Securities Law - College Fund Losses In Bright Start Plan

Do not assume that just because you invested in what you consider a conservative college fund for the education of your children that your investment is safe.

Lisa Madigan, the Illinois Attorney General, was a leader in obtaining a 77.2 Million dollar settlement from Oppenheimer Fund due to Oppenheimer’s alleged mismanagement of a fund with Illinois 529 College Savings Program. Lisa Madigan, the Illinois Attorney General, and the State Treasurer, Alexi Giannoulias, reached a settlement with Oppenheimer resolving an investigation into the firm’s mismanagement of the “Core Plus Fixed Income Strategy” fund. Illinois began to investigate Oppenheimer’s investment strategy after Core Plus lost about 38% of its value in the year 2008. The settlement means a recovery of about 50 cents on each dollar lost. Core Plus investors who incurred losses between January 1, 2008 and January 25, 2009 are eligible to participate in the recovery.

On December 22, 2009, Lisa Madigan stated “As a result of this agreement, Illinois families who invested in the funds will be able to recover substantial losses in their college savings account in a timely manner while avoiding the uncertainty of delay that would accompany lengthy and expensive litigation.” Five other states are negotiating settlement agreements with Oppenheimer. Those settlements so far range between 67 million and 20 million.

The Core Plus program was marketed as a conservative investment option for families with children near college age. However, suspicions emerged when Core Plus suffered losses of about 40% compared to the Bond Index used to benchmark the fund. The Bond Index showed gains of more than 5%.

Oppenheimer acknowledged the Illinois settlement but admitted no wrongdoing. It stated “Oppenheimer funds agreed to the settlement to resolve the investigation that commenced after the severe market volatility that impacted all investments in 2008, to enable the company to move ahead with its mission to provide high quality investment management services.” High quality management services! Why did they settle for $164 Million?

Investigators determined that Core Plus actually contained serious and risky investments and was leveraged by Oppenheimer’s management team. The risks were never disclosed to Illinois officials. Not surprising, the Investment Team at Oppenheimer responsible for the Core Plus strategy is no longer with Oppenheimer. Core Plus has been liquidated and replaced with alternate fixed-income investment options.
The lesson - monitor investment results frequently. Don’t wait for Lisa Madigan to bail you out.

Edward X. Clinton, Sr.
Copyright 2009

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Securities Law - Accounting and Legal Malpractice Claims

True Value, as a public company, is required to file its financial statements with the SEC pursuant to the Exchange Act. According to the SEC, there were accounting errors in the financial statements of True Value of about One Hundred Thirty Million Dollars ($130,000,000) and that for the year 1999 such loss was to be recognized. Accordingly, such statements had to be recast. Undoubtedly, the True Value stock which is publicly traded, took a hit when the news became public. That was only the start of True Value’s problems.

Management of True Value decided to pursue a remedy against its former accountants, Ernst & Young and decided that it would interview two law firms to sue Ernst & Young. The Firm of Goldberg, Kohn, Bell, Black, Rosenbloom & Moritz, Ltd. made the successful presentation to True Value and was selected. The Goldberg Firm filed an arbitration claim against Ernst & Young. The Ernst & Young Engagement Agreement with True Value required arbitration.

After four years and expenses of approximately twelve million dollars ($12,000,000) an arbitration panel ruled against True Value and ordered that True Value pay the fees and costs incurred by Ernst & Young. The panel found that True Value, through the Goldberg Firm’s actions, had exhibited “bad faith” because it failed to consider the extent of the audit work done by Ernst & Young and pressing its lawsuit on several issues where it had no chance of success. True Value opposed an Eighteen Million Dollars ($18,000,000) fee demand by Ernst & Young and ended up by paying about Eleven Million Dollars ($11,000,000) to Ernst & Young and new counsel. True Value then in December 2009 sued the Goldberg Firm in the Circuit Court of Cook County for legal
malpractice.

According to the Complaint, among other things, the Goldberg Firm advised True Value to sue its former auditors for accounting malpractice and, also, that the Goldberg Firm failed to analyze the merits of the claim and did not obtain at an early point an accounting expert.

Also True Value alleged that the Goldberg Firm failed to advise True Value that if it did not prevail in the case, it could be liable for the costs and fees to defend the accounting malpractice case. It alleged that the Goldberg Firm failed to inform True Value at an early stage that the malpractice claim would have to be arbitrated in accordance with the engagement letter and that the arbitration panel likely would consist of auditors.

The current lawsuit against the Goldberg Law Firm seeks to impose the costs incurred by Ernst & Young on the Goldberg Firm and seeks approximately Twenty Million Dollars ($20,000,000) in damages. Also, Goldberg, according to the Complaint gave negligent Securities Law advice, contributing to the above damages for which Goldberg was charged about One Million Dollars. True Value also seeks a recovery of that expense.
What started as an almost routine need to restate earnings ended up in a protracted arbitration by True Value against its former accountants and, now, in furtherance of the fiasco, True Value sues its former lawyers for legal malpractice.

Edward X. Clinton, Sr.
Copyright 2010

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Business Law - Why Incorporate?

Every now and then someone asks us why they should incorporate their business. After all, they say, why not just continue in business and use Schedule C of the IRS 1040 form to pay taxes on the business. Moreover, to incorporate invariably costs money - fees are paid to the Secretary of State (at least for an Illinois corporation) and annual fees are paid thereafter. There is also a modest legal fee as well.

Incorporation, however, is an absolute must for every business.

First, in most cases incorporation prevents a creditor from seeking to hold the owner of the business personally liable. If you are in business without a corporation, and something goes wrong, the creditor can seek to collect from your personally. This is the primary reason for the use of corporations. It is the oldest (several hundred years in the United Kingdom) and best form of "asset protection."

Second, incorporation separates the business from the owner's personal life. Your personal finances do not get mixed in with the business finances. This is an advantage.

Third, corporations provide additional flexibility and greater control. The owner may decide to reward an employee or business partner with a portion of the stock. With a corporation, provided that these decisions are properly documented, the owner may retain control by keeping the majority of the stock of the business. On the other hand, if the owner is in business without a corporation and then adds a "partner," a court may find that the owner has given away 1/2 of the business to this "partner." Worse still, both of the partners may be held personally liable for a debt of the business.

Recently we have seen advertisements on television for do-it-yourself corporations. Not surprisingly, we recommend against the do-it-yourself approach. The main reason why it is not a good idea for a nonlawyer to establish a corporation is that the nonlawyer may make a small technical mistake - which then voids the corporation. We have reviewed many do-it-yourself attempts that did not successfully form and maintain the corporation and were simply a waste of the owner's money. The Courts rarely give partial credit for a bungled attempt at incorporation.

If you have incorporated on your own, without legal advice, we recommend that you show your papers to a lawyer to obtain a professional opinion.

Edward X. Clinton, Jr.
Copyright 2010

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Fraudulent Transfer - Munson v. Rinke, 1-08-2998, Illinois Appellate Court November 20, 2009

Plaintiffs, Lester and Judith Munson, brought a fraudulent transfer action against the Defendants, Susan Rinke and her husband James P. Whitmer, alleging constructive fraud. The Munsons obtained a judgement against Rinke for $38,000 and Rinke appealed.

The fraudulent transfer case arose out of a previous lawsuit between Whitmer and the Munsons that was also filed in State Court. In 1994, the Munsons sought sanctions against Whitmer. The motion was denied. On November 27, 2002, the Illinois Appellate Court reversed the denial of sanctions and ordered the trial court to determine the correct amount of sanctions against Whitmer.

On February 13, 2003, Whitmer transferred the title of two cars from himself to his wife, Rinke. Rinke wrote two checks to Whitner in the amount of $29,000 for the two vehicles. At around the same time she withdrew $36,550.37 from her IRA to cover the checks. Whitner then wrote Rinke a check for $36,551, which Rinke used to purchase an annuity. (Thus, Ms. Rinke was not out of pocket for the purchase of the two cars. When the transaction concluded she paid $0 for the cars). Whitmer obtained the $36,551 by borrowing from his home equity line of credit. Whitmer and Rinke then executed a promissory note under which Rinke was to pay Whitner back the $36,551 without interest. Rinke never paid Whitmer back, but, instead made payments to satisfy Whitmer's home equity loan.

In August 2003, the trial court awarded the Munsons sanctions in the amount of $173,253.14 against Whitmer.

In October 2003, Whitmer filed a Chapter 11 bankruptcy petition. The Munsons intervened in the bankruptcy proceeding and obtained a declaration that the sanctions award of $173,253.14 was nondischargeable.

In February 2006, the Munsons filed a complaint for the avoidance of the transfers of the two vehicles on the ground that the transfers constituted actual fraud or constructive fraud.

After trial, the Court held that the transfers amounted to constructive fraud and entered judgment against Whitmer and Rinke.

Rinke appealed on the ground that the fraudulent transfer action was barred by the bankruptcy proceeding. The Court found that, although the bankruptcy trustee had the right to pursue the fraudulent transfer action and chose not to do so, that decision did not bar the fraudulent transfer action. Once the bankruptcy ended the Munsons had the right to proceed on the fraudulent transfer claim, which the bankruptcy court found to be nondischargeable.

Finally, the Court found that there was sufficient evidence to support the finding of constructive fraud under Section 5(a)(2) because there was evidence that the debtor made the transfer "'without receiving a reasonable equivalent value in exchange for the transfer,'" and the debtor "'intended to incur, or believed or reasonably should have believed that he would incur, debts beyond his ability to pay as they became due.". 740 ILCS 160/5(a)(2). The Court noted that the transactions occurred shortly after it became apparent that sanctions would be awarded and that Rinke had no real out of pocket cost for buying two cars. Thus, Whitmer ended up with more debt and received nothing for the cars.

The case illustrates that any transfers of property when an adverse lawsuit is pending are suspect.

Edward X. Clinton, Jr.
Copyright 2009

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Securities Law - SEC Acts On Proxy Voting Proposal

At the present time shareholders can hold corporate shares directly or indirectly through financial intermediaries such as brokers. Current New York Stock Exchange Rule 452 provides “in uncontested elections brokers can vote shares they hold in street name on behalf of customers when customers do not return voting instructions.”

The SEC in a divided vote approved the New York Stock Exchange proposal to halt brokers voting of customer shares in uncontested elections if voting instructions have not been received. Although the Rule is a NYSE rule, broker members would be required to comply with the Rule no matter where the shares are listed.

According to the SEC staff, this will improve corporate governance and accountability by helping to insure that only those with an economic interest in listed companies vote in director elections. However, there is concern about the effect of that amendment on shareholder participation because shareholders ordinarily expect the brokers to vote their shares [almost always in favor of current management]. Now that those shares will not be voted without specific instructions, what will it mean to the voting process? In other words, companies will have to find ways to communicate with shareholders more aggressively to get shareholders to vote their shares. The failure to get a sufficient number of votes might mean that quorum limits are not met and director elections might fall short of voting requirements. In other words, companies will be put to substantial greater cost to see to it that the requisite number of shareholders vote at elections.

The Amended Rule will be effective January 1, 2010.

Edward X. Clinton, Sr.
Copyright 2009

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Securities Law - Trading On Inside Information - The Penalty

The SEC sued Khaled Al Hashemi, a citizen of Abu Dhabi, United Arab Emigrates and a current technology manager at an Abu Dhabi oil refinery, charging that he engaged in unlawful trading on the basis of material non-public information concerning the acquisition of Nova Chemicals Corp. by International Petroleum Investment Co.

The case was filed in the Federal Court for the Southern District of New York, Civil Action no. 09-CIV-6650, on November 19, 2009.

The SEC alleged that Al Hashemi purchased approximately 120,000 shares of Nova at an average price of $1.41 per share shortly before a merger was announced and then sold those shares on the day the merger was announced. The price per share of the sale was $5.24, realizing a profit for Al Hashemi of $458,760. It is interesting to note that he purchased 50% of his Nova stock on the last trading day before the announcement of the acquisition by International.

Nova headquartered in Canada, with an office in Pennsylvania, produces plastics and chemicals. The Nova stock was registered with the SEC pursuant to Section 12(b) of the Exchange Act and is traded on the New York Stock Exchange.

International made a cash offer to acquire Nova for $6.00 per share. On the day following the announcement the stock of Nova increased to $5.21 per share, or a 289% increase with a substantially greater volume on the New York Stock Exchange.
Al Hashemi’s sold his entire 120,000 shares of Nova and received a return of 270%, equal to a profit of $458,000.

The SEC in its Complaint alleged that the sale by Al Hashemi of his other securities in order to find sufficient funds to purchase the Nova stock strongly suggested that he knew that the Nova common stock would rise on the news of the prospective purchase. It is further interesting to note that Al Hashemi incurred a loss of 66% on his other investments when he liquidated them (presumably to raise cash for the Nova stock purchase). The SEC alleged that Al Hashemi traded on the basis of material inside information that he misappropriated in violation of his fiduciary duty or similar duty of trust and confidence to the shareholders of Nova, or, to the source of whom he received such inside information.

Specifically, the SEC alleged that Al Hashemi employed devices, schemes or artifices to defraud, made untrue statements of material facts, or engaged in acts to operate as a fraud or deceit in connection with the purchase or sale of a security. Moreover, the SEC alleged that Al Hashemi violated a Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The SEC prayed for a permanent injunction to prevent him from violating Section 10(b) and to order Al Hashemi to disgorge unlawful trading profits and to pay a civil penalty pursuant to the Exchange Act.

Al Hashemi did not admit or deny wrongdoing, but did agree to the injunction and the penalties, including disgorgement of $558,760, $9,620 in pre-judgment interest, and a $406,620 civil penalty.

The SEC typically notices unusual trading volume shortly before the announcement of a cash offer for stock or a merger.

Edward X. Clinton, Sr.
Copyright 2009

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Contract Law - Lewitton v. ITA Software, Incorporated (Seventh Circuit 08-3725)

The Seventh Circuit Holds that An Employer Breached An Employment Contract When It Blocked A Former Employee From Exercising Options To Purchase Stock.

Lewitton was an employee of ITA Software, the Defendant. Three months after he stopped working for ITA Lewitton attempted to exercise options to purchase 138,900 shares of ITA's stock. ITA allowed Lewitton to purchase 34,722 shares, but blocked his effort to exercise the remaining options.

In April 2005, ITA and Lewitton entered into an employment contract under which Lewitton was to serve as ITA's vice president of sales. The contract granted Lewitton the right to purchase up to 200,000 shares of stock. According to the contract the options "'will vest...in equal monthly installments of 4,556 shares each... except that the first twelve months of options will all vest at Lewitton's one-year anniversary.'" The contract also provided that certain of the options were subject to forfeiture depending on whether ITA met certain performance goals. Under the contract, there was to be an assessment period during which sales would be calculated to determine if the company met its revenue goals. However, the contract also specified that the Assessment period would not apply if it were "materially deferred."

Lewitton's job was to supervise the development of the 1U program, a computer program that would apparently allow users to make online reservations for air travel. The software program was not successful and was not accepted by either travel agents or airlines.

The District Court granted summary judgment for Lewitton, holding that the contract unambiguously granted him the right to exercise the options. Under Illinois law, "our primary goal in construing the contract is to give effect to the parties' intent as expressed in the terms of their written agreement." The Court stated: "We first ask if the language of the contract is ambiguous, which is a question we determine as a matter of law...A contract is ambiguous if its terms are indefinite or have a double meaning...If the contract is unambiguous, we must enforce it as written."

ITA argued that the options were subject to forfeiture because the U1 software program did not meet performance goals.

The District Court and the Court of Appeals disagreed. They held that the Assessment Period did not apply (to allow forfeiture) because the U1 program was "materially deferred." "As the district court noted, 'materially deferred' is not a technical term; its ordinary meaning is 'significantly delayed.'" Because the U1 program was not rolled out on time, "the Assessment Period never began and, accordingly, ...the forfeiture provision does not apply."

Accordingly, Lewitton was entitled to exercise the options.

Edward X. Clinton, Jr.
Copyright 2009

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