Banking and Finance Law Report : Banking & Finance Lawyer & Attorney : Porter Wright Morris & Arthur Law Firm : Bankruptcy, Commercial Lending

Enforcement of a relatively new rule of the Financial Industry Regulatory Authority (FINRA) has resulted in significant fees in 2011 for small issuers with securities traded over-the-counter (OTC), such as some community banks. FINRA Rule 6490 requires issuers to provide notice to FINRA of certain company-related actions, such as dividends and stock splits, or face a $5,000 fee, which some might characterize as a fine.

FINRA’s ability to charge issuers is new as of 2010, and is a significant departure from FINRA’s historically ministerial role with respect to issuers. FINRA primarily oversees broker-dealer member firms, but it also performs certain functions for issuers of OTC securities. For example, it reviews and processes requests to announce or publish certain actions by issuers of OTC securities and maintains the symbols database for OTC securities. 

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In mid-August the SEC’s new whistleblower rules will take effect (click here for the Final Rule).  The new rules explain and further define the requirements of a whistleblower program that has been in place since the Dodd-Frank Act took effect on July 21, 2010. In general, anyone who provides information to the SEC relating to a possible violation of the securities laws is entitled to an award if the following requirements are met:

• The information must be provided voluntarily, before the SEC asks for it;
• The information must be based on the whistleblower’s independent knowledge and not already known to the SEC or derived from public filings;
• Providing the information must lead to successful enforcement by the SEC or a federal court or administrative action; and
• The SEC must obtain monetary sanctions above $1 million.

Successful whistleblowers can receive an award of between 10 and 30% of the total monetary sanctions collected. The whistleblower program is a significant expansion of previous SEC whistleblower rules that only applied to insider-trading cases and were capped at 10% of the penalties collected (click here for the SEC press release). 

The whistleblower rules do not require the whistleblower to comply with the company’s internal compliance program, but do encourage such internal compliance. For example, a whistleblower who reports through the company’s internal compliance program is still eligible for an award if the company reports the information to the SEC, and the whistleblower receives credit for all information proved by the company, even information not initially reported by the whistleblower to the company.

Despite the expansive new rules, awards are not available for, among others, whistleblowers with a pre-existing contractual duty to report the violation, a person who obtains the information illegally, or an officer or director who gains the information through the company’s internal process for identifying violations.

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Proper board meeting minute taking has recently increased in importance as a result of a number of court decisions. Bankers and other businessmen doing business in the corporate form should carefully consider the impact of cases such as In re Walt Disney Company Litigation (Del. Ch. 2004). 

In many states, minutes are considered to be prima facie (i.e., presumptive) evidence of what actions an entity actually took. Some courts have also taken the position that other evidence (such as witnesses testifying that serious debate did actually occur in a meeting, even when the minutes don't record such debate) won't be allowed unless minutes are clearly incomplete or ambiguous.

In re Walt Disney Company Litigation (Del. Ch. 2004) is a case in point and is particularly instructive with respect to the appropriate level of detail in board minutes. The Disney plaintiffs charged that the board of directors of Disney violated their duty of good faith when considering the CEO's hiring of a new president. When Disney's board met to discuss the hiring, the minutes did not review or approve: (i) any presentations or reports regarding the terms of the draft hiring agreement, (ii) any questions raised by any board members, and (iii) the employment agreement being authorized. The Disney board ultimately approved the hiring. The total space in the minutes dedicated to the hiring was less than one and one half pages.

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Last week, the SEC finalized a new proxy access rule for 3% shareholders (or larger) that was first proposed over a year ago. Proxy access refers to the right of a shareholder to use the company’s proxy statement to solicit votes for a nominee for the board of directors. Prior to the new rule, a shareholder that wanted to solicit votes for a nominee had to prepare its own proxy statement at significant cost. Now 3% shareholders (or larger) can use the company proxy statement to nominate directors.

In general, if a shareholder (or group of shareholders) holds at least 3% of the voting power of a company for at least three years, among other requirements, it can include nominees in the company proxy statement for as many as 25% of the seats on the board.

The new rule is in effect for the 2011 proxy season, except it will not apply to smaller reporting companies for three years.

The new rule has considerably more potential to affect smaller reporting companies because it is easier to obtain 3% of a smaller reporting company than a larger company. And, three years is a long time to tie up the estimated $3.5 billion needed to reach the 3% threshold at any of the 20 largest U.S. corporations by market cap. The 3% threshold may ensure that only significant long-term shareholders at large companies will be granted access, which was a stated goal of the Commission, but it could prove more likely to affect smaller reporting companies.

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            As you read this, annual meeting season is in full swing. One of the traditional hallmarks of the season is the annual proxy report which firms distribute in advance of the annual meeting. The ostensible purpose of the report is to solicit votes for the slate of directors, usually incumbents, to be elected at such annual meeting. But the broader purpose of the proxy of course is to describe the leadership of the firm, including such things as corporate governance practices, the overall structure of the board of directors, and the background of both management and the board of directors, including their compensation and real and potential conflicts of interest.

            The dramatic business environment over the last few years has led to numerous changes in both the form and the style of proxy disclosures. There is more emphasis now, for example, on what is called “transparency” for shareholders. In practice, this means more disclosures related to compensation and conflicts.

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