Not So Fabulous After All

ATTORNEY: TAMAR A. WEINRIB
POMERANTZ MONITOR, SEPTEMBER/OCTOBER 2013 

In August, the SEC scored a much-needed win when a nine-member jury, after deliberating for two days, found Fabrice Tourre, a former Goldman Sachs bond trader once known as “Fabulous Fab,” liable on six of seven civil fraud charges. 

The SEC brought the action in 2010 against both Mr. Tourre and Goldman Sachs, accusing both of misleading investors about a complex mortgage-based financial product known as “Abacus 2007-AC1.” Abacus was a “collateralized debt obligation,” a financial vehicle based on a collection of underlying mortgage-related securities. Tourre played a major role in putting Abacus together; but he (and Goldman) allegedly failed to disclose to potential investors that hedge fund titan John Paulson, a key Goldman Sachs client, had also played a major role in selecting the securities underlying Abacus. Paulson’s involvement was critical because he himself made a huge bet against Abacus, selling millions of shares short, and made a killing when Abacus failed. In other words, the SEC claimed that Abacus was secretly designed to fail so that Paulson could make a killing at the expense of Goldman’s other clients. 

Goldman settled the SEC’s claims some time ago, agreeing to pay a $550 million fine, without admitting or denying wrongdoing. Abacus, and the large fine it generated, heavily damaged Goldman’s reputation, helping to earn it the sobriquet “great vampire squid.” 

Even after Goldman settled, Tourre fought on, and lost. Tellingly, his lawyers opted not to call any witnesses at trial, an interesting strategy which perhaps reflected the weakness of their case. The SEC called two witnesses, Laura Schwartz from the ACA Financial Guaranty Corporation, and Gail Kreitman, a former Goldman saleswoman, who testified that they were misled about who was investing in Abacus. Also key to Mr. Tourre’s downfall was a number of emails to his girlfriend, which he called “love letters,” in which he joked about selling toxic real estate bonds to “widows and orphans.” 

As of Monitor press time, Mr. Tourre was planning to ask the court at the end of September to either overturn his securities fraud verdict or grant a new jury trial. If the judge declines that request, the question will then become one of punishment. Mr. Tourre faces three potential remedies. First, the court can impose civil monetary penalties ranging from $5,000 to $130,000 for each violation. Second, the court can order that Mr. Tourre forfeit any profits he received from his violations, though it is unclear at this point what that would encompass. Third, Mr. Tourre could also face an administrative proceeding before the SEC, which could permanently bar him from any future association with the financial industry. One potential obstacle for the SEC in pursuing a bar, however, is that it obtained the power to do this when Congress passed the Dodd-Frank Act in 2010, three years after Mr. Tourre’s violations occurred. It is unclear whether the SEC’s authority to issue a bar applies retroactively. Given that Goldman continues to bankroll all of Mr. Tourre’s legal fees, it is likely he will appeal any bar order, challenging retroactivity, and continue to drag this case on further. 

Mr. Tourre is now enrolled in a doctoral economics program at the University of Chicago and seems to be gearing up for a future in academia. Other than damage to his reputation, which he has already incurred in spades, it is questionable whether a bar would make much of a difference. 

Meanwhile, the Tourre trial, though clearly a success for the SEC, has led many to question why the agency continues to pursue mid-level employees like Mr. Tourre while leaving the high-level executives unscathed. Mr. Tourre clearly did not commit these violations on his own.

Mergers Foreclose Derivative Litigation

ATTORNEY: SAMUEL J. ADAMS
POMERANTZ MONTITOR, SEPTEMBER/OCTOBER 2013 

In a case involving the notorious Countrywide Corporation, with implications for derivative actions filed across the country, the Delaware Supreme Court, has declined to expand the circumstances under which a derivative action, brought on behalf of the injured corporation, can survive a merger of that corporation into another. Because mergers often happen while derivative suits are pending, and in fact are sometimes motivated by the directors’ desire to eliminate derivative claims against them, this decision will make it harder in many cases to hold directors of Delaware corporations accountable for their reckless mismanagement. 

As is well known, Countrywide played a major role in the financial crash of 2008, because it was probably the most prolific perpetrator of toxic mortgage securities. When the mortgage market imploded, Countrywide nearly collapsed and was sold under the gun to Bank of America (“B of A”) – the unlucky purchaser of last resort not only of Countrywide but also of equally ill-fated Merrill Lynch. If ever there were directors who deserved to be sued for destroying their company, the directors of Countrywide fit the bill. Yet, when they were sued by Countrywide shareholders, they claimed that the sale to B of A wiped out the plaintiffs’ claims. 

The directors were invoking the so-called “continuous ownership” rule, which says that in order to assert a derivative claim a plaintiff shareholder must have owned stock in the injured corporation continuously from the time of the alleged wrong until the resolution of the litigation. Should the corporation be sold in a cash-out merger before the litigation is resolved, the shareholder plaintiff would be divested of his holdings, and therefore his chain of continuous ownership would be broken. 

Here, plaintiffs sued the former directors of Countrywide in California federal court, claiming that they were responsible for allowing Countrywide to engage in a host of reckless and fraudulent mortgage practices. The District Court dismissed the derivative claims under the “continuing ownership” rule, holding that under Delaware law plaintiffs lost standing to pursue the derivative claims upon consummation of Countrywide’s Merger with B of A. Plaintiffs had argued that there was an exception to this rule in cases where it was the alleged wrongdoing that forced the company to enter into the merger in the first place. On appeal, the United States Court of Appeals for the Ninth Circuit asked the Delaware Supreme Court to consider, as a “certified question,” whether this exception actually existed and, if so, whether it applied here. The certified question was prompted, in part, by the fact that state and federal courts had reached divergent results in previous cases applying Delaware law in this situation. 

In a famous decision decades ago in Lewis v. Anderson, the Delaware Supreme Court recognized a “fraud exception” to the continuous ownership rule, allowing plaintiffs to litigate post-merger derivative claims “where the merger itself is the subject of a claim of fraud,” meaning that the merger served “no alternative valid business purpose” other than eliminating derivative claims. Although there is a very low threshold for finding a “valid business purpose” for a merger, it is a short step from this doctrine to the proposition that the exception should apply if the very fraud that was the subject of the derivative action also drove the corporation to enter into the merger. 

Arguing before the Delaware Supreme Court, plaintiffs, in a twist, urged the court to consider resolving the certified question by creating a new cause of action, which they referred to as a “quasi-derivative” claim. Defendants argued that there is “no need and no basis” to recognize an exception to the continuous ownership rule even where the conduct in question forced the company to merge with another company. 

The Delaware Supreme Court found in favor of defendants, holding that shareholders cannot pursue derivative claims against a corporation after a merger divests them of their ownership interest, even if a board's fraud effectively forced the corporation into the merger. However, the court was careful to note that shareholders who lose derivative standing in a merger may nonetheless have post-merger standing to recover damages from a direct fraud claim, should one be properly pleaded.

The Oxford Decision: the Silver Lining?

ATTORNEY: JENNIFER BANNER SOBERS
POMERANTZ MONITOR, JULY/AUGUST 2013 

Ten days before the American Express decision, the Supreme Court, in a case involving the Oxford health insurance company, unanimously affirmed an arbitrator’s decision to authorize class arbitration. He held that because the arbitration agreement stated that “all disputes” must be submitted to arbitration -- without specifically saying whether “all disputes” includes class actions -- nonetheless the agreement means that class action disputes can be arbitrated. 

This case was filed in court by a pediatrician in the Oxford “network” who alleged that Oxford failed to fully and promptly pay him and other physicians with similar Oxford contracts. The court granted Oxford’s demand that the case be arbitrated. The parties then agreed that the arbitrator should decide whether the contract authorized class arbitration. In finding that the contract did permit class arbitrations, the arbitrator focused on the language of the arbitration clause, which stated that “all” civil actions must be submitted to arbitration. Oxford tried to vacate the arbitrator’s decision, claiming that he exceeded his powers under the Federal Arbitration Act. The District Court denied the motion, and the Third Circuit affirmed. 

In agreeing with the lower courts, the Supreme Court held that when an arbitrator interprets an arbitration agreement, that determination must be upheld so long as he was really construing the contract. Whether this interpretation is correct is beside the point, as far as the courts are concerned. Judicial review of arbitrators’ decisions is far more constrained than the review of lower court decisions. 

This case may turn out to be the silver lining to the Supreme Court’s series of rulings curtailing class actions in arbitration. This decision will specifically benefit plaintiffs, including those, like the plaintiff here, whose claims lie in the health care arena. 

Moreover, the decision seems to narrow the effect of the court’s previous decision in 2010, which held that “silence” in an arbitration agreement usually means that the parties did not agree to arbitrate on a class-wide basis. To the extent that arbitrators in future cases interpret an agreement to arbitrate “all disputes” as including class-wide disputes, plaintiffs will be more likely in the future to have a realistic chance to have their claims resolved. That is, unless there is an explicit class action waiver. 

Many consumers are subject to arbitration agreements, including physicians who often have no choice but to accept such agreements if they want to be in-network providers for insurers. As Pomerantz and co-counsel argued in an amicus brief on behalf of the American Medical Association and the Medical Society of New Jersey in support of the pediatrician, without being able to arbitrate on a class-wide basis, physicians will have no effective means by which to enforce their contracts with insurers and challenge underpayments. The typical claim by a doctor against an insurer is relatively small. Prosecuting such small claims in individual arbitration is impossible, given that the cost of bringing an arbitration will almost always exceed the amount an individual doctor could potentially recover through arbitration. Moreover, individual arbitrations could not adequately address certain pervasive wrongful practices by insurers such as underpayment or delayed payment of claims and do not provide injunctive relief to stop such practices – a critical remedy sought in many class actions.

SEC Approves Use of Facebook and Twitter for Company Disclosures

POMERANTZ MONITOR, JULY/AUGUST 2013 

The Securities and Exchange Commission has issued a report that allows companies to use social media outlets like Facebook and Twitter to disclose material information as required by with SEC regulations, provided that investors are notified beforehand about which social media outlets the company will use to make such disclosures. In supporting the use of social media, the SEC stated that "an increasing number of public companies are using social media to communicate with their shareholders and the investing public. . .[w]e appreciate the value and prevalence of social media channels in contemporary market communications, and the commission supports companies seeking new ways to communicate." The new “guidance” is likely to change dramatically the way companies communicate with investors in the future. 

The SEC’s action actually began as an investigation into whether Netflix violated Regulation FD by disclosing financial information in the CEO’s personal Facebook page. Regulation FD requires companies to distribute material information in a manner reasonably designed to get that information out to the general public broadly and non-exclusively. It was designed to curtail preferential early access to information by institutions and other well-connected industry heavyweights. 

Netflix, as you may have heard, runs a service providing subscribers with online access to television programs and movies. In July of 2012, Netflix CEO Reed Hastings announced on his personal Facebook page that Netflix’s monthly online viewing had exceeded one billion hours for the first time. Netflix did not report this information to investors through a press release or Form 8-K filing, and a subsequent company press release later that day did not include this information either. The SEC claimed that neither Hastings nor Netflix had previously used his Facebook page to announce company financial information, and they had never before told investors that information about Netflix would be disseminated in Hastings’ personal Facebook page. The Facebook disclosure was nonetheless picked up by investors, and boosted the Netflix share price. 

In responding to the SEC investigation, Hastings contended that since his Facebook page was available to over 200,000 of his followers, he was in compliance with Regulation FD. The SEC ultimately refrained from bringing an enforcement action against Hastings or Netflix, stating in a press release that the rules around using social media for company disclosures had been unclear. 

Now the SEC has concluded that companies can comply with Regulation FD by using social media and other emerging means of communication, much the same way they can by making disclosures in their websites. The SEC had previously issued guidance in 2008, clarifying that websites can serve as an effective means for disseminating information to investors if they’ve been told to look there. The same caveat now applies to the use of social media. 

The SEC’s guidance brings corporate reporting into the social media age, where over one billion users of Facebook and 250 million on Twitter are sharing information. Indeed, a recent study suggests that while over 60% of companies will interact with customers using social media, very few use the medium to communicate business developments to investors. That could well be about to change dramatically.

Supreme Court Holds that “Pay-To-Delay” Deals Can Violate Antitrust Laws

ATTORNEY: ADAM G. KURTZ
POMERANTZ MONITOR, JULY/AUGUST 2013 

Last fall, we wrote about how brand name drug manufacturers have been paying large amounts of money to generic drug makers to induce them to delay bringing low-cost generic drugs to market. For years prior to this recent U.S. Supreme Court decision, many federal courts have refused to declare these pay-to-delay payments anti-competitive, or even subject them to the antitrust laws. 

On June 17, 2013, in a case involving the testosterone supplement Androgel, the U.S. Supreme Court handed healthcare consumers and union health and welfare funds a victory. Androgel, a treatment for low testosterone, had sales of $1 billion a year. It has no competition from generic alternatives. If there were generic competition, sales of the branded version would probably drop by 75% and its manufacturer, Solvay, would lose approximately $125 million in profits a year. To postpone generic competition, Solvay paid the generic company, Actavis, as much as $42 million a year to delay their competing generic version of Androgel until 2015. 

The Supreme Court ruled, 5-3, that such pay-to-delay deals are, in fact, subject to the antitrust laws. This is truly a big win, given the amount of healthcare costs involved. There were 40 such deals this past year alone, and they cost American consumers $3.5 billion a year in higher drug costs. The Androgel decision may not end pay-for-delay deals, but they will now be subject to the antitrust scrutiny. 

The legal arguments addressed by the Supreme Court were complicated and involved a clash between the antitrust and patent laws. On the one hand, the antitrust laws state that two competing companies cannot agree that one of them will stay out of the market. That is, the branded and generic company cannot agree to keep drug prices high by delaying introduction of a generic drug into the market. 

On the other hand, the patent laws give a company with a valid patent the right to exclude a competitor with a product that violates the patent. That is, a branded company can exclude a generic drug as long as the branded company had a valid patent. Pay-to-delay deals are part of a settlement in a patent infringement lawsuit, brought by the brand name manufacturer, alleging that the generic drug maker is violating the brand name patent. Settlements are generally encouraged as a good thing. 

In the end, the Supreme Court chose antitrust law over patent law and healthcare consumers over pharmaceutical companies in holding that, settlement or not, these deals can be struck down if they violate the antitrust laws. 

For years, Pomerantz – on behalf of health care consumers – and the Federal Trade Commission (“FTC”) have been fighting against pay-to-delay deals, arguing that they are anti-competitive and violate the antitrust laws. In fact, Pomerantz is co-lead counsel, on behalf of a putative end-payor class, in the companion case to the recently decided U.S. Supreme Court case, which is currently pending in the Northern District of Georgia. Now that the Supreme Court has agreed that pay-to-delay deals are not immune from the antitrust laws, Pomerantz will continue to represent vigorously our union health and welfare fund clients who end up paying unlawful supra-competitive prices for branded drugs as a result of these deals.

Appeals Court Grants Bail to Two Convicted of Insider Trading

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, JULY/AUGUST 2013 

Although it has had mixed results, at best, in cases related to the financial crisis of 2008, the government has done quite well in pursuing claims of criminal insider trading. For example, the U.S. Attorney in Manhattan has filed criminal charges against 81 defendants since he took office in 2009, and convicted 73 of them. Among them is former Galleon hedge fund boss Raj Rajaratnam, whose conviction and lengthy sentence were upheld by the Second Circuit in June. 

Insider trading may sound simple, but it isn’t. The federal courts have been struggling for decades to decide what inside information is, who may trade on it, and who can’t. If an investor or analyst calls someone up to ask how his company is doing, that can be legitimate information gathering, or it can be a violation. It all depends. 

One well-established element of an insider trading violation is that the tippee must know that the information is being disclosed in violation of the insider’s fiduciary duty. In one famous case, for example, someone disclosed that the company had received a takeover offer that had not yet been publicly disclosed. That kind of information is vital to the company; people working for the company cannot divulge it without breaching their fiduciary duties.

More recently, though, courts have been struggling with the question of whether the tippee also has to know that the person disclosing the information (the “tipper”) is receiving a “personal benefit” for disclosing it. If the tippee does know this, the Supreme Court held 30 years ago that he is liable; but the question now is, does the tippee have to know this in order to be liable? If the tippee is not paying for this information, he or she may not be aware that the tipper will benefit from the disclosure in some other way. 

This issue is coming to a head in a case now pending in the Second Circuit, which is hearing an appeal of an insider trading conviction involving two hedge fund managers. They did not pay for the information, and maintain that they did not know that the insiders were profiting from their disclosures in other ways. The trial court did not believe that this was a required element of the crime, and refused to instruct the jury on it. Defendants appealed on that issue. Defendants asked that they be granted bail pending their appeal. The trial court denied it, but the defendants appealed that decision as well. 

In late June, the Second Circuit granted their bail request. This has sent tongues wagging, because it may mean that the court is about to overturn the convictions and impose a “personal benefit” knowledge requirement for insider trading claims. 

This is happening just as the government is zeroing in on the biggest fish in the insider trading pond, Steve Cohen of SAC Capital Advisors. Several of his underlings have already pleaded guilty to insider trading charges, and SAC recently paid more than $600 million in a “no admit, no deny” settlement of insider trading charges with the SEC. Yet somehow, Cohen authorized this hefty settlement without obtaining an agreement from the feds that they would not seek additional punishments or remedies against either himself or the company. 

Perhaps he thought that, because it may be next to impossible for the feds to prove beyond a reasonable doubt that he had personal knowledge of the tippers’ motivation for revealing insider information, the would not pursue criminal charges against him. In this respect he is probably right. With the five year statute of limitations bearing down, the feds have reportedly given up on the idea of prosecuting Cohen on criminal charges. 

But he is not exactly getting a free pass. On July 19 the SEC brought an administrative action against him, seeking to bar him from the securities industry for life. The complaint alleges that Cohen ignored “red flags” of illegal insider trading by employees and allowed it to go on, violating his duty to supervise. 

And then, just before our press time, the feds announced that SAC Capital has been indicted. When and if that happens, it is all over. On Wall Street, an indictment is a death sentence.

SEC Weighs Companies' Disclosures of Their Political Expenditures

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, MAY/JUNE 2013 

In the wake of the Supreme Court’s decision in Citizens United, a gusher of so-called “independent” spending by private groups and organizations flooded into the last election cycle, with much of it coming from corporations. 

In its decision, the Court assumed that any adverse effects of corporate or union cash entering politics could be ameliorated by public disclosure of where the money came from; and in August of 2011, a petition signed by two law professors was submitted to the SEC, asking it to adopt a rule requiring such disclosures. 

The petition has been publicly supported by the AFL-CIO; Public Citizens; the Corporate Reform Coalition, and some Democratic members of Congress. It has generated over half a million comments, the most the SEC has ever received on any proposed rule, and most of them reportedly want the SEC to act. 

But opponents are pushing back. Republicans have lined up against it, to the point of submitting a House bill seeking to prevent the SEC from adopting any disclosure rule. 

So far, the two SEC commissioners appointed by Democrats have come out publicly in support of such a rule, and the two appointed by Republicans have come out against. Mary Joe White, recently confirmed as the new SEC Chairman, has not yet taken a public position. Although the issue was on the Commission’s April agenda, no decision had been made as of Monitor press time. 

The business community, by and large, wants no part of such a rule, fearing that disclosure might provoke a backlash from interest groups, customers, shareholders, or even from the politicians they are targeting. Another possible motivation is the desire to disguise the underlying agendas of those advancing particular political positions. Voters are likely to react differently to an ad that ostensibly comes from an independent group they never heard of, rather than from a group that they know is heavily financed by corporate interests with a particular axe to grind. 

It might be in a company’s interest for its involvement in political activities to remain hidden, but the public at large may have an even greater interest in knowing who is really responsible for the political speech to which they are being subjected. Perhaps the Federal Election Commission would, in theory, be the more logical place to hash this out. But that agency is moribund, permanently paralyzed by partisan gridlock. 

Currently, companies don’t have to disclose their political expenditures unless the amounts involved are “material.” But in this context, “materiality” is in the eye of the beholder. Even if the amount contributed is not that significant compared to a corporation’s overall expenditures, it could be considered important by many investors depending on what candidate, or what issue, is being targeted. Moreover, amounts that are immaterial to a giant company like Apple or Exxon might have a huge impact in a political campaign. As huge as political expenditures have become by historical standards, they are still dwarfed by the amounts spent by businesses for other things. 

Typically, corporations make political expenditures by contributing to advocacy groups. The petitioners to the SEC estimate that about $1.5 billion in corporate cash has been funneled through such groups over the last five years. Some groups, such as political action committees, are required to disclose their contributors; but others, such as so-called 501(c)(4) groups, don’t. Increasingly, that is where the corporate cash is going: these groups spent hundreds of millions of dollars in the last election cycle, without disclosing where any of it came from. 

If the SEC staff proposes a rule, yet another political donnybrook is certain to follow, after which will be the inevitable court case. The Court of Appeals for D.C., which reviews challenges to agency rules, has become increasingly aggressive in blocking agency rules it doesn’t like, often demanding “cost benefit” analyses. 

We should hear something any day now. 

Reportedly, most of the candidates and issues promoted by the heaviest “independent” expenditures did not do well last time around. But there is no guaranty that secret money won’t swing elections sooner or later.

Private Equity Firms Fail to Get Antitrust Case Dismissed

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, MAY/JUNE 2013 

Five years ago, investors sued 11 of the world’s largest private equity firms, including Kohlberg Kravis, TPG, Bain Capital, Apollo Capital Management and Goldman Sachs, on the grounds that defendants violated the antitrust laws by rigging the market for more than two dozen multibillion-dollar acquisitions of public companies, depriving those companies’ shareholders of billions of dollars they might have received in a true competitive bidding process. They claim that defendants had a gentlemen’s agreement not to outbid each other to acquire these companies. Defendants had tried nearly a dozen times in four years to get the suit tossed, with no luck. 

They were only partially successful this time. A federal judge in Boston has now refused to grant summary judgment dismissing the entire action. He narrowed the case significantly, however, dismissing all claims relating to 19 of the 27 deals that were targeted in the actions; and he dismissed JPMorgan Chase completely from the case. Nevertheless, he concluded that there was enough evidence of at least some collusion on eight of the deals among the rest of the defendants to take the case to trial. 

At the center of the case are “club deals,” acquisitions made by members of this “club” of private equity firms. Plaintiffs allege that there was a secret quid pro quo arrangement: If you don’t bid on my deal, I won’t bid on yours. 

In his summary judgment decision, Judge Harrington concluded that there was no grand conspiracy across all the 27 deals, but rather “a kaleidoscope of interactions among an ever-rotating, overlapping cast of defendants as they reacted to the spontaneous events of the market.” Yet he decided that there was enough evidence to sustain claims relating to 8 of the deals. 

As happens so often in litigation in the internet era, emails played a decisive role in this decision. Among them were comments from unnamed executives at Goldman Sachs and TPG in reference to the $17.6 billion takeover of Freescale Semiconductor by a consortium led by the Blackstone Group and the Carlyle Group. The Goldman executive said that no one sought to outbid the winning group because “club etiquette” prevailed. “The term ‘club etiquette’ denotes an accepted code of conduct between the defendants,” the judge wrote. “The court holds that this evidence tends to exclude the possibility of independent action.” 

Another email, from a TPG official said, “No one in private equity ever jumps an announced deal.” The judge also pointed to an e-mail sent by the president of Blackstone to his colleagues just after the Freescale deal was announced. “Henry Kravis [the co-founder of K.K.R .] just called to say congratulations and that they were standing down because he had told me before they would not jump a signed deal of ours.” 

The court singled out the $32.1 billion buyout of the hospital chain HCA as particularly problematic. K.K.R. expressly asked its competitors to “step down on HCA” and not bid for the company, according to an e-mail written by a then partner at Carlyle who is now the CEO of General Motors. One e-mail from Neil Simpkins of Blackstone Group to colleague Joseph Baratta said, “The reason we didn’t go forward [with a rival HCA bid] was basically a decision on not jumping someone else’s deal.” Baratta said, “I think the deal represents good value and it is a shame we let KKR get away with highway robbery, but understand decision.” 

KKR’s $1.2 billion investment in HCA has nearly doubled in value to $2 billion in four years.

Doing Well While Doing Good in Delaware

ATTORNEY: GUSTAVO F. BRUCKNER
POMERANTZ MONITOR, MAY/JUNE 2013 

On April 18, 2013, Delaware Governor Jack Markell introduced legislation enabling the formation of public benefit corporations. Because Delaware is already the legal home of more than one million businesses, including many of the nation’s largest publicly traded corporations, this legislation, if adopted, has the potential to radically transform the corporate landscape. 

Public benefit corporations are socially conscious for-profit corporations. While not new, until recently most public benefit corporations were established by government, not the private sector. Social entrepreneurs, a growing sector of the economy, argue that the current system, with corporations focusing only on profits, almost assures a negative outcome for society. They have been pushing the corporate focus towards pursuit of a “triple bottom line” of people, planet and profits, with the mantra “doing well while doing good.” Shareholders who value socially responsibility seek to invest in companies that are serious about sustainability, and such companies want to differentiate themselves from competitors. While it may come as no surprise that California and Vermont allow for creation of public benefit corporations, so do Illinois, New York, and South Carolina. 

Some states have “constituency statutes” that explicitly allow corporate directors and officers to consider interests other than those strictly related to maximizing value for shareholders, including the interests of the community. Nearly a third of constituency statutes apply only in the takeover context, allowing directors to consider interests of employees, for example, in deciding how to respond to a takeover offer. On the other hand, directors of a public benefit corporation have an affirmative obligation to promote a specified public benefit. 

The proposed legislation identifies a public benefit as a positive effect, or a reduction of negative effects, on people, entities, communities or other non-stockholder interests. Such effects could include, but are not limited to, effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, and scientific or technological nature. 

Directors of a public benefit corporation would have to balance the financial interests of stockholders with the best interests of those affected by the corporation’s conduct, as well as the specific public benefits identified by the corporation. 

If enacted, the legislation will take effect on August 1, 2013.

Court Hears Argument in BP Case

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, MAY/JUNE 2013 

As we have previously discussed in these pages, Pomerantz is currently representing several U.S. and foreign institutional investors seeking to recover investment losses caused by BP’s fraudulent statements issued prior to, and after, the April 20, 2010 Deepwater Horizon oil spill. Although the Supreme Court’s decision in Morrison v. National Australia Bank, Ltd. prevents investors from pursuing federal securities fraud claims for their BP common stock losses (because those shares traded on the London Stock Exchange), we are arguing that Texas state common law fills this enforcement void. 

On May 10, 2013, Judge Keith Ellison of the United States District Court for the Southern District of Texas held oral argument on BP’s motion to dismiss our claims. 

As we expected, much of the argument focused on the Dormant Commerce Clause, a Supreme Court doctrine which says that state statutes or regulations may not “clearly discriminates against interstate commerce in favor of intrastate commerce”; “impose a burden on interstate commerce incommensurate with the local benefits secured;” or “have the practical effect of ‘extraterritorial’ control of commerce occurring entirely outside the boundaries of the state in question.” BP argued that this doctrine prevented Texas state common law from reaching BP’s misconduct. In response, we pointed out that the doctrine did not apply to common law claims and that those claims targeted BP’s misstatements, not the underlying securities transactions on the London Stock Exchange. We also advanced a variety of policy-based arguments in support of our position. 

Although it is impossible to predict how the Court will come out on this issue, we believe that the oral argument advanced our cause. We expect the Court to issue a decision on the motion in the next few months.

Walking Dead Directors

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, MAY/JUNE 2013 

Did you know that forty-one directors who last year failed to receive the votes of 50% of the shareholders, are still serving as directors? At Cablevision, for example, three directors are still sitting there even though they lost shareholder elections twice in the past three years, and were renominated in 2013. Two directors of Chesapeake Energy in Oklahoma, V. Burns Hargis, president of Oklahoma State University, and Richard K. Davidson, the former chief executive of Union Pacific, were opposed by more than 70 percent of the shareholders in 2012. Chesapeake requires directors receiving less than majority support to tender their resignations, which they did. The company said it would “review the resignations in due course.” The company refused to accept one of the resignations but, mercifully, they both left. Other cases where this has occurred, according to Institutional Shareholder Services, include Loral Space and Communications, Mentor Graphics, Boston Beer Company and Vornado Realty Trust. 

Our favorite story, though, involves Iris International, a medical diagnostics company based in Chatsworth, Calif. There, shareholders rejected all nine directors in May 2011. They all submitted their resignations, but then voted not to accept their own resignations. The nine stayed on the board until the company was acquired the following year. 

Many of these cases involve companies that do not require directors to receive a 50% majority vote to win election to the board.

Delaware Takes On “Don’t Ask, Don’t Waive” Provisions

ATTORNEY: OFER GANOT
POMERANTZ MONITOR, MARCH/APRIL 2013 

In a previous issue of the Monitor, we discussed the relatively new concept in mergers and acquisitions of “don’t ask, don’t waive” provisions in standstill agreements between companies and potential acquirers. Under the law of Delaware and other states, the acceptance of a merger proposal by the target does not end the bidding process: directors must be free to consider better proposals that may come in after the merger agreement is signed, but before it is approved by shareholders. Bidders try to limit this risk by demanding “no solicitation” provisions in the merger agreement, preventing the target company from actively soliciting “topping” bids. 

However, coupling the no solicitation provisions with the don’t ask, don’t waive provisions essentially locks up the deal from all angles. Don’t ask, don’t waive provisions, set in advance of the actual bidding process, prevent bidders from increasing their bid for the target company – unless specifically invited to do so by the target’s board of directors – and from asking the target board to waive the prohibition. If losing bidders can’t make a topping bid for the target, nor ask its board to allow them to do so, and if the target can’t solicit or even consider post-merger-agreement bids, the deal is effectively locked up once the merger agreement is signed. In such a case, even if the merger agreement provides a grossly inadequate price, a court will be reluctant to enjoin its consummation for fear of killing the only offer that is actually on the table. 

Although in don’t ask, don’t waive situations the target can still consider unsolicited bids from bidders that were not part of the original bidding process and therefore never signed such standstill agreements, that doesn’t happen often. As we noted in our previous article, in the Delaware Court of Chancery’s recent ruling in the Celera Corporation litigation, Vice Chancellor Parson cast doubt on the legality of the combination of no solicitation and don’t ask, don’t waive provisions. “Taken together,” he said, these devices “are more problematic,” and that “[p]laintiffs have at least a colorable argument that these constraints collectively operate to ensure an informational vacuum” as to the best price reasonably available for the company, and that “[c]ontracting into such a state conceivably could constitute a breach of fiduciary duty.” 

In two more recent decisions, the Delaware Court of Chancery revisited this issue and reached different conclusions. In Complete Genomics, Vice Chancellor Laster echoed Judge Parsons, explaining that “by agreeing to this [“don’t ask, don’t waive”] provision, the Genomics board impermissibly limited its ongoing statutory and fiduciary obligations to properly evaluate a competing offer, disclose material information and make a meaningful merger recommendation to its stockholders.” The Court then enjoined the merger pending certain corrective disclosures and prevented the company from enforcing the standstill agreement with a certain bidder that contained this “don't ask, don't waive” provision, allowing it, if it chooses to do so, to make a topping bid. 

Three weeks later, in Ancestry.com, Chancellor Strine expressed a different view, holding that “don't ask, don't waive” provisions may actually be consistent with directors’ fiduciary duties to maximize shareholder value. Chancellor Strine stated that he was not “prepared to rule out that [the “don't ask, don't waive” provisions] can't be used for value-maximizing purposes” as long as the purpose allows the “well-motivated seller to use it as a gavel” as part of a meaningful sale process. According to the Court, if the “don’t ask, don’t waive” provisions are assigned to the winner of an auction process, allowing the winner to decide whether to let the losing bidders make a topping bid (highly unlikely), rather than left in the hands of target’s board, the Court was “willing to indulge that could be a way to make it as real an auction as you can.” 

If, on the other hand, the target’s board has the power to waive these provisions, and chooses not to waive them after signing a merger agreement with a buyer, there is “no reason to give any bid-raising credit” to this mechanism, “it has to be used with great care,” and the board has to disclose to its shareholders the fact that it continues to preclude certain potential bidders from making a superior bid for the company. Chancellor Strine cautioned board members employing don't ask, don't waive provisions to remain informed about the provisions’ potency, suggesting that a “nanosecond” after a definitive acquisition agreement was signed, he would have notified all parties subject to the provisions that they are waived, allowing them to make a superior offer. 

The court ultimately enjoined the deal at issue because the board did not disclose that certain bidders were foreclosed by a “don't ask, don't waive” provision, emphasizing that shareholders must be made aware of these provisions' effect if the provisions are to be used. 

The facts in Ancestry.com differed from those in Complete Genome, among other things, because the “don’t ask, don’t waive” provisions were already waived by the time Chancellor Strine had to rule on the issue. Would he, too, have enjoined such standstill agreements following the announcement of a merger -- as was the case in Complete Genome? That remains to be seen.

Second Circuit Hears Appeal of Citigroup Settlement Rejection

ATTORNEY: LOUIS C. LUDWIG
POMERANTZ MONITOR, MARCH/APRIL 2013 

In a decision heard around the world – or at least around Wall Street – in December of 2011, Federal District Judge Jed S. Rakoff famously rejected a settlement between the SEC and Citigroup. The SEC claims that, during the waning days of the housing bubble, Citi misrepresented facts when it sold investors over $1 billion of risky mortgage bonds that it allegedly knew would decline in value. Investors allegedly lost about $600 million on this deal. The same day the SEC filed its complaint, in October, 2011, it also filed a proposed “consent judgment”, a settlement agreement resolving those claims. The proposed deal called for $160 million in disgorgement (of fees and profits made by Citi on the deal), plus $30 million in interest and a civil penalty of $95 million. The settlement agreement did not require Citi to admit to any wrongdoing, allowing it to “neither admit nor deny” the charges, a staple provision of government settlement agreements. In addition to the financial penalties, the settlement would permanently restrain and enjoin Citigroup from future securities laws violations and would impose court-supervised “internal measures” designed to prevent recurrence of the type of securities fraud that (allegedly) occurred here. 

In deciding whether to approve a settlement between agencies and private parties, courts typically defer to the judgment of a federal agency, and rejections of settlements are rare. But Judge Rakoff is an exception to this rule: he is no rubber stamp for SEC settlements, and has used settlements to express his disdain for the SEC’s efforts to police the securities industry. Two years earlier, in 2009, he rejected a settlement between the SEC and Bank of America. 

In his decision in the Citi case, announced on November 28, 2011, Judge Rakoff did it again. He did not accept the “no admit, no deny” provision, and held that the settlement failed to provide the court with enough facts relating to the merits of the case “upon which to exercise even a modest degree of independent judgment.” He also noted that “there is an overriding public interest in knowing the truth,” and the reminded the SEC that it “has a duty ... to see that the truth emerges.” These comments leave the distinct impression that the judge was looking for a more or less definitive resolution of the allegations against Citi, as a price of a settlement. The opinion also rejected the $285 million in financial penalties, deriding it as mere “pocket change” for a bank Citi’s size, a penalty that would not deter future misconduct. 

The ruling has roiled the securities bar, to say the least. Any across-the-board requirement that defendants admit wrongdoing, or that the “truth” be established in order to settle a case, would make many cases almost impossible to settle. Such admissions or determinations could then be used by investors to recover even more in private lawsuits. Some have argued that, forced to try almost every case, federal agencies would be overwhelmed and the wheels of justice would come to a grinding halt. 

Others (the author included) have viewed the ruling as a long-overdue comeuppance to an agency that has not done enough to punish the miscreants who precipitated the financial crisis. The penalties imposed by the settlement would have no chance at all of reining in Citi’s bad behavior. 

Both the SEC and Citi appealed Judge Rakoff’s ruling to the Second Circuit. In his October 2011 ruling, Judge Rakoff had directed the parties to be ready for trial on July 16, 2012. On December 27, 2011, the SEC, joined by Citigroup, asked him to stay all proceedings, including the upcoming trial, pending determination of their appeals. When he denied the motions, Citi and the SEC appealed that decision as well; and in March 2012, the Second Circuit not only granted the stay, it expedited the appeals, chiding Judge Rakoff: “The district court believed it was a bad policy, which disserved the public interest, for the S.E.C. to allow Citigroup to settle on terms that did not establish its liability. It is not, however, the proper function of federal courts to dictate policy to executive administrative agencies[.]” 

In August, 2012, at the court’s direction, an attorney for Judge Rakoff filed a brief with the Second Circuit on his behalf, contending that he had never sought definitive proof of wrongdoing or an admission of Citigroup’s “liability” (as the court of appeals put it) but simply wanted to see some evidence before rendering a decision on a proposed settlement allegedly backed up by that same evidence. 

On February 8, 2013, the Second Circuit heard final argument on the merits, and comments from the judges seemed to confirm the impression that the Court intends to approve the settlement. The SEC – clearly emboldened by the first ruling in its favor – characterized the lower court’s ruling as being at odds with a century of judicial practice. Federal agencies’ decisions to settle cases, the SEC said, have historically been entitled to – and received – great deference. Citigroup agreed, arguing that, with respect to federal agencies, “the scope of a court’s authority to second-guess an agency’s discretionary and policy-based decision to settle is at best minimal.” At one point Judge Raymond Lohier “asked about deference and why an Article III judge would question the judgment of an executive agency that presumably reached its decision based on a sound review of the evidence.” When Judge Rakoff’s lawyer responded that the SEC was entitled to deference – but only to the point that they are wrong – his comment did not go over well. 

This appeal has thus largely turned into a referendum on how much deference a trial court should give to an agency proposing a settlement, and the extent to which the trial court can and should do its own review of the underlying evidence in the case, to test whether the agency has abused its discretion. 

Judge Rakoff’s ruling has spurred some federal judges elsewhere to demand more information before signing off on settlements brokered by the SEC and other government agencies, and even to question whether the “neither admit nor deny” clause is appropriate. And in the wake of Judge Rakoff’s ruling the SEC itself announced that it would no longer allow defendants to “neither admit nor deny” civil fraud or insider trading charges when, at the same time, they admit to or have been convicted of criminal violations. While this policy shift would have no impact on the Citigroup case – which lacked accompanying criminal charges – observers, including Edward Wyatt, writing in The New York Times, immediately noted a connection to Rakoff’s decision, which was then less than two months old. 

While the appeal was pending, Judge Rakoff presided over a jury trial of the agency’s claims against former Citigroup executive Brian Stoker in connection with in the same transaction that sparked the SEC’s initial complaint against Citi. After a full trial on the merits of these claims, the jury cleared Stoker of all wrongdoing. At this point, Judge Rakoff had more than enough information to evaluate the SEC’s settlement with Citigroup. By then, however, the significance of the case had moved well beyond the settlement itself to the role the courts are going to play in evaluating settlements proposed by the SEC and other agencies. 

The one silver lining here should be the existence – and persistence – of a vigorous plaintiff’s bar championing the rights of defrauded investors. Despite roadblocks like the Private Securities Litigation Reform Act of 1995 (devised as a “filter” to “screen out lawsuits”), the private shareholder class action remains investors’ – and the public’s – best hope of curtailing the financial sector’s worst excesses. The Supreme Court’s recent decision in Amgen v. Connecticut Retirement Plans bodes well for the future ability of investors to pool their limited resources to seek results the federally-designated “watchdogs” at the SEC appear either unwilling or unable to attain, a situation not likely to improve through the proposed handcuffing of the very courts meant to mete out justice.

Amgen Decision Favorable for Institutional Investors

ATTORNEY: MATTHEW L. TUCCILLO
POMERANTZ MONITOR, MARCH/APRIL 2013 

In order for a court to certify a case as a class action, it must usually determine that common questions “predominate” over questions that affect only individual class members. In securities fraud actions, plaintiffs must show, among other things, that investor “reliance” on defendants’ misrepresentations can be established on a class-wide basis. Otherwise, individual questions of reliance will “predominate”. 

A quarter century ago, in the landmark decision Basic v. Levinson, the Supreme Court adopted the so-called “fraud on the market” theory to address this problem. According to this theory, if the subject company’s stock trades on an “efficient market” (e.g. the NYSE), a court can presume that the market price of that company’s stock reflects all available information, including the facts misrepresented by the defendants. All investors presumably relied on the market price in buying their shares, reliance on the fraudulent statements can be established, indirectly, on a class-wide basis. The Basic decision held that the fraud on the market presumption was rebuttable by the defendant, but until recently that was interpreted to mean rebuttable at trial, not at the class certification stage. 

As the stakes have risen dramatically in securities fraud litigation, big corporations have been trying to find ways to make it more difficult for courts to certify class actions, since their settlement leverage drops precipitously once a class is certified. In the past few years they have been arguing that classes should not be certified unless plaintiffs can actually prove, and not merely allege, at the class certification stage that common questions will be established in their favor. For example, some defendants have argued that plaintiffs should have to prove, at a hearing, that the fraud actually caused investor losses on a class wide basis (“loss causation”). Such arguments would turn a class certification procedure into a “mini trial” on issues relating to the merits of the case, which would have to be re-litigated at trial. Last year, in Halliburton, the Supreme Court rejected the argument that loss causation should have to be proven at the class certification stage. 

Now, in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, the Supreme Court has rejected attempts to force a mini-trial on the fraud on the market contention at the class certification stage. Specifically, Amgen had argued that plaintiff should be required to prove, and not merely allege, that the fraudulent misrepresentations were material enough to affect the market price of its stock, and that it should be given a chance to rebut the basic presumption that the market price actually was affected by the fraud. If the fraud did not affect the market price, Amgen argued, plaintiff could never establish on a class-wide basis that the entire class relied on the fraudulent representations in buying their shares. Individual issues would predominate, so the argument went, making class certification inappropriate. 

In a victory for investors, the Supreme Court rejected Amgen’s arguments, holding that all a securities fraud plaintiff has to do -- at the class certification stage -- is plausibly allege facts showing that the fraud was material; and that defendants cannot attempt to rebut the fraud-on-the-market presumption at that stage in the case. 

Writing for a 6-3 majority that included Chief Justice Roberts and Justices Breyer, Alito, Kagan, and Sotomayor, Justice Ginsberg’s opinion holds that proof of materiality is not a class certification prerequisite. The question of whether fraudulent statements are material is provable (or not) through objective evidence common to all investors. Thus, even if defendants prevail on this issue at trial, they will do so in a manner that is common to the entire class, and as such, materiality is a common question to all class members. Moreover, if at trial the plaintiff failed to prove the common question of materiality, the result would not be a predominance of individual questions, but rather, the end of the litigation, because materiality is an essential element of each class member’s securities fraud claim. In that sense, the entire class lives or dies based on the common resolution of the question. 

In so holding, the majority rejected Amgen’s argument that materiality should be treated like certain other fraud on the market prerequisites (e.g., that the misrepresentations were public, that the market was efficient, and that the transaction at issue occurred between the misrepresentation and the time the truth was revealed), which do have to be proven at the class certification stage. The majority found these other issues relate solely to class certification and are not ultimate merits determinations for the entire class. It also rejected Amgen’s argument that barriers should be raised to class certification because the financial pressure of a certified class forces the settlement of even weak claims, finding it significant that Congress had addressed the settlement pressures of securities class actions through means other than requiring proof of materiality at the class certification stage. In so doing, Congress had rejected calls to undo the fraud on the market presumption of reliance. Finally, the majority noted that, rather than conserving judicial resources, Amgen’s position would require a time- and resource-intensive mini-trial on materiality at the class certification stage, which is not contemplated by the federal rules and which, if the class were to be certified, might then have to be replicated in full at trial. 

In separate dissents, Justice Thomas and Scalia expressed hostility toward certification of classes where the materiality of the alleged statements had not been established. Thomas and, in a separate concurrence, Alito also questioned the continued validity of the fraud-on-the-market theory, in light of more recent research questioning its premises. These remarks may only invite additional challenges to the fraud-on-the-market presumption itself in years to come.

Pomerantz Reaches Major Healthcare Settlement With Aetna

POMERANTZ MONITOR, JANUARY/FEBRUARY 2013 

Readers of the Monitor may recall our reports on our $250 million settlement with Health Net, followed by our $350 million settlement with United Healthcare. Both actions involved underpayments by health insurers of claims for out-of-network medical services based on miscalculations of “usual, customary and reasonable,” or “UCR,” rates. The $350 million settlement with United Healthcare represented the largest cash settlement of an ERISA healthcare class action ever. 

We continued to pursue UCR claims against other healthcare insurers, and are now pleased to report that we have reached a settlement with Aetna, Inc. This settlement, in In re Aetna UCR Litigation, pending in the District of New Jersey, will -- once it is approved by the Court -- result in the reimbursement, through three settlement funds Aetna will create, of up to $120 million to providers and plan members who were also subjected to out-of-network underpayments based on miscalculated UCR rates. 

This settlement arises out of an action that alleged that Aetna used databases licensed from Ingenix, a wholly-owned subsidiary of United Healthcare, to set UCR rates for out-of-network services. We alleged the Ingenix databases were inherently flawed, statistically unreliable, and unable to establish proper UCR rates. Aetna, United Healthcare, and a number of other healthcare insurers had agreed to stop using the Ingenix databases pursuant to settlements with the New York Attorney General in 2009 simultaneous with Pomerantz’s settlement with United Healthcare. The settlement involves Aetna’s use of other non-Ingenix-based reimbursement mechanisms as well. 

The Aetna settlement represents another successful milestone for Pomerantz’s Insurance Practice Group. We are proud of this latest success in forcing managed care companies to follow the law. This settlement provides an opportunity for providers to obtain reimbursement for monies taken by Aetna in the guise of usual, customary and reasonable payments. It brings to a successful close years of litigation on behalf of providers, for whom we have long fought against the largest health insurers in the country, including Aetna. 

Pomerantz’s Insurance Practice Group represents hospitals, provider practice groups and providers in litigation involving such issues as recoupments and offsets, internal medical necessity policies that are inconsistent with generally accepted standards, and misrepresentations of insurance coverage.

Government Goes After Insider Trading

ATTORNEY: EMMA GILMORE
POMERANTZ MONITOR, JANUARY/FEBRUARY 2013 

Whatever one thinks of the government’s record in punishing Wall Street for fomenting the financial crisis, the success rate against insider trading has been strong. Ever since Preet Bahara was appointed U.S. Attorney for the Southern District of New York in 2009, he has focused heavily on insider trading cases. In a 2010 speech to a room jam-packed with white collar criminal defense attorneys, he declared that “unfortunately from what I can see, from my vantage point as the United States Attorney here, illegal insider trading is rampant.” 

The law imposes liability for insider trading on anyone who improperly obtains material non-public information and trades based on such information, and also holds liable any “tippee,” the person with whom the “tipper” shares the information, as long as the tippee knows the information was obtained in breach of a duty to keep the information confidential or abstain from trading. Since the beginning of Bharara’s tenure in 2009, his office has secured 69 convictions or guilty pleas of insider trading without losing a single case. Many of those cases were developed jointly or in parallel with the SEC, which has commenced over 200 enforcement actions of its own since 2009. 

Critical to the prosecutors’ unblemished record of securing insider trading convictions has been the aggressive use of wiretaps and of informants. Private plaintiffs contemplating insider trading lawsuits can benefit from the treasure-trove of incriminating evidence collected by the government that private parties cannot get themselves through the normal “discovery” process. 

Of the 75 people recently charged by Bharara’s office, until now the biggest fish caught were Raj Rajaratnam, a billionaire investor who once ran Galleon Group, one of the world’s largest hedge funds, and Rajat Gupta, a former McKinsey chief and Goldman Sachs director who allegedly fed inside information to Rajaratnam. 

Wiretaps were key to the case against Mr. Rajaratnam. The case broke when prosecutors, while investigating a hedge fund owned by Rajaratnam’s brother Rengan, uncovered a slew of incriminating e-mails and instant messages between Raj and his brother, and wiretapped their conversations. In a call, Rengan told his brother about his efforts to extract confidential information from a friend who was a McKinsey consultant. Rengan referred to the consultant as “a little dirty” and touted that he “finally spilled his beans” by revealing non-public information about a corporate client. Other powerful evidence obtained from wiretapped calls was used to place Rajaratnam squarely in the forefront of the insider trading scheme: “I heard yesterday from somebody who’s on the board of Goldman Sachs that they are going to lose $2 per share,” Rajaratnam said to one of his employees ahead of the bank’s earnings announcement. 

Rajaratnam was found guilty on all 14 counts levied against him, and was sentenced to 11 years in prison and fined $10 million. It was the longest-ever prison sentence for insider trading, a watershed moment in the government’s aggressive campaign to rout out the illegal exchange of confidential information on Wall Street. He is currently appealing his conviction to the Second Circuit. 

Gupta, for his part, was accused of passing a flurry of illegal tips to Rajaratnam, including advance news that Warren Buffet was going to invest $5 billion in Goldman Sachs. Gupta received a two-year prison sentence and was ordered to pay $5 million in fines. 

More recently, in what federal prosecutors describe as the most lucrative insider trading scheme, prosecutors and the SEC filed separate insider trading charges against Mathew Martoma, a portfolio manager at CR Intrinsic Investors. CR Intrinsic is an affiliate of SAC Capital Advisors, a $10 billion hedge fund founded by billionaire Steven Cohen, one of Wall Street’s most successful and prominent investors. 

Martoma is accused of illegally trading on confidential information ahead of a negative public announcement poised to disclose the results of a clinical trial for an Alzheimer’s drug jointly developed by Elan Corporation and Wyeth Ltd. Armed with confidential information, Martoma allegedly emailed Cohen requesting that they speak (“Is there a good time to catch up with you this morning? It’s important.”). Martoma and Cohen subsequently spoke by phone for approximately 20 minutes. The next day, Cohen and Martoma instructed SAC’s senior trader to quietly begin selling the Elan position. At day’s end, the trader e-mailed Martoma that he had sold 1.5 million shares of Elan, and that “obviously no one knows except you me and [Cohen].” A few days later, the senior trader e-mailed Cohen the results of the week’s activity: “We executed a sale of over 10.5 million ELN for [four internal Hedge Fund account names] at an avg price of 34.21. This was executed quietly and effectively over a 4 day period through algos and darkpools and booked into two firm accounts that have very limited viewing access. This process clearly stopped leakage of info from either in [or] outside the firm and in my viewpoint clearly saved us some slippage.” 

From one end of Wall Street to the other, people are wondering whether Martoma, facing the likelihood of serious jail time, will “flip” on Cohen, creating probably the most sensational insider trading case ever. There is no doubt that Martoma is facing intense pressure: reportedly, when confronted by an F.B.I. agent in his front yard, Martoma fainted. If Martoma is convicted of the charges, federal guidelines call for a stiff 15-19 year sentence. And, while no SEC charges have yet been brought against Cohen, the Commission recently issued a Wells notice to SAC Capital, indicating that the staff is probably going to recommend that the SEC take action against SAC.

Companies Fight to Keep Their Political Contributions Secret

ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, JANUARY/FEBRUARY 2013 

In the wake of the Supreme Court’s 2010 Citizens United decision, which allowed corporations and unions to make unlimited expenditures for political purposes, a new battle has erupted to force companies to disclose these expenditures. Writing for the majority in that case, Justice Anthony Kennedy noted that prompt disclosure of political expenditures would allow stockholders and citizens to hold corporations accountable. Shareholders, he said, could determine whether the corporation’s financing of campaigns “advances the corporation’s interest in making profits.” But in many, perhaps most cases, disclosure and accountability are the last things that corporate managers want. 

Although dozens of major companies have voluntarily disclosed their political spending, most do not. Currently, the most common shareholder proposals submitted to public companies are those requesting information on political spending. Most, however, have not fared well. Many companies probably fear that revelation of their political expenditures would be an invitation to backlash from shareholders and others at the opposite end of the political spectrum. 

Months ago the “Committee on Disclosure of Corporate Political Spending,” headed by Professors Lucian Bebchuck of Harvard Law School and Robert M. Jackson of Columbia Law School, filed a rulemaking petition asking the SEC to adopt a disclosure rule for corporate political spending. Over 300,000 responses to this petition flooded the Commission, all but 10 of which supported it. The SEC recently announced that by April it plans to issue a Notice of Proposed Rulemaking to require disclosures of political spending. 

The Committee said that one of the main reasons for its proposal is that a significant amount of corporate political spending currently occurs under investors’ radar screen, particularly when public companies spend shareholder money on politics through intermediaries, who are never required to disclose the source of their funds. Investors clearly want to receive information about such spending. 

While we await action by the Commission, one investor, the New York State Comptroller Thomas P. DiNapoli, has taken matters into his own hands. He controls the New York State Common Retirement Fund, which holds about $378 million in stock of Qualcomm, one of the country’s largest makers of computer chips for mobile devices. After Qualcomm allegedly rebuffed his multiple requests for access to information on political spending, DiNapoli sued Qualcomm late last year in Delaware Chancery Court, seeking to allow him to review documents showing the company’s political expenditures. Mr. DiNapoli is trying to determine whether Qualcomm made corporate contributions to tax-exempt groups and trade associations that are not required to disclose their donors. Those groups poured hundreds of millions of dollars into the 2012 election, including money from large corporations seeking to avoid negative publicity or customer outcries. Although DiNapoli is a prominent Democratic politician, he cannot be accused of filing the petition for political purposes: Irwin Jacobs, Qualcomm’s controlling shareholder, is a prominent contributor to Democratic candidates and causes. 

Delaware, where Qualcomm is incorporated, has a statute that allows shareholders to gain access to corporate records, so long as they have a “proper purpose” for doing so. As we have noted previously in the Monitor, the question of what a shareholder has to show to establish a “proper purpose” has generated heated debate over the past few years, with corporations making some headway in raising the bar for shareholder access. 

Typically, shareholders have tried to gain access to company books and records to determine whether wrongdoing has occurred, such as breach of fiduciary duties by directors or executives. It is a novel question whether discovery of political activities is a proper purpose. Even if it can be a proper purpose in some cases, such as if the expenditures create some risk for the corporation, the next question is whether the investor will have to show some reason to be concerned in a particular case. Otherwise, the courts may view his request as simply a “fishing expedition.” 

The Council of Institutional Investors, an association of pension funds, foundations and endowments, supports Comptroller Di Napoli’s suit. Amy Borrus, deputy director of CII, reportedly has stated that the suit offers hope to investors stonewalled in their search for basic information about corporate political spending after Citizens United. “Shareholders have tried proxy proposals, and they’ve tried asking, but some companies are unfortunately resistant to providing basic disclosures," Borrus said Thursday. The present suit “certainly opens up a new avenue,” she said. 

If DiNapoli succeeds in obtaining this information, the next question will be whether he can publicly disclose it, allowing other shareholders and interested parties to weigh in on the appropriateness of the company’s actions.