July 10, 2020

Cybersecurity: The Ongoing Challenge of a Remote Workforce

Like many businesses, my law firm’s offices have been operating on a restricted schedule for the past several months, and even though we’re in the process of transitioning to a full reopening, I suspect that many of our lawyers will continue to spend a lot of time working from home.  My guess is that many other companies will have similar experiences. This Deloitte memo on the CLO’s role in reopenings highlights some of the cybersecurity challenges facing companies that will continue to have a large remote workforce. These include:

– Increases in socially engineered cyberattacks targeting financial and personally identifiable information (PII) data
– Cyber risk levels are elevated due to an increase in phishing and malware attacks.
– Some communication and collaboration tools may not be secure, even where these platforms have their own built-in controls.
– Client and customer data may be more vulnerable when employees work from home if employees are transmitting data on unsecure networks and/or saving or printing on home devices.
– Employees who previously did not work at home may not be familiar with cybersecurity and data protection leading practices. Most are likely to benefit from regular reminders related to cybersecurity leading practices.
– Potential threats to attorney-client privilege may arise where there are risks to cybersecurity or where attorney-client conversations may be overheard (by family members, for example).

In addition to reviewing cybersecurity insurance policies for potential coverage gaps associated with remote work, the memo recommends additional cybersecurity training to employees, communicating new and emerging threats as they arise, providing remote workers with the tools and instructions necessary to protect data and maintain data privacy protocols.

The memo also recommends that companies prioritize the preservation of the attorney-client privilege by taking actions such as reminding employees not to forward documents to personal email accounts or use other unsecure methods to transfer files or communicate with clients.

Covid-19: Changes to Internal Audit

Over on “Radical Compliance,” Matt Kelly blogged about the results of a recent survey conducted by the Institute of Internal Auditors that suggests that the Covid-19 crisis has resulted in some significant changes to the internal audit function.  In addition to the inevitable budget-cutting, the survey suggests that risk assessments & updates to audit plans are likely to increase:

Survey respondents also said they will both conduct risk assessments and update their audit plans more often. This should surprise nobody, given how Covid-19 has put standard risk scenarios through the blender. Fraud risk, cybersecurity risk, user access controls, management review and sign-off of reconciliations or controls; they’ve all gone haywire.

A majority of respondents expect to increase their risk assessments to at least some degree, and 11% expect to increase the frequency significantly. Meanwhile, 68% of respondents say they’ll at least increase the frequency of updates to the audit plan.

That’s a lot of change and improvisation for the audit function. It implies an embrace of “agile auditing” — a concept the IIA and many others in the audit profession heartily support. It’s the idea that an audit function will run light on staff, heavy on technology, and stand ready to jump on emerging or fast-changing risks by working with other parts of the enterprise.

Covid-19 poses new risks across the enterprise, and since audit teams don’t have the time or personnel to engage in “ponderous” risk assessment & remediation planning efforts, the blog says that they will need to embrace a more swift, data-driven approach to assessment, testing, and remediation.

B Corps: DGCL Amendments Ease Transition Process

This Freshfields blog highlights how the 2020 amendments to the DGCL make it simpler for corporations to transition from soulless entities devoted to maximizing stockholder value to virtuous “public benefit corporations” devoted to uplifting humanity. This excerpt addresses elimination of supermajority approval requirement & appraisal rights risks that previously applied to transitioning entities:

Prior to these amendments, the approval of two thirds of a company’s outstanding stock entitled to vote was required to amend its charter to become a PBC. And, in the case of private companies, the decision to convert to a PBC triggered an opportunity for dissenting holders to exercise appraisal rights and thereby monetize their unlisted shares at the expense of the issuer.

Both of these requirements were procedurally onerous and a deterrent to conversion. The amendments will remove both the supermajority requirement and the right to appraisal. Companies may now convert to PBCs through a simple majority vote of their stockholders (plus whatever additional approvals are required under their organizational documents).

The amendments also make clear that a director’s ownership of stock in the PBC does not disqualify the director from being “disinterested” so that the director can benefit from the protection of the business judgment rule and the broad PBC exculpatory provisions when balancing the interests of various constituencies.

John Jenkins

July 9, 2020

Responding to Activist Shorts: Are Internal Investigations a “Tell”?

FT’s Alphaville blog recently discussed a new study dealing with corporate responses to short sellers. Public companies sometimes decide that discretion is the better part of valor when it comes to responding to an activist hedge fund’s announcement of a “short thesis.” But many others – about 1/3rd according to the study – opt to respond. Some of those companies announce that they’re initiating an internal investigation into the activist’s allegations. If that happens, the study says investors should run for their lives:

We find that when activist short seller targets announce internal investigations, the disclosure is associated with a 383% greater chance of a fraud finding . . . and a 61% lesser chance of being successfully acquired as an exit strategy, compared to the whole sample of targeted firms.

The study suggests that initiating an internal investigation based on an activist’s allegations implies that the firm’s directors are not sufficiently confident in management to trust that the existing disclosures and management representations are accurate.

While an internal investigation may be a red flag, if allegations are credible, it may also be the board’s only option. But what’s the best way for a company to respond to a report that it knows is inaccurate? The blog points to GE’s successful efforts to refute Harry Markopolos’s 2019 short report – which focused on highlighting the errors in the analysis without trashing the analyst – as a model response.

Audit Committees: Navigating the Pandemic

Dealing with the issues presented by the Covid-19 crisis has increased the already significant demands placed on audit committees. This Sidley memo (p. 7) provides some advice to audit committees on how to navigate the pandemic. This excerpt addresses disclosure & reporting issues:

Plaintiffs’ attorneys are investigating whether COVID-19 disclosure-related issues can support opportunistic securities class actions, with multiple cases already filed. Companies that express public confidence about their general prospects or their supply chain sufficiency despite dismal news about the economy and COVID-19’s impacts face heightened risk.

As always, companies should be careful to have support for statements at the time they are made. Watch for changing circumstances and adverse trends, in particular, as those circumstances change rapidly; describe them accurately as new developments. Ensure that public reporting is consistent with what the board is being told privately.

Shareholders also may second guess board-level decisions or inaction. So, consider documenting COVID-19-related considerations and responses to create a diligence record. Shareholders looking to file derivative actions often seek books and records before filing or making demands. Having a record of board considerations and responses can be very protective. Shareholder demands and books and records demands often come by mail, so companies should be alert to incoming mail when personnel are out of the office.

Other issues addressed in the memo include the importance of the “tone at the top” when it comes to health & safety concerns, the need to stay on top of operations & risks, the importance of being in sync with management when it comes to reporting, and a variety of other matters.

Capital Markets: Converts are Having a Moment

They say that “every dog has his day,” and according to this “CFO Dive” article, that day has apparently come for convertible debt. The article says that $21 billion in converts were issued during May – the highest monthly total on record. Traditionally, it has been small caps that have been attracted to convertible securities, but some big companies that have found themselves in financial hot water have recently turned to them as well. This excerpt explains the attraction of converts to issuers & investors in the current environment – as well as some reasons to think twice before diving in:

Start to finish, an issue can take two days, compared to weeks for high yield debt. The heightened uncertainty facing companies and investors over the last several months as a result of the coronavirus pandemic has led to a doubling of convertibles outstanding, compared to the same time last year. “Given the current volatile market environment and downward pressure on stock prices, it’s no surprise investor sentiment has turned negative around companies issuing equities to raise capital, primarily because of the dilutive effect on their stock holdings,” Heather Hall, CFO of fixed income tech company 280 CapMarkets, said.

When convertibles are changed into equity, they can impact shareholder value negatively, and have adverse effects on a company’s earnings metrics and projections, she said. Companies in competitive industries might want to consider the potential future dilutive effects on their share price, and corresponding negative implications to their overall market share and earnings per share metrics, Hall said, noting the dilutive effects to shareholder value that will be much larger, proportionally, in a smaller company. “The phenomenon of an activist investor who could potentially acquire the majority of the convertible debt and ‘run away’ with the company should be contemplated,” Hall warned.

For a more in-depth look at the pros & cons of issuing converts in the current environment, check out this Wachtell Lipton memo.

John Jenkins

July 8, 2020

Reg Flex Agenda: Universal Proxy Rules Coming Soon?

Just a couple of years ago, media reports suggested that the SEC’s universal proxy rule proposal was an “ex-parrot.”  But this Davis Polk blog says that latest edition of the agency’s Reg Flex Agenda includes the proposal on the short list, together with proxy plumbing. Here’s an excerpt:

Worth noting is that the potential rulemaking related to universal proxies, proxy process amendments (a.k.a. “proxy plumbing”) and mandated electronic filings have moved up to the short-term agenda; formerly these were on the 2019 fall long-term agenda. The universal proxy is a proxy voting method meant to simplify the proxy process in a contested election and increase, as much as possible, the voting flexibility that is currently only afforded to shareholders who attend the meeting. Shareholders attending a meeting can select a director regardless of the slate the director’s name comes from, either the company’s or activist’s. The universal proxy card gives shareholders, who vote by proxy, the same flexibility.

The proxy process topic is a very large-complicated topic that involves voting mechanics and technology, including issues such as those associated with the complex system of share ownership and intermediaries. As customary, the Reg Flex Agenda provides no details; however, given the complexity of the issues, it is most likely that “low hanging fruit” will be addressed. Some of these were identified by the SEC Investor Advisory Committee Recommendation issued in September 2019, which included the use of universal proxies and were previously discussed in our blog.

The Reg Flex Agenda targets an October 2020 date for the finalization of the rule.  However, the blog points out that an agency is not required to consider or act on any agenda item, and that SEC Reg Flex Agenda reflects solely the priorities of the Chairman and does not necessarily reflect the position of any other Commissioner.

ICFR: How Will Covid-19 Impact Material Weaknesses?

This FEI report on ICFR addresses the potential implications of the Covid-19 crisis on the assessment of whether material weaknesses in internal controls exist. Not surprisingly, this excerpt suggests that we’re likely to see more conclusions that material weaknesses exist than we have in recent years:

We’ll definitely see an increase in delayed filings and we’ll likely see an increase in material weakness disclosures. If remote work arrangements, facility closures or unavailability of key personnel due to illness result in an inability to apply or test control procedures, management may be forced to conclude that one or more material weaknesses in internal control exist, unless compensating preventive or detective controls are in place and able to be tested.

Satisfying the external auditors with sufficient evidence that controls are performing as intended could also be challenging in this environment. For example, people working remotely may not have access to typical work tools such as printers and scanners, making it difficult to evidence control performance.

The article also cautions that pandemic-related declines in earnings, revenues & other materiality benchmarks could also result in the inclusion of some items in the scope of this year’s internal control assessment that were excluded in prior years.

Listing Standards: NYSE Extends Temporary Shareholder Approval Relief

In April, the NYSE adopted a temporary rule easing the shareholder approval requirements applicable to listed companies looking to raise private capital during the Covid-19 crisis. That temporary rule was set to expire at the end of June, but due to the continuation of the Apocalypse, the NYSE opted to extend it through the end of September. Here’s the intro from this Mintz memo discussing the extension:

As discussed in our earlier Viewpoints advisory, the New York Stock Exchange temporarily allowed NYSE-listed companies to complete certain capital raising transactions involving related party issuances or the issuance of 20% or more of a company’s stock without shareholder approval under limited circumstances. As a result of the continuation of the coronavirus (“COVID-19”) pandemic, on July 2, 2020, the Securities and Exchange Commission approved an extension of the NYSE’s waiver of these shareholder approval rules in the circumstances discussed below through September 30, 2020.

John Jenkins

July 7, 2020

No Good Deed Goes Unpunished: ESG Initiatives Attract Activist Funds

According to a recent study cited in this “Institutional Investor” article, companies that implement social responsibility plans are twice as likely to enter activist hedge funds crosshairs as firms that are not addressing these issues:

The study, evaluating data on U.S.-based activist campaigns from 2000 to 2016, found that hedge funds are significantly more likely to target companies that have a strong performance record in corporate social responsibility. In fact, the likelihood of a company being targeted increased from 3% to 5% if their CSR scores rose by two standard deviations above the average. If companies are trying to do the right thing in industries that have historically not addressed environmental, social, or governance issues, they’re even more likely to be in the sight lines of activists, according to the study.

Ain’t that a kick in the head? According to Prof. Rodolphe Durand, one of the study’s authors, activists believe that these initiatives are a waste of money & distract management from efforts to maximize profits.

Prof. Durand says that if you want to prioritize ESG without attracting the attention of activists, forget the greenwashing & go all-in: “management teams that clearly articulate their operational and financial strategies for impact and ESG initiatives have a better chance of escaping an activist campaign than those who are vague about their plans.”

Insurance: Michigan Court Nixes Covid-19 Coverage Claim

One of the top of mind issues for many companies in recent months has been whether their business interruption insurance policies will pick up part of the tab for Covid-19 losses. We blogged a few months ago that companies seeking to recover under those policies were likely to face an uphill climb. This Faegre Drinker memo reviews the first substantive judicial decision on Covid-19 coverage issues, and the result is consistent with that prediction:

Generally, insurers in such suits have taken the position that the virus has not caused physical damage to the insured’s property and therefore there has been no trigger for coverage under the terms of the policies at issue. Insurers have also argued that, under the terms of the policies, there can be no coverage for business interruption because losses caused by viruses are specifically excluded.

On July 2, 2020, a judge in Ingham County, Michigan issued what appears to be the first substantive decision in a COVID-19 business interruption coverage case. In Gavrilides Management Company, et al. v. Michigan Ins. Co., the insured argued that the virus exclusion did not apply because the loss of access was caused by the government orders, not by the virus. In addition, the insured argued that the loss of use of the property caused by the governmental orders constituted “direct physical loss” within the meaning of the policy. Applying Michigan law, the court rejected both arguments.

Ruling from the bench on a motion to dismiss, the judge held that “direct physical loss or damage” requires more than mere loss of use or access. The judge then held that the virus exclusion unambiguously excluded coverage caused by the impact of COVID-19.

Since the insureds’ arguments are similar to the arguments made in other cases, the memo says that case will undoubtedly be cited by insurers in other business interruption coverage cases pending throughout the country.

Financial Reporting: Staff Comments on Covid-19 Impairment Testing Disclosure

The pandemic’s economic impact has caused many companies to conclude that they need to conduct impairment testing. Companies that find themselves in that position may want to take a look at this Audit Analytics blog, which highlights a recent Staff comment on a Covid-19 Q1 impairment charge disclosure. Here’s the comment letter and here’s the company’s response.

John Jenkins

July 6, 2020

Q2 Reporting: Investors Focus on Liquidity & Human Capital Disclosure

On June 30th, the SEC held a roundtable on 2nd quarter reporting & Covid-19 disclosure. The panelists included a bunch of big shots from private equity firms and asset managers. This Mayer Brown blog summarizes the panel’s recommendations on Q2 & Covid-19 disclosure. Many of these recommendations focused on liquidity & human capital-related issues. Here are some of them:

– Provide specific and forward-looking guidance on the company’s liquidity position, including its expected cash burn and upcoming capital expenditures. Companies should consider including a best, middle and worst case liquidity scenario.

– Separately disclose the company’s short-term and long-term liquidity plans. Identify the company’s primary use of cash during the second quarter as compared to prior quarters.

– Specify, in a standardized format, the amount of liquidity that is currently available under the company’s existing financing facilities and if financial covenants prevent the company from accessing or drawing down from a disclosed financing source. Identify the time period that the company can expect to continue to operate with limited or no cash revenue.

– Explain management’s rationale for implementing announced executive compensation or staff reductions. Disclose changes to the company’s work force and expected impact on the company’s operations.

– Disclose the impact of the pandemic on the company’s human capital. Explain if the company’s employees will be able to work remotely and disclose the company-specific challenges. Estimate costs if the company expects to spend significantly on personal protective equipment in order to safely reopen.

The panelists said that investors also want to see qualitative disclosures addressing a company’s operational challenges & resiliency, as well as forward-looking disclosures & trend guidance, particularly around capital raising activities. In addition, investors are looking for companies to address the effect of recent social unrest on their business & employees, along with standardized disclosure about their racial and gender diversity, including a description of applicable hiring practices.

Beyond EBITDAC: Quantifying Covid-19’s Impact in Public Company Disclosures

Earlier this year, I blogged about the practice of presenting “EBITDAC”- type disclosures that adjust for Covid-19’s impact. A more recent blog from Liz suggests that this practice is growing in popularity. Clearly, disclosures about the effects of Covid-19 are very important, but non-GAAP disclosures that include estimates of lost revenue from the pandemic aren’t likely to make you many friends at the SEC.

Unfortunately, the quantitative disclosures about Covid-19 that can raise compliance issues aren’t limited to EBITDAC, and guidance about where to draw the line has been hard to come by. That’s why this Cleary Gottlieb memo about disclosures quantifying Covid-19’s impact is a very helpful resource. This excerpt addresses potential concerns about the accuracy & verifiability of Covid-19 adjustments:

Not all adjustments are created equal. Adjustments stemming from fairly objective charges, such as COVID-related contract terminations or purchases of personal protective equipment, are easier to isolate, quantify and support than charges related to supply chain interruptions and operational inefficiencies, which may reflect drivers beyond COVID-19. The more judgment calls that are needed in a company’s assessment of an adjustment, the more the company should consider its assumptions.

The SEC may be more likely to question the accuracy of the disclosure during its normal-course review of the company’s periodic filings, and there is also litigation risk surrounding COVID-impact disclosure that contains a misstatement or is otherwise inaccurate or unsupportable. In addition, it may be difficult for auditors to comfort such an adjustment in an underwritten offering. such as COVID-related contract terminations or purchases of personal protective equipment, are easier to isolate.

Through a user-friendly format that incorporates Q&As and concrete examples, the memo also provides insight on determining whether or not a particular disclosure involves a non-GAAP financial measure, whether the disclosure is permissible or potentially misleading, and other matters.

Companies looking into using non-GAAP financial measures to address the impact of Covid-19 should also check out this Deloitte memo on the topic.

Covid-19 Disclosure: Choose Your Words with Care!

A recent post over on the Jim Hamilton Blog discussed a webcast hosted by Securities Docket in which representatives of Latham & FTI participated. The webcast addressed a variety of pandemic-related disclosure & litigation issues, but one that I wanted to highlight involved the importance of careful attention to the wording of disclosure – particularly the use of the term “material adverse effect” when discussing Covid-19. Here’s an excerpt from remarks by Latham’s Keith Halverstam:

Halverstam also advised against using the term “material adverse effect” when it comes to making COVID-related disclosures related to company operations. While it might look good to the SEC, other parties such as the company’s lenders might see it as a violation of a covenant, making it harder for the company to draw on their revolving credit. Instead of using “material adverse effect,” companies can say, for example, that the pandemic has had “significant effects on revenue,” he recommended.

For some situations, there may be no choice but to use the “material adverse effect” terminology, but the point is that the words you chose to use may have implications that go well beyond the confines of the disclosure document.

John Jenkins

July 3, 2020

Thomas Jefferson’s Big Deadline

Did you know that Thomas Jefferson had only 17 days to write the Declaration of Independence? I admit feeling conflicted that we still celebrate someone who turned out to be so pro-slavery in his older years, but I also find it impressive that young TJ met that deadline.

Beware EDGAR Technical Issues

It’s not the news I want to be bringing as we head into a holiday weekend, but it’s time to end the silent suffering of those who’ve attempted filings this week. With end-of-period equity awards triggering Form 4s, that’s a lot of people!

After a day of headaches on Monday, the SEC’s EDGAR Filer Communications circulated an email late that evening reporting the issues experienced at 4:30pm – right as many were trying to make filings – had been resolved (there had been no notice earlier in the day that an issue was occurring, and there were a lot of frustrated people attempting filings and questioning whether their filing agent was to blame). The “EDGAR News & Announcements” page offers this relief:

The SEC will automatically date as June 29, 2020 all filings made between 5:30 p.m. ET and 10:30 p.m. ET on June 29, 2020. For other filing date adjustments, please contact Filer Support at 202-551-8900 option 3.

However, Monday’s email also warned that filers could continue to experience technical problems with their custom codes. That happened yesterday, with a notice in the morning that EDGAR was experiencing technical difficulties and a notice in the afternoon that EDGAR would be down for a short amount of time for technical repair.

Kudos to the SEC for making real-time announcements yesterday and for keeping the “EDGAR News & Announcements” page updated – you should visit that page and follow the posted instructions if you’re having problems. Fingers crossed that the issue is now fully resolved!

Liz Dunshee

July 2, 2020

NYSE “Direct Listings” Proposal: Now With Price Range & Round Lot Requirements

Late last year, we were tracking the saga of the NYSE’s “direct listing” proposal for primary offerings. A lot has happened since then, and you’d be forgiven if you assumed that going public without the benefit of a traditionally marketed & placed IPO was no longer a very attractive option. But the NYSE hasn’t given up hope that we’ll return to better times. Last week, they filed the third version of a proposed rule change that would permit companies to raise money in a “direct listing.”

As this Davis Polk memo explains, this version of the proposal gives more detail about the mechanics of a direct listing – but it would also make this path available to fewer companies:

The NYSE’s current proposal eliminates the 90-day grace period that was previously proposed for the minimum holder requirement. As a result, both primary and secondary direct listings would continue to be subject to the requirement to have 400 shareholders at the time of initial listing.This requirement will continue to preclude many private companies from pursuing a direct listing because they do not having the required number of round lot holders.

Unlike the prior proposals, this version also provides more granular detail around the auction process for a primary direct listing. Significantly, the auction process would require that the company disclose a price range and the number of shares to be sold in the SEC registration statement for a primary direct listing, and would require that the opening auction price be within the disclosed price range. For purposes of the opening auction, the company would be required to submit a limit order for the number of shares that it wishes to sell, with the limit set at the bottom end of the price range. The proposed rule changes would not allow the company’s limit order to be cancelled or modified, and the limit order would need to be executed in full in order to conduct the primary direct listing

Suspending Preferred Dividends? Your Form S-3 Might Be At Risk

As some companies look to suspend dividend payments due to economic fallout from the pandemic, here’s a reminder from a recent Mayer Brown blog:

In order to remain eligible to use a Form S-3 registration statement, among other requirements, neither the issuer nor any of its consolidated or unconsolidated subsidiaries shall have failed to pay any dividend on its preferred stock since the end of the last fiscal year for which audited financial statements are included in the registration statement (General Instruction I.A.4 of Form S-3). The reference to materiality in the instruction does not apply to the failure to declare dividends on preferred stock.

A declared but unpaid dividend on preferred stock would disqualify an issuer from using Form S-3, as would the existence of accrued and unpaid dividends on cumulative preferred stock. The issuer also would be disqualified from using Form S-3 even if it has a history of accumulating such dividends for three quarters before paying them at the end of each year.

The blog notes a few ins & outs of this analysis – including that eligibility remains intact if a board doesn’t declare a dividend on non-cumulative preferred stock, or if the terms of the debt permit deferred payments and the deferral isn’t a default, since no liability arises under the terms of the stock. Also, even if a dividend payment on cumulative preferred stock was missed, a company can continue to use an already effective Form S-3 registration statement so long as there is no need to update the registration statement.

Secured Notes Offerings: Covid-19 Trends

In these desperate times, more companies are turning to secured notes to keep them afloat – and it’s not a terrible option, given current pricing and the possibility that other loans will be unaffected. This 3-page Cleary Gottlieb memo discusses current trends to consider – including disclosure, timing, covenants, collateral & intercreditor issues, call protection and reporting. Here’s an excerpt:

A common trend for these new secured notes offerings has been a five-year maturity, with two years of call protection, resulting in a much shorter tenor than the usual seven- to eight-year maturity for secured notes. This trend for a shorter tenor offers more flexibility to the issuer for refinancing if circumstances improve but still provides noteholders with more call protection than would be typical for a credit facility.

One feature in pre-crisis secured notesofferings, a 10% per annum call right at 103% for the first years after the offering (or if shorter, during the non-call period), appears to have fallen away in these recent secured notes deals.

Liz Dunshee

July 1, 2020

Tangible “Corporate Purpose”: Investor Views

Amidst the pandemic, the “corporate purpose” debate continues – a few say it’s even intensified, given some companies’ need to prioritize long-term viability & employee well-being over dividend payments or other capital allocation decisions that would benefit shareholders. A recent Wachtell Lipton memo defines “purpose” as:

The purpose of a corporation is to conduct a lawful, ethical, profitable and sustainable business in order to create value over the long-term, which requires consideration of the stakeholders that are critical to its success (shareholders, employees, customers, suppliers, creditors and communities), as determined by the corporation and the board of directors using its business judgment and with regular engagement with shareholders, who are essential partners in supporting the corporation’s pursuit of this mission.

In response to Wachtell’s positions, Skadden published this memo – which argues that shareholder primacy is still the name of the game. And practically speaking, companies’ ability to accommodate non-shareholder stakeholders is likely to turn on shareholder preferences.

That’s why this recent SquareWell Partners survey – of investors who collectively manage over $22 trillion in assets – is a worthwhile read. It covers whether “corporate purpose” is relevant to investors, who they believe should be responsible for delivering it, how it should be measured and how investors intend to hold companies responsible for putting it into practice. Here are a few key takeaways (also see this Harvard Law School blog):

1. 93% of shareholders believe that purpose is a necessary grounding for a successful long-term strategy

2. Nearly half of the participating investors suggested that they expect the company’s purpose to be in line with the UN Sustainable Development Goals

3. 86% expect firms to report on the delivery of purpose – with 75% emphasizing the need for KPIs

4. Most investors suggest that the company’s purpose has a dedicated section within their annual report (or equivalent document) closely followed by a formal statement from the board addressing the company’s purpose

5. Investors will look to see if there is consistent disclosure regarding the implementation of the purpose, stakeholder concerns, employee turnover, etc. to evaluate whether the company’s purpose is effective

6. Only one-third of participating investors expect to have a vote on a company’s purpose but almost two-thirds are engaging with companies on the topic

7. Whilst a quarter of the participating investors suggested that they will not oppose any agenda items if they are not satisfied with a company’s purpose, investors will most likely target the election of board members (including the board chair), discharge (where possible), etc.

Proxy Advisors & Shareholder Proposals: SEC’s Investor Advocate Still Wants a Proposal “Do-Over”

Way back in January, Lynn blogged on our “Proxy Season Blog” that the SEC’s Investor Advisory Committee recommended to the Commission that it revise and re-propose its rules on proxy advisors & shareholder proposal submission thresholds. Earlier this week, the SEC’s “Office of the Investor Advocate” – which is a member of the Investor Advisory Committee – reiterated that recommendation in its “Report on Objectives for Fiscal Year 2021.”

The Investor Advocate’s report on objectives is due by June 30th each year and relates to the government fiscal year that begins October 1st. It goes directly to Congress without any review or comment by the Commission or Staff. The report has this to say about proxy plumbing:

Much of the concern expressed by investors has centered on the economic analysis in the rulemakings. For example, the SEC’s Investor Advisory Committee submitted a recommendation to the Commission that it revise and repropose the rules, citing a number of ways in which the proposing releases failed to meet the SEC’s published guidance for conducting economic analyses.

The recommendation also noted that there are well-known problems with respect to so-called “proxy plumbing,” or the processes by which shares are voted and counted, and suggested that the Commission should prioritize efforts to address those concerns. In other words, before addressing concerns of the business community about the advice investors seek, the Commission should ensure that investors’ votes are actually counted.

In addition, the Investor Advocate includes in its 2021 policy agenda “corporate disclosure and investor protection in registered & exempt offerings” – calling for:

– Improved “human capital management” disclosure, possibly going beyond the “principles-based” approach that the Commission proposed last August

– Attention to “machine readable” disclosures outside of financials – noting that prior “disclosure effectiveness” changes have catered to investors who are manually accessing & analyzing info, but more & more investors are now using digital processes

– Consideration of whether the expansion of registration exemptions undermines public markets and ignores the value of registered offerings & public disclosure

The report also includes a special 3-page overview of the impact of Covid-19 on investors – highlighting eroding confidence of individual investors in stocks & mutual funds as beneficial long-term investments.

Our July Eminders is Posted!

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Liz Dunshee

June 30, 2020

D&O Insurers: Bracing for Litigation By Hiking Your Costs

D&O insurance premiums jumped somewhere between 44% and 104% in the first quarter of this year, compared with last year. That’s according to survey data from Aon & Marsh cited in this WSJ article. The cause of the increase is the ever-expanding specter of securities litigation, including event-specific litigation and suits over emerging ESG issues, which Lynn blogged in January would be likely to influence rates.

The latest threat? Covid-19 reopening decisions. Lynn blogged last week on “The Mentor Blog” about what boards need to consider to manage reopening risks – if boards get it wrong, they’ll not only be facing remorse over upended lives and a struggling workforce, they’ll also become a litigation target. Some believe that rates will more than double in the wake of the pandemic, according to this “Business Insurance” article. The WSJ reports that on top of tough decisions about the business, companies are having to decide whether to change deductibles, policy limits or insurance budget. Here’s an excerpt:

According to Aon, no primary policies that renewed in the first quarter with the same limits and deductibles fetched a lower price. To contain the increases, nearly half of the clients changed their deductibles or policy limits, and sometimes both.

In a June 10 report, A.M. Best Co. said a spike in litigation caused by specific events, such as cyberattacks, the #MeToo movement and wildfires, was driving the increases. Companies also face potential litigation over “emerging exposures” such as Environmental, Social and Governance, or ESG, issues and climate change, it says.

Exchange Act reporting is a key factor in reigning in premiums and reducing risk. According to the Journal and insurance companies, some companies also are setting up captive insurance companies in places like Singapore or Bermuda – as wholly owned subsidiaries that provide insurance to the sponsoring company alone.

Earnings Guidance: Most Important for Smaller Companies?

In this recent 6-minute interview with Andrew Ross Sorkin, Barry Diller – Chair of Expedia and IAC – takes a pretty firm stance against giving earnings guidance, and says the companies he oversees will no longer be providing granular predictions of the near-term future. This article argues that guidance isn’t a waste of management’s time and outlines ways in which the practice can benefit companies – especially smaller companies. Here are some high points:

1. Volatility: Stocks are valued on expectations of future performance. Companies that give guidance help narrow the standard deviation of those expectations, and their words and numbers carry weight because they have the most information about their future. Volatility is less of an issue for widely-followed mega-caps, which have a “crowdsourced consensus on future value that can make guidance unnecessary.”

2. Visibility: For smaller companies, guidance is an important tool to enhance visibility on the Street. It makes analysts’ and investors’ jobs easier and shows management can deliver, which builds their credibility — the most valuable non-monetary asset on Wall Street.

3. Vulnerability: Companies that give guidance take the lead in shaping investor perception about future potential. Those that don’t leave a “consensus” opinion to a handful of research analysts who don’t have full perspective on the issuer’s culture, plans, and opportunities. Worse yet, management is nonetheless still held accountable by the market for hitting that consensus.

“All-Purpose” Securities Law Disclosure: Are We Reaching the Breaking Point?

As demands mount for “stakeholder”-oriented disclosure – and as the SEC faces understandable backlash about whether that type of disclosure is useful to investors – there’s a growing contingent suggesting that shoehorning extra info into an investor-focused disclosure scheme is a lot like two-in-one shampoo & conditioner: it simply doesn’t work. This article from Tulane Law prof Ann Lipton discusses whether the SEC has been a victim of “mission creep” – and why now’s the time to look at other avenues for required “stakeholder” disclosure. Here’s an excerpt:

The assumption — stated or unstated — that all public disclosure must necessarily run through the securities laws has distorted the discourse for decades. Academics, regulators, and advocates have conflated the interests of investor and stakeholder audiences, to the detriment of both. There has been little, if any, discussion of the informational needs of the general public, or when and whether businesses should operate under a duty of public transparency. At the same time, advocates for myriad causes try to flood the securities disclosure system with information relevant to their own idiosyncratic interests, overburdening the SEC and making it more difficult for investor audiences to interpret the information they are given.

How would this type of system work? Ann looks at the EU system “both as a model and a point of contrast” – and suggests that stakeholder disclosure would apply to these categories:

– Financial information – including issues pertaining to tax payments, anticorruption measures, and antitrust compliance

– Corporate governance

– Environmental impact

– Labor relationships – including diversity, working conditions, and pay practices

– Political activity

– Customer protection – transparency, safety, privacy

To minimize burdens on business, the initial system could focus on information that has already been compiled internally, such as reports that companies are already required to file with government agencies, or financial and governance information likely to be on hand. Doing so would spare companies the additional burdens of data gathering, and would go a long way toward standardization.

To be clear, this isn’t a call to “abolish” the SEC. Rather, it would emphasize the SEC’s focus on investors and use other ways to provide complementary info. However, we could see some ripple effects in SEC rules if something like this came to fruition, and it could expand the scope of work for people in our community, since we’re already involved with disclosure.

Liz Dunshee

June 29, 2020

ICOs: SEC Shows No Love For SAFTs

Last year, I blogged about an SEC enforcement action to halt an unregistered ICO that was being conducted in the most “best practices” way possible – through a “Simple Agreement for Future Tokens.” Under this structure, the company sells “pre-token” securities to accredited investors, which flip into non-security tokens at or after launch of a platform on which to use them. In this particular case, the SEC took issue with the fact that there would be no established cryptocurrency ecosystem at the point when the pre-tokens flipped to tokens.

On Friday, the SEC announced that it had settled the enforcement action – and the results aren’t encouraging for the crypto crowd. Here’s the highlights:

– The company agreed to return more than $1.2 billion to the initial purchasers in the offering

– The company’s paying an $18.5 million civil penalty

– For the next 3 years, the company has to notify the SEC before participating in the issuance of any digital assets

Yikes. The announcement includes this quote from the Chair of the SEC Enforcement Division’s Cyber Unit: “New and innovative businesses are welcome to participate in our capital markets but they cannot do so in violation of the registration requirements of the federal securities laws.” But with this SAFT arrangement drawing ire, a lot of folks are wondering how exactly a token offering would do that.

Reg S-T: Corp Fin Extends Temporary Relief for Signatures

In March, John blogged about Corp Fin’s temporary relief for manual signature retention requirements under Rule 302(b) of Regulation S-T. Last week, the Staff updated that statement to say that it’ll remain in effect until a date specified in a public notice, which will be at least two weeks from the date of the notice. So while the Staff continues to expect compliance, it won’t recommend enforcement if:

– a signatory retains a manually signed signature page or other document authenticating, acknowledging, or otherwise adopting his or her signature that appears in typed form within the electronic filing and provides such document, as promptly as reasonably practicable, to the filer for retention in the ordinary course pursuant to Rule 302(b);

– such document indicates the date and time when the signature was executed; and

– the filer establishes and maintains policies and procedures governing this process.

The Staff also extended for an indefinite period its temporary relief for submission of paper forms under Rule 144 and other rules – which had been set to expire June 30th. For more detail, see this Cooley blog.

Last week, the SEC, Corp Fin, the Division of Investment Management and the Division of Trading & Markets also issued this joint statement, which summarizes all of the relief & assistance that the Commission provided during the pandemic to accommodate capital raising & reporting, and says the Commission won’t be extending the relief that gave companies additional time to file disclosure reports that were due on or before July 1st.

But not everyone is happy about “deregulatory” efforts by the SEC these last few months – here’s a letter to SEC Chair Jay Clayton from Chair of the House Financial Services Committee, Congresswoman Maxine Waters (D-CA), calling for the Commission to halt rulemakings unrelated to the pandemic.

Climate Change Litigation: The Next “Mass-Tort” Frontier?

BP is facing state court action for nuisance claims from the cities of Oakland & San Francisco, after the Ninth Circuit denied the company’s motion to remove the case to federal court and dismiss the claims. This Wachtell Lipton memo predicts that the decision will invite “countless actions by states, municipalities, and private litigants in state courts all over the country” – and that liabilities will extend far beyond the energy sector.

Meanwhile, as Reuters reported a couple weeks ago, PG&E is pleading guilty to 84 counts of involuntary manslaughter in connection with the 2018 Camp Fire. Although no individuals will be held criminally accountable, this plea is pretty unique because the company is admitting criminal guilt. The company is also paying up to $19 million in fines & costs accepting tighter oversight – and pledging billions of dollars to improve safety and help wildfire victims. The company cited more than $30 billion in potential wildfire damages when it filed for bankruptcy, and it’s reached various settlements and rate agreements as part of the Chapter 11 plan.

Liz Dunshee