July 2010
Authors: Irwin A. Kishner, Edward B. Stevenson
The Herrick Advantage
Herrick will host our Fourth Annual Capital Markets Symposium on September 16. A distinguished panel of financial and legal experts will speak on the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, including regulation of systemic risk; expanded regulation of private investment fund managers; reforms for the asset-backed securitization market; and regulation of swap markets. Stay tuned for further details.
Supreme Court Limits Application of Federal Securities Laws Abroad
The Supreme Court has issued a landmark ruling that sharply limits the extraterritorial application of the U.S. securities laws. The court specifically addressed whether Section 10(b) of the Securities Exchange Act of 1934 applies to private "foreign-cubed" lawsuits. A "foreign-cubed" securities claim involves foreign purchasers of securities that bring a claim against foreign issuers for violations of U.S. securities laws with regard to securities traded on foreign stock exchanges.
Australian plaintiffs sued National Australia Bank for NAB's alleged misstatements made in the U.S. relating to NAB's mortgage lending subsidiary. For decades, federal courts had subjected claims to U.S. jurisdiction where wrongful conduct occurred in the U.S. or wrongful conduct had a substantial effect in the U.S. or on U.S. citizens. But the court reversed that precedent, finding that the "conduct" and "effects" tests were not the appropriate standards by which to assess jurisdiction of foreign-cubed claims.
The court held that pursuant to a "longstanding principle of American law," a U.S. court should not apply a U.S. statute extraterritorially where that statute provides no "affirmative indication" that it should have that effect. The court found that Section 10(b) of the Exchange Act "contains nothing to suggest it applies abroad." The court's decision will effectively bar private foreign-cubed cases in the
The impact of
Morrison v. National Australia Bank Ltd., U.S., No. 08-1191
Supreme Court Rules PCAOB Constitutional
The Supreme Court has held that the Public Company Accounting Oversight Board is constitutional, while striking down certain provisions of the Sarbanes-Oxley Act relating to the removal of PCAOB members. After the accounting debacles of Enron and WorldCom, Congress established the PCAOB to inspect and monitor accounting firms. Every accounting firm that audits public companies under the securities laws must register with the PCAOB and comply with its rules and oversight.
The petitioner, Free Enterprise Fund, argued that the PCAOB's broad powers were unconstitutional, in part, because its board was illegally constituted and its officers were not lawfully appointed under the Appointments Clause of the Constitution. They alleged that its members must be appointed by the President with the advice and consent of the Senate, which was not the case. The court, however, found the PCAOB constitutional despite its board's appointment process, but that its provisions addressing board member dismissal violated the Constitution's separation of powers. Under SOX, only the SEC can remove PCAOB members, and then only under limited circumstances. The effect of these provisions, according to the Court, was to double-insulate the board members from Executive Branch control, as the SEC could only remove them for good cause, and the President's power to remove SEC Commissioners is, similarly, limited to good cause. The court noted that "[t]he result is a Board that is not accountable to the President, and a President who is not responsible for the Board." The ruling reinforces the scope of executive control over financial regulatory agencies and authorities.
Free Enterprise Fund et al. v. Public Company Accounting Oversight Board et al.
SEC Issues Concept Release on the U.S. Proxy Statement
The SEC has issued a concept release on proxy reform and proxy mechanics to solicit public comment on whether it should update its proxy rules "to promote greater efficiency and transparency in the U.S. proxy system and enhance the accuracy and integrity of the shareholder vote."
The SEC noted that proxies are often the principal means for shareholders and public companies to communicate with each other, and for shareholders to weigh in on issues of importance. The concept release, available at www.sec.gov/rules/concept/2010/34-62495.pdf, covers topics on shareholder communication and proxy voting, including: (i) the potential conflicts of proxy advisory firms; (ii) issuer communications with shareholders; (iii) means to facilitate retail investor participation—including through advance voting instructions (commonly referred to as "client-directed voting"); (iv) over-voting and under-voting; (v) proxy distribution fees; and (vi) empty voting.
Although the concept release does not contain actual rule proposals, it does offer insight into the SEC's areas of concern and potential regulatory responses.
More information on the concept release is available at www.sec.gov/news/speech/2010/spch071410klc.htm
NASDAQ Clarifies Noncompliance Reporting Rules and Proposes Additional Amendments
NASDAQ has amended its corporate governance rules to require listed companies to promptly notify NASDAQ after an executive officer becomes aware of noncompliance with NASDAQ's corporate governance rules. Previously, the rules required notification of "material" noncompliance; however, NASDAQ stated that it has always considered anyinstance of noncompliance to be material, and this amendment is simply a clarification. The New York Stock Exchange recently made an identical change to its rules. In light of this, NYSE- and NASDAQ-listed companies should review their internal reporting procedures to monitor compliance and to ensure that all executive officers, including any person who performs a policy-making function for the company, report any noncompliance.
NASDAQ has also filed a proposal with the SEC to change its corporate governance rules and to replace its disclosure requirements with references to Regulation S-K, which sets out disclosure requirements for public companies' quarterly and annual reports. Another NASDAQ proposal would require companies to disclose their use of exceptions to audit committee independence requirements. Other recent NASDAQ proposals allow companies to make disclosures on their websites rather than through filings with the SEC. They also address company reliance on exceptions to NASDAQ's director independence rules and code of ethics waivers if the website disclosures comply with Form 8-K requirements.
NY Court of Appeals Confirms Lenders Can Rely on Borrower Representations in Loan Agreements
The New York State Court of Appeals held that lenders may rely on borrower representations and warranties and that they have no affirmative duty to conduct independent investigations of their borrowers' books and records. The case examined whether, under New York law, a lender's reliance
The lenders made a $40 million loan to American Remanufacturers Holdings, Inc. (ARI). While negotiating the terms of the loan, ARI provided DDJ Management, LLC, which acted as agent for the lenders, its unaudited financial statements, which the lenders alleged were drafted to intentionally contain false and misleading financial information. The loan documentation contained standard borrower representations and warranties, including that there were no material adverse changes, that the financial statements presented its financial position accurately and in accordance with GAAP, and that the loan agreement and financial statements contained no false statements or omission of material facts. Within eight months of closing the loan, ARI declared bankruptcy and the lenders sued ARI for fraud, alleging that ARI's representations were false and materially misleading. ARI countered that because the lenders did not conduct sufficient due diligence, they should be precluded from reasonably relying on its financial statements and books and records, and that the representations and warranties did not provide them an avenue for redress. The lower court agreed with ARI and dismissed the fraud claim.
The Court of Appeals, however, found that the lenders "made a significant effort to protect themselves against the possibility of false financial statements" by requiring the borrower to make specific representations regarding the financial statements, including that nothing in the financial statements was materially misleading and that the financial statements were prepared in accordance with GAAP. The court noted that "where a plaintiff has gone to the trouble to insist on a written representation that certain facts are true, it will often be justified in accepting that representation rather than making its own inquiry."
The lenders were joined by the Loan Syndicate and Trading Association, the Commercial Finance Association and The Clearing House Association L.L.C., which filed an amicus brief with the court, arguing that the lower court's ruling would cause "serious disruption to the vast amount of commercial lending that occurs in or is governed by the law of New York."
DDJ Management, LLC, et al. v. Rhone Group L.L.C., et al
For more information on these issues or other corporate matters, please contact:
NY Irwin Kishner at (212) 592-1435 or ikishner@herrick.com
NJ Edward Stevenson at (973) 274-2025 or estevenson@herrick.com
Copyright © 2010 Herrick, Feinstein LLP. Corporate Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.
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