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INDEMNITY PROVISIONS IN AGREEMENTS FOR SALE OF A BUSINESS

Business Agreements

When business owners receive an agreement for the purchase of their business, it is easy to feel lost in a sea of legalese. The agreement generally can be anywhere from 40 to 100-plus pages, covering a broad range of representations and warranties, tax matter procedures and so on.

Although it is obviously imperative to have experienced counsel guide a business owner through this process, it is also helpful for the owner to understand certain fundamental components of the deal, to be able to analyze the risk profile and assist the attorney in negotiating a final agreement that protects the owner to the fullest extent possible.

Indemnity Provision Component

One such fundamental component of the deal is the indemnity provision, which is a mutual obligation of the buyer and seller to defend and hold one another harmless from certain acts or breaches of the agreement. When a party’s indemnity obligation is triggered, that party will have to pay attorney fees and costs of defending any claim, as well as paying for any monetary loss, arising from that claim, including a settlement, judgment, fine or penalty. In other words, the indemnity provision is (generally speaking) the one way that a seller will have to pay money back to the buyer from the sale of the business. Because of this, it is vital for a seller to understand the mechanics of indemnity, and the ways in which indemnity obligations may be limited.

As an initial matter, a seller’s indemnity obligation generally applies to the following: (1) a breach of the seller’s representations and warranties in the agreement; and (2) a breach of the seller’s contractual obligations in the agreement.

The first prong is the source of most post-closing indemnity claims. In the sale agreement, a seller will typically make a lengthy series of representations and warranties, from basic items such as attesting to full and unimpaired ownership of the equity and assets of the company, to highly detailed representations and warranties regarding compliance with employment or environmental laws, and an absence of claims for violating any such laws. If there is any legal violation that seller is aware of, that will be listed on a disclosure schedule to the agreement. In typical sale agreements, there are twenty to thirty such representations and warranties, covering the full spectrum of the business. Therefore, unless an item of potential liability is specifically excluded, any breach of the representations and warranties that the business has been run in compliance with the laws, is not encumbered, and is not subject to any claims, can serve as the basis for an indemnity claim by the buyer.

Because of this, it is important for a seller to thoroughly review all the representations and warranties with counsel and identify any potential gaps in compliance and/or future claims. Once identified, seller and counsel can address the matter with buyer’s team and negotiate provisions to address the matter. In most cases, the parties are able to reach agreeable terms on the issue, but identifying it ahead of time and being able to decide whether or not to proceed is invaluable for a seller. It is far better to decide to proceed with a known risk than it is to be surprised later.

Indemnity Protections

A seller can also have certain protections built into the indemnity section of the agreement to limit the indemnity obligations in most instances. For example, the use of baskets and caps are typical in sale agreements, both of which limit a seller’s obligations.

Indemnity Basket

An indemnity basket functions like a deductible of sorts; i.e., until the amount of buyer’s loss reaches X dollars, the seller does not have to make payment for any indemnified loss. Most agreements use what is called a tipping basket, so that when the loss threshold is met, the seller owes indemnity on the entirety of the loss from dollar one.

Indemnity Cap

An indemnity cap is an even more important tool for the seller. A cap will limit the amount of money a seller has to pay for indemnified claims post-closing, subject to certain exclusions. In most mid-market deals, the typical indemnity cap ranges from 5-15% of the total purchase price. Say for instance the indemnity cap is 10% of the purchase price; in such event, if the purchase price is $20 million, the seller’s total indemnity obligation would be limited to $2 million, again subject to certain exceptions. The logic behind this limitation is that the seller needs a certain level of assurance that once it sells the business, the buyer is not going to come back with a slew of claims to essentially claw back the entirety of the purchase price, while still remaining in control of the business.

The limited exceptions to the applicability of the cap track this logic as well. For example, fraud is the main exception to applicability of the indemnity cap. This makes logical sense in that, if the seller has actively defrauded the buyer about the state of the business, the seller should not be able to hold buyer to an indemnity limit that was negotiated on the presumption all parties were dealing in good faith. The inapplicability of the cap to what are deemed “fundamental representations” like unencumbered ownership of equity and assets is logical as well – if the seller does not truly own what it is purporting to sell, then the buyer should not be bound by any cap, as it truly did not receive what it paid for.

Important Provision For The Seller

Lastly, a common protection for the seller in the indemnity section is that indemnity will be set forth as the exclusive remedy for breaches of the agreement, subject to common exceptions for fraud or for a party seeking equitable relief. This is an important provision for seller, because it prevents a buyer from making an “end run” around the carefully-negotiated indemnity provisions and seeking relief from the seller which is not subject to the baskets and caps, among other things.

The various permutations of an indemnity section in an agreement for sale of a business are too involved to address fully here, but identifying some fundamental components of how indemnity works can help facilitate communications with counsel when that large stack of deal documents hits the seller’s inbox.

October 20, 2020/by The Law Offices of Jeff Petersen Team

NEGOTIATING FAVORABLE TAX TREATMENT OF EARNOUTS

Mergers & Acquisitions, News

What is an earnout?

If a company’s owners are negotiating a sale of their business, one facet of compensation the buyer may propose is an earnout, i.e., a contingent payment tied to a benchmark for the company’s performance post-sale.

An earnout is generally a tool of compromise between buyer and seller – if the parties cannot agree on a purchase price, using an earnout is a way to protect the buyer on the downside if the company does not perform as well as anticipated post-closing, while providing an upside in earnings for the seller if the agreed benchmark is met. The range of calculations for arriving at an earnout is infinite, but in general, the earnout will be some multiple of a financial metric or a fixed or variable number based on some measure of company performance. A seller, if confident about the company’s future, may view an earnout as a way to realize more money on the sale of the business than settling for a fixed number that is lower than what seller is willing to accept.

Risk Factors

With all that being said, there is always a degree of risk involved in agreeing to contingent compensation which may or may not be realized, so most sellers are not inclined to agree to an earnout that will comprise too substantial a portion of the overall purchase price (with exceptions, as with all things). Another potential drawback to using an earnout is that it can result in less favorable tax treatment. If the transaction documents provide that the entirety of the earnout constitutes ordinary income to the seller receiving the payment, then seller will be taxed at an ordinary income tax rate, rather than at the preferred capital gains rate that could otherwise be available to seller.

Restructuring The Earnout Benefits

In light of this, it is important for a selling owner of a company to consider structuring the earnout so that the preferred capital gains rate can be attained on as much of the post-closing proceeds as is allowable under applicable law. A common method by which a buyer and seller do so is by agreeing on a separate payment that will constitute reasonable compensation to the individual for his or her post-closing services, and will thus be taxed at an ordinary income rate. Then the earnout monies that are separate from such reasonable compensation amount will be categorized in the deal documents as “deferred purchase price” being paid for the company’s equity or assets, and thus will be taxed at the same rate for the initial payment at closing. Taxation for a sale of equity will be at the capital gains rate, and for a sale of assets, as the facts allow and when structured correctly, the capital gains rate will predominate as well. Thus, the selling party will attain a preferred tax rate on the post-closing compensation that is separate from the set ordinary income.

As with most facets of a large-scale M&A transaction, the legal considerations in structuring the earnout terms correctly are far too varied and involved to cover in depth here, but there is great benefit in knowing beforehand that the structure of the earnout can result in vastly different tax treatment, and that advance planning and utilizing proper terms can help a seller achieve a much better position with regard to after-tax proceeds on a sale.

October 19, 2020/by The Law Offices of Jeff Petersen Team

NEGOTIATING AN ENGAGEMENT AGREEMENT WITH AN INVESTMENT BANKER

Mergers & Acquisitions, News

A company looking to sell its business will often engage an investment banker to assist in the process.

Such a firm can be an invaluable asset to a prospective seller, assisting the company in preparing for sale, providing a rolodex of suitable buyers, helping negotiate the terms of the deal and facilitating the transaction all the way to a close. The right investment banking firm can help a company sell its business for substantially more than it otherwise would have.

Before an investment banker will engage with a selling company, however, it will require a written agreement setting forth material terms such as the scope of the investment banker’s engagement, the term of the engagement and the compensation it will receive. Negotiating the key terms of this engagement agreement is important for the selling company, as it will dictate the range of services the investment banker will provide and be compensated for, how and when it will be paid, and the types of transactions for which the investment banker will be paid even after the engagement has terminated. We discuss each of these issues below.

Things To Lookout For In The Scope Of Engagement

With regard to the scope of engagement, it is important not only to mutually determine what the investment banker will do for the company, but also what the investment banker will not do. The “Transaction” for which the investment banker will be entitled to fees must be precisely defined so that the investment banker cannot claim a fee for a transaction where it did not provide services. For example, if the engagement is for the sale of the company’s equity or assets, then the investment banker should not be able to claim any fees for a debt financing the company arranges itself in the interim. But a broad definition of “Transaction” could lead to such result.

The term of the engagement will also be addressed in the agreement.

The investment banker will require exclusivity in just about all cases, as it will not want to compete with other firms to sell the company. A term of one year is fairly standard, with investment bankers preferring to have sufficient time to locate a buyer and process the transaction. And we will discuss later in this post the protections in the engagement agreement for the investment banker in the event a deal it has brough to the table does not close by the end of the term.

The compensation owing to the investment banker will also be addressed.

Two main components of this compensation are a retainer and an overall success or transaction fee. Many investment bankers require a retainer for the engagement, which is a non-refundable fee paid at the outset of the engagement. The selling company should try to negotiate the retainer out of the engagement completely if it can, and if that can’t be done, the retainer should be a minimal part of the overall contemplated compensation, as well as being creditable against the success fee.

What is a success fee?

The success fee is generally a percentage of the purchase price of the company. The range of percentage charged for a success fee can vary greatly based on deal size, so it is important to confer with an attorney or other adviser with knowledge of the industry to ensure the fee listed in the engagement agreement is commercially reasonable. The investment banker may also seek to impose a minimum success or transaction fee, which guarantees a floor on payment to the investment banker at close of sale regardless of the sale price. Any minimum fee is obviously not desirable for a seller, as it imposes an obligation to potentially pay significantly more to the investment banker than the purchase price would otherwise dictate. The company can push back on this with a logical argument the investment banker’s sales pitch will lend some support to, namely, “If we’re such a great company, as you’ve been telling us, and you’re so good at your job, why do you need to charge a minimum fee?” The investment banker’s rebuttal is likely, among other things, that they cannot control what happens to the company between time of engagement and time of sale, and the minimum serves as downside protection in the event due diligence or other matters result in sale at a lower price than the parties anticipated. If the company is to agree to any such fee, it should have a high degree of confidence about the purchase price it can obtain. The seller should also use language giving it broad discretion to choose not to do a deal in the event the only offer obtained is prohibitively low.

What is a fee on any contingent compensation owing on a deal?

If there is money to be paid after the closing, which can include a return of money escrowed for indemnity claims, an earnout to be paid, or payments pursuant to a seller note, the investment banker will want to include that in its fee. Although doing so makes some logical sense, as post-closing payments are part of the overall compensation to the selling shareholders, a seller will want to ensure it has no obligation to make payment until actual receipt of any contingent monies.

Some investment bankers will use language in their engagement agreements imposing an obligation on the sellers to pay at closing a fee on all contingent compensation that may be owing after closing. But doing so imposes obligations on the sellers to pay: (1) before they ever receive the money, and (2) the full amount of the contingent compensation, which may never be realized. As to the last point, say a buyer makes an indemnity claim, and the escrow amount is reduced by $2,000,000 as a result. If the investment banker fee is 3%, the seller will have paid $60,000 in investment banking fees on money it never actually received. For this reason, negotiating terms that contingent payments will be paid promptly after the money is received, and only to the extent that contingent payments are actually received, can prevent a seller from having to make premature and excessive payments.

What does the engagement agreement address?

Finally, the engagement agreement will address what fees may be owing to the investment banker for a transaction that closes after the engagement agreement is terminated. This is often referred to as a “tail period” for the engagement. Here, the investment banker is seeking to ensure the seller does not attempt to either stall a transaction until after the term, or pretend not to be interested in a prospective purchaser introduced by the investment banker, only to contact that prospective purchaser after termination to consummate a deal.

In general, a one-year tail period is acceptable to cover the consummation of a deal with a prospective purchaser the firm has introduced to the seller. Careful attention will have to be paid to this clause, however, to preclude the investment banker from casting too wide a net here – for instance, by defining a sale giving rise to its fee to include a deal with any buyer during the tail period, even if that buyer was never introduced to the seller by the investment banker.

The investment banking relationship can definitely be a beneficial one for a selling company, but given that the sale of a business is the single most important transaction the company will ever have, it makes sense to review all agreements material to that sale carefully to ensure appropriate safeguards are in place.

October 18, 2020/by The Law Offices of Jeff Petersen Team

ADDRESSING IMPORTANT DEAL POINTS IN YOUR LETTER OF INTENT

Corporate Transactional Law, News

A letter of intent for the purchase of a business sets forth the major deal points for that transaction, including the purchase price, the structure of the deal (asset purchase, stock purchase, etc.), whether an earnout will be utilized, and so forth. The letter of intent is almost always non-binding, meaning that deal points may be modified as the parties mutually agree during the course of due diligence and drafting final documents.

The fact that the letter of intent is non-binding and chiefly addresses business points of the deal sometimes lulls business owners into a sense of complacency on the legal aspects of the deal, with the mindset being that the lawyers can hash out the legal terms later. This mindset can be bolstered by the boilerplate language used in letters of intent on legal items such as indemnification, where the letter of intent may just generally state that the parties will indemnify one another pursuant to standard indemnity terms.

Why Boiler-Plate Shouldn’t Be Ignored

Business owners would be well served, however, by taking the time and using counsel to put some concrete terms around the important legal aspects of the deal. Although the letter of intent will be non-binding, having these terms addressed will set the expectations for both sides of the deal, and without a major issue arising during due diligence, it will be difficult for a buyer to justify making significant changes on these legal items. On the contrary, if important items are not addressed, a seller is left to try to negotiate mid-deal, where the buyer has an exclusive period of 90 days or so where the seller is unable to sell to anyone else (generally one of the only binding terms in a letter of intent), and seller is incurring significant costs like attorney and other adviser fees. This circumstance gives a seller less leverage to negotiate important legal terms.

So what are these important legal points a business owner will want to address in that letter of intent? Indemnification is one major item. Rather than say indemnity will be provided pursuant to “standard terms”, the letter of intent should address several things, including: (1) an indemnity basket or cap for the seller, as well as the survival period for indemnity claims; (2) the exceptions to the basket, cap, or standard survival period; and (3) the use of any escrow or setoff for indemnity purposes.

The Indemnity Basket

An indemnity basket functions like a deductible, where generally the business owner is not liable to indemnify buyer until losses exceed a set threshold amount. Then, once that amount is met, the seller is liable for indemnification for the entire amount of any loss. An indemnity cap is a limitation on the amount seller will owe for indemnity, generally an amount in the range of 10-20% of the purchase price. One can see that having an indemnity cap limiting the amount of the indemnity obligation would be crucial for a seller. Lastly, it is important to address the survival period for representations and warranties, which governs for how long a buyer may make an indemnity claim for breach of representation and warranty. Generally speaking, this survival period is between 12 and 18 months.

The most common exception to the application of the basket or cap, or to the survival period, is for fraud perpetrated by the seller. For example, if a seller has willfully concealed a problem with the business resulting in a loss, it is fair and reasonable to say that loss should not be excused or capped, and that if the loss arises after say a one-year survival period, the defrauding seller should not be able to avoid liability for the loss.

Escrow Equal to Cap on Indemnity

Finally, buyers generally like to set up an escrow where a portion of the purchase price will sit for the survival period to ensure payment of any indemnity obligation that may arise. Typically, the escrow amount will equal the cap on indemnity. If an earnout is contemplated, buyers may also demand the ability to “set off” any amounts owing on an indemnity claim against any earnout payments owing to a seller. Say, for instance, that seller claims $200,000 in damages for an indemnifiable claim and has an upcoming $500,000 earnout payment to a seller. The buyer in this case would unilaterally deduct the $200,000 from the payment owing and remit only $300,000 to the seller.

With all the possible permutations in the indemnity provision, one can see that it’s helpful at the outset to nail down items like the amount of the indemnity cap, the use of an escrow, etc. Doing so will also reveal whether the buyer is contemplating inserting exceptions to the cap or survival period that are outside commercial norms. Finding this out sooner, and addressing it before a buyer is in the thick of the deal process, will provide a better negotiating position.

What About Earnout

Another important item to flesh out in the letter of intent is how the earnout will be treated. Generally speaking, an earnout will be tied to EBITDA or some other measure of financial performance, i.e., the seller will receive X amount of money based on company performance. Defining clearly in the letter of intent how that benchmark is measured is crucial. Will certain revenues be excluded, how is the time period for such benchmark calculated and will any adjustment be made for deals booked prior to the cutoff where revenues have not been collected yet? Each particular scenario will raise its own questions, but much better to address those specific questions upfront.

Lastly, on the earnout, a seller has the ability to categorize a portion of any earnout as deferred purchase price rather than income, which results in preferred capital gains tax treatment on that portion of earnout as opposed to an ordinary income tax rate. The resulting difference in proceeds can be substantial, so it is well worth putting in the letter of intent what the amount of fair compensation for services provided will be, with any earnout monies over that amount to be treated as deferred purchase price.

Selling a business is a complex and time-consuming process in the best of circumstances. Given that, it makes good sense to address the important issues at the initial stage in detail to provide a clear forward path. Whoever said an ounce of prevention is worth a pound of cure may not have worked in the M&A space, but they were right on the money when they said it.

October 17, 2020/by The Law Offices of Jeff Petersen Team

DELAWARE CHANCERY CASE HAS SIGNIFICANT IMPLICATIONS ON USE OF SUPERMAJORITY PROVISIONS WITH DELAWARE CORPORATIONS

Corporate Transactional Law, News

A recent case from the Delaware Chancery Court has cast doubt on the validity of bylaws containing supermajority voting requirements on items where Delaware’s General Corporation Law (“DGCL”) contains a specific voting threshold.

Frechter v. Zier, C.A. No. 12038-VCG (Del. Ch. Ct. Jan. 24, 2017)

In Frechter v. Zier, C.A. No. 12038-VCG (Del. Ch. Ct. Jan. 24, 2017), a shareholder of Nutrisystem, Inc. sued the company and its directors for declaratory judgment to invalidate a provision in Nutrisystem’s bylaws requiring a vote of two-thirds of the company’s shares before a director could be removed from the board.

The plaintiff relied on Section 141(k) of the DGCL, which provides that “[a]ny director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors” (with certain exceptions that were not applicable). Defendants argued that the board was empowered to adopt the bylaw pursuant to DGCL Sections 109(b) and 216 of the DGCL —which provide for, respectively, the adoption of bylaws not inconsistent with law or the certificate of incorporation, or bylaws specifying the required vote for a transaction subject to other provisions of the DGCL.

Chancery Court Chancellor & Plaintiff Agree

The Chancery Court Chancellor agreed with plaintiff, concluding that Section 141(k) prohibits any bylaw requiring a supermajority vote for director removal because any such requirement would be inconsistent with “the plain language of the statute.” The Chancellor added that any contrary interpretation would render Section 141(k) “an effective nullity.”

This opinion has significant implications for any bylaw provision requiring supermajority shareholder votes for any item for which the DGCL provides a specific voting threshold. Corporations should consider removing any such supermajority voting requirements from their bylaws and instead placing them in the certificate of incorporation.

Placement of supermajority provisions in the certificate of incorporation is preferable because Section 102(b)(4) of the DGCL permits a corporation to include in its certificate of incorporation “

Provisions requiring for any corporate action, the vote of a larger portion of the stock or of any class or series thereof, or of any other securities having voting power . . . than is required by this chapter.” The DGCL has no similar provision with respect to bylaws.

February 13, 2017/by The Law Offices of Jeff Petersen Team

SEC CHARGES CHINESE NATIONAL CITIZENS WITH INSIDER TRADING, OBTAINS ORDER FREEZING $29 MILLION IN U.S. ACCOUNTS

News, Securities Law

Words insider trading written on a book.

Emergency Court Order – Securities & Exchange Commission

The Securities and Exchange Commission announced Friday that it obtained an emergency court order freezing brokerage accounts holding more than $29 million in allegedly illegal profits from insider trading that took place prior to the April 2016 acquisition of DreamWorks Animation SKG, Inc. by Comcast Corp.

In its complaint, the SEC alleged that in the weeks leading up to news of the acquisition, Shaohua (Michael) Yin attained more than $56 million of DreamWorks stock in U.S. brokerage accounts of five Chinese nationals, including his parents. The stock was allegedly obtained over a three-week period after a confidential bid had been placed to buy the studio. After the acquisition was announced, DreamWorks stock price rose over 47%.

S

$29M In Profit From The DreamWorks Trade

The SEC’s complaint further alleged that the five accounts gained $29 million in profits from the DreamWorks trades, and that the accounts profited from other suspicious trading in another U.S.-based company and three China-based companies ahead of market-moving news.

Yin, a partner at Summitview Capital Management Ltd., a Hong Kong-based private equity firm, allegedly did not trade in DreamWorks stock through his own account but instead through five accounts from addresses in Beijing and Palo Alto and on a computer that also accessed his email accounts.

Michele Wein Layne, Director of the SEC’s Los Angeles Regional Office, stated in the SEC press release that, “Despite the defendant’s alleged attempts to hide his control over these accounts, the SEC’s data analytic investigative tools enabled us to determine who was behind the suspicious trades. Our action today shows that the SEC will not hesitate to freeze the assets of foreign traders when they use our markets to conduct illegal activity.”

SEC Restraining Order Was Successful

The SEC was successful in securing a temporary restraining order freezing the assets in the five brokerage accounts in the U.S. District Court for the Southern District of New York. A hearing on an order to show cause why an injunction and other relief should not be issued has been scheduled for February 17.

The SEC’s complaint charges Michael Yin with securities fraud and names the holders of the five brokerage accounts – Lizhao Su, Zhiqing Yin, Jun Qin, Yan Zhou and Bei Xie – as relief defendants. The SEC is seeking a permanent injunction, return of all allegedly ill-gotten profits, civil money penalties, and other relief.

The SEC’s press release can be viewed at the following link:

https://www.sec.gov/news/pressrelease/2017-44.html

February 13, 2017/by The Law Offices of Jeff Petersen Team

UBS ANNOUNCES HONG KONG SECURITIES REGULATORS INVESTIGATING ITS WORK ON IPOS

News

We posted earlier this month about the China Securities Regulatory Commission investigating several IPOs as part of its regulatory push in the area. (http://lawofficesjtp.wpenginepowered.com/chinese-securities-regulator-announces-ipo-investigations-on-six-com panies/)

Report Discrepancy

Now, there’s news this week that Hong Kong’s Securities and Futures Commission is investigating UBS’s conduct in sponsoring IPOs. UBS made the announcement in its most recent quarterly earnings report. UBS announced that the Commission gave notice it would take action against the company and certain unnamed employees for their work in sponsoring IPOs.

In the filing, UBS announced that possible penalties for the alleged violations include fines, a restitution order or suspension from providing corporate financial advisory services in Hong Kong.

Hong Kong has strengthened its securities laws in the past few years by making banks that conduct due diligence and prepare IPO documentation subject to potential liability for misrepresentations and material omissions in offering documents.

Jeff Petersen is a securities attorney licensed in California and Illinois representing clients in a wide variety of regulatory investigations and enforcement matters. He can be reached in California at 858.792.3666 and in Illinois at 312.583.7488.

October 30, 2016/by The Law Offices of Jeff Petersen Team

SEC RESPONDS TO SAN DIEGO INVESTMENT ADVISER RAYMOND LUCIA’S PETITION FOR REHEARING ON CLAIM SEC IN-HOUSE COURTS ARE UNCONSTITUTIONAL

Corporate Transactional Law, News

San Diego-based investment adviser Raymond Lucia’s request that the court consider his challenge to the constitutionality of the SEC’s use of in-house courts was recently rejected by a panel of the U.S. Court of Appeals for the District of Columbia Circuit.

Misleading Claims

Lucia, a well-known investment adviser with a long career, was charged by the SEC with conducting misleading investment seminars that promoted a “buckets of money” investing strategy that was purportedly supported by empirical testing, when no such reliable testing had been done. The SEC proceeding resulted in what Lucia’s own attorneys described as a “career-ending lifetime industry bar”.

Lucia petitioned the Circuit Court for rehearing, contending the SEC’s selection of administrative law judges violated the Appointments Clause of the Constitution, and that the Circuit panel erred in finding that the Appointments Clause did not apply because SEC ALJ’s are not “inferior officers” under the Constitution. The SEC has now responded to the petition.

Decision of the SEC Stands

In its response, the SEC stressed that the panel correctly found that ALJ’s are not inferior officers because those ALJ’s cannot exercise final decision-making authority under the pertinent regulatory scheme. Specifically, the SEC addressed Lucia’s reliance on Freytag v. Commissioner, 501 U.S. 868 (1991), with the SEC arguing that Lucia misconstrues the import of that decision. The SEC asserted that, because the tax court judge in the Freytag case had final decision-making authority, the commentary by the Supreme Court in the case Lucia’s counsel relied on in the petition was immaterial; the decisive point of difference is that the tax court judge was an inferior officer due to its final decision-making authority, and an ALJ, without any such authority, is not.

We will update this matter when the D.C. Circuit Court rules.

Jeff Petersen is an attorney licensed in California and Illinois representing clients in a wide variety of SEC investigations and SEC enforcement matters. He can be reached in California at 858.792.3666 and in Illinois at 312.583.7488.

October 26, 2016/by The Law Offices of Jeff Petersen Team

INVESTMENT ADVISER PLEADS GUILTY TO INSIDER TRADING

News

The U.S. Attorney’s office for the Southern District of New York announced today that David Hobson, who served as an investment adviser in the Providence, Rhode Island, offices of two different national broker-dealer and investment advisers, pled guilty to engaging in a scheme to commit insider trading on deals involving pharmaceutical company Pfizer.

Breach of Duty

Per the release by the U.S. Attorney, Hobson participated in a scheme with his friend Michael Maciocio, who worked at Pfizer. Maciocio, while employed by Pfizer, regularly possessed material, nonpublic information about pending acquisitions and transactions under consideration. The U.S. Attorney asserted that over a period of several years, Maciocio breached his duty of confidentiality by providing inside information about potential acquisitions and transactions to Hobson. The indictment alleged that Hobson would then use this inside information to execute trades in favor of Maciocio, Hobson and other clients of Hobson.

Protecting the Fair Marketplace

In the press release, U.S. Attorney Preet Bharara stated: “As he admitted today, David Hobson exploited inside information provided by his friend and client Michael Maciocio to reap illegal profits for both of them. With Maciocio’s earlier guilty plea, both participants in this illegal insider trading scheme have now admitted to their crimes. Insider trading rigs the markets, and through prosecutions like this, we seek to make the securities markets fair.”

The U.S. Attorney stated in the release that as a result of the scheme, Hobson obtained more than $350,000 in ill-gotten gains for himself, Maciocio, and other clients of Hobson.

Per the release, Hobson pled guilty to one count of conspiracy to commit securities fraud, and to one count of securities fraud, while. Maciocio previously pled guilty on May 20, 2016, to one count of conspiracy to commit securities fraud, one count of conspiracy to commit wire fraud, and two counts of securities fraud.

The case is U.S. v. Hobson, U.S. District Court, Southern District of New York, No. 16-cr-351

Jeff Petersen is an attorney licensed in California and Illinois representing clients in a wide variety of SEC investigations and SEC enforcement actions. He can be reached in California at 858.792.3666 and in Illinois at 312.450.4584.

October 26, 2016/by The Law Offices of Jeff Petersen Team

OPENING ARGUMENTS BEGIN IN SEC CASE AGAINST PARTRIARCH’S LYNN TILTON

News

Lawyers for the SEC argued yesterday that Patriarch Partners’ Lynn Tilton cheated investors in failing companies of more than $200 million and should be permanently banned from the industry.

Action Against Tilton

The SEC asserted that Tilton and her firm improperly collected the money in fees and other payments for over 10 years without disclosing to investors that companies were defaulting on loans the investors had made to the failing companies attempting turnarounds.

The SEC claimed this conduct was a clear breach of fiduciary duty, and that had investors known the material facts, they would not have invested with Patriarch.

The SEC is seeking in the action, among other things, disgorgement of the $200 million Tilton and her companies received in fees and other payments, a permanent ban on Tilton from the industry and monetary penalties against Tilton and her companies.

Tilton’s Rebuttal to Action

Tilton’s attorneys argued that there was no logic behind the SEC’s asserted fraud case, since Tilton was already worth $1 billion at the time and had no motivation to deceive any investors. Moreover, her attorneys claimed she put nearly half a billion dollars of her own money into the companies and investment funds during the financial crisis, which cuts against any argument she was seeking to dupe investors out of money.

Tilton’s counsel also emphasized the broad discretion Tilton and her companies had to revive the failing companies, stating that this also cut against any claim that investors were deceived about the state of the companies.

Tilton released a statement Monday before trial, stating, “For years now, I have been fighting for truth and justice, and I’m glad that we have reached the point where we can finally put the SEC’s case on trial.” She further said in the statement: “I’ve never fit the mold of Wall Street and the private equity industry, and it appears that this has made me a target. But I believe that ultimately the truth will prevail.”

The trial is expected to take several weeks. We will keep you updated on its progress.

Jeff Petersen is an attorney licensed in California and Illinois representing clients in a wide variety of SEC investigations and SEC enforcement actions. He can be reached in California at 858.792.3666 and in Illinois at 312.450.4584.

October 25, 2016/by The Law Offices of Jeff Petersen Team