Loss Causation in Class Certifications
In a recent decision authored by Chief Justice John G. Roberts, Jr., the Supreme Court unanimously held that loss causation was not essential for class certification in a securities fraud action. Following this decision, investors need not prove that their investment losses were caused by corporate misstatements in order to certify a class.
In Erica P. John Fund, Inc. v. Halliburton Co., investors brought a putative securities fraud class action against Halliburton, alleging misrepresentations designed to inflate the company's stock price in violation of Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5. The investors sought to invoke the "fraud-on-the-market" theory, which presumes that reliance is present whenever an investor buys or sells market-priced stocks in the face of public misstatements.
The Fifth Circuit ruled, in accordance with its precedent, that in order to show that common questions of law or fact predominate pursuant to Federal Rule of Civil Procedure 23 the plaintiffs must demonstrate that the alleged fraud caused the drop in stock price. The U.S. Supreme Court rejected this approach, making clear that the investors need only demonstrate that public misstatements led to the stock purchase transactions, not its losses.
The U.S. Supreme Court's ruling resolves a split between the circuits on this issue by bringing the Fifth Circuit into line with the majority position, which rejects loss causation as an element of class certification. Looking forward, plaintiffs seeking class certification in the Fifth Circuit will no longer need to show loss causation at that early stage. As has been the case in other circuits, class certification in securities fraud actions will continue to focus on questions of reliance.
SEC Guidance on Security-Based Swaps
On June 15, 2011, the SEC confirmed its efforts to preserve the pre-Dodd-Frank Act legal framework with respect to security-based swaps until further rulemaking is complete. In an official release, the SEC announced that it had "provided guidance as to which of the Title VII requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act will apply to security-based swap transactions as of July 16, the effective date of Title VII…and granted temporary relief to market participants from compliance with certain of these requirements."
Title VII of the Dodd-Frank Act establishes a comprehensive framework for regulating over-the-counter derivatives and authorizes the SEC to regulate "security-based swaps." The new regulatory regime for security-based swaps, addressed in Subtitle B of Title VII, generally will take effect on July 16, 2011 (360 days after the date of the Dodd-Frank Act's enactment). Also effective July 16, 2011, under the Dodd-Frank Act security-based swaps would be included in the definition of "security" under the Exchange Act. Market participants have been awaiting additional guidance on rules governing security-based swaps in advance of the July 16 effective date.
In the release, the SEC states that "the guidance issued today makes clear that substantially all of Title VII's requirements applicable to security-based swaps will not go into effect on July 16.
The Commission's action also grants temporary relief from compliance with most of the new Exchange Act requirements that would otherwise apply on July 16, but confirms that Exchange Act provisions addressing fraud and manipulation will be effective as to security-based swaps. The SEC goes further to grant "temporary relief from Section 29(b) of the Exchange Act, which generally provides that contracts made in violation of any provision of the Exchange Act shall be void as to the rights of any person who is in violation of the provision" in an effort to create a more certain legal environment for market participants.
For more detailed information regarding which of the Title VII requirements will be effective as of July 16, see the SEC's exemptive order.
Corporate Policy Implications of Say-On-Pay
According to a survey of attorneys conducted by Law360, there is evidence that the "say-on-pay" provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act are a more effective means for shareholders to scrutinize executive compensation than people had expected. Some commentators believe that these provisions will lead to the executive pay packages of companies receiving a shareholder "no" vote being increasingly challenged in court, as well as these companies' board members being removed more quickly by the shareholders if the board members ignore shareholder disapproval of executive compensation.
The "say-on-pay" provisions under the Dodd-Frank Act require publicly traded U.S. companies to hold nonbinding shareholder votes on executive compensation. These provisions went into effect in January, 2011 and mandate that such companies put their pay packages and "golden parachute" provisions up for shareholder vote at least once every three years. Additionally, the provisions require a "say-on-frequency" vote at least once every six years in which shareholders vote on how often they want to vote on executive pay packages. Although the votes are only advisory in nature (though there is still some ambiguity surrounding whether the results of the "say-on-frequency" vote would be binding), they are proving to be a compelling symbol of shareholder discontent at some companies.
Recently, several companies have been forced into court over pay packages receiving shareholder disapproval, and proxy advisory services have threatened to support the replacement of boards that approve pay practices disapproved by the shareholders. As of June 24, 2011, 36 companies have lost their shareholder "say-on-pay vote," with their shareholders voting against their executive compensation packages. Six of those companies have faced shareholder derivative suits in which the plaintiffs contest increasing executive compensation in the face of weakening corporate financial performance. Specifically, each lawsuit generally claims that the directors of each defendant company breached their fiduciary duties in approving an increase in executive compensation out of line with each company's disclosed pay-for-performance policy, which was an invalid exercise of the directors' business judgment.
Many attorneys believe that the plaintiffs in such lawsuits have a very remote chance of success for at least two reasons. First, the nonbinding natures of the shareholder votes means that companies do not have to follow the results of these votes. Second, the plaintiffs in such cases must overcome the presumption of business judgment rule, which shields directors and officers of a company from liability if they "acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). Because of the high bar that must be reached to prove such actions, shareholder suits are likely to be no more than an expensive nuisance for the companies affected.
A more long-term concern for companies is the potential that shareholders will vote to remove directors that approve the compensation packages voted down by shareholders. This could have a greater impact on board members who are also members of the compensation committee. Institutional Shareholder Services Inc., the largest proxy advisory firm, has warned that it will oppose the re-election of board members who approve pay packages that are voted down by shareholders as part of its benchmark voting policy in the United States. As most companies are aware, ISS can be very influential on shareholder voting, especially by institutional shareholders who typically rely on ISS recommendations when deciding how to vote.
Ninth Circuit Ruling on SOX Whistleblower Provisions Could Have Stifling Effect
The Ninth Circuit's recent decision holding that the whistleblower provisions of the Sarbanes-Oxley Act of 2002 ("SOX") do not protect employees who release information to the media could cause employees to hesitate in disclosing information. The decision could also be used as precedent to persuade other courts to read the statute narrowly in other contexts, thereby stripping potential whistleblowers of certain protections in other areas.
On May 3, 2011, the Ninth Circuit ruled in Tides v. The Boeing Co., Case No. 10-35238 (9th Cir. May 3, 2011) that SOX prohibits public companies from retaliating against employees who disclose evidence of fraud to only three entities (federal regulatory or law enforcement agencies, Congress or workplace supervisors), which are "specifically enumerated" in the statute. The Court reasoned that if Congress had intended to protect employee reports to the media, it would have added the media as one of the entities to which protected reports may be made or it could have, like in the language of the Whistleblower Protection Act that covers federal employees, protected "any disclosure" of specified information without limiting the recipients of such information.
The plaintiffs, two auditors at Boeing Co. who tested the company's information technology controls as part of a SOX compliance program, had disclosed internal documents to a Seattle Post-Intelligencer reporter who ran an investigative report about the security of Boeing's computer systems. The plaintiffs claimed that they believed their disclosures were protected under the National Labor Relations Act, which allows employees to discuss working conditions, and also alleged accounting deficiencies at the company. According to Boeing, the employees were fired for violating its policy prohibiting the release of information to the media without approval from its corporate communications department.
Although whistleblower cases involving media leaks are relatively rare, the Ninth Circuit's reading of Section 806 of SOX appears to adhere so closely to the statutory language that the ruling could impact cases involving disclosures in other contexts, such as those made to spouses, during a picketing campaign or to state authorities. But arguably the decision is consistent with the intent of SOX to limit protected activity to employees who raise concerns of fraud or violations of the securities laws to those authorized to act on the information. Under that line of reasoning, allowing employees to release information to reporters or other sources and simultaneously preventing employers from taking any disciplinary action would defeat the purpose of the legislation and allow possibly inaccurate allegations to reach the public.
Contributors to this issue are Robin Preussel, Nina Skinner and Mara Rogers.