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In February, the Article 29 Working Party of the European Commission adopted a pan-European approach to Sarbanes-Oxley whistleblowing. Recently, the Article 29 Working Group and the SEC’s Office of International Affairs exchanged a total of four letters (although the SEC’s letters are dated September, they were just recently posted). This is the first time we’ve seen the SEC Staff’s views in writing on what the Europeans are doing in – and should dispel some of the confusion about how to implement whistleblower procedures taking into account multiple regulatory frameworks. We have posted this set of letters in our “Whistleblowers” Practice Area.

In this podcast, Mark Schreiber of Edwards Angell Palmer & Dodge discusses this latest development. Once you hear this podcast, you will realize that companies should now be creating whistleblower policies and procedures that comply with both Sarbanes-Oxley and EU data protection laws, which a number of companies are now doing.

Proposal: Nasdaq Listed Securities as “Covered Securities”

Last week, the SEC issued this proposal, based on a petition from Nasdaq, so that Nasdaq’s listed securities would be considered “covered securities” under Section 18 of the ’33 Act and thus exempt from state law registration. This proposal covers what used to be known at the Nasdaq SmallCap market and is now known as the Nasdaq Capital Market. The top two tiers of Nasdaq (which were all formerly Nasdaq National Market) are already covered securities.

I note that as part of getting the more favorable “covered securities” treatment for the Capital Market, Nasdaq has proposed raising the NCM listing standards. (See SR-NASDAQ-2006-032, filed 8/23/06). Sort of a “cod liver oil” feature. Getting covered securities treatment for NCM securities would be a big help for NCM-listed companies, who sometimes have trouble getting blue sky exemptions. The trade-off is that it will probably become harder to get on NCM. Thanks to Linda DeMelis for prodding my memory on some of this stuff…

Books & Record Demands: Recent Caselaw

Below are excerpted portions from Francis Pileggi’s “Delaware Corporate & Commercial Litigation Blog” regarding a recent books & records case:

In Polygon Global Opportunities Master Fund v. West Corp., (Del. Ch., October 12, 2006), the Delaware Chancery Court addressed another request for books and records under DGCL Section 220 by a hedge fund and found it wanting, as explained in this thoroughly reasoned opinion. For another recent Chancery decision, Highland Select, denying a Section 220 request by an equity fund, due at least in part to the request being overly burdensome in scope, see the summary on this blog here. In that Highland case, trial was held about 6 weeks after the complaint was filed.

This case involved a trial that took place about 2 months after the complaint was filed. To state the obvious, the limited scope of the trial was for the purpose of determining entitlement to the documents sought–something that in the ordinary case one would obtain in routine discovery.

The court noted that the plaintiff hedge fund often invested in arbitrage situations and in this case heavily invested in the defendant corporation following the announcement of a going private transaction. The stated purpose of the demand under 220 was to: (i) value their stock; (ii) determine whether to seek appraisal; (iii) investigate breaches of duty; and (iv) communicate with other stockholders.

The court found no entitlement in this case under Section 220 because the plaintiff: (i) had already obtained “all necessary, essential and sufficient” data to determine whether to seek appraisal; (ii) did not have a proper purpose to investigate wrongdoing; and (iii) did not seek a stockholder list for a proper purpose.

Notably, after suit was filed, the court asked the plaintiff to “prepare a chart” linking :(i) the documents sought with (ii) the proper purpose for each document sought, as asserted in the demand for records (resulting in a pared-down list prior to trial).

The court made clear that valuation of shares is a proper purpose for a Section 220 demand, especially in the context of determining whether to pursue an appraisal–but if the data is already available in the public domain (e.g., in an SEC filing) the Section 220 claim may be obviated. It was also made clear that SEC Rule 13e-3 requires, as here, more data about valuation in a going private transaction than would otherwise be available. This highlights the different lens through which a demand involving a public company will be viewed as opposed to a closely-held one. Although there is no per se rule that a Section 220 claim for valuation purposes may be mooted in a squeeze-out merger subject to disclosures under SEC Rule 13e-3, in this case that was the result.

It was also made clear (as stated in many cases) that a Section 220 case is not a substitute for normal discovery in a regular lawsuit, nor will it be allowed as a substitute for discovery in a subsequent appraisal action. The scope of documents available in regular discovery under Rule 34 is much different than the scope of documents available under Section 220 (citations omitted).

Referring to DGCL Section 327 and related cases, the court emphasized the important public policy against “the evil of purchasing stock in order to attack a transaction which occurred prior to the purchase of the stock” (citations omitted)(i.e., purchasing a basis for litigation). Due to the claim here that the investigation into wrongdoing related to an event prior to the purchase of stock, the court observed that the plaintiff did not have standing for a derivative claim; nor did it have standing to make allegations based on entire fairness.

Regarding its alleged interest in communication with other stockholders, though the burden is on the corporation in this type of request to establish an improper purpose for the request of a stockholder list, and is rarely denied, here the reason for the request was based on the 2 prior reasons which were rejected by the court. (e.g., the list was not requested for a proxy solicitation but merely to “share” what it got from the Section 220 case and to inquire about anyone else who might be seeking appraisals.) In sum, on this point, the court said that simply because a stockholder may communicate with other stockholders based on Federal Securities Laws, that fact in and of itself does not support a proper purpose under Section 220.

Though it might be tempting to do so, I don’t think this case can be read as imposing a higher hurdle for hedge funds making a Section 220 demand. Rather, the relevant background of the stockholder, to the extent it provides insight into the stockholder’s intent in buying the stock, and its “end-game”, will be part of the court’s analysis of whether the requirement of a “proper purpose” has been satisfied.