Corp Law Blog

As Amended

When you refer to the Securities Act of 1933, do you write "Securities Act of 1933, as amended?"

If so, what do you accomplish by appending "as amended?"

When you use the words "as amended," do you mean as it has been amended from 1933 through today? If so, why do you use indefinite words like "as amended" when you mean something like "as amended to date" or "as in effect as of the date hereof" instead?

Or, when you use the words "as amended," do you mean as it has been amended and may be further amended in the future? If so, why not use "as now or hereafter in effect, or any successor thereto" instead?

Either way, when you see a citation to the "Securities Act of 1933" without the words "as amended," is it your position that the citation refers only to the statute as it existed in 1933?

And how do you interpret Section 1 of the Securities Act of 1933, which tells us that the short title of the Securities Act of 1933 is the "Securities Act of 1933" (no reference to "as amended")?

Just wondering.

Scrushy to SOX: "906 Must Go!"

Last month Richard Scrushy's attorneys filed their much anticipated challenge to Section 906 of the Sarbanes-Oxley Act of 2002. For Corp Law Blog's carefully managed build-up to this great event, see "Scrushy to SOX: 'You're Illegal!'" and "Scrushy to SOX: 'Parts of You May or May Not Be Illegal, I'm Not Sure Yet'."

The pages of Corp Law Blog are filled with Scrushy's exploits. Who can resist a guy who turns a Big 4 auditing firm into certified toilet auditors, who hires big brother Wayne from "The Wonder Years" as a corporate executive, who refuses to leave his company's board while fighting criminal and civil actions and who oversees the worst special litigation committee ever?

This time he's serious. And I'm taking him seriously.

Scrushy's motion to dismiss the Section 906 counts (PDF) carefully dissects Section 906, revealing the many flaws of statute I've previously observed must have been "drafted on the back of a used cocktail napkin."

Consider the following points made by Scrushy's lawyers:

• SOX makes it a crime not to file a 906 certification, even if the CEO or CFO is unable to determine whether or not the certification is true. This puts the CEO and CFO in a "damned if you do and damned if you don't" situation.
• Section 906 can create criminal liability for certifying underlying conduct that itself isn't criminal.
• Section 906 is too vague -- terms like "fairly present" and "in all material respects" are too subjective to serve as the basis for criminal liability.
• A lot depends on the word "willful," a word of many meanings none of which are specified in Section 906. An officer whose certification is knowing faces up to $1 million in fines and 10 years behind bars, while an officer whose certification is knowing and willful faces up to $5 million in fines and 20 years behind bars.
• Section 906 was drafted in "careless haste" by a Congress that doesn't, to this day, understand it.

I'm no con law or crim law expert, but I think he's onto something.

All this reminds me of a penetrating and prescient analysis of Section 906's perniciousness penned by Sy Lorne only a month after Sarbanes-Oxley passed. Sy, a former general counsel of the SEC and a former colleague of mine, identified three concerns with Section 906's "extraordinary legislative mandate" that echo throughout Scrushy's motion:

First, it is not clear who has liability, if anyone, for a failure to observe the obligation. Written in the passive voice, the statute . . . merely provides that "[e]ach periodic report containing financial statements . . . shall be accompanied by a written statement . . ." to the effect that the report complies with the requirements and contains information that "fairly presents . . . the financial condition and results" of the issuer. Although Section 3(b)(1) of Sarbanes-Oxley provides generally that there are criminal penalties for violations of the statute, it is not clear whether it is the issuer or the executives who are susceptible to being charged.

Second, due to its curious wording, the only clear basis for "violating" the statutory requirement (which, as a criminal statute, presumably will be strictly construed) is to submit a certificate in a form that does not comply with the statutory requirement. There is no clear provision in the statute that the certificate must be correct, or that one would violate the law by submitting a certificate that, although containing the requisite language, is false. . . .

Third, the Section 906 requirement suggests the lack of Congressional (and popular) appreciation for the endless judgments that are necessarily a part of accounting. The popular view is that the numbers should be "right." But what does "right" mean? A country club has acres of land in the middle of town that were bought a hundred years ago for $10,000 and remain on the books at that value. Accounting convention generally forbids writing it up. Is that number right? Do those financial statements "fairly present" the financial position of the club in some abstract sense? Clearly not.

From "Sarbanes-Oxley: The Pernicious Beginnings of Usurpation?" from the Wall Street Lawyer (footnote citations omitted).

For more, see "A Challenge to Sarbox Constitutionality" (CFO.com) and Scrushy's press release announcing the motion. Thanks to Broc Romanek for locating the motion and linking to it in his essential blog.

Solving the World's Problems In SEC Reports

Once upon a time, the federal securities laws had the parochial goal of ensuring that companies provided investors with information material to investment decisions.

These days those laws are spreading their wings to accommodate all sorts of goals.

Earlier this year, Congress directed the SEC to require companies to disclose their ties to rogue states.

Last month, New York Congressmen Anthony Weiner and Steve Israel introduced the Publish What You Pay Act of 2004 (PDF), a bill that would require issuers to disclose in SEC reports payments made to foreign governments for the extraction of natural resources:

The Securities and Exchange Commission shall revise its rules and regulations . . . to require each [reporting] issuer to disclose in the annual and quarterly reports of such issuer the aggregate payments by such issuer made in connection with the securing of exploration, development, exploitation, extraction, and production rights for natural resources to any foreign government or any other public entity of a foreign country. Such aggregate payments shall include taxes, royalties, fees, and other amounts paid in such connection.

The Congressmen's joint press release reports that these disclosures will protect U.S. companies and consumers from corrupt foreign governments:

"The added sunshine on these deals will level the playing field, and allow corporations to make reasoned judgments about the costs and returns associated with contracting with a particular foreign government," said Rep. Weiner. "Corrupt regimes will be less able to shake down one corporation and move on to another because everyone will know what’s going on. Just as important, investors will know that their dollars are being spent wisely."

Israel added, "With the release of today’s report, Americans find that the record high prices they’re paying at the pump are being spent to prop up dictators and pay off corrupt regimes. This legislation requires full disclosure so that we can finally open the books to consumers, investors and government officials and slam the door on corruption and human rights abuse."

Nothing in the law would require private companies, or foreign companies not obligated to report in the U.S., from making unreasoned judgments when contracting with corrupt foreign governments. I suppose that oversight could be fixed during the rulemaking process.

The federal securities laws: Is there any problem they can't solve?

UPDATE: An alert reader points out that the Investor Network on Climate Risk is trying to get the SEC to require issuers to discuss global warming risks in their SEC reports. See "Thirteen Pension Leaders Call on SEC Chairman to Require Global Warming Risks in Corporate Disclosure" from the INCR website.

Technicolor Dreams Fade

On December 31, 1982, MacAndrews and Forbes Group acquired a little over 82% of Technicolor at $23.00 per share, and soon afterwards acquired the rest of the shares by a cash-out merger at the same price.

Holders of 201,200 shares dissented, invoking Delaware's appraisal rights statute.

Over twenty years later, after five remands from the Delaware Supreme Court and two trials, Chancellor Chandler, in Cede & Co. v. Technicolor, Inc. (Del. Ch. 2003), awarded the dissenters $23.22, a whopping 22 cents over the acquisition price.

Magnifying the pointlessness of this modern day Jarndyce v. Jarndyce, Chancellor Chandler emphasized that, even after decades of litigation with reams of expert reports and days of expert testimony, in reaching his holding he pretty much pulled the number out of a hat:

Although 8 Del. C. § 262 requires this Court to determine "the fair value" of a share of Technicolor on January 24, 1983, it is one of the conceits of our law that we purport to declare something as elusive as the fair value of an entity on a given date, especially a date more than two decades ago. Experience in the adversarial battle of the experts’ appraisal process under Delaware law teaches one lesson very clearly: valuation decisions are impossible to make with anything approaching complete confidence. Valuing an entity is a difficult intellectual exercise, especially when business and financial experts are able to organize data in support of wildly divergent valuations for the same entity. For a judge who is not an expert in corporate finance, one can do little more than try to detect gross distortions in the experts’ opinions. This effort should, therefore, not be understood, as a matter of intellectual honesty, as resulting in the fair value of a corporation on a given date. The value of a corporation is not a point on a line, but a range of reasonable values, and the judge’s task is to assign one particular value within this range as the most reasonable value in light of all of the relevant evidence and based on considerations of fairness.

No word yet whether this latest holding will be appealed.

What Weblogs Can Do To You

In "What Weblogs Can Do For You" (Illinois Bar Journal), Evan Schaeffer takes some shots at Corp Law Blog:

Mike O'Sullivan's Corp Law Blog is as well written as any legal magazine. [faint praise, indeed] The blog's focus is suggested by its title; O'Sullivan covers "issues encountered by corporate lawyers." But he does it with style and verve [he left out "pizzazz" and "flash"], regularly making topics like Sarbanes-Oxley almost fun to read about ["almost" fun means not quite fun which means the opposite of fun which means boring -- we get the message, Evan, loud and clear].

Evan obviously thought he could pick on a dormant blog, one that wouldn't have the will to respond. Evan, you thought wrong. Corp Law Blog is back with a vengeance, and promises to pump out even more long and boring Sarbanes-Oxley posts and whiny attacks on Eliot Spitzer and ill-informed explications of Microsoft's option exchange program and obscure diatribes against unused clause identifiers and ill-used amongs and betweens.

You wondered what a weblog could do FOR you? Pretty soon you'll learn what a weblog can do TO you!

You might think I'm overreacting, that Schaeffer is just a tough critic. How, then would you explain the way he gushes like a lovesick teenager when he describes ProfessorBainbridge.com as "an always-entertaining blog," Stay of Execution as "always witty and entertaining," Benefitsblog as "original [and] timely" and My Shingle as "free"?

In fairness, Evan did manage to hit the bulls-eye when he warned potential readers of Howard Bashman's How Appealing blog that "you'll have trouble" with that blog. Nothing but trouble.

Barney Frank Proposes Eliminating Stock Options

In late April, Massachusetts Representative Barney Frank introduced a bill to eliminate stock options for executives and directors.

Frank's "Executive Stock Option Profit Recapture Act (H.R. 4208)" (PDF) would achieve this result indirectly by limiting gains on the exercise of options to the lesser of (1) the gain realized on the date of exercise or (2) if the company's stock price declines by a "material amount" within one year following exercise, the gain that would have been realized if the option had been exercised at the end of that one year period:

The Commission shall prescribe rules requiring that, if, at the end of a period ending one year after one or more of the five most highly compensated executive officers or the directors of an issuer have exercised options on securities of an issuer granted to the executive officer or director as compensation, the stock of the issuer has declined by a material amount, as determined by the Commission by rule, then such executive officer or director shall be required to reimburse the issuer for all gains realized on the sale of securities obtained as a result of the option exercise that are in excess of any gains that would have been realized had the securities been sold at the stock price at the end of such one-year period.

Frank's proposed legislation would be inserted into Section 304 of the Sarbanes-Oxley Act. Unlike current Section 304(a), which requires a CEO and CFO to repay bonuses and stock sale profits after "an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct," Frank's legislation would punish executives and directors whether or not they engaged in any misconduct or their companies were in compliance with law.

So, if Frank's bill passes, and the stock markets suffer steep declines due to interest rate increases, war, terrorism or election concerns, executives and directors lucky or smart enough to have exercised options before the market tanked would have to forfeit much of their gains.

Microsoft's move to restricted stock looks smarter and smarter. . . .

(Thanks to the Securities Law Beacon for the pointer.)

The Martin Act: A Weapon of Mass Destruction

The four horsemen of corporate law? These days they're the '33 Act, the '34 Act, the Sarbanes-Oxley Act and the Martin Act.

New York's Martin Act is a fierce sword of uncertainty when wielded by New York Attorney General and Future Governor-Elect Eliot Spitzer. Nicholas Thompson, in "The Sword of Spitzer" (Legal Affairs), delves deep into the history of the Act and recounts Spitzer's masterful exploitation of its seemingly endless possibilities:

The push of the Martin Act is to arm the New York attorney general to combat financial fraud. It empowers him to subpoena any document he wants from anyone doing business in the state; to keep an investigation totally secret or to make it totally public; and to choose between filing civil or criminal charges whenever he wants. People called in for questioning during Martin Act investigations do not have a right to counsel or a right against self-incrimination. Combined, the act's powers exceed those given any regulator in any other state.

Now for the scary part: To win a case, the AG doesn't have to prove that the defendant intended to defraud anyone, that a transaction took place, or that anyone actually was defrauded. Plus, when the prosecution is over, trial lawyers can gain access to the hoards of documents that the act has churned up and use them as the basis for civil suits. "It's the legal equivalent of a weapon of mass destruction," said a lawyer at a major New York firm who represents defendants in Martin Act cases (and who didn't want his name used because he feared retribution by Spitzer). "The damage that can be done under the statute is unlimited."

The article offers many interesting details, including:

When a securities lawyer and fellow Morgenthau alum named Eric Dinallo talked about the Martin Act during a job interview, Spitzer grasped its potential in a way that his predecessors hadn't. . . .

Spitzer's boldness has attracted great attention, and talent, to his office. "When we were prosecuting worm farms, it didn't make the front page of The Times, and law students weren't coming to us," said Assistant Attorney General Elizabeth Block. . . .

Yet Spitzer is nonchalant about what could happen to the Martin Act once his term ends. At a recent speech to alumni of New York University School of Law, he admitted the potential pitfalls of allowing 50 states to regulate the international financial markets. Diminishing the states' power would be okay, he said, as long as it didn't happen in "the next three years" -- a period that conveniently stretches until January 2007, when Spitzer might well have a new job in Albany.

See also "Why It Isn't Fair to Compare the SEC to Eliot Spitzer" for more on the Martin Act.

Eliot Spitzer's Urtext

Recently while engaging in some particularly deep legal research, I came across the earliest-known version of New York's Martin Act:

102. If a merchant entrust money to an agent (broker) for some investment, and the broker suffer a loss in the place to which he goes, he shall make good the capital to the merchant.

This urtext is, literally, an Ur-text, taken from The Code of Hammurabi. I'm sure some hotshot prosecutor with political ambitions made hay out of this one in Babylonia.

The Code of Hammurabi is principally known today as the source of the "an eye for an eye" school of criminal justice. But it's so much more. For instance, it provides the legal basis for an early form of secured lending:

117. If any one fail to meet a claim for debt, and sell himself, his wife, his son, and daughter for money or give them away to forced labor: they shall work for three years in the house of the man who bought them, or the proprietor, and in the fourth year they shall be set free.

To help debtors avoid this harsh foreclosure process, the Code offers its own force majeure clause:

48. If any one owe a debt for a loan, and a storm prostrates the grain, or the harvest fail, or the grain does not grow for lack of water; in that year he need not give his creditor any grain, he washes his debt-tablet in water and pays no rent for this year.

The Code also contains an early illustration of the term "poetic justice":

25. If fire break out in a house, and some one who comes to put it out cast his eye upon the property of the owner of the house, and take the property of the master of the house, he shall be thrown into that self-same fire.

Essential Sources: These Are a Few of My Favorite Corp Law Web Sites

A few months ago I penned a paean to the SEC's website (see "A Random Walk Through the SEC's Website"), gushing that it was the most "essential corporate law source of them all."

At the time, I figured I'd soon be pounding out tributes to my other favorite corp law sites. Instead, I got really busy with work. Instead of writing about these other sites, I found myself using them in my work more than ever before. Many of them on a daily basis.

Below I've listed the eight sites I used the most in my work over the last few months. This list doesn't include all my favorite sites, just those I found myself returning to day after day over the last few months to help with work-related issues.

10kWizard. EDGAR is the world's best precedent library for corporate lawyers. In order use all the features of this library, you need a premium EDGAR retrieval service that gives you flexible search, display and downloading options. I've used 10kWizard since it was free. Even now that it's not free, I appreciate that its fee structure permits unlimited searches for a fixed annual fee. That permits me to surf EDGAR in a mildly focused way, unconcerned that my aimless searches are racking up huge client charges. Instead of printing out or downloading SEC reports, I often just call them up on 10kWizard when I want to review them. I'm sure other premium EDGAR services offer these features and more -- many of my colleagues swear by the feature-rich LivEDGAR -- but I'm used to 10kWizard and unwilling at this point to try anything else.

TheCorporateCounsel.net. When I was a pup, the cumulative index to the bound editions of The Corporate Counsel was my main source for locating practical securities law commentary. Whenever I had a securities law question, after checking the law and the relevant SEC telephone interpretations, I would stroll to the library, peruse the The Corporate Counsel's cumulative index, and usually end up finding two or three articles on point. Today those binders filled with yellowed newsletters are all online in a fully searchable database at TheCoporateCounsel.net. While that database is, in my view, reason enough to obtain an online subscription, you can also find law firm memos organized by topic, special pages devoted to topics like Regulation G and Rule 402 Cashless Exercises, and many other features only a corporate lawyer could love.

TheCorporateCounsel.net Blog (aka Broc's Blog). Years ago Broc Romanek started the first corporate law blog at RR Donnelly's RealCorporateLawyer.com. When Broc moved over to The Corporate Counsel, he brought his blog with him. While I enjoy reading many blogs, none are more useful to me in my day-to-day practice than Broc's. Broc has his finger on the pulse of corporate law departments and corporate lawyers, often anticipating issues before the rest of us have thought of them. Best of all, Broc's blog is free, so you can read it every day (like I do) even if you don't subscribe to The Corporate Counsel.

DealBook. The New York Times's DealBook is the best business blog. It's not listed on my sidebar because it's not a website. Instead, it's delivered the old-fashioned way -- by email. Every business day DealBook serves up blurbs from and links to 30 to 40 business-related stories from the New York Times and, importantly, many other newspapers, magazines and other publications. Some subscription-only publications make selected content freely available to DealBook readers. In times like these, when I don't have enough time to read my favorite business publications, DealBook provides me with a quick injection of business news without any fuss. DealBook is free to those who register with the New York Times's online edition.

FindLaw. Convenience. That's why I so often find myself navigating to Findlaw when I could instead be flipping through a code book. Sometimes I'm on a call and want to call up a provision I thought I knew by heart. Other times I want to send a snippet from a code to someone and find it easiest to just copy and paste it from Findlaw into an email. Still other times I run across a statutory reference and wonder what it is. And that's just when I'm looking for codes and rules. Findlaw is still the largest repository for, and directory to, free case law. I don't think it's any secret that this is one of the best free legal resources on the web.

Google. It's unbelievable how much legal information I get off Google these days.

RealCorporateLawyer.com. RR Donnelly's contribution to the corporate lawyer's cornucopia of web sites has several features that keep me coming back. Its home page is a model of clarity, displaying headlines under four categories (SEC Daily Briefs, SEC & Other Regulatory Developments, Breaking News and Special Features). Donnelly's staff does a good job keeping the headlines up to date each day. The site's "What's New on the SEC's Website?" feature tells you -- you guessed it -- what's new on the SEC's website each day. A real timesaver for habitual SEC website surfers like me. I've long felt that Wachtell Lipton's client memos are the best in the field -- timely, succinct and opinionated. If you do not have the good fortune to be on Wachtell Lipton's mailing list, you can usually find their latest offerings in RealCorporateLawyer.com's Special Features section, which links to recent law firm memos.

Securities Lawyer's Deskbook. The University of Cincinnati cranks out such a good compendium of securities laws, the SEC doesn't even try to compete. I probably have more printed sources for federal securities laws and rules than anything else, yet I find myself clicking through to the Securities Lawyer's Deskbook all the time. I appreciate the clean redesign, the word search feature, the quick navigation, the focus on just the laws and rules I work with the most. It's really a nice service. And best of all, it's available wherever you have a computer and an internet connection, allowing you to leave those bulky Appeal and CCH binders back at the office.

These are a few of my favorite corp law-related web sites. Do you have other favorite corp law sites? If so, please let me know and I'll consider them for future Essential Sources postings. Just drop me a line at corplawblog at yahoo dot com.

SEC Adopts "Real-Time" 8-K Disclosures

Yesterday the SEC announced that it adopted new 8-K reporting rules previously proposed in June 2002.

Although initially proposed before the Sarbanes-Oxley Act passed, the new rules are intended to respond to Section 409 of the Act, which requires public companies to:

disclose to the public on a rapid and current basis such additional information concerning material changes in the financial condition or operations of the issuer, in plain English, which may include trend and qualitative information and graphic presentations, as the Commission determines, by rule, is necessary or useful for the protection of investors and in the public interest.

Form 8-K disclosures will need to be made within four business days, down from the current five business day/fifteen calendar day deadlines assigned to different 8-K items. The original rule proposal called for a two business day deadline.

The new rule will be effective on August 23, 2004. The text of the new rule isn't available yet. The SEC's press release lists eight new disclosure categories:

• entry into a material non-ordinary course agreement;
• termination of a material non-ordinary course agreement;
• creation of a material direct financial obligation or a material obligation under an off-balance sheet arrangement;
• triggering events that accelerate or increase a material direct financial obligation or a material obligation under an off-balance sheet arrangement;
• material costs associated with exit or disposal activities;
• material impairments;
• notice of delisting or failure to satisfy a continued listing rule or standard; transfer of listing; and
• non-reliance on previously issued financial statements or a related audit report or completed interim review (restatements).

Two other disclosure items have been moved into Form 8-K from other forms:

• unregistered sales of equity securities; and
• material modifications to rights of security holders.

Finally, the SEC has also expanded disclosure requirements for two items already included in Form 8-K:

• departure of directors or principal officers, election of directors, or appointment of principal officers; and
• amendments to Articles of Incorporation or Bylaws and change in fiscal year.

In a securities conference I reported on last year, Marty Dunn of the SEC acknowledged that the new 8-K triggers would have to be precisely defined so that companies would know right away whether they had an 8-K disclosure obligation. Some of these items should not be difficult to report -- you don't need to spend much time deciding whether you've amended your certificate of incorporation and it shouldn't be too difficult to describe the amendment. It may take a great deal of thought for companies to figure out whether other items are reportable -- for instance, it's not always clear which agreements are material, non-ordinary course agreements -- and what should be said about them. I'm hoping the final rules provide this precision.

If a company fails to disclose some of these events in a timely manner, the new rules will offer a limited exemption from the Exchange Act's anti-fraud provisions:

The amendments will create a limited safe harbor under Exchange Act Section 10(b) and Rule 10b-5 for failure to file timely seven of the new items on Form 8-K. The safe harbor will not apply to, or impact, any other duty to disclose a company may have and extends only until the due date of the company's periodic report for the relevant period.

This is certainly welcome, but the main late filing gotcha that concerns most companies is losing S-3 eligibility for a year -- the instructions to Form S-3 require the issuer to have "filed in a timely manner all reports required to be filed during the twelve calendar months and any portion of a month immediately preceding the filing of the registration statement." The Form 8-K is a report and, presumably, 8-Ks filed after the four business day deadline will not be considered timely for purposes of the S-3 eligibility instructions. The SEC's press release doesn't discuss this issue, but I expect the final rule release will.

House Finl Svcs Comm Assists SEC, Slams Top 250 Companies

Yesterday the House Committee on Financial Services announced that it had approved the Securities Fraud Deterrence and Investor Restitution Act (H.R. 2179). The committee print of H.R. 2179 and the various amendments offered at yesterday's hearing can be viewed here. I initially discussed this bill back in May 2003 in "House Offers SEC More Enforcement Tools."

The version approved by the committee omits a controversial provision that would have limited the authority of state regulators, such as Eliot Spitzer, to regulate brokers and dealers. This makes it much more likely the bill will eventually pass. See "House panel kills 'anti-Spitzer' measure, boosts SEC" (Reuters) for more details on the ins-and-outs behind the committee's consideration of the anti-Spitzer provision and a somewhat less controversial anti-homestead law provision that survived yesterday's mark-up.

Of more interest to me are two provisions that haven't received much media attention.

First, the bill would permit companies to share documents with the SEC and the DOJ without waiving the attorney-client privilege or the protection of the work product doctrine for those documents:

Notwithstanding any other provision of law, whenever the Commission or an appropriate regulatory agency and any person agree in writing to terms pursuant to which such person will produce or disclose to the Commission or the appropriate regulatory agency any document or information that is subject to any Federal or State law privilege, or to the protection provided by the work product doctrine, such production or disclosure shall not constitute a waiver of the privilege or protection as to any person other than the Commission or the appropriate regulatory agency to which the document or information is provided.

This provision would prevent situations like the one McKesson HBOC recently found itself in -- forced to share privileged documents with plaintiffs' counsel because it had previously shared them with the SEC and the DOJ (see "Caught Between a Regulatory Hammer and the Rabid Plaintiffs' Bar").

The privilege protections in this provision are not absolute, however. As I discussed in "Caution: Read This Before Giving Privileged Documents to the SEC!," the SEC will always retain the right to share the privileged and protected documents with others if, in the words of Enforcement Chief Stephen Cutler, the SEC determines that it is "necessary in furtherance of the discharge of its duties and responsibilities." When the SEC starts sharing documents with others, it's possible that any privileges or protections for those documents would be lost.

Second, the bill retains the Sherman Amendment, a provision that requires the SEC, within one year following enactment of the bill, to:

conduct a thorough review of the financial statements contained in the most recent periodic disclosures filed with the Commission by the largest 250 reporting issuers . . .[and to] query such issuers with respect to any confusing, ambiguous, or unclear statement in such disclosures that would be of interest to investors.

The bill also invites the SEC to require a company to obtain an auditor's opinion certifying that the company's responses to the SEC's queries comply with GAAP. I previously criticized this ill-considered amendment in "Proposed Bill Would Require SEC to 'Thoroughly Review' Top 250 Companies" and I continue to think it's unnecessary, it's costly (both to the SEC and issuers), its review standards themselves are confusing, ambiguous and unclear and it will make it more difficult for the top 250 companies to access the capital markets while they are subject to this needless review process.

Painful Lessons: How Pete Rose Paid $1,000,000 For a Meaningless Contract Clause

Last month Sports Illustrated reprinted an excerpt from Pete Rose's quasi-semi-sorta-confessional book My Prison Without Bars.

The baseball part of my brain started reading the excerpt, but the corp law part of my brain took over when I got to the following paragraphs:

On Aug. 24, 1989, commissioner Bart Giamatti held a press conference at the Hilton New York and announced I had agreed to be placed on the permanently ineligible list in accordance with Major League Rule 21. The settlement stated: "The Commissioner will not make any formal findings or determinations on any matters including without limitation the allegation that Peter Edward Rose bet on any Major League Baseball game." The settlement also stated, "Neither the Commissioner nor Peter Edward Rose shall be prevented by this agreement from making any public statement relating to this matter so long as no such public statement contradicts the terms of this agreement and resolution."

Shortly after the commissioner announced the settlement, he fielded questions from the media. When asked about his personal opinion, Mr. Giamatti replied that based upon reading the Dowd Report [the 225-page product of the commissioner's investigation headed by special counsel John Dowd, available here], he believed that I did bet on baseball. My lawyers and I were slack-jawed. We felt like we had been slapped in the face. Within hours after signing the agreement, which made "no finding," the commissioner had reneged on his own terms!

Wait a minute. The settlement agreement prevented Commissioner Giamatti from making formal findings or determinations. When Giamatti offered his "personal opinion" at the news conference, he was hardly making a formal finding or determination.

Also, contrary to Rose's account, the Agreement and Resolution that Rose signed does contain a finding -- an admission by Rose, of all people:

Peter Edward Rose acknowledges that the Commissioner has a factual basis to impose the penalty provided herein.

It's difficult to imagine this being anything other than an admission by Rose that he bet on baseball -- the only factual matter being penalized. So when Commissioner Giamatti gave his personal opinion that Rose bet on baseball, he was arguably just saying what Rose had already acknowledged in the agreement.

But this is all technical and largely beside the point. Does anyone think the commissioner of baseball would go to the trouble of imposing a lifetime ban on a star player like Rose if the commissioner didn't personally believe the allegations made against Rose? How could Rose have thought anyone would interpret the entire action against him as anything less than a very strong finding that he bet on baseball?

Sadly for Rose, he appears to have paid dearly for his practically meaningless contract clause:

I spent over a million dollars on legal fees and investigators. I fought through baseball's worst scandal ever. And at the end of the day I came away with the exact settlement I would have received if I had confessed in the beginning -- lifetime ban, the death penalty. But I got something they would not have given me without a fight -- an agreement that made no finding that I bet on baseball. An agreement that I believed would allow me to return to the game I loved and eventually be inducted into the Hall of Fame. As it turned out, the agreement wasn't worth the paper it was written on.

The agreement was worth a great deal -- to baseball, if not to Rose. In the agreement, Rose acknowledged the "factual basis" for the allegations against him, acknowledged the power of the commissioner to ban him from baseball and agreed to withdraw a pending lawsuit against the commissioner.

Rose apparently thought he was getting something in return. Only after signing the contract did he learn that he wasn't. Before reading the excerpt from Rose's book, I assumed the "no formal finding" language was there because Rose believed Giamatti was out to get him, and the lack of a formal finding would make it easier to persuade a future commissioner to lift the ban. After reading Rose's excerpt, it seems instead that Rose thought if he could only muzzle Giamatti, he could preserve his halo from the taint of the gambling charges. Rose seems to have forgotten that most of us would assume, on hearing that he was banned from baseball for gambling, that he did in fact gamble on baseball. We wouldn't wait for further findings, or reserve judgment on the matter until Giamatti weighed in with his personal opinion. We'd just know.

Some painful lessons teach us that the devil is in the details -- if we'd only crafted the provision with more care, we could've achieved our goal and avoided the pain. This painful lesson teaches us that contracts can't accomplish the impossible. Even if some of the technical drafting details in Rose's contract had been handled differently -- if formal and informal findings and personal opinions had been banned, if Rose hadn't acknowledged the "factual basis" for the penalty -- Rose's lifetime ban from baseball could only be perceived by the world as a strong finding of Rose's guilt. No amount of clever contract drafting would have prevented this. It's too bad Pete Rose had to pay more than $1,000,000 to learn this painful lesson.

California Bill Would Replace SEC, Throw Open Doors of Direct Access

Today Broc Romanek of TheCorporateCounsel.net Blog points out a troubling development in my own backyard.

The Corporation Elections Fairness Act of 2004 (AB 2752), introduced in the California State Assembly last Friday, attempts to preempt the Williams Act and the SEC's own direct shareholder access proposal.

If enacted, the bill would attempt to require public companies doing business in California to permit shareholder groups holding at least 2% of a company's voting securities to nominate directly at least 40% of the company's directors in each board election. Each public company would have to facilitate the direct nomination process by permitting shareholder groups to solicit support on the company's website and in its proxy statement.

The bill would also require a corporation doing business in California to implement any shareholder proposal that passed by a majority vote, unless the proposal was clearly advisory in nature.

I'd guess that most public companies do business in California. Therefore the bill, if passed, would attempt to transfer authority over most public company elections from the SEC to the California Secretary of State. That's a pretty neat trick. Imagine if New York, Texas, Florida, Illinois and other big states also stretched their long arms to take a crack at regulating public company proxy procedures. What a crazy patchwork quilt that would be. It's times like this that I wish we had some sort of federal constitutional clause establishing the supremacy of federal laws over state laws.

The bill was introduced by Assemblymember Judy Chu and, according to Broc, is being pushed by California Secretary of State Kevin Shelley. Union and government employee pension funds and other anti-corporate crusaders can thank Chu and Shelley for offering them what the SEC failed to offer in its recent shareholder access proposal. I've previously discussed the politics behind the SEC's direct access proposals in "Public Pension Funds Reveal True Stripes" and "Separating Investors from Activists."

California's legislature is a fertile breeding ground for anti-business bills (see "A Trip to the Sausage Factory" and "Four Bills for Lerach") but, thankfully, most of them get killed before they can do any damage. Here's hoping this one has the lifespan of a mayfly.

Caught Between a Regulatory Hammer and the Rabid Plaintiffs' Bar

Last Friday, a California Court of Appeal held that a public company waived the protections of the attorney-client privilege and the work product doctrine when it shared protected documents with the SEC and the U.S. Attorney. See McKesson HBOC v. Superior Court (available in PDF or Word).

After discovering accounting problems at an acquired company (see "McKesson and the Public Company Premium" for some background), McKesson HBOC found itself facing private securities litigation and investigations by both the SEC and the U.S. Attorney. McKesson hired outside counsel to investigate the issues. McKesson's outside counsel conducted 37 witness interviews and delivered a report to McKesson's audit committee.

A company facing this situation has two conflicting goals. On the one hand, it wants to avoid the regulatory hammer by cooperating with government investigations and, if necessary, sharing privileged documents. On the other hand, it wants to avoid lining the pockets of a "rabid plaintiffs' bar" with these protected documents by blowing the privilege when it provides them to the government.

McKesson tried to ford this obstacle by working out confidentiality agreements with the SEC and DOJ designed to preserve the privileges and protections for its witness interviews and audit committee report. The plaintiffs in the private securities litigation sought the report and the interviews, arguing that when McKesson provided them to the government, it waived the documents' privileges and protections.

McKesson argued that providing documents to the SEC and U.S. Attorney fits within a provision of California's attorney-client privilege law that permits sharing documents when it is reasonably necessary for the accomplishment of the purpose for which the counsel was consulted. McKesson retained its outside counsel "to provide legal advice to McKesson and its Audit Committee and to assist McKesson in civil litigation pending in state and federal court." Unfortunately for McKesson, the court found that "it was unnecessary to share the audit report or interview memoranda with the government to accomplish that assignment." One wonders whether, if McKesson had instead retained its outside counsel "to provide legal advice to McKesson and its Audit Committee and to assist McKesson in civil litigation pending in state and federal court and criminal investigations and proceedings," it would have been able to preserve the privilege.

McKesson also argued that its interests were aligned with the government's interests, in that both wanted to investigate and root out the accounting irregularities at McKesson's newly acquired subsidiary. The court instead saw it as an attempt by McKesson to share documents with two plaintiffs and not the other, something not normally permitted in California without waiving the privilege.

In order to maintain the work product protection in California, McKesson had to demonstrate that the government had an interest in maintaining the confidentiality of the documents. The court instead found that SEC's and DOJ's interests were in obtaining the documents, and that they agreed to keep the documents confidential only to the extent they had to in order to get them from McKesson. Mindful that this separation of defendants from the government might dissuade future McKessons from sharing documents with the SEC and the DOJ, to neither's advantage, McKesson, joined by the SEC and the SIA as amici curiae, argued to the court for a "selective waiver" that would permit McKesson to disclose protected documents to the government without waiving the protection. The court found that this concept had some appeal, but found no support for it in the relevant California law.

Although this case only applies California law, and it may have come out differently with slightly different facts, the upshot is that the investigation conducted by McKesson's attorneys for McKesson's benefit will now be made available to the plaintiffs for McKesson's harm.

This is not the first time McKesson has encountered this issue. In Delaware, it managed to preserve the protections of most of these documents pursuant to the selective waiver rejected by the California court (see Saito v. McKesson HBOC (PDF) and "Confidentiality Agreement Saves Privilege When Company's Internal Report Is Disclosed to SEC" from BNA) while in Georgia it lost the protection (see "Voluntary Cooperation with SEC Waives Attorney-Client Privilege: McKesson HBOC, Inc. v. Adler" from Sutherland Asbill & Brennan LLP).

Last year the House proposed legislation that would have preserved the protections of the attorney-client privilege and work product doctrine for documents shared with the SEC (see "House Offers SEC More Enforcement Tools"). The legislation never passed. At the time, I expressed concern that even if the legislation passed, the SEC would be free to share the documents with others (see "Caution: Read This Before Giving Privileged Documents to the SEC!"), which, once shared, might have blown the privilege anyways.

If you are asked to share privileged documents with the government, you'll find yourself caught in a cliche-strewn place. Some call it between a rock and hard place. Others between Scylla and Charybdis. I'm thinking of it as between a regulatory hammer and a rabid plaintiffs' bar.

Where Have You Gone, Corp Law Bloggio?

You may have noticed that there isn't much to notice at Corp Law Blog these days.

Have I lost interest in corp law? No. Is the corp law writing muse torturing me with writer's block? No. Am I holding out for a bigger signing bonus and a no trade clause? No. Am I so busy with work that the phrase "drinking from a firehose" comes to mind? Bingo.

Writing a blog entry doesn't take much time. It's finding the fuel for the writing that takes time -- reading news articles, keeping up with legal developments, thinking about issues. Even when I'm busy, I can usually reserve some brain space for reading, digesting and thinking about other issues. But when I'm really really really busy, the work completely fills my brain, leaving no space for reading news articles, unravelling the details of recent legal developments and thinking about issues outside of my work.

My interest in Corp Law Blog remains high, and my recent work experiences have broadened my vision and provided me with new insights into the brave new world of corporate law practice. Unfortunately, for the time being, my ability to fill Corp Law Blog with new material remains uncertain. I might change the blog's name to "Corp Law Monthly" or "Corp Law Quarterly" to better reflect my new posting schedule. "Corp Law Sporadically" might be the most appropriate name.

During this fallow blogging period, I've been amazed that well over 1,000 of you continue to visit Corp Law Blog each day. I'm touched by your loyalty, but I'm concerned that your reservoir of good will for Corp Law Blog is being depleted by seeing the same stale posts day after day. To make your Corp Law Blog viewing experience more efficient, I suggest signing up for Corp Law Blog's free email notification service. It will send you a short email whenever I post something on the blog, saving you the trouble of fruitless visits. See "Corp Law Blog Offers to Spam Its Readers" for the simple details.

Thanks for your continued interest in Corp Law Blog. Now back to the mines!