In Case You Missed It - Interesting Items for Corporate Counsel - April 2015

Stoel Rives LLP

  1. We knew someone would do this for us if we just waited long enough. A summary of early trends in proxy access responses suggests most are including the shareholder proposal and recommending a no vote. See here. Only a single (brave? misguided?) company has so far excluded a shareholder proposal in favor of a company proposal, a la Whole Foods. We expect the statements recommending no votes all look remarkably alike. Some additional fodder for statements in opposition might be found here.
  2. In February, we reported on a troubling district court decision that Wal-Mart must include a shareholder-proposed amendment to Wal-Mart’s charter requiring it to consider, and report on, whether selling firearms made it look bad. The Third Circuit Court of Appeals reversed the district court. The decision, here, overturned a permanent injunction against Wal-Mart from excluding the shareholder proposal and was published ahead of the Court’s opinion, which will come later. Because of the scare created by the district court, expect to read about this again when the opinion is published, even though we hope it will say not much more than “duh - ordinary business exception.”
  3. The SEC recently brought an enforcement action against KBR, Inc., claiming it violated whistleblower Rule 21F-17 : “No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.” Part of KBR’s internal investigation process, in place before Rule 21F-17 was adopted, required that internal whistleblowers acknowledge that “I understand that in order to protect the integrity of this review, I am prohibited from discussing any particulars regarding this interview and the subject matter discussed during the interview, without the prior authorization of the Law Department. I understand that the unauthorized disclosure of information may be grounds for disciplinary action up to and including termination of employment.” Even though the SEC had no evidence that the language was ever enforced or threatened to be enforced, or that it actually affected behavior, KBR settled the action by paying $130,000 and notifying those who signed the agreement that they weren’t prohibited from reporting potential violations of law to the SEC. The SEC’s cease and desist order is here and its press release is here. A cautionary editorial about yielding constitutional rights by rushing to modify your confidentiality agreements, at least in a way that allows a person to provide confidential documents to regulatory authorities, penned by Eugene Scalia (yes, relation) is here. Scalia’s editorial points out the SEC’s continuing efforts to expand its investigatory power and the ambiguity of what “communicating” with the SEC encompasses. Another piece decrying the SEC’s expansion into employment law is here. As you ponder whether and how to change your whistleblower and confidentiality agreements and policies, keep in mind that:
    • The SEC picked low-hanging fruit for its enforcement target – an implied threat of enforcement of confidentiality restrictions in the context of an actual whistleblower report – after, apparently, digging deep for a claim to bring (see here and here). The SEC may have neither the time nor the budget to go after companies with run-of-the-mill confidentiality agreements.
    • The SEC wouldn’t dare go after run-of-the-mill confidentiality agreements, as opposed to confidentiality provisions that apply specifically to settlements or internal investigations like KBR’s, and risk losing a challenge to what it hopes companies will believe is new federal policy . . . would it?
    • Presumably, nothing about the SEC’s actions prohibit the standard “Upjohn warning” to employees at the beginning of an interview that the interview is subject to attorney-client privilege and should remain confidential (as opposed to a blanket statement like KBR’s that the subject matter of the claim is confidential).
    • If Rule 21F-17 meant to say you must amend all confidentiality agreements to specifically carve out reports to federal agencies, it would have said that. But that might have been (gasp) unconstitutional. Even the SEC’s position with KBR is far from unassailable, to say nothing of downright un-American.
    • Considering the above, if you don’t have agreements that explicitly prohibit federal whistleblowing or that reinforce confidentiality obligations when a whistleblower has reported internally, doing nothing may be a reasonable strategy. (After all, in its settlement, KBR only agreed to send a corrective notice to whistleblowers who signed the confidentiality statement, not to all employees who might have confidentiality obligations generally.) You should pay particular attention to severance agreements and settlement agreements, which should not prohibit federal whistleblowing.
    • A statement in your whistleblower policy or employee handbook that “your obligations to protect and keep confidential Company information, whether under a confidentiality agreement or otherwise, do not restrict you from reporting potential violations of federal law under federal whistleblower laws” might suffice, rather than amending all existing employment agreements and in lieu of the more expansive language KBR adopted that allowed “reporting of any possible violations of federal law . . . to any governmental agency or entity.” More elaborate or nuanced statements that set the correct tone at the top to encourage internal reporting but that identify the company’s legitimate interest in preserving the confidentiality of its information, even from the federal government, might also be OK. Some additional in-house training on whistleblower compliance may be appropriate.
    • The SEC isn’t the only federal agency that has targeted confidentiality agreements in whistleblower contexts. See, e.g., the items here, here and here about the National Labor Relations Board’s efforts in this area.
    Law firm memos abound on the topic. A few are here, here, here and here.
  4. As a reminder about the SEC’s whistleblower program generally , which pays tipsters a bounty of 10-30% of monetary sanctions (if at least $1 million), recall:
    • Section 922 of Dodd-Frank, here, inserted a new Section 21F into the Securities Exchange Act to implement additional whistleblower protections.
    • SEC implementing rules, here, became effective August 2011.
    • The SEC Office of the Whistleblower publishes annual reports, available here. In 2012, the office received 3,001 tips and paid $50,000 to one whistleblower (this whistleblower subsequently collected $335,000 more through continued enforcement activities based on his information); in 2013, the office received 3,238 tips and paid $14,831,966; and in 2014, the office received 3,620 tips and paid $1,932,864. (Award amounts and payment amounts in a year don’t necessarily match.)
    • The SEC made awards to 14 whistleblowers under the program, one in 2012, five in 2013 and nine in 2014.
    • The SEC awarded a record $30 million to a whistleblower in September 2014, the fourth award to an individual in a foreign country.
    • The SEC awarded $300,000 in 2014 to an officer with internal audit responsibilities for reporting a matter that surfaced through the internal audit process, but was not acted on by the company for more than 120 days.
  5. The SEC adopted final “Regulation A+” rules, here. The rules will be effective sometime in June. The final rules look a whole lot like the proposed rules. Expect law firms to inundate you with summaries of the rules (see, e.g., here, here and here), but a few highlights are below.

    Tier 1 offering:
    • “Bad actors” not eligible.
    • Up to $20 million in a 12-month period, including up to $6 million from affiliated shareholders.
    • Limit selling shareholders to 30% of any offering.
    • “Test the waters” communications permitted.
    • Abbreviated registration statement subject to SEC staff review, with a few additions to existing requirements. Confidential submission process available.
    • Form 1-Z filed upon completion or termination of the offering.
    • Exemption does not preempt state blue sky law.
    Tier 2 offering:
    • “Bad actors” not eligible.
    • Up to $50 million, including up to $15 million from affiliated shareholders.
    • Limit selling shareholders to 30% of any offering.
    • “Test the waters” communications permitted.
    • Same abbreviated registration statement subject to SEC staff review as Tier 1, but audited financial statements are required. Confidential submission process available.
    • Ongoing public reporting requirements, including annual report on Form 1-K, semi-annual reports on Form 1-SA and current reports on Form 1-U.
    • May file a Form 1-Z to exit reporting obligations after reporting for one full fiscal year, if fewer than 300 shareholders of record.
    • May use short form 8-A to register shares for trading on an exchange.
    • Investment limited to the greater of 10% of investor's annual income or net worth.
    • Exemption preempts state blue sky law.
    Likely, not many will make a Tier 1 offering, which requires compliance with state securities laws. Proposed Tier 2 offerings, which are really mini-IPOs, have more potential and might prove a useful fundraising alternative to Rule 506 under Regulation D. The two primary advantages of Regulation A+ over Regulation D are that the securities sold are not “restricted securities” subject to resale limitations under Rule 144 and that sales may be made to an unlimited number of non-accredited investors.
  6. The U.S. Supreme Court clarified in Omnicare v. Laborers District Council Construction Industry Pension Fund, here, that a “belief” expressed in a registration statement does not form the basis for a material misstatement as long as the belief was honestly held and as long as the belief rested on a reasonable basis (or, phrased in a more syntactically complex way: “Thus, if a registration statement omits material facts about the issuer’s inquiry into or knowledge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself, then §11’s omissions clause creates liability.”). Although how “reasonable” a belief must be begs for more litigation, I believe the holding is obvious. (I base that view on no external sources whatsoever; I did go to law school, however. Which way that cuts on the reasonableness of my belief is up to you. My belief is not valid for residents of South Carolina and Pennsylvania.)
  7. Finally, as if we needed more memos on cybersecurity , here is another, albeit one geared toward directors and officers that promises to be “practical.”

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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