Contract Law - Seventh Circuit Blocks An Attempt to Hold Shareholders Liable For Corporate Debts

On August 2, 2010, the Seventh Circuit issued an opinion (written by Judge Easterbrook) in the case captioned Fusion Capital Fund II, LLC v. Richard Ham and Carla Aufdenamp, 09-3723, reversing a decision by Judge Shadur, holding that corporate shareholders could be liable for the corporation's debts.

The Plaintiff sought to collect a debt incurred by a corporation directly from the corporation's shareholders. The debt arose as a result of an ill-fated merger transaction.

Millenium Holding corporation was insolvent. However, it had previously gone public and its stock was tradeable. Another company, Sutura, Inc., sought to go public by merging into Millenium. As the Court noted, "Sutura wanted to go public without all the fuss and bother (and expense) of a registration statement and the release of audited financials." As a part of the merger agreement, Millenium agreed to raise $15 million in new capital. Later, Plaintiff Fusion and Millenium signed a contract and agreed to provide the $15 million.

When the merger with Sutura failed to close, Fusion "wrote to Millenium that the money would not be forthcoming." Sutura then terminated the merger agreement.
Fusion prevailed in contract litigation and later sued in the Northern District of Illinois to collect its legal fees incurred.

Fusion brought its claim against Ham and Aufdenkamp, Millenium's controlling shareholders. The District Court held that the Ham and Aufdenkamp were personally liable for the debt under Nevada law. The District Court ruled that Ham and Aufdenkamp became the "alter ego" of the corporation because (a) they influenced and governed it; (b) there was a "unity of interest" between the shareholders and the corporation; and (c) "adherence to the corporate fiction of a separate entity would sanction fraud or promote manifest injustice." Opinion at 4.

The Seventh Circuit agreed with the analysis with respect to the first two elements of the alter ego test. However, there was no fraud because Fusion was well aware - when it entered into the contract - that Millenium had no assets and was insolvent.

The Court reasoned that Fusion should have been aware that it could never enforce its contract (for the payment of legal fees) because Millenium was broke.

"When Millenium signed a contract promising to reimburse Fusion's legal expenses if litigation ensued, Fusion knew beyond a doubt that Millenium would be unable to keep that promise - unless the merger closed. Someone who wants to protect himself against the possibility that a thinly capitalized corporation will be unable to pay its debts asks the investors for a guaranty. It is feckless to do business with a corporation such as Millenium without one. Yet Fusion did not get a guaranty but also did not even ask for one....A business such as Fusion that neglects to arrange for payment if the worst comes to pass is not well positioned to seek judicial aid....Fusion wants to be protected from this asymemetry [the risk that Millenium would not be able to pay], but to get this protection Fusion should have negotiated for a guaranty and refused to deal if the Hams would not give one."

The Court distinguished the situation where the debtor is solvent when the contract is signed, but later siphons off its assets to avoid payment.

Comment: This is a thoughtful opinion that takes the polar opposite view of the District Court. It is a reminder to lawyers that anything can happen on appeal and that the underlying economics of a transaction are often far more persuasive than case citations and three-factor tests.

Edward X. Clinton, Jr.

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Securities Law - A Rare Loss For the SEC

A District Court case (Southern District Of New York) involves allegations of insider trading in violation of Section of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)-(5). The case is captioned SEC v. Nelson J. Obus, et. al., 06 Civ 3150, United States District Court for the Southern District of New York. The opinion was written by George B. Daniels, District Judge. The opinion can be found in the Pacer Systems. It is Document 77 and is dated September 20, 2010.

Following a SEC investigation, the SEC filed a Complaint alleging insider trading in violation of Section 10(b) and Rule 10(b)-5 against Tom Strickland, an employee of GE Capital Corp. The SEC alleged that Strickland tipped a friend, Peter Black, an analyst at Wynnefield Capital, about the potential acquisition of SunSource by a financial buyer. Black then, according to the SEC Complaint, passed the information to his superior, Opus, who purchased the stock of SunSource. The Court referred to the “Classical” and “Misappropriation” theories of insider trading.

Under each theory the SEC must prove five elements: (1) the tipper possessed material non-public information concerning a publicly traded company; (2) the tipper disclosed this information to the tippee; (3) the tippee traded in the company’s securities while in possession of the insider information; (4) the tippee knew or should have known that he tipper had violated a relationship of trust by providing the non-public material information and (5) the tippee benefited from the disclosure of the information. S.E.C. v. Warde, 151 F.3s 42, 47 (2d Cir. 1998). All of the Defendants filed a motion to dismiss the Complaint for failure to state a cause of action.

GE Capital sought to do business with SunSource. GE submitted a best effort proposal to provide 95 million dollars of financing in support of a potential buyer’s buyout of SunSource. Strickland was the front person for the GE underwriting team. Strickland learned that Wynnefield was an owner of SunSource stock and that his college classmate, Black, worked at Wynnefield. Following Strickland’s call to Black, Wynnefield purchased a block of SunSource Stock.

GE was subpoenaed by the SEC to testify pursuant to Federal Rule Of Civil Procedure 30(b)(6) about Strickland’s employment history. The GE employee testified that Strickland was trying to do some underwriting when he talked to his friend, Black.
The SEC based its insider trading allegations on the premise that by tipping Black about the impending SunSource merger, Strickland breached the fiduciary duty he owed to SunSource as a “temporary insider.” The District Court noted that neither Strickland nor his employer GE was a corporate insider of SunSource and that accordingly the classical theory of insider trading was not violated.

The Court said that the SEC cannot prove that GE or Strickland owed a duty of confidentiality to SunSource on the date of Strickland’s call to his friend Black and that summary judgment was rendered in favor or the Defendants in regard to the “classical” theory of insider trading.

The Court then considered whether the misappropriation theory applies when a person commits fraud in connection with the securities transaction. The Court concluded that Strickland engaged in no active deception. Such being the case the misappropriation theory did not apply.

Accordingly, the Court dismissed the SEC Complaint against all Defendants.

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Securities Law - Verdict Upheld by Seventh Circuit

RK Company sued Jackie R. See for violations of the Federal and State Securities Laws. The case is entitled RK Company v. Jackie R. See, No. 07-3984 decided September 22, 2010 by the Court Of Appeals for the Seventh Circuit.

The Seventh Circuit summarized the basis for the case as follows:

"Harvard Scientific Corporation and its founder Jackie R. See claimed to be developing a new product to treat male and female sexual dysfunction. Dr. See touted HSC's soon-to-be success in creating this product in a series of press releases and securities filings. This attracted an investment by RK Company..."

Plaintiffs invested $500,00 in Defendant’s LLC.

"Unfortunately, HSC's claims of success were not true, and following a bench trial, the court found Dr. See violated federal and state securities laws, state deceptive practices law, and committed common law fraud." The Seventh Circuit noted that the evidence showed that HSC's press releases included false statements and material omissions, "such as HSC's claims that the FDA had authorized clinical studies when it had actually suspended them..."

At trial, Plaintiffs sought damages equal to its investment of $500,000, prejudgment interest and attorneys’ fees. At trial, the plaintiff RK Company was successful. The opinion makes virtually no direct mention of the Securities Laws but rather discusses and rejects various claims of error by
Magistrate Judge Keys who presided.

Jackie See claimed to have a new product to treat sexual dysfunction of men and women. However, his company never received Federal Drug Administration approval and eventually went bankrupt. Defendant’s claim of FDA approval was false. The $500,000 investment by plaintiff was lost.

Following a bench trial, judgment was entered for plaintiff for the amount of the investment, prejudgment interest and attorneys’ fees.

The Seventh Circuit in an opinion by Judge Williams affirmed the ruling of the District Court. The Defendant claimed that the attorneys’ fees were excessive and that it had insufficient time to review the invoices. The invoices of the plaintiff’s attorney had been paid by his client which according to the Seventh Circuit was evidence of reasonableness. The Seventh Circuit noted that the Defendant received copies of plaintiff’s paid invoices on April 9, 2007 and had until August 2, 2010 to review and object to the invoices. The period of review was far in excess of the 15 days provided by the Local Rule.

A full victory for the Plaintiff.

Edward X. Clinton, Sr.

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Securities Law - Mark Cuban Fouls Out!

The SEC sued Mark Cuban, owner of the Dallas Mavericks and other businesses claiming that he wrongfully traded insider information in violation of § 17(a) of the Securities Act of 1933 and § 10 of the Securities Exchange Act by trading in the stock of Mamma.com in breach of his duty to the CEO of Mamma.com and Mamma.com amounting to insider trading under the misappropriation theory of liability. Cuban was a large minority stockholder of Mamma.com. In a telephone call from the CEO of Mamma.com, Cuban learned that Mamma.com was going to trade a public equity offering (PIPE). Cuban agreed in that call to keep the information confidential. Cuban then sold his stake in the Mamma.com to avoid losses from the inevitable fall in share price when the offering was announced. Cuban moved to dismiss.

The District Court found that the SEC Complaint alleged an agreement to keep information confidential, but did not include an agreement not to trade. The SEC appealed arguing that a confidential agreement creates a duty to disclose or abstain and that regardless the confidentiality agreement alleged in the Complaint contained an agreement not to trade on the information. (If interested, see our prior posts on this topic below).

The SEC alleges that Cuban’s trading constituted insider trading and violated Section 10(b) of the Securities Exchange Act. Section 10(b) makes it
unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . [t]o use or employ, in connection with the purchase or sale of any security … any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

Pursuant to this section, the SEC promulgated Rule 10b-5, which makes it unlawful to
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

The Supreme Court has interpreted Section 10(b) to prohibit insider trading under two complementary theories, the “classical theory” and the “misappropriation theory.” The Cuban case involved the misappropriation theory.

The misappropriation theory rests on the principle that if a person violates Section 10(b) when he misappropriates confidential information for securities trading purposes, in a breach of a duty owed to the source of information. This theory was adopted by the United States Supreme Court in United States v. O’Hagan, 521 U.S. 642 (1997). In O’Hagan, the Supreme Court held that a lawyer who traded on confidential information misappropriated that information breaching a duty of trust and confidence he owed to his law firm and the law firm’s client.

The CEO of the Mamma.com was instructed to contact Cuban and to preface the conversation by informing Cuban that he had confidential information to convey to him in order to make sure that Cuban understood before the information was conveyed that he would have to keep the information confidential. Cuban agreed to keep the information concerning the PIPE offering confidential. At the end of the call, after learning about the offer, Cuban said “Well, now I’m screwed. I can’t sell.” Cuban then had a call with a sales representative of the proposed offering to get details of the offering. Following that call he immediately sold his entire stake in the company consisting of over six percent (6%).

The District Court found that the Complaint asserted no facts that reasonably suggest that the CEO intended to obtain from Cuban an agreement to refrain from trading on the information as opposed to an agreement merely to keep it confidential.

The Fifth Circuit held that it was entirely plausible that the CEO understood that in addition to keeping the information confidential, Cuban would not sell. Accordingly, the Fifth Circuit without taking a stand on whether the disclosure by the CEO was intended to restrict Cuban from trading would only be determined following further proceedings in the District Court. Accordingly, the motion dismissing the case was vacated and the parties can proceed with discovery, a summary judgment motion and a trial, if necessary.

Edward X. Clinton, Sr.
Copyright 2010

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Seventh Circuit Approves Securities Class Certification in Conseco Case

The United States District Court for the Seventh District of Indiana approved class certification for a class of Conseco Investors. (Later Conseco changed its name to CND Financial Group.) Defendant challenged the granting of class certification to the investor class and appealed to the Seventh Circuit in the case of Schleicher v. Wendt, et al., No. 09-2154 (decided August 20, 2010). The Seventh Circuit affirmed the decision to certify a class.

The Court states that class treatment is appropriate when issues common to class members dominate over those that affect them individually. Fed.R.Civ.P. 23(b)(3). The necessary elements under Rule 23(b)3 are: (1) whether the statements were false; (2) whether the false statements are intentional; (3) whether the stock’s price was affected, and (4) whether the magnitude of such effect shows that the false information was material.

The elements of a claim under §10(b) of the Securities Exchange Act of 1934 and the SEC’s Rule 10b-5 are falsehood in connection with the purchase or sale of securities, scienter, materiality, reliance, causation, and loss. Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005). Reliance usually shows how the false statements caused the loss. Until Basic Inc. v. Levinson, 485 U.S. 224 (1988), defendants tried to resist class certification by contending that each investor was bound to have received different information about the company, and that many investors would not have read the supposedly false statements at all. Thus it was argued that each investor’s fund of information differed from every other investor’s. But Basic concluded that the price of a well-followed and frequently traded stock reflects the public information available about a company.

The opinion discusses the fraud-on-the-market doctrine and states that when a statement that adds to the supply of available information that news passes on to each investor through the price of the stock. As stated, the price transmits the information and causes the change in the stock’s price. The approach supplants “reliance” as an independent element by establishing a more direct method of causation. When a stock trades in an efficient market, the contestable elements of Rule 10(b)(5) reduce to falsehood, scienter, materiality, and loss. Therefore, each investor’s loss can be established mechanically – common questions predominate and class certification is routine.

The Defendants mounted an aggressive and comprehensive defense. For example, the Defendants contend that before certifying a class, the District Court must determine that the contested statements actually caused material changes in stock prices.
Defendants also contended that even if the evidence shows scienter, materiality, causation, and loss, individual damages questions still predominate and prevent class certification.

Judge Easterbrook who wrote the opinion for the Seventh Circuit acknowledged the aggressive efforts of the defendants by stating “a more thoroughgoing challenge to class treatment of securities litigation is hard to imagine.”

In other words, the merits of the case must be proven to obtain class certification. As the Court stated, if the Defendants’ arguments were accepted, it would end the use of class actions in securities cases.

Defendants in effect contended that before certifying a class the district judge must first determine that the contested statements actually caused material changes in
stock prices.

The opinion points out that the fact that the Conseco stock was falling during the class period is irrelevant; fraud could have affected the speed of the fall. That is to say if a firm says it lose one hundred million when it actually lost two hundred million, then the announcement of the two hundred million will cause the price to continue to fall.

The Defendant’s contention that before certifying a class, a court must determine whether false statements materially affected the price, but whether the statements were false or whether the effects were large enough to be called material are questions on the merits. The Court expressly stated that the contention of Defendants that class certification is proper only when the class is sure to prevail on the merits, the opinion concluded that the chances, even the certainty that a class will lose on the merits does not prevent certification of the class.

In the writer’s opinion this case will be followed closely because there is a comprehensive review of the elements necessary for class certification and a rejection of various defensive arguments.

The lawyers for the plaintiffs were The Wagner Firm and the Law Offices of Brian Barry, Glancy Binkow & Goldberg LLP, among others and the lawyers for the defendants were Kirkland & Ellis, LLP, Baker & McKenzie, LLP and Barnes & Thornburg LLP, among others.

Edward X. Clinton, Sr.

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Evidence - Admissibility of Business Records

Obtaining the admission of business records is a often a critical component of any trial. It is a must in any business litigation and can cause problems if it is not carefully considered. Obviously, if you cannot obtain the admission in evidence of business records, such as invoices, you can't win even the most simple collection lawsuit.

Under Rule 803(6) if a document qualifies as a business record, it is not hearsay. The rule applies whether or not the declarant is available as a witness. The Rule presupposes that a business will have strong incentives to keep accurate records. Timberlake Construction Co. v. U.S. Fidelity and Guaranty Co., 71 F.3d 335 (10th Cir. 1995). I will discuss several recent decisions discussing the admission of business records.

I. The Rule

The Rule defines a business record as "a memorandum, report, record, or data compilations, in any form, of acts, events, conditions, opinions, or diagnoses, made at or near the time by, or from information transmitted by, a person with knowledge." Rule 803(6) is not limited to businesses. The Rule specifies that "the term 'business' as used in this paragraph includes business, institution, association, profession, occupation, and calling of every kind, whether or not conducted for profit." Rule 803(6).

A business record is admissible if it is "kept in the course of a regularly conducted business activity, and if it was the regular practice of that business activity to make the [record]." Id. A business record is not admissible where "the source of information or the method of circumstances of preparation indicate lack of trustworthiness." Rule 803(6).

The Ninth Circuit summarizes the Rule's requirements as follows: "a business record is admissible when (1) it is made or based on information transmitted by a person with knowledge at or near the time of the transaction; (2) in the ordinary course of business; and (3) is trustworthy, with neither the source of information nor method or circumstances of preparation indicating a lack of trustworthiness." The Monotype Corporation PLC v. Int'l Typeface Corp., 43 F.3d 443, 449 n.6 (9th Cir. 1994).

II. Regularly Conducted Business Activity

The key foundational inquiry is whether the document was prepared in the course of "a regularly conducted business activity." The document must concern business activity. In Hargett v. National Westminster Bank, 78 F.3d 836 (2d Cir. 1996), plaintiff, an african-american, was terminated from his position as an executive of the defendant bank after he allegedly retained a stripper to perform at an office meeting. Plaintiff alleged that he was terminated by reason of his race. At trial, he sought to introduce a handwritten note allegedly prepared by a co-employee of the defendant bank in which the co-employee admitted that he had procured the services of the stripper. The note was unsigned. The district court denied plaintiff's offer of admission because plaintiff could not establish a foundation for its admissibility as a business record. Indeed, it is hard to imagine that the letter was "a record of regularly conducted activity." Moreover, plaintiff could not offer testimony concerning when and where the handwritten letter was prepared.

The business activity must also be regular. In The Monotype Corporation, the defendant and plaintiff entered into a licensing agreement to allow plaintiff to distribute several of defendant's typefaces. Plaintiff developed several typefaces independently and began selling them to purchasers. Defendant claimed that plaintiff's typefaces were copies of its typefaces. Plaintiff sued to bar defendant from making such claims to plaintiff's customers, including Microsoft. At trial, defendant sought to admit a report prepared by an employee of plaintiff's customer Microsoft concerning the similarities in several typefaces sold by plaintiff and defendant. The report was not a business record because it was not Microsoft's regular practice to prepare such reports. Id. at 449-50 (also excluding an electronic mail message which was a one-time event).

III. The Chain Of Knowledge

The proponent must establish a chain of knowledge. According to Weinstein's Evidence, "Each participant in the chain producing the record -- from the initial observer-reporter to the final entrant -- must be acting in the course of the regularly conducted business." 4 Jack B Weinstein & Margaret A. Berger, Weinstein's Evidence P803(6) [04] (1994). In United States v. Warren, 42 F.3d 647 (D.C. Cir. 1994), the defendant was found in a room containing drugs and a handgun. The defendant sought to introduce a statement from a police report that two other occupants of the apartment were dealing drugs and carried handguns. The police report did not qualify as a business record because the defendant could not show that the report's author had personal knowledge concerning the activity of the other occupants of the apartment or had based the statement on information provided to him by a person with personal knowledge acting in the regular course of business. Id. at 656.

IV. The Custodian's Knowledge

The custodian of business records need not have detailed knowledge concerning who prepared a particular business record. The custodian need only show that he is "sufficiently familiar with the business practice" of the business and show that the record was made pursuant to that practice. Phoenix Associates III v. Stone, 60 F.3d 95 (2d Cir. 1995). In Phoenix Associates, the plaintiffs claimed that they had an oral contract with defendant. At trial, plaintiffs sought to introduce a record of a wire transfer to substantiate the claimed oral contract. Plaintiff's witness, its records custodian, testified that plaintiff's accounting department regularly compiled records of every wire transfer it received or issued. The district court denied plaintiff's offer of the exhibit on the ground that the records custodian worked for both the plaintiff and another company which made the wire transfer. The Court of appeals reversed. The custodian's source of employment was irrelevant "as long as his testimony can supply a sufficient foundation." Id. at 101. Moreover, the custodian was not required to demonstrate personal knowledge of the actual creation of the document. Nor was he required to identify the specific employee who prepared the document. The Rule required only that the proponent prove that the business entity's regular practice was to obtain the information from the person who created the document. Id.

V. Is The Document Trustworthy?

The Rule requires the court to determine whether the source of the information or the method or circumstances of the preparation of a document cast doubt on its trustworthiness. In Hoselton v. Metz Banking Co., 48 F.3d 1056 (8th Cir. 1995), plaintiffs, minority shareholders in defendant's business, claimed that defendants breached their fiduciary duties when they were excluded from a sale of the business to a third party. Notes taken by plaintiffs' accountant were properly admissible because they were prepared in the regular course of the accountant's activity. The notes appeared to be trustworthy because the accountant had professional duties to his clients which would give him strong motivation to make accurate notes. Id. at 1061.
Information provided by the customers of a business can create problems under the Rule because many businesses do not verify information received from customers. Such information may be admissible under Rule 803(6) if the proponent can show that "the business entity has adequate verification or other assurance of accuracy of the information provided by the outside person." United States v. McIntyre, 997 F.2d 687 (10th Cir. 1993), cert. denied, 114 S.Ct. 736 (1994). In McIntyre, the court listed two ways to demonstrate reliability: (1) proof that the business has a policy of verifying patrons' identities by examining their credit cards and other forms of identification; or (2) "proof that the business possesses 'sufficient self-interest in the accuracy of the [record]' to justify an inference of trustworthiness." United States v. Cestnik, 36 F.3d 904, 908 (10th Cir. 1994) (quoting McIntyre, 997 F.2d 687, 700 (10th Cir. 1993). In McIntyre, the court held it was improper to admit a hotel's guest registration cards because it was unclear whether the hotel had procedures to verify the accuracy of the cards. 997 F.2d at 701.

VI. Documents Prepared In Anticipation of Litigation

Documents prepared in anticipation of litigation are usually not admissible because they were not prepared in the regular course of business. Timberlake Construction Co., 71 F.3d 335; Fed. R. Evid. 803(6) Advisory Committee Note. In Timberlake Construction, the plaintiff claimed that the defendant insurer wrongfully denied insurance coverage. At trial, plaintiff introduced several letters written by plaintiff's president and by plaintiff's attorney containing legal conclusions claiming the existence of insurance coverage. The court of appeals reversed on the ground that the letters were written in anticipation of litigation and therefore did not fall within Rule 803(6).

However, an auditor's report prepared in anticipation of litigation may also qualify as a business record. In United States v. Frazier, 53 F.3d 1105 (10th Cir. 1995), the defendant was convicted of falsely describing his use of government funds on official forms. At trial, the Government admitted the report of a government auditor as a business record. The defendant objected that the report was prepared in anticipation of litigation. The court found that the report was trustworthy because the auditor prepared it pursuant to a contract with the government, the auditor had ten years experience in preparing that type of audit report and the auditor was a "neutral party" who had "nothing to gain" from litigation against the defendant. Id. at 1110.

VII. Laying A Foundation

The lawyer seeking to admit the business record must, however, lay a foundation that the record was, in fact a business record. A recent Seventh Circuit case discusses the requirement that a foundation be laid. In United States v. Adrianoros, 578 F.3d 703 (7th Cir. 2009), the Government obtained the admission of a summary of telephone and bank records of the illegal activity. The Government called a policeman to testify that he obtained records by serving a subpoena. The Government sought to admit the records under FRE 1006, which allows a party to present, and enter into evidence, a summary of voluminous writings, recordings or photographs. However, the Seventh Circuit held that the records were improperly admitted because there was no testimony to establish that the records were kept in the course of regularly conducted business activity and there was no certification by the custodian of the records. Thus, no foundation was laid and it was error for the district judge to admit the document in evidence.

A foundation must even be laid in the summary judgment context. The party seeking admission of the business record need not have secured the deposition testimony of the records custodian. The proponent of the document must establish sufficient indicia of reliability. Thanongsinh v. Board of Education, 462 F.3d 762 (7th Cir. 2006).

VIII. Specific Types of Documents

1. Laboratory Reports

It is well established that a laboratory report identifying a substance as a narcotic is admissible as a business record because such reports are routinely prepared by government lab technicians. United States v. Roulette, 75 F.3d 418 (8th Cir. 1996). Additionally, in Roulette, the defendant argued that under the Confrontation Clause, the government should be required to provide proof of the unavailability of the lab technician when admitting the report. The court disagreed reasoning that the exception to the hearsay rule was "firmly rooted." Id. See also Sherman v. Scott, 62 F.3d 136, 140-41 (5th Cir. 1995).

2. Computer Records

Computer business records are admissible if (1) they are kept pursuant to a routine procedure designed to assure their accuracy, (2) they are created for motives that tend to assure accuracy (e.g., not including those prepared for litigation), and (3) they are not themselves mere accumulations of hearsay." United States v. Hernandez, 913 F.2d 1506, 1512 (10th Cir. 1990), cert. denied, 499 U.S. 908 (1991). Computer records are thus treated no differently than other business records.

VIII. Conclusion

The business records exception is commonly used to admit documents which contain hearsay declarations. The rule presupposes that a business has strong incentives to keep accurate records. Thus, it is difficult to resist the admission of a business record, unless the record was prepared in anticipation of litigation or its trustworthiness can be legitimately questioned.

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Securities Law - The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform And Consumer Protection Act (the “Act”) is a massive revision of the way in which financial services are furnished. The Act was signed by President Obama on July 23, 2010.Many of the changes become law on the effective date. However, the Act promulgates various studies which could lead to other changes. Some changes may not go into effect but will become bogged down in contentious disputes. If control of Congress should change in November, some changes may never go into effect. The Act will cause a disruption in the way various issues are perceived.

Mayer Brown has published a complete summary of the Act. It was a massive undertaking. At least eight Mayer Brown lawyers worked on the summary.

The securities section of the Act sets forth a significant number of investor protection measures. Those sections of the Act dealing with Securities Law changes will be referred to as the “Amendments.” The Amendments require the SEC to conduct a six-month study of the need to impose a fiduciary duty on brokers providing personalized investment advice to retail customers. Various factors must be taken into account in determining the effectiveness of existing standards of care.

The Amendments establish within the SEC an Investment Advisory Committee composed of (1) an investor advocate who reports directly to the Chairman of the SEC, (2) a representative of State Securities Commissionaires, (3) a representative of the interest of senior citizens and (4) between ten and twenty additional members appointed by the SEC. The Committee has a responsibility of consulting with the SEC on regulatory priorities, the substance of proposed regulations and initiatives by the SEC to protect investors and promote investor confidence in the market.
The Chairman of the SEC will appoint an Investor Advocate to lead a new office within the SEC. An ombudsman will act as liaison between retail investors and the SEC in resolving issues with the SEC and/or the securities Self-Regulatory Organizations (“SRO”). The Chairman of the SEC is responsible to take action to address deficiencies identified by a report of investigation by the SEC.
The stock exchanges must, as directed by the SEC, enforce requirements in the Amendments for clawing back incentive compensation paid to executives mistakenly paid based on erroneous results later corrected and restated within three years of such payment.

The SEC must hire a consultant to study its operations and the possible need for reform of the agencies and furnish within 150 days a report to the SEC and Congress making legislative regulatory and administrative recommendations for improvement in the SEC.

The Controller General of the United States is to issue rules surrounding employees who leave the SEC for employment with regulated firms in the securities industry and report to the SEC and the House Financial Services Committee (“HFSC”) within one year of enactment of the Act.

The SEC must establish an Investor Protection Fund from revenues from certain sanctions. The Fund to be used among other things to pay whistle-blowers who provide original information in a SEC action.

The SEC will be authorized to make nationwide service of subpoenas of civil actions filed in federal court.

The Amendments change who qualifies as an “accredited investor”. These investors must now have $1 million excluding the value of their primary residence, whereas the old standard was simply a $1 million net worth.

The Amendments also authorize the SEC to limit or prohibit the mandatory predispute arbitration clauses that apply to most brokerage accounts. Such clauses force brokerage customers to take any disputes that may arise with their broker before arbitration panels, which critics claim often favor the brokerage industry, rather than taking their claims to court.

The Anti-Fraud provisions of the Federal Securities Laws were extended to apply to “conduct within the United States that constitute significant steps in the furtherance of a violation even if the securities transactions occur outside of the United States and involve only foreign investors.”

The Government Accountability Office (“GAO”) must report to Congress within one year regarding the potential consequences of authorizing a prior right of action against any person who aids or abets another person in violation of the Federal Securities laws. In other words, the new statute reverses the Stoneridge ruling. Stoneridge Investment Partners, LLC v. Scientific Atlantic, Inc., 522 U.S. 148 (2008). In Stoneridge, the U.S. Supreme Court held that those who aid or abet securities fraud are not liable.

Various changes regarding the regulation of credit rating agencies are prescribed. For example, the SEC must establish an office of credit ratings designed to administer the SEC rules applicable to Nationally Recognized Statistical Rating Organizations (“NRSRO). It can make exceptions for smaller NRSRO’s as it considers appropriate. At least two persons on the Board of Directors of NRSRO’s must be independent directors.
Not later than 270 days after the enactment of the Amendments, the SEC, Federal Reserve Board (“FRB”), Federal Deposit Insurance Corporation (“FDIC”) and (Office of the Comptroller of the Currency (“OCC”) must issue rules requiring a securitizer of an asset backed security (other than a residential mortgage-backed security) to retain at least 5% of the credit risk in any asset that the securitizer transfers or sells to a third party. The rules become effective two years after the final version is published in the Federal Register.

Executive compensation is to be revised as follows:

Effective six months after enactment of the Amendments, publicly traded companies must hold a non-binding vote to approve the compensation of executives who are among those disclosed in public filings pursuant to SEC rules (i.e., say-on-pay votes) at least once every three years, and a separate resolution must be offered at least once every six years for a vote to determine whether say-on-pay votes should occur every one, two or three years. Although a “no vote” is not binding, it would likely cause the Board of Directors to take some action to adjust compensation standards.

The Conference Committee also agreed to require these companies to provide a non-binding vote to approve golden parachutes (effective six months after enactment). Institutional investment managers subject to Section 13(f) of the Exchange Act must annually disclose how they vote on say-on-pay and golden parachute matters unless their votes are otherwise publicly reported under SEC rules. The Amendments place ultimate responsibility for compensation decisions for executives with the respective Compensation Committees, which must be comprised of independent directors and advised by compensation consultants, legal counsel, and other advisers who are independent as well.

The SEC is required to amend item 402 of Regulation S-K under the Securities Act to require companies to disclose the relationship between executive compensation and financial performance and the ratio between the CEO’s compensation and the median compensation of all other employees.

The SEC must issue a rule requiring publicly traded companies to disclose whether executives are permitted to hedge the value of any equity securities granted to such executives as compensation.

The SEC must conduct a study, and report to Congress within two years of enactment, regarding the use by publicly traded companies of compensation consultants.

The FRB, in consultation with the OCC and FDIC, has the responsibility of establishing standards making it an unsafe and unsound practice for the holding companies of depository institutions to pay compensation that is excessive or could lead to material financial loss to the holding companies.

There will be many 3 – 2 notes by the SEC with the Commissioners nominated by the democrats winning the contentious issues but only after delays and many dissents.

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