Securities Industry Commentator by Bill Singer Esq

February 12, 2019

Statement on Shareholder Proposals Seeking to Require Mandatory Arbitration Bylaw Provisions by SEC  Chairman Jay Clayton (SEC Public Statement)


SEC Division of Corporation Finance "Staff No-Action Letter" RE; Johnson & Johnson incoming letter dated December 11, 2018 (SEC No-Action Letter February 11, 2019 to Marc S. Gerber, Skadden Arps, Slate, Meagher & Flom, LLP.)

SEC Chair Clayton's statement addresses "the ability of domestic, publicly-listed companies to require shareholders to arbitrate claims against them arising under the federal securities laws . . ." In the latest iteration of this issue, Chairman Clayton characterizes in part the circumstances as involving a:
domestic, publicly-listed company has received a shareholder proposal that would require the company to take steps to adopt mandatory arbitration provisions.  The company has asked the staff of the Division of Corporation Finance for informal guidance on whether the company may exclude the proposal from its proxy statement.  Specifically, the request seeks the staff's view on whether, under Rule 14a-8(i)(2), the company may omit from its proxy statement a shareholder proposal relating to mandatory arbitration of shareholder claims arising under the federal securities laws.  Rule 14a-8(i)(2) permits exclusion of a proposal that, if implemented, would cause the company to violate any state, federal or foreign law to which it is subject.  The company has argued that the proposal, if implemented, would result in a violation of both federal and state law. 

In response to the recent request, Clayton notes that

[H]ere, the parties have each asserted different interpretations of state law, neither party has identified New Jersey case law precedent directly on point, and the Attorney General has provided an opinion that implementation of the proposal would violate state law.  In light of the submissions, and in particular the letter of the Attorney General of New Jersey, I believe the approach taken by the staff -- to not recommend enforcement action in this complex matter of state law -- is appropriate. 

Clayton admonishes that he is unaware of the SEC having weighed in on the legality of mandatory shareholder arbitration in the context of federal securities law; and, further that a "court is a more appropriate venue to seek a binding determination of whether a shareholder proposal can be excluded." 

In pertinent part, the No-Action Letter responds as follows:

The Proposal requests that the board take all practicable steps to adopt a bylaw provision to require disputes between a shareholder and the Company, its directors, officers or controlling persons relating to certain claims under the federal securities laws to be exclusively and finally settled by arbitration. 

The Company requested that the staff concur in the Company's view that it may exclude the Proposal from its 2019 proxy materials pursuant to rule 14a-8(i)(2), which permits a company to exclude a shareholder proposal "[i]f the proposal would, if implemented, cause the company to violate any state, federal, or foreign law to which it is subject." The Company argued that the Proposal would cause the Company to violate federal and state law. 

As to state law, the Company argued that implementation of the Proposal would cause the Company to violate the state law of New Jersey, where it is incorporated, and provided a New Jersey legality opinion from counsel supporting its view. The Proponent raised arguments in rebuttal. We carefully considered the parties' submissions. 

When parties in a rule 14a-8(i)(2) matter have differing views about the application of state law, we consider authoritative views expressed by state officials. Here, the Attorney General of the State of New Jersey, the state's chief legal officer, wrote a letter to the Division stating that "the Proposal, if adopted, would cause Johnson & Johnson to violate New Jersey state law." We view this submission as a legally authoritative statement that we are not in a position to question. 

In light of the submissions before us, including in particular the opinion of the Attorney General of the State of New Jersey that implementation of the Proposal would cause the Company to violate state law, we will not recommend enforcement action to the Commission if the Company omits the Proposal from its proxy materials in reliance on rule 14a-8(i)(2). To conclude otherwise would put the Company in a position of taking actions that the chief legal officer of its state of incorporation has determined to be illegal. In granting the no-action request, the staff is recognizing the legal authority of the Attorney General of the State of New Jersey; it is not expressing its own view on the correct interpretation of New Jersey law. The staff is not "approving" or "disapproving" the substance of the Proposal or opining on the legality of it. Parties could seek a more definitive determination from a court of competent jurisdiction. . . .
In a recent FINRA expungement arbitration, we find FINRA member firm National Securities Corporation being sued by none other than its former President/CEO, who ran the place for some 16 years.  As part of the absurd legal fiction that drives FINRA's expungement process, the former head honcho was forced to sue his former firm in an effort to get a customer complaint removed from his industry record. That complaint was the only apparent blot on a three-decade career in the biz. National didn't put up much of a fight over the requested expungement, but the firm appeared in quite a lather over being forced to pay Claimant's fees and costs of the proceeding. As it turned out, the assessed fees/costs against Claimant were a not-so-whopping $150.
Former Quintillion Chief Executive Officer Elizabeth Ann Pierce pled guilty in the United States District Court fo r the Southern District of New York to one count of wire fraud and eight counts of aggravated identity theft. As set forth in part in the DOJ Release:

Until July 2017, PIERCE was the chief executive officer of Quintillion, a telecommunications company based in Anchorage, Alaska that built, operates, and markets a high-speed fiber optic cable system (the "Fiber Optic Cable System").  This System consists of three segments: a subsea segment that spans the Alaskan Arctic; a terrestrial segment that runs north to south along the Dalton Highway; and a land-based network of fibers that connects the subsea and terrestrial segments.  The Fiber Optic Cable System is connected to the lower 48 states through other existing networks.

Between May 2015 and July 2017, PIERCE engaged in a scheme to induce two investment companies to provide more than $250 million to construct the Fiber Optic Cable System by providing them with eight forged broadband capacity sales contracts and related order forms under which Quintillion would obtain guaranteed revenue once the Fiber Optic Cable System was built (the "Fake Revenue Agreements").  Under the Fake Revenue Agreements, four telecommunications services companies appeared to have made binding commitments to purchase specific wholesale quantities of capacity from Quintillion at specified prices.  The cumulative value of the Fake Revenue Agreements was more than $24 million during the first year of the subsea segment's operation, approximately $10 million during the first year of the terrestrial segment's operation, and approximately $1 billion over the life of the Fake Revenue Agreements.  In reality, the Fake Revenue Agreements were completely worthless because PIERCE had forged the counterparties' signatures.

Certain of the Fake Revenue Agreements never existed at all, while others were falsified versions of genuine revenue agreements.  PIERCE fabricated the terms of the false versions of the agreements to make them more favorable to Quintillion and, therefore, more appealing to investors than the genuine agreements.  For example, under one of the Fake Revenue Agreements, the customer purportedly agreed to buy increasing amounts of gigabits per second of capacity over a period of 20 years from Quintillion.  That agreement, if genuine, would have assured Quintillion hundreds of millions of dollars in future revenue.  In reality, negotiations over that deal had ended unsuccessfully, which fact PIERCE never disclosed to the investors.  Under another Fake Revenue Agreement, the customer purportedly agreed to buy a fixed, predetermined amount of capacity from Quintillion regardless of subsequent market conditions.  In truth, that customer was not obligated to buy any capacity.

After the terrestrial system was built, PIERCE attempted to prevent the discovery of the Fake Revenue Agreements by accelerating the timing of incoming payments under certain genuine agreements to make those payments appear to be based on the Fake Revenue Agreements.  PIERCE also sought to prevent Quintillion and the investors from invoicing one of the customers that had no real contract with Quintillion by fabricating e-mail correspondence PIERCE purportedly had with that customer.  PIERCE's scheme started to unravel when a customer disputed invoices that it received from Quintillion pursuant to one of the Fake Revenue Agreements.  Shortly thereafter, in the midst of Quintillion's internal investigation, PIERCE abruptly resigned.  Quintillion self-reported PIERCE's conduct to the Department of Justice.

Stockbroker fined and suspended for real-estate management outside business activities
In the Matter of John Kasel, Respondent  (FINRA AWC 2017053496701 / February 11, 2019)
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, John Kasel, submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In accordance with the terms of the AWC, FINRA imposed on Kasel s a $5,000 fine and a three-month suspension from association with any FINRA member firm in any capacity as a result of his allegedly engaging in an outside business in violation of FINRA Rules 3270 and 2010. As set forth in the AWC under the heading "Facts and Violative Conduct":

In May 2011, DK became a customer of KMS. Around the same time, Kesel and DK entered into a written agreement, which Kasel never disclosed to KMS, under which Kesel received a fee to perform a myriad of management duties with respect to several real estate rental properties that DK owned. Over the ensuing fourteen months, Kasel actively managed DK's rental properties on a daily basis for up to 20 hours per week. With respect to four properties, Kesel visited the properties daily; dealt with property managers, real estate agents, and developers; talked to and helped secure tenants; determined what work needed to be done on each property; dealt with and paid contractors; and paid insurance policies, water bills, landscapers, homeowners' fees, and property taxes. Kasel determined the properties' value and decided which properties to rent and which to sell. Kesel had less involvement with several other properties, but still handled incoming payments and occasionally dealt with property managers on DK's behalf. In connection with managing DK's properties, Kasel became a signatory on DK's company's checking account and received a debit card tied to the account, which Kasel used to pay expenses related to DK's properties. 

For his real estate management services for DK, Kasel was paid $2,000 per month (later increased to $4,000 per month) for a total of at least $26,500. Kesel never disclosed these outside business activities to KMS, even though the Firm's procedures required him to do so. In addition, Kasel incorrectly responded on two KMS annual compliance questionnaires that he had no outside business activities. 

Stockbroker Wins Expungement of Customer Complaint Settled for $100,000
In the Matter of the Arbitration Between Dominic Fredo Galati, v. TD Ameritrade, Inc., Respondent (FINRA Arbitration Decision 18-03114)
In a FINRA Arbitration Statement of Claim filed in September 2018, associated person Claimant Galati sought an expungement of a customer complaint. Respondent TD Ameritrade did not object to Claimant's requested relief. Although notified, the public customer did not contest the requested expungement or participate in the hearing. In recommending the expungement, the sole FINRA Arbitrator penned a superb rationale replete with adequate content and context:

The customer alleges Claimant recommended an unsuitable investment. The broker/dealer maintains a list of independent financial advisory firms that a customer may be referred to, based on a suitability survey. Claimant referred the customer to two of these firms in 2014. The alleged damages were $340,000.00. A Statement of Claim was filed through FINRA. Claimant was not listed as a Respondent. His employer TD Ameritrade, Inc., was a Respondent. Also, the independent financial advisory firm ("advisor firm") was listed as a Respondent. Subsequently, a Settlement Agreement was reached. The advisor firm paid the customer $100,000.00. Claimant and his employer TD Ameritrade did not contribute to the settlement amount. Pursuant to Rule 2080 the claim, allegation or information is false. Based upon the pleadings, exhibits and the testimony of Claimant: The Claimant did not recommend any unsuitable investments. The Claimant did not make any recommendations on investments and/or their suitability, nor was it his responsibility to do so, and the customer acknowledged this in several forms that he signed. The Claimant, through TD Ameritrade, provided the customer with two referrals to independent financial advisory firms. The customer chose to hire one of the advisor firms. On or about April 1, 2014, the customer signed a TD Disclosure and Acknowledgement Form (Answer Exhibit C). In this form, the customer acknowledged and agreed that upon hiring the advisor firm, he would be responsible for monitoring the advisor firm's performance, that TD Ameritrade was not responsible for (1) selecting his investments, or (2) for the performance of his investments, or (3) for monitoring the performance of his investments. Further, TD Ameritrade would have no discretionary authority or control regarding his assets under the management of the firm. On or about April 1, 2014, the customer signed a TD Ameritrade Client Options Account Agreement ."(Answer Exhibit G Client Options Account Agreement) where he acknowledged that options trading involved a significant degree of risk, not suitable for all investors. He further acknowledged that he discussed his options information and suitability of trading options with his advisor firm. He and his advisor firm determined that his most aggressive level of options trading for his account which is suitable is level tier 3-Advanced; "Write uncovered options, create spreads, purchase options, write covered calls, write cash-secured puts. Requires margin account." He also acknowledged that as the account holder, the customer, will hold TD Ameritrade blameless for any losses or damages caused as a result of the actions of such authorized person or persons. He also agreed to hold TD Ameritrade harmless from any liability, financial or otherwise, as a result of any losses his account may suffer with respect to any transaction or strategy. On or about April 1, 2014, the customer signed a Limited Power of Attorney (Answer Exhibit H). In this document, the customer agreed to indemnify and hold harmless TD Ameritrade and its employees and agents from and against all claims, actions, costs and liabilities, including attorney's fee arising out of reliance on this limited power of attorney. Claimant did not make any recommendations to the customer regarding suitability of investments. Claimant did not have an obligation to do so, as acknowledged by the customer. The allegations are false. The allegations against Claimant should be expunged.


Biotech Company Employee Pleads Guilty to Securities Fraud Charges (DOJ Release)

In a civil Complaint filed in the United States District Court for the District of Massachusetts, the SEC alleged that biotehcnology company Pixarbio Corp, its President/Chief Executive Officer/Chief Financial Officer/Chief Science Officer Francis M. Reynolds, its Chief Information Offier/Vice President of Investor and Public Relations Kenneth A. Stromsland, and Reynolds long-time friend M. Jay Herod engaged in the fraudulent offering, READ the SEC Complaint
The SEC Complaint alleged that: 
  • Reynolds and Stromsland misled investors with false claims about PixarBio's progress in developing a purported method of delivering non-opiate, post-operative pain medication; and
  • Reynolds, Stromsland, and Herod engaged in a fraudulent scheme to acquire and merge PixarBio with a publicly traded company and to secretly manipulate the sales of shares in the new entity. 
The SEC's litigation is pending and seeks permanent injunctions, disgorgement of ill-gotten gains with interest, penny stock bars, officer and director bars, and financial penalties.
On September 7, 2018, and February 7, 2019, Stromsland and Herod, respectively, pled guilty in a parallel criminal proceeding to one count of securities fraud, relating to their manipulative trading in the company's stock, and one count of obstructing an agency proceeding, relating to their false testimony to the SEC during its 2017 investigation. Stromsland and Herod had falsely denied purchasing PixarBio shares in order to affect the company's share price -- and falsely denied that they had been instructed to do so by Reynolds.