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TheSummer 2015Advocate

F O R I N S T I T U T I O N A L I N V E S T O R S

Face-Off in the BoardroomActivist Investors Demand a Seat at the Table

In Newman, SecondCircuit NarrowsDefinition of InsiderTrading

Forging Ahead onMultiple Fronts:SEC Pursues NewInitiatives

In Omnicare, theSupreme Court Considers OpinionVersus Fact in IPOs

FOR INSTITUTIONAL INVESTORS

2 Bernstein Litowitz Berger & Grossmann LLP www.blbglaw.com

Summer 2015

Features

3 Inside Look

16 Eye on the Issues

32 Contact Us

Departments

The Resurgenceof the Activist Investor

Investors IncreasinglyFight for Change in the BoardroomBy John Vielandi

4

In Memoriam

Harvey Goldschmid

Remembering theBeloved Professor and Dedicated PublicServant

9Update on Fee-Shifting Bylaws

Will This Threat to Investor Rights TakeRoot?By Edward Timlin

10

Sharing, WallStreet Style

Second Circuit NarrowsDefinition of InsiderTradingBy Catherine McCaw

12Forging Ahead onMultiple Frontsat the SEC

Amid Fractured Leadership, the AgencyPursues New InitiativesBy Abe Alexander

20

A Matter of Opinion?

The Supreme Court’s Decision in Omnicare Makes it Harder to Mask Misrepresentations asOpinion Statements in IPOs

By David Kaplan

26

As part of BLB&G’s firmwide Going

Green Initiative, this publication

has been printed on recycled paper.

If you would prefer to receive The

Advocate for Institutional Investors

as an electronic PDF file instead of a

printed copy, please contact us at

[email protected].

GOING GREEN

Contents

Summer 2015 The Advocate for Institutional Investors 3

Inside Look

T he financial media is awash with analysis and coverage of shareholder activism, one of the leading

issues of the day. The relationship between shareholders and management can raise many complicated

issues, yet shareholders remain a critical check on corporate overreach, and an important voice in

ensuring sound corporate governance. In this issue’s cover story, BLB&G Associate John Vielandi examines the

recent increase of shareholder activism by institutional investors, and how it is impacting the way corporations

do business in “The Resurgence of the Activist Investor.”

In “Dispatches from the Battlefield: Will Fee-Shifting Bylaws Keep Shareholders from the Courthouse?” BLB&G

Associate Ed Timlin provides an update on the latest developments surrounding fee-shifting bylaws, including

widespread calls to ban them.

Former BLB&G Associate Catherine McCaw discusses the recent controversial appellate ruling in the high-profile

insider trading case United States v. Newman in “Sharing, Wall Street Style: The Second Circuit Narrows

Definition of Insider Trading.” Ms. McCaw outlines how the Second Circuit’s narrow ruling overturned the insider

trading convictions of two traders, how the decision has potentially made it more difficult for future insider

trading prosecutions, and offers possible solutions to ensure an effective insider trading regime in light of

modern realities on the Street.

BLB&G Associate Abe Alexander’s “Forging Ahead on Multiple Fronts” provides an overview of the SEC’s efforts

to expand its enforcement regime and infrastructure, and considers hard questions from critics and threatening

legal challenges.

In “A Matter of Opinion?” BLB&G Associate and Co-Editor of The Advocate David Kaplan analyzes the Supreme

Court’s recent decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund. A

victory for shareholders, Omnicare encourages better disclosure and clarifies a robust standard of liability for

companies who include false or misleading “opinions” in their public offering documents.

In our regular “Eye on the Issues” column, BLB&G Associate Ross Shikowitz highlights the most significant

recent developments in domestic and international securities litigation and regulations that affect institutional

investors.

Finally, we pay tribute to Columbia Law School professor and former SEC Commissioner Harvey J. Goldschmid,

who passed away this past February at the age of 74. Professor Goldschmid, renowned for his work and

expertise in corporate governance, leaves behind a great legacy as an advocate and public servant, a teacher,

and a loving husband and father.

Please note that we always make the current issue of The Advocate (as well as all past issues) available on our

website at www.blbglaw.com. We are very pleased to be the new editors of The Advocate, and our sincere

thanks go out to our predecessors.

The Editors, David Kaplan and Katherine Stefanou

Activist shareholders are increasingly demandinga seat in the boardroom

and a say in corporategovernance issues.

Shareholders do not have any direct

control over a company’s day-to-day

operations. Instead, shareholders

enjoy three core rights: the right to sell, the

right to sue, and the right to vote. Electing

directors to manage and oversee the

company, and voting on other important

matters, are critical to ensure the proper

stewardship of shareholder investments.

Pension funds and other institutional

investors have historically been passive

shareholders, voting their shares each

year in accordance with a board’s recom-

mendation. However, in recent years,

there has been a sharp rise in shareholder

activism by the institutional investor

community. According to Hedge Fund

Research, activist institutions now have

approximately $120 billion in assets

under management, a more than five-fold

increase over the last decade. Modern

shareholder activists typically encourage

corporate boards to take certain actions

to improve the value of the company, im-

prove its governance, or further the social

good. These suggestions are designed

so that all corporate shareholders will

benefit through an increased stock price.

Modern activists typically take relatively

modest positions in corporations and will

only profit if the value of the entire com-

pany increases or if the entire company

is sold to a third party at a premium. This

is a stark contrast to the notorious corpo-

rate raiders of the 1980s, who employed

coercive tactics to acquire an entire



The Resurgenceof theActivistInvestor

Investors are Challenging Entrenched Corporate Boards — and Winning

By John Vielandi

Activist investors willoften advise a target

company’s board that if it does not take prompt

action to address the activist’s concerns, it willlaunch a proxy contest toreplace some or all of the

resisting board.

company and profit, to the exclusion of

other shareholders, often by tearing the

company apart.

Over the last five to ten years, activist

investing has become widespread and

mainstream. According to The Economist,

since 2009, 15 percent of the members of

the S&P 500 index have been the target

of known activist campaigns and 50 per-

cent have had known activists invested in

their stock. According to Activist Insight,

in 2014, 344 corporations were known to

be targeted by activists. This was up 18

percent from the 291 companies targeted

in 2013 and over double the average

number of proxy solicitation campaigns a

decade ago. Moreover, roughly two-thirds

of activist campaigns never become pub-

lic, so the true level of activism is unknown.

These numbers reflect an enormous in-

crease in activist investing over the last

ten years that continues to trend upward.

The most common activist complaint

takes the form of either a private or public

letter to a corporation’s board of directors

in which the activist will list a variety of

reasons why it believes the company’s

stock is undervalued and offer its sugges-

tions to improve the company’s operations.

The looming threat behind all modern

activist demands is that the activist will

attempt to replace some or all of the

directors through a proxy contest if the

board refuses to take the recommended

action. However, most activists will only

take such drastic action if a company’s

incumbent board ignores their sugges-

tions and fails to create value for all share-

holders. Incumbent boards are typically

only in danger of an activist campaign if

they deny shareholders a voice in the

direction of the company.

In recent years, activists have also taken

an increased interest in more specific

areas of corporate governance and have

developed novel approaches to effectu-

ate their goals. This includes attempts to

unseat an entire board of directors in one

election, an increased focus on the corpo-

rate governance structures at corporate

spinoffs, and widespread proxy access

proposals.

Typically, when an activist runs a proxy

contest, it is only trying to replace a

minority of the company’s directors.

Occasionally, an activist will run a major-

ity slate of candidates. However, it is un-

usual for an activist to attempt to replace

a company’s entire board of directors and

it is extremely difficult to succeed at

doing so. Nonetheless, in 2014, Starboard

Value, an activist hedge fund, succeeded

in replacing the entire board of directors

of Darden Restaurants. Starboard’s suc-

cess can be attributed to the complete

and utter indifference the Darden board

showed to its shareholders and their

voting rights.

In December 2013, Darden announced

that it would separate and sell its Red

Lobster operations in a transaction that

would be completed before the company’s

next annual meeting. This was vocally

opposed by several large shareholders,

who demanded that the shareholders be

given an opportunity to vote on such a

transformative transaction. The board

refused. When Starboard announced its

intention to call a special meeting so

shareholders could express their views,

the board amended Darden’s bylaws to

make it much more difficult for share-

holders to exercise their core voting

rights. The Board then sold Red Lobster





before a shareholder vote could be held.

In response, Starboard ran a proxy con-

test to unseat the entire Darden board.

Darden’s shareholders believed the in-

cumbent board was not acting in their

interests and supported Starboard’s

nominees by a three-to-one margin, thus

replacing the entire board in one election.

Activist investors have also recently

focused on corporate spinoffs. While ac-

tivists routinely propose that a company

spin off a business unit in the expectation

that the resulting two companies will

have a higher combined stock price than

the pre-spinoff company, activists have

become increasingly concerned with the

newly spun-off company’s corporate gov-

ernance structures. They want to ensure

that the new boards of spinoffs will be re-

sponsive to shareholder concerns. In par-

ticular, famed activist investor Carl Icahn

has targeted eBay, Gannett, and the Man-

itowoc Company, arguing that all three

should spin off certain business units and

that those units spun-off should be estab-

lished with extremely shareholder-friendly

corporate governance provisions. Icahn

settled his dispute with Manitowoc in

February 2015, when the board agreed to

spin off its food services business and

appoint a designee of Icahn to both its

board and the spinoff board. The Mani-

towoc board also agreed to ensure that

the spinoff has shareholder-friendly cor-

porate governance by agreeing that,

among other things: (1) any poison pill

provision will not have a trigger below 20

percent and must be ratified by share-

holders within 135 days; (2) all directors

will stand for reelection each year; (3) the

holders of 10 percent of the spinoff’s

shares will have the power to call a

special meeting of the shareholders; and

(4) the spinoff’s organizational docu-

ments will not contain any supermajority

voting provisions. Icahn entered into a

very similar settlement agreement with

eBay regarding its planned spinoff of its

PayPal operations.

In the 2015 proxy season, the most visible

issue for activist investors concerns

proxy access proposals. Currently, if any

shareholder wishes to nominate its own

director candidates at a company’s annual

meeting, it typically must file and deliver

its own extensive proxy materials, which

can be very time-consuming and expen-

sive. Over the last several months there

has been a large push from the activist

community to encourage changes in

company bylaws to allow shareholders

who hold a large portion of a company’s

stock, typically 3 percent or 5 percent, to

place their director nominees on the com-

pany’s own proxy materials. This change

would make it much easier and more

viable for large shareholders to nominate

directors and thus influence the direction

of a company.

For example, beginning in the fall of

2014, New York City Comptroller, Scott

In the 2015 proxy season,the most visible issue foractivist investors concernsproxy access proposals.In order to increase shareholder influence,there has been a largepush to encouragechanges in company bylaws to allow share-holders who hold a largeportion of stock to placetheir director nomineeson the company’s ownproxy materials.

The rise in high-profile activist investing has led

to a vociferous debatewithin the business and

institutional investor communities regarding

whether activists actuallyprovide a net benefit to

the other shareholders ofthe companies they

invest in.

Stringer, on behalf of the City’s public

pension funds, filed proposals to be

voted on at the upcoming annual meet-

ings of 75 companies requesting that

each company’s board change the com-

pany’s bylaws to permit the inclusion of

shareholder nominees on the company’s

proxy statements. Some of the largest

asset managers in the country are back-

ing proxy access reforms, including

Vanguard Group, BlackRock Inc., and

TIAA-CREF. TIAA-CREF, which has $851

billion under management, has gone as

far as requesting that 100 companies in

which it is invested adopt proxy access

proposals. A handful of large companies,

including General Electric, Citigroup,

Prudential Financial, and Bank of America

have embraced proxy access reform

without a fight. However, many others

are attempting to block these efforts.

The rise in high-profile activist investing

has led to a vociferous debate within the

business and institutional investor com-

munities regarding whether activists

actually provide a net benefit to the other

shareholders of the companies in which

they invest. Most activists do not plan to

hold a single company’s stock over the

long term, and thus are often labeled as

pushing for short-sighted changes at a

company that may increase the stock

price over the near term, but will damage

the company over the long term.

Supporters of the activists argue that they

are representing the interests of all share-

holders and only profit in a manner

commensurate with their ownership

percentage.

John Vielandi is an Associate in BLB&G’s

New York office. He can be reached at

[email protected].



QuotableModern corporate law recognizes that stockholders

have three fundamental, substantive rights: to vote, to

sell, and to sue…. the serious policy questions

implicated by fee-shifting bylaws in general, includ[e]

whether it would be statutorily permissible and/or

equitable to adopt bylaws that functionally deprive

stockholders of…the right to sue to vindicate their

interests.

Delaware Court of Chancery, March 2015



T he institutional investor community lost one of its

brightest lights and most valuable advocates this year.

Harvey J. Goldschmid, who served as both a Commissioner

and top attorney at the US Securities and Exchange Commis-

sion, was a universally esteemed Columbia Law School

Professor and renowned corporate governance expert. He

died on February 12, 2015 at the age of 74.

An alumnus of Columbia Law School and Columbia College,

Goldschmid joined the Law School faculty in 1970. A two-time

winner of the Law School’s top

teaching prize, he said that for

him the most important part

of teaching was “to think

about not only what the law is,

which students need to know,

but what it ought to be.”

Goldschmid served as General

Counsel of the SEC from 1998

to 1999, as special senior ad-

viser to then Chairman Arthur

Levitt in 2000, and as a Commissioner for the agency from

2002 to 2005.

A Democrat, he was appointed as an SEC Commissioner by

President George W. Bush, just after the president signed the

Sarbanes-Oxley Act, one of the most sweeping reforms of the

financial markets in modern US history. Goldschmid played

a key role in implementing SOX, which was passed in the wake

of the Enron and WorldCom collapses, and served during

some of the most tumultuous times in the agency’s history.

Frequently quoted in the media for his views on financial

regulation, he remained an influential voice on economic

policy even after his tenure at the SEC. After the financial crisis,

Goldschmid advocated

for the creation of a

systemic risk agency —

separate from existing

regulatory bodies — that

would have far-reaching

authority in the financial

sector and, in 2012, was

appointed to the result-

ing body, the Systemic

Risk Council. Among other official projects, he worked on the

creation of rules on shareholder resolutions in the late 1990s,

served as an advisory board member of the Millstein Center

for Corporate Governance, was a member of the governing

board for the Center for Audit Quality, and served as a public

governor for Wall Street’s self-funded regulator, the Financial

Industry Regulatory Authority.

Goldschmid displayed his dedication to investor rights during

his SEC confirmation testimony in 2002: “Our nation, as this

Committee has indicated, is now witnessing the most dramatic

business scandals that have occurred during my professional

life. On a very personal level, I feel the pain of the retirees and

the investors whose futures have been jeopardized.”

BLB&G Senior Founding Partner and Columbia Law alumnus

Max Berger on his friend and colleague’s passing: “He was

an exceptional professor, public servant and person. Harvey’s

only agenda was serving the Commission, his students, his

law school and his family. On his watch, in the face of major

systemic and moral failures, he fought to make certain that

our capital markets remained vibrant and transparent, and

the envy of the world. He will be missed in every way.”

Goldschmid is survived by his wife, Mary, and his sons

Charles, Paul and Joseph.

Harvey Goldschmid1940 to 2015

Former SEC Commissioner, Beloved Professor and Public Servant was a Tireless Advocate for Investor Rights

“Students adored him;

practitioners respected

him; and government

agencies depended on

him. We will not soon

see his like again.” John C. Coffee Jr., the Adolf A. BerleProfessor of Law at Columbia LawSchool

Investors are rightlytroubled by the ATP Tourruling. Many publicly-traded corporationshave already adoptedfee-shifting provisions,potentially makingshareholder litigationuntenable. Institutionalinvestors are fightingback.

By Edward Timlin

A s discussed in the last edition

of The Advocate, the Delaware

Supreme Court’s May 8, 2014

ruling in ATP Tour, Inc. v. Deutscher Tennis

Bund, 91 A.3d 554 (Del. 2014) presents a

serious threat to meritorious stockholder

litigation. ATP held that a non-stock cor-

poration could adopt a bylaw “shifting”

its attorneys’ fees and expenses to any

member that brought a lawsuit against

the corporation (or its directors and offi-

cers) and failed to achieve “substantially

all” of the relief sought. In other words,

the Court upheld a fee-shifting bylaw that

put a suing member on the hook for all of

the corporation’s attorneys’ fees and ex-

penses unless the plaintiff achieved com-

plete victory in its lawsuit. Because no

rational stockholder will seek to vindicate

their rights in the face of personal expo-

sure to unknown, uncapped, and uncon-

trollable defense costs, fee-shifting bylaws

could chill even the most important and

meritorious claims.

In the wake of ATP, dozens of publicly

traded companies rushed to adopt one-

way fee-shifting provisions. Investors were

rightly troubled, and the institutional in-

vestor community mobilized to combat this

threat to their rights. In response, corpo-

rate lobbyists led by the US Chamber of

Commerce spent millions trying to derail

efforts to prevent the expansion of ATP

to public Delaware corporations. In a

show of audacity, the Chamber has char-

acterized its actions as in the interest of

stockholders. But, make no mistake — the

Chamber’s goal is to shut the courthouse

door on those same stockholders.



Dispatches from the Battleground:

Will Fee-Shifting Bylaws Keep Shareholders from the Courthouse?



The Chamber’s campaign is ongoing and

remains dangerous. Some recent devel-

opments, however, suggest that investors

may win this round of the battle, success-

fully limiting the dangerous precedent set

in ATP.

First, legislative efforts to limit ATP to non-

stock business associations are advancing.

A bill limiting ATP was proposed almost

immediately after the Court’s decision in

2014. Unfortunately, the Chamber’s mas-

sive lobbying effort succeeded in remov-

ing the bill from the 2014 calendar.

Fortunately, investors did not give up. In

November 2014, institutional investors

with approximately $2 trillion of assets

under management wrote Delaware’s

Governor Jack Markell and other key pol-

icymakers, urging swift legislative action

to limit ATP’s reach.

In March 2015, the Corporate Law Section

of the Delaware State Bar Association —

a respected, bipartisan body typically re-

sponsible for proposing amendments to

Delaware’s General Corporation Law —

presented a revised bill to the Delaware

State Legislature. The revised bill would

prohibit fee-shifting provisions, in either the

bylaws or charters of Delaware corpora-

tions, that apply to “intra-corporate claims”

such as stockholder breach of fiduciary

duty claims and appraisal actions.

On May 12, 2015, the upper house of the

Delaware State Legislature passed the

revised bill, and, on June 11, the lower

house passed the revised bill. The bill will

now be presented to Governor Markell

for his signature.

Second, the Delaware Chancery Court

issued a decision in March 2015 voicing

its concern with the policy implications of

allowing fee-shifting bylaws at public

companies. In Strougo v. Hollander, 111

A.3d 590 (Del. Ch. 2015), a controlling

stockholder caused the company to con-

duct a reverse stock split, cashing out the

public stockholders involuntarily. Stock-

holders initiated a lawsuit challenging the

conflicted transaction. After the stock-

holders had been cashed out, the com-

pany adopted a fee-shifting bylaw. The

stockholders then amended their com-

plaint to challenge the bylaw in addition

to the transaction itself. The Chancery

Court ruled that the bylaw was not en-

forceable because it was not adopted

until after the stockholders’ shares were

cashed out and a corporation cannot

adopt bylaws purporting to govern its re-

lationship with former stockholders.

Because the Court in Strougo ruled for

the stockholders based on the timing of

the bylaw’s adoption, it did not reach the

broader issue of the validity of fee-shift-

ing bylaws in general. But, Chancellor

Bouchard made clear the Court’s skepti-

cism regarding the propriety of such pro-

visions. Specifically, Chancellor Bouchard

wrote that “[m]odern corporate law rec-

ognizes that stockholders have three fun-

damental, substantive rights: to vote, to

sell, and to sue.” The Court recognized

that, in a case like Strougo, a fee-shifting

bylaw would prevent “rational stock-

holder[s]” from initiating meritorious suits

because each stockholder’s recovery

would be dwarfed by the “[d]efendants’

uncapped attorneys’ fees.” “This reality

demonstrates the serious policy ques-

tions implicated by fee-shifting bylaws in

general, including whether it would be

statutorily permissible and/or equitable to

adopt bylaws that functionally deprive

stockholders of an important right: the

right to sue to vindicate their interests as

stockholders.”

Third, on March 19, 2015, Securities and

Exchange Commission Chair Mary Jo

White expressed her disapproval of fee-

shifting bylaws, perhaps signaling how

the SEC will respond if corporations

adopt fee-shifting bylaws purporting to

apply to federal securities claims. Ms.

White told Tulane University Law School’s

Corporate Law Institute that she is “con-

cerned about any provision in the bylaws

of a company that could inappropriately

stifle shareholders’ ability to seek redress

under the federal securities laws.”

Dozens of publicly-traded corporations

have already adopted fee-shifting bylaws,

and the threat of more widespread adop-

tion remains imminent. However, recent

developments hopefully signal that legis-

lators, judges, and regulators will be re-

sponsive when the investment community

acts in a united fashion.

Edward Timlin is an Associate in BLB&G’s

New York office. He can be reached at

[email protected].

Because no rationalstockholder will seek to vindicate their rights in the face of personal exposure to unknown, uncapped, and uncontrol-lable defense costs, thesefee-shifting bylaws couldchill even the most impor-tant and promising claims.

The Court’s controversialdecision in United States

v. Newman potentiallyraises the bar for

prosecutors in future insider trading cases.

A controversial appellate court

ruling in the high-profile insider

trading case United States v.

Newman, 773 F.3d 438 (2014), recently

rattled federal prosecutors and got the

attention of Wall Street and the financial

community nationwide. A federal jury

had previously convicted two traders,

Todd Newman and Anthony Chiasson,

of trading on inside information about

publicly traded companies that they had

received through a group of rogue Wall

Street analysts. The group of analysts

formed what they referred to as a “Fight

Club,” trading inside information within

their circle, and then passing the infor-

mation along to portfolio managers at

their funds. Newman and Chiasson, who

worked at two different hedge funds,

were two of these portfolio managers.

The Second Circuit Court of Appeals

overturned the convictions, dealing a loss

to prosecutors in the Southern District of

New York, potentially making it more dif-

ficult for future insider trading prosecu-

tions. The ruling could also raise the bar

for prosecutors by requiring authorities

to prove that a defendant knew that the

insider who provided the tip personally

benefited by doing so, even if the

defendant is several steps removed from

the insider. In addition, the case limited

what can be considered a personal bene-

fit, shedding light on a seedy corner of

Wall Street, where non-public informa-

tion is so routinely passed around in

advance of its public release that some-

one trading on it can now potentially avoid

liability by claiming to be several steps

removed from its origin. In the wake of

Newman, calls for the enactment of a

focused and powerful insider trading

statute have become widespread in both

the legal and financial communities.



Sharing,Wall Street

Style Second Circuit NarrowsDefinition of InsiderTrading

By Catherine McCaw

The Second Circuit requires prosecutors to

prove that a defendantknew that the insider

providing a tip personallybenefited in doing so,

even if the defendant isseveral steps removed

from the insider. The case also limited what

can be considered a personal benefit.

Overview of Insider Trading Law

Federal prosecutors use the same basic

legal tools to bring criminal insider trad-

ing prosecutions that private investors

use to seek damages on a class-wide

basis for securities fraud: Section 10(b)

of the Securities Exchange Act of 1934

and Rule 10b-5. Rule 10b-5 prohibits the

use of “any device, scheme, or artifice to

defraud.” Violation of Section 10(b) and

Rule 10b-5 can give rise to criminal sanc-

tions where the defendant is shown to

have acted “willfully.”

Section 10(b) and Rule 10b-5 do not specif-

ically mention insider trading. Instead,

Congress and the Securities and Exchange

Commission intended Section 10(b) and

Rule 10b-5 to be catchall provisions pro-

hibiting a wide variety of fraudulent activ-

ity, and left considerable latitude to the

courts to define the types of behavior

prohibited and to develop standards for

enforcement. In accordance with Congress

and the SEC’s intent, courts have

interpreted these laws broadly, and a

variety of court-made doctrines have

arisen that prohibit certain types of fraud-

ulent activity, including insider trading.

Courts have crafted rules that govern

when a person can be criminally liable for

insider trading. This doctrine began with

the premise that corporate insiders owe

a fiduciary duty to the company’s share-

holders and that they violate that duty if

they personally profit by trading on inside

information at their shareholders’ expense.

Similarly, insiders violate their fiduciary

duty – and thus can be criminally liable —

if they profit by sharing that information

with a third party outside their corpora-

tion. Courts have also held that someone

who receives a tip from an insider and

trades on that information can be held

criminally liable. But tippees’ criminal

liability derives from the insider’s liability

— they can only be held liable if the

information came from an insider who

breached a fiduciary duty by disclosing

inside information and received a benefit

in return.

United States v. Newman

Against this backdrop, federal prosecutors

brought charges against Newman and

Chiasson for trading on inside informa-

tion that they had received about two

technology companies, Dell and NVIDIA.

Both Newman and Chiasson were three

to four degrees removed from the person

who originally received information from

an insider, and they received the infor-

mation after it passed through multiple

hands within the investment community.

With respect to the information from Dell,

Rob Ray, who worked in Dell’s investor

relations department, originally provided

the information to Sandy Goyal. Goyal

and Ray both attended business school

and worked at Dell together. The informa-

tion concerning NVIDIA was passed

along by Chris Choi, who worked in

NVIDIA’s finance unit, to Hyung Lim, the

original tippee, whom Choi knew socially.

Goyal and Choi then shared this informa-

tion with a number of people within their

professional networks.

Newman and Chiasson eventually received

and traded on this material non-public in-

formation. At trial, the government argued

that because of their experience in the

finance industry, Newman and Chiasson

must have known that the information





was disclosed by insiders in breach of

their fiduciary duty, rather than just an in-

nocent stock tip. A federal jury agreed,

and both men were convicted of insider

trading. Newman and Chiasson appealed

to the Second Circuit.

The Second Circuit Imposes NewRestrictions on Prosecutions

On appeal, the Second Circuit decided

two issues, both of which could have im-

portant ramifications for future insider

trading prosecutions. First, the Second

Circuit examined whether Newman and

Chiasson could be found guilty of securi-

ties fraud when they received a tip that

was three or four levels removed from

the original tipper. The government argued

that it needed to show only that Newman

and Chiasson traded on material non-

public information that an insider had

disclosed in return for a personal benefit.

The government argued that it did not

need to show that Newman and Chiasson

knew that the insider received a benefit

for disclosing the information. The mere

fact that they traded on the information

was enough. The Second Circuit disagreed.

It held that insider trading defendants can

only be found guilty if the government

shows that they knew or should have

known that the insider received a per-

sonal benefit for the information. Perhaps

even more disturbing, the Second Circuit

found that despite their sophistication

and strong connections to Wall Street,

Newman and Chiasson could not have

concluded that something illicit was going

on based on the timing and frequency of

the stock tips they typically receive.

More controversially, the Second Circuit

conducted a highly technical examination

of the benefit that insider tippers Ray and

Choi had received and found it insuffi-

cient to support a conviction for insider

trading. Newman and Chiasson could be

found guilty only if Ray and Choi had dis-

closed inside information in return for a

“personal benefit.” Prior cases had held

that an insider had to receive a “personal

benefit,” but defined that benefit broadly,

stating that a “reputational benefit that

will translate into future earnings or the

benefit one would obtain from simply

making a gift of confidential information

to a trading relative or friend.” The Sec-

ond Circuit examined the nature of the

relationships between Ray and Goyal and

between Choi and Lim and concluded

that the friendships were too casual for

Ray or Choi to have derived a true “per-

sonal benefit” from tipping. In the Sec-

ond Circuit’s view, were this enough to

count as a “personal benefit,” virtually

anything could, rendering the require-

ment a nullity. Instead, it held that if the

government wishes to show a personal

benefit through a personal relationship,

“such an inference is impermissible in

The government arguedthat it did not need toshow that defendantsknew that the insider received a benefit for disclosing the information.The mere fact that theytraded on the informationwas enough. The SecondCircuit disagreed.

Continued on page 31.


US Endorses Fiduciary Standard forFinancial Advisors

President Obama, the SEC and the Depart-

ment of Labor have all endorsed rules

forcing brokers to put the interests of

their clients ahead of their own. Currently,

advisers simply need to recommend in-

vestments that are “suitable,” a relatively

lax standard that often allows advisers to

place clients in high-fee investments that

reduce returns. According to the White

House Council of Economic Advisers,

“[t]he current regulatory environment

creates perverse incentives that ultimately

cost savers billions of dollars a year.”

Indeed, President Obama stated at an

event in Washington in February 2015

that “[i]f your business model rests on

taking advantage, bilking hardworking

Americans out of their retirement money,

then you shouldn’t be in business. Out-

dated regulations, legal loopholes, fine

print, all that stuff today makes it harder

for savers to know who they can trust.”

While the Department of Labor’s proposed

rules — rules that President Obama en-

dorsed — are limited to professionals who

advise on retirement accounts, the SEC

is recommending that the rules impose

a fiduciary standard on all investment

advice — not just advice pertaining to

retirement accounts. The texts of the pro-

posals are currently being harmonized

and will be made public in the coming

months.

> Sources: News Release, United States Department of Labor, US Labor DepartmentSeeks Public Comment on Proposal to Protect Consumers from Conflicts of Interestin Retirement Advice (Apr. 14, 2015); The Wall Street Journal (Feb. 17, Feb. 23,Mar 17 – 2015).

Former CFO Found Liable of Securities Fraud in Rare Trial

In November 2014, a federal jury in New

York found Derek Palaschuk, the ex-CFO

of China-based Longtop Financial Tech-

nologies, liable for fraudulently mislead-

ing investors by inflating and falsifying

Longtop’s financial results. The verdict — which the jury reached after less than a

day of deliberations — is a rare trial victory for investors in securities class actions,

with only 13 other such cases reaching a verdict since 1995. While the jurors deter-

mined that Palaschuk was liable and caused investors’ losses, they ruled that he

was only 1 percent responsible for investors’ harm, and that Longtop’s CEO,

Weizhou Lian, bore 50 percent of the responsibility and that Longtop itself was

49 percent responsible. Lian and Longtop failed to respond to investors’ claims and

Judge Shira Scheindlin entered a default judgment of over $882 million against

each of them in November 2013. Given the size of the judgment and Palaschuk’s

level of culpability, he could be forced to pay almost $9 million to the investors that

he defrauded.

> Sources: Reuters (Nov. 21, 2014); Reuters (Nov. 24, 2014).

Approximately eight years removed from

the subprime meltdown, Standard &

Poor’s became the first and only credit

rating agency to face and resolve signifi-

cant government lawsuits arising out of

claims that a rating agency gave triple-A

ratings to subprime products that were

destined to fail. While S&P agreed to pay

$1.5 billion to settle suits filed against

it by the US Department of Justice, 19

states, and CalPERS, S&P resolved the

action without admitting to any wrong-

doing. According to former Attorney

General Eric Holder, S&P’s “leadership

ignored senior analysts who warned that

EyeBy Ross Shikowitz

on the Issues

the company had given top ratings to

financial products that were failing to

perform as advertised. While this strategy

may have helped S&P avoid disappoint-

ing its clients, it did major harm to the

larger economy, contributing to the worst

financial crisis since the Great Depres-

sion.” Relatedly, S&P also settled a case

with the SEC for $80 million to resolve

allegations that it misled investors in

2011 about ratings of commercial mort-

gage-backed securities. As part of that

settlement, the SEC gave S&P a one-year

suspension from the CMBS market.

> Source: Bloomberg (Feb. 3, 2015).

S&P Fined $1.5 Billion for Giving Pristine Ratings to Toxic Subprime Products


The SEC has recently come under fire — from the public, law-

makers, and from several of its own commissioners — for its

practice of allowing recidivist violators of the securities laws to

continue participating in certain capital markets activities when

the companies would otherwise be barred from doing so under

the terms of prior settlements. One of the most recent exam-

ples of this practice is the SEC’s grant of a regulatory waiver to

Deutsche Bank AG from the “ineligible issuer status” that was

triggered by the criminal conviction of its subsidiary, DB Group

Services (UK) Ltd, for manipulating LIBOR. Without the waiver,

Deutsche Bank’s status as a well-known

seasoned issuer, which allows it to raise

capital quickly without going through

a long SEC approval process,

would have been automatically

revoked as a result of the con-

viction. The SEC has recently

granted waivers to other large

Wall Street firms including

JPMorgan Chase & Co., Royal

Bank of Scotland Group Plc,

Citigroup, Inc. and Bank of

America, drawing strong dis-

sents from Commissioners Kara Stein and Luis Aguilar. For ex-

ample, Commissioner Stein issued a statement in dissent to

the Deutsche Bank waiver citing the “egregious criminal nature

of the conduct” that went on for nearly a decade and stated

that the Commission continues to erode even this lowest of

hurdles for large companies, while small and midsize business

appear to face different treatment.” In response to public criti-

cism and the dissenting voices of the two Commissioners, SEC

Chairperson Mary Jo White defended the waiver process as

“thorough, rigorous, and principled.” Congress is considering

the SEC’s waiver practices, including proposed legislation

barring such reprieves. Representative Maxine Waters (D-CA)

commented, “I have been disappointed with the seemingly

reflexive granting of waivers to bad actors, which can enshrine

a policy of ‘too big to bar.’” Senator Elizabeth Warren (D-MA)

has also publically rebuked the Agency for granting “special

regulatory privileges” to large public issuers, specifically noting

its waiver practices. For large financial institutions, fines are

often a mere cost of doing business, and waiving disqualifica-

tion provisions allows bad actors to continue to operate in the

marketplace undeterred.

> Sources: http://www.sec.gov; The Wall Street Journal (Mar. 12,2015); The New York Times DealBook (Mar. 23, 2015).

According to a study issued by the Insti-

tute for Policy Studies and Center for

Effective Government, seven of the largest

30 US companies in 2013 — Boeing,

Ford, Chevron, Citigroup, Verizon, JP-

Morgan, and General Motors — paid

more to their CEOs than they did to the

IRS in federal income taxes. Specifically,

these seven companies lavished their

CEOs with over $120 million in com-

bined pay in 2013, with three of them —

Boeing, Ford, and Chevron — writing

$20 million-plus paychecks for each of

their chief executives. But at the same

time that these stalwarts of American

industry were cutting huge paychecks


for their CEOs, they were also utilizing

special credits, deductions and loopholes

to effectively eliminate their tax obligations,

with the US government actually owing

them approximately $2 billion. Strikingly,

these companies were able to avoid pay-

ing any taxes despite the fact that they

earned a combined $74 billion in US pre-

tax profits in 2013. Similarly, when ana-

lyzing the pay packages of America’s

highest 100-paid CEOs, the Institute for

Policy Studies and Center for Effective

Government found that 29 US corpora-

tions that those CEOs helmed — or almost

one third — paid more to the CEO than

they paid to the US government in taxes.

> Source: Scott Klinger and Sarah Anderson,“Fleecing Uncle Sam: A Growing Numberof Corporations Spend More on ExecutiveCompensation Than Federal IncomeTaxes,” Center for Effective Governmentand the Institute for Policy Studies (2014).

Largest US Companies Pay More to CEOs than in Taxes

SEC Turns a “Blind Eye” to Law-Breaking Financial Firms

EU Issues Measure to RestrictBenchmark Setting

In the wake of the billions of dollars in

fines that major EU institutions paid for

rigging the critical London Interbank

Offered Rate (“LIBOR”) — which reflects

the rate that some of the world’s largest

banks charge each other for short-term

loans, and influences virtually every other

interest rate in the world — the European

Parliament issued a draft law to curb the

conflicts of interest that precipitated the

LIBOR scandal. Specifically, under the

draft law, the setting of “critical bench-

marks,” such as LIBOR, “would be over-

seen by a ‘college’ of supervisors, including

the European Securities and Markets

Authority [] and other competent author-

ities.” Further, the data used to set the

critical benchmarks must be verifiable

and originate from “reliable contributors

who are bound by a code of conduct for

each benchmark.” The administrators of

the benchmarks would also have to reg-

ister with regulators in Europe, describe

how reliable the benchmark is, and dis-

close any existing or potential conflicts of

interest. Currently, none of these safe-

guards are in place to help protect the

reliability of LIBOR. The text of the draft

law is slated to be put to a vote by the

European Parliament.

> Source: European Parliament News —Press Release, Economic & Monetary AffairsCommittee, (Mar. 31, 2015).


European Commission Seeks to Create Capital Markets Union

On February 18, 2015, the European Commission — the executive body of the

European Union responsible for proposing legislation in the EU — issued a

white paper to strengthen the EU’s capital markets. The core of the plan is to build

a “Capital Markets Union” that would improve the free flow of capital between the

EU’s 28 Member States by removing barriers to cross-border investment and

fostering stronger connections with global capital markets. These steps would, in

turn, provide small businesses across Europe with greater access to financing,

allow for greater diversity in the sources of funding available to businesses, and

would make the EU’s integrated markets function more effectively and efficiently.

Traditionally, Europe has relied heavily upon direct financing from banks, which

has left businesses in the EU vulnerable when capital markets have seized-up or

when banks tighten their lending standards. The European Commission is currently

engaging in a three-month consultation period to develop an action plan based on

the white paper it released in February. The action plan will detail the actions the

European Commission intends to carry out over the next five years.

> Sources: European Commission Paper “Building a Capital Markets Union” (2015); “Making it Big” — Presidents Institute Summit — Copenhagen” (Apr. 9, 2015).

EyeBy Ross Shikowitz

on the Issues


On March 6, 2015, Germany passed a

law requiring some of Europe’s largest

companies to increase the presence of

women on their boards of directors.

By enacting the measure, Germany

became one of the largest and most sig-

nificant countries to join the growing

trend in Europe of improving board

diversity through law. Norway, Spain,

France, Iceland, Italy, and Belgium have

already passed similar legislation. Under

the new German law, major companies

must allot 30 percent of seats on non-

executive boards to women starting in

2016. Currently, women occupy fewer

than 20 percent of the seats on boards

of directors in Germany, despite the fact

that some of the world’s largest compa-

nies — including Volkswagen, BMW,

Daimler, Siemens, Deutsche Bank, and

Merck— are based there. According

to Heiko Maas, the German Federal

Minister of Justice, “You have

to be sparing with the

word ‘historic’…[b]ut I

think today we can apply

it.…[the law is] the great-

est contribution to gender

equality since women got the

vote [in Germany in 1918].” In

contrast with the new law passed in

Germany and other countries in Europe,

the only measure that the US has en-

acted to improve gender diversity on

corporate boards is to require disclo-

sure of the consideration of diversity in

the process of board nomination. In the

US, women currently hold just 19 per-

cent of the board seats of companies

listed in the S&P 500 index.

> Sources: The New York Times (Mar. 6,2015); SEC Final Rule, 17 CFR Parts 229,239, 240, 249, and 274, Proxy DisclosureEnhancements; Fortune (Mar. 12, 2015).


Germany Enacts Law Improving Gender Diversity on Boards

Proposed EU Rules to Curb Money Manager Spending on Research

Rules currently being crafted in the EU are set to tackle the decades-old problem of

the conflicts of interest that cause money managers to spend too much of their

clients’ money on research. Since at least as early as the 1970’s, Wall Street analysts’

research has been funded by commissions that clients pay when they trade securities.

Now, new EU rules are seeking to change that regime by requiring money managers

to pay for research services out of their own pockets. This shift will ensure that money

managers have some skin-in-the-game when purchasing expensive research reports,

and prompt them to analyze what research is actually worth purchasing and what is

not, which may ultimately save investors money and improve returns. The proposed

rules, which banks have opposed and which are subject to change, are set to be

implemented in 2017.

> Source: The Wall Street Journal (Feb. 9, 2015).

UK Regulator Proposes that SeniorBankers Must Prove Innocence

Under a new regime proposed by the

Financial Conduct Authority — a financial

regulatory body in the UK — top bankers

will face a “presumption of responsibility”

and will be forced to prove that they acted

reasonably to stop misconduct from occur-

ring in order to avoid liability. According

to the FCA, the new rules are being pro-

posed in light of the culture within banks

that played a role in precipitating the

financial crisis and the need to “encour-

age accountability for decision-making in

relevant firms, focusing particularly on

senior management, while aiming for

good conduct at all levels.” Indeed,

“[i]ndustries characterized by weak ac-

countability—or by individuals seeking to

protect themselves on a ‘Murder on the

Orient Express’ defense [where a group

of malfeasants disclaims any individual

responsibility] — are almost invariably

less financially stable, and more prone to

misconduct,” according to FCA Chief

Executive Martin Wheatley. The new rules

are set to go into effect on March 7, 2016.

> Sources: Financial Conduct Authority (Mar. 2015); The Telegraph (Mar. 16, 2015).

Martin Wheatley, CEO of UK regulatory body the Financial Conduct Authority

EUROPEAN FOCUS

Ross Shikowitz is an Associate in BLB&G’s New York office. He can be reached at [email protected].

Under Mary Jo White,the agency’s new

initiatives represent anaggressive expansion ofits enforcement regimeand infrastructure, which

faces opposition and obstacles.

Under Chairwoman Mary Jo White,

the SEC has rolled out a variety

of initiatives exploiting new pow-

ers granted to the agency by the Dodd-

Frank Wall Street Reform and Consumer

Protection Act and utilizing new technolo-

gies to bring its investigative capabilities

up to speed with the modern realities of

electronic trading. While the SEC has

promised that its new initiatives will en-

hance the agency’s policing power and

benefit investors, a number of the pro-

grams have proven controversial, with one

initiative facing a constitutional challenge.

What’s more, Chairwoman White’s pledge

to “expeditiously” finalize a variety of

post-crisis rules, complete probes into

financial misconduct, and push forward

enforcement matters has been thwarted

by political discord among the Commis-

sion’s five members. Consequently, several

big-ticket projects remain uncompleted

two years into Ms. White’s tenure.

“Broken Windows” Enforcement

In an October 9, 2013 speech, Chairwoman

White announced that the SEC would

pursue a “broken windows” approach to

securities enforcement. The “broken win-

dows” theory of law enforcement posits

that aggressive prosecution of relatively

petty crimes (e.g., vandalism, vagrancy,

public intoxication) helps set broad norms

of lawfulness, order, and compliance in a

particular community, thereby reducing

the incidence of more serious offenses.

As Chairwoman White explained, “when



Forging Ahead

From “Broken Windows” Enforcement to InnovativeTechnologies, the SEC Pursues Several Strategic

Initiatives Amid Fractured Leadership

By Abe Alexander

MultipleFrontson

Under the “broken windows” enforcement

philosophy, the SEC haspursued broader, more

comprehensive enforce-ment action for a wider

range of misconduct that,in many cases, would

likely have gone largelyunpunished in past years.By focusing on minor but

systemic violations, theagency is attempting to force change at an

institutional level in a waythat will yield an

industrywide culture ofcompliance.

a window is broken and

someone fixes it — it is a

sign that disorder will not

be tolerated. But, when a

broken window is not fixed, it

‘is a signal that no one cares, and so

breaking more windows costs nothing.’”

In White’s view, “[no] infraction is too

small to be uncovered and punished.”

Following its new “broken windows”

enforcement philosophy, the SEC has

pursued broader, more comprehensive

charges for a wider range of ostensibly

non-fraudulent misconduct that, in many

cases, may have gone largely unpunished

in past years. For instance, in 2014, for

the first time, the SEC filed numerous

actions targeting a variety of non-fraud

violations, including enforcement actions

against a broker-dealer for failing to pro-

tect a client’s confidential information,

and against a private equity firm for mis-

allocated fees and expenses. According

to SEC Enforcement Director Andrew

Ceresney, this approach is “not about

turning every violation into an enforce-

ment action,” but rather “targeting im-

portant rules [where] we’ve seen a pattern

of lack of compliance,” and using these

cases to foster “compliance across the

board.” In other words, by focusing on

minor but systemic violations, the SEC

is attempting to force change at an insti-

tutional level and yield an industrywide

culture of compliance.

The SEC’s new approach has its critics,

including former agency officials. In their

view, pursuing “minor” infractions squan-

ders already scarce agency resources.

Additionally, these critics worry that the

SEC’s commitment to punishing ostensi-

bly victimless, non-fraud offenses, such

as late or incomplete filings not made in

bad faith, might deter issuers from volun-

tarily reporting and correcting such defi-

ciencies for fear of being penalized.

Finally, critics have questioned whether

the Agency is as hard on large companies

as it is on smaller entities — noting, for

example, the increasing number of re-

prieves granted to large financial institu-

tions, allowing prominent financial firms

to continue to participate in capital market

activities from which they would be other-

wise barred as a result of repeat violations.

Whether the SEC’s broken windows en-

forcement policy engenders an enduring

industrywide culture of compliance, and

whether the Agency will be as tough

on large companies as it is on low-level

offenders, remains to be seen. In the short-

term, at least, the agency has attributed

its recovery of a record $4.16 billion in

disgorgement and civil penalties in 2014,

in part, to its aggressive prosecution of

minor violations.

Administrative Courts

The Dodd-Frank Act greatly expanded the

SEC’s power to seek financial penalties in

administrative proceedings, allowing the

agency to avoid more costly and cumber-

some litigation in federal courts. The SEC’s

use of these administrative tribunals has

increased significantly during Chairwoman

White’s tenure. Indeed, nearly half of the

agency’s enforcement actions in 2014

were filed as administrative proceedings.

The SEC’s new power to seek monetary

penalties against a wide range of wrong-

doers in administrative proceedings has

been a tremendous boon to the agency,

as the forum provides the SEC with con-





siderable advantages it would not have in

federal court. For example, hearings are

held on an accelerated schedule; pre-

hearing discovery is not permitted; and

federal courts reviewing the agency’s

determinations must grant a substantial

degree of deference to its factual findings

and legal conclusions. The procedural

simplicity and expediency of administra-

tive enforcement actions allow the SEC

to conserve scarce resources, while the

substantial deference the Commission’s

determinations receive when reviewed

by federal courts provides the agency with

considerable leverage to quickly extract

settlements on favorable terms.

The SEC’s increased use of administra-

tive courts for enforcement proceedings,

however, has engendered criticism and

prompted serious legal challenges. Pre-

liminarily, gridlock among the Commis-

sion’s five members — two of whom are

Republicans, two of whom are Democ-

rats, and one of whom is an independent

(Ms. White) — have troubled the initiative

and resulted in public discord. For exam-

ple, nearly one-third of high-profile cases

the SEC filed with administrative law

judges between November 2014 and April

2015 drew dissents from the SEC’s two

Republican commissioners, according to

a Wall Street Journal study.

Moreover, defendants in SEC adminis-

trative enforcement proceedings have

increasingly argued that the proceedings

are unconstitutional. For instance, in Bebo

v. SEC, the former CEO of Assisted Living

Concepts, a senior living operator, sought

to enjoin the SEC from bringing an ac-

counting fraud claim against her in its

administrative forum. Bebo argued that

the forum deprived her of a constitutional

jury trial right and, given the absence of

discovery and accelerated timetable, her

ability to adequately prepare a defense.

The district court found Bebo’s claims

“compelling and meritorious,” but ruled

that it lacked subject matter jurisdiction

over the case because Bebo had not yet

exhausted her other remedies. Bebo has

appealed the court’s decision to the Sev-

enth Circuit Court of Appeals. The Sev-

enth Circuit agreed to hear Bebo’s appeal

on an expedited basis. Oral argument was

held early June, and the Seventh Circuit’s

decision on the threshold jurisdictional

question is expected soon.

Additional challenges pending in the Sec-

ond and Eleventh Circuits have attacked

the SEC’s new policy on a different

ground, arguing that an administrative

enforcement proceeding represents an

unconstitutional delegation of the Presi-

dent’s authority to enforce the law to

individuals — namely, administrative law

judges (“ALJ”) — who are not sufficiently

answerable to the President. While such

challenges continue to mount, the results

have been mixed. For example, in April a

New York federal court refused to block an

administrative enforcement proceeding

pending against a former Standard &

Poor’s executive, rejecting her argument

that such proceedings are unconstitutional.

In contrast, in June, an Atlanta federal

district halted an SEC administrative pro-

ceeding, finding that the defendant’s con-

stitutional challenge to the agency’s use

of in-house courts was likely to succeed.

In addition, Judge Jed S. Rakoff (S.D.N.Y.)

is a prominent critic of the SEC’s flight to

administrative fora. In a 2011 case, Gupta

The fast pace, proceduralsimplicity and expediencyof SEC administrativecourt enforcement actionslet the agency conservescarce human and financialresources. In addition, thesubstantial deference itsdeterminations receivewhen reviewed by federalcourts provides the agencywith considerable leverageto quickly extract settle-ments on favorable terms.

Since the inception of theSEC’s whistleblower

program, the number oftips the agency has

received has increasedeach year. In that sametime frame the SEC has

authorized awards to 17whistleblowers.

v. SEC, Judge Rakoff ruled against the

SEC and sided with the defendant, who

alleged he would be deprived of his equal

protection rights if the case were allowed

to proceed in the administrative court,

rather than in federal court. According to

Judge Rakoff, the SEC’s increased use of

administrative proceedings raises the

danger that divergent and inconsistent

bodies of securities jurisprudence will de-

velop in parallel, one framework evolving

in federal court, the other in administra-

tive court. Judge Rakoff notes that this

concern is compounded by the fact that

an ALJ’s interpretations of controlling

statutes are relatively insulated from fed-

eral court review, yet those same statutes

must be applied by federal judges in

criminal securities cases. Judge Rakoff

also fears that ALJs, as SEC appointees,

are less likely to impartially adjudicate

cases brought by their own agency than

federal judges. Indeed, the SEC has won

nearly all of its recent enforcement pro-

ceedings brought before ALJs, but has

not fared nearly as well when its cases

are decided by federal juries. Whether

this disparity is a function of the relative

sophistication and subject-matter expert-

ise of administrative judges or an artifact

of institutional bias, as Judge Rakoff

suggests, remains unclear.

Whistleblower Program

To encourage the reporting of potential

securities violations, the Dodd-Frank Act

entitles whistleblowers to receive between

10 and 30 percent of any penalties over

$1 million recovered by the SEC based on

information they have provided, and pro-

tects those whistleblowers from retalia-

tion by their employers.

Since the inception of the whistleblower

program in August 2011, the SEC has

authorized awards to seventeen whistle-

blowers, with nine of those awards made

in 2014. The SEC claims that “[i]n each in-

stance, the whistleblower provided high-

quality original information that allowed

the Commission to more quickly uncover

and investigate the securities law viola-

tion.” Larger bounties are also being paid

as the program matures. In October 2013,

one whistleblower was paid a then-record

$14 million. In September 2014, this record

was broken when another tipster received

more than $30 million. According to

the SEC, this jump reflects the growing

quality and significance of the tips it has

received.

Likewise, the number of tips the agency

has received from whistleblowers has

increased each year since the program’s

inception. In 2014, the SEC received 3,620

tips, up 21 percent from two years earlier.

According to the SEC, every tip is reviewed

by the agency’s Office of Market Intelli-

gence, which forwards the most specific,

credible, and timely tips to the Division

of Enforcement for more extensive inves-

tigation.

At the same time, the SEC is experiencing

significant backlog in paying awards to

the vast majority of those tipsters: of the

297 whistleblowers who have applied for

awards since 2011, 247 — about 83 per-

cent — have yet to receive a decision on

their claim. In some cases, award claims

have been delayed for more than two

years. Thus, while the SEC has indeed

paid outsized bounties to a handful of tip-

sters, most claimants have yet to receive

any remuneration from the agency, and





have complained about the bounty pro-

gram’s lack of transparency.

Notwithstanding the delays in doling out

whistleblower awards, the SEC has vigi-

lantly enforced the whistleblower law’s

anti-retaliation provisions. In June 2014,

the agency brought its first anti-retalia-

tion enforcement action against Paradigm

Capital Management, asserting that the

company retaliated against its head trader

for reporting that it had engaged in pro-

hibited transactions. Ultimately, Paradigm

paid $2.2 million to settle the charges.

The SEC took its efforts to police retalia-

tion a step further in early 2015, when the

agency sent letters to a number of com-

panies, asking for years of non-disclosure

agreements, employment contracts, and

all other “documents that refer to or relate

to whistleblowing,” along with lists of ter-

minated employees. Further, on April 1,

2015, the SEC reached a settlement with

KBR, Inc., which used improper tactics to

prevent its employees from reporting

possible violations of the securities laws.

Specifically, the SEC settled claims with

KBR for $130,000 arising out of allegations

that the company prohibited its employees

from reporting any potential misconduct

to the government, and threatened to ter-

minate employees if they reported any-

thing to the SEC.

Focus on Accounting Fraud

In 2007, the SEC filed more than 200 en-

forcement actions for accounting fraud.

In every year since, the agency has filed

progressively fewer such cases, with only

79 accounting fraud actions filed in 2012.

Historically, the SEC has relied heavily

on restatements to identify accounting

malfeasance, and when restatements,

which peaked in 2006, began to decline,

the SEC lost a principal tool for detecting

wrongdoing. In late 2013, with Chair-

woman White’s support, the Division of

Enforcement announced it would refocus

its efforts on identifying, investigating,

and prosecuting accounting fraud proac-

tively. The Division’s plan has two central

components: (1) the creation of a Fraud

and Audit Task Force devoted solely to

proactively identifying accounting irreg-

ularities; and (2) the use of sophisticated

analytic tools to identify potential ac-

counting fraud.

The SEC’s Financial Reporting and Audit

Task Force, made up of lawyers and ac-

countants from across the agency work-

ing in close consultation with several of

the agency’s accounting and corporate

finance departments, dedicates full-time

resources to identifying securities-law

violations relating to the preparation of

financial statements, issuer reporting and

disclosure, and audit failures. In an effort

to be more efficient and effective, the

Task Force focuses on specific accounting

areas that are particularly susceptible to

fraudulent reporting.

Complementing the SEC’sinitiatives under White’stenure has been the utilization of more advanced technology in its monitoring and enforcement functions.Its Market InformationData Analytics System, or MIDAS, collects morethan one billion records,time-stamped to the microsecond, every day,from each of the thirteennational equity exchanges.

Continued on page 32.



T he US Supreme Court delivered

a recent victory for investors

with a decision that clarifies

what companies can say in their IPOs

and other securities offerings. In short,

the Court’s long-awaited decision in

Omnicare, Inc. v. Laborers District Council

Construction Industry Pension Fund,

135 S.Ct. 1318 (Mar. 24, 2015), clarifies a

robust standard of liability and encour-

ages better disclosure by securities issuers

for statements couched as “opinions.”

Omnicare concerns false and misleading

opinions in securities offering documents.

The Court’s decision makes clear that

those bringing securities to market can-

not shield themselves from liability by

cloaking material misrepresentations as

mere opinions. Instead, consistent with

the core philosophy of our federal secu-

rities laws, companies must provide full

and fair disclosure, including information

in the company’s possession that may

draw into question the accuracy of state-

ments it couches as opinions. Omnicare

reinforces the integrity of our capital mar-

kets and advances investor rights by

encouraging more extensive disclosure

of the reasoning behind stated corporate

opinions, enabling investors to make

informed decisions and bolstering their

ability to recover losses when offering

materials omit key information.

The specific issue before the Court in

Omnicare was the standard of liability for

false statements of opinion in securities

registration statements under Section 11

of the Securities Act of 1933. The Securi-

ties Act was enacted in the aftermath of

the 1929 stock market crash, its primary

purpose being to ensure that potential

buyers of securities receive complete and

By David Kaplan

The recent SupremeCourt ruling advances

investor rights and encourages better disclosure in IPOs

and other securities offerings.

Opinion?A Matter of

The Omnicare Decision WillMake it Harder for IPO Issuersto Mask Misrepresentations as Opinion Statements

The specific issue beforethe Court in Omnicare was

the standard of liability for false statements of

opinion in securities registration statementsunder Section 11 of the

Securities Act of 1933. Inparticular, registration

statements — which contain a variety of

material informationabout a company and

must be approved by theSEC before any securitycan be sold — must not

contain any misstatementsor omissions about a matter which may be

important to investors.

accurate information before they invest.

In particular, registration statements —

which contain a variety of material infor-

mation about a company and must be

approved by the SEC before any security

can be sold — must not contain any mis-

statements or omissions about a matter

which may be important to investors.

Section 11 of the Securities Act of 1933

allows investors to pursue a legal remedy

when purchasing stock in a public offering

in which the registration statement con-

tains a materially false or misleading

statement or omission. Unlike other pri-

vate rights of action under the federal

securities laws, a claim under Section 11

imposes “strict” liability on issuers, i.e.,

without requiring proof of fault, intent

to deceive (“scienter”), causation or

“reliance” (proof that an investor relied

directly on misleading statements). As

such, Section 11 is one of the most

powerful remedies available to investors

under the federal securities laws.

The Omnicare litigation arose out of a

2005 initial public offering by Omnicare,

the nation’s largest provider of pharmacy

services for nursing home residents. The

registration statement for Omnicare’s IPO

— which raised three-quarters of a billion

dollars from investors — stated that the

company “believed” its contracts and prac-

tices were in compliance with applicable

state and federal law. Unbeknownst to

investors, Omnicare had been engaged

in a long-running scheme whereby it

solicited and received millions of dollars

in kickbacks from pharmaceutical manu-

facturers and nursing homes. When the

scheme was exposed, Omnicare was

forced to pay hundreds of millions of

dollars to federal and state authorities to

resolve charges of systemic misconduct,

and investors in the company’s IPO

suffered substantial losses.

Thereafter, several pension funds sued

Omnicare and certain of its directors and

officers under Section 11 for representing

that the company’s arrangements with

healthcare providers and pharmaceutical

suppliers complied with the law. Omni-

care, the US Chamber of Commerce, and

other well-funded corporate interests ar-

gued that there should be no liability

whatsoever under Section 11 for objec-

tively untrue statements of opinion in

offering materials unless investors can

plead and prove that the opinion was not

genuinely held. Notably, Omnicare and

its supporters in the business community

pressed for a standard that, as a practical

matter, would bar investors from seeking

any recovery for omissions in opinion

statements.

The Supreme Court rejected that position

and set forth three distinct bases of liabil-

ity for false or misleading opinion state-

ments in offering documents. First, the

Court confirmed that statements of opin-

ion in offering documents that are both

false and not honestly believed give rise

to Section 11 liability. Second, the Court

explained that opinion statements can

also give rise to Section 11 liability if they

contain “embedded” untrue statements

of fact. For example, “we believe X be-

cause Y,” where Y is false. Third, an opin-

ion statement may be actionable under

Section 11 if it omits key facts about the

basis for the opinion. In particular, the

Court held that a statement of opinion is

materially misleading under Section 11

when the “registration statement omits





material facts about the issuer’s inquiry

into or knowledge” about the opinion

and “those facts conflict with what a rea-

sonable investor would take from the

statement itself.”

Providing guidance for future cases, the

Court explained that investors reasonably

believe that an opinion included in a reg-

istration statement is the product of a

meaningful investigation and “aligns with

the information in the issuer’s possession

at the time.”Thus, an opinion may be

materially misleading — and actionable

— under Section 11 if the company failed

to conduct a careful inquiry before pro-

viding an opinion, or if an inquiry yielded

unfavorable information, such as contrary

advice by lawyers, adverse analysis from

technical experts, or a negative position

from regulators. As Justice Kagan sum-

marized, under our securities laws, “say-

ing one thing and holding back another”

is not allowed. Indeed, the Court noted

that at least one attorney had specifically

warned Omnicare that its dealings “car-

rie[d] a heightened risk” of legal expo-

sure under anti-kickback laws.

The issues presented in Omnicare are

of great importance to the institutional

investor community. Institutional investors

commit billions of dollars annually to

public stock offerings, and the past year

witnessed a record number of IPOs —

over 860 deals globally raising over $160

billion, more than a third of which came

from the United States. Groundless opin-

ions have no place in securities offering

materials. Investors rely on registration

statements, and expect that opinions in

offering materials are made responsibly

as the product of a meaningful inquiry

and careful consideration. These standards

are critical to the strength and effective

functioning of the US capital markets,

and to the protection of valuable retire-

ment assets.

Omnicare is a clear victory for investor

rights and the integrity of our capital mar-

kets, particularly given recent rulings by

lower federal courts. Omnicare overrules

contrary precedent in both the Second

and Ninth Circuits, which had imposed

onerous standards on investors, requir-

ing them to marshal detailed facts at the

outset of a case showing that a speaker

did not honestly hold an opinion. Obvi-

ously, that is an extremely difficult stan-

dard for investors to meet without the

investigation and fact-finding afforded by

litigation discovery. Omnicare removes

that barrier in Section 11 cases involving

opinion statements. Moreover, Omnicare

is likely to be extended beyond the offer-

ing context and applied to other provisions

of the federal securities laws, including

those covering stock purchased on the

open market or acquired through mergers

and acquisitions.

While it remains to be seen how Omni-

care will be applied by the lower courts,

it bears emphasis that Omnicare is not

“an invitation to Monday morning quar-

terback an issuer’s opinions,” as Justice

Kagan explained. Instead, Omnicare re-

quires a complaint to “identify particular

(and material) facts going to the basis

for the issuer’s opinion—facts about the

inquiry the issuer did or did not conduct

or the knowledge it did or did not have —

whose omission makes the opinion state-

ment at issue misleading to a reasonable

person reading the statement fairly and

Omnicare is a clear victory for investor rightsand the integrity of our capital markets, particularly given recentrulings by lower federalcourts. Omnicare over-rules contrary precedentin both the Second andNinth Circuits, which had imposed onerousstandards on investors,requiring them to marshaldetailed facts at the outset of a case showingthat a speaker did nothonestly hold an opinion.

The registration statementis central to the mission of the Securities Act —

transparency. A sacrosanctdocument for investors, itrequires disclosure of an

array of detailed and important information

about the company, itsbusiness operations and

financial condition, andthe security being issued.

Investors should be allowed to take these

statements at face value,and not be forced to incur

additional costs of independent verification.

in context.” In most cases, this will require

a thorough investigation by counsel and

careful deliberation by the judge. How-

ever, it is likely that many more meritori-

ous Section 11 cases will survive as a

result of Omnicare’s sensible “reasonable

investor” test.

More broadly, Omnicare is a strong state-

ment from the nation’s highest court

affirming that investors properly rely on

the integrity of all statements in offering

documents and the special knowledge of

the company, its officials, underwriters,

auditors, and other experts who sign the

registration statement and convey infor-

mation to investors. The registration state-

ment is central to the mission of the

Securities Act — transparency. A sacro-

sanct document for investors, it requires

disclosure of an array of detailed and im-

portant information about the company,

its business operations and financial con-

dition, and the security being issued.

Investors should be allowed to take these

statements at face value, and not be forced

to incur additional costs of independent

verification. As the Court explained, the

utility of a securities prospectus would be

substantially eroded if those involved in

its preparation could avoid liability for

demonstrably untrue statements by hiding

behind “magic words” like “we believe.”

In reaching its decision, the Omnicare

Court considered amicus curiae (or “friend

of the court”) briefs supported by nearly

fifty prominent institutional investors

with more than $2 trillion of assets under

management. The Court’s decision in

Omnicare adopted many of the points

made in the institutional investor amicus

briefs, including that “[w]ere Omnicare

right, companies would have virtual carte

blanche to assert opinions in registration

statements free from worry about §11” —

an outcome that would “ill-fit Congress’s

decision to establish a strict liability of-

fense promoting ‘full and fair disclosure

of’ material information.” Additionally,

the Court firmly rejected the notion that

its ruling would chill useful disclosures.

The Court noted that issuers and others

involved in securities issuances have

“strong economic incentives” to sell and

“[t]hose market-based forces push back

against any inclination to underdisclose.”

Accordingly, the Court explained, its ruling

would chill only misleading opinions while

keeping “valuable information flowing”

and ensuring better disclosure to the mar-

kets. The voice of the institutional investor

community was clearly heard by the

Omnicare Court.

David Kaplan is an Associate at BLB&G’s

California office. He can be reached at

[email protected].



DILBERT © 2003 Scott Adams. Used By permission of UNIVERSAL UCLICK. All rights reserved.



the absence of proof of a meaningfully

close personal relationship that generates

an exchange that is objective, consequen-

tial, and represents at least a potential gain

of a pecuniary or similarly valuable nature.”

Analysis

In the wake of the Second Circuit’s deci-

sion, many respected commentators have

found the Court’s result to be dangerously

out of step with the realities of insider

trading as it is practiced today. The United

States Attorney’s Office for the Southern

District of New York, in a petition for the

Second Circuit to rehear the case en banc

(with all the judges hearing it, not just a

panel), “[p]ut simply, if the opinion stands,

the panel’s erroneous redefinition of the

personal benefit requirement will dramat-

ically limit the government’s ability to

prosecute some of the most common,

culpable and market-threatening forms of

insider trading.”

It is unclear what steps the government

will take in response to the decision. The

Second Circuit recently denied the gov-

ernment’s request to review its decision

as a full court en banc, meaning that the

government’s only legal resort in this

case is to petition the Supreme Court to

hear the case. Of course it is never a cer-

tainty that the Supreme Court would take

the government’s petition, but, at this

time, it is unclear whether the government

will even petition the Supreme Court.

Nearly six months after Newman made it

harder to win insider trading cases, in a

June 5 letter to the Court, federal prose-

cutors said they are “still considering”

whether to seek Supreme Court review of

the decision.

Many commentators have suggested that

the Second Circuit’s decision and the

facts of Newman demonstrate just how

pervasive a “tipping” culture is on Wall

Street and that the state of the law is

inadequate to combat insider trading.

Ray and Choi freely disclosed material,

non-public information to acquaintances,

apparently without expecting anything

in return. At trial, multiple Wall Street

insiders testified that companies routinely

leak financial results to select analysts, or

even provide them with feedback con-

cerning the accuracy of their models

when analyzing the company’s earnings.

The problem for institutional investors

then, is that there are people trading with

greater information to which they do not

have access.

Recently, Representative Jim Himes of

Connecticut introduced a bipartisan bill

that would define insider trading as a

crime separate and apart from Section

10(b). It would have the effect not only

of undoing the Second Circuit’s holding

in Newman, but also of codifying and

expanding the reach of insider trading

prohibitions. Commentators have noted

that such a statute could also be fairer to

criminal defendants because it would

give them more notice about what is and

is not illegal than the judicially-made pro-

hibitions in place today. Time will tell

whether any legislation gets passed, but

if Newman prods Congress to pass an in-

sider trading statute at long last, it will

have had at least some positive effect.

Catherine McCaw is a former Associate in

BLB&G’s New York Office.

In the wake of the SecondCircuit’s decision, manyrespected commentatorshave found the Court’s result to be dangerouslyout of step with the realities of insider tradingas it is practiced today.They have suggested thatthe Second Circuit’s decision and the facts ofNewman demonstrate thepervasiveness of the “tipping” culture on WallStreet, and that the stateof the law is inadequate tocombat insider trading.

Insider TradingContinued from page 15.



800-380-8496

E-mail: [email protected]

Editors: David Kaplan and Katherine StefanouEditorial Director: Alexander Coxe“Eye” Editor: Ross ShikowitzContributors: Abe Alexander, David Kaplan,Catherine McCaw, Edward Timlin andJohn Vielandi

The Advocate for Institutional Investors ispublished by Bernstein Litowitz Berger &Grossmann LLP (“BLB&G”), 1285 Avenueof the Americas, New York, NY 10019, 212-554-1400 or 800-380-8496. BLB&Gprosecutes class and private securitiesand corporate governance actions, nationwide, on behalf of institutions andindividuals. Founded in 1983, the firm’spractice also concentrates in general com-mercial litigation, alternative dispute reso-lution, distressed debt and bankruptcycreditor representation, patent infringement,civil rights and employment discrimination,consumer protection and antitrust actions.

The materials in The Advocate have been preparedfor information purposes only and are not intendedto be, and should not be taken as, legal advice.The thoughts expressed are those of the authors.

© 2015. ALL RIGHTS RESERVED. Quotation with

attribution permitted.

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How to Contact Us

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(212) 554-1584 [email protected]

Key to the Task Force’s mission is the

implementation of sophisticated analytic

tools to preemptively identify unusual

accounting treatments. Among the most

critical of the Task Force’s tools is its

Accounting Quality Model, a predictive

model that attempts to identify firms that

have made unusual accounting choices

relative to their peer group, such as an

unusually high number of off-balance

sheet transactions. In addition, the agency

is also developing a groundbreaking text

analytic tool that looks for potentially

false or misleading disclosures in finan-

cial statement footnotes and the “Manage-

ment Discussion and Analysis” portions

of firm filings.

With the economy improving, and incen-

tives for companies to engage in “earn-

ings management” on the rise, the SEC’s

Task Force could play an important role

in uncovering accounting misconduct

in the near term. That is, of course, if

resulting enforcement proceedings and

attendant policy matters are not ham-

pered by political dissent among the

SEC’s commissioners.

MIDAS

Complementing the SEC’s initiatives

under White’s tenure has been the Com-

mission’s utilization of more advanced

technology in its monitoring and enforce-

ment functions. Chief among these is its

Market Information Data Analytics Sys-

tem (“MIDAS”). Initiated in response to

the Flash Crash of May 26, 2010, and un-

veiled in January 2013, MIDAS collects

more than one billion records, time-

stamped to the microsecond, every day,

from each of the thirteen national equity

exchanges. Through MIDAS, the SEC

has access to almost real-time data

about every displayed order posted in

the national exchanges. This information

enhances the SEC’s forensic capabilities,

allowing the agency to investigate and

understand one-off events in the market,

like the 2010 Flash Crash that served as

the impetus for the program. For example,

if a particular stock or symbol dropped

five percent in a matter of seconds, then

skyrocketed, only to settle back to its

original price a few seconds later, MIDAS

would allow the SEC to reconstruct this

anomalous activity and better understand

whether it was caused by market forces

or manipulative trading.

In sum, the SEC’s new initiatives repre-

sent an aggressive expansion of the

agency’s enforcement regime and infra-

structure. However, these initiatives face

internal and external headwinds, and

only time will tell whether they are effec-

tive, and, in some circumstances, legally

viable.

Abe Alexander is an Associate in

BLB&G’s New York office. He can be

reached at [email protected].

SEC: Forging AheadContinued from page 25.

Follow us on social media:

and other key policymakers in Fall 2014,

urging prompt legislative action to limit

ATP Tour. The Delaware legislature and

Governor Markell agreed with investors.

By signing into law Senate Bill 75,

Delaware has prohibited the spread

of corporate fee-shifting provisions for

stockholder claims against Delaware cor-

porations or their directors and officers.

The institutional investor community,

which spoke with a clear voice in oppo-

sition to the ATP Tour decision, was

instrumental in delivering this victory for

shareholder rights.

Unfortunately, this key victory does not

end the matter. While stockholders have

won this battle, corporate interests will

almost certainly continue their efforts to

restrict stockholder rights and powers.

The U.S. Chamber of Commerce, for ex-

ample, may direct its lobbying efforts on

the fee-shifting issue to other states

where corporations frequently incorpo-

rate, opening new battlegrounds on this

critical issue. It is thus important that in-

vestors remain vigilant.

For further background on this ongoing

issue, please see “Dispatches from the

Battlefield: Will Fee-Shifting Bylaws Keep

Shareholders from the Courthouse?” on

page 10 of The Advocate.


Final WordSummer 2015

The institutional investor community,

which spoke with a clearvoice in opposition to

the ATP Tour decision,was instrumental in

delivering this victory forshareholder rights.

Delaware Enacts Legislation Banning Fee-Shifting Bylaws

The Editors O n June 25, 2015, shortly after

this issue of The Advocate went

to press, Delaware Governor

Jack Markell tendered investors a victory

in their ongoing battle against fee-shifting

provisions. By signing into law Senate

Bill 75, Governor Markell curbed the

Delaware Supreme Court’s recent deci-

sion in ATP Tour upholding a non-stock

corporation’s bylaw “shifting” its attor-

neys’ fees and expenses to any member

that brought a lawsuit against the corpo-

ration (or its directors and officers), but

failed to achieve a complete victory in the

lawsuit. The Delaware Supreme Court’s

decision attracted a great deal of atten-

tion in the financial community, spawning

a vociferous debate. While corporate

interests sought to expand fee-shifting

bylaws to public companies, the institu-

tional investor community understood

that if these provisions are allowed to

infect the charters of public corporations,

they would effectively eliminate stock-

holders’ ability to sue, even in the most

meritorious cases.

Recognizing the manifest unfairness

of such fee-shifting provisions and the

importance of this issue to the integrity

of the public capital markets, institutional

investors representing approximately $2

trillion in assets wrote Governor Markell

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