E-Minders September 2019
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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Following an open meeting in late August, the SEC issued guidance on proxy advisors - a topic that many can't get enough of. Here's what they did:
1. The SEC issued this 14-page interpretive release about how the proxy rules impact proxy advisors. It forces proxy advisors to take more steps to disclose how they craft their recommendations - and the SEC issued a broad warning for when they convey incorrect information.
2. The SEC issued this 26-page interpretive release about proxy voting responsibilities for investment advisors, providing steps that mutual fund managers should consider if they become aware of potential factual errors or weaknesses in a proxy advisor's analysis. (Here's the press release about both of the SEC's new interpretive releases - and here's a WSJ article.)
3. Each piece of guidance passed with a vote of 3-2, with the two Democrat Commissioners dissenting (Robert Jackson & Allison Herren Lee).
4. All five of the SEC Commissioners pushed out their opening statements about the new guidance promptly - they came out even before the SEC's press release. We believe that was a first...
We're posting the flood of memos in our "Proxy Advisors" Practice Area. And we will be covering this topic at our "Proxy Disclosure Conference" coming up in less than two weeks - in New Orleans and by video webcast. Register now...
Although the SEC cancelled its open Commission meeting that had been scheduled for early August, the Commissioners voted to issue this 116-page proposing release to modernize parts of Regulation S-K - specifically, Item 101 (business description), Item 103 (legal proceedings) and Item 105 (risk factors).
We speculated before the release was issued that some parts of the proposal might be somewhat based on the SEC's Reg S-K concept release from 2016 - and it appears that they are (though the proposal doesn't cover everything that was in the concept release). Another part of the proposal relates to human capital - a topic that SEC Chair Jay Clayton has indicated in recent speeches may be growing in importance. The "Fact Sheet" in the SEC's press release highlights these proposed changes (also see this Cooley blog):
Item 101(a) (Development of Business):
- Make the Item largely principles-based by providing a non-exclusive list of the types of information that a registrant may need to disclose, and by requiring disclosure of a topic only to the extent such information is material to an understanding of the general development of a registrant's business;
- Include as a listed disclosure topic, to the extent material to an understanding of the registrant's business, transactions and events that affect or may affect the company's operations, including material changes to a registrant's previously disclosed business strategy;
- Eliminate a prescribed timeframe for this disclosure; and
- Permit a registrant, in filings made after a registrant's initial filing, to provide only an update of the general development of the business that focuses on material developments in the reporting period, and with an active hyperlink to the registrant's most recent filing that, together with the update, would contain the full discussion of the general development of the registrant's business.
Item 101(c) (Business Narrative):
- Clarify and expand its principles-based approach, by including disclosure topics drawn from a subset of the topics currently contained in Item 101(c);
- Include, as a disclosure topic, human capital resources - including any human capital measures or objectives that management focuses on in managing the business - to the extent such disclosures would be material to an understanding of the registrant's business, such as, depending on the nature of the registrant's business and workforce, measures or objectives that address the attraction, development, and retention of personnel; and
- Refocus the regulatory compliance requirement by including material government regulations, not just environmental provisions, as a topic.
Item 103 (Legal Proceedings):
- Expressly state that the required information about material legal proceedings may be provided by including hyperlinks or cross-references to legal proceedings disclosure located elsewhere in the document in an effort to encourage registrants to avoid duplicative disclosure; and
- Revise the $100,000 threshold for disclosure of environmental proceedings to which the government is a party to $300,000 to adjust for inflation.
Item 105 (Risk Factors):
- Require summary risk factor disclosure if the risk factor section exceeds 15 pages;
- Refine the principles-based approach of that rule by changing the disclosure standard from the "most significant" factors to the "material" factors required to be disclosed; and
- Require risk factors to be organized under relevant headings, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.
This proposal was based on seriatim action taken by the Commissioners. As to the issue of whether the SEC is required to propose (or adopt) rules at an open Commission meeting, see Broc's blog entitled "When is the SEC Required to Hold an Open Commission Meeting?"
Last week, the SEC issued this fee advisory that sets the filing fee rates for registration statements for fiscal 2020. Right now, the filing fee rate for Securities Act registration statements is $121.2 per million (the same rate applies under Sections 13(e) and 14(g)). Under the SEC's new order, this rate will increase to $129.8 per million, a 7.1% increase.
Although we saw a modest 2.6% reduction in fee rates last year, this price hike puts fees back on the upward trajectory - they increased by 7-15% in fiscal 2018 and 2017. And since the annual adjustments to the SEC's fee rate have been made under a formula prescribed by the Dodd-Frank Act since 2010, the "politics" of the timing and amount have been removed for a while.
As noted in the SEC's order, the new fees will go into effect on October 1st (as has been the case since 2011, and as mandated by Dodd-Frank). That's a departure from the old way of doing things - before Dodd-Frank, the new rate didn't become effective until five days after the date of enactment of the SEC's appropriation for the new year - which often was delayed well beyond the October 1st start of the government's fiscal year as Congress and the President battled over the government's budget.
In July, Broc noted in his Inline XBRL blog that an incorrect eCFR of the Item 601(a) table was causing some confusion about iXBRL requirements. The SEC has now issued this 18-page release, which corrects the exhibit table and a few other items from the original Fast Act amendments. The technical corrections to the final rules do the following:
- Reinstate certain item headings in registration statement forms under the Securities Act of 1933 that were inadvertently changed
- Relocate certain amendments to the correct item numbers in these forms and reinstates text that was inadvertently removed
- Correct a portion of the exhibit table in Item 601(a) of Regulation S-K to make it consistent with the regulatory text of the amendments
- Correct certain typographical errors and a cross-reference in the regulatory text of the amendments
In response to the mechanical questions about how to handle the Inline XBRL for '34 Act filings - including the exhibit index - Corp Fin issued a set of 9 CDIs on that topic. Here's a Gibson Dunn blog about them.
By the way, the new CDIs don't show up under "What's New" on the Corp Fin page. And the way the relatively new CDI section is constructed, the only way to sleuth which CDIs are new - when the SEC pushes out an email indicating there is something new - is to click on each section of the CDIs and look at the "update" date. Something for which we receive a handful of complaints from members each time any CDIs are added or changed...
The comment letters have been rolling in on the SEC's proposed amendments to the "accelerated filer" definition - which would make fewer companies subject to the auditor attestation requirement. Predictably, accounting firms aren't in favor of the change and say that it would weaken the quality of financial reporting (here's EY's letter as an example). CII has also joined that camp - its letter argues that the amendment may cause investors to lose confidence in the integrity of financial statements.
CII also takes issue with the SEC's economic analysis of the proposal - by citing to another recent comment letter from four B-School profs. That letter adds data to the assertion that some companies can't be trusted to report material weaknesses when left to their own devices (as does this blog about Canada's experience with a similar rule). Here's an excerpt from this WSJ article about the letter and its underlying study:
More than 100 companies that could get relief have reported restatements that altered combined net income by $295 million from 2014 through 2018, according to a comment letter from researchers at Stanford University, the University of Pennsylvania, the University of North Carolina and Indiana University. Eleven of the restatements occurred in 2018 and wiped out about $294 million in market value, the researchers wrote.
One company in the group is Insys Therapeutics Inc., said Prof. Taylor, who co-wrote the letter. Insys, an opioid manufacturer whose market value peaked at $3.2 billion in 2015, sought bankruptcy protection in June after pleading guilty to bribing doctors to boost use of its spray version of fentanyl, a synthetic opioid. It agreed to pay $225 million in fines and forfeiture.
Insys effectively failed the internal-controls audits in 2015 and 2016, according to securities filings. The company later restated results for several quarters in 2015 and 2016. The company said at the time that neither fraud nor misconduct caused the errors. Auditors in 2017 and 2018 reported its internal controls were free from material weaknesses.
The comment letter emphasizes that the analysis in the SEC proposal quantifies the cost of internal control audits - but not the potential benefits. Of course, there are two sides to this heated debate - and the WSJ article also emphasizes the high cost of compliance for smaller companies, and that investing that money in the core business rather than compliance could improve returns for shareholders...there are letters supporting the proposal from Nasdaq, the Chamber, Proskauer and a score of life science companies, among others.
In late August, the SEC brought this Reg FD enforcement case against TherapeuticsMD based on its sharing of material, nonpublic information with sell-side analysts without also disclosing the same to the public. This should be one of the least controversial FD actions the SEC has brought - with pretty clear "selective disclosure" violations of FD on two occasions. Really egregious conduct including the fact that the company didn't have FD policies or procedures. The company was fined $200k...
The SEC hadn't brought a Reg FD case since September 2013 (the SEC never did bring a Reg FD enforcement action against Elon Musk for his tweets last year) - here's a list of the 16 SEC enforcement actions involving Reg FD over the years...
The Business Roundtable has been getting a ton of press by issuing this statement with its view that the "purpose" of a corporation should be changed so that "shareholder primacy" is a thing of the past. Nearly 200 CEOs signed onto the BRT's statement. Bye-bye Milton Friedman's decades-old theory to "maximize value for shareholders." How many of you will need to cover your tattoo of that phrase?
Shifting from shareholder primacy would be quite a change in focus for management & boards - from one devoted primarily to shareholders to one that would be a mix of stakeholders, including employees, customers, suppliers, the environment, communities and shareholders. Under the BRT's new formulation, companies say they'll consider the competing interests of the stakeholders (presuming they're not conflicted). While most state corporate law already allows for this in some form, things like promoting employee welfare at the short-term expense of shareholders are typically justified by boards & management as something that will also improve long-term shareholder value (some shareholders are more amenable to that than others).
Elizabeth Warren loves the idea - she proposed legislation along these lines last year. But understandably, large shareholders aren't happy about the BRT's move - here's a statement from the Council of Institutional Investors.
In preparing an article for the most recent issue of "The Corporate Counsel" print newsletter, we looked at a bunch of 10-K filings made by large accelerated filers after the effective date of the Fast Act disclosure simplification rules. One of the more interesting things that we found was that nearly half of the filers whiffed on the requirements of new Item 601(b)(4)(vi) of Regulation S-K - which requires companies to include an exhibit briefly describing all securities registered under Section 12 of the Exchange Act.
So, consider this a reminder that you've got to include this exhibit in your next 10-K if you're a large accelerated filer. If you're wondering what it should look like, check out this recent blog from Stinson's Steve Quinlivan, which reviews the new exhibit requirement & provides some samples.
Hogan Lovells' David Crandall also contacted us with an idea about why so many companies may be overlooking this requirement:
We noticed that form checks by our associates were not picking up the new requirement, and it turns out that the eCFR website for Reg S-K Item 601 incorrectly lists the exhibit requirement as applying to Form 10-Ds rather than 10-Ks.
The adopting release omitted the headers to the Item 601 exhibit table and had the incorrect number of columns (14 compared to 16), which undoubtedly contributed to the error on the eCFR website. I'm not aware of any source that correctly lists the new requirement as applying to 10-Ks, absent the discussion of the amendment in the adopting release. There may be many diligent registrants out there who looked at Item 601 and figured that the new requirement only applied to asset-backed issuers filing on Form 10-D.
But, just a few hours after posting David's comments, the eCFR website reference was fixed! Thanks to David and to the folks in the government who addressed this so promptly.
Given the times in which we live, we guess it's not surprising that some companies have added "risk factor" disclosure about the potential implications of an active shooter to their SEC filings. Here's an excerpt from this WSJ article:
A handful of public companies have begun quietly warning investors about how gun violence could affect their financial performance. Companies such as Dave & Buster's Entertainment Inc., Del Taco Restaurants Inc. and Stratus Properties Inc., a Texas-based real-estate firm, added references to active-shooter scenarios in the "risk factor" section of their latest annual reports, according to an analysis of Securities and Exchange Commission filings. The Cheesecake Factory Inc. has included it in its past four annual reports.
So, what do these risk factors look like? Here's what The Cheesecake Factory said in its 2019 10-K (pg. 25):
Any act of violence at or threatened against our restaurants or the centers in which they are located, including active shooter situations and terrorist activities, may result in restricted access to our restaurants and/or restaurant closures in the short-term and, in the long-term, may cause our customers and staff to avoid our restaurants. Any such situation could adversely impact customer traffic and make it more difficult to fully staff our restaurants, which could materially adversely affect our financial performance.
Dave & Buster's 10-K included identical language (pg. 23). The language in Del Taco's 10-K (pg. 21), and Stratus's 10-K (pg. 17) was a little different. While we understand why companies are doing this, we aren't sure this kind of thing is what risk factor disclosure is intended to capture. Everyone (us included) seems to have a tendency to throw any item that's been added to our national anxiety closet into a risk factor, which isn't very helpful to investors. The problem is that not all disclosure adds value - some just creates "noise."
In the U.S., we've learned that an active shooter is the kind of random event could happen to anyone, and the effect of such an event on any business would be terrible. So to us, it's sort of like getting struck by a killer asteroid. We think this is the kind of thing that Judge Easterbrook was getting at in this excerpt from his 1988 opinion in Weilgos v. Commonwealth Edison:
Issuers need not "disclose" Murphy's Law or the Peter Principle, even though these have substantial effects on business. . . Securities laws require issuers to disclose firm-specific information; investors and analysts combine that information with knowledge about the competition, regulatory conditions, and the economy as a whole to produce a value for stock.
But let's face it - you're not going to change your approach here and neither are we. That's because while we can debate risk factor metaphysics, the reality is that the explosive growth in event-driven securities class actions is a big part of our personal anxiety closets too.
1. Which factor is most important in allowing a blackout period to end one day after an earnings release:
- Filer status being
large accelerated filer and a WKSI - 19%
2. How many analysts covering the company is considered sufficient to allow blackout period to end one day after an earnings release:
- 1-5 - 3%
3. What average daily trading volume is considered sufficient to allow blackout period to end one day after an earnings release:
- 1% of its
outstanding common stock - 7%
Please take a moment to participate anonymously in these surveys:
Hats off to Stinson's Steve Quinlivan for listing recent SEC filings with CAMs in them. Steve notes that "there are a number of audit reports from smaller accounting firms on smaller issuers which indicate no CAMs were identified. Some may think this will change when the Big 4 start issuing reports on those beneath the large accelerated filer tier. That may be the case, but large accelerated filers by their nature seem to have complex accounting, which may not be true for smaller issuers and a finding of no CAMs may be appropriate." And note this quote from this article by MarketWatch's Francine McKenna:
Even though CAMS should, in theory, "enhance the informativeness of the audit report," the researchers caution that their findings suggest that business priorities "may discourage auditors from disclosing important direct-to-investor communications that might make their clients look bad, and instead encourage auditors to withhold such information."
In March, Broc blogged on our "Proxy Season Blog" that lobbying & political spending proposals were "coming up big" this year. And now that the height of proxy season is behind us, the Center for Political Accountability is elaborating on their recent successes in this blog. Here's an excerpt:
The average vote was 36.4 percent at 33 companies that held annual meetings. That was up from 34 percent last year, when 18 resolutions went to a vote. In 2017, the resolution averaged 28 percent over the 22 resolutions that went to a vote. CPA and its shareholder partners reached disclosure agreements and withdrew resolutions at 13 companies this year. That compares with three in 2018 and seven in 2017.
The 2019 Proxy Season breakdown is as follows:
- Two majority votes in support of the resolution at Cognizant Technology Solutions Corp. (53.6%) and Macy's Inc. (53.1%).
- Eleven votes in the 40% range, including Kohl's Corp. (49.8%), NextEra Energy Inc. (48.7%), Allstate Corp. (46.9%), Chemed (46.2%), Western Union Co. (44.3%), Fiserv Inc. (43.8%), Alaska Air Group (43.5%), Roper Technologies Inc. (43.0%), Netflix Inc. (41.7%), Centene Corp. (41.6%) and Nucor Corp (40.6%).
- Twelve votes in the 30% range. The companies included Illumina Inc. (37.7%), Simon Property Group Inc. (37.1%), American Water Works Company Inc. (37.0%), Duke Energy Corp. (35.8%), Wyndham Destinations (35.6%), American Tower Corp. (35%), Royal Caribbean Cruises Ltd. (34.5%), Wynn Resorts Ltd. (34.4%) CMS Energy Corp. (34.3%), Equinix Inc. (34.2%), DTE Energy Co. (33.6%), and J.B. Hunt Transport Services Inc. (31.7%).
This Cooley blog explores why companies might be coming around to greater oversight of this type of spending, and discusses some of the CPA's recommendations...
In August, the CII published a list of 159 directors who served on boards of 2018 & 2019 IPO companies that went public with dual-class share structures & no sunset provisions. The CII's "Dual-Class Enablers Spreadsheet" identifies the other public boards on which these directors serve. Here's an excerpt from the CII's press release discussing its rationale for the "naming & shaming" approach:
"The board that brings a company to public markets with unequal voting rights is responsible for the decision to disempower public shareholders," said CII Executive Director Ken Bertsch. "The board's decision can be a red flag of discomfort with accountability to outside shareholders." He said that investors "may want to raise concern about that in their engagement with other boards on which these directors serve. Some investors may choose to vote against directors of single-class companies who participated in pre-IPO board decisions to adopt dual-class equity structures without sunsets elsewhere."
The release also says that the list may have a deterrent effect on private companies considering dual class structures. Perhaps that's the case. After all, this is the first time that the CII has taken action that provides a potential reputational downside for the directors of these companies. But personally, we're skeptical. We still think that companies will only be deterred from going public with dual class structures when investors finally abandon their "buy now, whine later" approach to investments in them.
As noted in this press release, Judicial Watch has sued the State of California over its new law that requires up to three women being placed on the boards of companies incorporated in that state. The primary claim of the lawsuit is that the law is unconstitutional. Here's an article from the "Sacramento Bee" - and see this Cooley blog...
In mid-August, the CLS Blue Sky Blog summarized a study on the use of humor in corporate earnings calls. The results were kind of interesting:
We find that managers are less likely to use humor on a call when the tone of analysts' questions is negative, suggesting managers are deliberate about when to use humor. Further, our results indicate that managers are more likely to use humor if an analyst first uses humor on the call. We also find that the market reaction in the three days surrounding the conference call is more positive when managers use humor, a result that is partially driven by a muted reaction to negative manager tone when managers use humor. Additionally, our tests of analysts' reactions indicate that managers' use of humor is generally associated with upward revisions in analysts' stock recommendations shortly after the call.
It looks like the takeaway here is that a little humor from your execs can give a bit of a bounce to your stock price. Everybody's trying to make their earnings call stand out from the pack these days, and given the potential upside here it wouldn't surprise us to see companies make a conscious effort to inject comic relief into the proceedings. Well, you folks can do what you want, but if you ask us, we'd be very cautious about trying to throw your CEO into the deep end of the humor pool.
Our point is that comedy is a high-wire act, and chances are pretty good that your CEO isn't funny. Worse, it's almost a lock that most CEOs think they're hysterical. After all, a lot of CEOs spend their days surrounded by people who tell them how awesome they are and laugh at all their jokes. That can lead to catastrophic consequences for CEOs who decide that Dave Chappelle has nothing on them and that breaking out their standup act on an earnings call is a great idea.
Here's a case in point - last year at about this time, the subscription software provider Zuora attempted to turn its earnings call into a "dialogue" featuring ad-libbed attempts at humorous asides. The execs involved likely thought they were being amusing. According to this MarketWatch.com article, the market thought otherwise:
Wall Street didn't seem too amused by the strange new take on an earnings call, which took place as shares were falling in the aftermarket. Zuora's stock closed down 19% in Friday's session, the largest single-day percentage drop in Zuora's history as a public company.
Yikes! Any company that's considering turning their next earnings call into an SNL skit should keep in mind Zuora's cautionary tale - as well as the old theatrical adage that says "Dying is easy. Comedy is hard."
We recently mailed the July-August issue of The Corporate Counsel. This issue includes pieces on:
1. Early Returns From the Fast Act Rule Changes
- Changes to the Form 10-K Cover Page
2. Unpacking Stock Splits
- Stock Split v. Stock Dividend: What's the
3. A Few Words About Delaware's "Legal Capital" Requirements
Among other new additions, during the last month we have posted the following:
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