As Liz recently blogged, it’s no secret that public companies have been declining nearly as fast as honeybees – & in some circles, their endangered status is just as disquieting. However, this EY report says we all need to chill out about this. Here’s an excerpt from the intro:
US public companies are fewer in number today than 20 years ago but much larger by market capitalization. They are also more stable, and delisting rates are much lower than immediately following the dot-com boom. In general, the total number of domestic US-listed companies has stabilized, especially post-2008, and the number of foreign companies listed on US exchanges has steadily increased over the same time.
A lower number of IPOs than during a boom-bust cycle should not automatically be viewed as problematic. There is ample evidence that today’s IPOs are creating stronger, healthier companies than at any time in the past. Growth companies choosing to sell shares to the public today are typically stable and have solid prospects for growth. Today’s healthy IPO market is a stark contrast to the post-dot-com bubble years, when companies with uncertain business prospects that went public, often shortly after formation, later collapse.
Is it a good thing that we have fewer public companies that are larger and more stable? As “The Economist” notes, how the market came to be dominated by those larger & more stable companies matters too:
Some firms get bought by private-equity funds but most get taken over by other corporations, usually listed ones. Decades of lax antitrust enforcement mean that most industries have grown more concentrated. Bosses and consultants often argue that takeovers are evidence that capitalism has become more competitive. In fact it is evidence of the opposite: that more of the economy is controlled by large firms.
As for the previous IPO boom & bust cycles, it’s hard to defend the dot.com bubble, but is it really a bad thing that “companies with uncertain business prospects” were able to go public during hot markets? Some win; most lose – you pay your money & you take your chances. An appetite for some risk isn’t such a bad thing.
So… Is Private the New Public?
No sooner do I finish my rant about the decline of public companies than Prof. Ann Lipton blogs that “publicness” is now increasingly an attribute of a lot of private companies. Here’s what she means:
“Publicness,” a concept first developed by Hillary Sale, refers to the general social obligations a corporation is perceived to have toward the public in terms of transparency and regularity of operations.
The growing private resale market for shares in high-profile private companies is blurring some of the lines between “public” and “private” companies. So perhaps it’s not surprising that in today’s environment, a company like Uber is perceived by the public to have certain duties in terms of ethics and responsible governance – despite not having public shareholders.
Small Cap IPOs: First Reg A+ Listing on NYSE.MKT
Here’s a little good news on the IPO front – a few months ago, I blogged about medical device company Myomo’s efforts to obtain a listing on the NYSE.MKT in conjunction with its Reg A+ IPO.
This Duane Morris blog reports that the company completed its offering and became the first Reg A+ IPO issuer to officially begin trading on an exchange. This excerpt provides an upbeat take on the results of Reg A+ & this listing milestone:
The Reg A+ rules permit non-listed companies a “light reporting” option after their IPO, further reducing costs and burdens as a public company while retaining strong investor protections. The SEC also has given extremely limited review to these filings, and has reported an average of 74 days from initial filing to SEC approval or “qualification.” As a result, companies are reporting a speedier, more cost-efficient and simpler process in completing their Reg A+ offerings than with traditional IPOs.
To date, the SEC has reported that dozens of Reg A+ deals have been consummated and hundreds of millions of dollars raised since the SEC’s final rules were implemented in 2015. Only a handful of these companies, however, have commenced trading their stock. To have completed the first Reg A+ deal to trade on a national exchange, therefore, is a very significant development for those working to redevelop a strong new IPO market for smaller companies.
This Shearman note flags the SDNY’s recent decision in Xiang v. Inovalon Holdings. To make a long story short, the plaintiff in a Section 11 case alleged that the issuer should’ve disclosed the effect of pending tax changes on its earnings in response to Item 303’s “known trends” requirement. The court refused to dismiss this claim, holding that the plaintiff adequately pled knowledge on the part of the company.
How did the plaintiff establish knowledge? That’s where the plot thickens. Here’s what the blog has to say:
The Court also found that plaintiffs had adequately pleaded that Inovalon should have disclosed its increased tax liability under Item 303, which requires disclosure of known trends reasonably expected to have a material impact on the registrant’s revenues or income.
Plaintiffs adequately pleaded that defendants knew of the tax change by pleading that Inovalon was a client of Deloitte, and as such “would have received Deloitte’s January 23, 2015 client alert” regarding the impending tax reforms. This directed communication, the Court held, adequately alleged actual knowledge even though allegations of public information alone have been held insufficient to establish such knowledge in other cases.
Aside from making a subscription to our sites even more of a necessity, this case shows both the resourcefulness of the plaintiffs’ bar and the potential need for companies to incorporate the “client alert” communications from their professional advisors into their disclosure controls & procedures.
Board Diversity: Female CEOs Have More Women on the Board
This Equilar blog says that S&P 500 companies whose CEO is a woman have more women on their boards – a lot more. Check out the stats in this excerpt:
In analyzing the boards of directors at those companies with female CEOs using BoardEdge data, Equilar found that 33.2% of board seats were occupied by women. In 2016, just 21.3% of S&P 500 boards overall were female, according to the Board Composition and Recruiting Trends report, and just 15.1% of board seats in the Russell 3000 overall were occupied by females in 2016, as noted in the recent Equilar Gender Diversity Index report.
Also on the board gender diversity beat, this Davis Polk blog says that SEC Chair Jay Clayton is getting heat from Congress to push for more gender diversity disclosure:
Citing research that found that only half of S&P 100 companies referenced gender when disclosing their board diversity, Representatives Carolyn Maloney (D-NY) and Donald Beyer (D-VA) asked Clayton to consider the SEC staff’s review of the existing rule previously ordered by former SEC Chair White. In March, Representative Maloney reintroduced a bill on board gender diversity that would require the SEC to establish a group to study and make recommendations on ways to increase gender diversity on boards. Companies must also disclose the gender composition of their boards.
Representative Gregory Meeks (D-NY), along with 28 other House Democrats, requested that Clayton go further, and to work on a rule proposal. That letter also asked the SEC to share with Congress the status of the SEC staff’s review.
10b5-1 Plans: They Really Do Work
Over on CompensationStandards.com, Mike Melbinger recently blogged about Harrington v. Tetraphase Pharma., Inc. (D. Mass.; 5/17), which held that the use of a 10b5-1 plan implemented prior to an alleged fraud will undermine allegations that trades made pursuant to that plan are indicative of scienter.
As Mike put it, the decision is important “because it illustrates how executives’ sales of stock made (or begun) prior to a period of adverse public information and declining stock price can still be protected.”
We’ve already blogged quite a bit about the new revenue recognition standard, but this blog by Steve Quinlivan provides advice on preparing the first post-adoption MD&A – and it’s definitely worth a look. Here’s the intro:
The SEC has made clear its expectations regarding MD&A disclosure for periods prior to the adoption of the new revenue recognition standard. What has received less attention is the content of MD&A after the new revenue recognition standard has been adopted. Set forth below are some guidelines to be considered. While putting pen to paper to draft the first MD&A is still months away, public companies need to begin crafting disclosures controls and procedures so they will be in place when disclosures must be made.
Steve recently followed up with this blog reviewing the MD&As filed by early adopters of the new revenue recognition standard.
FASB Lease Standard: We Have An Early Adopter!
Speaking of early adopters, although companies have until 2019 to implement the new FASB lease standard, Microsoft will adopt it on July 1, 2017 (the first day of their next fiscal year). This SEC Institute blog has an excerpt of the disclosure about the impact of the new standard from the company’s most recent 10-Q.
FCPA: Kokesh Case Will Impact DOJ Pilot Program
It seems that the fallout from the Supreme Court’s recent Kokesh decision– which held that SEC disgorgement claims are subject to a 5-year statute of limitations – is going to hit other regulators as well. As this McGuire Woods blog notes, the DOJ’s FCPA pilot program could feel a major impact:
The five year statute of limitations at issue in Kokesh is a general one that applies in FCPA civil enforcement actions as well as in the securities laws underlying Kokesh. Indeed, the parties’ briefing in the case referenced the large amounts of disgorgement in FCPA cases and that disgorgement in FCPA cases often goes directly to the U.S. Treasury and not to any victims as they may be difficult to ascertain in the FCPA context.
In holding that the statute of limitations applies to disgorgement, the Supreme Court affected a critical component of the DOJ’s FCPA Pilot Program. DOJ guidance expressly requires that to be eligible for the Program’s main benefit of mitigation credit, a company must disgorge all profits resulting from the FCPA violation. Accordingly, published declinations pursuant to the Program have indicated substantial disgorgements.
Potential responses to Kokesh include DOJ conditioning participation in the program on waivers of the statute of limitation, or requiring full disgorgement in order to award cooperation credit. The blog also notes that the decision may also increase the reluctance of parties whose conduct occurred primarily outside of the statute of limitations to participate in the program.
The article also makes clear that, if the Corp Fin Staff questions the use of a non-GAAP financial measure in the comment letter process, a public company may be able to convince the Staff that the use of a particular non-GAAP financial measure is appropriate and compliant.
The article notes, however, that the ability of public companies to prevail may be correlated with the nature of the non-GAAP financial measure being used, and that public companies have been less successful in defending their usage of non-GAAP revenue-based measures (which have been the subject of particular scrutiny by the Staff) in comparison to non-GAAP earnings-based measures.
Just like with other types of Staff comments, resolving a non-GAAP comment without being required to make a change in disclosure remains quite common. For example, the Corp Fin Staff has said at multiple conferences that they didn’t expect practice to change much for restructuring & related exclusions – and that is exactly what happened. And on the speaking circuit, Corp Fin Staffers have been talking recently about the success of the non-GAAP project and how they expect comment volume in this area to drop…
Audit Reports: Will “Critical Audit Matters” Become “Fighting Words”?
Like most of what is referred to – apparently without irony – as “accounting literature,” the definition of the term “critical audit matters” seems dull & lifeless. Under the PCAOB’s new auditing standard, critical audit matters are “matters communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment.”
The definition may not sound exciting – but this recent blog from Cooley’s Cydney Posner says that its application may result in some real battles between auditors & management:
I don’t think I’d be going too far out on a limb if I predicted that we might see some disputes erupt over CAM disclosure. Essentially, the concept is intended to capture the matters that kept the auditor up at night, so long as they meet the standard’s criteria.
But will auditors’ judgments about which CAMs were the real nightmares be called into question? Will the new disclosure requirement precipitate many auditor-management squabbles over the CAMs selected or the nature or extent of the disclosure? And just how enthusiastic will the CFO be about the prospect of the auditor’s sharing with the investing public the convoluted nature or opacity of the company’s policies or the struggles involved in performing the audit or reaching conclusions about the financials?
While the process of identifying CAMs is supposed to involve collaboration, auditors may be unlikely to give much weight to management & audit committee input – and may use the new requirement as a leverage point in disclosure disputes with management.
Tomorrow’s Webcast: “Proxy Season Post-Mortem – Latest Compensation Disclosures”
Tune in tomorrow for the CompensationStandards.com webcast — “Proxy Season Post-Mortem: The Latest Compensation Disclosures” – to hear Mark Borges of Compensia, Dave Lynn of CompensationStandards.com and Jenner & Block, Ron Mueller of Gibson Dunn analyze what was (and what was not) disclosed this proxy season.
This Reuters article says that SEC Enforcement Co-Directors Stephanie Avakian & Steve Peikin have identified cyber crime as the top threat facing US securities markets:
“The greatest threat to our markets right now is the cyber threat,” said Peikin, who was still wearing a guest badge because he has not yet received his formal SEC credentials yet. “That crosses not just this building, but all over the country.”
The SEC has started to see an “uptick” in the number of investigations involving cyber crime, as well as an increase in reports of brokerage account intrusions, Avakian said. As a result, the agency has started gathering statistics about cyber crimes to spot broader market-wide issues.
The kinds of cyber crimes the SEC has been noticing range from stealing information for the purpose of insider trading, to breaking into accounts to either steal assets, trade against them or manipulate markets.
SEC enforcement actions involving cyber crime include notable insider trading cases based on information obtained by hacking into computer systems of major newswires and – more recently – two prominent law firms.
Cybersecurity: Target Settlement & Emerging Best Practices
In addition to acting against cyber criminals, the SEC & other authorities are demanding increased vigilance on the part of businesses to prevent these crimes from happening. Just last month, Target announced a $18.5 million settlement with 47 state attorneys general & DC to resolve issues arising out of its 2013 customer data breach. As part of the deal, Target also agreed to implement new measures to safeguard consumer privacy.
This Davis Polk memo points out that the measures agreed to in this settlement are much more detailed and specific than those contained in the company’s 2015 consumer class action settlement:
Comparing the measures that were required in the 2015 settlement with those in the 2017 settlement highlights the dramatic increase in expectations for cybersecurity over the last two years. Indeed, the requirements set forth in the recent Target settlement closely track the cybersecurity measures that were recently imposed by the New York Department of Financial Services (“DFS”) through Rule 23 NYCRR 500, which New York Governor Cuomo described as “strong, first-in-the-nation protections,” and which the DFS characterized as “landmark regulation.”
The memo includes a chart comparing the terms of the recent settlement with the 2015 settlement and the DFS’s requirements. The significant overlap between what Target signed up for & New York’s requirements suggests that the measures prescribed in the DFS regs may be emerging as “best practices” when it comes to data protection.
Tomorrow’s Webcast: “Flash Numbers in Offerings”
Tune in tomorrow for the webcast — “Flash Numbers in Offerings” — to hear Cravath’s LizAnn Eisen, Simpson Thacher’s Joe Kaufman and Latham & Watkins’ Joel Trotter analyze all the issues related to the use of flash numbers in offerings.
While the rest of us were listening to former FBI Director James Comey’s testimony before the Senate Intelligence Committee, the House passed the Financial Choice Act by a vote of 283-186, with 11 abstentions. Here’s a shock – the vote was along party lines, with Rep. Walter Jones of North Carolina being the sole Republican to vote against the bill.
Here’s an executive summary of the legislation provided by the House Financial Services Committee. Speaker Paul Ryan praised the bill for reining in “the overreach of Dodd-Frank.” Investor advocates have a different perspective. CII Director Ken Bertsch commented that “The Choice Act would dismantle important shareholder rights, make investing in public companies riskier and undercut the ability of the Securities and Exchange Commission to protect investors.”
As I previously blogged, this bill is likely “face down & floating” in the Senate – but it’s just the opening salvo.
Enforcement: Stephanie Avakian & Steve Peikin Named Co-Directors
Last week, Liz blogged about reports that Acting Director Stephanie Avakian and Sullivan & Cromwell’s Steve Peikin would serve as co-heads of the SEC’s Division of Enforcement. Yesterday, the SEC made it official with this press release announcing Stephanie and Steve’s appointment as Co-Directors.
Private Company Employee Stock Valuations: A Shell Game?
This DealBook article criticizes tech companies’ use of 409A valuations for employee stock issuances – calling the approach Silicon Valley’s “dirty little secret”:
This type of valuation allows hot, privately owned technology companies — like Uber, Airbnb or Nextdoor — to issue common stock or stock options to employees at a low price and, at the same time, or nearly the same time, sell preferred stock to outside investors at a price that is often three or four times higher. It’s also a way for company founders to control the market for the stock of their private companies while rewarding themselves and key employees with cheap shares that seem instantly worth a lot more than the price at which they were issued.
I don’t think I’d necessarily call this a “valuation shell game” as DealBook contends. Employees are typically buying common stock, loaded down with fairly outrageous restrictions on transfer. Outside investors are buying “Series Whatever” preferred, with a whole different bundle of rights. Under those circumstances, it doesn’t require a huge leap of faith to justify a significant discount from what outside investors are paying.
DealBook is also critical of the false precision in these 409A valuations – but the same thing can be said of almost any third party valuations. False precision is sort of the nature of the beast. The other thing is, if this is a shell game, it’s one that’s been going on for ages – and in a lot of places other than Silicon Valley. This is just another variation on the theme of “cheap stock”, which has been an issue in IPOs for decades.
This Reuters article says that the President’s budget proposal would eliminate the SEC’s reserve fund, which was established under Dodd-Frank to be used “as the [SEC] determines is necessary to carry out the functions of the Commission.” The Administration says that eliminating the fund would reduce the deficit by $50 million.
In recent years, the fund – which is separate from the SEC’s budget and is funded with registration fees – has been used to support the SEC’s IT modernization efforts. According to this House Financial Services Committee memo, since FY 2012, the SEC has spent more than $205 million from the reserve fund for improvements to its website & internal IT systems.
The reserve fund has also attracted a lot of opposition from Republican lawmakers. The version of the Financial Choice Act recently passed by the House Financial Services Committee would also eliminate the fund, while the Congressional spending proposal put forth in early May would have slashed it by $25 million.
Insider Trading: Will Reserve Fund Cut Curb New Cases?
This Proskauer blog notes that the SEC’s Enforcement Division is making increased use of advanced data analytics in insider trading investigations. My Cleveland Browns are trying to do the same thing in football – but this excerpt suggests that the SEC has actually made progress:
Over the past few years, the SEC has taken strides to find cases on its own, not simply waiting for tips or FINRA referrals. Much of the SEC’s work on insider trading matters occurs within the Enforcement Division’s Market Abuse Unit, which proactively launches its own investigations through data mining and advanced detection. The co-chief of that unit, Joseph Sansone, has repeatedly noted that it makes sense to invest resources into investigations when analysts notice patterns in multiple trades over a period of time.
The blog points out several recent insider trading cases that the SEC developed through its own data analysis efforts. However, it also notes that cutting the $50 million annual reserve fund “may affect the SEC’s funding to mine and analyze large data sets.”
SEC Budget Proposal: On the Other Hand. . .
This Wolters Kluwer report notes that all things considered, the SEC could be doing worse in the budget battle. As things stand, it would essentially be getting what it asked for in its budget request. What about the hit to the reserve fund? Under the President’s proposal, those reserve fund cuts won’t kick in until after 2018.
Of course, as the SEC points out in its budget request, it has one thing going for it that many other agencies don’t:
It is important to note that the SEC’s funding is deficit-neutral, which means that any amount appropriated to the agency will be offset by transaction fees and therefore will not impact the deficit or the funding available for other agencies.
Here’s the results from our recent survey on compensation committee minutes & consultants:
1. When it comes to providing comp committee minutes to consultants, our company:
– Provides upon request in electronic form only – 41%
– Provides upon request in paper form only – 5%
– Provides upon request in both electronic & paper form – 11%
– Doesn’t provide – but does allow inspection onsite – 25%
– Doesn’t provide – nor allow inspection onsite – 18%
2. Our compensation consultants ask for copies – or inspection – of committee minutes:
– Prior to each meeting – 12%
– Once a year – 4%
– On irregular basis – 25%
– They never ask for them- 59%
Section 2(a)(19)(C) of the Securities Act says that a company can lose “emerging growth company” status by issuing more than $1 billion in non-convertible debt over a rolling 3-year period. This MoFo blog reviews what counts – and what doesn’t – when determining whether you’re over the limit. This excerpt addresses the treatment of asset-backed securities:
In calculating whether an issuer exceeds this $1 billion debt limit, the SEC Staff has interpreted all non-convertible debt securities issued by an issuer and any of its consolidated subsidiaries, including any debt securities issued by such issuer’s securitization vehicles, to count against the $1 billion debt limit. As a result, asset-backed securities that are considered non-recourse debt and consolidated on a parent issuer’s financial statements for accounting purposes should be included when calculating the applicability of the $1 billion debt limit.
Issuers do get to exclude debt issued in an A/B exchange offer, since this involves simply replacing those securities with ones that are identical in all respects – except for their registered status.
Audit Reports: “Dear Audit Committee Member”
This recent blog from Davis Polk’s Ning Chiu provides a good example – in the form of a “Dear Audit Committee Member” letter – of a user-friendly way to communicate with directors about the PCAOB’s decision to modify the form of the auditor’s report to address “critical audit matters.”
Yesterday, a unanimous US Supreme Court held that the 5-year statute of limitations contained in 28 U.S.C. §2462 applies to SEC disgorgement claims. Justice Sotomayor’s opinion in Kokesh v. SEC concluded that since disgorgement involved violations of “public laws” (i.e., the harm was done to the United States, not an individual) & was punitive and non-compensatory, it was a “penalty” subject to the 5-year limitations period in the statute.
Disgorgement is a big part of the SEC’s enforcement arsenal – in fiscal 2016, the SEC obtained disgorgement orders totaling $2.8 billion, compared to only $1.3 billion in civil penalties. Nothing in the Supreme Court’s opinion prohibits the SEC from continuing to seek a disgorgement remedy, but now it’s got to keep an eye on the clock. We’re posting memos in our “SEC Enforcement” Practice Area.
The backstory in the Kokesh case may be more interesting than the opinion itself. I take that back – actually, it’s a lot more interesting.
Compliance Consultants: Coming to An Insider Trading Case Near You?
While we’re on the topic of remedies, this Drinker Biddle blog points out that a unique aspect of the SEC’s insider trading settlement with Leon Cooperman & his Omega Advisors hedge fund was the requirement that the firm retain a “compliance consultant.” Compliance consultants are a tool that the Division of Enforcement has used in other settings, but this is their first use in an insider trading case.
The blog points out that this requirement sets a precedent that could have a major impact on future cases:
The SEC’s use of this remedy may allow it to “lower the bar” for insider trading investigations knowing that it may be able to obtain settlements such as this which do not result in a suspension or bar. While the avoidance of the suspension or bar is of course paramount to individuals, an undertaking such as this involves an invasive-type relationship with a third party who – while “independent” – may have an allegiance to a regulator or a court.
The costs of a consultant – which are not insignificant – are always borne by the defendant firm, and the blog says it’s not a stretch to describe them as additional/hidden monetary penalties that over a period of years “may increase to hundreds of thousands of dollars or more.” The adoption of this new enforcement tool may turn out to be bad news for individuals and entities whom the SEC may not have considered charging before this settlement.
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This Bloomberg article says that the number of CEOs in the US & Canada fired for ethical lapses has more than doubled in the past five years:
Fourteen North American CEOs were ousted for ethical lapses from 2012 to 2016, compared with six in the preceding five-year period, according to a study of 2,500 global companies by PwC. The researchers included executives who left because of their own improper conduct or that of employees, so if, for example, a CEO was forced out because of widespread fraud in the organization, that counted as well.
The 102% increase in North American firings of wayward CEOs compares to an overall global increase of 36%. Western Europe saw these CEO terminations increase by 41%, while BRICS countries saw a 132% increase. According to one of the study’s authors, the crackdown reflects a number of factors, including shareholder activism & increased director exposure to liability for corporate malfeasance.
Did the CEO Quit – or Was it a Resig-firing?
Reading the tea leaves to determine whether a CEO was forced out is sometimes difficult. Corporate transition announcements tend to be ambiguous, and investors are often left to sort out for themselves whether the CEO was fired or resigned.
Now financial journalist Daniel Schauber has come up with a model – the “Push-out Score” – that he contends will help shed light on whether a CEO left voluntarily, or was shoved out the door. Here’s an excerpt from a Stanford article describing the model:
Unlike models that strictly categorize executive departures as forced or voluntary, the Push-out Score produces a score on a scale of 0 to 10 that amounts to a confidence level that the CEO was compelled to leave. (A score of 0 indicates that it is “not at all” likely that the executive was terminated or pressured to resign; a score of 10 indicates that termination is “evident.”)
The Push-out Score incorporates publicly available data along nine dimensions, including the form & language of the announcement, the time between announcement & departure, the official reason given for the change, the circumstances surrounding it and the nature of the succession. The model also takes into account extenuating circumstances and judgment, and assigns a score based on its assessment of the various dimensions reviewed.
As one of my law school profs was fond of saying in response to my brilliant insights – “so what?” Well, it turns out that there’s a correlation between a high Push-out Score and increased volatility (both positive & negative) in the market for the company’s stock. So the article suggests that this model may provide investors & companies with important information to assist in interpreting the market’s reaction to a CEO departure:
A positive reaction might indicate that shareholders approve of a decision to push out the CEO because of the potential for operational improvements or future sale of the company. On the other hand, a negative reaction to a high Push-out Score situation might indicate that shareholders view a forced termination as evidence of deeper operating, financial, or governance problems, or that shareholders disapprove of the decision to fire the CEO.
Keith Higgins: Back at Ropes & Gray!
After a nice healthy break, former Corp Fin Director Keith Higgins has resurfaced at his old firm – Ropes & Gray – to serve as Chair of that firm’s corporate department. Good to see Keith back in the saddle!