Reportedly, SEC Chair Jay Clayton plans to tap one of his former Sullivan & Cromwell partners to lead the SEC’s Enforcement Division – Steve Peikin. Sounds like Steve will be the co-head with Stephanie Avakian, who was elevated from Deputy Director to Acting Director back in December. Here’s an excerpt from this WSJ article by Dave Michaels:
The decision to hire two top managers for the SEC’s enforcement division would ease some of the issues created by Mr. Peikin’s past work for Wall Street. Mr. Peikin has done high-profile defense work for Barclays PLC and Goldman Sachs Group Inc. Under SEC ethics rules, he would be barred for one year from supervising any cases that affect Goldman or other clients of Sullivan & Cromwell.
Mr. Peikin, a graduate of Harvard Law School, leads the criminal defense and investigations group at Sullivan & Cromwell. From 1996 to 2004 he was an assistant U.S. attorney in Manhattan, where he oversaw the Southern District of New York’s securities and commodities task force. During that era, Mr. Peikin earned headlines for his prosecution of star technology banker Frank Quattrone, who was convicted of obstructing a government investigation and witness tampering, although an appeals court later threw out the judgment.
More recently, Mr. Peikin was part of the defense team for futures trader Michael Coscia, who became the first U.S. trader criminally convicted of spoofing, a fraudulent trading strategy. Spoofing, which became illegal under the 2010 Dodd-Frank Act, involves placing orders that one doesn’t intend to fulfill, in an effort to trick other traders into altering their prices in a direction that benefits the spoofer. Mr. Coscia’s case is now pending before a federal appeals court.
This wouldn’t be the first time the Enforcement Division had Co-Directors. Broc blogged about Mary Jo White’s decision to “split the baby” back in 2013. The use of co-heads solves any conflict issues caused by bringing in someone from outside the agency to lead the Division…
D&O Insurance: Structuring Concerns
No director wants sub-par insurance coverage – and counsel is at least partially on the hook if that happens. This blog by Kevin LaCroix explains why program structure matters & how competing interests affect coverage decisions. Here’s the intro:
Most D&O insurance buyers understand the critical importance of limits selection – that is, deciding how much insurance to buy. But an equally important question involves the issue of program structure – that is, how the insurance program is put together.
Many insurance buyers understand that, in order to be able to purchase an insurance program with the desired limits of liability, their D&O insurance will be structured with a layer of primary insurance and one or more layers of excess insurance. In addition, these days many D&O insurance buyers also purchase an additional layer – usually on the top of program – of Side A Difference in Condition (DIC) insurance.
As noted in a recent post on the “Pillsbury Policyholder Pulse” blog, no coverage may be less understood than the Side A DIC policy. But even if frequently misunderstood, the coverage provides corporate directors and officers an important safety net. Moreover, there are other important D&O insurance program structure issues, beyond just the need for Side A DIC insurance.
D&O Insurance: What Startups Need To Know
D&O insurance is also important for private companies – more than 25% have had claims in the last three years & the average loss was $387,000. For early-stage ventures, it’s purchased around the time the company gets outside investors & directors, or at the time of hiring employees – but the list of potential claimants can also include customers, vendors, suppliers, creditors & others.
A startup can plan on approximately $15,000 in premiums for $1 million of coverage, depending on market condition & policy wording. Specific premium amounts are largely determined by the company’s current financial statements – income statement & balance sheet. Any prior claims will also have a negative impact on pricing.
It’s critical to be able to negotiate policy wording to extract the broadest coverage grants for the business. Policy premiums may vary among insurance providers, but a startup can expect to pay higher premiums for greater coverage.
Back in March, the SEC adopted new rule & form amendments requiring that the exhibit index in registration statements & ’34 Act reports contain links to the exhibits that are listed – & that these filings be made in HTML. We’ve posted in memos in our “Exhibits” Practice Area.
The effective date is delayed for most companies until September 1st – and for smaller reporting companies and non-accelerated filers that use the ASCII format, until September 1, 2018. But companies can comply earlier of course – and some indeed have. Here’s some examples from the most recent group of Form 10-Qs – note the different approaches:
Links to Exhibits: SEC Staff Still Needs to Update Edgar Manual
Interestingly, these companies have experimented by including links to their exhibits voluntarily – without the benefit of an updated Edgar Manual. Some members told me that the updated Manual was expected in mid-May – but we haven’t seen that happen yet (nor do I think we’ll see anything soon). Without the updated Manual, companies are lacking clear instructions on how to do accomplish what the SEC will be expecting…
Per Weil Gotshal’s Howard Dicker, here are other issues that might be addressed by the Staff:
1. Amended Reg S-K Item 601(a)(2) requires an “Exhibit Index” appearing before the signatures. Current rule is immediately preceding the exhibits.
2. For exhibits that have been previously filed, what should companies do about (a) exhibits that were filed in ASCII and (b) exhibits that are not separate files (e.g., pre-2000 when the exhibits and the report were all included in one single ASCII file.
How To Fix “In Progress” Edgar Filings
In the latest issue of Edgar Filer Support’s newsletter, there’s a discussion of how to handle “in progress” Edgar filings. Here are 3 pointers:
1. If your filing shows this status for 4 hours or more, there might be a technical issue with your CIK, tax ID or filing fee.
2. If you see the “in progress” status for over 12 hours, call Edgar Filer Support at 202.551.8900.
3. Your filing will usually show up with the original filing date once the issue is resolved.
Last month, John blogged about disclosing material changes to ICFR that result from the new revenue recognition standard – which takes effect at the start of next year. It’s also worth noting that revenue recognition is one of the most common accounting issues that trigger a material weakness. And having a material weakness is more than just embarrassing – SEC Chief Accountant Wes Bricker cited these nasty consequences in his recent speech:
– Companies disclosing internal control deficiencies have credit spreads on loans about 28 basis points higher than that for companies without internal control deficiencies
– After disclosing an internal control deficiency for the first time, companies experience a significant increase in cost of equity, averaging about 93 basis points
According to this Deloitte memo, companies can avoid a material weakness by identifying controls necessary to make judgments under the new standard. Here’s a teaser:
The new revenue standard requires companies to apply a five-step model for recognizing revenue. As a result of the five steps, it is possible that new financial reporting risks will emerge, including new or modified fraud risks, and that new processes and internal controls will be required. Companies will therefore need to consider these new risks and how to change or modify internal controls to address the new risks.
For example, in applying the five-step model, management will need to make significant judgments and estimates (e.g., the determination of variable consideration and whether to constrain variable consideration). It is critical for management to (1) evaluate the risks of material misstatement associated with these judgments and estimates, (2) design and implement controls to address those risks, and (3) maintain documentation that supports the assumptions and judgments that underpin its estimates.
You’ll need to consider one-time controls that relate to implementing the new standard as well as ongoing controls to track information and support sound revenue recognition judgments going forward. And remember – strong controls are also a “must” for your pre-adoption transition disclosures…
Revenue Recognition: Enhance All Of Your Revenue Disclosures…
This blog from Cydney Posner digs in to the myriad of revenue recognition disclosure issues that are coming our way. I blogged last month about transition disclosures – but those are just the tip of the iceberg. In recent remarks, Sylvia Alicea of the SEC’s Office of Chief Accountant explained:
The disclosures required by the new standard are designed to allow an investor to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
The pertinent facts and related reasonable judgments related to a registrant’s contracts with customers, including the significant judgments made in applying the principles of the new revenue standard, should be disclosed to better inform investors’ decisions.
This disclosure will be different & more detailed than what currently exists – and it’s best to think through it before you face a looming reporting deadline.
Revenue Recognition: Impact on Contracts
Here’s a friendly reminder that you should already be incorporating the new revenue recognition concepts in your contracts. This blog by Steve Quinlivan elaborates on drafting tips that align with the 5 steps outlined in the new standard. Here are a few things to watch for:
– In some situations, you might have to combine contracts entered into around the same time with the same customer & account for them as a single contract
– If the contract involves both goods & services – and you want to separately recognize revenue for these deliverables – make sure to draft them as distinct obligations and allocate the contract price
– Variable consideration can make it tricky to estimate & recognize revenue
– Make sure your team understands that performance under the contract – not necessarily timing of payments – triggers revenue recognition
For even more detail on these points, take a look at this speech from Sylvia Alicea of the SEC’s Office of Chief Accountant.
I recommend that you watch my quasi-parody below before you watch the SEC’s video. When I fed my buddies their lines before we taped, I didn’t inform them that this was a spoof. They thought I had written the lines as a joke. After we taped – in just one take! – I showed them that the lines were actually drawn from the SEC’s real video. I call my video a “quasi-parody” because I think we showed more teamwork in creating our version. Let us know your feelings about them in the poll below…
This Nixon Peabody memo cracked me up. It describes a criminal insider trading conviction based on one buddy sliding a napkin to his pal at a bar with the name of a company that was going to be acquired (ie. nonpublic material information – “MNPI”)). What cracks me up is the manner in which some folks share MNPI – as if sliding over a napkin solves the problem of his pal placing a huge order that is totally out of character for him!
Which reminds me of this “Cap’n Cashbags video” that parodies another real-life SEC enforcement action involving napkins & insider trading tips. What’s with the napkins!
I’m thinking of compiling a list of “Top 50 Funny Stories of Insider Trading.” Please send me your ideas. I won’t attribute to you unless you give me permission (as always)…
NYSE Turns 225!
Congrats to the NYSE! As noted in this article, the NYSE celebrated 225 years of trading stocks last week — back in 1792, 24 stockbrokers created the exchange when they signed an agreement to trade with each other…
Tom Conaghan on Doing Beer Deals
In this 27-minute podcast, McDermott Will’s Tom Conaghan discusses his career – including:
– How did you wind up becoming a lawyer?
– How did you wind up selecting securities laws?
– What was the most interesting/challenging thing you have worked on?
– How do you think the practice of securities law has changed over the years?
– How did you get into alcohol beverage deals?
This podcast is also posted as part of my “Big Legal Minds” podcast series. Remember that these podcasts are also available on iTunes or Google Play (use the “My Podcasts” app on your iPhone and search for “Big Legal Minds”; you can subscribe to the feed so that any new podcast automatically downloads…
If you’re a regular reader of this blog, you know that nothing excites me more than when someone fools the SEC’s Edgar & makes a fake filing! A little drool perhaps. Plug the term “fake” into the search box of this blog & you’ll see plenty of fake filings coverage.
The latest involves the filing of a fake Schedule TO-C, making it look like Fitbit was in play (here’s an article from back when that happened). The SEC brought a civil case; the DOJ brought a criminal one. And this dude went through all this trouble – and got into so much trouble – for a measly $3k in profit! Dummy.
According to the SEC’s complaint, Robert W. Murray purchased Fitbit call options just minutes before a fake tender offer that he orchestrated was filed on the SEC’s EDGAR system purporting that a company named ABM Capital LTD sought to acquire Fitbit’s outstanding shares at a substantial premium. Fitbit’s stock price temporarily spiked when the tender offer became publicly available on Nov. 10, 2016, and Murray sold all of his options for a profit of approximately $3,100.
The SEC alleges that Murray created an email account under the name of someone he found on the internet, and the email account was used to gain access to the EDGAR system. Murray then allegedly listed that person as the CFO of ABM Capital and used a business address associated with that person in the fake filing. The SEC also alleges that Murray attempted to conceal his identity and actual location at the time of the filing after conducting research into prior SEC cases that highlighted the IP addresses the false filers used to submit forms on EDGAR. According to the SEC’s complaint, it appeared as though the system was being accessed from a different state by using an IP address registered to a company located in Napa, California.
Shareholder Proposals: The Battle Over BRT’s Reform Proposal Begins
Raising the bar for proponents to get their shareholder proposals on the ballot is a theme in the “Financial Choice Act,” as well as the reform package offered by the Business Roundtable last year. The Choice Act’s reform would go beyond what the BRT seeks, as noted in this Bloomberg article. This article also notes how shareholders are asking questions about the BRT proposal this proxy season. Here’s an excerpt:
Anne Sheehan, director of corporate governance at the California State Teachers’ Retirement System (CalSTRS), and Tim Smith, who leads Walden Asset Management’s shareholder engagement, have also sent letters to the CEOs of nearly 50 companies that are members of the roundtable asking where they stand on shareholder proposals. “We do not believe that the Business Roundtable is reflecting the views of companies with a history of meaningful and constructive engagement with investors,” the letters say.
Another letter from Sheehan and other institutional investors with more than $4 trillion in combined assets was sent May 17 to all members of the House of Representatives as they gear up to vote on the bill soon.
I blogged this on our “Proxy Season Blog” on Friday, but it bears repeating: As noted in this Reuters article, a shareholder proposal at Occidental Petroleum – often referred to as “Oxy” – earned 67% support last week even though the company’s board recommended against. This was a “climate risk two-degree scenario analysis” proposal. As discussed in the Reuters article, BlackRock supported the Oxy proposal — its first support for a climate resolution, which bodes well for future climate proposals (but not all of them).
Now, all eyes are on the ExxonMobil vote on this same issue, May 31st in Dallas (where interestingly, ISS also came out against Exxon CEO’s pay package)…
I worry that some companies might be relying on Congress to step in and delay the implementation of the pay ratio rule. That’s looking less likely by the day. So the time that you have to prepare is narrowing.
It’s also far from clear whether the SEC would take action to delay implementation of a rule required by Dodd-Frank. Then-Acting SEC Chair Piwowar’s re-opening of comments earlier this year did not result in an outpouring of complaints from companies. Beyond 13,000 form letters in favor of pay ratio disclosures, the SEC received about 180 comment letters – of which only about 15% were against the rule. In this blog a few months ago, I linked to some of the comment letters from specific companies. And Ning Chiu blogged yesterday about a specific comment letter.
I strongly believe that executive pay should be reformed. My own research demonstrates the substantial benefits to firms of treating their workers fairly. However, disclosure of pay ratios may have unintended consequences that actually end up hurting workers. A CEO wishing to improve the ratio may outsource low-paid jobs, hire more part-time than full-time workers, or invest in automation rather than labor. She may also raise workers’ salaries but slash other benefits; importantly, pay is only one dimension of what a firm provides. Research shows that, after salary reaches a (relatively low) level, workers value nonpecuniary factors more highly, such as on-the-job training, flexible working conditions, and opportunities for advancement. Indeed, a high pay ratio can indicate promotion opportunities, which motivates rather than demotivates workers. A snapshot measure of a worker’s current pay is a poor substitute for their career pay within the firm.
The pay ratio is also a misleading statistic because CEOs and workers operate in very different markets, so there is no reason for their pay to be linked — just as a solo singer’s pay bears no relation to a bassist’s pay. This consideration explains why CEO pay has risen much more than worker pay. As an analogy, baseball player Alex Rodriguez was not clearly more talented than Babe Ruth, but he was paid far more because baseball had become a much bigger, more global industry by the time he was playing. Even if the best player is only slightly better than the next-best player at that position, the slight difference can have a huge effect on the team’s fortunes and revenues.
I agree with some of what Alex says – but he also doesn’t understand that boards can take internal pay into consideration as just one factor in their decisionmaking. And instead of comparing pay ratios of different companies – a company should just be looking at its own pay ratio over an extended period (ie. decades).
In fact, one reason why a company should be doing this internal look is that comparing a CEO’s pay package to peers is a primary cause of how we got into this mess in the first place – peer group benchmarking where CEOs got paid in the top quartile for years & years…
Pay Ratio: From the ’77 Archives
Hat tip to Deloitte Consulting’s Mike Kesner for sharing this 1977 WSJ op-ed from Peter Drucker on the notion of pay ratios. Executive pay was considered excessive even back then!
The full House is expected to vote on – and pass – the “Financial Choice Act” as soon as next week. But as John blogged a few weeks ago, it’s not expected that the Senate will act on the Choice Act. As noted in this article from “The Hill” (and this Bloomberg article), Senator Mitch McConnell reiterated the view that Dodd-Frank reform faced long odds in an interview yesterday. And those remarks came before the Special Counsel Mueller bombshell. Events in DC may dramatically slow down legislation in all areas.
So for those expecting pay ratio to be repealed, you might want to still prepare since time is getting tight for reform…
Meanwhile, as noted in this press release, CII and 53 institutional investors with collectively more than $4 trillion in assets sent letters to all members of the House asking them to not vote for the Choice Act…
A Pet Peeve: Use of PR Firms
One of the “bennies” of this job is that I hear from PR firms all day long. Most of the pitches are completely unrelated to the topics covered on our sites. But some do fit – and sometimes I actually take up an offer to work with a client.
But what annoys me is when I get pitched to talk to someone that I already know. I just received an email to talk to three people that I used to work with! Why didn’t they just email me directly? All it takes is a one-sentence email: “Hey dude. How would you like to [blank].” In my opinion, you’re wasting money on PR – just sit down & bang out a dozen emails – should take about 10 minutes.
I pride myself on being one of the more approachable people in our community. That’s the philosophy upon which I built our sites. It just feels odd. Just south of “I’ll have my assistant call your assistant – and we’ll do lunch.” But maybe I’m overreacting. Let me know what you think…
“Deal Tales”: Our New 3-Volume Series
Education by entertainment. This series of three paperback books – “Deal Tales” – teaches the kind of things that you won’t learn at conferences, nor in treatises or firm memos. With the set containing over 600 pages, John Jenkins – a 30-year vet of the deal world – brings his humorous M&A stories to bear.
This series is perfect to help train those fairly new to deals. And it’s also perfect for more experienced practitioners interested in what another vet has to share. John’s wit will keep you coming back for more. Check it out!
Occasionally, we get asked about how someone who’s in-house can make the case to their bosses to obtain more staff for their department. In our “Hiring More Staff” Practice Area, I have posted a six-page PowerPoint that you can modify to make your own business case.
I’ve talked to some in-house members about this – and here are some responses:
– Aggregate the outside legal bills for the subject matter at hand and then estimate the savings (and remember to argue the benefits of internal expertise).
– If trying to add a lawyer, one hard part is how to quantify the intangible benefits of having counsel pro-actively involved in matters, and how to quantify the opportunity cost of having someone else in the company (typically a controller, accountant or even the CFO) tackle the things a lawyer should do – minutes, coordinating meeting materials, Section 16 filings, etc. One general counsel I spoke with also placed value in having less volatile cost fluctuations, which she viewed as flattening out slightly with in-house counsel.
– In my experience, companies bring a lawyer in-house when outside counsel bills get so high that it just makes sense. Outside counsel can often recommend someone to the company – or even one of their lawyers decides to go in-house.
– The typical justification is based on the difference between (a) the avoided cost of outside counsel, usually based on hourly rates, versus (b) the fully-loaded cost (i.e. including benefits and other overhead) of in-house counsel performing the same functions. This does not assume that in-house counsel fully displaces the need for outside counsel – which is not practical for a lot of reasons. For some, there is about a 3-to-1 cost advantage. That doesn’t take into account enterprise risk management, efficiencies and other benefits that might be gained from using in-house counsel who may be more proactively focused broadly on the business than outside counsel who are typically engaged for more narrowly-defined purposes (e.g. a particular transaction or litigation matter).
– ACC has an info-pak titled “Establishing the In-House Law Department: A Guide for an Organization’s First General Counsel.” One relevant discussion in that publication says: “The simplest metric that a first GC can use to demonstrate the law department’s value involves calculating the hourly cost of performing work in-house in order to compare this cost to outside counsel hourly billing rates. ACC’s Value Challenge Tool Kit Resource, “Demonstrating the Law Department’s Value: Calculating In-house Counsel Costs,” provides a template to use and a description of the required calculations necessary for determining this metric. In general, this metric calculates total law department employee expenses (including adjustments for the costs of salaries, benefits, and facilities expenses) and divides by the total number of law department hours worked. The resulting metric will provide a number for the hourly cost of performing work inhouse, which can be compared to the hourly rates charged by outside counsel. This comparison can demonstrate to company management the amount of money that is saved by performing work in-house.”
Nasdaq’s “Regulation Reform” Proposal
Recently, Nasdaq published its own version of a blueprint to modernize the equity markets & streamline regulations. Like other reform proposals, its comprehensive – covering the “Big 3” of: restructuring the regulatory framework; modernizing market structure; and promoting long-termism.
Also see this op-ed published in the WSJ by Nasdaq’s CEO Adena Freidman…
The 2008 financial crisis was a global economic catastrophe that triggered years of new regulations designed to prevent another meltdown. Now that tide of rules is cresting, with officials across the globe talking about pulling back regulations instead of adding new ones. The defenders of the current regime are fighting to save it.
At the heart of the debate are opposing philosophies about free markets, regulation and the role of government. After 2008, the Obama administration in the U.S. pursued an aggressive rule-making path, injecting the government further into bank boardrooms, loan-underwriting decisions and conversations about retirement advice—all in the name of protecting citizens from a financial crisis and risky financial products.
With Republicans in control of the White House and Congress, the U.S. is seeing a resurgence of a different philosophy, one that favors freer markets and is skeptical of Washington’s recent approach to overseeing Wall Street. The government, these critics say, has repeatedly overreached in trying to prevent another crisis. It should take stock of all the work that has been done since the crisis—and consider rolling back many rules that critics say aren’t working as intended or weren’t needed in the first place.
As the debate rages on, here’s a closer look at the two competing visions for financial regulation.
Rein In the Banks: The Need for Discipline
Advocates who support active financial oversight favor an approach that can be summed up this way: Let the markets work, but within significant regulatory constraints to protect society from excesses. Left to their own devices, financiers can cause a lot of trouble, advocates say. Big banks have incentives to seek short-term profits without regard for the long-term consequences of their actions—and the 2008 crisis provided an example of just how much damage they can do if they succumb to those incentives.
Financial firms and consumers lent or borrowed too much, and regulators failed to act on warning signs before this excessive risk-taking spiraled out of control. Worst of all, the government bailed out some firms because it determined they were “too big to fail” without the financial system imploding. The result was a panic so sweeping, it dried up credit for Main Street and threatened the entire economy.
Regulatory hawks concede that government housing policies may have played some role in inflating the housing bubble but say it wasn’t central to the meltdown. Lack of oversight was. So, they argue, the government has an obligation to protect the economy from risky behavior—by banning those behaviors entirely or adopting policies that act like a tax on it, making it less attractive in the short term. Financial firms and their customers may have less freedom under these rules, but these advocates say that the effects of those restrictions pale in comparison to the cost of a huge financial crisis.
The 2010 Dodd-Frank law, approved by a Democratic Congress and signed by Democratic President Barack Obama, expanded the government’s power to react to what it viewed as emerging risks in financial markets. Firms considered “systemically important” to the economy now face tougher rules and more intrusive oversight than smaller competitors. A new regulatory committee can designate any firm for these tougher rules.
The idea is that if these firms pose an outsize risk, they should pay for it though higher regulation, even if those rules are complex. Federal Reserve Chairwoman Janet Yellen has said huge banks must “bear the costs that their failure would impose on others.” If the firms don’t like the regulation, so be it, these policy makers say: They can shrink or split themselves apart.
Tougher rules have meant that regulators take a far more active role in the continuing management of large firms, and to some extent smaller ones as well. The pro-regulation advocates acknowledge that such involvement might be uncomfortable, but say it’s a lot better than burdening taxpayers in the event of future bailouts.
Take the case of dividends. Large banks can no longer decide on their own to raise the dividend they pay to shareholders. They must get permission from the Federal Reserve first as part of their annual stress tests. The Fed justified the restrictions by pointing out that in the lead-up to the 2008 crisis, big banks paid out capital via dividends, then months later needed capital from taxpayers to stay alive. These restrictions are just one example of the myriad extra rules firms must now keep in mind as they make day-to-day business decisions.
In another case, when financial firms started ramping up a practice bank examiners considered dangerous—“leveraged loans” to companies already deep in debt—regulators at the Fed and the Office of the Comptroller of the Currency responded with prescriptive lending standards that they relentlessly enforced. Critics say the regulators should have let firms make their own lending decisions, but the Fed and Office of the Comptroller say that when a type of lending poses a risk to the broader economy, they have an obligation to try to nip it in the bud.