Monthly Archives: August 2019

August 16, 2019

WeWork’s Proposed IPO: The Latest Unicorn Doesn’t Disappoint. . .

Around here, we’ve come to expect big things from unicorn IPO filings – and I’m delighted to say that ’The We Company’’s Form S-1 does not disappoint. I’ll let others comment on the company’s decision to use an Up-C structure, its financial performance & its corporate governance.  I’m just going to let the document speak for itself. I’m sure the lawyers involved spent lots of time toning this thing down from what the business folks wanted – but in the end, “unicorns gonna unicorn.”  Here’s the paragraph that leads off the “Prospectus Summary”:

We are a community company committed to maximum global impact. Our mission is to elevate the world’s consciousness. We have built a worldwide platform that supports growth, shared experiences and true success. We provide our members with flexible access to beautiful spaces, a culture of inclusivity and the energy of an inspired community, all connected by our extensive technology infrastructure. We believe our company has the power to elevate how people work, live and grow.

My oldest son works for a startup in Chicago that’s housed in a WeWork space, but I haven’t seen any evidence of elevated consciousness in him. I don’t think they have free beer – or as page 145 of the prospectus refers to it, “Craft on Draft” – in the Chicago locations anymore, so maybe that’s what’s missing. Anyway, the company’s mission statement may sound goofy to a middle-aged guy like me, but management wants everybody to know they’re serious – so they put it in the “Risk Factors” section:

We may make decisions consistent with our mission that may reduce our short- or medium-term operating results.

Our mission is integral to everything we do, and many of our strategic and investment decisions are geared toward improving the experience of our members and the attractiveness of our community. While we believe that pursuing these goals will produce benefits to our business in the long-term, these decisions may adversely impact our short- or medium-term operating results and the long-term benefits that we expect to result from these initiatives may not materialize within the timeframe we expect or at all, which could harm our business and financial results.

Given how much media attention has been devoted to this offering, it’s no surprise that there’s also a gun-jumping risk factor on page 49.  Apparently, it relates to comments that CEO Adam Neumann & CFO Artie Minson made to Axios & Business Insider back in May. Hey, if you’ve got a mission to raise the world’s consciousness, you’re sort of obligated to preach your evangel whenever the opportunity presents itself, right?

Related Party Transactions:  We’ll Get to That Stuff – But First, Adam is Awesome!

I could go on like this, but I’ll do just one more –  the “Related Party Transactions” section. To soften the blow of the nearly 11 full pages of related party transactions disclosure, the section begins with a testimonial to the CEO’s overall awesomeness:

Adam has served as the Company’s Chief Executive Officer and Chairman of the Company’s board of directors since our inception. From the day he co-founded WeWork, Adam has set the Company’s vision, strategic direction and execution priorities. Adam is a unique leader who has proven he can simultaneously wear the hats of visionary, operator and innovator, while thriving as a community and culture creator. Given his deep involvement in all aspects of the growth of our company, Adam’s personal dealings have evolved across a number of direct and indirect transactions and relationships with the Company. As we make the transition to a public company, we aim to provide clarity and transparency on the history of these relationships and transactions, as well as the background to the strategic governance decisions that have been made by Adam and the Company.

I’ve read this several times, and I love it more each time – especially the part about how the CEO’s “personal dealings have evolved across a number of direct and indirect transactions. . .”  Of all the unicorn disclosure I’ve ever read, this just may be the “unicorniest”!

The Weed Beat: U.S. Capital Markets More Open to Cannabis-Related Businesses

This recent blog from Duane Morris’s David Feldman reviews recent U.S. financing activities involving cannabis-related businesses, and says that they have positive implications for U.S. based-businesses:

These developments likely will lead to fewer US companies feeling the need to go public in Canada, where previously companies believed capital was easier to access. Second, the growers and sellers of cannabis in the US, those that “touch the plant,” have not yet been permitted to list their shares on a national exchange. It will be interesting to see if and when the exchanges relent on their reticence to list these now large and fast-growing entrepreneurial enterprises as the march to US legalization continues. In the meantime, capital as fuel for growth is more and more available to these US businesses.

John Jenkins

August 15, 2019

Survey: Ending Blackout Periods

Every few years, we survey the practices relating to blackout & window periods (we’ve conducted over a dozen surveys in this area). Here’s the results from our latest one:

1. Which factor is most important in allowing a blackout period to end one day after an earnings release:
– Filer status being large accelerated filer and a WKSI – 19%
– Number of analysts providing coverage on company – 23%
– Average daily trading volume for the company – 10%
– None of the above is important – 48%

2. How many analysts covering the company is considered sufficient to allow blackout period to end one day after an earnings release:
– 1-5 – 3%
– 6-10 – 26%
– 11-15 – 13%
– 16 or more – 6%
– None of the above is important – 52%

3. What average daily trading volume is considered sufficient to allow blackout period to end one day after an earnings release:
– 1% of its outstanding common stock – 7%
– $5 million or more in average daily trading volume (daily trading volume x stock price) – 3%
– $10 million or more in average daily trading volume (daily trading volume x stock price) – 6%
– $25 million or more in average daily trading volume (daily trading volume x stock price) – 15%
– None of the above is important – 69%

Please take a moment to participate anonymously in these surveys:

Board Evaluations
Management Representation Letters

Dual Class: CII Names & Shames “Dual-Class Enabler” Directors

Last week, the CII published a list of 159 directors who served on boards of 2018 & 2019 IPO companies that went public with dual-class share structures & no sunset provisions. The CII’s “Dual-Class Enablers Spreadsheet” identifies the other public boards on which these directors serve. Here’s an excerpt from the CII’s press release discussing its rationale for the “naming & shaming” approach:

“The board that brings a company to public markets with unequal voting rights is responsible for the decision to disempower public shareholders,” said CII Executive Director Ken Bertsch. “The board’s decision can be a red flag of discomfort with accountability to outside shareholders.” He said that investors “may want to raise concern about that in their engagement with other boards on which these directors serve. Some investors may choose to vote against directors of single-class companies who participated in pre-IPO board decisions to adopt dual-class equity structures without sunsets elsewhere.”

The release also says that the list may have a deterrent effect on private companies considering dual class structures. Perhaps that’s the case. After all, this is the first time that the CII has taken action that provides a potential reputational downside for the directors of these companies. But personally, I’m skeptical. I still think that companies will only be deterred from going public with dual class structures when investors finally abandon their “buy now, whine later” approach to investments in them.

BlackRock: “Remain Calm! All is Well!”

Remember my recent blog about BlackRock’s defense of the size of its investment positions in public companies? Well, it published another blog on the Harvard Governance Forum that defends the voting power those investments represent. BlackRock reviews various proxy voting scenarios – elections, M&A, say-on-pay & shareholder proposals and the average margins of victory for each. From that data, they draw this conclusion:

The view that asset managers are ‘determining’ the outcome of proxy votes is not supported by the data. The vast majority of ballot items are won or lost by margins greater than 30%, meaning that even the three largest asset managers combined could not change the vote outcome. While the small subset of votes on shareholder proposals tend to be closer, the considerable variation in voting records among asset managers negates the concept of a multi-firm voting bloc as the ‘swing vote”.

In other words, – “most votes aren’t close, so you shouldn’t worry that we have the ability to determine the outcome of all close votes.”  These blogs certainly suggest that BlackRock is worried about the potential for regulatory intervention. But I don’t think they’re helping themselves by putting forward arguments that are so specious you can practically see beads of sweat forming on their upper lip.

John Jenkins

August 14, 2019

SEC Calendars ‘Open Meeting’: Proxy Advisors on the Agenda!

Yesterday, the SEC announced an open Commission meeting next Wednesday – August 21st – during which it will consider two agenda items. The first relates to potential guidance “regarding the proxy voting responsibilities of investment advisers under Rule 206(4)-6 under the Investment Advisers Act.” With this agenda item, the SEC may be considering guidance that revisits the extent to which an asset manager can outsource voting decisions to proxy advisors consistent with its fiduciary obligations. (See this Cydney Posner blog).

As this Gibson Dunn blog notes, the second agenda item also relates to proxy advisors:

The second agenda item is a Division of Corporation Finance matter captioned “Commission Interpretation and Guidance Regarding the Applicability of the Proxy Rules to Proxy Voting Advice.” The notice describes this matter as follows:

The Commission will consider whether to publish an interpretation and related guidance regarding the applicability of certain rules, which the Commission has promulgated under Section 14 of the Securities Exchange Act of 1934, to proxy voting advice.

This item appears related to the rulemaking addressed in the SEC’s most recent Reg Flex agenda, which stated that the Division of Corporation Finance “is considering recommending that the Commission propose rule amendments to address certain advisors’ reliance on the proxy solicitation exemptions in Rule 14a-2(b).”

As I blogged at the time the SEC updated its Reg Flex Agenda, it’s unclear exactly what the SEC is going to propose about the ability of proxy advisors to continue rely on exemptions from proxy solicitation rules. Some commenters have called for the SEC to reconsider those exemptions – or at least impose additional conditions upon their use – as part of a broader initiative to regulate the proxy advisory industry.

These are controversial topics, so this should be an interesting meeting – well, I mean, if it goes forward. They seem to cancel these things with the same frequency as I cancel ‘Open Table’ reservations. We will be talking about the outcome of the SEC’s meeting at our “Proxy Disclosure Conference” coming up in a few weeks.

Fast Act S-K Simplification: Don’t Forget the New “Description of Securities” Exhibit!

In preparing an article for the most recent issue of “The Corporate Counsel” print newsletter, I looked at a bunch of 10-K filings made by large accelerated filers after the effective date of the Fast Act disclosure simplification rules.  One of the more interesting things that I found was that nearly half of the filers whiffed on the requirements of new Item 601(b)(4)(vi) of Regulation S-K – which requires companies to include an exhibit briefly describing all securities registered under Section 12 of the Exchange Act.

So, consider this a reminder that you’ve got to include this exhibit in your next 10-K if you’re a large accelerated filer. If you’re wondering what it should look like, check out this recent blog from Stinson’s Steve Quinlivan, which reviews the new exhibit requirement & provides some samples.

After I posted this, Hogan Lovells’ David Crandall reached out with an idea about why so many companies may be overlooking this requirement:

We noticed that form checks by our associates were not picking up the new requirement, and it turns out that the eCFR website for Reg S-K Item 601 incorrectly lists the exhibit requirement as applying to Form 10-Ds rather than 10-Ks.

The adopting release omitted the headers to the Item 601 exhibit table and had the incorrect number of columns (14 compared to 16), which undoubtedly contributed to the error on the eCFR website. I’m not aware of any source that correctly lists the new requirement as applying to 10-Ks, absent the discussion of the amendment in the adopting release. There may be many diligent registrants out there who looked at Item 601 and figured that the new requirement only applied to asset-backed issuers filing on Form 10-D.

. . . And now, just a few hours after posting David’s comments, the eCFR website reference has been fixed!  Thanks to David and to the folks in the government who addressed this so promptly.

Buybacks are Bad. Buybacks are Declining. The Decline in Buybacks is Bad.

The much criticized practice of corporate stock buybacks appears to have declined significantly this year. That’s great news, right?  This Axios Markets report says “not exactly.” Here’s an excerpt:

After buying back more than $1 trillion of their own stock last year, public companies are slowing their share repurchases in 2019, and that will add to troubles for the market and the economy.

Why it matters: Buybacks have been a major catalyst for the market’s rise in recent years and remain an important driver of higher prices, as earnings growth has slowed and investors have become net sellers of equities. With the trade war weighing on business spending and confidence and earnings growth expected to weaken into negative territory for companies in both the second and third quarters this year, the stock market’s legs look increasingly fragile.

By the numbers: The record buyback binge in 2018 accounted for almost half of stocks’ EPS growth, the highest share since 2007. S&P reported earlier this year that Q1 2019 was the first quarter in 7 that the pace of buybacks slowed. That theme has continued through the year, as the 4-week average pace of buybacks has fallen 30% from 2018’s pace as of this week, data from Bank of America Merrill Lynch shows.

The report quotes a recent client note from BAML that says that investors have become “less enamored with buybacks,” and that late 2018 was “the turning point in this cycle of expanding debt balance sheets, buying growth and rewarding shareholders.”  It says that the bottom line is that companies are preparing for the economy to slow and want to pare debt and hold cash in the event of a downturn.

John Jenkins

August 13, 2019

Earnings Calls: Make ’em Laugh (If You Can)

Last week, the CLS Blue Sky Blog summarized a study on the use of humor in corporate earnings calls.  The results were kind of interesting:

We find that managers are less likely to use humor on a call when the tone of analysts’ questions is negative, suggesting managers are deliberate about when to use humor. Further, our results indicate that managers are more likely to use humor if an analyst first uses humor on the call. We also find that the market reaction in the three days surrounding the conference call is more positive when managers use humor, a result that is partially driven by a muted reaction to negative manager tone when managers use humor. Additionally, our tests of analysts’ reactions indicate that managers’ use of humor is generally associated with upward revisions in analysts’ stock recommendations shortly after the call.

It looks like the takeaway here is that a little humor from your execs can give a bit of a bounce to your stock price. Everybody’s trying to make their earnings call stand out from the pack these days, and given the potential upside here it wouldn’t surprise me to see companies make a conscious effort to inject comic relief into the proceedings. Well, you folks can do what you want, but if you ask me, I’d be very cautious about trying to throw your CEO into the deep end of the humor pool.

My point is that comedy is a high-wire act, and chances are pretty good that your CEO isn’t funny. Worse, it’s almost a lock that most CEOs think they’re hysterical. After all, a lot of CEOs spend their days surrounded by people who tell them how awesome they are and laugh at all their jokes. That can lead to catastrophic consequences for CEOs who decide that Dave Chappelle has nothing on them and that breaking out their standup act on an earnings call is a great idea.

Here’s a case in point – last year at about this time, the subscription software provider Zuora attempted to turn its earnings call into a “dialogue” featuring ad-libbed attempts at humorous asides. The execs involved likely thought they were being amusing. According to this article, the market thought otherwise:

Wall Street didn’t seem too amused by the strange new take on an earnings call, which took place as shares were falling in the aftermarket. Zuora’s stock closed down 19% in Friday’s session, the largest single-day percentage drop in Zuora’s history as a public company.

Yikes! Any company that’s considering turning their next earnings call into an SNL skit should keep in mind Zuora’s cautionary tale – as well as the old theatrical adage that says “Dying is easy. Comedy is hard.”

The Dark Web: Troll Targets SEC Staffers

Like many governmental agencies, the SEC is never short of critics. The agency usually takes that criticism in stride – but one critic appears to be targeting individual Staff members online.  This Claims Journal article says that the SEC thinks that crosses the line, and is taking some extraordinary steps to address potential reputational damage:

Elon Musk mocked it as the “Shortseller Enrichment Commission.” Billionaire Mark Cuban said it’s “useless.” Hedge fund legend Leon Cooperman called it “abusive.” For the U.S. Securities and Exchange Commission, such attacks come with the territory. But brushing them off is getting harder in the age of social media. One online foe has so troubled the agency’s staff that it’s made the remarkable move of seeking to hire an expert to burnish their images.

The contractor’s duties will include monitoring content about employees in the SEC’s vaunted enforcement division on the web and removing anything that’s “false or harmful,” according to a July 22 posting on a federal job site. The listing didn’t name the detractor, but the individual isn’t a well-known executive like Musk or Cuban, said a person familiar with the matter who asked not to be identified. The SEC accused the mystery adversary of violating securities laws, and the individual started assailing agency officials online, while taking steps to ensure Google and other search engines picked up the critiques.

While individual crackpots weren’t unheard of in the past, the article quotes John Reed Stark as saying that “before social media accounts became ubiquitous, most threats were confined to stock message boards.” Now everyone’s online, including most of the Staff – and that makes them easier targets for trolls.

Transcript: “How to Handle Hostile Attacks”

We have posted the transcript for the recent webcast: “How to Handle Hostile Attacks.”

John Jenkins

August 12, 2019

Risk Factors: “Active Shooters” Join the Parade of Horribles

Given the times in which we live, I guess it’s not surprising that some companies have added “risk factor” disclosure about the potential implications of an active shooter to their SEC filings. Here’s an excerpt from this WSJ article:

A handful of public companies have begun quietly warning investors about how gun violence could affect their financial performance. Companies such as Dave & Buster’s Entertainment Inc., Del Taco Restaurants Inc. and Stratus Properties Inc., a Texas-based real-estate firm, added references to active-shooter scenarios in the “risk factor” section of their latest annual reports, according to an analysis of Securities and Exchange Commission filings. The Cheesecake Factory Inc. has included it in its past four annual reports.

So, what do these risk factors look like? Here’s what The Cheesecake Factory said in its 2019 10-K (pg. 25):

Any act of violence at or threatened against our restaurants or the centers in which they are located, including active shooter situations and terrorist activities, may result in restricted access to our restaurants and/or restaurant closures in the short-term and, in the long-term, may cause our customers and staff to avoid our restaurants. Any such situation could adversely impact customer traffic and make it more difficult to fully staff our restaurants, which could materially adversely affect our financial performance.

Dave & Buster’s 10-K included identical language (pg. 23). The language in Del Taco’s 10-K  (pg. 21), and Stratus’s 10-K (pg. 17) was a little different.  While I understand why companies are doing this, I’m not sure this kind of thing is what risk factor disclosure is intended to capture. Our tendency (mine too) to throw any item that’s been added to our national anxiety closet into a risk factor isn’t very helpful to investors. The problem is that not all disclosure adds value – some just creates “noise.”

In the U.S., we’ve learned that an active shooter is the kind of random event could happen to anyone, and the effect of such an event on any business would be terrible. So to me, it’s sort of like getting struck by a killer asteroid. I think this is the kind of thing that Judge Easterbrook was getting at in this excerpt from his 1988 opinion in Weilgos v. Commonwealth Edison:

Issuers need not “disclose” Murphy’s Law or the Peter Principle, even though these have substantial effects on business. . . Securities laws require issuers to disclose firm-specific information; investors and analysts combine that information with knowledge about the competition, regulatory conditions, and the economy as a whole to produce a value for stock.

But let’s face it – you’re not going to change your approach here and neither am I. That’s because while we can debate risk factor metaphysics, the reality is that the explosive growth in event-driven securities class actions is a big part of our personal anxiety closets too.

Venture Capital: Snoop’s Got His Mind on His Money & His Money on His Mind

My kids think I’m dorkier than Ari Melber when I reference hip-hop.  But there’s no way I’m not going to use a “Gin & Juice” reference in the title when this Pitchbook article says that Snoop Dogg is an investor in Swedish payment services provider Klarna, which is now Europe’s second most valuable VC-backed company with a $5.5 billion valuation following its recent $460 million capital raise.  Here’s an excerpt:

Founded in 2005, Klarna provides consumer financing for purchases at third-party merchants. Rather than requiring consumers to pay in full via credit card at the time of sale, Klarna acts as a middleman to front the payment for a purchase, with merchants receiving the full amount upfront while the consumer repays Klarna over time.

The Swedish company is perhaps most recognizable for its partnership and investment relationship with Calvin Broadus, better known as Snoop Dogg. Broadus is front-and-center in Klarna’s recent marketing campaign, known as “Smoooth Dogg.” Such marketing efforts could prove beneficial as Klarna plans to use its new windfall to significantly expand in the US, Broadus’ home country and where his career grew rapidly in the 1990s.

Regular readers of this blog know that Snoop has some impressive culinary skills, but you also should note that this isn’t his first rodeo when it comes to venture capital. He’s an investor in both Reddit & the trading app Robinhood, and a general partner in Casa Verde Capital, which recently completed a $45 million capital raise & focuses on investments in – here’s a shock – the cannabis industry.

Cryptocurrencies: Kik Claps Back at SEC Complaint

In June, I blogged about the SEC’s decision to bring an enforcement action against Kik Interactive for its $100 million unregistered token deal.  As that blog noted, Kik’s founders are crypto-evangelists who have raised a $5 million war chest to fund its defense against the SEC’s allegation that its tokens are “securities.” It recently filed a 130-page answer to the SEC’s complaint, in which it accuses the agency of “twisting the facts” about its Kin token.  Check out this TechCrunch article for more details.

John Jenkins

August 9, 2019

SEC Proposes Reg S-K Modernization! (For Items 101, 103 & 105)

Although the SEC cancelled its open Commission meeting that had been scheduled for yesterday, the Commissioners voted to issue this 116-page proposing release to modernize parts of Regulation S-K – specifically, Item 101 (business description), Item 103 (legal proceedings) and Item 105 (risk factors).

I speculated on Monday that some parts of the proposal might be somewhat based on the SEC’s Reg S-K concept release from 2016 – and it appears that they are (though the proposal doesn’t cover everything that was in the concept release). Another part of the proposal relates to human capital – a topic that SEC Chair Jay Clayton has indicated in recent speeches may be growing in importance. The “Fact Sheet” in the SEC’s press release highlights these proposed changes (also see this Cooley blog):

Item 101(a) (Development of Business):

– Make the Item largely principles-based by providing a non-exclusive list of the types of information that a registrant may need to disclose, and by requiring disclosure of a topic only to the extent such information is material to an understanding of the general development of a registrant’s business;

– Include as a listed disclosure topic, to the extent material to an understanding of the registrant’s business, transactions and events that affect or may affect the company’s operations, including material changes to a registrant’s previously disclosed business strategy;

– Eliminate a prescribed timeframe for this disclosure; and

– Permit a registrant, in filings made after a registrant’s initial filing, to provide only an update of the general development of the business that focuses on material developments in the reporting period, and with an active hyperlink to the registrant’s most recent filing that, together with the update, would contain the full discussion of the general development of the registrant’s business.

Item 101(c) (Business Narrative):

– Clarify and expand its principles-based approach, by including disclosure topics drawn from a subset of the topics currently contained in Item 101(c);

– Include, as a disclosure topic, human capital resources – including any human capital measures or objectives that management focuses on in managing the business – to the extent such disclosures would be material to an understanding of the registrant’s business,such as, depending on the nature of the registrant’s business and workforce, measures or objectives that address the attraction, development, and retention of personnel; and

– Refocus the regulatory compliance requirement by including material government regulations, not just environmental provisions, as a topic.

Item 103 (Legal Proceedings):

– Expressly state that the required information about material legal proceedings may be provided by including hyperlinks or cross-references to legal proceedings disclosure located elsewhere in the document in an effort to encourage registrants to avoid duplicative disclosure; and

– Revise the $100,000 threshold for disclosure of environmental proceedings to which the government is a party to $300,000 to adjust for inflation.

Item 105 (Risk Factors):

– Require summary risk factor disclosure if the risk factor section exceeds 15 pages;

– Refine the principles-based approach of that rule by changing the disclosure standard from the “most significant” factors to the “material” factors required to be disclosed; and

– Require risk factors to be organized under relevant headings, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.

There’s a 60-day comment period – and we’ll be posting memos in our “Business Disclosure,” “Litigation” and “Risk Factors” Practice Areas.

This proposal was based on seriatim action taken by the Commissioners. As to the issue of whether the SEC is required to propose (or adopt) rules at an open Commission meeting, see Broc’s blog entitled “When is the SEC Required to Hold an Open Commission Meeting?”

Shareholder Proposals: Big Year for “Political Spending”

In March, Broc blogged on our “Proxy Season Blog” that lobbying & political spending proposals were “coming up big” this year. And now that the height of proxy season is behind us, the Center for Political Accountability is elaborating on their recent successes in this blog. Here’s an excerpt:

The average vote was 36.4 percent at 33 companies that held annual meetings. That was up from 34 percent last year, when 18 resolutions went to a vote. In 2017, the resolution averaged 28 percent over the 22 resolutions that went to a vote. CPA and its shareholder partners reached disclosure agreements and withdrew resolutions at 13 companies this year. That compares with three in 2018 and seven in 2017.

The 2019 Proxy Season breakdown is as follows:

– Two majority votes in support of the resolution at Cognizant Technology Solutions Corp. (53.6%) and Macy’s Inc. (53.1%).

– Eleven votes in the 40% range, including Kohl’s Corp. (49.8%), NextEra Energy Inc. (48.7%), Allstate Corp. (46.9%), Chemed (46.2%), Western Union Co. (44.3%), Fiserv Inc. (43.8%), Alaska Air Group (43.5%), Roper Technologies Inc. (43.0%), Netflix Inc. (41.7%), Centene Corp. (41.6%) and Nucor Corp (40.6%).

– Twelve votes in the 30% range. The companies included Illumina Inc. (37.7%), Simon Property Group Inc. (37.1%), American Water Works Company Inc. (37.0%), Duke Energy Corp. (35.8%), Wyndham Destinations (35.6%), American Tower Corp. (35%), Royal Caribbean Cruises Ltd. (34.5%), Wynn Resorts Ltd. (34.4%) CMS Energy Corp. (34.3%), Equinix Inc. (34.2%), DTE Energy Co. (33.6%), and J.B. Hunt Transport Services Inc. (31.7%).

This Cooley blog explores why companies might be coming around to greater oversight of this type of spending, and discusses some of the CPA’s recommendations…

Just Mailed: July-August Issue of The Corporate Counsel

We recently mailed the July-August issue of The Corporate Counsel. This issue includes pieces on:

1. Early Returns From the Fast Act Rule Changes
– Changes to the Form 10-K Cover Page
– Item 102 of S-K—Description of Property
– Item 303 of S-K—MD&A- Item 601 of S-K—Exhibits: Description of Securities
– Some Takeaways

2. Unpacking Stock Splits
– Stock Split v. Stock Dividend: What’s the Difference?
– Companies Need “Surplus” To Pay Dividends
– Do You Have Enough Shares?
– Directors’ Fiduciary Duties
– Reverse Splits: Appraisal Rights & Fair Value of Fractional Shares
– Federal Income Tax Treatment of Splits & Reverse Splits
– Federal Securities Law Compliance
– Exchange Act Compliance
– Stock Exchange Rules
– 5 Key Takeaways

3. A Few Words About Delaware’s “Legal Capital” Requirements

Liz Dunshee

August 8, 2019

Inline XBRL: Ins & Outs of “Exhibit 104”

A couple weeks ago, Broc blogged about some confusion around the Inline XBRL requirements that will be required for Form 10-Q filings by large accelerated filers this quarter. And with the 10-Q deadline looming for those with a June 30th quarter-end (tomorrow!), the dialogue has continued in our “Q&A Forum” (see #9960). Yesterday, Bass Berry also shared this blog about how to handle the iXBRL requirements. Here’s an excerpt about Form 10-Q – as well as Form 8-K (and see this Gibson Dunn blog for even more pointers):

Form 10-Q Question: As a large accelerated filer, should our 10-Q exhibit list include a separate reference to Exhibit 104?

Based on our discussions with SEC Staff within the SEC’s Division of Corporation Finance, we understand the position of the Staff in Corp Fin’s Office of Chief Counsel is that a registrant should explicitly reference an Exhibit 104 in the list of exhibits. And because the recent EDGAR Filer Manual makes clear that a registrant meets its obligation under Exhibit 104 by providing the cover page interactive data file using an Inline XBRL document set with Exhibit 101, the registrant should simply cross-reference to Exhibit 101.

For example, Exhibit 104 could include a cross-reference as follows: “104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).”

We also remind large accelerated filers that the recent instructions to Item 601(b)(101) of Regulation S-K were amended to require that for interactive data files, the Exhibit Index must include the word “Inline” within the title description for any XBRL-related exhibits. See Instruction 1 to Paragraphs (b)(101)(i) and (ii) of Regulation S-K.

Form 8-K Question: In a Form 8-K, are you required to explicitly reference Exhibit 104 in the Exhibit Index?

Answer: In discussions with SEC Staff within the SEC’s Division of Corporation Finance, we received the following guidance related to a registrant’s Exhibit 104 reference obligation in 8-Ks:

– If the 8-K does NOT otherwise have an exhibit being filed or furnished under Item 9.01(d), then the company does not need to include Item 9.01(d) in the 8-K solely for the Exhibit 104 reference. (The cover page tagging is still required in the background, but there is no standalone Exhibit 104 reference in an Item 9.01.)

– In contrast, if the 8-K does have another exhibit being filed or furnished under Item 9.01(d) (e.g., there is a material contract), then the company should include a reference to Exhibit 104 in the Item 9.01(d) disclosure because there is already disclosure being provided under this Item. For example, the reference could be as follows: “104 Cover Page Interactive Data File (embedded within the Inline XBRL document)”

– The principle behind this position is that Item 9.01 is intended to have an informational component to it, and if an Exhibit 104 reference is required in every 8-K then the informational benefit of item 9.01 is weakened.

Fast Act: SEC Issues “Technical Corrections”

A couple weeks ago, Broc noted in his Inline XBRL blog that an incorrect eCFR of the Item 601(a) table was causing some confusion about iXBRL requirements. The SEC has now issued this 18-page release, which corrects the exhibit table and a few other items from the original Fast Act amendments. The technical corrections to the final rules do the following:

– Reinstate certain item headings in registration statement forms under the Securities Act of 1933 that were inadvertently changed

– Relocate certain amendments to the correct item numbers in these forms and reinstates text that was inadvertently removed

– Correct a portion of the exhibit table in Item 601(a) of Regulation S-K to make it consistent with the regulatory text of the amendments

– Correct certain typographical errors and a cross-reference in the regulatory text of the amendments

Today’s Open Commission Meeting: Cancelled

The SEC has cancelled the open meeting that it had previously scheduled for today to consider whether to propose additional Regulation S-K disclosure reforms. No word on rescheduling yet.

Next Wednesday: SEC’s “Small Business Forum”

The SEC will hold its 38th annual “Small Business Forum” next Wednesday – August 14th – in Omaha, Nebraska (and if you’re like me, you now have this ‘Counting Crows’ song stuck in your head). The SEC’s announcement summarizes what topics will be covered and explains how to access the meeting (you need to register by tomorrow if you want to attend or listen in on any of the breakout sessions):

As in past years, the format of the Forum will include a live webcast informational morning session followed by an afternoon working session where participants will formulate specific policy recommendations in groups. The morning panels will cover capital formation (“success stories from the Silicon Prairie”) and efforts to harmonize the offering framework, based on the SEC’s June concept release.

The afternoon breakout group sessions will not be webcast but will be accessible by teleconference for those not attending in person. Anyone wishing to participate in a breakout group either in person or by teleconference must register online by August 9.

Also, about a month ago, the SEC posted its final report from last year’s Forum – which included recommendations about modernizing disclosure requirements and harmonizing private offering exemptions.

Liz Dunshee

August 7, 2019

Voluntary Disclosures of SEC Investigations: No Good Deed Goes Unpunished?

Here’s something from Dan Goelzer’s latest newsletter: A challenge faced by a company under non-public SEC investigation is whether to publicly disclose the investigation before the company knows whether it will result in any charges. There are no firm rules on whether investigations must be disclosed. The decision is inherently a judgment call and depends on an assessment of materiality after considering the costs and consequences of the investigation, the issues underlying the inquiry, the likelihood and potential impact of any eventual SEC enforcement proceeding, and other factors. It is frequently assumed that transparency is the more conservative approach and that, in the long run, the market rewards candor.

Dan goes on to say that a recent paper by David H. Solomon, of Boston College’s Carroll School of Management, and Eugene Soltes, of Harvard Business School, casts doubt on these assumptions. Professors Solomon and Soltes conclude:

– Even if no charges are ultimately filed, companies that voluntarily disclose an SEC financial fraud investigation have “significant negative returns, underperforming non-sanctioned firms that stayed silent by 12.7% for a year after the investigation begins.”

– Disclosing in a “more prominent manner” (e.g., in a press release as distinguished from an SEC filing) is associated with worse returns.

– A CEO whose company discloses an investigation is 14 percent more likely to “experience turnover” within two years than a CEO whose company opts to remain silent, regardless of the outcome of the SEC investigation.

These findings won’t come as a surprise to anyone who’s been involved in responding to fraud allegations. Even if the SEC ultimately drops their inquiry, a years-long investigation can tear apart the company and make it pretty hard for management to stay focused on their day jobs. But in his newsletter, Dan notes that:

The circumstances which lead to SEC financial fraud investigations vary widely, as do the pros and cons of voluntary disclosure. The Solomon and Soltes research, while intriguing, should not be a factor in deciding whether to disclose an investigation. The paper does, however, underscore how seriously the markets are likely to take news of a financial fraud investigation. The audit committee needs to treat such a matter equally seriously.

Securities Class Actions: M&A Filings Down, But Plaintiffs Still Loving Disclosure Fraud

Last week, Cornerstone Research published its midyear assessment of securities class action filings. Here’s a few takeaways from the press release:

– Plaintiffs filed 126 “core” class actions (excluding M&A claims) – that’s just one shy of the record set in the first half of 2017 – due to delayed market volatility in late 2018 and an uptick in filings against consumer-focused and tech companies

– Plaintiffs have filed more than 1,000 securities class actions in the last 2.5 years – accounting for more than 20% of the total number of filings since 1997

– M&A-related filings declined more than 20% since last year – to 72 – and dropped below 90 for the first time since the second half of 2016

– Six mega-dollar disclosure loss (DDL) filings (at least $5 billion) and 11 mega maximum dollar loss (MDL) filings (at least $10 billion) propelled aggregate market capitalization losses to the highest and fourth-highest levels on record, respectively

– Due to the Supreme Court’s 2018 Cyan decision, plaintiffs continue to shift securities fraud claims against IPOs from federal to state court – 61 new 1933 Act filings have appeared post-Cyan, which consists of 23 parallel filings, 12 filings in federal courts only, and 26 filings in state courts only

’33 Act Class Actions: NY State May Not Be So Plaintiff-Friendly After All

People have been predicting that SCOTUS’s 2018 Cyan decision – which held that class actions alleging claims under the Securities Act of 1933 may be heard in state court – would be a boon for the plaintiffs’ bar…and a big problem for IPO companies & their D&O carriers. Cornerstone’s midyear assessment of securities class action filings certainly suggests that plaintiffs have found the decision encouraging.

But this D&O Diary blog points to a glimmer of hope in New York – where many post-Cyan suits are being filed because the state’s pleading standards are less onerous than at the federal level. The blog explains that a New York State trial judge recently dismissed a case brought against an IPO company & its underwriters under Sections 11 and 12(a)(2) of the Securities Act. Here’s an excerpt (and here’s a call for reform):

To the extent that the plaintiffs’ lawyers were motivated to file in state court based on perceived advantages at the motion to dismiss stage, Judge Borrok’s decision represents something of a reality check. Judge Borrok’s opinion is thorough, sure-handed, and shows no discomfort in working with the federal securities laws and relevant case law. (In that regard, Judge Borrok’s reliance on the Omnicare decision underscores the importance of that ruling in opinion cases.) The state court pleading standard does not seem to have been a factor in the ruling. And no one would mistake Judge Borrok’s opinion as plaintiff friendly.

The decision in the Netshoes case is of course just one ruling by one trial court judge. It has no precedential value and may have only limited value as an indicator of how New York state courts generally may deal with the new influx of securities cases. Moreover, Judge Borrok’s dismissal of the Netshoes case was without prejudice; the plaintiffs will have an opportunity to try to cure the shortcomings Judge Borrok noted in his decision. For all we know, the plaintiffs might well succeed in amending their complaint and in surviving the next round of dismissal motions.

However, one can hope that Judge Borrok’s ruling may help send a message that the plaintiffs may need to reconsider whatever perceived advantages they may think they have in proceeding in state court rather than federal court.

Liz Dunshee

August 6, 2019

CAMs: Early Returns From the “Big 4”

Back in December, Stinson’s Steve Quinlivan spotted the first CAM. Now we owe him another hat tip for finding the first few CAMs in audits issued by the “Big 4” accounting firms – see page 93 of Microsoft’s Form 10-K and page 107 of Open Text’s Form 10-K. Both companies had a CAM relating to revenue recognition. Steve noted in his blog (also see his follow-up entry):

The CAM is straightforward and does not reflect negatively on the company or its audit committee or cast doubt on its financial reporting. If anything, it most likely reflects an attitude by the auditor that “we have to find something to protect us in the case of a PCAOB inspection.” I think revenue recognition CAMs are going to become somewhat boiler plate and not likely to attract a lot of attention absent special circumstances.

Auditor Attestations: No Shortage of Comments on SEC Proposal

The comment letters have been rolling in on the SEC’s proposed amendments to the “accelerated filer” definition – which would make fewer companies subject to the auditor attestation requirement. Predictably, accounting firms aren’t in favor of the change and say that it would weaken the quality of financial reporting (here’s EY’s letter as an example). CII has also joined that camp – its letter argues that the amendment may cause investors to lose confidence in the integrity of financial statements.

CII also takes issue with the SEC’s economic analysis of the proposal – by citing to another recent comment letter from four B-School profs. That letter adds data to the assertion that some companies can’t be trusted to report material weaknesses when left to their own devices (as does this blog about Canada’s experience with a similar rule). Here’s an excerpt from this WSJ article about the letter and its underlying study:

More than 100 companies that could get relief have reported restatements that altered combined net income by $295 million from 2014 through 2018, according to a comment letter from researchers at Stanford University, the University of Pennsylvania, the University of North Carolina and Indiana University. Eleven of the restatements occurred in 2018 and wiped out about $294 million in market value, the researchers wrote.

One company in the group is Insys Therapeutics Inc., said Prof. Taylor, who co-wrote the letter. Insys, an opioid manufacturer whose market value peaked at $3.2 billion in 2015, sought bankruptcy protection in June after pleading guilty to bribing doctors to boost use of its spray version of fentanyl, a synthetic opioid. It agreed to pay $225 million in fines and forfeiture.

Insys effectively failed the internal-controls audits in 2015 and 2016, according to securities filings. The company later restated results for several quarters in 2015 and 2016. The company said at the time that neither fraud nor misconduct caused the errors. Auditors in 2017 and 2018 reported its internal controls were free from material weaknesses.

The comment letter emphasizes that the analysis in the SEC proposal quantifies the cost of internal control audits – but not the potential benefits. Of course, there are two sides to this heated debate – and the WSJ article also emphasizes the high cost of compliance for smaller companies, and that investing that money in the core business rather than compliance could improve returns for shareholders…there are letters supporting the proposal from Nasdaq, the Chamber, Proskauer and a score of life science companies, among others.

Sarbanes-Oxley Compliance: Still a Lot of Work, But Automated Controls Might Help

There was a slight decrease in Sarbanes-Oxley compliance costs last year – according to Protiviti’s annual survey on the topic – but spending remains significant ($1.3 million on average among large accelerated filers – and that excludes external audit fees). In addition, hours & control counts continue to increase. Protiviti predicts that new technologies – along with a desire to strengthen controls and (finally) lower costs – will usher in “SOX Compliance 2.0.” Here’s an excerpt:

A growing number of SOX executives recognize that more dramatic improvements, fueled by a new mindset and advanced technologies, are required. To illustrate, our results reveal that the use of analytics has jumped significantly and that a broader range of compliance activities are being subjected to advanced technology — with even more plans to do so in the future. It also appears many organizations are huddling with their external auditors to figure out how the auditor’s use of advanced automation can deliver greater compliance effectiveness.

Protiviti also found that the use of automated controls testing is increasing, more companies are using outside providers for Sarbanes-Oxley compliance, and cybersecurity is substantially increasing compliance hours. Nearly half of companies said they were now required to issue a “cybersecurity disclosure” based on guidance from the SEC & Corp Fin.

Liz Dunshee

August 5, 2019

This Thursday! SEC’s Open Meeting on “Modernizing Reg S-K” (Again)

The SEC announced that it’s holding an open Commission meeting this Thursday – August 8th – to consider whether to propose rule amendments to modernize these Regulation S-K disclosure requirements:

1. Business Description

2. Legal Proceedings

3. Risk Factors

I’ll admit that my first reaction to this news was, “Didn’t they already do this (twice) last year?” But then I remembered that the 341-page Reg S-K concept release from 2016 went well beyond the Fast Act and Disclosure Update & Simplification amendments. We don’t know yet whether a proposal coming out of this meeting – if any – will address any of those ideas (the agenda just says that any proposal would be intended to update these rules to account for developments since their adoption or last amendment, to improve these disclosures for investors, and to simplify compliance efforts for companies). We’ll keep you updated in any event.

By the way, we’ve overhauled about 4000 pages of our “Handbooks” to reflect the latest disclosure requirements, accommodations and best practices – including all of the Fast Act and Disclosure Update & Simplification amendments. They’re a great resource for making sure that your forms & disclosures are up to date.

Board Diversity: S&P 500 No Longer Has Any All-Male Boards

A couple weeks ago, the WSJ reported that all S&P 500 boards now include at least one female director – a pretty significant milestone, given that one in eight boards in that index were all male as recently as 2012. The “Thirty Percent Coalition” – which coincidentally was formed by investors in 2012 with the goal of improving female representation – also announced that 85 companies appointed a woman to their board for the first time during the last year and that more company boards include a woman now than at any other time since the campaign launched.

Of course, there are plenty of companies outside of the S&P 500 that haven’t diversified – and as this Korn Ferry blog points out, business benefits are best realized when 20-30% of the board is “diverse.” The Thirty Percent Coalition’s investors will be asking companies to undertake the following:

1. Disclosure in the Proxy of board composition inclusive of gender, race, and ethnicity

2. Language committing to diversity in Governance charter

3. Disclosure of future plans to make progress on board diversity

4. Adaptation of the “Rooney Rule” for board candidates and senior leadership (investors want each company to commit to include women & people of color in every pool from which Board nominees are chosen and to state this in their Board Refreshment Policies and/or Nominating & Corporate Governance Committee Charter)

5. Consideration of candidates outside of CEOs for board positions.

Tomorrow’s Webcast: “Joint Ventures – Practice Pointers (Part II)”

Tune in tomorrow for the webcast – “Joint Ventures: Practice Pointers (Part II)” – to hear Troutman Sanders’ Robert Friedman, Proskauer’s Ben Orlanski, Cooley’s Marya Postner and Aon’s Chuck Yen provide an encore to our popular June webcast with even more practical advice on navigating your next joint venture. The topics include:

1. Joint Ventures vs. Contractual Collaboration
2. IP Issues: JVs Based on An Owner’s Platform Technology
3. Negotiating “Divorce” Up Front
4. Consider Piloting a JV Before Full Commitment
5. Majority/Minority Dynamics
6. Acting By Written Consent
7. Clarifying JV’s Purpose
8. Pay Principles: Benchmarking & Long-Term Incentives
9. How Key Pay Decisions Are Made

Liz Dunshee