by T. GormanPosted on Posted in SECActions

The number federal securities class action suits filed in the first half of 2011 decreased compared to the second half of 2010. At the same time however the number of cases filed increased compared to the first half of 2010, according to a new report by Cornerstone Research (here). For the first half of 2011 there were 94 suits filed. That is below the 104 suits filed in the second half of 2010 but more than the 72 suits filed in the first half of 2010.

Securities class action filings in the first half of 2011 were driven by suits arising from M&A activity and those associated with Chinese issuers who conducted a reverse merger. In the first six months of the year 24 class actions were filed involving reverse merger cases. During the period 21 were associated with M&A activity. In contrast only two suits related to the credit crisis were brought.

If class action securities suits continue to be filed at the present pace, the report projects there will be a total of 190 cases brought in 2011. This is on par with the average number of filings from 1997 to 2010. However, if the number involving Chinese reverse mergers is excluded from the projection since there are only a finite number of these companies, only 165 filings would be made in 2011. That would be the second lowest number of suits brought during the period 1997 to 2010.

A decline in filings would be consistent with patterns in market volatility which tends to serve as a barometer for securities class action filings. For example, during periods of high volatility such as the fourth quarter of 2008, filings tend to increase. Over the last four quarters, in contrast, the downward trend in market volatility is mirrored by the decline (absent the Chinese issuer cases) in class action securities suit filings.

During the first half of 2011 there was also a decline in the number of suits filed involving companies in the S&P 500. In that period only 8.5 % of the cases involved a company on the index compared to 15.5% during the second half of 2010. This is partially explained by the number of cases involving Chinese issuers and M&A transaction related cases which tended to involve smaller issuers.

While M&A transactions cases continue to be a “notable phenomenon,” according to the report, the number of these actions declined in the first half of 2011 to 21 filings compared to the last half of 2010 in which there were 27 cases brought. At the same time however there was an increase in M&A activity. While the M&A related cases typically are filed in state court, at the end of 2010 a trend of filing a parallel federal court action took off and has continued into 2011. This trend may continue the report notes because the litigation creates an obstacle and financial risk to the completion of the transaction which tends to favor settlement.

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by T. GormanPosted on Posted in SECActions

The Commission’s new “proxy access” Rule was vacated by the Circuit Court of the District of Columbia for failing to comply with the Administrative Procedure Act or APA. The Court sustained the challenges to the Rule by the Business Roundtable and the Chamber of Commerce. Business Roundtable v. SEC, No. 10-1305 (D.C. Cir. Decided July 22, 2011). This is the second time in two years that the Circuit Court has sustained a challenge to a Commission rule for failing to comply with the APA. See also American Equity Investment Life Ins. Co. v. SEC, 613 (F. 3d 166 (D.C. Cir. 2010).

Rule 14a-11 was enacted under Section 971 of Dodd-Frank. Essentially the Rule requires that an issuer include in its proxy materials the names of persons nominated by shareholders who have continuously held at least 3% of the voting securities for three years. The Rule is intended to ensure that the “’proxy process functions, as nearly as possible, as a replacement for an actual in-person meeting of shareholders,’” according to the issuing release. Slip. Op. at 3. The Rule applies to all issuers subject to the Exchange Act proxy requirements including investment companies. The SEC, by a 3-2 vote, concluded that the Rule could create potential benefits of “improved board and company performance and shareholder value” sufficient to justify its potential costs.

In reviewing a rule under the APA the Court has the obligation to determine if the agency examined the relevant data and articulated a satisfactory explanation for its action according to the Court. This includes a rational connection between the facts found and the choices made. In this regard the SEC has a unique obligations to consider the effect of the new rule on the “efficiency, competition, and capital formation” the Court stated. Otherwise the rule must be vacated as arbitrary and capricious.

Here the SEC failed to comply with the requirements of the APA. The SEC “inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters. For these and other reasons, its decision to apply the rule to investment companies was also arbitrary” the Court held. Id. At 7.

To support its conclusion the Court detailed the failures of the SEC to conduct the proper analysis. For example, in the adopting release the SEC acknowledged that company boards my be motivated when faced with the rule to expend significant amounts of corporate resources opposing shareholder offered slates of directors. The SEC opined, however, that this would not occur because the directors have a fiduciary obligation to act in the best interest of the shareholders. This conclusion is supported by noting but “mere speculation” the Court found.

The SEC also failed to marshal sufficient empirical data to conclude that Rule 14a-11 would improve board performance and increase shareholder value. Yet there are a significant number of studies which support the opposite result. While the Commission acknowledged this fact, it “completely discounted those studies . . .” while electing to rely on two other studies. The Court found this inadequate.

A third point the SEC failed to properly consider is the potential impact of investors with special interests such as unions, pension funds and others. While this issue was presented by various commentators “the Commission failed to respond to . . .[the fact that] investors with a special interest, such as unions and state and local governments whose interests in jobs may be greater than their interest in share value, can be expected to pursue self-interested objectives rather than the goal of maximizing shareholder value . . “

Finally, in adopting the Rule the SEC “arbitrarily ignored” its impact on the total number of election contests. Absent this data the Court concluded that “the Commission has no way of knowing whether the rule will facilitate enough election contests to be of net benefit.” Accordingly, the Court vacated the Rule. Whether the SEC will attempt to reissue the rule is at this point an open question.

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