Monthly Archives: July 2020

July 17, 2020

SEC Calendars ‘Open Meeting’: Proxy Advisor Rules on Agenda

Earlier this week, the SEC issued a Sunshine Act notice for an open meeting scheduled for this coming Wednesday – July 22nd.  Here’s the agenda that lists two items:

The Commission will consider whether to adopt proxy rule amendments to provide investors who use proxy voting advice with more transparent, accurate, and complete information on which to make voting decisions, without imposing undue costs or delays.

The second item on the agenda says the Commission will consider whether to publish supplementary guidance to the Commission Guidance Regarding Proxy Voting Responsibilities of Investment Advisers, Release No. IA-5325 (Aug. 21, 2019), 84 FR 47420 (Sept. 10, 2019), regarding how the fiduciary duty and rule 206(4)-6 under the Investment Advisers Act of 1940 relate to an investment adviser’s proxy voting on behalf of clients.

The last time I blogged about the Commission calendaring an open meeting it was cancelled on fairly short notice.  The proposed rules on proxy advisors are top of mind for many so hopefully the Commission keeps this meeting – those interested can listen in via audio webcast on the SEC’s website.

And, if rules are adopted, we’ll be covering this and discussing what it means at our upcoming “Proxy Disclosure” & “Executive Pay” Conferences – which will be held entirely virtually over three days – September 21 – 23.  We’ve offered a Live Nationwide Video Webcast for our conferences for years – one of the only events to do so – and we’re excited to build on that platform and make your digital experience better than ever. Act now to get an “early bird” discount – here’s the registration information.

Return to Sender: Company Received $250 Million in Relief Funds – But Board Gives it Back

A recent Harvard Business Review article provides a quick read about how one company decided to return $250 million in government relief funds.  The funds weren’t part of the PPP rollout fiasco where some companies applied for funds and then returned them as questions mounted about good-faith need certifications.  So, with continued economic uncertainty some might question what led a company entitled to funds to give the money back.

As the article explains, the board decided to do what was right and made a unanimous decision to return the money.  The article is in the form of a Q&A with the company’s CEO and provides a good case study illustrating board deliberations that considered “stakeholder interests.”  The article says the CEO hopes to influence discussions in other boardrooms:

We’re a publicly traded company, and if our decision to return the money helps give other companies a bit of air cover to make the same decision, that’s a good thing. If more companies that aren’t risking their survival decide to return the money, millions will turn into billions of extra funding that can go to those truly in need. Then, hopefully, we emerge stronger as a country. There’s been a decade-long debate about ESG and the role of a company. In my opinion, we’re at a unique time in which CEOs need to act.

Fall Shareholder Engagement: Prep Questions

Here’s something I recently blogged on Off-season shareholder engagement is always important but this year it may be even more so with attention focused on social issues, company responses to the pandemic and related matters.  As proxy seasons seem to be rolling from one right into the next, Teneo recently issued a memo titled “20 Imperatives for Fall 2020 Shareholder Engagement” to help companies prepare for upcoming off-season shareholder engagement and the 2021 proxy season.

The memo lists 20 topics and questions, primarily focused on diversity and executive compensation and suggests companies prepare for Fall engagement by asking themselves those questions. Here are a few:

– Strategy: How are we reassessing and resetting our strategy, business, brand, and reputation to align with the new normal? Over the medium and long term, the new normal may call for a different strategy, brand changes that mitigate inclusiveness concerns, or a reprioritization of business lines. Stakeholders will view the strategy through a new lens and expect companies to do the same.

– Diversity Goals: Should we set and disclose concrete diversity goals? The evolution of sustainability reporting has led to the practice of companies setting and disclosing concrete goals, typically relating to the environment. It is less common for companies to set and disclose any goals relating to social issues. However, the current environment could prompt investor calls for goal setting on this issue as well.

– Consistent Grant Values: How will our year-over-year grant values be perceived by investors? Maintaining year-over-year grant values during periods of extreme stock price volatility poses a unique set of challenges. While lowering annual grant values may raise retention and motivation concerns, proxy advisors and many shareholders expect lower grant date values when the stock price is low, as granting more shares has a dilutive effect. The recent stock market rally has only increased the scrutiny of significant gains from equity awards at the height of the pandemic.

– Lynn Jokela

July 16, 2020

Virtual Board Meetings: Here to Stay?

Virtual board meetings offer basic benefits like no travel and potentially better attendance and a recent Harvard Business Review article says some fast-adapting companies have found virtual board meetings are better than the real thing.  Other benefits mentioned in the article include improved governance and collaboration through shorter agendas, crisper presentations and broader exposure to key executives and outside experts.

The article quotes several board members providing positive feedback and cites Spencer Stuart’s North American CEO practice leader, Jim Citrin, as saying several CEOs have told him ‘they’re not going back to the way it was.’  Citrin also predicts most companies will move to a single physical meeting and a series of online sessions throughout the year.  The article lists 8 tips to prepare for and get the most out of the next virtual board meeting, here’s a few:

– Shorten and energize the agenda – consider building the agenda in 15-minute increments to help avoid virtual meeting fatigue

– Spread sessions over a week or two – instead of holding a 3-day strategy session, one company held a 1 to 2-hour session a week for 4 weeks resulting in more engaged and productive meetings

– Use breakout rooms productively – if possible, keep the groups to no more than 3 participants and keep discussions to no more than 10 to 30 minutes then reconvene the board as a group to hear the report-outs

– Build in “candor breaks” – consider including short candor breaks on the agenda and ask what’s not being said

Investor Group Calls for Worker Protections During Covid-19

Not too long ago, I blogged about investors calling for mandated Covid-19 related disclosure requirements.  Although Corp Fin appeared to address some of the requested disclosures in its most recent Covid-19 guidance, this recent blog entry cites activist investors as saying the latest guidance falls short:

Activist investors plan to continue pushing the SEC for stronger disclosure requirements from public companies about COVID-19-related business risks and worker protection programs.

One such investor said ‘the pandemic has exposed a wide range of risks faced by businesses that are financially material to investors, including, but not limited to, employee health and safety, access to paid leave, access to health care, supply chain management, worker engagement, political lobbying, and executive compensation.  Unfortunately, the existing SEC guidance is not sufficient to ensure that investors have access to material information to properly assess whether companies are adequately confronting the risks.’

Separately, a blog post from a human rights advocacy organization says that 118 investors, representing $2.3 trillion in assets under management and led by the Interfaith Center on Corporate Responsibility, recently released a statement directed to meat processing companies calling for increased worker protections due to Covid-19.  Here’s an excerpt:

While we are acutely aware that the COVID-19 pandemic creates unprecedented economic challenges for businesses around the globe, companies have a responsibility to implement enhanced protections to protect workers fulfilling corporate operations and those in their supply chains. The pandemic exposes meat processing companies to reputational, legal and financial risks that may significantly disrupt operations if COVID-19 outbreaks in plants continue.

The letter acknowledges that several companies have implemented some enhanced safety measures, health protocols and worker benefits but they want to ensure companies implement safeguards across all facilities and operations.  The letter urges companies, for the long-term sustainability of their operations and the health and safety of their employees, to comply fully and in a manner that provides the greatest protection for workers.

The blog post says some of the targeted companies have responded and includes links to those responses.

Taking Cues from Pandemic Response to Prepare for Future Outlier Events

A recent study out of the Rock Center for Corporate Governance at Stanford University reviewed Covid-19 disclosure practices in SEC filings for the period between January 1 and May 29, 2020.  The study shows how, over time, the focus of Covid-19 disclosures shifted from supply-chain impacts in the early months to disclaimers to forward-looking statements and disclosure on cash positions as fears about liquidity and solvency increased.  Given the trajectory of the pandemic, the exponential growth in disclosures isn’t all that surprising.  Understanding the pandemic is out of the ordinary, here’s what the study suggests we can take from analyzing the related disclosure practices:

The COVID-19 pandemic provides a unique opportunity to examine disclosure practices of companies relative to peers in real time about a somewhat unprecedented shock that impacted practically every publicly listed company in the U.S. We see that decisions varied considerably about whether to make disclosure and, if so, what and how much to say about the pandemic’s impact on operations, finances, and future.

The study examines competitor companies within the beverage, apparel, airline and big box sectors where it found vast differences in frequency of disclosures.  Noting the differences in company disclosure practices, the study suggests boards might use insights from a company’s pandemic response to prepare for other possible outlier events such as climate events, terrorism, cyber-attacks and other emergencies while also considering whether to share these insights with shareholders.

– Lynn Jokela

July 15, 2020

Survey: Hedging Policy Disclosure

We’ve wrapped up our latest survey relating to hedging policy disclosure.  Here are the results:

1. We’re refining our hedging policies & practices in light of the new disclosure rule:
– Yes – 22%
– We considered it and decided not to – 22%
– We’ve seen no need to revisit our existing policy – 56%

2. In our proxy, we’ll include disclosure about our hedging policies & practices:
– Only as part of the CD&A – 56%
– Outside of the CD&A, and also incorporated into it – 19%
– In both the CD&A (for NEOs only) and another part of the proxy (for everyone covered) – 25%

3. To disclose our hedging policies & practices, we’ll provide:
– Our full policy – 7%
– A “fair & accurate summary” – 93%

Please take a moment to participate anonymously in these surveys:

Signature Authority Thresholds

Insider Trading Policies – COVID-19 Adjustments

Providing Clarity: SASB & GRI Announce Collaboration

Last year, Liz blogged about calls for standardized sustainability disclosure and the “alphabet soup” of reporting frameworks, which haven’t diminished with time.  But now, in an effort to help companies and investors, the SASB and GRI announced a “collaborative work plan.”  Each organization issued an announcement – here’s the SASB announcement and GRI’s.  The collaboration sounds promising, an Accounting Today article helps explain what this means:

The collaboration aims to demonstrate how some companies have used both sets of standards together and the lessons that can be shared. SASB and the GRI also hope to help the consumers of sustainability data, such as investors and financial analysts, understand the similarities and differences in the information created from these standards.

The collaboration will initially focus on delivering communication materials to help stakeholders better understand how the standards can be used together. GRI and SASB also plan to develop examples based on real-world reports to demonstrate how the standards can be employed concurrently. These resources are expected to be delivered before the end of this year.

GRI and SASB both provide compatible standards for sustainability reporting, but the groups pointed out that they’re designed to fulfill different purposes and are based on different approaches to materiality. The two groups noted that independence is important to both the GRI and SASB standard-setting processes, and they plan to maintain their independence. This collaborative work plan may identify opportunities to consider how the SASB and GRI standards may be developed in the future. Decisions about standard setting, content of standards, and their interpretation are the sole responsibility of the independent standards-setting functions, which rest with the Global Sustainability Standards Board on behalf of GRI, and of the SASB Standards Board.

Transcript: “M&A Litigation in the Covid-19 Era”

We have posted the transcript for the recent webcast: “M&A Litigation in the Covid-19 Era.”

– Lynn Jokela

July 14, 2020

Shareholder Derivative Suits Launched Over Diversity Concerns

Board diversity has been an area of focus for investors for a while now but with recent social unrest, board diversity is being scrutinized even more.  With attention on diversity, a pair of recent shareholder derivative suits have been launched against two tech companies over diversity concerns.  First, this D&O Diary blog reports that an activist investor has launched a suit against Oracle’s directors alleging the directors breached their fiduciary duties by failing to diversify the company’s board and failing to address diversity and equality issues.

Separately, a Law360 blog describes a suit targeting Mark Zuckerberg and several other Facebook directors with claims of breach of fiduciary duty, abuse of control and unjust enrichment for allegedly deceiving “stockholders and the market by repeatedly making false assertions about the company’s commitment to diversity.”

As noted in the D&O Diary blog, these lawsuits show how concerns raised in the wake of current social unrest can indirectly lead to claims against corporate boards – saying activists are likely to bring further lawsuits against corporate boards as they seek to advance diversity objectives, introducing a potential new area of D&O litigation.  Both complaints seek several forms of relief, including:

That at a certain number of directors resign prior to their next annual meeting, and the companies should include Black or minority nominees as replacements; that the defendants should return all of their 2020 compensation; that the companies should require their board receive annual diversity training.  In Oracle’s case, the shareholder also requests that the company set specific goals on the number of Black individuals and minorities to hire over the next five years; and that the company publish an annual Diversity Report.  In Facebook’s case, the shareholder also requests Zuckerberg be replaced as company chairman, the company create a $1 billion fund to hire Blacks and other minorities and maintain a mentorship program, tie executive pay to achievement of diversity goals and replace Facebook’s auditor.

California Assembly Introduces Another Bill with Potential Director Quota

We’ve blogged before about California’s board gender diversity quota.  Recently, as reported in Keith Bishop’s blog, a bill similar to California’s board gender diversity law has been introduced in the California Assembly.  The bill would impose a requirement on public companies headquartered in California to have a minimum number of directors from an “underrepresented community” no later than the end of 2021. The bill defines a “director from an underrepresented community” to mean an individual who is African-American, Hispanic, or Native American.

California was the first state to introduce legislation requiring publicly-held companies headquartered in the state to diversify all-male boards.  California’s board gender quota law has been challenged in lawsuits and earlier this year, I blogged about a federal court dismissal of one lawsuit – although the dismissal was promptly appealed.  Meanwhile, another case challenging California’s board gender diversity law is ongoing in California state court – here’s Keith Bishop’s blog discussing the status of that case.

Tomorrow’s Webcast: “Coronavirus: Next Steps For Disclosure & Governance”

Tune in tomorrow for the webcast – “Coronavirus: Next Steps For Disclosure & Governance” – to hear to hear Ning Chiu of Davis Polk, Meredith Cross of WilmerHale, Keir Gumbs of Uber and Dave Lynn of Morrison & Foerster and discuss lessons learned about securities law compliance and corporate governance issues brought on by Covid-19 and considerations going forward.

– Lynn Jokela

July 13, 2020

SEC Proposes to Increase Form 13F Reporting Thresholds

On Friday, the SEC proposed amendments to Form 13F for institutional investment managers.  If adopted, the primary proposed change would raise the Form 13F reporting threshold for investment managers – from the current $100 million to $3.5 billion – and as stated in the SEC’s press release, would thereby provide relief for smaller managers who are currently subject to Form 13F reporting.  Other proposed changes include:

The proposed changes also would direct the staff to review the Form 13F reporting threshold every five years and recommend an appropriate adjustment, if any, to the Commission. Additionally, the proposal would eliminate the ability of managers to omit certain small positions, thereby increasing the overall holdings information required from larger managers. The proposal also would require managers to report additional numerical identifiers to enhance the usability of the information provided on the form, and amend the instructions relating to requests for confidential treatment of Form 13F information.

The proposed reporting threshold change from $100 million to $3.5 billion is a big increase but as the announcement points out, the threshold hasn’t been updated since the Commission adopted the form over 40 years ago!  In the time since the form was adopted, the announcement says the overall value of U.S. public corporate equities has grown over 30 times (from $1.1 trillion to $35.6 trillion).

Even though the press release notes that the Commission has received recommendations to revisit the Form 13F reporting thresholds over the years, not all are in agreement with the proposed changes. Commissioner Allison Lee issued a dissenting statement saying the proposal decreases transparency and that it lacks sufficient analysis.  The National Investor Relations Institute (NIRI) tweeted its disagreement and said it “shared Commissioner’s Lee’s concerns about the ill-advised proposal.”  NIRI also referenced its position paper on 13F reforms, which is dated just last fall and among other things, advocates for shortening the 13F reporting deadline.

Market-Wide Crisis: Impact on Independent Chair Proposals?

A recent Georgeson blog assesses whether the Covid-19 pandemic had an impact on independent chair proposals voted on during the 2020 proxy season. In their analysis, Georgeson compared voting results during the five-year period leading up to, and including, the COVID-19 crisis with the five-year period surrounding the 2008 financial crisis. Georgeson found key similarities between the two crises’ impact on voting support for independent chair proposals – saying it appears preference for an independent chair gets stronger during the time of a market-wide crisis.

Independent chair proposals have been prolific since the mid-2000s and were the most common type of governance proposal voted last year. Despite their popularity, these proposals have experienced average support in the range of 29% to 32% since 2012, with only one proposal having received majority support in the last five calendar years. Accordingly, there has been a relative surge in shareholder support this proxy season, averaging approximately 35%, with two proposals receiving majority support and 15 receiving support in excess of 40%. The COVID-19 crisis seems likely to have fueled shareholders’ focus on improving board oversight effectiveness by requiring an independent chair.

In comparison, looking at the shareholder support trend for independent chair proposals during the most recent prior crisis, average support for independent chair proposals had similarly jumped from 29.6% to 34.2% in 2009, coinciding with the year when major stock market indices hit their lows in the wake of the 2008 financial crisis.

The blog also analyzes the impact of ISS’s voting recommendation on vote outcomes and says ISS’s favorable recommendation ‘did strongly influence voting outcomes in 2020.’  In 2020, although ISS recommended in favor of a significantly greater percentage of these proposals compared to 2019, ISS’s support was well below its level of support for such proposals during 2016 – 2018. The blog attributes increased average support during 2020 as being driven more by individual investors’ decision-making – demonstrating that investors made case-by-case decisions.

Although support for independent chair proposals rose this year, one key point mentioned in a ISS Governance Analytics report is that ‘momentum on this topic appears to be somewhat tepid as roughly half of the companies where independent chair resolutions appeared on ballots in both 2019 and 2020 witnessed year-over-year declines in voting support.’

Tomorrow’s Webcast: “Executive Compensation Planning in a Down Market”

Tune in tomorrow for the webcast – “Executive Compensation Planning in a Down Market” – to hear Tony Eppert of Hunton Andrews Kurth, Richard Harris of Aon and Jamin Koslowe of Simpson Thacher discuss emerging disclosure practices and how companies and compensation committees should approach executive compensation planning in a turbulent environment.

– Lynn Jokela

July 10, 2020

Cybersecurity: The Ongoing Challenge of a Remote Workforce

Like many businesses, my law firm’s offices have been operating on a restricted schedule for the past several months, and even though we’re in the process of transitioning to a full reopening, I suspect that many of our lawyers will continue to spend a lot of time working from home.  My guess is that many other companies will have similar experiences. This Deloitte memo on the CLO’s role in reopenings highlights some of the cybersecurity challenges facing companies that will continue to have a large remote workforce. These include:

– Increases in socially engineered cyberattacks targeting financial and personally identifiable information (PII) data
– Cyber risk levels are elevated due to an increase in phishing and malware attacks.
– Some communication and collaboration tools may not be secure, even where these platforms have their own built-in controls.
– Client and customer data may be more vulnerable when employees work from home if employees are transmitting data on unsecure networks and/or saving or printing on home devices.
– Employees who previously did not work at home may not be familiar with cybersecurity and data protection leading practices. Most are likely to benefit from regular reminders related to cybersecurity leading practices.
– Potential threats to attorney-client privilege may arise where there are risks to cybersecurity or where attorney-client conversations may be overheard (by family members, for example).

In addition to reviewing cybersecurity insurance policies for potential coverage gaps associated with remote work, the memo recommends additional cybersecurity training to employees, communicating new and emerging threats as they arise, providing remote workers with the tools and instructions necessary to protect data and maintain data privacy protocols.

The memo also recommends that companies prioritize the preservation of the attorney-client privilege by taking actions such as reminding employees not to forward documents to personal email accounts or use other unsecure methods to transfer files or communicate with clients.

Covid-19: Changes to Internal Audit

Over on “Radical Compliance,” Matt Kelly blogged about the results of a recent survey conducted by the Institute of Internal Auditors that suggests that the Covid-19 crisis has resulted in some significant changes to the internal audit function.  In addition to the inevitable budget-cutting, the survey suggests that risk assessments & updates to audit plans are likely to increase:

Survey respondents also said they will both conduct risk assessments and update their audit plans more often. This should surprise nobody, given how Covid-19 has put standard risk scenarios through the blender. Fraud risk, cybersecurity risk, user access controls, management review and sign-off of reconciliations or controls; they’ve all gone haywire.

A majority of respondents expect to increase their risk assessments to at least some degree, and 11% expect to increase the frequency significantly. Meanwhile, 68% of respondents say they’ll at least increase the frequency of updates to the audit plan.

That’s a lot of change and improvisation for the audit function. It implies an embrace of “agile auditing” — a concept the IIA and many others in the audit profession heartily support. It’s the idea that an audit function will run light on staff, heavy on technology, and stand ready to jump on emerging or fast-changing risks by working with other parts of the enterprise.

Covid-19 poses new risks across the enterprise, and since audit teams don’t have the time or personnel to engage in “ponderous” risk assessment & remediation planning efforts, the blog says that they will need to embrace a more swift, data-driven approach to assessment, testing, and remediation.

B Corps: DGCL Amendments Ease Transition Process

This Freshfields blog highlights how the 2020 amendments to the DGCL make it simpler for corporations to transition from soulless entities devoted to maximizing stockholder value to virtuous “public benefit corporations” devoted to uplifting humanity. This excerpt addresses elimination of supermajority approval requirement & appraisal rights risks that previously applied to transitioning entities:

Prior to these amendments, the approval of two thirds of a company’s outstanding stock entitled to vote was required to amend its charter to become a PBC. And, in the case of private companies, the decision to convert to a PBC triggered an opportunity for dissenting holders to exercise appraisal rights and thereby monetize their unlisted shares at the expense of the issuer.

Both of these requirements were procedurally onerous and a deterrent to conversion. The amendments will remove both the supermajority requirement and the right to appraisal. Companies may now convert to PBCs through a simple majority vote of their stockholders (plus whatever additional approvals are required under their organizational documents).

The amendments also make clear that a director’s ownership of stock in the PBC does not disqualify the director from being “disinterested” so that the director can benefit from the protection of the business judgment rule and the broad PBC exculpatory provisions when balancing the interests of various constituencies.

John Jenkins

July 9, 2020

Responding to Activist Shorts: Are Internal Investigations a “Tell”?

FT’s Alphaville blog recently discussed a new study dealing with corporate responses to short sellers. Public companies sometimes decide that discretion is the better part of valor when it comes to responding to an activist hedge fund’s announcement of a “short thesis.” But many others – about 1/3rd according to the study – opt to respond. Some of those companies announce that they’re initiating an internal investigation into the activist’s allegations. If that happens, the study says investors should run for their lives:

We find that when activist short seller targets announce internal investigations, the disclosure is associated with a 383% greater chance of a fraud finding . . . and a 61% lesser chance of being successfully acquired as an exit strategy, compared to the whole sample of targeted firms.

The study suggests that initiating an internal investigation based on an activist’s allegations implies that the firm’s directors are not sufficiently confident in management to trust that the existing disclosures and management representations are accurate.

While an internal investigation may be a red flag, if allegations are credible, it may also be the board’s only option. But what’s the best way for a company to respond to a report that it knows is inaccurate? The blog points to GE’s successful efforts to refute Harry Markopolos’s 2019 short report – which focused on highlighting the errors in the analysis without trashing the analyst – as a model response.

Audit Committees: Navigating the Pandemic

Dealing with the issues presented by the Covid-19 crisis has increased the already significant demands placed on audit committees. This Sidley memo (p. 7) provides some advice to audit committees on how to navigate the pandemic. This excerpt addresses disclosure & reporting issues:

Plaintiffs’ attorneys are investigating whether COVID-19 disclosure-related issues can support opportunistic securities class actions, with multiple cases already filed. Companies that express public confidence about their general prospects or their supply chain sufficiency despite dismal news about the economy and COVID-19’s impacts face heightened risk.

As always, companies should be careful to have support for statements at the time they are made. Watch for changing circumstances and adverse trends, in particular, as those circumstances change rapidly; describe them accurately as new developments. Ensure that public reporting is consistent with what the board is being told privately.

Shareholders also may second guess board-level decisions or inaction. So, consider documenting COVID-19-related considerations and responses to create a diligence record. Shareholders looking to file derivative actions often seek books and records before filing or making demands. Having a record of board considerations and responses can be very protective. Shareholder demands and books and records demands often come by mail, so companies should be alert to incoming mail when personnel are out of the office.

Other issues addressed in the memo include the importance of the “tone at the top” when it comes to health & safety concerns, the need to stay on top of operations & risks, the importance of being in sync with management when it comes to reporting, and a variety of other matters.

Capital Markets: Converts are Having a Moment

They say that “every dog has his day,” and according to this “CFO Dive” article, that day has apparently come for convertible debt. The article says that $21 billion in converts were issued during May – the highest monthly total on record. Traditionally, it has been small caps that have been attracted to convertible securities, but some big companies that have found themselves in financial hot water have recently turned to them as well. This excerpt explains the attraction of converts to issuers & investors in the current environment – as well as some reasons to think twice before diving in:

Start to finish, an issue can take two days, compared to weeks for high yield debt. The heightened uncertainty facing companies and investors over the last several months as a result of the coronavirus pandemic has led to a doubling of convertibles outstanding, compared to the same time last year. “Given the current volatile market environment and downward pressure on stock prices, it’s no surprise investor sentiment has turned negative around companies issuing equities to raise capital, primarily because of the dilutive effect on their stock holdings,” Heather Hall, CFO of fixed income tech company 280 CapMarkets, said.

When convertibles are changed into equity, they can impact shareholder value negatively, and have adverse effects on a company’s earnings metrics and projections, she said. Companies in competitive industries might want to consider the potential future dilutive effects on their share price, and corresponding negative implications to their overall market share and earnings per share metrics, Hall said, noting the dilutive effects to shareholder value that will be much larger, proportionally, in a smaller company. “The phenomenon of an activist investor who could potentially acquire the majority of the convertible debt and ‘run away’ with the company should be contemplated,” Hall warned.

For a more in-depth look at the pros & cons of issuing converts in the current environment, check out this Wachtell Lipton memo.

John Jenkins

July 8, 2020

Reg Flex Agenda: Universal Proxy Rules Coming Soon?

Just a couple of years ago, media reports suggested that the SEC’s universal proxy rule proposal was an “ex-parrot.”  But this Davis Polk blog says that latest edition of the agency’s Reg Flex Agenda includes the proposal on the short list, together with proxy plumbing. Here’s an excerpt:

Worth noting is that the potential rulemaking related to universal proxies, proxy process amendments (a.k.a. “proxy plumbing”) and mandated electronic filings have moved up to the short-term agenda; formerly these were on the 2019 fall long-term agenda. The universal proxy is a proxy voting method meant to simplify the proxy process in a contested election and increase, as much as possible, the voting flexibility that is currently only afforded to shareholders who attend the meeting. Shareholders attending a meeting can select a director regardless of the slate the director’s name comes from, either the company’s or activist’s. The universal proxy card gives shareholders, who vote by proxy, the same flexibility.

The proxy process topic is a very large-complicated topic that involves voting mechanics and technology, including issues such as those associated with the complex system of share ownership and intermediaries. As customary, the Reg Flex Agenda provides no details; however, given the complexity of the issues, it is most likely that “low hanging fruit” will be addressed. Some of these were identified by the SEC Investor Advisory Committee Recommendation issued in September 2019, which included the use of universal proxies and were previously discussed in our blog.

The Reg Flex Agenda targets an October 2020 date for the finalization of the rule.  However, the blog points out that an agency is not required to consider or act on any agenda item, and that SEC Reg Flex Agenda reflects solely the priorities of the Chairman and does not necessarily reflect the position of any other Commissioner.

ICFR: How Will Covid-19 Impact Material Weaknesses?

This FEI report on ICFR addresses the potential implications of the Covid-19 crisis on the assessment of whether material weaknesses in internal controls exist. Not surprisingly, this excerpt suggests that we’re likely to see more conclusions that material weaknesses exist than we have in recent years:

We’ll definitely see an increase in delayed filings and we’ll likely see an increase in material weakness disclosures. If remote work arrangements, facility closures or unavailability of key personnel due to illness result in an inability to apply or test control procedures, management may be forced to conclude that one or more material weaknesses in internal control exist, unless compensating preventive or detective controls are in place and able to be tested.

Satisfying the external auditors with sufficient evidence that controls are performing as intended could also be challenging in this environment. For example, people working remotely may not have access to typical work tools such as printers and scanners, making it difficult to evidence control performance.

The article also cautions that pandemic-related declines in earnings, revenues & other materiality benchmarks could also result in the inclusion of some items in the scope of this year’s internal control assessment that were excluded in prior years.

Listing Standards: NYSE Extends Temporary Shareholder Approval Relief

In April, the NYSE adopted a temporary rule easing the shareholder approval requirements applicable to listed companies looking to raise private capital during the Covid-19 crisis. That temporary rule was set to expire at the end of June, but due to the continuation of the Apocalypse, the NYSE opted to extend it through the end of September. Here’s the intro from this Mintz memo discussing the extension:

As discussed in our earlier Viewpoints advisory, the New York Stock Exchange temporarily allowed NYSE-listed companies to complete certain capital raising transactions involving related party issuances or the issuance of 20% or more of a company’s stock without shareholder approval under limited circumstances. As a result of the continuation of the coronavirus (“COVID-19”) pandemic, on July 2, 2020, the Securities and Exchange Commission approved an extension of the NYSE’s waiver of these shareholder approval rules in the circumstances discussed below through September 30, 2020.

John Jenkins

July 7, 2020

No Good Deed Goes Unpunished: ESG Initiatives Attract Activist Funds

According to a recent study cited in this “Institutional Investor” article, companies that implement social responsibility plans are twice as likely to enter activist hedge funds crosshairs as firms that are not addressing these issues:

The study, evaluating data on U.S.-based activist campaigns from 2000 to 2016, found that hedge funds are significantly more likely to target companies that have a strong performance record in corporate social responsibility. In fact, the likelihood of a company being targeted increased from 3% to 5% if their CSR scores rose by two standard deviations above the average. If companies are trying to do the right thing in industries that have historically not addressed environmental, social, or governance issues, they’re even more likely to be in the sight lines of activists, according to the study.

Ain’t that a kick in the head? According to Prof. Rodolphe Durand, one of the study’s authors, activists believe that these initiatives are a waste of money & distract management from efforts to maximize profits.

Prof. Durand says that if you want to prioritize ESG without attracting the attention of activists, forget the greenwashing & go all-in: “management teams that clearly articulate their operational and financial strategies for impact and ESG initiatives have a better chance of escaping an activist campaign than those who are vague about their plans.”

Insurance: Michigan Court Nixes Covid-19 Coverage Claim

One of the top of mind issues for many companies in recent months has been whether their business interruption insurance policies will pick up part of the tab for Covid-19 losses. We blogged a few months ago that companies seeking to recover under those policies were likely to face an uphill climb. This Faegre Drinker memo reviews the first substantive judicial decision on Covid-19 coverage issues, and the result is consistent with that prediction:

Generally, insurers in such suits have taken the position that the virus has not caused physical damage to the insured’s property and therefore there has been no trigger for coverage under the terms of the policies at issue. Insurers have also argued that, under the terms of the policies, there can be no coverage for business interruption because losses caused by viruses are specifically excluded.

On July 2, 2020, a judge in Ingham County, Michigan issued what appears to be the first substantive decision in a COVID-19 business interruption coverage case. In Gavrilides Management Company, et al. v. Michigan Ins. Co., the insured argued that the virus exclusion did not apply because the loss of access was caused by the government orders, not by the virus. In addition, the insured argued that the loss of use of the property caused by the governmental orders constituted “direct physical loss” within the meaning of the policy. Applying Michigan law, the court rejected both arguments.

Ruling from the bench on a motion to dismiss, the judge held that “direct physical loss or damage” requires more than mere loss of use or access. The judge then held that the virus exclusion unambiguously excluded coverage caused by the impact of COVID-19.

Since the insureds’ arguments are similar to the arguments made in other cases, the memo says that case will undoubtedly be cited by insurers in other business interruption coverage cases pending throughout the country.

Financial Reporting: Staff Comments on Covid-19 Impairment Testing Disclosure

The pandemic’s economic impact has caused many companies to conclude that they need to conduct impairment testing. Companies that find themselves in that position may want to take a look at this Audit Analytics blog, which highlights a recent Staff comment on a Covid-19 Q1 impairment charge disclosure. Here’s the comment letter and here’s the company’s response.

John Jenkins

July 6, 2020

Q2 Reporting: Investors Focus on Liquidity & Human Capital Disclosure

On June 30th, the SEC held a roundtable on 2nd quarter reporting & Covid-19 disclosure. The panelists included a bunch of big shots from private equity firms and asset managers. This Mayer Brown blog summarizes the panel’s recommendations on Q2 & Covid-19 disclosure. Many of these recommendations focused on liquidity & human capital-related issues. Here are some of them:

– Provide specific and forward-looking guidance on the company’s liquidity position, including its expected cash burn and upcoming capital expenditures. Companies should consider including a best, middle and worst case liquidity scenario.

– Separately disclose the company’s short-term and long-term liquidity plans. Identify the company’s primary use of cash during the second quarter as compared to prior quarters.

– Specify, in a standardized format, the amount of liquidity that is currently available under the company’s existing financing facilities and if financial covenants prevent the company from accessing or drawing down from a disclosed financing source. Identify the time period that the company can expect to continue to operate with limited or no cash revenue.

– Explain management’s rationale for implementing announced executive compensation or staff reductions. Disclose changes to the company’s work force and expected impact on the company’s operations.

– Disclose the impact of the pandemic on the company’s human capital. Explain if the company’s employees will be able to work remotely and disclose the company-specific challenges. Estimate costs if the company expects to spend significantly on personal protective equipment in order to safely reopen.

The panelists said that investors also want to see qualitative disclosures addressing a company’s operational challenges & resiliency, as well as forward-looking disclosures & trend guidance, particularly around capital raising activities. In addition, investors are looking for companies to address the effect of recent social unrest on their business & employees, along with standardized disclosure about their racial and gender diversity, including a description of applicable hiring practices.

Beyond EBITDAC: Quantifying Covid-19’s Impact in Public Company Disclosures

Earlier this year, I blogged about the practice of presenting “EBITDAC”- type disclosures that adjust for Covid-19’s impact. A more recent blog from Liz suggests that this practice is growing in popularity. Clearly, disclosures about the effects of Covid-19 are very important, but non-GAAP disclosures that include estimates of lost revenue from the pandemic aren’t likely to make you many friends at the SEC.

Unfortunately, the quantitative disclosures about Covid-19 that can raise compliance issues aren’t limited to EBITDAC, and guidance about where to draw the line has been hard to come by. That’s why this Cleary Gottlieb memo about disclosures quantifying Covid-19’s impact is a very helpful resource. This excerpt addresses potential concerns about the accuracy & verifiability of Covid-19 adjustments:

Not all adjustments are created equal. Adjustments stemming from fairly objective charges, such as COVID-related contract terminations or purchases of personal protective equipment, are easier to isolate, quantify and support than charges related to supply chain interruptions and operational inefficiencies, which may reflect drivers beyond COVID-19. The more judgment calls that are needed in a company’s assessment of an adjustment, the more the company should consider its assumptions.

The SEC may be more likely to question the accuracy of the disclosure during its normal-course review of the company’s periodic filings, and there is also litigation risk surrounding COVID-impact disclosure that contains a misstatement or is otherwise inaccurate or unsupportable. In addition, it may be difficult for auditors to comfort such an adjustment in an underwritten offering. such as COVID-related contract terminations or purchases of personal protective equipment, are easier to isolate.

Through a user-friendly format that incorporates Q&As and concrete examples, the memo also provides insight on determining whether or not a particular disclosure involves a non-GAAP financial measure, whether the disclosure is permissible or potentially misleading, and other matters.

Companies looking into using non-GAAP financial measures to address the impact of Covid-19 should also check out this Deloitte memo on the topic.

Covid-19 Disclosure: Choose Your Words with Care!

A recent post over on the Jim Hamilton Blog discussed a webcast hosted by Securities Docket in which representatives of Latham & FTI participated. The webcast addressed a variety of pandemic-related disclosure & litigation issues, but one that I wanted to highlight involved the importance of careful attention to the wording of disclosure – particularly the use of the term “material adverse effect” when discussing Covid-19. Here’s an excerpt from remarks by Latham’s Keith Halverstam:

Halverstam also advised against using the term “material adverse effect” when it comes to making COVID-related disclosures related to company operations. While it might look good to the SEC, other parties such as the company’s lenders might see it as a violation of a covenant, making it harder for the company to draw on their revolving credit. Instead of using “material adverse effect,” companies can say, for example, that the pandemic has had “significant effects on revenue,” he recommended.

For some situations, there may be no choice but to use the “material adverse effect” terminology, but the point is that the words you chose to use may have implications that go well beyond the confines of the disclosure document.

John Jenkins