Following up on John’s blog about whether “non-IPOs” will become the new IPOs, on Friday, Slack Technologies filed a Form S-1 for its anticipated direct listing on the NYSE. Slack is the second big company to go this route (the first being Spotify). There are no lock-ups and no new shares being issued – but will this fundamentally change how IPOs get done? After delving into the unique parts of Slack’s “Plan of Distribution,” Bloomberg’s Matt Levine notes:
There is a sense of a sort of shadow-bookbuilding process: Slack’s banks are not underwriting an IPO, they’re not marketing stock to potential investors on behalf of Slack and its existing investors. But they are having chats with the existing private investors in Slack to see what their interest is in selling, and they’re having chats with potential public investors to see what their interest is in buying, and at what price, and those chats are all being relayed to the designated market maker, who will … just take binding bids and offers for the stock and set a price that clears the market? That last part seems pretty mechanical, which makes it not entirely clear why you need the first part, but I guess it is hard to let go of the IPO process entirely.
At any rate, there seems to be no shortage right now of “unicorn IPOs” – in one form or another. Yesterday, The We Company (otherwise known as “WeWork”) announced that it’s confidentially submitted an amended draft Form S-1. The WSJ reported that the filing was made without the assistance of bankers, but that doesn’t mean they won’t be hired eventually. If you’re a cynic, you’re not alone…
More on “Regulation G: Coming to a CD&A Near You?”
A couple weeks ago, John blogged that SEC Commissioner Rob Jackson wants the SEC to require explanations & reconciliations when non-GAAP numbers are used in the CD&A. Yesterday, the Council of Institutional Investors announced that it agrees with that suggestion – and it’s filed this petition with the SEC to recommend rule changes. Specifically, the petition requests that the SEC:
1. Amend Item 402(b) of Reg S-K to eliminate Instruction 5 (which says that disclosure of target levels that are non-GAAP financial measures won’t be subject to Reg G and Item 10(e))
2. Revise the Non-GAAP CDIs to provide that all non-GAAP financial measures presented in the CD&A are subject to Reg G and Item 10(e) – and that the required reconciliation must be included within the proxy statement or through a link in the CD&A
CII says it isn’t seeking a ban on using non-GAAP measures in compensation plans. However, it says that its members are concerned about the complexity in executive pay structures – and the challenges in understanding the link between pay & performance.
Lease Accounting: Compliance Still Costing a Pretty Penny
Late last year, “Accounting Today” reported that companies expected to spend $1-5 million to implement the new lease accounting standard, ASC 842. And a recent Deloitte poll is showing that, for many companies, compliance efforts will continue to require time & money for the rest of this year. Here’s the intro from Deloitte’s press release:
Nearly half of public company executives see no slowdown ahead in the time and effort to be spent on compliance with the new lease accounting standards issued by the Financial Accounting Standards Board and the International Accounting Standards Board, according to a new Deloitte poll conducted in February 2019. In fact, after they file Q1 2019 earnings, one-quarter (25 percent) expect to spend the same amount of time and effort on lease implementation related activities and nearly as many (23.9 percent) plan to spend more.
It’s no wonder that people are working so hard to get implementation right – Audit Analytics predicts that the standard will have a material balance sheet impact on 80% of companies.
It’s no secret that a small group of giant institutional investors exercise significant voting control over almost all large companies. One suggestion that’s been floated to “re-democratize” the proxy process – including in this research paper and in this WSJ op-ed from Vanguard’s founder John Bogle – is for funds to give up some voting power.
Last week, Vanguard announced that it’s doing just that. Starting later this year, the external firms who make investment decisions for 27 Vanguard funds – representing about 9% of its total assets – will also be making voting decisions for those funds. The practical takeaway is that you’ll now need to look more closely at which Vanguard funds own your shares – and you may need to familiarize yourself with the voting policies of these 25 firms. This WSJ article discusses the background & impact of the change:
Wellington Management Co., a Boston firm that serves as Vanguard’s biggest external manager, will gain the most voting power from the shift. Wellington oversees roughly $230 billion of the roughly $470 billion affected by the move. Twenty-four other outside firms control votes on the remaining amount.
“We are passing the baton to give active managers direct control over voting the shares of companies in which they invest,” said Glenn Booraem, who heads investment stewardship at Vanguard. “It’s to integrate their voting and engagement processes with their investment decisions.”
Wellington, in a rare public rebuke this year, said it opposed Bristol-Myers Squibb Co.’s deal to buy Celgene Corp. Wellington, however, wasn’t able to cast votes for all shares it managed. Vanguard retained control over a chunk of votes. Wellington had voting control over roughly 28 million shares of its some 126 million shares earlier this year. Shareholders ultimately approved the Bristol-Myers deal. Vanguard voted most of its shares in favor of the deal, said a person familiar with the matter.
The first Vanguard fund where an outside active manager has the power to vote shares will be launched in late May to early June. The fund will target companies with strong environmental, social and governance practices, and Wellington will manage it.
CEO Succession: Trends
Recently, Spencer Stuart released its annual report on CEO transitions in the S&P 500. Here’s the key takeaways:
– In 2018, the number of CEO transitions fell slightly, to 55 from 59 in 2017
– 69% of CEOs retired or stepped down; 22% of CEOs resigned under pressure, 5% left for health reasons, 2% left as a result of a company acquisition/merger and another 2% for other reasons
– 73% of new CEOs were promoted from inside the company, compared to 69% in 2017 and 90% in 2016
– Of the 12% of CEOs to resign under pressure, only 42% of candidates who took the role were internal promotions
– 1 of the 55 new CEOs is a woman and 20% had prior public company CEO experience
– 15% of new CEOs were also named board chair, compared to 7% in 2017 – and 35% of outgoing CEOs stayed on to serve as board chair, compared to 51% in 2017
CEO Succession: Why Boards (Not CEOs) Should Own the Process
CEO succession is a collaborative process involving the board, CEO, senior management and outside advisors. Although the CEO should be a productive partner in the process, the board – not the CEO – should drive the process, and clearly define and manage all participants’ roles& expectations.
This WSJ article gives a bunch of reasons why that’s the case. Here’s an excerpt (also see this Korn Ferry memo about the benefits of continuous “CEO progression” planning):
CEOs might not have the right perspective to evaluate successors. At the end of a long career, many CEOs are concerned about their legacy. This can bias them toward favoring candidates who will guide the company in the same direction—and in the same manner—that they themselves led it. Research bears this out: When powerful CEOs play a role in the succession process, they steer the choice toward someone with similar characteristics to themselves. However, the future is rarely like the past, and if the company’s success going forward requires a change in strategy or a different mix of skills, duplicating the old CEO—even a very successful one—can be a costly mistake.
CEOs can also distort the process through their behavior. Because they generally control top talent development in their companies, they control the flow of information that the board receives about how internal candidates are progressing, as well as shaping the board’s assessment of that information. In addition, they control access—the opportunity for directors to meet face-to-face with the people they will be evaluating. Subtle actions can serve to block a disfavored candidate or promote a favored one, biasing the board’s understanding of the candidates’ strengths and weaknesses, skewing the evaluation process, and ultimately leading to the incorrect choice.
Broc recently blogged about SEC Commissioner Robert Jackson’s concerns that insiders were using buybacks as an opportunity to cash out. Well, it turns out that they aren’t alone – buybacks are providing a frightening amount of the overall demand for corporate equities. This excerpt from a recent Bloomberg article on the effects of a ban on corporate buybacks just blew me away:
With political scrutiny of stock buybacks growing, Goldman Sachs started assessing an extreme scenario: “a world without buybacks.” The picture doesn’t look pretty. That’s because corporate demand has far exceeded that from all other investors combined, according to strategists led by David Kostin. Since 2010, net buybacks averaged $420 billion annually, while buying from households, mutual funds, pension funds and foreign investors was less than $10 billion for each, Federal Reserve data compiled by Goldman showed.
The article says that corporate repurchases represent the “largest source of U.S. equity demand,” and says that because other potential buyers are pretty saturated with equity investments, they’re unlikely to step in if companies pull back. According to Goldman, “aggregate equity allocation totals 44% across households, mutual funds, pension funds and foreign investors — and that ranks in the 86th percentile relative to the past 30 years.”
So, on the one hand, if buybacks stop, the market will lose its largest source of demand for equities, which is really bad news. But on the other hand, the market’s dependence on buybacks to provide demand cannot possibly be healthy – or sustainable – over the long term. And that may be even worse news.
According to this recent WSJ article, shareholders continue to gain clout in public companies, and the latest sign of that is increasing support for ESG shareholder proposals. Here’s an excerpt:
The median level of support for environmental and social shareholder proposals as a percentage of votes cast rose from the middle single digits from 2000 until 2008 to 24% in 2018, representing record levels of support, according to proxy-advisory firm Institutional Shareholder Services Inc.
But the real measure of success is the record 48% of proposals characterized as social or environmental that were filed and then withdrawn in 2018, according to ISS. That’s up from an average of 38% over the prior seven years. Such proposals are often withdrawn after a company accedes to at least some of the shareholder demands.
That’s all interesting, but to me, the best example of how much things have changed when it comes to shareholder clout is another WSJ piece from an earlier time that’s referenced in the article. That 1996 piece describes the response of ever-combative former Cypress Semiconductor CEO T.J. Rodgers to a letter from Sister Doris Gormley pressing for women to be represented on the company’s board.
While Rodgers’ letter was praised by some at the time as a strike against “political correctness,” today it reads as both condescending & more than a little misogynistic. For instance, can you imagine a CEO today responding to a shareholder seeking board gender diversity by saying that only a person with an advanced technical degree or CEO experience was qualified – and that few women or minorities “fit the bill?”
Fast Act Rules: Informal Staff Guidance on Expanded Hyperlinking Requirement
As part of the new Fast Act disclosure simplification rules, companies will be required to hyperlink to information incorporated by reference into a registration statement or report if the information is publicly available on EDGAR “at the time the registration statement or form is filed.”
This recent blog from Bass Berry’s Jay Knight discusses some informal Staff guidance on how this new requirement applies to information incorporated by reference from one item to another within the same filing. Here’s an excerpt:
The SEC staff has provided informal interpretive guidance that they believe it is reasonable for registrants to interpret the phrase “at the time the registration statement or form is filed” to mean that such information would need to be on EDGAR prior to the time the registration statement or form is filed.
In other words, an active hyperlink would not be required by the new rules if such hyperlink would be to information within the same filing. The SEC Staff noted that companies are permitted, if technically feasible, to include such hyperlinks to information within the same filing, but that they do not view the rule as requiring this.
I know that Delaware’s Chief Justice Leo Strine is the kind of guy who could make his breakfast order sound provocative, but you’ve really got to check out his recent interview with “Directors & Boards.” The Chief Justice has all sorts of interesting things to say about the role of independent directors – including suggesting that perhaps we’d be better off with a few less of them. Here’s an excerpt:
We have a lot of unrealistic expectations for independent directors, and I think it would be better to rebalance boards a little bit. We need folks who are genuinely independent directors, but we also need directors with expertise, and we need directors who were active in business and who understand the industry. And some of the rules and incentives can get so tight that we actually discourage people with the right kind of qualities from serving on boards.
It doesn’t really matter if you’re independent if you don’t have expertise. But can you be independent and also have the expertise and the knowledge? I’m sure you can. We just independent director-ized the world. We went from having a bare majority of them to having a supermajority of them. We don’t actually empower them. We take away their ability to think long term because we put in place Say on Pay. We don’t do Say on Pay every four years or five years, where you would really have a long-term pay plan, we do it every year as a vote on generalized outrage.
Corporate management and employees are the most important thing to corporate success, especially employees — who, frankly, boards of directors, managers and institutional investors have undervalued for 30 years — which is part of why there are the tensions we have in society right now.
It’s refreshing to hear somebody with influence in the corporate governance debate finally say something like this. As I’ve blogged previously, my guess is that in 50 years people may really wonder why we thought it was a good idea to demand that the boards of the world’s largest corporations be comprised overwhelmingly of people with no ties to or experience with the company. Who knows? Maybe Chief Justice Strine’s remarks are a signal that we won’t have to wait 50 years for people to start asking that question.
Insider Trading: Another Lawyer in the Cross-Hairs
Earlier this year, I blogged about the SEC’s insider trading enforcement action against a former Apple lawyer who exploited his access to the company’s draft earnings releases. The SEC recently brought another proceeding against an in-house lawyer for SeaWorld who allegedly engaged in similar conduct. Here’s an excerpt from the SEC’s press release announcing the action:
The SEC alleges that Paul B. Powers had early access to key revenue information as the company’s associate general counsel and assistant secretary, and he purchased 18,000 shares of SeaWorld stock the day after he received a confidential draft of the 2018 second quarter earnings release that detailed a strong financial performance by the company after a lengthy period of decline. According to the SEC’s complaint, Powers immediately sold his SeaWorld shares for approximately $65,000 in illicit profits after the company announced its positive earnings and the company’s stock price increased by 17 percent.
“As alleged in our complaint, Powers blatantly exploited his access to nonpublic information by misusing SeaWorld’s confidential revenue data to enrich himself,” said Kurt Gottschall, Director of the SEC’s Denver Regional Office. “Investors should feel confident in the integrity of corporate officers, particularly attorneys. The SEC is committed to swiftly pursuing insiders who breach their duties to investors.”
According to the SEC, the defendant consented to a permanent injunction and disgorgement in an amount to be determined by the court. As seems to be almost standard operating procedure in these cases, parallel criminal proceedings were also filed. Sigh. Don’t insider trade.
Insider trading cases involving corporate officials who trade ahead of good or bad news are like shooting fish in a barrel for the SEC. Whenever I read about one, I’m reminded of the story of a buddy of mine, who while he was in college at Georgetown got good & liquored up one night and decided to jump into the Tidal Basin with a few equally inebriated cohorts. Upon pulling himself out of the water, he found himself at the feet of a very large & completely unamused member of the National Park Police. The officer looked down at my friend, shook his head, and inquired – “How stupid can you be?”
Tesla Tweets: Will The D&O Carriers Ultimately Rein in Elon Musk?
This recent article from MarketWatch’s Francine McKenna tries to answer the question: “how do you handle a problem like Elon?” Several notables weighed in with their views, but the response that I found most intriguing came from Betsy Atkins, a Wynn Resorts director:
Atkins believes that market forces will cause the correction needed before any regulatory sanction, even a bigger fine for Musk, does. “If I were on that board, I would be very concerned and want the company to buy additional liability insurance for directors,” Atkins told MarketWatch. “Plaintiffs attorneys are already circling and at some point the current directors and officers insurance carrier may become fatigued and potentially unwilling to immunize the board from the public and private litigation.”
It’s a truism that there’s always somebody out there who will provide some kind of D&O insurance if you’re willing to pay enough for it – but whether that price is something that an increasingly independent Tesla board would be willing to stomach in order to allow Elon Musk to keep on tweeting is another issue.
I’ve always been very skeptical about whether most institutional investors really care about “corporate governance” when it comes to decisions to part with their investment dollars – and the continued willingness of non-index funds to buy into IPOs for dual class companies is a big reason for that skepticism. But this article from TheStreet.com suggests that institutional investors may finally be pushing back:
Much has been written about the advantages and pitfalls of the multi-class system, which grants founders who own relatively small stakes in the company disproportionate control of votes. On one hand, founders can drive growth unencumbered by squabbling activists; on the other, it can be extremely difficult to remove founders who underperform.
In the case of Uber, it took the dramatic ouster of founder and ex-CEO Travis Kalanick by the company’s board in August 2017 to ditch the dual-class structure it favored in its earlier days. Once the founder-knows-best mentality collides with institutional money, companies are increasingly facing pushback from institutional investors or would-be activists whose authority to push for changes is kneecapped.
Once dual-class stocks are traded publicly, unicorns can find themselves “instantly unpopular” among those constituencies, said Wei Jiang, a Chazen Senior Scholar at Columbia Business School. “I certainly think they will need to get used to it,” Jiang said of the growing pushback, some of which was codified in a 2018 letter co-signed by Blackrock, pension plans and other long-term investors, which condemned the dual-class model as poor corporate governance.
So, that’s it? Dual class companies will be “unpopular” & won’t be able to sit at the cool kids table during lunch at investor conferences? If that’s the sanction, my guess is that most of these companies will tough it out & see how much more popular they become if they beat their growth forecasts. (Spoiler alert: they will become very popular).
Do you know what makes me dubious about claims that dual class companies are “increasingly facing pushback” from institutions? TheStreet.com wrote the exact same story a year and a half ago. And yet, here we are. . .
Activism: A Watershed Moment for Active Fund Managers?
According to this Barron’s article, active fund managers are becoming. . . well. . . more “active” – and Wellington Management’s recent decision to publicly oppose Bristol-Myers Squibb’s acquisition of Celgene may represent a watershed moment for them:
In the past, fund managers simply sold a stock if they didn’t like what a company was doing. Today, more and more are nudging companies whose shares are trading far less than they should be to make changes that will close the valuation gap. Why ghost a company when you can help it become the investment you need it to be? These new voices are being heard: Whether they shout or they whisper, the market listens.
Consider Wellington Management, the venerated, press-shy $1 trillion firm that, for the first time ever, has publicly opposed management. In late February, Wellington, which runs $359 billion for Vanguard, announced it would oppose Bristol-Myers Squibb ’s plan to acquire Celgene. Celgene shares fell 8% in a matter of hours. Wellington’s protest coincided with a behind-the-scenes critique by Dodge & Cox, another old-school money-management firm with $300 billion in assets. In every story about the Celgene deal, Dodge & Cox was described as a detractor.
“If I were asked to rank the most important moments of this era and name the one event that figures to have the most lasting impact, I would save the top spot for Wellington and its decision to become a public shareholder activist,” says Don Bilson, head of event-driven research at Gordon Haskett. “Corporate America had better take note, because the folks who actually pick stocks have finally decided to flex their muscles.”
I’m a lot less skeptical about institutions speaking up when it comes to opposing deals they don’t like than putting their money where their mouths are when it comes to dual class structures. As I’ve previously blogged over on DealLawyers.com, there’s some pretty good evidence that this kind of buy-side M&A activism pays tangible dividends for investors.
Wells Fargo Annual Meeting: “That Went Well . . .”
According to this Dallas Morning News report, it sounds like yesterday’s Wells Fargo annual meeting was kind of a train wreck. Here’s an excerpt:
C. Allen Parker was interrupted more than a dozen times during Wells Fargo & Co.’s annual meeting by activists who called executives “frauds” and “criminals” and demanded the interim chief executive officer turn the scandal-plagued bank around. “Frauds, all of you,” one heckler shouted as Parker tried to deliver his opening remarks in Dallas on Tuesday. “Wells Fargo, you cannot be trusted,” yelled another.
In what will likely turn out to be 2019’s least sincere CEO statement, Parker responded to the heckling by saying, “One of the wonderful things about shareholder democracy in this country is that we have meetings like this. . .”
In the “all’s well that ends well” department, Wells Fargo announced that the board was reelected, say-on-pay was approved & a new comp plan passed.
There’s no love lost for corporate CEOs on Capitol Hill these days – particularly among Democratic lawmakers. Here’s a case in point – Sen. Elizabeth Warren (D – Mass.) has introduced “The Corporate Executive Accountability Act,” which would impose criminal liability on any executive officer who negligently permits or fails to prevent a violation of law by their company. Yup, she said “negligently.” Here’s an excerpt from this Cleary Gottlieb blog:
If enacted, the bill would constitute a dramatic departure from the typical requirements for a criminal conviction. Traditionally, crimes require both a wrongful action and a particular mental state—the mens rea, or guilty mind. The required mental state is usually (at a minimum) knowledge with respect to the actions that constitute the crime.
The Supreme Court has observed that “[t]he contention that an injury can amount to a crime only when inflicted by intention . . . is as universal and persistent in mature systems of law as belief in freedom of the human will and a consequent ability and duty of the normal individual to choose between good and evil.” Negligence—which is the mental state required for conviction under the Corporate Executive Accountability Act—is a much lower threshold, requiring only that a person act unreasonably, and is usually reserved for the context of civil liability.
The blog notes that there’s precedent for imposing criminal liability on executives who aren’t directly involved in or aware of wrongdoing – the “Responsible Corporate Officer Doctrine” has made that possible under a handful of federal statutes. The blog points out that this doctrine has been applied narrowly to offenses against public health & welfare.
In contrast, Sen. Warren’s proposed legislation – which could not conceivably have anything to do with the fact that she’s running for president – would expand the doctrine’s reach to any crime committed by a company with at least $1 billion in revenue, “regardless of whether the crime affects the public health or welfare or impacts the general public at all.”
China IPO Pig Outs: Credit Where It’s Due
Last fall, I blogged about the new standard in management pig-outs being set by Chinese tech IPOs – apparently, several newly public companies were giving their CEOs $1+ billion bonuses for their role in taking the companies public.
According to this recent article from The Guardian, one of the recipients of that corporate largesse – Xiaomi founder & CEO Lei Jun – has opted to give his bonus to charity. At a measly £750 million, it doesn’t even amount to $1 billion at current exchange rates, but it’s the thought that counts.
Inside the SEC’s Investor Advisory Committee
If you’re looking for insight into the role that the SEC’s Investor Advisory Committee plays in the agency’s regulatory initiatives, check out this recent “Dimensions” interview of IAC member & UVA law professor Paul Mahoney. Here’s what Prof. Mahoney says about why you should keep an eye on IAC findings & recommendations:
The statute mandates that the SEC review any findings or recommendations that the IAC brings it. Moreover, the SEC must respond publicly to those findings and recommendations and disclose what action, if any, it intends to take in response. So, of course, securities lawyers and financial-reporting professionals should want to know what the IAC is doing because we have, at a minimum, the power to draw the SEC’s attention to an issue.
Beyond that, the IAC has a statutorily mandated consultative role in the SEC’s ongoing work to modernize and simplify the ongoing disclosure requirements for public companies under Regulations S-K and S-X, which the SEC calls the Disclosure Effectiveness Project.
As we’ve previously blogged, much of the clamor for proxy advisor regulation on the part of “main street” investors has been coming from the “Main Street Investors Coalition” – an organization that is essentially a sock puppet for the U.S. Chamber of Commerce & the National Association of Manufacturers.
It looks like we may finally have some data on what real retail investors actually think. That’s because Spectrem Group recently surveyed over 5,000 retail investors to get their views on proxy advisors. And guess what? If you buy into the survey’s results – which not everybody does – it appears that the sock puppet may have had its finger on the pulse of retail investors all along. Here’s an excerpt from the intro:
The results of an extensive survey of 5,159 retail investors points to a growing disconnect between the expectations of those everyday investors and the increasing influence of proxy advisors, companies that provide voting services to the investment firms managing retail investor money. The survey presented here directly asks retail investors about issues raised in the debate over proxy advisory firms, revealing retail investors’ level of concern with fundamental flaws in the proxy advisor industry, including, but not limited to, conflicts of interest, robo-voting and insufficient transparency.
The increased focus of fund managers and proxy advisors on political and social activism, rather than maximizing returns, is out of sync with the expectations of ordinary investors. This practice has the potential to negatively impact returns for all retail investors by increasing the burden on public companies with no clear link to shareholder value. The absence of the inclusion of retail investors in the proxy process – as demonstrated by the participation levels and their inability to influence institutional shareholder voting – means that the voice of retail investors, who own 30 percent of public corporations in the United States, is being drowned out.
In terms of specific issues, 36% of investors cited conflicts of interest as their top concern with proxy advisors, 23% named lack of transparency & 20% identified errors in proxy advisor reports. Enabling robo-voting was named as the top concern by only 13% of investors – but 40% ranked it in their top 3.
Reminder: Your 10-Q Needs a Statement of Changes in Shareholders’ Equity!
Since a lot of companies are closing the books on Q1 of 2019, here’s a timely reminder from this SEC Institute blog on a new requirement for your Form 10-Q:
As a quick reminder for first quarter-end, the SEC’s Disclosure Update and Simplification Rule last fall added a requirement to the Form 10-Q to include a statement of changes in stockholders’ equity. This requirement was added via this addition to Article 10-01(a) of Regulation S-X:
(7) Provide the information required by §210.3-04 for the current and comparative year-to-date periods, with subtotals for each interim period.
Article 3.04 referred to in the paragraph above is the requirement to provide a statement of changes in stockholders’ equity.
When the disclosure simplification changes went into effect last fall, the Staff issued Exchange Act Forms CDI 105.09 indicating that companies wouldn’t be required to provide this disclosure in their 10-Qs for the 3rd quarter, but that the disclosure would be required in subsequent 10-Q filings – and for most companies, that means the upcoming Q1 filing.
Transcript: “Activist Profiles & Playbooks”
We have posted the transcript for the recent DealLawyers.com webcast: “Activist Profiles & Playbooks.”
The White House on Thursday moved to curb the power of federal regulators by directing them to submit nonbinding guidance documents to the budget office for review, a step that could slow down the enactment of any rule with a potentially large impact on the economy. A memo from acting Office of Management and Budget Director Russell Vought would vastly broaden Congress’s ability to reject such guidance, subjecting the documents to the same scrutiny as regulations that carry the force of law.
The move is the latest salvo in a war waged by corporations and their Republican allies in government against what they view as backdoor rulemaking: agencies issuing regulatory documents that don’t go through the formal notice-and-comment process but can still be used as a cudgel against certain behavior.
The memo will have a potentially sweeping impact on agencies throughout the government including independent regulators like the Federal Reserve and the SEC. It calls on the agencies to regularly notify the Office of Information and Regulatory Affairs of upcoming guidance, along with determinations of whether it qualifies as “major” — the threshold for notifying Congress under the Congressional Review Act. Any guidance document deemed major by OIRA would need to be sent to Congress, which would then have the ability to strike it down under the review act, a law that gives lawmakers a short window to roll back a rule.
Compliance professionals should be very wary of what the Trump White House is trying to do here. In theory, restrained rulemaking is a reasonable idea — but time and again, we’ve seen this president and his sycophants in the White House playing with forces they’re too ignorant to use, bollixing up life for the rest of us.
For example, compliance officers of a certain age can remember the summer of 2008, and the feverish, improvisational rulemaking banking regulators tried back then to stave off the financial crisis. You’d really want OIRA review in the middle of something like that? You’d want Congress slowing down the process with 60-day approval windows?
In the real world, of course, if another crisis were to come along, you could bet your mortgage payment that the Trump Administration and Congress would grant some emergency stay of OIRA review, so regulators could move more quickly — and be left as the scapegoats, should the crisis explode anyway.
This isn’t the first time the Trump Administration has moved to curtail what it views as “rulemaking by guidance” – in 2017, former AG Jeff Sessions banned the DOJ from issuing guidance purporting to “create rights or obligations binding on persons or entities outside the Executive Branch.”
ESG: Trump Executive Order May Signal ERISA Fiduciaries to Watch Their Step
Last week was a big week for corporate America. In addition to the OMB memo, President Trump issued an executive order that contains a section directing the Secretary of Labor to “complete a review of available data filed with the Department of Labor by retirement plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) in order to identify whether there are discernible trends with respect to such plans’ investments in the energy sector.”
That sounds innocuous enough, but this Davis Polk blog suggests that something more significant may be afoot:
While the section does not directly address environmental, social and governance (ESG) disclosure, it restates the definition of materiality from the U.S. Supreme Court case, TSC Industries, Inc. v. Northway, Inc., and reiterates a company’s fiduciary duties to its shareholders to strive to maximize shareholder return, consistent with the long-term growth of the company.
This order comes on the heels of last week’s U.S. Senate Committee on Banking, Housing, and Urban Affairs hearing on ESG Principles in Investing and the Role of Asset Managers, Proxy Advisors and Other Intermediaries, as well as ongoing activity at the U.S. Securities and Exchange Commission level, with certain institutional investors agitating for additional ESG disclosure requirements.
The blog says that while the order is silent about how the study might be used, it may well serve as the starting point for a crackdown on plan fiduciaries’ ESG activism. One “obvious use” of the study’s results could be to enforce the DOL’s April 2018 guidance prohibiting plan fiduciaries from focusing on ESG factors “solely to benefit the greater societal good.”
SEC Staff Guidance: A “Secret Garden” of Private Law?
You know who else has some issues with regulatory guidance? SEC Commissioner Hester Peirce. In a recent speech, Commissioner Peirce expressed concern about the extent to which the SEC Staff provides non-public guidance about unresolved regulatory questions. Here’s an excerpt:
Some requests for clarification or guidance are inappropriate for handling through a time-consuming process that results in a published response. Indeed, as a Commissioner, I hope that the staff is engaging productively and responsively with market participants. I would not want to see this engagement become so burdensome to either staff or market participants that it discourages people from seeking informal guidance or the staff from providing it.
However, when staff provides non-public guidance, Professor Davis’s concerns become much more pronounced, and I believe that there is a line that can be crossed where non-public staff guidance goes from being merely helpful “l-o-r-e” lore to something that is more akin to secret law that, for all practical purposes, binds at least some (though perhaps not all) market participants without any opportunity for review or appeal.
Commissioner Pierce suggests that private interactions between the Staff and private parties in certain areas have created a “secret garden” of guidance that raises questions of fairness & transparency. Peirce isn’t suggesting eliminating the practice of providing private guidance, but does see a need to “take down the walls of the secret gardens at the SEC, or at least to make doorways into these gardens, so that the public can get a glimpse inside, assess the quality of what is growing within, and hold us accountable for what is found there.”
Yesterday, Corp Fin announced a streamlined procedure for extending previously granted confidential treatment orders covering information in material contracts. The announcement notes that, when it comes to extensions, simply filing the redacted exhibit as contemplated by the new Fast Act rules will not provide confidential treatment for information in the previously filed CTR. This excerpt from the announcement summarizes the new procedure:
We have developed a short form application to facilitate and streamline the process of filing an application to extend the time for which confidential treatment has been granted. It is a one-page document by which the applicant can affirm that the most recently considered application continues to be true, complete and accurate regarding the information for which the applicant continues to seek confidential treatment. With that affirmation, the applicant indicates its request that the Division extend the time period for confidential treatment for an additional three, five or 10 years and provides a brief explanation to support the request.
Companies don’t have to refile the unredacted contract with the extension request, and if the supporting analysis remains the same as presented in the most recent CTR, they won’t have to refile that either. If the applicant reduces the redactions, the revised redacted version of the contract must be filed with the short form extension application.
The short form application may only be used if the contract has already been the subject of an order granting a CTR, and it can’t be used to add new exhibits to the application or make additional redactions. For a deeper dive into the new process, check out this Cydney Posner blog. We’ve also updated our “Checklist on Confidential Treatment Requests” to reflect this new procedure.
Cybersecurity: Beware Cyberinsurance’s War Exclusion
This recent NYT article says that the cyberinsurance policy you pay big bucks for may have a big hole in it – thanks to the standard “war exclusion” contained in most policies. Here’s an excerpt:
Mondelez, owner of dozens of well-known food brands like Cadbury chocolate and Philadelphia cream cheese, was one of the hundreds of companies struck by the so-called NotPetya cyberstrike in 2017. Laptops froze suddenly as Mondelez employees worked at their desks. Email was unavailable, as was access to files on the corporate network. Logistics software that orchestrates deliveries and tracks invoices crashed.
Even with teams working around the clock, it was weeks before Mondelez recovered. Once the lost orders were tallied and the computer equipment was replaced, its financial hit was more than $100 million, according to court documents. After the ordeal, executives at the company took some solace in knowing that insurance would he lp cover the costs. Or so they thought.
Mondelez’s insurer, Zurich Insurance, said it would not be sending a reimbursement check. It cited a common, but rarely used, clause in insurance contracts: the “war exclusion,” which protects insurers from being saddled with costs related to damage from war.
The U.S. government said that Russia was responsible for the cyberattack, which made Mondelez & other companies “collateral damage in a cyberwar” & gave insurers an opening to deny coverage under the war exclusion. Mondelez & Merck, which was also denied coverage, sued their insurers & the issue is working its way through the courts. The stakes are high – given the prevalence of state-sponsorship when it comes to big cyberattacks, the article suggests that the outcome could go a long way to determining whether cyberinsurance is worthless.
ICOs: Reg D Remains the Preferred Route
I blogged last year about a MarketWatch article highlighting coin offerings’ increased reliance on Regulation D following the Staff’s 2017 guidance on coin offerings. This recent MarketWatch article says that while the volume of coin offerings is down, Reg D still seems to be the preferred route. Here’s an excerpt addressing the number of Form D filings for token deals:
MarketWatch counted 33 ICO-related fundraisings accepted by the SEC in the first quarter of 2019, with a total stated value of $1.9 billion. That is down from a peak of 99 in the second quarter of 2018. MarketWatch estimated there were 287 ICO-related fundraisings accepted by the SEC with a total stated value of $8.7 billion in 2018. That was a significant increase from 44 fundraisings filed with a total stated value of $2.1 billion in 2017.
Now that I’ve seen both Lyft’s prospectus & Uber’s recent filing, I’ve reached the conclusion that we here at TheCorporateCounsel.net need our own mission statement. Here’s what I’ve come up with: “Our mission is to end global warming, poverty & tooth decay by publishing online and print resources for corporate and capital markets lawyers.”
Does that mission statement seem a bit unrealistic given the nature of our business? Well, I think ours is arguably more tightly tethered to reality than what either of these two high profile tech companies cab dispatchers are peddling.
Lyft says its mission is to “Improve people’s lives with the world’s best transportation,” while Uber says that “our mission is to ignite opportunity by setting the world in motion.” Both companies extensively embellish on their mission statements, with Lyft contending that it is at the forefront of a “massive societal change,” while Uber counters with a statement that it “believes deeply” in its “bold mission” and has a “massive market opportunity.”
This is heady stuff for companies with core businesses based on an app that does what Danny DeVito did in the ’80s sitcom “Taxi” & whose financials suggest that they spend a lot of time shoveling money into a furnace. Although to be fair, Uber will also deliver your Pad Thai order, and it’s . . .you know. . . sorry about the other stuff.
These messianic mission statements & the puffery that accompanies them have become a cliché in tech deals. But it seems to me that they do little to aid investors and a lot to obfuscate what companies actually do. The whole approach reminds me of nothing so much as “The Great & Powerful Oz” exhorting Dorothy to “pay no attention to the man behind the curtain” – only what’s frequently behind the curtain in tech deals is an endless string of huge losses, and a path to future profitability that is far from certain.
By the way, there’s plenty of disclosure about what’s behind the curtain in these prospectuses, if you take a moment to look for it. For instance, Uber accompanies its announcement of the new millennium with a 46-page “Risk Factors” section, while Lyft’s “Risk Factors” section is 41 pages long. So investors who get carried away with the hype have only themselves to blame. Read the prospectus.
Regulation G: Coming to a CD&A Near You?
SEC Commissioner Robert Jackson recently co-authored a WSJ opinion piece calling for increased transparency about the use of non-GAAP numbers in setting executive pay. The article notes that Reg G generally requires companies to provide comparable GAAP information & a reconciliation, but acknowledges that this doesn’t apply to the CD&A discussion. The authors think it should:
Unfortunately, those requirements do not apply to the reports that compensation committees of corporate boards disclose to investors each year. Thus, committees choosing to use adjustments when deciding on payouts need not explain why an adjusted version of earnings is the right way to determine incentive pay for the company’s top managers. This increases the risk that adjustments will be used to justify windfalls to underperforming managers.
The SEC’s disclosure rules have not kept pace with changes in compensation practices, so investors cannot easily distinguish between high pay based on good performance and bloated pay justified by accounting gimmicks. That’s why we’re calling on the SEC to require companies to explain why non-GAAP measures are driving compensation decisions—and quantify any differences between adjusted criteria and GAAP. A few public companies already provide investors with this kind of transparency. Others can too.
Transcript: “The Top Compensation Consultants Speak”
We have posted the transcript for the recent CompensationStandards.com webcast: “The Top Compensation Consultants Speak.”