May 22, 2008

Countrywide Derivative Litigation: Rule 10b5-1 Sales in the Spotlight Again

Last week’s ruling permitting plaintiffs to move forward on some claims in a derivative suit against Countrywide Financial Corp. received quite a bit of attention (see, e.g., this NY Times article and this Bloomberg article), but perhaps the most interesting elements of the case detailed in the order were allegations about insiders’ sales of substantial amounts of Countrywide stock right around the time of a company repurchase plan and pursuant to Rule 10b5-1 plans.

I blogged about reports of the SEC’s interest in Countrywide CEO Angelo Mozilo’s use of Rule 10b5-1 plans last Fall, and his trades under 10b5-1 plans were a topic of great interest during the hearing before the House Committee Oversight and Government Reform earlier this year. Now, with the May 14th Order of Judge Mariana Pfaelzer on the motions to dismiss for In re Countrywide Financial Corp. Derivative Litigation, much more detail about the trading activity of Countrywide insiders in advance of the company’s troubles has come to light.

Among the most notable allegations regarding insider sales were large trades conducted around the time of the announcement of Countrywide’s stock repurchase programs in November 2006 and May 2007. The judge asks regarding these trades: “how could the Board members approve a repurchase of $2.4 billion dollars worth of stock, and nearly contemporaneously liquidate $148 million of their personal holdings just months before the stock dropped some 80-90%?” Ultimately, while noting that these trades appear to be suspicious, the judge didn’t find sufficient detail in the complaint for the allegations to survive a motion to dismiss.

It was a very different story when considering Mozilo’s trades. Noting that Mozilo actively amended and modified his 10b5-1 plans, Judge Pfaelzer states: “Mozilo’s actions appear to defeat the very purpose of 10b5-1 plans, which were created to allow corporate insiders to ‘passively’ sell their stock based on triggers, such as specified dates and prices, without direct involvement…[a]ccordingly, his amendments of 10b5-1 plans at the height of the market does not support the inference ‘that the sales were pre-scheduled and not suspicious.'” The judge rejected claims that inferences of scienter were mitigated by the fact that Mozilo’s trades involved amounts of stock that represented only a small proportion of his substantial holdings, citing a 9th Circuit holding that “where, as here, stock sales result in a truly astronomical figure, less weight should be given to the fact that they may represent a small portion of the defendant’s holdings.” Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d 1226, 1232 (9th Cir. 2004).

While not discussed in the Order, it appears from Countrywide’s filings that the company actually instituted a special kind of repurchase program around the time of the insiders’ sales called an “accelerated share repurchase program,” which usually involves a company purchasing shares of its own stock from a broker-dealer at a set price on one or more specified dates. The broker-dealer borrows the shares that are sold to the issuer and thereby puts itself in a short position, which it then covers by conducting open market purchases over time. From the disclosures, it appears that the company financed the purchase of the stock through the issuance of debt securities.

One thing that makes an accelerated share repurchase program different from the usual buyback program is that companies often complete the buyback all at once or over a very short period of time, rather than entering the market over a long period of time to buy back stock at attractive prices.

SEC Publishes CIFiR Subcommittee Reports for Comment

Last week, the SEC published for public comment the four subcommittee reports that were presented to the Advisory Committee on Improvements to Financial Reporting at its May 2, 2008 open meeting. The Subcommittee Reports largely reflect additional considerations and comment on previously identified proposals.

The “Delivering Financial Information” Subcommittee’s report reflects some further consideration of issues briefly identified in the Committee’s February Progress Report as issues for future consideration. For example, the Subcommittee has developed some “Preliminary Hypotheses” with respect to the use of Key Performance Indicators (KPIs), improvements to quarterly earnings release disclosure and timing and the use of executive summaries in Exchange Act periodic reports (similar to summaries found in offering documents). The Subcommittee’s report outlines some suggestions and considerations that could ultimately result in Committee recommendations in these areas.

In more accounting committee news, the Treasury Department’s Advisory Committee on the Auditing Profession posted a notice regarding the Committee’s activities, along with a request for comment on the Committee’s draft report until June 13.

Sovereign Wealth Funds and Activism

In this podcast, Ron Orol, Senior Writer for The Daily Deal, The Deal and and author of, “Extreme Value Hedging: How Activist Hedge Fund Managers Are Taking on the World,”discusses sovereign wealth funds, including:

– What is a “sovereign wealth fund”?
– How are they working with activist investors, particularly in a post-Dubai Ports World politically charged environment?
– What about sovereign wealth fund as activists themselves?
– What are regulators in Washington doing regarding sovereign wealth funds?

– Dave Lynn