Monthly Archives: March 2012

March 16, 2012

The JOBS Act: Congress on the Bizarro Fast Track

On Tuesday, I posted a list of links to articles and letters criticizing Congress and its proposed JOBS Act for planning to deregulate the securities markets. Since then, there have been hordes of articles reporting in a similar vein (there are have been over 2000 articles on the Act this week).

Rather than list another dozen pieces attacking the bill, below is an update from Lynn Turner explaining the bizarre process of this bill so far:

There have been many stories about how the Senate is conducting its business in recent days. The Senate has often claimed it is more reasoned and thoughtful than the US House of Representatives, but that is not necessarily so. In the case of the JOBS Act, its process has been much worse.

Usually a bill is introduced. To get any traction though, it needs to be introduced and sponsored by a Senator on the appropriate Senate Committee with jurisdiction over the subject matter of the bill. If the committee chair, and sufficient number of committee members are supportive, hearings about the legislation are held in the committee, as well as in subcommittees. The regulators are called to testify, as well as people who are expected to support or oppose the bill.

Typically the party in power picks most of the panel members testifying and the minority party is given one or at most two slots in which people they pick can testify. Then comes what is known as a “mark-up” when the committee members in a public meeting discuss the proposed bill, make proposed amendments and vote on those amendments. If approved, the marked up bill goes to the full floor for debate, when the Majority Leader puts in on the agenda and schedule for debate.

However, in the case of this legislation, a Senate hearing in a subcommittee planned for March 21st was canceled. And the legislation was pulled from the Senate circumventing any mark-up session and further hearings. None of the SEC Commissioners testified. The SEC Chair has written this letter to the Senate citing serious problems and deficiencies in the bill leaving investors further exposed to scams and schemes ala Bernie Madoff.

On Wednesday morning, I understand Harry Reid went to the floor saying he was pulling this out of the hands of the Banking Committee and he began pushing it through in rapid fire this week. That was not what some Senators expected. There was a caucus of the Democratic Senators on Wednesday over lunch at which Senators expressed concern with what Harry Reid and Charles Schumer were doing.

Later on as widely reported, a trade off of relief for blocked judges in exchange for deregulation of securities markets entered the fray making things even more confusing. First thing on Wednesday morning, some thought the Dems would introduce their own version of the bill, but Harry Reid in a nod of the cap to the venture capitalist and bio tech lobbyists (and their campaign contributions) decided that he would go with the House Republican’s bill (probably following the White House’s directions). While an amendment would be offered making it look like investors protections requested by the state regulators, the SEC and many investor and consumer groups would be entertained, that is merely a facade – a token effort which was dead on arrival before it was even introduced.

Perhaps the funniest thing, is that only people in Congress are calling this a jobs bill. It has become widely referred to in the media as “The Bucket Shop Reauthorization Act of 2012.” Most of the people that the Dems did call to testify have said it will not create new jobs, (except perhaps among law enforcement agencies and prison guards)!!! As they say, God Bless America.

And if you want to read about more bizarre behavior from Congress, read this piece – entitled “What’s Behind Congressional Freeze on SEC Funding?” – which explains how the House Financial Services Subcommittee has voted against the SEC’s budget – not because the government doesn’t have the money – but as a way to punish the SEC for conducting unnecessary rulemaking. Except that rulemaking was mandated by Congress in Dodd-Frank…

Second Circuit Stays Judge Rakoff’s Citigroup Decision

Yesterday, in a sharply worded per curiam opinion, a three-judge panel of the Second Circuit granted the motions of Citigroup and the SEC to stay district court proceedings in the SEC’s enforcement action against the company, so that the appellate court could consider the merits of the question of whether Judge Rakoff had properly rejected the parties’ $285 million settlement agreement. Here’s some analysis from Kevin LaCroix in his “D&O Diary Blog” and David Smyth’s analysis from the “Cady Bar the Door Blog.”

SEC Marks The Ides By Bringing Actions Involving Secondary Market For Private Company Shares

As noted in this blog, Keith Bishop has been writing about some of the issues related to secondary trading in private company shares for a few years. Two days ago, the SEC brought an action against several firms and individuals related to activities involving secondary trading of private company shares. Read more in Keith’s blog as well as this analysis from Vanessa Schoenthaler’s “100 F Street Blog.”

– Broc Romanek

March 15, 2012

Corp Fin to Consider Tweaking Foreign Private Issuer Reporting System

Last week, Corp Fin Director Meredith Cross delivered this speech that kicks off with a quick recent history of the SEC’s FPI rulewriting in various areas as a way to demonstrate that the Staff is always evaluating: does this make sense anymore? I’m not sure that I read this speech as the Staff seeking to undertake a “full review” of the SEC’s FPI framework as noted in this Jones Day memo (although the memo does a great job of recapping the speech), particularly given all the Dodd-Frank rulemaking still ahead for the Staff…

Transcript: “Conduct of the Annual Meeting”

We have posted the transcript for the recent webcast: “Conduct of the Annual Meeting.”

The Latest in GRC Software

In this podcast, John Banas and Bruce Olcott of MyComplianceManager provide some insight into how software can make GRC compliance easier, including:

– What are the biggest trends you’re seeing in GRC over the past few years?
– We hear about GRC frequently, what does that term mean to you and what functions does it encompass?
– So what should a Compliance, Legal or Audit Executive look for when considering purchasing a GRC Suite or specific GRC modules?

Please take a moment to participate in this “Quick Survey on GRC Software” – and this “Quick Survey on Board Minutes & Auditors.”

– Broc Romanek

March 14, 2012

Our New “Director Resignation & Retirement Disclosure Handbook”

Spanking brand new. And shiny to boot! If you have a director that is resigning, retiring, not standing for re-election, quitting in disgust, being appointed or dying, we have the Handbook for you. Posted in our “Director Resignations” Practice Area, this comprehensive “Director Resignation & Retirement Disclosure Handbook” provides practical guidance – including numerous hypotheticals – about how to handle these situations including how to prepare in advance for them. In particular, the Handbook focuses on the company’s reporting obligations under Item 5.02 of Form 8-K when these inevitable situations arise…

A “Fresh Eyes” Restatement Report

Ahead of next week’s PCAOB roundtable – on March 21st and 22nd – on whether it should propose an auditor rotation requirement for the largest companies, Audit Analytics prepared this report that examines the restatements disclosed by the Russell 1000 – as well as their auditor changes – in an attempt to determine if auditor changes in any way played a part in the discovery of outstanding accounting misstatements and, if so, to what extent. For the report, Audit Analytics reviewed 1,355 companies (a five-year aggregate), 378 restatements, and 173 auditor departures.

Some of the observations contained the report:

– About 7.5% (4 out of 53) of the Annual Restatements linked to an auditor departure were detected, in part, by the “fresh eyes” of the newly engaged auditor.

– About 64% (34 out of 53) of the Annual Restatements linked to an auditor departure were detected prior to the auditor’s departure (“no fresh eyes”).

– About 15% (8 out of 53) of the Annual Restatements linked to an auditor departure were detected by the companies themselves or their regulators, such as the SEC (“no fresh eyes”).

– About 13% (7 out of 53) of the Annual Restatements linked to an auditor departure were restatements that corrected misstatements that occurred after the new auditor’s engagement (no restatement of work during predecessor auditor engagement).

– About 82% (238 out of 291) of the Annual Restatements disclosed by the Russell 1000 were disclosed by companies that did not experience an auditor departure.

– The total auditor changes experienced by the Russell 1000 since January 1, 2005 had a “fresh eyes” restatement discovery rate of no more than about 3.0%.

Lynn Turner notes: “This report highlights just how poor quality audits really are today and just exactly what are they worth. Of 1335 Russell 1000 companies, 291 or 21.8% had errors in their financial statements that went undetected and had to be corrected. These audits are exclusively done by the Big 4 who are suppose to be the best of the best – one can only wonder then what an error rate for the worst is like.

Not only does these findings call into question the quality (or lack thereof) of audits, it also continues to call into question the competence of the CFO/Controller at these companies, the lack of internal controls, and the continuing unreliability and lack of oversight by the audit committees. Why was it the error was not detected at least by the auditors before the original financial statements with errors in them were released to investors? Were the auditors either incompetent or lacking independence or devoid of skepticism? Was the audit committee members merely going thru the motions and what steps did they take to establish accountability for the problems?

What the report is unable to report, as there is often no transparency in SEC 8-K and other reports, is just exactly what did turn up the errors in each of these instances where the restatement occurred prior or subsequent to a change in auditor. While a few instances are noted, such as the SEC finding three of the 291 errors, in most instances how the error is actually found and by whom is not disclosed.

Using Online Video to Announce a Restatement

Thanks to Howard Dicker of Weil Gotshal for turning me onto this restatement announcement study which used executive MBA students as guinea pigs. The study finds that although text-based press releases have been the norm for years, companies have recently begun using online video for such announcements. And that when a CEO accepts responsibility by making an internal attribution for a restatement, investors viewing the announcement online via video recommend larger investments in the firm than do investors viewing the announcement online via text. Pretty wild…

– Broc Romanek

March 13, 2012

The JOBS Act: Congress Being Congress

Yesterday, Dave did a great job in describing the JOBS Act and how it would fast-track capital formation reform (we are posting memos on the Jumpstart Our Business Startups Act in our “IPOs” Practice Area). Dave also noted that the Senate was fast tracking the bill – and that some were questioning the measures in the bill.

As I’ve blogged before, count me among those that think this is a wrongheaded thing that Congress is doing in the capital formation area. This bill has nothing to do with jobs and everything to do with fewer protections for investors. I am not the only one who feels that way as noted in these articles (note that last one that argues that the bill won’t even be good for IPOs!):

They Have Very Short Memories – NY Times
Imaginary Problems – Motley Fool
Extraordinary Popular Delusions and the Madness of Crowd (Funding) – Huffington Post
Financial regulations gutted in new bill – San Francisco Chronicle
Job-Creation Legislation Seen Eviscerating Shareholder Protections in U.S. – Bloomberg
Alone in a Crowd: How Crowdfunding Could Strand Startups – Bloomberg BusinessWeek
JOBS Act enables Chinese fraud – China Accounting Blog
Sarbanes, Edwards say jobs bill hurts transparency – Baltimore Sun
The JOBS Act and the IPO Off Ramp: Discouraging IPOs – Race to the Bottom Blog

And here are a bunch of letters from organizations arguing against the new legislation:

Group of organizations, including Consumers Federation and AFL-CIO
Americans for Financial Reform
Council for Institutional Investors
North American Securities Administrators Association (NASAA)

Yesterday, the SEC posted two sets of recommendations from its Advisory Committee on Small and Emerging Companies – one for reporting obligations and one for market access. And last week, Facebook filed its Pre-Effective Amendment No. 2 to its Form S-1

US Investors as an “Easy Mark”: More Evidence

As noted in this blog, it’s now pretty well known how scores of Chinese companies – that turned out to be fraudulent – listed their securities here in the US because they weren’t able to do so in China. As noted in this article from “The Telegraph,” the London Stock Exchange is exploring ambitious plans to push its junior AIM market into the United States. To be honest, I thought AIM was dead since so many of the companies that have gone public and listed there have since gone down the tubes. As noted in the article: “In 2007, Roel Campos, a commissioner at the Securities and Exchange Commission voiced his concerns that 30% of new firms listing on AIM “are gone in a year.”

Transcript: “Company Buybacks: Best Practices”

We have posted the transcript for our recent webcast: “Company Buybacks: Best Practices.”

– Broc Romanek

March 12, 2012

House Passes JOBS Act, Seeking to Fast-Track Capital Formation Reforms

Late last week, the House of Representative passed H.R. 3606, The Jumpstart Our Business Startups (JOBS) Act, with strong bi-partisan support. This bill was comprised of a collection of bills that have been introduced in the House over the past year, all of which focus in one way or another on the ability of companies to raise capital and stay private longer. The key measures included in the JOBS Act are:

Title I, Reopening American Capital Markets to Emerging Growth Companies. This portion of the Act is what is most commonly referred to as the “IPO On-Ramp” legislation, and it is meant to encourage smaller companies to go public through a process where public company obligations would be phased in over time (hence the on-ramp reference). This legislation would amend the 1933 Act and 1934 Act to create a new category of issuer referred to as an “emerging growth company,” which is an issuer with total annual gross revenues of less than $1 billion, and would continue to have this status until (i) the last day of the fiscal year in which the issuer had $1 billion in annual gross revenues or more; (ii) the last day of the fiscal year following the fifth anniversary of the issuer’s initial public offerings; and (iii) the date when the issuer is deemed to be a “large accelerated filer” as defined by the SEC. The legislation provides for scaled regulation to be applied to the emerging growth company for up to five years following the IPO, including breaks on compliance with things like Section 404(b) of the Sarbanes-Oxley Act, mandatory Say-on-Pay, and the Dodd-Frank CEO pay ratio rules (to come). On the 1933 Act registration front, the legislation would permit greater pre-filing communications, allow for expanded research at the time of the IPO by offering participants, and would provide for pre-filing confidential review of draft registration statements by the SEC Staff.

Title II, Access to Capital for Job Creators. This portion of the legislation would remove the prohibition against general solicitation and general advertising in private offerings under Regulation D, provided that all of the purchasers of securities are accredited investors. Similarly, general solicitation and general advertising would not be prohibited in secondary sales so long as only QIBs are purchasers in the offering. In addition, the legislation would provide that offline and online forums bringing together companies and investors would not be treated as broker-dealers unless they receive transaction-based fees for their activities.

Title III, Entrepreneur Access to Capital. This part of the bill would provide an exemption for crowdfunding, by permitting offerings up to $1 million ($2 million in some cases), provided that investor contributions are limited to $10,000 or 10% of the investor’s annual income, whichever is less. Requirements targeted at investor protection are imposed on the issuer and/or the intermediary involved in the crowdfunding effort.

Title IV, Small Company Formation. This part of the legislation is what is commonly referred to as Regulation A reform, raising the limit for Regulation A offerings from $5 million to $50 million. Most importantly, the legislation would exempt Regulation A offering from state securities laws when the Regulation A securities are (i) offered or sold through a broker-dealer; (ii) offered or sold on a national securities exchange; or (iii) sold to a qualified purchaser as defined by the SEC.

Title V, Private Company Flexibility and Growth. This portion of H.R. 3606 increases the 1934 Act registration shareholder of record threshold from 500 to 2,000 (only 500 of which can be non-accredited investors). Employees receiving company securities under employee benefit plans would be excluded from calculating the number of record holders.

Title VI, Capital Expansion. This portion of the Act would increase the shareholder of record threshold from 500 to 2,000 for banks and bank holding companies, and would provide that a bank or bank holding company could terminate 1934 Act registration if the number of holders of record drops to less than 1,200.

Title VII, Outreach on Changes to the Law. This part of the Act requires SEC outreach to certain small and medium-sized businesses informing them of the effect of the law, so that these business are made fully aware of the benefits of the legislation.

What’s Next for These Legislative Efforts?

The Administration issued a statement supporting the JOBS Act. Meanwhile, Senate Majority Leader Harry Reid (D-NV) has said that the Senate will move forward with its own legislation, most likely consolidating a number of the companion bills that have been introduced in the Senate over the last year, and Senate Banking Committee Chairman Tim Johnson (D-SD) said his panel will hold a hearing tomorrow on the content of the legislative package. All reports are pointing toward quick action in the Senate, although at this point it is difficult to say if and when a bill that can be reconciled with the House bill will be passed.

Questions Remain About These Measures

Not everyone is wild about the approaches contemplated by these JOBS Act measures. Beyond the obvious question of whether, as the name implies, these securities law tweaks will actually have any impact at all on the employment market, some have raised concern with the investor protections that might be compromised by some of these legislative initiatives. For example, last week Lynn Turner testified before the Senate Banking Committee on the state of IPOs and capital formation in the US and noted: “The proposed legislation is a dangerous and risky experiment with the U.S. capital markets, and the savings of over 100 million Americans who depend on those markets. The evidence does not support the need for it. In fact, it contradicts it. I do not believe it will add jobs but may certainly result in investor losses. … As a result, I do not support the various bills including the IPO on ramp and crowd funding legislation.” Similar concerns have been expressed by groups such as the Council for Institutional Investors, Consumers Federation, Americans for Financial Reform, and AFL-CIO.

– Dave Lynn

March 9, 2012

Proxy Access: The Staff Weighs In on No-Action Requests

Yesterday, the Staff posted responses to a number of no-action requests relating to proxy access shareholder proposals. This sort of “batch” posting of letters related to one particular topic tends to happen with shareholder proposals that relate to difficult policy issues for the Staff, and in this inaugural year of proxy access private ordering, this has certainly been the biggest issue of the season thus far. The requests that the Staff answered deal with several different bases for exclusion, reflecting the different approaches taken by the proponents and the particular issues raised by the wording of their proposals. Here is a summary of how the Staff came out on these letters:

1. More than one proposal. In responses to Bank of America Corporation, The Goldman Sachs Group, Inc. and Textron, the Staff indicated that there appeared to be some basis that the companies could exclude the proxy access proposals under Rule 14a-8(c), which provides that a proponent may submit no more than one proposal. In particular, the Staff noted that several paragraphs of the proponents’ submissions contained a proposal relating to the inclusion of shareholder director nominations in the companies’ proxy materials, while one paragraph of the submissions included a proposal relating to events that would not be considered a change in control. The Staff concurred with the view that this paragraph constituted a separate and distinct matter from the proposal relating to the inclusion of shareholder nominations for director in the companies’ proxy materials.

2. Vague and indefinite. In responses to Chiquita Brands, Inc., MEMC Electronic Materials, Inc. and Sprint Nextel Corporation, the Staff indicated that there appeared to be some basis for the view that the companies could exclude the proxy access proposals under Rule 14a-8(i)(3) as vague and indefinite. The Staff particularly noted that the proposals provided that the companies’ proxy materials shall include the director nominees of shareholders who satisfy the “SEC Rule 14a-8(b) eligibility requirements,” without describing the specific eligibility requirements. The Staff viewed the specific eligibility requirements as representing a central aspect of the proposals, and that while some shareholders voting on the proposals may be familiar with the eligibility requirements of Rule 14a-8(b), many other shareholders may not be familiar with the requirements and would not be able to determine the requirements based on the language of the proposal. Based on this ambiguity, the Staff believed that neither shareholders nor the companies would be able to determine with any reasonable certainty exactly what actions or measures the proposals required.

3. Website Reference Cannot be Omitted Under 14-8(i)(3). In responses to The Charles Schwab Corporation, Wells Fargo & Company and The Western Union Company, the Staff indicated that it was unable to concur with the view that the companies could exclude a reference to the proponent’s website in the proposal under Rule 14a-8(i)(3), which permits the exclusion of a proposal or a portion of a proposal if it is materially false or misleading. The Staff particularly noted that the proponent had provided the companies with the information that would be included on the website, the companies had not asserted that the content to be included on the website was false or misleading, and the proponent represented that it intended to include the information on the referenced website when the companies filed their 2012 proxy materials. For these reasons, the Staff was unable to conclude that the companies demonstrated that the portion of the proposal was materially false or misleading and could be omitted.

4. One Proposal Not Excludable Based on a Substantially Implemented Argument. In a response to KSW, Inc., the Staff addressed a proposal seeking to amend the company’s bylaws to require that the company include in its proxy materials the name, along with certain other disclosures and statements, of any person nominated for election to the board by a shareholder or a group of shareholders who beneficially owned 2% or more of the company’s outstanding common stock and to allow shareholders to vote with respect to such nominee. The company had adopted a bylaw that allows a shareholder who has owned 5% or more of the company’s outstanding common stock to include a nomination for director in the company’s proxy materials. Given the differences between the shareholder proposal and the company’s bylaw, including the difference in ownership levels required for eligibility to include a shareholder-nominated director nominee in the company’s proxy statement, the Staff was unable to concur that the proposal could be omitted as substantially implement under Rule 14a-8(i)(10).

What’s Next for Proxy Access?

What can we glean from these responses on proxy access proposals? Probably not much in terms of what will happen with private ordering in seasons to come. As we noted in the January-February 2012 issue of The Corporate Counsel, this current crop of proxy access shareholder proposals demonstrates the principle that it is important to focus on the specific language of the proposal itself, which often paves the way for substantive bases for exclusion that might be available even without the company having to go out and take defensive measures like adopting some sort of proxy access regime. As is usually the case with the type of exclusions that we see here on a number of these proposals, the proponents will no doubt get smarter next year and try to correct the language which led to exclusion this year, so the landscape might be quite different in 2013. Over the next few months, we will see how these proposals go over with shareholders, which of course will be the real test of whether shareholders really want proxy access in the first place.

Webcast Transcript: “Transaction Insurance as a M&A Strategic Tool”

We have posted the transcript for our recent webcast: “Transaction Insurance as a M&A Strategic Tool.”

– Dave Lynn

March 8, 2012

Delaware Joins States Changing Escheat Laws: A Sleeper

With states hungry for money, many have changed their escheat laws to make it easier for them to grab dormant accounts. This has been widely covered in the mass media (egs. ABC’s Good Morning America; NPR’s All Things Considered; UK’s Tonight Show with Sir Trevor McDonald).

In our “Q&A Forum,” we recently got a question (#7007) stating: “It appears the State of Delaware is re-interpreting “period of dormancy.” We have discussed the new interpretation with Delaware and according to the Delaware State Escheator, “period of dormancy means the full and continuous period of time during which an owner has ceased, failed or neglected to exercise dominion of control over property or to assert a right of ownership or possession or to make presentment and demand for payment and satisfaction or to do any other act in relation to or concerning such property.” That is, the statue requires that accounts for which shareholders have not exercised dominion, control or any other act related to the account for three years be turned over to the State of Delaware. As a result of this reinterpretation, several thousand shareholder accounts not considered “lost” under rule 17Ad-17 have now been identified as eligible for escheatment if contact cannot be established with the holder. What is going on here?”

Since this is not my area of expertise, I turned to Bill Palmer – who knows this stuff cold – who answered:

Clearly the State of Delaware is attempting to cast the net out as broadly as possible with its new interpretation, but there are more than a few problems with it. The Unclaimed Property Law (UPL) statutes first purpose is to reunite lost and unknown owners with their unclaimed property, and the secondary purpose is to allow the states an opportunity to make use of the property while the primary purpose is accomplished. As a result, starting with the opening definitions, the statutes require that the individual shareholder or owner actually be “lost” and “unknown” to the financial institution or holder.

A review of the statutes will show that the definition includes the requirement that the shareholder is “lost/unknown” and that the specific dormancy period has run. There’s an important conjunction in the definition with the word “and,” so to the extent that the individual is part of a dividend reinvestment plan, an ESPP, a custodial trust, or any number of scenarios, then it is not reasonable to conclude that the individual is “lost” and “unknown” for purposes of escheating their stock or assets to the various states. Based on the short note below, there are potentially serious statutory and constitutional issues regarding Delaware’s new interpretation of escheat.

Another problem is created by the State of Delaware’s approach is in the area of corporate liability, because it places the holder and its transfer agent in a difficult position vis-à-vis their common law and statutory duties to the shareholders or owners. The corporation is acts under common law, federal and state securities laws that require it to operate with the utmost care regarding the shareholder, and to convey material information to the shareholder. This is the dilemma created by Delaware’s new definition, because “known” shareholders are about to have their stock transferred potentially without proper notice, where the investment will be sold and permanently destroyed so that the funds from the sale may be used by the state.

Mailed: January-February Issue of “The Corporate Counsel”

We mailed the January-February Issue of The Corporate Counsel and it includes pieces on:

– Mine Safety Disclosure Is Here–And The Forms They Are A-Changin’
– New Four-Month Deadline for Form 20-F
– Staff Weighs In on Say-on-Pay Wording on the Proxy Card/Voting Instruction Form
– Proxy Summaries
– Proxy Access Private Ordering (Barely) Up and Running
– NYSE About-Face on Shareholder-Friendly Governance Proposals
– The Staff’s Waiver Position on Item 5.07 8-K/A Evolves
– Global Section 12(g) No-Action Relief for RSUs
– Trading in Securities of Pre-Public/Private Companies
– Loss Contingency Disclosures–Latest Input from the Staff
– The Staff Clarifies New Standards for Confidential IPO Filings for Foreign Private Issuers

Act Now: Get this issue for free when you try a 2012 No-Risk Trial today.

SEC Brings Increasingly Rare Financial Fraud Case

In his “Cady Bar the Door” blog, David Smyth of Brooks Pierce has been doing an excellent job and I’ve been learning a lot about SEC enforcement issues from reading his missives. Here’s a recent one below:

A curious aspect of the SEC’s enforcement program in recent years has been the lack of significant accounting fraud cases. The Enforcement Division has created a number of specialized units, including ones studying structured products and hedge funds, but dismantled its financial fraud task force in 2010, reasoning that accounting fraud was the specialty of the entire staff, and not just one group. Perhaps as a result of that, or maybe as a result of Sarbanes-Oxley or other reasons, accounting fraud cases just have not been brought in the numbers they were in years past.

But the SEC filed an interesting case last month in the Southern District of Florida, one that combines traditional accounting fraud with the problems underlying the most recent credit crisis. The Miami Regional Office sued BankAtlantic Bancorp and its CEO, Alan Levan, for making misrepresentations about the bank’s loan portfolio and then using accounting tricks to conceal the misstatements. The case is not settled, so the facts that follow are unproven, and may not actually be true.

Disclosure Issues

In 2007, BankAtlantic had about $1.5 billion in its commercial residential real estate loan portfolio. The borrowers intended to develop large tracts of land for residential housing construction, and the portfolio included three types of loans: (1) Builder Land Bank loans, in which the borrowers’ sole intent was to “flip” the raw land to a national builder at a later date. The bank usually required the borrower in one of these BLB loans to have option contracts in place in which the builder agreed to give a down payment and close on a minimum number of lots by a specific date; (2) Land Acquisition and Development (LAD) Loans, in which the borrower bought land and conducted “horizontal development” such as building utilities and roads; and (3) Land Acquisition, Development, and Construction (LADC) loans, which were the same as LAD loans, but also included financing for “vertical development,” or houses, as well.

Signs of problems in BankAtlantic’s commercial residential portfolio began to appear in early 2006. Builders were starting to walk away from their option contracts with BLB borrowers at other banks, and BankAtlantic started to scrutinize its own portfolio more closely. By the time BankAtlantic filed its first quarter 10-Q, the bank had granted extensions on eleven loans constituting a book value of $147 million, or 26% of the commercial residential portfolio. For most of these extensions sales had slowed or stopped, and borrowers were having to resort to entirely different development plans to salvage their projects. While these problems were affecting all three types of loans in the bank’s commercial residential book, Levan didn’t say as much publicly. In the bank’s first quarter earnings call, Levan discussed the BLB segment and acknowledged that some problems were developing with the underlying projects. But when asked by an analyst whether the problems extended to the LAD and LADC loans, Levan said no, that those loans were “proceeding in the normal course” and the bank was experiencing no significant problems with them. The bank’s 10-Q for that quarter discussed the commercial residential portfolio in board terms, but did not alert investors to the problems already existing at that time.

BankAtlantic’s loans continued to be downgraded in the second quarter, and the value of the downgraded loans was nearly an even split between BLB and non-BLB loans. The second quarter earnings call continued the pattern from the first, as an analyst again asked if the bank was concerned about the non-BLB loans. Levan said again that the BLB side was the only one forecasting any problems. The 10-Q for that quarter also made no mention of any problems with the LAD and LADC loans, though those loans were having significant problems as well. BankAtlantic eventually released the extent of the bank’s loan difficulties with an 8-K filed on October 26, 2007, that announced a $29 million loss due to the commercial residential loan portfolio. On the third quarter earnings call, Levan said the earnings release would have been very different if it had been done on September 30, 2007, suggesting that the problems were a surprise that came about after quarter-end.

Accounting Issues

This wasn’t the end of BankAtlantic’s problems, though. In the fourth quarter of 2007, the bank began efforts to sell many of its problem loans, and even engaged an investment bank, JMP Securities, in the effort. Unfortunately for the bank, the AICPA’s Statement of Position 01-6 says that once a decision has been made to sell loans not previously classified as “held for sale,” those loans should be transferred to the “held for sale” classification and carried on the books at the lower of cost or fair value. But that is not what BankAtlantic did. Instead, the bank changed its contract with JMP Securities to refer to the sales efforts as a “market test.” At the end of 2007, the bank continued to record as held for investment the loans subject to the JMP engagement. The bank also represented to its auditor that “management had the intent and ability to hold loans classified as held-for-investment for the foreseeable future or until maturity or payoff.” Meanwhile, JMP’s efforts – to “sell” the loans or “test market” them or whatever – continued apace, and eventually some bids for the loans came in, all at 28-50% of book value.

BankAtlantic didn’t like the bids enough to sell, but also did not like having the loans on the bank’s books. So it made a deal to give an inactive subsidiary $100 million, which the subsidiary then gave back to the bank in exchange for the problem loans. For the bank, it was a perfect deal, in that it released the loans from BankAtlantic’s books, and at the same time gave the bank an quick infusion of cash. JMP valued the loans for purposes of this transaction based on appraisals, and ignored the bids that came in at 28-50% of their book value. BankAtlantic continued to try to sell these loans, and even reached agreements to sell some of them, but never reclassified any of the loans as “held for sale.”

The SEC has sued BankAtlantic for violations of Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act, and Levan for aiding and abetting all of those violations. The Commission has also sued Levan for direct violations of Section 13(b)(5) of the Exchange Act.

Lessons from the Case

One thing we can learn from the matter is that accounting fraud is alive and well, and the SEC is still pursuing it. Also, publicly traded banks in particular should take note that the contents of their portfolios have to be characterized accurately, both in public statements to investors and with respect to accounting conventions established by the AICPA. If particular loans are being shopped to other buyers, you have to say as much, or you’re out of compliance with GAAP, and are breaking the accounting rules. Finally, the public misstatements did not go on for a terribly long time. It was only two quarters before BankAtlantic owned up (sort of) to the problems on its books. But that was enough. The case is being litigated; it will be interesting to see what happens as it proceeds.

– Broc Romanek

March 7, 2012

SEC Asks for 19% Budget Boost

As noted in this Reuters article, SEC Chair Schapiro testified before the House Financial Services Committee over the SEC’s budget yesterday. The Chair seeks a 18.5% boost from its current fiscal 2012 budget to $1.56 billion to hire more Staff – 46 more Corp Fin Staffers – and implement multi-year technology initiatives including modernizing Edgar. Did you know the SEC’s site gets roughly 20 million hits daily?

As seems to happen over the past decade, the SEC faces an uphill climb for more resources, particularly with recent press like this Reuters piece over how much Booz Allen and other consultants have been charging the SEC to reform its workflows, etc.

As I’ve blogged, the SEC would be freed from this annual dog-and-pony show with Congress if it were self-funded as an independent agency should be. Here is a blog entitled “Free the SEC” from another SEC alumni, accountant John Feeney.

Shareholder Proposals: Corp Fin Rules on Proof of Ownership for DTC Participants

Yesterday, Ning Chiu of Davis Polk wrote this blog:

The SEC Staff made several recent decisions on questions of proof of ownership for submission of shareholder proposals, in light of the requirement under Staff Legal Bulletin 14F, which we previously discussed. SLB 14F makes clear that only DTC participants are viewed as record holders of securities that are deposited at DTC.

The Staff declined to grant no-action relief to companies that argued that the proof of ownership was not from a DTC participant when the brokers’ letters were from TD Ameritrade, Inc. instead of TD Ameritrade Clearing, the entity named on the DTC participant list. The proponents in some of these situations provided an additional letter of support from TD Ameritrade in response to the company’s no-action letter request, but the SEC Staff gave the same ruling even when proponents did not. The Staff noted that the proof of ownership from TD Ameritrade, Inc. was sufficient since it was provided by a broker that provides proof of ownership statements of behalf of affiliated DTC participants.

But even when the Staff agreed with Allergen that the proponent, John Chevedden, failed to provide a statement from the record holder evidencing appropriate documentary support of continuous beneficial ownership, the Staff gave Mr. Chevedden seven additional days to address the deficiency. Mr. Chevedden had provided proof of ownership only from Ram Trust and not the DTC participant. The Staff indicated in its response that the company failed to informed the proponent of what would constitute appropriate documentation in its request for additional information from the proponent, and noted SLB 14F states that they will grant no-action relief to a company on the basis that a proponent’s proof of ownership is not from a DTC participant only if the company’s deficiency letter describes the required proof. It appears from the filed correspondence that while the company clearly pointed out the problem to Mr. Chevedden in its notice, only a copy of Rule 14a-8, and not a copy of SLB 14F, was included with the letter. The Staff denied the company’s request to reconsider its decision.

Improving the Board Evaluation Process

In this podcast, Susan Shultz of the Board Institute describes how the Board Institute’s methodology improves the board evaluation process, including:

– What is the Board Institute’s methodology for board evaluations?
– What is the advantage of this over traditional evaluation techniques?
– How do evaluations that tend to be narrative and somewhat subjective work with numerical scales?
– How can boards best use this type of methodology?

– Broc Romanek

March 6, 2012

The Going In-House Handbook

In this podcast, multi-talented Susan Wolf describes her vast experience on being an in-house lawyer and corporate secretary (as explained in detail in her new book: “The Going In-House Handbook: A Concise Guide to Making Big Career Changes“), including:

– Why did you decide to write the book?
– What are the most important practical points you make?
– Any surprises while writing it?
– How do you suggest that readers use it?

SEC Warning: Beware the Fake Whistleblower Office

Recently, the SEC posted this warning about someone is impersonating its new Office of the Whistleblower by sending out bogus emails claiming that the recipient has a material misstatement or omission in their public filings or financials. It seems like such a bizarre and narrow topic to attempt to pull a hoax that you would think the bogus email would be sophisticated – but there are just enough oddities in it that I doubt the perpetrator comes from our industry. Here are what the emails said:

Dear customer, Securities and Exchange Commission Whistleblower office has received an anonymous tip on alleged misconduct at your company, including Material misstatement or omission in a company’s public filings or financial statements, or a failure to file Municipal securities transactions or public pension plans, involving such financial products as private equity funds. Failure to provide a response to this complaint within 14 day period will result in Securities and Exchange Commission investigation against your company. You can access the complaint details in U.S. Securities and Exchange Commission Tips, Complaints, and Referrals portal under the following link:

SEC Posts Whistleblower List (Means Little)

In his “Cady Bar the Door” blog, David Smyth of BrooksPierce provides an explanation of why the SEC’s Office of the Whistleblower is constantly updating its list of “potential whistleblower” candidates.

– Broc Romanek

March 5, 2012

Survey: HSR & Executives’ Acquisitions from Equity Compensation Plans

Recently, as noted in this Sullivan & Cromwell memo (other memos are posted in the “Antitrust” Practice Area), the DOJ and FTC extracted their first publicized penalty for a corporate executive’s failure to make a Hart-Scott-Rodino Act filing before receiving stock of his employer as part of his compensation. As a result, many members have been researching what the typical practice is for HSR filing fees that the corporate executive would have to pay to comply with the HSR filing requirement. To help in that effort, please take a few moments to participate in this anonymous “Quick Survey on HSR & Executives’ Acquisitions from Equity Compensation Plans.

Greed is Not Good? Michael Douglas Rails Against Insider Trading

As noted in this NY Daily News article, Michael Douglas – aka Gordon Gecko from the “Wall Street” movies – is featured in a recent one-minute FBI commercial warning about the perils of insider trading.

The StockTwits CEO Explains His Social Media Platform

Recently, I blogged about how StockTwits was a game-changer for investors in the social media world. In this podcast, co-founder and CEO Howard Lindzon explains how to best use his StockTwits, including:

– What is StockTwits?
– When was StockTwits born and what is its growth rate?
– How can companies claim their “ticker page” – and why would they want to do so?
– Why should companies monitor what is being said about them on StockTwits?

– Broc Romanek