E-Minders October 2018
In This Issue:
E-Minders is our monthly e-mail newsletter containing the latest developments and practical guidance for corporate & securities law practitioners.
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That was fast. In late September, the SEC announced the filing of an enforcement action against Tesla CEO Elon Musk arising out of his ill-considered tweetstorm & subsequent comments about a potential "going private" transaction during the first two weeks of August. The SEC's complaint makes it clear that Enforcement isn't messing around - this is a Rule 10b-5 securities fraud case, unaccompanied by any non-scienter based allegations. Here's an excerpt from the SEC's press release:
On August 7, 2018, Musk tweeted to his 22 million Twitter followers that he could take Tesla private at $420 per share (a substantial premium to its trading price at the time), that funding for the transaction had been secured, and that the only remaining uncertainty was a shareholder vote.
The SEC's complaint alleges that, in truth, Musk had not discussed specific deal terms with any potential financing partners, and he allegedly knew that the potential transaction was uncertain and subject to numerous contingencies. According to the SEC's complaint, Musk's tweets caused Tesla's stock price to jump by over six percent on August 7, and led to significant market disruption.
Co-Director of Enforcement Stephanie Avakian added that taking care to provide truthful & accurate information is one of a CEO's "most critical obligations" - and one that applies equally when communications are made via social media instead of through traditional media. Speaking of issues surrounding the use of social media - be sure to check out our new "Social Media Handbook."
Musk's predicament calls to mind another automotive industry visionary with whom he's been compared - Preston Tucker. Check out this article for an overview of Tucker's innovative "Tucker Torpedo" & the fallout from the SEC's 1948 investigation into his company. Of course, let's not get carried away - Tucker's story had elements of tragedy to it, but Musk's is pure farce.
Elon Musk is one of the world's wealthiest people, so financial penalties that might prove ruinous to anyone else may not provide that much of a sting. However, the potential raised by this portion of the SEC's prayer for relief would definitely leave a mark:
Ordering that Defendant be prohibited from acting as an officer or director of any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act or that is required to file reports pursuant to Section 15(d) of the Exchange Act.
That's a D&O bar, and it's not unusual for the SEC to seek one - in fact, this 'Compliance & Enforcement' blog says that they are sought in more than 70% of cases involving individual defendants.
But let's face it, Elon Musk isn't Joe Bagadonuts - we're talking about a guy who figured out how to land a rocket standing up. There are few CEOs more closely identified with their companies than Elon Musk, and some question whether Tesla could survive without him. That means the SEC's decision to pursue a bar raises the stakes for Musk, Tesla, and Tesla's investors.
In mid-September, the SEC came out with two salvos against "informal" staff guidance. First, there was this statement from SEC Chair Jay Clayton reminding us that all Staff guidance is non-binding (ie. creates no enforceable legal rights or obligations for the SEC or other parties) because it hasn't been subject to notice & comment under the Administrative Procedures Act. That statement noted that the SEC "will continue to review whether prior staff statements and staff documents should be modified, rescinded or supplemented in light of market or other developments."
A few moments later, the Division of Investment Management issued this statement that — ahead of the upcoming "proxy plumbing" roundtable — it was withdrawing two no-action letters granted in 2004 to ISS and Egan-Jones Proxy Services. This Cooley blog does a nice job of explaining what the letters were about — here's an excerpt:
By way of background, as fiduciaries, investment advisers owe their clients duties of care and loyalty with respect to services provided, including proxy voting. Accordingly, in voting client securities, an investment adviser must adopt and implement policies and procedures reasonably designed to ensure that the adviser votes proxies in the best interest of its clients.
The two now-withdrawn no-action letters indicated that one way advisers could demonstrate that proxies were voted in their clients' best interest was to vote client securities based on the recommendations of an independent third party—including a proxy advisory firm—which served to "cleanse" the vote of any conflict on the part of the investment adviser. Historically, investment advisers have frequently looked to proxy advisory firms to fill this role. As a result, the staff's guidance was often criticized for having "institutionalized" the role of—and, arguably, the over-reliance of investment advisers on—proxy advisory firms, in effect transforming them into faux regulators.
IM's statement noted that the withdrawal would "facilitate" discussion at the roundtable. Based on some of the reactions to the withdrawal (see Commissioner Jackson's statement), it may do more than "facilitate" — it may lead to "fisticuffs"...
The movement against "informal" Staff guidance has been growing over the past decade. And it's not just at the SEC — the GOP-led attacks have focused on all of the federal agencies. Here's a few quick thoughts from Broc:
1. Government-Wide Movement — The DOJ was the first to emphasize it wouldn't conduct "rulemaking by guidance" late last year — see this blog. As noted in this Cooley blog, the SEC's announcement was preceded by a bunch of the banking regulators issuing something along these lines.
2. Chamber's Influence — Having these proxy advisor no-action positions overturned has been a plank in the US Chamber's platform for some time (for example, see pages 10-11 of this Chamber letter for their arguments about why the Staff should have never granted those letters). It wasn't that long ago that I blogged that the Chamber seemed to be losing influence. Spoke too soon?
3. Impact on You — In practice, we rely heavily on the guidance that Corp Fin provides us — CDIs, no-action letters, Staff Legal Bulletins, FAQs, speeches and even informal comments at conferences. What does our world look like if we need to rely on a small group of SEC Commissioners to perform that function? Remember that the Commissioners are not even allowed to meet as a group except in very limited circumstances due to the Sunshine Act.
4. Shorter Adopting Releases Too? — As noted in this blog, it wasn't even that long ago that one SEC Commissioner wanted the guidance provided by the Commissioners in the SEC's adopting releases to be shorter!
5. Collector's Items — This one is completely an "aside." It's hard to find the Egan-Jones and ISS letters online — these letters were issued by the Division of Investment Management. And I believe by withdrawing them, IM might have pulled them from their list of posted letters. Which makes sense since they are withdrawn. So the letters are now officially a "collector's item."
In mid-September, Broc blogged about how the SEC's Division of Investment Management issued this statement that — ahead of the upcoming "proxy plumbing" roundtable — it was withdrawing two no-action letters granted in 2004 to ISS and Egan-Jones Proxy Services. In that blog, he gave some initial thoughts that related mainly to SEC Chair Clayton's statement about informal Staff guidance in general. Here's some of his thoughts about IM's withdrawal in particular:
1. What Does This Mean for the "Proxy Plumbing" Roundtable? — I worry that this means that the upcoming "proxy plumbing" roundtable (date not set yet; likely in November) — and perhaps the SEC's "proxy plumbing" project as a whole — will focus mainly on proxy advisors. There is so much more to tackle than just proxy advisor reform, as Commissioner Jackson articulated nicely in his recent statement.
2. Any "Real World" Impact? — I doubt IM's withdrawal of the two no-action letters will cause investors to suddenly drop their use of proxy advisors. It's standard practice for an adviser to avoid a conflict by delegating the responsibility to someone who doesn't have the same conflict.
3. Withdrawal Didn't Change the Law? — There is a solid argument that the withdrawal of the '04 letters hasn't really changed the law. That "conflicts" law was on the books before the letters were issued — see this '03 adopting release (in particular, see the section about resolving conflicts of interest). The letters didn't create a safe harbor. In fact, the letters probably never should have been issued because the requests were motivated by a competitive spat between Egan-Jones and ISS.
The '03 adopting release was a Commission action, not a Staff one. I should also note that the recent withdrawal didn't extend to Staff Legal Bulletin No. 20. That 2014 bulletin — issued by both IM and Corp Fin — provides guidance to advisers on voting client proxies and retaining proxy advisory firms, and makes reference to both of the withdrawn no-action letters. SLB #20 promises to be a big topic of conversation during the proxy plumbing roundtable.
4. How Much Do Companies Rely on Proxy Advisors? — As I've blogged several times over the years, be careful what you wish for if you're hoping for the demise of proxy advisors (a different issue than conflicts). If proxy advisors disappear, that means there will be a need for more shareholder engagement as companies try to ascertain how their biggest shareholders intend to vote. And even if companies are willing & able to staff up their corporate secretary departments to facilitate that, that might not be the case for investors themselves. In other words, your phone calls may go unanswered — and you may get deep into the proxy season without a firm sense of knowing how your votes will turn out. I blogged about this initially way back when — and again a year later.
As for the notion that SEC Staff guidance doesn't carry the force of law, that may be true — but there are cases that indicate Staff guidance has some influence with the judiciary. For example, here's an excerpt from Ganino v. Citizens Utilities (US Court of Appeals — 2nd Cir.; 9/00):
With respect to financial statements, the SEC has commented that various "[q]ualitative factors may cause misstatements of quantitatively small amounts to be material." SEC Staff Accounting Bulletin ("SAB") No. 99, 64 Fed.Reg. 45150, 45152 (1999) (to be codified at 17 C.F.R. pt. 211, subpt. B) (representing interpretations and practices followed by the SEC's Division of Corporation Finance and the Office of the Chief Accountant in administering disclosure requirements of federal securities law).6 Of particular relevance to this action are the following:
- whether the misstatement masks a change in earnings or other trends
Id. Unlike, for example, a rule promulgated by the SEC pursuant to its rulemaking authority, see 15 U.S.C. § 78w(a), SAB No. 99 does not carry with it the force of law. See, e.g., Christensen v. Harris County, 529 U.S. 576, 120 S.Ct. 1655, 1662-63, 146 L.Ed.2d 621 (2000) (explaining that interpretations contained in opinion letters, like those in policy statements, agency manuals, and enforcement guidelines, which are not, for example, the result of a formal adjudication or notice-and-comment process, lack the force of law); General Elec. Co. v. Gilbert, 429 U.S. 125, 141, 97 S.Ct. 401, 50 L.Ed.2d 343 (1976) (stating that courts may give less weight to guidelines than to administrative regulations which Congress has declared shall have the force of law or to regulations which, under the enabling statute, may themselves supply the basis for imposition of liability) (superseded by statute on other grounds).
Nonetheless, because SEC staff accounting bulletins "constitute a body of experience and informed judgment," Skidmore v. Swift & Co., 323 U.S. 134, 140, 65 S.Ct. 161, 89 L.Ed. 124 (1944), and SAB No. 99 is thoroughly reasoned and consistent with existing law-its non-exhaustive list of factors is simply an application of the well-established Basic analysis to misrepresentations of financial results-we find it persuasive guidance for evaluating the materiality of an alleged misrepresentation. See Christensen, 529 U.S. 576, 120 S.Ct. at 1663 (quoting Skidmore, 323 U.S. at 140, 65 S.Ct. 161); Gilbert, 429 U.S. at 125, 97 S.Ct. 401.
Another example is U.S. v Miller, 833 F.3d 274 (D.C. Cir., Mar. 15, 2016): "We defer to [The SEC staff Guidance in Release 1092] because of the SEC's expertise and the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control." (internal cites and quotes omitted).
In late September, the SEC charged five companies with failing to have their independent auditors review their 10-Q interim financials. This is the first time the SEC has brought enforcement actions for violations of the Regulation S-X interim review requirement - and resulted from a review of filings, Staff comment letters and other metrics that indicated potential violations. Each company agreed to settle the SEC's charges, with the agency collecting a total of $250k in penalties.
Question 105.09: On August 17, 2018, the SEC adopted amendments to certain disclosure requirements in Securities Act Release No. 33-10532, Disclosure Update and Simplification. The amendments will become effective 30 days after publication in the Federal Register. Among the amendments is the requirement to presentthe changes in shareholders' equity in the interim financial statements (either in a separate statement or footnote) in quarterly reports on Form 10-Q. Refer to Rules 8-03(a)(5) and 10-01(a)(7) of Regulation S-X. When are filers expected to comply with this new requirement?
Answer: The amendments are effective for all filings made 30 days after publication in the Federal Register. In light of the anticipated timing of effectiveness of the amendments and expected proximity of effectiveness to the filing date for most filers' quarterly reports, the staff would not object if the filer's first presentation of the changes in shareholders' equity is included in its Form 10-Q for the quarter that begins after the effective date of the amendments. For example, assuming an effective date of October 25, a December 31 fiscal year-end filer could omit this disclosure from its September 30, 2018 Form 10-Q. Likewise, a June 30 fiscal year-end filer could omit this disclosure from its September 30, 2018 and December 31, 2018 Forms 10-Q; however, the staff would object if it did not provide the disclosures in its March 31, 2019 Form 10-Q. (Sept. 25, 2018)
So the Staff says that although the new rules apply to any filings after the effective date, companies can hold off one quarter on the "Statement on Stockholders Equity." That's good news, as this Gibson Dunn blog notes, companies with 12/31 fiscal year ends will be able to wait to make the new disclosure until after their 3rd quarter 10-Q. And no, the rules haven't yet been published in the Federal Register...
As we've blogged, studies that show many investors are now taking ESG seriously. For example, in this "Proxy Season Blog", we noted that State Street's Rakhi Kumar was encouraging boards to become more familiar with SASB and the growing importance of ESG scores in driving investment.
So it's not a big surprise that proxy advisors have begun incorporating ESG ratings into their reports & recommendations. Broc's blogged about how ISS is starting to do this through its "E&S QualityScore" (aided by its slew of recent acquisitions in the ESG space). Now, Glass Lewis has announced that it's taking a step in that direction. It will soon start displaying SASB standards in its research reports and on its voting platform — which is a nice boost for SASB in light of all the competition in the "ESG disclosure framework" space. Here's more detail (also see this blog from Davis Polk):
Guidance on material ESG topics from the Sustainability Accounting Standards Board (SASB) will be integrated into Glass Lewis Proxy Paper research reports and its vote management application, Viewpoint. As a SASB Alliance Organizational Member since mid-2017 Glass Lewis is familiar with the value provided by SASB's industry-specific standards, and has now been granted the right to display this content directly within its standard proxy research as well as its vote management platform.
As such, users of Glass Lewis' services will be able to easily identify whether items are aligned with the SASB standards, helping inform the clients' proxy voting and engagement activities. SASB's information will be incorporated into Glass Lewis' products in advance of the 2019 season after the SASB standards are codified, and available for thousands of companies across Glass Lewis' global coverage universe.
The "Ceres Investor Water Hub" — a working group of more than 100 investors that represent $20 trillion in assets — has published an "Investor Toolkit" to foster engagement with companies on water issues. Among other topics, it covers:
— Types of water risks — physical, regulatory, social — and how to assess materiality
— Shareholder resolutions & trends linked to water
— Database of proxy voting guidelines that integrate water issues
— Engagement tips for investors
— Recommendations for incorporating water issues into investment decisions
This Forbes op-ed from Ceres' CEO Mindy Lubber notes that 81% of major U.S. companies in water-dependent sectors have water stewardship programs — though only 37% have set qualitative targets to better manage water resources. It doesn't take too much imagination to predict that there'll be more requests for disclosure in this area.
Check out the latest report from BarkerGilmore — a boutique executive search firm — about in-house counsel compensation trends. Among the findings:
1. The median salary increase fell 0.5% — to 3.8%
2. 41% of in-house counsel believe they're underpaid
3. GCs at public companies earn a lot more than GCs at private companies, due to long-term incentives
4. On average, female in-house counsel earn 84% of what their male counterparts are paid — the gap is wider at the GC level
5. The lowest paying in-house jobs tend to be in the professional services industry
In our "Q&A Forum" (#9598), we were recently asked which companies did a good job providing proxy disclosure about their E&S situation. There are many to choose from — but we mentioned these:
— State Street
Here's the lowlights from this new report from the CFA Institute based on the new "lead audit engagement partners" disclosure made by companies in their proxies this year (the report covers much more ground than gender of the lead partners):
— Only 15% of lead engagement partners of the S&P 500 were female
Last month, John blogged about President Trump announcement that he had asked the SEC to study the possibility of companies moving from quarterly to semi-annual reporting. John blogged that this wasn't a new idea — and he indicated that making this change likely wouldn't promote a longer-term focus, nor perhaps even result in companies foregoing reporting quarterly results. I jump in with these additional thoughts:
1. With semi-annual reporting, there would be a higher risk of insider trading since blackout periods would be far longer.
2. Semi-annual reporting would create more 10b5-1 plan business because blackout periods would be longer.
3. Bigger investors would get an advantage over smaller ones because they would likely get access to more nonpublic information.
4. As noted in this blog, Cooley's Cydney Posner summarizes this article that indicates that cost-savings from the elimination of two quarterly reports would be partly offset by higher fees for the semi-annual reports. It appears that any cost-savings would benefit smaller companies the most.
5. Funny how things can change with time. Long ago, it was Republicans pushing for more frequent reporting. For example, this SEC report was conducted under a Republican regime. See #10 in the summary in particular.
This September-October issue of the Deal Lawyers print newsletter was just posted — & also mailed — and includes articles on:
— #MeToo Clauses Being Added to Merger Agreements
Right now, you can subscribe to the Deal Lawyers print newsletter with a "Free for Rest of '18" no-risk trial. And remember that — as a "thank you" to those that subscribe to both DealLawyers.com & our Deal Lawyers print newsletter — we are making all issues of the Deal Lawyers print newsletter available online. There is a big blue tab called "Back Issues" near the top of DealLawyers.com — 2nd from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.
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We continue to post new items daily on our blog — "Proxy Season Blog" — for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:
— More on "Shareholder Meetings: What to Do With a Tied Vote?"
Among other new additions, during the last month we have posted the following:
Elad Roisman Confirmed as SEC Commissioner: In early September, the Senate confirmed former Senate Banking Committee staffer Elad Roisman to serve as an SEC Commissioner.
The SEC Conducts Far More Town Halls These Days: As part of the ongoing effort to promote capital formation, it seems that one of the priorities of SEC Chair Jay Clayton is to engage with small businesses across the country and to conduct town halls with entrepreneurs & retail investors (which Jay started calling "Main Street" investors before the "Main Street Investor Coalition" was formed).
In fact, all five Commissioners attended a town hall in Atlanta in June - and Corp Fin Director Bill Hinman joined Jay recently at a "fireside chat" with the Tennessee Governor at Nashville's "Wildhorse Saloon". We don't recall a Corp Fin Director attending a town hall before - but it's possible that happened in the past...
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