Monthly Archives: May 2019

May 16, 2019

What Do In-House Lawyers Want From Law Firm CLE?

There are few non-chargeable events that law firms fret about more than their CLE programs for clients & potential clients. Of course, that fretting usually focuses more on the PowerPoint slides than things like actually seeking input from prospective attendees about what they’re looking for and who they would like to see participate in the program.

This recent In-House Focus survey of in-house lawyers concerning their own experiences with law firm CLE provides some interesting perspectives on these topics. For example:

– 70% of survey respondents said CLE programming should feature diverse lawyers, presenters and faculty. But just 30% of respondents agreed that diversity is adequately represented in current CLE content. At the same time, nearly two-thirds of respondents believe that participating in CLE programming is an effective way for law firms to connect diverse lawyers to clients.

– 52% of respondents to IHF’s survey agreed that law firms should do a better job of facilitating introductions of their diverse lawyers to their clients, while just 5% disagreed. Further, 62% believe CLE programming is a good way to cultivate relationships between diverse lawyers and clients.

– 62% of respondents believe law firm CLE is not adequately tailored to in-house lawyers. Additionally, two-thirds agree that CLE content is more tailored to law firm practitioners than in-house lawyers. In fact, another 79% of respondents said they would be more inclined to watch a CLE program that included in-house lawyers as presenters who speak to their issues.

– When asked what are some things that would make CLE more pertinent to in-house lawyers, many responses revolved around the need for real-world examples. Some responses included: “concepts to reduce outside legal expenses,” “when to involve outside counsel and how to engage them,” and “case studies and sample scenarios from current in-house lawyers.”

You should really check out the whole survey. As somebody who has spent his entire career in a law firm environment, I thought it was pretty eye-opening.

Crypto Mom Wants SEC to Wear “Reasonableness Pants”

You may agree or disagree with her remarks, but a speech by SEC Commissioner Hester Peirce – aka “Crypto Mom” – is always bloggable Her recent speech at Rutgers-Camden Law School is no exception. In discussing the SEC’s enforcement program, she makes no bones about her opposition to the enforcement approach favored during the tenure of former Chair Mary Jo White:

Most enforcement recommendations the Commission receives from the staff are legally straightforward and not controversial, but a small subset causes me to ask whether we are wearing our reasonableness pants.

In particular, I am not a fan of the so-called “broken windows” philosophy, a more-is-always-better, punish-the-small-violations approach to enforcement. Instead, I assess, when reviewing an enforcement recommendation from our staff, whether the recommendation is using our enforcement resources wisely. I ask, was there a meaningful violation? Is this a matter that could have been handled by our exam program? Are there other appropriate responses in lieu of an enforcement action, such as a rulemaking, interpretative guidance, or an educational bulletin for investors?

While she devotes much of her discussion to the SEC’s enforcement program, her “reasonableness pants” comments extend to the agency’s approach to rulemaking & interpretive guidance as well:

Lots of people want the SEC to wade into a whole range of issues that are not properly within our purview. Increasingly, we are urged to tell companies how many women to have on their boards, to limit the ways companies and their shareholders may resolve disputes, to direct financial firms to avoid providing capital for certain industries, or to prohibit investors from getting access to certain products we think investors should not have in their portfolios.

We do not have the time, resources, or authority to do these things. We have other things to do that are not headline-grabbers, but are neatly within our core mission.

Issues that should take priority in her view include things like updating transfer agent rules, disclosure modernization, fixed income & equity market structure, and ensuring that companies and investors across the country can participate in the capital markets. Peirce said these issues may not be as “trendy” as those that the SEC is being urged to undertake , but “subsequent generations will look back at us in disgust and wonder why we sacrificed the health of our capital markets for the chance to look cool for a moment.”

Rookies of the Year:  Do New Activist Directors Add Greater Value Than Other Newbies?

According to this recent study, “rookie activist directors” – unseasoned independent directors appointed at the prompting of activists – add greater value to a company than other unseasoned independent directors.  Here’s the abstract:

We examine the value-enhancing role of unseasoned independent directors nominated through shareholder activism events (Activist UIDs). Firms appointing Activist UIDs experience a larger value increase than those appointing Nonactivist UIDs, particularly when Activist UIDs have relevant experience, when they sit on the monitoring committees, and when their sponsors hold large target ownership.

Most of the companies in the study seem to have been small caps, and I think that needs to be taken into account when considering the study’s results. Established activist investors are likely to have access to a deeper and higher quality pool of director candidates than most small caps could find on their own.

John Jenkins

May 15, 2019

SEC Modifies 10-Q & 8-K Cover Pages (Again)

Yesterday, a couple of our sharp-eyed members alerted us to the fact that the SEC tweaked the cover pages of Form 10-Q & Form 8-K yet again over the past few days. The changes were made to bring these forms more closely in alignment with Form 10-K.  Here’s an excerpt from this Gibson Dunn blog with the skinny on the latest changes:

– In the Form 8-K, the table showing the “Title of each class,” “Trading Symbol(s),” and “Name of each exchange on which registered” appears immediately after the checkbox for “Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))”; and

– In the Form 10-Q, the table showing the “Title of each class,” “Trading Symbol(s),” and “Name of each exchange on which registered” appears immediately after the line “(Former name, former address and former fiscal year, if changed since last report).”

Here are the SEC’s updated versions of  Form 10-Q & Form 8-K. You can find the Word version of the Form 10-Q cover page in our “Form 10-Q” Practice Area, and the Word version of the Form 8-K cover page in our “Form 8-K” Practice Area.

Staggered Boards: Investors Still Want Them Gone

Remember waaay back on Monday when I blogged about how staggered boards are now good again? Yeah, well, investors don’t appear inclined to agree.  You don’t have to take my word for it – this Corporate Secretary article says that you can just ask Kellogg’s:

Kellogg Company shareholders have backed a move to introduce annual elections for directors but will have to vote for additional measures if the change is to be implemented – a hurdle they have not overcome at a previous attempt. The vote took place at the Kellogg AGM held late last month in Battle Creek, Michigan. Specifically, the proposal called on the company’s board to reorganize itself into one class with each director subject to election every year.

The hurdle referenced in the article is a clause requiring a charter amendment to remove the staggered board to be approved by 2/3rds of the outstanding shares – and that supermajority vote requirement has thwarted previous attempts to undo these provisions.

Corporate Governance: Wait, Nobody Said Anything About a Test!

For me, the best part of passing the bar examination was the knowledge that I’d never have to take another test again in my life.  That’s why it was disheartening to learn that I just might have to take another one in the highly unlikely event that a public company someday wants to consider adding me to its board.

That’s because this fall, the NACD plans to roll out a voluntary certification program for board members, and it includes a certification exam.  Don’t expect it to be quite as easy as the written exam you took when you got your driver’s license – the test has been designed by a committee whose members include a former Delaware Supreme Court Justice, a former SEC general counsel, & a former head of the FASB.

UCLA’s Prof. Stephen Bainbridge wants to sign up for the exam.  He was a year ahead of me in law school and was an editor of the Law Review.  On the other hand, I was one of those people who will be eternally grateful for UVA’s “B mean” grading policy.  I’m guessing he probably wouldn’t even have to study for it.  Me?  Well, if I ever do have to take it, let’s just say that I hope it’s open book & there’s some kind of prep course.

John Jenkins

May 14, 2019

Proxy Strike Suits: What We’re Hearing About This Year’s Targets

It’s proxy season, which means it’s also proxy strike suit season. We’ve recently heard reports from several members that plaintiffs are targeting disclosures surrounding whether brokers will be permitted to vote on particular proposals & the effect of abstentions and non-votes, as well as disclosures relating to compensation plans being submitted for a shareholder vote.

Here’s what we have learned:

– The plaintiffs’ bar has been sending demand letters to companies alleging inadequate or inaccurate disclosure about the vote required to approve proposals included on the company’s proxy materials, and threatening legal action in the event that corrective disclosure is not provided.

– Similar demand letters have been sent to companies with compensation plans on the ballot, alleging inadequate disclosure under Item 10(a) of Schedule 14A, which relates to general disclosures relating to compensation plans being submitted for shareholder approval.

– These demand letters typically arrive shortly before the scheduled date for the annual meeting, and a number of companies have filed DEFA 14As to reflect revised disclosure relating to these matters.

– Resolution of the issues raised in the demand letters is typically accompanied by a demand for legal fees.

These are not new areas of proxy disclosure for plaintiffs to pursue. Compensation plan disclosures have long been an attractive target, and disclosures about the effect of abstentions & non-votes were the subject of at least one high-profile case in 2014 & a number of demand letters over the last few years. It’s also easy to see why plaintiffs might like to single out disclosures in these areas for potential challenges.

When it comes to broker non-vote disclosures, the application of NYSE Rule 452 is sometimes unclear, and the Exchange’s interpretation of what proposals are “routine” does not always align with what one might expect. On top of that, the impact of broker non-votes on the outcome of any given proposal may depend on state law, charter provisions, and the nature of the proposal itself. In other words, this is complicated stuff – and it’s easy to make a mistake.

Item 10(a) of Schedule 14A seems more straightforward – essentially requiring companies to summarize the material features of the plan and information about the number of participants & how they are selected. But these requirements are also very open-ended, and leave plenty of room for second-guessing disclosure decisions. We’ll have more on this in the next issue of The Corporate Counsel newsletter.

Uber IPO: The Biggest Loser?

Uber’s IPO didn’t exactly have a gangbusters first day of trading.  There have been plenty of IPOs that have had worse openings than Uber’s 7.6% decline from its IPO price, but according to this Gizmodo article, the sheer size of the deal made the dollar losses suffered during Uber’s first day the largest in U.S. history:

According to University of Florida professor Jay Ritter, Uber’s 7.62 percent decline since hitting the NYSE makes it “bigger than first day dollar losses of any prior IPO in the U.S.” In terms of percentage losses, Uber’s dip doesn’t even scratch the surface of the worst IPOs. But the staggering valuation of the company makes it, in raw scale, “among the top 10 IPOs ever” including companies outside the U.S., Ritter told Gizmodo in a phone interview. That single digit decline resulted in an estimated $617 million paper losses.

Oh well, easy come, easy go. To make matters worse, the article points out that this first-day loss comes despite the fact that Uber’s IPO valuation of $76.5 billion represented a significant haircut from the  $90 billion and $120 billion valuation that some analysts placed on the company just a month before the offering.

Direct Listings: A Lot to Like If You’re a Venture Investor

We’ve previously blogged about the willingness of some unicorns to bypass IPOs and pursue direct listings. With Uber & Lyft’s IPOs both landing with a resounding thud, this WSJ article says that there may be a lot to like about this alternative for venture investors. This excerpt quotes Canaan Partners’ Michael Gilroy on why that’s the case:

Mr. Gilroy said one advantage of direct listings is they are cheaper. Companies holding direct listings still hire bankers, but the costs are notably lower than the traditional process. “The fees are far too high for what they’re doing” in an IPO, he said. A direct listing lacks mechanisms like greenshoe options, which allow bankers to buy shares to help keep the price stable—so direct listings risk a large drop in prices when shares first hit public markets. However, because direct listings don’t raise new capital, existing shareholders benefit because their ownership isn’t diluted.

In addition, direct listings eliminate lockup agreements, which restrict the sale of shares by existing holders. That can be attractive for employees and venture capital investors, who can sell shares immediately. With traditional IPOs, they often have to wait several months to sell their holdings. “VCs are not professional public investors,” said Mr. Gilroy. “Six months can be a significant difference in your return profile for the company.”

As Liz blogged last month, Slack’s already on its way to a direct listing – and if the stock pops, that may prompt more high-profile, cash-rich unicorns to consider this alternative.  Regardless of its deal structure, a lot may be riding on how Slack performs out of the gate. If it lays an egg, this Axios Pro Rata newsletter says that unicorns may be yesterday’s news as far as Wall Street’s concerned.

John Jenkins

May 13, 2019

Insider Trading: So That’s What Friends Are For?

One of the worst things about insider trading is how frequently people are apparently willing to betray the trust of their friends and family. It’s just uncanny how often you see situations involving husbands and wives, parents and children, and longtime friends who trade on information provided to them in confidence. The SEC recently announced a settled enforcement action that allegedly involved another example of this kind of conduct.  Here’s an excerpt from the SEC’s press release:

According to the SEC’s complaint, while Brian Fettner was a guest in the home of a longtime friend who was also the general counsel of Cintas Corporation, Fettner surreptiously viewed documents contemplating an acquisition of G&K Services Inc. by Cintas.  Based on that information and without telling his friend, Fettner then purchased G&K Services stock in the brokerage accounts of his ex-wife and a former girlfriend, and persuaded his father and another girlfriend to purchase G&K shares.  The complaint further alleges that after Cintas and G&K announced the merger on Aug. 16, 2016, G&K’s stock price jumped more than 17 percent, resulting in illicit profits from Fettner’s misconduct of more than $250,000.

The defendant consented to a permanent injunction prohibiting him from future violations of Rule 10b-5 and agreed to pay a penalty of approximately $250,000.  Despite the outcome, if you read the complaint, you may wonder at first what separates what this guy did from Barry Switzer’s infamous eavesdropping?  After all, the SEC alleges that Fettner “surreptiously viewed” documents that were left in relatively plain sight in a room that he seems to have entered with his friend’s permission.

As this recent blog from Keith Bishop points out, the difference may lie in the nature of the relationship between the parties. Under the misappropriation theory endorsed by the Supreme Court in U.S. v. O’Hagan, 521 U.S. 642 (1997), a person who misappropriates material nonpublic information from another may violate the law even without a duty to contemporaneous traders. It’s enough that there be some kind of obligation not to use the information – and the existence of  “relationship of trust and confidence” with the source of the information will do the trick.

While Switzer and the person he overheard were merely casual acquaintances, the people involved here were close friends since middle school – and the SEC’s complaint alleged that was sufficient to establish the kind of relationship whose breach could trigger insider trading liability.  And in this excerpt from his blog, Keith says that’s a conclusion you can add to the list of things that don’t make a lot of sense about insider trading law as it exists today:

The SEC’s allegations illustrate how the misappropriation theory of insider trading has become completely unmoored from the purposes of the securities laws.  Congress did not enact Section 10(b) with a view to protecting guest-host relations.  It is absurd that innocence and guilt turns on whether the guest and the host met in middle school or were only recently introduced.

If you stop & think about the implications of misappropriation theory, then maybe it isn’t all that uncanny about how many of these cases involve friends & family – the way the law has evolved, it’s those relationships that give insider trading allegations force.

Staggered Boards: Now They’re a Good Idea Again

A few weeks ago, I read an article that said eggs are bad again.  As you may recall, eggs were good, then they were bad, then they were good, and now they’re bad again.  Forgive me if I thought about the 50 year controversy over eggs when I read this Fortune article reporting on a new study that says staggered boards are a good thing.  Here’s an excerpt on how stocks of companies with staggered boards have performed in recent years:

In recent years, staggered-board companies have wound up outperforming their peers—and significantly at that. For the five years through March, S&P 500 companies that utilized non-annual voting registered an average total return of 125%; for the index as a whole, the figure was 52%.

Honestly, sometimes the teeter-totter of corporate governance trends is harder to keep track of than the “scrambled, fried, poached or ‘OMG! One bite will kill you!'” controversy surrounding the food formerly known as the “incredible, edible egg.”

Tomorrow’s Webcast: “How to Handle a SEC Enforcement Inquiry Now”

Tune in tomorrow for the webcast – “How to Handle a SEC Enforcement Inquiry Now” – to hear to hear King & Spalding’s Dixie Johnson, Jones Day’s Joan McKown and Cooley’s Randall Lee analyze how to handle a SEC enforcement inquiry now.

John Jenkins

May 10, 2019

SEC Proposes Amended “Accelerated Filer” & “Large Accelerated Filer” Definitions

Yesterday, the SEC voted 3-1 – with Commissioner Jackson dissenting – to propose changes to Exchange Act Rule 12b-2’s definitions of “accelerated filer” & “large accelerated filer.” Here’s the 150-page proposing release. This excerpt from the “fact sheet” in the SEC’s press release announcing the proposal summarizes the proposed changes (we’ll be posting memos in our “Accelerated Filers” Practice Area):

The proposed amendments would:

– Exclude from the accelerated and large accelerated filer definitions an issuer that is eligible to be an SRC and had no revenues or annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available

– Increase the transition thresholds for accelerated and large accelerated filers becoming a non-accelerated filer from $50 million to $60 million and for exiting large accelerated filer status from $500 million to $560 million

– Add a revenue test to the transition thresholds for exiting both accelerated and large accelerated filer status

As Liz noted in her blog last week about the SEC’s decision to put these proposals on the agenda for yesterday’s meeting, the SEC didn’t change these definitions last year when it adopted rules increasing the size limit for companies to qualify as “smaller reporting companies” from $75 million to $250 million in public float – and that was a point of contention among some Commissioners.

The rule proposals would allow more companies to file periodic reports on a non-accelerated basis.  But seriously, who cares about that?  What’s likely to generate some fireworks during the comment period is the fact that the proposals would increase the number of companies that won’t have to obtain an auditor’s attestation on management’s report on ICFR.

The two sides of the argument didn’t waste any time lining up – here’s SEC Chair Jay Clayton’s statement in favor of the rule proposals, and here’s Commissioner Jackson’s statement on his dissent from the SEC’s decision to issue them.

Internal Investigations: The Consequences of Government “Outsourcing”

The SDNY attracted quite a bit of attention last week with Judge McMahon’s opinion in United States v. Connolly and Black – a decision indicating that government entanglement in an internal corporate investigation could raise the 5th Amendment concerns if the government tried to use testimony provided in the investigation in a subsequent criminal proceeding.

This Wachtell Lipton memo summarizes the implications of the case for companies using internal investigations as a tool for cooperating with governmental authorities:

The lesson for companies conducting internal investigations is not, of course, to stop cooperating with governmental inquiries. Indeed, the judicial admonitions of the Connolly and Black decision are directed principally at the government itself. The opinion is nonetheless important for companies and their counsel; it plainly suggests that, when designing an internal investigation, care must be taken from the outset to ensure that the company (or, in appropriate cases, the board) directs and supervises the investigation, selecting the witnesses to be interviewed, developing the questions to be asked, and assessing the record.

Yes, as the government has often signaled, companies should provide proactive, constructive cooperation in order to secure maximum credit for their efforts. When done properly, such efforts discharge the company’s fiduciary obligations to act in the best interests of its shareholders and other constituents to achieve the best possible resolution under the circumstances.

But the memo goes on to say that, thanks to the Connolly and Black decision, companies should not be afraid to push back if the government attempts to take control over its own internal investigation, and notes that such pushback is consistent with the DOJ’s own guidance to its prosecutors that the DOJ “will not take any steps to affirmatively direct a company’s internal investigation efforts.”

SEC Settlement Policy:  Another Former Enforcement Target Challenges “Gag Rule” 

Earlier this year, I blogged about The Cato Institute’s lawsuit seeking to have the SEC’s rule mandating that enforcement targets agree to “neither admit nor deny” the allegations against them declared unconstitutional on 1st Amendment grounds.  This recent blog from Steve Quinlivan reports that another individual who settled with the SEC on these terms – former Xerox CFO Barry Romeril – has filed a lawsuit seeking relief from the gag rule.  Here’s an excerpt:

The New Civil Liberties Alliance has filed a Motion for Relief from Judgment with the U.S. District Court for the Southern District of New York on behalf of Barry D. Romeril. Mr. Romeril served as the Chief Financial Officer of the Xerox Corporation from 1993-2001. NCLA has asked the court to remove a gag order placed on Mr. Romeril on June 5, 2003 as part of a Consent Order with the Securities and Exchange Commission (SEC) because it violates the First Amendment of the U.S. Constitution. Despite the passage of nearly 16 years, Mr. Romeril continues to be bound by the gag order provision. You can find the associated Memorandum of Law here.

Like The Cato Institute’s action, the motion in this case contends that the gag rule is a content-based restriction on speech, and an unlawful prior restraint under the 1st Amendment.

John Jenkins

May 9, 2019

Activism: Sometimes It Feels Like Somebody’s Watching Me. . .

Check out this truly wild “Institutional Investor” article about hedge funds’ use of private investigators to dig up dirt on executives of potential targets. Some of the tactics these investigators use definitely push the envelope – but “hokey smoke, Bullwinkle” what they sometimes find!

The article tells one story involving the president of a large U.S. asset manager who was discovered by investigator Peter Barakett to have been arrested twice for art theft. The guy even had one of the stolen paintings hanging in his office. He avoided prison only because the statute had run, but is still managing $2 billion of other people’s money. This excerpt reveals a few other eye-opening discoveries:

Another case involved a Bear Stearns executive whose murder conviction had previously gone undetected because, Barakett suspects, a casual background check either did not look at records in every state he had lived in or checked the wrong name or date of birth. “Our client [an asset manager who was considering hiring the man for an IR position] could not believe it, and we showed him the proof,” he recalls.

Work for activist hedge funds is a particularly revealing task, according to Barakett. “I’m never surprised by what we find,” he says, mentioning a public company executive who had a “wife and kids in one city, and another wife and kids in another city in another — nonadjacent — state.”

The article also makes it pretty clear that hedge funds won’t hesitate to use the information they find as leverage. I guess the takeaway is that when people say certain activist hedge funds take no prisoners, they aren’t kidding around. So, if you’re a public company CEO with any skeletons in your closet, you’ve now got something else to worry about when one of these hedge funds comes knocking. And I’m sure they wouldn’t have it any other way.

ESG: New York Comptroller Releases Decarbonization Panel Report

Okay, I served dessert as the first course this morning – now you’ve got to eat your vegetables. And by that I mean it’s time for a couple of very earnest ESG blogs that may make your eyes glaze over.  That’s ESG’s problem in a nutshell isn’t it?  Some people think that the future of humanity may hinge on what nations & companies do about some of this stuff, but so help me, the nuts & bolts of it are often more boring than C-SPAN.

Anyway, it’s my duty to report that New York’s Comptroller recently released a 38-page report containing the recommendations of the “Decarbonization Advisory Panel” that the Governor convened last year.  The panel was composed of experts from a variety of fields and was tasked with offering strategies for NYS’s Common Retirement Fund to use to identify, assess & manage the investment risks and opportunities of climate change.  The Comptroller issued a press release summarizes the panel’s recommendations, and this excerpt lays out some of the specifics:

– The Fund should establish a new climate solutions investment program and increase its funding of investments with a proactive approach to climate risk and opportunity.

– The Fund should establish minimum standards to measure the readiness of its investments for climate change impacts and the transition to a low-carbon economy. These standards may vary by asset class, sector of the economy or geography, but could be used to construct indices, evaluate managers, direct engagement and define exclusion from the Fund’s portfolio.

The press release also said that the panel did not recommend divestment of specific stocks, but said that setting minimum standards could guide subsequent divestment decisions and provide guidance to help the Fund avoid investment managers with non-sustainable operations and strategies.  The panel recognized that its recommendations would take time to implement, but encouraged the Fund to start working on a plan “with urgency.”

ESG: Not Just for Institutional Investors

ESG issues are usually considered to be priorities for certain institutional investors, but this Corporate Secretary article reviews a recent Allianz survey that says some of those issues move the needle with retail investors too.  Here’s an excerpt:

Respondents were asked to rate the importance of a range of factors when deciding whether to invest in a company. The two highest-rated issues both fall under the ‘social’ section of the ESG umbrella, with 84% of respondents pointing to ‘the impact of [the company’s] product/service on people’s health or well-being’ and 84% pointing to ‘workplace safety/working conditions of employees.’

The next two highest-rated factors are both governance-related. ‘Transparency in business practices and finances’ is cited by 81% of respondents, while ‘wages provided to their employees’ is important to 80% of those taking part. The top two highest-rated environmental issues are ‘natural resource conservation (such as water conservation, species conservation)’ at 76% and ‘[the company’s] carbon footprint/impact on climate change’ (69%).

The article acknowledges that companies face challenges in communicating information about ESG issues to investors. There are no uniform disclosure standards, an assortment of intangible factors to assess & often an avalanche of data to sort through.  It didn’t say anything about the need to tackle the “more boring than C-SPAN” issue though.

John Jenkins

May 8, 2019

Insider Trading: Facebook Directors Tagged in Derivative Suit

This Steve Quinlivan blog summarizes a recent derivative action filed against Facebook’s directors in connection with alleged insider trading involving sales of stock by Facebook’s CEO Mark Zuckerberg, its COO Sheryl Sandberg, and its former director & WhatsApp co-founder Jan Koum.  Here’s an excerpt from the blog addressing the insider trading allegations:

In a wide ranging derivative action, a Facebook shareholder has filed a 193 page complaint in the Delaware Court of Chancery alleging three Facebook directors sold a total of $1.5 billion of stock while in possession of inside information.  Specifically, the complaint alleges that at the time of the stock sales Facebook faced a looming crisis over privacy concerns and that the value of Facebook equity shares did not reflect such “inside information.” According to the complaint, when the directors sold their respective shares of Facebook stock, Facebook had been aware of the activities of Cambridge Analytica and the other misconduct referred to in the complaint.

The complaint also alleges violations of the proxy rules and breaches of fiduciary duty by the board in connection with Facebook’s repurchases of stock during the relevant period.  In addition to 10b-5 claims against the three directors who traded during the relevant period, the complaint also alleges that “The sales of defendants Zuckerberg, Sandberg and Koum’s shares of Facebook common stock while in possession and control of this material adverse non-public information was a breach of their fiduciary duties of loyalty and good faith.”

Bringing fiduciary duty claims based on insider trading may seem somewhat incongruous given the pervasiveness of federal law in this area, but Delaware has recognized these so-called “Brophy claims” ever since the Delaware Supreme Court’s 1949 decision in Brophy v. Cities Service.

After a long period of relative dormancy, Brophy claims have become increasingly popular among plaintiffs in recent years.  Part of the reason for that is a 2011 Delaware Supreme Court decision holding that disgorgement of all gains from insider trading is a potential remedy for the breach of fiduciary duty.  But as this 2014 Business Law Today article suggests, there’s more to its increasing popularity than that:

The incentives of stockholder plaintiffs and their counsel to bring Brophy claims would seem to have increased with the confirmation that disgorgement of all gain by the alleged wrongdoer is a potential measure of damages. And, not only are the potential awards higher, but in certain circumstances, successfully pleading a Brophy claim will be less of a burden than a federal securities claim which is subject to the heightened pleading standards imposed by PSLRA.

Like other derivative claims, Brophy claims are generally subject to the heightened standard of pleading demand futility. But when it comes to the demand futility requirement, one of the interesting aspects of the Facebook complaint is that the plaintiffs allege that they made a demand on Facebook’s board – and received no response to that demand letter during the more than 10 months preceding the filing of the complaint.

IPOs: Founder’s Letters Get Some Love

If you’ve read my recent blog on Uber’s IPO, you know that I’m not a fan of founder’s letters in IPO prospectuses. I think they’re one of the many tech IPO clichés that investors could do without. But others hold them in much higher esteem than I do. This recent Olshan blog mounts a spirited defense of the founder’s letter & also reviews how the SEC looks at them during the comment process:

Based on our review of publicly available SEC comments, the SEC has frequently remarked in its comment letters that IPO letters need to serve a supplementary purpose that is meaningful to investors and directly relevant to the public offering. Given that the SEC’s prescriptive disclosure regime is designed to capture all material disclosures necessary for an investment decision, the SEC staff appears to have carefully reviewed the content and bounds of IPO letters.

Without specific rules applicable to such letters, however, the SEC appears to look primarily to the closest regulatory guidance, which is Item 503 of Regulation S-K. Item 503 requires a brief, clear and plain English business overview for the prospectus summary and risk factors touching on the most significant aspects of the company’s business and the offering.

In its reviews of IPO filings, the SEC has commented that IPO letters should be limited to a discussion of the company’s current business (particularly if the issuer is in its preliminary stage of development) and the risks of investing in the offering. The IPO letter must present a balanced summary of the business including, if presented, its current financial condition, future prospects and challenges.

The blog also discusses specific SEC comments on founder’s letters – including directives to discuss topics addressed only in those letters in other relevant prospectus sections, such as MD&A, as well as comments focusing on perceived inconsistencies between those letters and the other information in the filing.

IPOs:  Here’s Why Founders Like High Vote Stock

Speaking of both Uber & founders, this recent letter from CtW Investment Group to Uber’s Board Chair Ronald Sugar is “Exhibit A” when it comes to why founders are so fond of sticking the public with low vote stock.  After first acknowledging that “the company has a single voting structure, annual director elections, and a separate Chair and CEO,”  the letter goes on to demand sweeping changes to its board over the course of the next 3 single-spaced pages.

Specific demands include the removal of John Thain as a director & that Sugar reduce his outside board commitments “prior to Uber’s stock being listed on the NYSE.”  CtW also wants an overhaul of the board so that it is “more representative of its potential investor base.”  I guess that’s not as urgent as the other stuff though – CtW gives the company until September 1, 2019 to get its act together on this.

It’s not lost on founders that while Uber’s shareholder-friendly governance structure is rewarded with investor ultimatums even before the IPO launches, a dual class company that received a letter like this could simply crumple it up & throw it in the waste basket. Investor advocates may find that appalling. Many entrepreneurs find it very reassuring.

John Jenkins

May 7, 2019

Tesla Tweets: Who Will Bell the Cat?

As Liz blogged last week, the SEC & Tesla resolved their latest bit of unpleasantness late last month. The revised settlement gets pretty granular about what types of information Musk has to run by an “experienced securities lawyer.”

Statements that need to be run by this lawyer include those addressing the company’s financial results, including earnings of guidance, potential M&A activity, production, sales & delivery information, new business lines, previously undisclosed projections about the company’s business, and information relating to “events regarding the Company’s securities,” including Musk’s own transactions in them.

The settlement’s reference to the need to run all this past an “experienced securities lawyer” raises the question of “who will bell the cat?”  According to this story, that particular position hasn’t been filled yet.  I bet.  It’s not exactly a plum assignment.  After all, here’s what I think is a pretty realistic summary of the job description:

“The position involves telling our supervillain CEO who tweets at all hours and at a Trumpian pace that he can’t say what he wants to say on a regular basis. Oh, and just so you know, it’s entirely possible that he’ll  be baked out of his gourd when you’re called upon to try to talk him into putting down his phone.  Thoughts & prayers!”

And when Elon inevitably does fire off a non-compliant tweet, who wants to sign-up to be on the receiving end of the fire-breathing telephone calls from the Division of Enforcement, the Tesla board – and just maybe a federal judge?

Putting aside the job’s inherent undesirability, what makes anybody think that some lawyer is going to have any more success in keeping Elon’s fingers off the keyboard than his board, the plaintiffs’ bar and the SEC have had?  Yeah, this is not gonna end well. . .

Quick Poll:  How Does the SEC v. Musk Saga End?

Please take part in this anonymous poll on how the SEC v. Musk situation plays out.

bike tracks

Tomorrow’s Webcast: “M&A Stories – Practical Guidance (Enjoyably Digested)”

Tune in tomorrow for the webcast – “M&A Stories: Practical Guidance (Enjoyably Digested)” – to hear Mayer Brown’s Nina Flax, Baker Bott’s Sam Dibble, Shearman & Sterling’s Bill Nelson and our own John Jenkins share M&A “war stories” designed to both educate and entertain.

John Jenkins

May 6, 2019

SEC Proposes Overhaul of Rules on Financial Info for M&A

On Friday, the SEC issued this 224-page proposing release that would make significant changes to the rules governing the financial information that public companies must provide for significant acquisitions and divestitures.  Here’s the SEC’s press release – and we’ll be posting memos in our “Accounting Overview” Practice Area.

The “fact sheet” that the SEC included with its press release summarizes the changes that it proposes to make. As this excerpt indicates, they are fairly extensive and, in some cases, quite significant:

The proposed changes would, among other things:

– Update the significance tests under these rules by revising the investment test and the income test, expanding the use of pro forma financial information in measuring significance, and conforming the significance threshold and tests for a disposed business;
– Require the financial statements of the acquired business to cover up to the two most recent fiscal years rather than up to the three most recent fiscal years;
– Permit disclosure of financial statements that omit certain expenses for certain acquisitions of a component of an entity;
– Clarify when financial statements and pro forma financial information are required;
– Permit the use in certain circumstances of, or reconciliation to, International Financial Reporting Standards as issued by the International Accounting Standards Board;
– No longer require separate acquired business financial statements once the business has been included in the registrant’s post-acquisition financial statements for a complete fiscal year;

The changes would also impact financial statements required under Rule 3-14 of Regulation S-X (which deals with acquisitions of real estate operations), amend existing pro forma requirements to improve the content and relevance of required pro forma financial information, and make corresponding changes in the rules applicable to smaller reporting companies under Article 8 of Regulation S-X.

Interestingly, while Commissioner Jackson voted in favor of moving forward with the rule proposal, he also issued a statement in which he expressed concern that the proposals seem to proceed from the assumption that mergers and acquisitions are “an unalloyed good.”  He expressed some skepticism about that, contending that the proposals ignore “decades of data showing that not all acquisitions make sense for investors.”

Ultimately, Jackson urged investors “to help us engage more carefully and critically with longstanding evidence that corporate insiders use mergers as a means to advance their private interests over the long-term interests of investors.”

For more detail on the rule proposals, check out this blog from Cooley’s Cydney Posner.

Exclusive Forum Bylaws: Fertile Ground for Corp Fin Comments

This Bass Berry blog says that companies that have adopted exclusive forum provisions in their charter or bylaws shouldn’t be surprised to receive comments on their disclosures about them in SEC filings. The blog includes links to a handful of recent comment letters touching on various aspects of exclusive forum provisions. Check it out!

Tomorrow’s Webcast: “Termination – Working Through the Consequences”

Tune in tomorrow for the webcast – “Termination: Working Through the Consequences” – to hear Orrick’s JT Ho, Pillsbury’s Jon Ockern, Equity Methods’ Josh Schaeffer and PJT Camberview’s Rob Zivnuska discuss how the timing of when an executive officer becomes entitled to severance benefits can impact accounting, SEC disclosures, taxes, say-on-pay and shareholder relations. Please print out these “Course Materials” in advance.

John Jenkins

May 3, 2019

Next Thursday! SEC’s Open Meeting on “Large Accelerated” & “Accelerated Filer” Def’ns

Yesterday, the SEC posted this Sunshine Act notice of an open Commission meeting next Thursday – May 9th – to consider whether to propose amendments to the “accelerated filer” & “large accelerated filer” definitions and related transition thresholds (the Commission will also be discussing the cross-border application of rules for security-based swaps). The agenda says that any proposed amendments would be intended to promote capital formation for smaller reporting companies that are currently included in the larger filer categories.

When the SEC adopted the higher $250 million definition for “smaller reporting company” last year, the definitions of “accelerated filer” and “large accelerated filer” didn’t change. As a result, companies with $75 million or more of public float that qualify as SRCs are still subject to the requirements that apply to accelerated filers, including the timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal control over financial reporting – and I blogged that that was a point of contention among the Commissioners.

We’ve blogged a few times since then about SEC Chair Jay Clayton’s desire to promote capital formation – and his view that the SOX 404(b) thresholds play into that. So a proposal to amend the definitions wouldn’t come as a surprise.

Audit Committee Independence: Still Important

We get a pretty regular stream of questions on our “Q&A Forum” to the effect of, “Is it really *that* important for our audit committee members to avoid any potentially conflicting relationships with the company?” And we know our members aren’t just making up these questions for fun – let’s just say, the enhanced independence requirements aren’t always front of mind for every director. If I had a dime for every time one of my clients discovered a consulting agreement that had some sort of tie to an audit committee member…well, anyway:

In remarks yesterday, SEC Chief Accountant Wes Bricker called out independence of committee members as one of the main drivers of audit committee effectiveness – along with time, information quality and training & experience.

So yes, it’s still important to at least one influential person, even as we debate whether the overall trend of “supermajority” director independence is worthwhile. Wes also suggested that the auditor’s understanding of the company’s business & audit risks should be something the audit committee considers when evaluating their performance. And he implied that the idea of mandatory auditor rotation remains pretty dead in the US, despite some European regulators requiring it:

As relevant information for the audit committees’ oversight, I believe it is also essential for the committee members to familiarize themselves with relevant research evidence. For example, existing academic research has not been conclusive on the relationship between an auditor’s tenure and either audit quality or auditor independence. Some studies document that mandated rotation may worsen an auditor’s efforts to be skeptical and may mask company “opinion shopping.” There is also some evidence suggesting that professional skepticism can, in some cases, benefit from a long-term auditor-client relationship.

ESG Ratings: The Field Gets More Crowded

There’s some consensus that ESG ratings are impacting investment decisions – but it’s getting very difficult to keep up with all the offerings. S&P recently jumped into the mix with this “ESG Ratings Tool,” which allows companies to participate in the ratings process from start to finish. Assessments are conducted at the request of & in consultation with a company, and the company can then also decide whether & how to disclose the rating.

Meanwhile, State Street Global Advisors is fed up with the ESG ratings free-for-all and is now applying its own scoring system – “R-Factor.” This Davis Polk blog has the details:

An April 2019 SSGA article provides further insight into which resources SSGA is actually using to generate its R-Factor score for any company. For environmental and social scoring, R-Factor leverages the Sustainability Accounting Standards Board (or SASB) Materiality Map as the key framework for materiality.

SSGA writes that, “The R-Factor scoring model is powered by multiple best-in-class ESG data providers — Sustainalytics, Vigeo EIRIS, Institutional Shareholder Services (ISS) Governance and ISS Oekom — as well as SASB meta-data for categorizing and weighting.” SSGA uses another in-house proprietary tool for governance scoring that takes into account region- or country-specific norms. State Street has stated in other publications that it utilizes the Task Force on Climate-related Financial Disclosures Framework (known as TCFD) and that CDP’s (formally the Carbon Disclosure Project) Framework is another possibility.

Liz Dunshee