On April 19, 2012, the United States Bankruptcy Court for the Southern District of New York granted in part a motion to dismiss claims asserted by Lehman Brothers Holdings Inc. (together with its debtor-affiliates, “Lehman”) against JPMorgan Chase Bank, N.A (“JPMorgan”). [1] The claims at issue arose from JPMorgan’s efforts in the months leading up to Lehman’s bankruptcy to mitigate its exposure as Lehman’s primary clearing bank by requiring Lehman to post a significant amount of additional collateral and expand the scope of the obligations secured by that collateral. Lehman and its creditors’ committee challenged these transactions under the avoidance provisions of the Bankruptcy Code and asserted other causes of action, including common law claims for unjust enrichment and invalidation of the contractual amendments that improved JPMorgan’s position.

The decision applies the safe harbor protections of Section 546(e) to dismiss Lehman’s preference and constructive fraud claims. However, the court rejected JPMorgan’s efforts to apply Section 546(e) more broadly, allowing Lehman’s parallel common law claims to proceed even where they are based on similar allegations. The decision also applies a relaxed pleading standard to Lehman’s claims for actual fraud, under which it found that Lehman had adequately alleged facts to state a claim under Section 548(a)(1)(A). The decision thus provides support for a literal application of the safe harbor protections to dismiss certain claims at the pleading stage. However, the decision also suggests that even where a transaction falls within the scope of Section 546(e), artful pleading may permit plaintiffs to survive a motion to dismiss. The decision thus underscores the importance of considering potential litigation risks and costs when analyzing transactions with distressed counterparties.

…continue reading: Lehman Bankruptcy Court Interprets Safe Harbor Protections

On March 26, 2012, in Credit Suisse Securities (USA) LLC v. Simmonds, the U.S. Supreme Court held 8-0 that the two-year statute of limitations for suits under the short-swing liability rules of Section 16(b) of the Securities Exchange Act of 1934 is not tolled (i.e., suspended) until an insider files a Section 16(a) disclosure statement; the limitations period can begin running even if the disclosure statement is filed at a later date or never filed at all. The Court’s decision provides insiders of U.S. public companies with better protection and more certainty against time-barred claims.

The Supreme Court reversed the Ninth Circuit, which had held, citing to its precedent, that the limitations period is tolled until an insider files the Section 16(a) disclosure statement “regardless of whether the plaintiff knew or should have known of the conduct at issue”. In dicta, the Supreme Court also rejected the Second Circuit’s rule that the limitations period is tolled until the plaintiff “gets actual notice that a person subject to Section 16(a) has realized specific short-swing profits that are worth pursuing”.

The Supreme Court did indicate some willingness to permit equitable tolling of the Section 16(b) limitations period, but under circumstances more limited than the “disclosure” rule of the Ninth Circuit or the “actual notice” rule of the Second Circuit.

…continue reading: Court Rules on Short-swing Liability Rules

In February 2012, several purported class action lawsuits were filed in the Delaware Court of Chancery challenging corporate bylaw amendments adopted by companies pursuant to 8 Del. C. § 109. Generally speaking, the challenged bylaw amendments would require that certain types of corporate law claims by shareholders be brought and resolved in the Delaware Court of Chancery, and not elsewhere. [1] In the Delaware class actions, the shareholder plaintiffs sued a dozen companies, as well as members of their respective boards of directors. Each of the cases was assigned to Chancellor Leo E. Strine, Jr.

The complaints in the various actions are similar. Plaintiffs allege that the forum selection bylaw amendments are invalid under Delaware and other law, that they violate shareholder rights because they were adopted by boards of directors without the consent of the shareholders, and that the directors who adopted the bylaw amendments violated their fiduciary duties.

Of the 12 companies that were sued, the majority repealed the challenged bylaw prior to the deadline for responding to the complaint. In those cases, the parties stipulated that the claims were moot, and the actions were dismissed.

…continue reading: An Update on the Forum Selection Bylaw Cases

The financial press and blogs were abuzz in late January 2012 about the Securities Act of 1933 (Securities Act) registration statement filed by The Carlyle Group L.P. for its initial public offering. Its limited partnership agreement required all shareholder disputes with the partnership to be resolved by mandatory, binding and confidential arbitration. The provision included a prohibition against shareholders bringing class actions. Much of the discussion that was critical of the provision focused on the elimination of class actions and not on the pros and cons of arbitration as such.

According to published reports, the SEC advised Carlyle that it would not grant an acceleration order permitting the registration statement to become effective unless the arbitration provision was withdrawn. As a practical matter, Carlyle had no means to challenge the Commission and no practical alternative other than to withdraw its arbitration provision, which it did.

I object to the process by which the SEC killed Carlyle’s arbitration provision.

…continue reading: Arbitration Provisions in Corporate Governance Documents

On March 19, 2012, the Securities and Exchange Commission (“SEC”) announced that it had credited the substantial cooperation of a former senior executive of an investment adviser in an investigation [1] by declining to take enforcement action against him. The SEC’s announcement can be found here. This is the first time the SEC has publicly recognized the cooperation of an individual since the announcement two years ago of its policy statement intended to incentivize individuals to cooperate in investigations, found here. [2] This announcement provides some much needed insight into the potential benefits of cooperating in an SEC investigation. However, the unique facts of the case mean that it will have limited application to other cases.

I. SEC’s Cooperative Initiative

As we have discussed in a prior alert, SEC’s Initiative to Foster Cooperation–Perspective and Analysis (Jan. 14, 2010), [3], the SEC announced a new policy under which individuals could cooperate in an enforcement investigation to avoid a civil enforcement action or receive a lesser sanction. Although the evaluation of cooperation requires a case-by-case analysis of the specific circumstances presented, the Cooperation Policy Statement explained that the SEC’s general approach would be to determine whether, how much, and in what manner to credit cooperation by individuals by evaluating four considerations: (1) the assistance provided by the cooperating individual in the SEC’s investigation or related enforcement actions; (2) the importance of the underlying matter in which the individual cooperated; (3) the societal interest in ensuring that the cooperating individual is held accountable for his or her misconduct; and (4) the appropriateness of cooperation credit based upon the profile of the cooperating individual.

…continue reading: SEC Investigation Recognizes Individual’s Contribution

There were 65 court-approved securities class action settlements involving $1.4 billion in total settlement funds in 2011—the lowest number of approved settlements and corresponding total settlement dollars in more than 10 years, according to Securities Class Action Settlements—2011 Review and Analysis, an annual report by Cornerstone Research. The number of settlements approved in 2011 decreased by almost 25 percent compared with 2010 and was more than 35 percent below the average for the preceding 10 years. Further, the total dollar value of settlements declined by 58 percent, from $3.2 billion in 2010 to $1.4 billion in 2011. The change in the number of settlements from 2010 to 2011 is one of the two largest year-over-year declines and, combined with a year-over-year decrease in settlements in 2010, the first time there has been a decline in the number of settled cases for two consecutive years.

…continue reading: Securities Class Action Settlements

The UK Financial Services Authority (“FSA”) imposed fines of £3.651 million ($5.77 million) on Greenlight Capital Inc., a US hedge fund manager (“Greenlight”), £3.638 million ($5.74 million) on David Einhorn, Greenlight’s owner, and £350,000 ($553,000) on Andrew Osborne, a former Bank of America Merrill Lynch banker. These fines were levied in connection with Greenlight’s trading in the shares of Punch Taverns Plc (“Punch”), a UK pubs business, ahead of a planned equity offering. The FSA imposed the fines on the grounds that Greenlight traded on inside information conveyed to David Einhorn during a conference call with Punch’s CEO and Andrew Osborne, its broker. Greenlight specifically declined to be made an insider for the purposes of the call and David Einhorn requested that he would not be “wall crossed.” Notwithstanding this, the FSA determined that the information conveyed amounted to inside information, that trading on this information was prohibited by the UK’s market abuse regime and that Greenlight, David Einhorn and Andrew Osborne should have been aware of this. It is unlikely that Greenlight’s trading would have triggered an enforcement action by the US Securities and Exchange Commission (“SEC”) if it had occurred in the context of a US exchange. However, US financial institutions and other market participants active in UK financial markets should take note of the FSA’s actions as this case illustrates key differences between the regulation of insider trading and market abuse in the US and the UK, and the FSA’s more aggressive policing of UK markets.

…continue reading: Differences Between US and UK Market Abuse Regimes

At the recent “SEC Speaks” conference in Washington, DC this year, Chairman Mary Schapiro and senior Enforcement officials vowed to increase investor protection through use of the SEC’s expanded authority under the Dodd-Frank Act and initiatives designed to help the SEC enforcement staff proactively detect and prevent securities law violations. In her speech, Schapiro pointed to numerous modernization initiatives as central to this effort, including better hiring, more training, more sophisticated IT systems, and better management structures. Schapiro noted that the Commission now has Wall Street traders, asset managers, and quantitative analysts on staff alongside attorneys, economists and accountants and has more than doubled its training budget since 2009. She also touted the SEC’s new TCR system (tips, complaints, and referrals) as allowing the SEC to better “triage” the information it receives and use that information more effectively in terms of opening new investigations, directing information to existing investigations, and uncovering and tracking emerging trends.

Schapiro pointed to the SEC’s record 735 enforcement actions, which returned more than $2 billion to investors, as evidence that these efforts to modernize the agency and bolster its knowledge base are already bearing fruit. Division of Enforcement Director Robert Khuzami echoed these remarks, saying that the agency’s risk-based initiatives are paying off and that the SEC is being more proactive, which has, in his view, resulted in more deterrence. Declaring a new “entrepreneurial” spirit and ethos, Schapiro and Khuzami made clear that the SEC intends to redouble its enforcement efforts across the board.

…continue reading: An “Entrepreneurial” and Restructured SEC Pledges Proactive Enforcement

The private equity industry should expect increased scrutiny by the Securities and Exchange Commission (SEC), particularly with respect to insider trading and how firms address conflicts of interest, according to recent speeches by representatives of the SEC Division of Enforcement’s new Asset Management Unit. Moreover, The Wall Street Journal has reported that the SEC has “launched a wide-ranging inquiry into the private equity industry.” [1]

The Enforcement Division’s increasing attention to private equity corresponds with the implementation of new rules under the Dodd-Frank Act that will significantly increase the number of private equity firms subject to SEC regulation as “investment advisers.” The Asset Management Unit, one of a number of specialized enforcement units formed by the Division of Enforcement in 2010 to focus on “priority areas,” [2] is staffed with 65 professionals, including private equity experts.

Once registered as investment advisers, private equity firms must appoint a chief compliance officer and maintain written policies and procedures reasonably designed to prevent violation of the federal securities laws, including laws prohibiting insider trading. According to the SEC Staff, these policies and procedures should also promote compliance with firms’ fiduciary duties and regulatory obligations, including identifying and addressing conflicts of interest.

…continue reading: SEC Enforcement to Focus on Private Equity Insider Trading and Conflicts of Interest

I. Introduction

The most significant impact of SEC registration on private fund advisers is that the adviser becomes subject to inspection by the SEC’s Office of Compliance Inspections and Examinations (OCIE). The greatest risk arising from an examination is that the inspection staff decides to refer finding from an inspection to the Division of Enforcement for an investigation. This article discusses the risks of an examination becoming an investigation and strategies for anticipating and mitigating those risks. [1]

II. The Risk That an Examination Results in a Referral to Enforcement

Asset managers are particularly vulnerable to collateral consequences of a government investigation. Particularly in the wake of recent cases, many investors have little tolerance for fund managers who are subject to an investigation, thus making flight of capital a real risk for advisers under investigation. Stark examples of this played out over the last year when the F.B.I. executed search warrants in November 2010 on four hedge funds. Of the four funds raided, three ceased doing business even in the absence of criminal charges. [2]

…continue reading: The Blurring Line Between SEC Examinations and Enforcement