In March, I wrote that the Bulldog group of funds had asked the United States Supreme Court to determine the constitutionality of Massachusetts’ ban general solicitations in connection with the offer and sale of unregistered securities.  Despite representation by Harvard Law School Professor Laurence H. Tribe and an amicus brief from the Cato Institute, the Supreme Court on Monday denied Bulldog’s petition for certiorari.

Oxfam America Sues the SEC

In a post entitled “Waiting For the SEC . . .“, I wrote about Oxfam America’s threat to sue the SEC for failing to comply with Congress’ mandate to adopt regulations governing disclosures by resource extraction issuers pursuant to Section 1504 of the Dodd-Frank Act.  Earlier this week, Oxfam America followed through on its threat by filing this complaint against the SEC in the U.S. District Court in Massachusetts (Oxfam America is headquartered in Boston).

As I mentioned in my earlier post, one hurdle for Oxfam America will be whether it can establish standing.  To establish constitutional standing, a plaintiff must generally establish injury, causation and redressability The complaint alleges that Oxfam America is directly injured both as an investor in issuers and as an organization with a mission to “end the resource curse”.   As to causation, Oxfam America alleges that its inability to access information is “directly traceable” to the SEC’s failure to adopt regulations.  As to redressability, Oxfam America claims that this injury can only be redressed by a court order.  However, the court can’t adopt the rule itself.  It can only order the SEC to do so and the SEC has already failed to comply with one order – Congress’ order.  As to the question of whether a court order carries more weight than a Congressional order, I’m reminded of the apocryphal quotation attributed to President Andrew Jackson after the Supreme Court’s decision in Worcester v. Georgia, 31 U.S. (6 Pet.) 515 (1832):  “John Marshall has made his decision; now let him enforce it!”

Timely Topics – JOBS Act

As a reminder, I will be speaking next week in San Diego at CONNECT’s program on new ways to raise capital under the JOBS Act.

It’s a close question because the Supreme Court in Chevron, U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984) held that courts should defer to an agency’s construction of a statute that it administers.  In a later case, the Supreme Court clarified that a ”court’s prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambiguous terms of the statute.”  National Cable & Telecommunications Assn. v. Brand X Internet Services, 545 U.S. 967, 982 (2005) (emphasis added).

The problem for the court in Home Concrete & Supply was that in Colony it had said that the statutory language at issue was not unambiguous.  Thus, the IRS argued that the Supreme Court’s prior judicial construction of the statute did not preclude Chevron deference to the IRS’ statutory interpretation embodied in the regulation.  Although a majority of the court (Breyer, Roberts, Thomas, Alito and Scalia) agreed that the IRS couldn’t overturn the Supreme Court’s holding, only four of those justices could agree on Part IV-C of the opinion explaining why.  Justice Scalia, dissenting from this majority on this part of the opinion, urged the Court to jettison Brand X altogether.  For more analysis of the case, see Alan Horowitz’ excellent post on SCOTUSblog.

California’s Administrative Procedure Act directly addresses the question of whether an agency can adopt a rule that conflicts with a prior court decision.   When an agency proposes to adopt a rule, the Office of Administrative Law is required to review the proposed rule in light of six statutory standards.  Cal. Govt. Code § 11349.1(a).  One of these is the standard “adored by little statesmen and philosophers and divines” - consistency.   To meet the consistency standard, a rule must be “in harmony with, and not in conflict with or contradictory to, existing statutes, court decisions, or other provisions of law.”  Cal. Govt. Code § 11349 (d) (emphasis added).  The APA further provides that a court may declare a rule invalid  invalid for a substantial failure to comply with the APA.  This would seem to to include failure to comply with any of the six substantive standards (including consistency) applicable to the OAL’s review of proposed rules.

Thus, it is a bit of a mystery why the legislature omitted a reference to consistency with judicial decisions in another APA statute:

Whenever by the express or implied terms of any statute a state agency has authority to adopt regulations to implement, interpret, make specific or otherwise carry out the provisions of the statute, no regulation adopted is valid or effective unless consistent and not in conflict with the statute and reasonably necessary to effectuate the purpose of the statute.

Cal. Govt. Code § 11342.2.

This was in essence the scenario considered by U.S. District Court Judge James Boasberg in Chamber of Commerce v. NLRB (U.S. Dist. Ct. D.C., May 14, 2012).   He concluded that the NLRB had not validly adopted a rule shortening the time for union elections because no quorum existed when the NLRB voted to approve the final rule.  While there are significant differences between corporate law and the National Labor Relations Act, the issues raised in the case should be of interest to corporate practitioners.

First, the NLRB argued that the board member’s opposition on preliminary matters sufficed to constitute participation in the decision.  The court, however, concluded that participation in preliminary votes did not constitute final agency action.  In the corporate context, it seems obvious that participation in votes authorizing management to negotiate the terms of a transaction or approving  procedural matters does not count as being present at a meeting to approve the transaction. 

Second, the NLRB argued that mere “presence” was sufficient to constitute a quorum.  Because the NLRB didn’t hold a physical meeting, the court had to consider how a quorum is constituted in an online context:

When the very concept of a quorum seems designed for a meeting in which people are physically present in the same place, what does it mean to be present or to participate in a decision that takes place across wires? In other words, how does one draw the line between a present but abstaining voter (who may be counted toward a quorum) and an absent voter (who may not be) when the voting is done electronically?

Judge Boasberg found that while the dissenting member had been sent notice that an electronic vote would be held, he was not present for quorum purposes: “he simply did not show up – in any literal or even metaphorical sense”.  The court did observe that had the board member affirmatively expressed his intent to abstain or even acknowledged receipt of the notification, he “may well have been legally ‘present’ for the vote and counted in the quorum.”

The California General Corporation Law permits, subject to specific conditions, participation in a board meeting either in person or by a variety of electronic methods.  Cal. Corp. Code § 307(a)(6).  Thus, the same question of what constitutes “presence” in an electronic meeting may also arise in the corporate context.

Finally, for administrative law buffs, Judge Boasberg has a footnote discussing whether the court should pay deference to the NLRB’s interpretation of the NLRA under Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 843 (1984).  He doesn’t mention, however, the U.S. Supreme Court’s recent, earlier decision in United States v. Home Concrete & Supply, LLC, No. 11-139, 2012 BL 101632 (U.S. Apr. 25, 2012) in which the court struggles with the question of Chevron deference.

The exemption is subject to three requirements, one of which is that the issuer must file a notice of transaction with the Department of Corporations (see 10 CCR § 260.102.19(c)).  In 2001, the Business Law Section of the California State Bar successfully sponsored legislation making it clear that the failure to file the notice or to file within the period prescribed by statute does not vitiate the exemption.  Stats. 2001 ch 58 § 1.

When must the filing be made?  The statute requires that a notice of transaction must be filed no later than 30 days after the initial issuance of any security under the plan.  If the issuer fails to do so, the issuer must file the notice within 15 days after it discovers its dereliction.

With this background in mind, let’s turn to Facebook, Inc.  Recently, I came across this Business Insider article by Owen Thomas entitled “MYSTERY: Someone Got $239 Million In Facebook Shares in February“.   Mr. Thomas discusses a filing made by Facebook with the Department of Corporations in February.  It turns out that the filing was made with respect to options to purchase 10 million shares of Class B Common Stock under Facebook’s 2005 Stock  Plan.  It is unclear why Facebook decided it was required to make this filing.  According to Facebook’s most recent pre-effective amendment to its registration statement (No. 6), securities have been previously granted under its 2005 Stock Plan.  Also, a review of Facebook’s filings on CalEASI reveals that Facebook had already filed a notice of transaction with respect to the plan.

This story is also a reminder that many filings with the Department of Corporations are readily available on the Internet through CalEASI.  In fact, I found 48 separate items filed by Facebook with the DOC.  While these filings do not provide much detail, they do provide information about transaction values.  Thus, these filings may provide a window into a company’s assessment of the value of its shares.  Companies may also want to take these reported valuations into account for both SEC and IRS purposes.

For more about CalEASI, see “California’s Big EASI“.

Some of those investors entrusted their entire life savings to brokers who used the money to make high-interest loans to people who either didn’t qualify for a traditional bank loan or who needed money fast.

In reaction, the Senate Committee on Business Professions and Economic Development and the Senate Committee on Banking & Financial Institutions held a joint oversight hearing on hard-money lending in January.  Thereafter, the co-chairs of those committees co-authored a bill, SB 978, intended to address these problems.  Unfortunately, SB 978 as amended to date imposes significant legal burdens not only on most borrowers but also the entire real estate industry.  In effect, the bill requires the building of a haystack of new filings to find some needles of information about hard-money lenders.

First, the bill would amend Section 25102(e) to require a notice-filing for the offer or sale of evidences of indebtedness.  This change alone would impact a huge number of borrowers. Section 25019 defines “security” to include any evidence of indebtedness.  Currently, borrowers can rely on Section 25102(e) as a self-executing exemption from the qualification provisions of Section 25110 provided the offer and sale does not involve a public offering.  Although SB 978 wouldn’t condition the availability of the exemption on filing a notice, issuers would be required to do so.  This means that if the bill is enacted in its current form, the Department will be inundated with filings, the vast majority of which will not be made by hard-money lenders.

Second, SB 978 would impose additional informational, recordkeeping and suitability requirements on virtually any real estate related issuer.  The bill would add a new Section 25102.2 to require any issuer that relies upon an exemption from Section 25110 with respect to the offer or sale of securities, other than an exemption provided by Section 25102.5, and that is principally engaged in the business of purchasing, selling, financing, or brokering real estate, to provide additional information regarding the nature of the proposed offering on a form prescribed by the Commissioner. These issuers would also be required to make reasonable efforts to ensure all of the following:

• All persons to whom securities are sold can be reasonably assumed to have the capacity to understand the fundamental aspects of the investment, by reason of their educational, business, or financial experience.
• All persons to whom securities are sold can bear the economic risk of the investment.
• The investment in the security is suitable and appropriate for each purchaser, given the purchaser’s investment objectives, portfolio structure, and financial situation.

SB 978 would affect a wide swath of the real estate industry, including, for example, real estate investment companies that offer and sell equity securities in reliance on Section 25102(f) or real estate brokers implementing stock option plans in reliance on Section 25102(o).  These new regulatory burdens will weigh not just on the real estate industry and borrowers generally, but also on the Department of Corporations.  If SB 978 is enacted, the Department will be forced to contend with a massive influx of new filings largely unrelated to the problem of hard-money lending.

• regulatory priorities,
• regulation of securities products,
• trading strategies,
• fee structures,
• the effectiveness of disclosure, and
• on initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace.

The new committee is comprised of 21 members.  California’s two big retirements systems, the California Public Employees Retirement System (CalPERS) and the California State Teachers Retirement System (CalSTRS), each have representatives on the committee.  Section 911 of the Dodd-Frank Act provides committee members are entitled to compensation.

This raises the question of whether these appointments of California state officials violate Article VII, Section 7 of the California Constitution which provides that with certain exceptions ”A person holding a lucrative office under the United States or other power may not hold a civil office of profit.”  The purpose of the provision is to prevent “dual office-holding by one person under two separate and distinct governments, and the separation of the allegiance justly due one by its officers from that due to another power.” McCoy v. Board of Supervisors, 18 Cal.2d 193, 196 (1941).

Interestingly, Congress expressly exempted the committee from the Federal Advisory Committee Act (FACA), 5 U.S.C. app.  You may not be familiar with the FACA, but it was the law at issue when former President Clinton established the President’s Task Force on National Health Care Reform and named his wife as its chairman.  Ass’n of American Physicians & Surgeons, Inc. v. Hillary Rodham Clinton, 997 F.2d 898 (D.C. Cir. 1993).  It was also the law at issue a few years later when Public Citizen challenged presidential consideration of evaluations by the American Bar Association’s Standing Committee on the Federal Judiciary of potential judicial nominees.  Public Citizen v. U.S. Dept. of Justice, 491 U.S. 440 (1989).

President Nixon signed the FACA into law in 1972 to create a structured process for the creation, operation and termination of advisory committees.  For example, the FACA requires that advisory committees:

• File a charter with the Administrator of the General Services Agency containing specified provisions (§ 9);
• Make their meetings open to the public (§ 10(a)(1));
• Give interested persons the opportunity to attend, appear before, or file statements with the committee (§ 10(a)(3));
• Keep and publish minutes of each meeting (§ 10(c)); and
• Allow public inspection of their records (§ 10).

I also wasn’t able to find the committee in the FACA database supported by the General Services Administration’s Committee Management Secretariat even though other SEC committees are included.  The FACA database provides a wealth of information about federal advisory committees, including information about meetings, reports, members, and costs.

At the Civil War military prison at Camp Sumter near Andersonville, Georgia, the “dead line” clearly mattered – as reflected in the Secretary of War’s report of the post bellum trial of the camp’s commander, Heinrich “Henry” Wirz:

And he, the said Wirz, still wickedly pursuing his evil purpose, did establish and cause to be designated within the prison enclosure containing said prisoners a “dead line,” being a line around the inner face of the stockade or wall enclosing said prison and about twenty feet distant from and within said stockade; and so established said dead line, which was in many places an imaginary line, in many other places marked by insecure and shifting strips of [boards nailed] upon the tops of small and insecure stakes or posts, he, the said Wirz, instructed the prison guard stationed around the top of said stockade to fire upon and kill any of the prisoners aforesaid who might touch, fall upon, pass over or under [or] across the said “dead line;” . . .

Trial of Henry Wirz : letter from the Secretary of War ad interim, in answer to a resolution of the House of April 16, 1866, transmitting a summary of the trial of Henry Wirz (1868).  See also Rules and Regulations of the Prison (1865) (“No prisoner must cross the dead line, nor speak to any sentinel on post nor attempt to buy or sell anything to a sentinel.  The sentinel having orders to fire on anyone crossing the dead line or attempting to speak to or trade with them.”).

When Congress enacted the Dodd-Frank Wall Street Reform Act two years ago, it imposed many deadlines on the Securities and Exchange Commission.  In Section 1504, Congress ordered the SEC to issue final rules requiring disclosure of payments by resource extraction issuers within 270 days.  The SEC proposed rules in December 2010 and its website currently estimates that rules will be adopted in the first half of this year.  This means that the SEC has missed Congress’ deadline by over a year.

Unlike Vladimer and Estragon, Oxfam America has grown over tired of the wait.  In April, EarthRights International sent this letter on behalf of Oxfam America to the SEC asking (demanding) that the SEC schedule a vote on a final rule implementing Section 1504.  The letter threatens legal action if the SEC fails to do so by May 16, 2012.  Implicit in this threat is the idea that the SEC will be more heedful of a court order than a congressional one.

Is the Congressional deadline enforceable?  Oxfam America cites Section 706(1) of the Administrative Procedure Act (5 U.S.C. § 706(1)).  That statute prescribes the scope of judicial review and states that a reviewing court shall “compel agency action unlawfully withheld or unreasonably delayed”.  However, before there can be judicial review, there must be standing.  If the SEC doesn’t issue a final rule soon, the first challenge for Oxfam America (or anyone else) is likely to be whether they can meet the requirements of both constitutional and prudential standing.

In general, constitutional standing requires that a plaintiff show injury, causation and redressability.  With respect to prudential standing, the APA requires that the plaintiff be within the “zone of interests” of the statute claimed to have been violated (i.e., Section 1504 of the Dodd-Frank Act).  5 U.S.C. § 702 (“A person suffering legal wrong because of agency action, or adversely affected or aggrieved by agency action within the meaning of the relevant statute, is entitled to judicial review thereof.”)

Without standing, the federal courts are without jurisdiction and this could be a case in which there is “nothing to be done”.

Fired, Disabled, or Quit?

The bill does not define “retirees” and this could become a problem for corporations.  Ernest Hemingway thought “retirement” to be the ugliest word in the language.  In common parlance, “retirement” occurs when one’s employment ends upon reaching retirement age.  A broader definition would termination of employment as a result of a disability.  A still broader definition would include termination of employment for any reason at any age.

Naming Names

The bill also requires that corporations disclose the names of the retirees.   These people won’t necessarily be former executive officers.  It may be that they have never set foot in California.  Moreover, they may have retired before their former employer became a publicly traded corporation.  Simply working for a publicly traded company doesn’t make one a public figure.  These former employees are likely to be surprised and distressed to learn that their identities and retirement benefits are being made available on the Internet.  Since these individuals are not current employees, there is no legitimate reason to require corporations to name names.   In fact, public disclosure may place retirees at risk for fraudulent schemes targeting seniors or harassment.  Mandating disclosure is at odds with the California Constitution’s explicit guaranty of the right to pursue and obtain privacy (Art. I, § 1).

*   *   *

JOBS Act Program in San Diego

On May 22, 2012, I’ll be participating in a program in San Diego about new ways to raise capital under the JOBS Act.  The other presenters will be Tim Holl, a partner at Ernst & Young, and Byron Roth, Chairman and CEO of Roth Capital Partners, LLC.  The program is being presented by CONNECT, a program that catalyzes the creation of innovative technology and life sciences products in San Diego County.  More information about the program is available here.

Under California’s Administrative Procedure Act, any standing, select, or joint committee of the Legislature may request a priority review of an existing regulation.  Govt. Code § 11349.7.  The Office of Administrative Law is then required to review the regulation for the compliance with the six statutory standards applicable to all regulations: Necessity,    Authority, Clarity, Consistency, Reference, and Nonduplication.  Govt. Code § 11349.1(a).  The OAL has 90 days to complete its review.  If the OAL determines that a regulation does not meet the one or more of the standards, it issues and order to show cause.  This sets in motion a lengthy review process that could (unless the Governor overrules the OAL) result in repeal of the regulation.  I asked the OAL about the frequency of these requests and was informed that this was the first in more than six years.  Here is the most recent request from the Senate Rules Committee and the notice from the OAL.

For those bothered by a particularly irksome regulation, the priority review process may offer an interesteing alternative to a costly court challenge.

For more on the Ivory-Billed Woodpecker, see this April 30, 2012 article in the Arkansas News.

The state funds the fund with one-half of the $5 fee imposed on annual statements filed with the Secretary of State by California by corporations and foreign corporations qualified to transact intrastate business here.  Cal. Corp. Code §§ 1502(i) and 2117(d).  This brings in approximately $1.5 million annually.

Recently, I reported that the Secretary of State has proposed amending its regulations governing the fund. Senator Ted Lieu has also introduced a bill, SB 1058, that is intended to codify the claims process currently set forth in the Secretary of State’s regulations.

The bill is not without its technical oddities.  For example, it would define “corporation” as a “domestic corporation as defined by Section 162″.  The Corporations Code defines “corporation” in Section 162 and “domestic corporation” in Section 167.  Even more interestingly, the bill defines “court of competent jurisdiction” as “state or federal court or United States bankruptcy court situated in California and applying California law”.  Apparently, this is an attempt to limit pay-outs to victims of corporate fraud in California.  However, it confuses choice of law with the location of the victim.

A more fundamental question is why the state has a victims of corporate fraud fund at all. People are victimized by fraud committed by individuals, limited liability companies, partnerships and limited partnerships.  Yet the legislature has seen fit only to protect victims of corporate fraud.  Further, a claimant has to be “lucky” enough to have been defrauded by a corporation that has incorporated in California or qualified to transact intrastate business here.  Anyone unfortunate enough to have been swindled by a corporation that transacts purely interstate business or that simply ignored the qualification requirement is out of luck.

The Sacramento Bee unfairly blamed the Secretary of State’s office for the fund’s problem.  The real fault rests with the legislature that allowed AB 55 to be gutted and amended in the last few days of the session.  Sudden and complete metamorphosis may have been good for Ovid but it does little good for legislation.

For more information on the fund, see this post.