases of the NEPA/EIS process. MMS announced that alternatives to the proposal would be considered in the EIS.[lxvii]

MMS published the Cape Wind draft EIS in January 2008 and the final EIS and in 2009, MMS announced the release of the Final Environmental Impact Statement (FEIS) for the Cape project, noting that it had “assessed the physical, biological, and social/human impacts of the proposed project and 13 alternatives.”[lxviii] In 2010, MMS announced its Notice of Availability of an Environmental Assessment and Draft Finding of No New Significant Impact (FONNSI) for Public Review and Comment for the Cape project.[lxix] On April 28, 2010, the Department of Interior announced the availability of the Record of Decision (ROD) for the Cape Wind Project.[lxx] With the ROD, Cape’s future was the brightest it had since it had overcome many obstacles, and yet the project was challenged again in 2010. But again, the Supreme Court of Massachusetts upheld the project for satisfying its requirements and meeting applicable standards.[lxxi] Since the project was at its final stages when MMS was reformed into BOEMRE and then subsequently BOEM, Cape did not have to undergo additional reviews but continues to face criticism, even after construction began.

Construction of the offshore wind plant finally commenced in 2011.[lxxii] The project is still being challenged for failing to meet certain requirements under NEPA and other environmentally protective provisions. From start to finish Cape has had to endure a decade of challenges in dealing with regulatory inconsistency, jurisdictional conflicts, and from proponents claiming to promote environmental protection. Not many investors would be attracted to a project that needed at least ten years before completion, not to mention the additional time needed to make a return on the investment. It is hard to reconcile the goals of those challenging a renewable energy project as being concerned with environmental protection with the fact that no fossil fuel project has faced such challenges to delay construction for a decade. It would seem more logical that proponents claiming to promote environmental protection would be supportive of renewable energy production and would focus their efforts on delaying fossil fuel production, such as offshore oil rigs that have the potential for a blow out that would devastate the marine life and surrounding environments as witnessed by the BP oil spill.

IV. Progressive Policy Initiatives Need to Progress

With the reorganization and restructuring of the controlling agencies, the environmental review process need not be met with similar obstacles apparent throughout history. The United States Department of Energy (DOE) recognizes a potential for wind energy to contribute 20% of United States electricity by 2030, if significant obstacles are overcome.[lxxiii] These obstacles include: 1) improving turbine technology, 2) changing transmission systems to deliver the energy to the grid system, 3) expanding markets to purchase and use it, 4) policy development and 4) environmental regulation. [lxxiv] Concentrated, domestic wind energy has enormous potential to supply electricity, but its maximum effectiveness has only occurred in localized areas such as Nantucket Sound because of wind patterns and jurisdictional battles. Recent advanced technological enhancements have improved performance and the industry is gaining some momentum but the governmental agencies need to make substantial changes.

Recognizing the difficult nature of the environmental review process, BOEMRE introduced the “Smart from the Start” wind energy initiative, to identify suitable areas for wind energy projects on the OCS.[lxxv] The two primary purposes of the initiative are to 1) provide decision makers with the most current data, by calling for public and expert inputs, and 2) to streamline the issuance of leases and approval of site assessment activities, in accordance with the DOI and CEQ regulations implementing the provisions of NEPA.[lxxvi] Another purpose of the initiative is to identify areas that are most suitable for offshore wind energy projects.[lxxvii] The initiative “focuses on the identification and refinement of areas on the OCS that are most suitable for renewable energy development,” and “utilizes coordinated environmental studies, large-scale planning processes, and expedited review processes within these areas to achieve an efficient and responsible renewable energy leasing process.”[lxxviii]

If the initiative is successful, it should reduce the time, expense, and energy required to complete the environmental review requirements while still promoting environmentally safe activities. Initiatives such as this should be pursued in order to provide developers with efficiency and success, while providing the nation with a more diverse energy scheme and loosening the nation’s dependency on fossil fuel resources. This goal is countered by the Energy Policy Act of 2005. The Act is dedicated to supporting oil and gas production by providing incentives to developers, but the Act neglects to give wind energy equal support.[lxxix] There are other provisions, though not as supportive as those for the fossil fuels, dedicated to geothermal and hydroelectric energy.[lxxx] However there should be specific details under the act, or a similar act, supporting wind energy production, which is the largest contributor of electricity among the renewable energies. Wind energy should be given the same initiatives, if not more, than fossil fuels.

The DOE established the Federal Energy Management Program (FEMP) to help federal agencies obtain funding for energy efficiency, renewable energy, water conservation, and greenhouse gas (GHG) management projects.[lxxxi] The DOE recognized the risk of federal energy projects temporarily stopping or completely stopping because Congressional appropriations, alone, were insufficient to fund federal energy project needs’ to meet federal requirements.[lxxxii] Additional funding options include energy savings performance contracts (ESPCs), utility energy service contracts (UESCs), power purchase agreements (PPAs), and energy incentive programs.[lxxxiii] However in constructing a scenario where federal contributions would be feasible for the future, the DOE neglected to compare the scenarios for renewable energy projects to fossil fuel energy plans and neglected to lay out an action plan which would benefit the renewable energy market.[lxxxiv] The DOE, through the FEMP, should extend ESPCs, UESCs and PPAs to potential renewable energy projects such as Cape to foster the development and production of sites so that renewable energy markets can become competitive with fossil fuel markets and in turn attract investors and establishing a perpetual cycle leading to a diversified national energy structure.

Special Thanks to Eric Hull.

[i]Jared Wiesner, A Grassroots Vehicle for Sustainable Energy: The Conservation Reserve Program & Renewable Energy, 31 WM. & MARY ENVTL. L. & POL’Y REV. 571, 588(2006).

[ii]ENERGYEFFICIENCY ANDRENEWABLE ENERGY, U.S.DEP’T OF ENERGY, 20% WIND ENERGY BY 2030: EXECUTIVESUMMARY 1(May 2008), available athttp://www1.eere.energy.gov/wind/pdfs/42864.pdf.

[iii]W. MUSIAL & S.BUTTERFIELD, FUTURE FOR OFFSHORE WIND ENERGY IN THE UNITED STATES 7 (National Renewable Energy Laboratory 2006), available at http://www.nrel.gov/docs/fy04osti/36313.pdf.

[iv]Bent Ole Gram Mortensen, International Experiences of Wind Energy, 2 ENVTL. & ENERGY L. & POL’Y J. 179, 207 (2008).

[v]Supra note 6.

[vi]Potential risks for wind projects include: visual obstructions, noise obstructions, frequency and flight obstructions, placement in marine and avian habitats, cleanup if a wind turbine falls over or into waters, etc.

[vii]Proclamation No. 2667, 3 C.F.R. 40 (1945).

[viii]43 U.S. §§ 1301-1315 (2011).

[ix]Id. § 1314(a).

[x]Id. § 1331-1356.

[xi]Ten Taxpayer Citizens Group v. Cape Wind Associates, LLC, 373 F.3d 183 (1st Cir. 2004) (citing 420 U.S. 515, 522); see also 43 U.S.C. §§ 1301, 1331(a).

[xii]43 U.S.C.§ 1337(a).

[xiii]ADAM VANN, CONG. RESEARCH SERV., RL 32658, WIND ENERGY: OFFSHORE PERMITTING 5 (2008), available athttp://www.cnie.org/NLE/crs/abstract.cfm?NLEid=254; 33 U.S.C. §§ 407-687.

[xiv]43 U.S.C. § l337(p)(l) (2011) (“The Secretary … may grant a lease, easement, or right-of-way on the outer Continental Shelf.. . if those activities .. (C) produce or support production, transportation, or transmission of energy from sources other than oil and gas.”).

[xv]Renewable Energy and Alternate Uses of Existing Facilities on the Outer Continental Shelf, 74 FR 19638-01.

[xvi]43 U.S.C. § l337(p)(9). (“Nothing in this subsection displaces, supersedes, limits, or modifies the jurisdiction, responsibility, or authority of any Federal or State agency under any other Federal law”).

[xvii]See Memorandum of Understanding Between the U.S. Department of the Interior and the Fed. Energy Regulatory Comm’n (Apr. 9, 2009), available athttp://boemre.gov/regcompliance/MOU/PDFs/DOI_FERC_MOU.pdf.

[xviii]Id.

[xix]42 U.S.C.A. § 4344 (2011).

[xx]Id. at § 4332.

[xxi]Outer Continental Shelf, Headquarters, Cape Wind Offshore Wind Development 2007, 71 FR 30693-01.

[xxii]Id.

[xxiii]Outer Continental Shelf, Headquarters, Cape Wind Offshore Wind Development 2007, 71 FR 30693-01.

[xxiv]An EIS is “a detailed written statement as required by section 102(2)(C) of [NEPA].” 40 C.F.R. § 1508.11(2010).

[xxv]An EA is “a concise public document for which a Federal agency is responsible that serves to: (1) [b]riefly provide sufficient evidence and analysis for determining whether to prepare an environmental impact statement or a finding of no significant impact[;] (2) [a]id an agency’s compliance with the Act when no environmental impact statement is necessary[;] [and] (3) [f]acilitate preparation of a statement when one is necessary.” Id. § 1508.9(a).

[xxvi]42 U.S.C. § 4332(2)(C).

[xxvii]Id.

[xxviii]Supra note 38.

[xxix]Id. at 19,685-6 (“We chose this approach for a commercial lease because there are two distinct phases for commercial development for renewable energy projects: (1) A site assessment phase, where a lessee may install a meteorological or marine data collection facility to assess renewable energy resources; and (2) a generation of power phase, which includes construction, operations, and decommissioning.”)

[xxx]See 30 C.F.R.285.611 (2010) (describing NEPA information required to be submitted in conjunction with SAP); 30 C.F.R. §285.646 (describing NEPA information required to be submitted in conjunction with COP).

[xxxi]Preamble to the Rules, supra note 21, at 19670.

[xxxii]Peter J. Schaumberg & Angela F. Colamaria, Siting Reneable Enargy Projects on the Outer Continental Shelf: Spin, Baby, Spin!, 14 Roger Williams U. L. Rev. 624, 634-35 (2009).

[xxxiii]Supra note 54.

[xxxiv]Id, at 19690.

[xxxv]Id.

[xxxvi]Request for Information and Nominations of Areas for Leases Authorizing Alternative Energy Resource Assessment and Technology Testing Activities Pursuant to Subsection 8(p) of the Outer Continental Shelf Lands Act, as Amended. 72 F.R. 62674 (2007).

[xxxvii]Stephanie Showalter & Terra Bowling, Offshore Renewable Energy Regulatory Primer (Nat’l Sea Grant L. Center), July 2009, at I, available athttp://nsglc.olemiss.edu/offshore.pdf.

[xxxviii]Preamble to the Rules, supra note 21, at 19647.

[xxxix]Id.

[xl]Id. at 19691tbl.2.

[xli]16 U.S.C. § 1452(1) (2011).

[xlii]Id. § 1451(i)-(m).

[xliii]Id. § 1456(d).

[xliv]U.S. Dep’t of the Interior, Change of the Name of the Minerals Management Service to the Bureau of Ocean Energy Management, Regulation, and Enforcement, Order No. 3302 (June 18, 2010) available athttp://www.doi.gov/deepwaterhorizon/loader.cfm?csModule=security/getfile&PageID=35872.

[xlv]30 C.F.R. § 585.100 (“The Secretary of the Interior delegated to the Bureau of Ocean Energy Management (BOEM) the authority to regulate activities under section 388(a) of the EPAct. These regulations specifically apply to activities that: (a) Produce or support production, transportation, or transmission of energy from sources other than oil and gas; or (b) Use, for energy-related purposes or for other authorized marine-related purposes, facilities currently or previously used for activities authorized under the OCS Lands Act.”).

[xlvi]The Reorganization of the Former MMS. The Bureau of Ocean Energy Management. 2011. Available at http://boem.gov/About-BOEM/Reorganization/Reorganization.aspx.

[xlvii]Id.

[xlviii]Id. § 585.102.

[xlix]Alliance To Protect Nantucket Sound, Inc. v. U.S. Dept. of Army, 288 F. Supp. 2d 64, 78 (D. Mass. 2003) aff’d, 398 F.3d 105 (1st Cir. 2005).

[l]Id. at 66-78.

[li]Ten Taxpayers Citizen Group v. Cape Wind Associates, LLC, 278 F.Supp.2d 98, 99 (D. Mass. 2003).

[lii]Supra note 72.

[liii]Alliance To Protect Nantucket Sound, Inc. v. U.S. Dept. of Army, 398 F.3d 105, 115 (1st Cir. 2005).

[liv]Id.

[lv]Ten Taxpayer Citizens Group v. Cape Wind Associates, LLC, 373 F.3d 183, 185 (1st Cir. 2004).

[lvi]Id. at 188-89.

[lvii]Intent To Prepare a Draft Environmental Impact Statement (DEIS) for Proposed Cape Wind Energy Project, Nantucket Sound and Yarmouth, MA Application for Corps Section 10/404 Individual Permit, 67 FR 4414-01; compare with Outer Continental Shelf, Headquarters, Cape Wind Offshore Wind Development 2007, 71 FR 30693-01 (stating the proposal was for 130 WTGs generating approximately 454 MW).

[lviii]Id.

[lix]Id.

[lx]Id. (Resources included: recreational and commercial boating and fishing activities, endangered marine mammals and reptiles, birds, aviation, benthic habitat, aesthetics, cultural resources, radio and television frequencies, ocean current.)

[lxi]Intent To Prepare a Draft Environmental Impact Statement (DEIS) for Proposed Cape Wind Energy Project, Nantucket Sound and Yarmouth, MA Application for Corps Section 10/404 Individual Permit, 67 FR 4414-01 (“To the fullest extent possible, the EIS will be integrated with analyses and consultation required by the Endangered Species Act of 1973, as amended (Pub. L. 93-205; 16 U.S.C. 1531, et seq.); the Magnuson-Stevens Fishery Conservation and Management Act, as amended (Pub. L. 94-265; 16 U.S.C. 1801, et seq.), the National Historic Preservation Act of 1966, as amended (Pub. L. 89-655; 16 U.S.C. 470, et seq.); the Fish and Wildlife Coordination Act of 1958, as amended (Pub. L. 85-624; 16 U.S.C. 661, et seq.); the Coastal Zone Management Act of 1972, as amended (Pub. L. 92-583; 16 U.S.C. 1451, et seq.); and the Clean Water Act of 1977, as amended (Pub. L. 92-500; 33 U.S.C. 1251, et seq.), Section 10 of the Rivers and Harbors Act of 1899, 33 U.S.C. 403 et seq.); the Outer Continental Shelf Lands Act (Pub. L. 95-372; 43 U.S.C. 1333(e))”).

[lxii]Continental Shelf, Headquarters, Cape Wind Offshore Wind Development 2007, 71 FR 30693-01.

[lxiii]Cape Wind: America’s First Offshore Wind Farm on Nantucket Sound. 2011.Available at http://www.capewind.org/article72.htm.

[lxiv] Continental Shelf, Headquarters, Cape Wind Offshore Wind Development 2007, 71 FR 30694. (In 2006, the Cooperating Agencies on the Cape Wind project EIS included: United States Fish and Wildlife Service, Cape Cod Commission, United States Department of Energy, United States Coast Guard, United States Department of the Interior/Office of Environmental Policy and Compliance, Wampanoag Tribe of Gay Head, Federal Aviation Administration, Massachusetts Coastal Zone Management, Massachusetts Environmental Policy Act Office, National Oceans and Atmospheric Association/National Marine Fisheries Service, United States Environmental Protection Agency, United States Army Corps of Engineers.)

[lxv]Id. Under guidelines from CEQ, qualified agencies and governments are those with “jurisdiction by law or special expertise.”

[lxvi]Id.

[lxvii]Id.

[lxviii]Environmental Assessment Prepared for Proposed Cape Wind Energy Project in Nantucket Sound, MA, 75 FR 10500-01.

[lxix]Id.

[lxx]Id.

[lxxi]See ALLIANCE TO PROTECT NANTUCKET SOUND, INC., et al., Town of Barnstable, and Cape Cod Commission, Petitioners, v. ENERGY FACILITIES SITING BOARD, Department of Environmental Protection, Cape Wind Associates, LLC, et al., Respondents; Town of Barnstable and Cape Cod Commission, Plaintiffs-Appellants, v. Massachusetts Energy Facilities Siting Board, and Cape Wind Associates, LLC, Defendants-Appellees., 2010 WL 3612847 (Mass.).

[lxxii]America’s First Offshore Wind Farm on Nantucket Sound: The true cost of electricity. December, 2011. Available at http://www.capewind.org/article32.htm.

[lxxiii]Id.

[lxxiv]Id.

[lxxv]Commercial Wind Lease Issuance and Site Characterization Activities on the Atlantic Outer Continental Shelf (OCS) Offshore Rhode Island and Massachusetts, 76 FR 51391-01.

[lxxvi]Id.

[lxxvii]Id.

[lxxviii]Id.

[lxxix]42 U.S.C. §§ 15902-15912 (2011).

[lxxx]42 U.S.C. §§ 15872, 15881 (2011).

[lxxxi]ENERGY EFFICIENCY AND RENEWABLE ENERGY, U.S. DEP’T OF ENERGY, FEDERAL ENERGY MANAGEMENT PROGRAM (July 2011), available athttp://www.nrel.gov/docs/fy11osti/52085.pdf. DOE SCIENTIFIC AND TECHNICAL INFORMATION, Alternative Financing for Energy Efficiency and Renewable Energy: Quick Guide (May 1, 2009). Available athttp://www.nrel.gov/docs/fy11osti/52085.pdf.

[lxxxii]Id.

[lxxxiii]Id.

[lxxxiv]Id.

Inside Counsel presents the 12th Annual Super Conference in Chicago

The National Law Review is pleased to bring you information about the upcoming 12th Annual Super Conference in Chicago sponsored by Inside Counsel.

Reasons why you should Attend This Year’s Event:

Who Should Attend – General Counsel and Other Senior Legal Executives from Top Companies Attend SuperConference:Meet with Decision Makers: You’ll meet face-to-face with senior-level in-house counsel
Networking Opportunities: SuperConference offers several networking opportunities, including a cocktail reception, refreshment breaks, and a networking lunch.
Gain Industry Knowledge: You will hear the latest issues facing the industry today with your complimentary full-conference passes.

Chief Legal Officers
General Counsel
Corporate Counsel
Associate General Counsel
CEOs
Senior Counsel
Corporate Compliance Officers

The 12th Annual IC SuperConference will be held at the NEW Radisson Blu Chicago.
Radisson Blu Aqua Hotel

221 N. Columbus Drive

Chicago, IL 60601

Don’t forget – The early discount deadline using the NLR discount code is February 24th!

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

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

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

Key Developments in SEC Enforcement During 2011

Record-Setting Numbers

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

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

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

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

Major Enforcement Areas in 2011

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

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

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

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

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

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

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

Breakdown of Major Categories of SEC Actions¹⁰

Changing the Structure of Enforcement Actions

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

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

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

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

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

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

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

Janus and the Future of “Scheme Liability”

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

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

SEC’s Pursuit of Negligence-Based Claims

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

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

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

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

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

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

Judicial Guidance on Key Issues Relating to the FCPA

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

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

Securities Enforcement in the Next Year

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

More Dodd-Frank Initiatives: In addition to the continued development of the whistleblower program and other initiatives implemented this year, the SEC plans to conclude the voluminous rulemaking required by the Dodd-Frank Act, including finalizing rules on executive compensation.
More Financial Crisis Cases: While the SEC ramped up the number of cases stemming from the financial crisis, it will likely bring more such cases and name more individuals. Both Congress and the media have criticized the SEC for not holding more individuals accountable for wrongdoing that fueled the crisis.
Tougher Sentencing Guidelines: On January 19, 2012, in response to a Dodd-Frank directive to re-evaluate the sentencing guidelines for fraud offenses, the U.S. Sentencing Commission proposed amending the federal sentencing guidelines to include harsher penalties for senior leaders implicated in insider trading and increase the “offense level” and penalties for instances of “sophisticated insider trading.”²⁴These amendments, which could be approved later this year, would impact not only public companies, but also brokerage firms and investment advisers.
Shift to SEC Administrative Proceedings: The SEC will likely continue the trend of more enforcement actions through administrative proceedings, especially due to the SEC’s expanded remedies and claims in such proceedings coupled with the increased federal court scrutiny of settlements.
Continued Focus on High-Priority Areas: The SEC will continue to be active in its designated and traditional high-priority areas. Mostly notably, the SEC will likely focus on Asset Management (hedge funds, investment advisers, and private equity), Market Abuse (large-scale insider trading and other market manipulation schemes), FCPA, and insider trading cases. Also, with the SEC’s Whistleblower program underway, the SEC will likely institute more investigations and enforcement actions based on fraudulent financial reporting, which has waned over the last few years.
Increased Focus on Compliance Programs: The SEC will more heavily focus on the operations of compliance programs, both in examinations of registered advisers and broker-dealers and when making enforcement decisions as to SEC registrants where fraud has occurred. In addition to the right “tone at the top,” companies need to ensure that they have good policies covering key-risk areas (such as financial reporting, anti-corruption, business conduct and ethics, insider trading, and internal reporting channels for employees who suspect wrongdoing), appropriate training, and adequate oversight and testing.

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

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

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

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

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

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

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

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

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

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

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

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

13. Id.

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

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

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

17. Id.

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

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

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

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

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

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

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

2012 Launching & Sustaining Accountable Care Organizations Conference

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

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

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

Should Investors Buck the Status Quo with LLCs?

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

Sometimes change is good.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

2012 Young Professionals in Energy International Summit

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

2012 YOUNG PROFESSIONALS IN ENERGY INTERNATIONAL SUMMIT

April 23-25, 2012

Planet Hollywood Resort & Casino

Las Vegas, Nevada

About the YPE:

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

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

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

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

One Individual and 20 Organizations Receive Inaugural Climate Leadership Awards

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

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

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

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

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

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

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

IBM
San Diego Gas & Electric

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

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

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

Port of Los Angeles
SAP
UPS

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

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

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

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

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

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

The ICC Rules of Arbitration training

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

Through this training, you will:

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

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

Who should attend?

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

The National Law Forum

Liability for inside bridge rounds?

What’s the BIG deal?

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RIMS 2012 Annual Conference & Exhibition

No Boundaries

What’s New!

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Increasing Offshore Wind Projects: A Focus on Regulatory Authority

II. Regulatory Background of Offshore Management – Jurisdictional Conflict Among Agencies

III. Cape Wind

IV. Progressive Policy Initiatives Need to Progress

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

Key Developments in SEC Enforcement During 2011

Record-Setting Numbers

Major Enforcement Areas in 2011

Breakdown of Major Categories of SEC Actions¹⁰

Changing the Structure of Enforcement Actions

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

Janus and the Future of “Scheme Liability”

SEC’s Pursuit of Negligence-Based Claims

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

Judicial Guidance on Key Issues Relating to the FCPA

Securities Enforcement in the Next Year

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2012 Launching & Sustaining Accountable Care Organizations Conference

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Should Investors Buck the Status Quo with LLCs?

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2012 Young Professionals in Energy International Summit

2012 YOUNG PROFESSIONALS IN ENERGY INTERNATIONAL SUMMIT

About the YPE:

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One Individual and 20 Organizations Receive Inaugural Climate Leadership Awards

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The ICC Rules of Arbitration training

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What’s the BIG deal?

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Like this:

No Boundaries

What’s New!

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Like this:

II. Regulatory Background of Offshore Management – Jurisdictional Conflict Among Agencies

III. Cape Wind

IV. Progressive Policy Initiatives Need to Progress

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Like this:

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Key Developments in SEC Enforcement During 2011

Record-Setting Numbers

Major Enforcement Areas in 2011

Breakdown of Major Categories of SEC Actions10

Changing the Structure of Enforcement Actions

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

Janus and the Future of “Scheme Liability”

SEC’s Pursuit of Negligence-Based Claims

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

Judicial Guidance on Key Issues Relating to the FCPA

Securities Enforcement in the Next Year

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2012 YOUNG PROFESSIONALS IN ENERGY INTERNATIONAL SUMMIT

About the YPE:

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Breakdown of Major Categories of SEC Actions¹⁰