Last week, Palantir filed the Form S-1 for its anticipated “Spotify-style” IPO. Despite new NYSE rules on “primary” direct listings, the company isn’t selling any shares in this deal – rather, existing shareholders will resell shares of Class A common stock on the NYSE.
For a company that’s been cloaked in mystery and has bestowed the title “legal ninja” on its in-house lawyers, the registration statement – much like a direct listing – is anti-climactic. Which is a compliment to everyone involved! As John tweeted, “the S-1 looks like it was written for grownups.” And unlike some of the other direct listings that we’ve seen, this one does include a D&O lock-up that runs until after the company announces its year-end results.
A few other things that jump out are:
– Prospectus cover page – Underwriter logos are conspicuously absent (like other direct listing companies, Palantir has engaged several financial advisors on the deal – whose names first appear in a risk factor on page 65 – and of course their role is further described in the Plan of Distribution)
– Plan of Distribution – Although there’s no formal book-building, there’s still the impression of some “shadow book-building.” The disclosure is clear that the banks are conducting investors communications & presentations only in connection with “investor education” and not to coordinate price discovery or sales…but it also says that the designated market maker will consult with Morgan Stanley on the opening public price, who will provide input based on pre-listing selling & buying interest that it becomes aware of. I’m sure this section was pored over by legal counsel & banks in excruciating detail, so check out the full thing if you’re interested in how the mechanics are described.
– CEO Letter – Typical stuff we see from unicorns – soaring language about the company and its rejection of a typical business model – but also a critique of Silicon Valley’s “values & commitments” and a pitch that Palantir is forward-thinking, moral and justified in its approach to data collection.
– Privacy – Under the heading “Our Team” on page 168, Palantir describes its “Privacy & Civil Liberties Engineering” team and its “Council of Advisors on Privacy & Civil Liberties” – as well as privacy-enhancing technologies.
– Board Composition & Governance – Three of the six independent directors joined the board in July. The governance structure isn’t in place yet but is contemplated as part of the NYSE listing.
– Multi-Class Cap Structure – In addition to the Class A common shares being resold in the offering, the company describes its Class B common stock (10 votes per share) and Class F common stock (a variable number of votes, all shares held in a voting trust established by co-founders Alex Karp, Stephen Cohen and Peter Thiel, and controlling up to 49.99% of total voting power). A risk factor notes that the company’s cap structure could make it ineligible for inclusion in certain indices.
– Founder Voting Agreements – The company has yet to file the charter with the terms of the “Class F” shares – or the stockholders agreements – and that’s probably the most interesting part of the offering.
This registration statement will likely go effective before the new Reg S-K rules go into effect, so Palantir won’t have to worry about immediately revising its disclosure. While nobody seems too surprised about the net loss figures (this is a unicorn, after all), this Reuters article says that the offering will “test the appetite of capital market investors who have in recent years shown an increasing wariness of backing loss-making startups, most notably WeWork, which botched its IPO last year.” But as we’ve seen, 2020 is a whole new animal.
Shelf Registrations & Takedowns: 10-Page Guide
This 10-page Mayer Brown memo gives a nice overview of the shelf registration & takedown process – including permitted offerings, liability & diligence issues, benefits of the shelf registration process, filing requirements, and a timely section on how market volatility may affect WKSI status and shelf eligibility. The memo gives this checklist of key questions to ask if you’re contemplating a shelf registration or takedown (also see our 140-page “Form S-3 Handbook” for lots of detailed guidance):
1. Is the issuer planning to sell new securities or outstanding securities?
2. Are securities being immediately offered after the registration statement becomes effective?
3. Will the issuer choose to offer securities in a delayed primary offering?
4. Is the issuer considered a well-known seasoned issuer?
5. Is the issuer subject to the baby shelf limitation?
6. Is the issuer considering using a shelf registration for one or more acquisitions?
7. Will the issuer be required to file a post-effective amendment as opposed to a prospectus supplement?
New this year, we have also added interactive roundtables to discuss pressing topics! We hope you’ll join us for one of these half-hour breakout sessions – you can sign up here. To make the most of your experience, check out this blog for tips for “virtual networking” for lawyers. Here’s an excerpt:
– Be On-Camera: Speaking of cameras, please do not participate in a zoom networking event without being able to have a camera available. That black square with your name will not allow others to see who you are. It would be the equivalent to going to an in-person event and wearing a paper bag over your head. People would like to see who you are. Also, make sure that you are well lit when you are on camera. Too many people are on camera with the light behind them and you cannot see their faces clearly. A light should be in front of you.
– Show up on time (or even early): This is something I advocate for IRL networking, but concerning virtual networking, it is even more important. It is distracting to have someone enter a conversation in the middle of a virtual event, as opposed to a live networking event, and should be avoided at all costs. And, if you have to leave early, you can just make mention that you have an appointment that you have to attend to and thank everyone who was there. You can send a note to the host using the chat feature. Or, you can just leave quietly.
As the blog notes, there are no marketing and business development tactics that cannot be done virtually. So take advantage of this opportunity to meet with your fellow practitioners in a low pressure way, have a good conversation, and make a connection or two.
Earlier this summer, I blogged about how Calvert called on companies and investors to take more tangible steps in addressing racial inequities. SSGA is also pushing for more change and yesterday, the asset manager posted a letter from its Global Chief Investment Officer specifying SSGA’s expectations for public companies relating to diversity, strategy, goals & disclosure. Many companies disclose some of this information and if companies haven’t starting thinking about disclosure on these issues, this call from SSGA, one of the largest asset managers, might be the nudge that starts the ball rolling.
Addressed to board chairs, the letter says ongoing issues of racial equity have led SSGA to focus on ways racial and ethnic diversity impacts the asset manager as an investor. The letter says that starting in 2021, SSGA is asking companies to disclose more information relating to diversity and it breaks this information into five key areas. SSGA plans to cover these topics in engagement conversations and the letter says engagement is SSGA’s primary tool to understand a company’s plan and how the board carries out its oversight role – but for companies that don’t meet the asset manager’s expectations, it says SSGA is prepared to use its proxy voting authority to hold companies accountable. Here are SSGA’s five key areas for which it’s asking for more diversity disclosure:
Strategy: Articulate what role diversity plays in the firm’s broader human capital management practices and long-term strategy
Goals: Describe what diversity goals exist, how these goals contribute to the firm’s overall strategy, and how these goals are managed and progressing
Metrics: Provide measures of the diversity of the firm’s global employee base and board, such as by disclosing EEO-1 data (or data based on that framework) and at the board level, by disclosing diversity characteristics, including the racial and ethnic make-up of the board
Board: Articulate goals and strategy related to racial and ethnic representation at the board level, including how the board reflects the diversity of the company’s workforce, community, customers and other key stakeholders
Board Oversight: Describe how the board executes its oversight role in diversity and inclusion
SEC Approves NYSE “Direct Listings” Proposal!
It’s been a busy week and late Wednesday, the SEC issued an order giving the go ahead to the NYSE on its “Direct Listings” proposal. This will allow companies to sell newly issued primary shares on its own behalf into the opening trade and offers an alternative to the traditional underwritten IPO, providing a more cost-effective means to access capital. Some may recall the NYSE amended the proposal twice after the SEC initially rejected the proposal last December.
The SEC’s order states that “after careful review, the Commission finds that the proposed rule change, as modified by Amendment No. 2, is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to a national securities exchange.” Last November when the proposal was originally filed, some expressed concern about investor protection issues when not using the traditional IPO process, but the SEC’s order includes discussion rejecting that concern.
For those wondering about Nasdaq, Reuters reported that Nasdaq filed a similar proposal with the SEC earlier in the week. To help members stay up to date on these developments, we’ll be posting memos in our “Direct Listings” Practice Area.
SEC’s Filing Fees: Going Down Nearly 16% on October 1st!
Earlier this week, the SEC issued this fee advisory that sets the filing fees for registration statements for 2021. Right now, the filing fee rate for Securities Act registration statements is $129.80 per million (the same rate applies under Sections 13(e) and 14(g)). Under the SEC’s new order, the rate will decrease to $109.10 per million, a 15.9% decrease.
Last year, the rates went up a little over 7% so it’s nice to see the rates turn the other direction. As noted in the SEC’s order, the new fees will go into effect on October 1st as mandated by Dodd-Frank – which is a departure from back in the day when the new rate didn’t become effective until five days after the date of enactment of the SEC’s appropriation for the new year – which often was delayed well beyond the October 1st start of the government’s fiscal year as Congress and the President battled over the government’s budget.
Yesterday at an open meeting, the SEC adopted amendments to parts of Regulation S-K – specifically relating to Item 101 (business description), Item 103 (legal proceedings) & Item 105 (risk factors). As anticipated, the amendments include increased focus on human capital.
These are the first significant amendments to these disclosure items in 30 years – and the updates have been many years in the making, as they’re part of the “disclosure effectiveness initiative” that emerged with the SEC’s 2016 concept release and continued up through last year’s proposal. These go beyond the “cleaning out the garage” amendments of a couple years ago and are intended to simplify the substantive disclosure requirements while also improving the readability of disclosure documents. The amendments shift away from prescriptive disclosures to a more principles-based disclosure framework. Here’s an excerpt from the SEC’s press release with highlights:
– Amend Item 101(a) by:
making it largely principles-based, requiring disclosure of information material to an understanding of the general development of the business;
replacing the previously prescribed five-year timeframe with a materiality framework; and
permitting a registrant, in filings made after a registrant’s initial filing, to provide only an update of the general development of the business focused on material developments that have occurred since its most recent full discussion of the development of its business, which will be incorporated by reference;
– Amend Item 101(c) by:
clarifying and expanding its principles-based approach, with a non-exclusive list of disclosure topic examples drawn in part from topics currently contained in Item 101(c);
including, as a disclosure topic, a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business; and
refocusing the regulatory compliance disclosure requirement by including as a topic all material government regulations, not just environmental laws;
– Amend Item 103 by:
expressly stating that the required information may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document to avoid duplicative disclosure; and
implementing a modified disclosure threshold for certain governmental environmental proceedings resulting in monetary sanctions that increases the existing quantitative threshold for disclosure of those proceedings from $100,000 to $300,000, but that also affords a registrant some flexibility by allowing the registrant, at its election, to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or one percent of the current assets of the registrant; and
– Amend Item 105 by:
requiring summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages;
refining the principles-based approach of Item 105 by requiring disclosure of “material” risk factors; and
requiring risk factors to be organized under relevant headings in addition to the subcaptions currently required, 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.
The Commission adopted the amendments by a 3-2 vote – Commissioners Allison Herren Lee and Caroline Crenshaw dissented. Some may have hoped for more prescriptive human capital disclosure requirements and the two dissenting statements each express concern with the principles-based nature of the rule. In Commissioner Lee’s dissenting statement, she said she would have supported the final rule “if it had included even minimal expansion on the topic of human capital to include simple, commonly kept metrics such as part time vs. full time workers, workforce expenses, turnover, and diversity.” Commissioner Lee also cited the rule’s “ill-advised omissions” of diversity and climate change. Commissioner Crenshaw’s dissenting statement says the rule fails to deal adequately with climate change risk and human capital and suggests the Commission form an external ESG Advisory Committee to help the Commission respond to ESG trends.
One aspect of the amendments some companies likely aren’t thrilled with is the new requirement to include summary risk factor disclosure when risk factor disclosure exceeds 15 pages. Commissioner Hester Peirce’s statement says she views this change as a “bit of an experiment” and wonders whether the “penalty” of needing to prepare a summary will overcome the fear of litigation that leads companies to produce voluminous risk factor disclosures.
The rules will be effective 30 days after publication in the Federal Register and we’ll be posting the avalanche of memos in our “Reg S-K” Practice Area. We’ll also be updating our Handbooks on these topics.
There’s More! SEC Amends Definition of “Accredited Investor” & QIBs
Before yesterday’s meeting even began, the SEC also adopted amendments to the definition of “accredited investor” in Reg D and the definition of “qualified institutional buyer” in Rule 144A under the Securities Act. The new “accredited investor” definition expands the number of investors eligible for this status – by allowing individuals to qualify based on their professional knowledge, experience or certifications while also expanding the list of entities that may qualify. In determining whether an individual would qualify as an accredited investor based on a particular certifications or credentials, under the amended definition, the SEC will consider, among other things, whether the certification, designation or credential arises out of an examination designed to reliably and validly demonstrate an individual’s comprehension and sophistication in the areas of securities and investing – examples being a Series 7, 65 or 82 license.
The SEC’s amendments to the definition of “qualified institutional buyer” broaden it by including LLCs, RBICs and any institutional accredited investor not already listed in Rule 144A when they meet the existing threshold of $100 million in securities owned and invested.
Although the SEC’s Press Release says the “SEC Modernizes the Accredited Investor Definition”, Commissioners Allison Herren Lee and Caroline Crenshaw issued a joint dissenting statement on the “Failure to Modernize the Accredited Investor Definition” that says despite support for indexing the accredited investor wealth thresholds to inflation, the amended definition fails to do so while also putting vulnerable investors at risk. And Commissioner Hester Peirce tweeted about her statement that the rule didn’t go far enough.
SEC Calendars Open Meeting: Amendments to Whistleblower Rules on the Agenda
Yesterday, the SEC also scheduled another open meeting – it’s scheduled for this coming Wednesday, September 2nd. The Sunshine Act notice says that the Commission will consider whether to adopt amendments to rules relating to the SEC’s whistleblower program – it’s not clear whether they’ll move forward on some of the controversial amendments that were under consideration last year. Here’s an excerpt from the notice:
The amendments would enhance claim processing efficiency, and clarify and bring greater transparency to the framework used by the Commission in exercising its discretion in determining award amounts, as well as otherwise address specific issues that have developed during the whistleblower program’s history. The Commission will also consider whether to adopt interpretive guidance concerning the term “independent analysis” in the Commission’s rules implementing its whistleblower program.
Last week, the NYT DealBook column said that shipping giant, A.P. Moller-Maersk, not only reinstated full-year financial guidance but also pegged it higher than pre-pandemic levels. If your company is on the fence about what to do, you’re not alone as companies seem to be all over the map.
A recent AlphaSense Analyst blog analyzed trends in companies providing or withdrawing quarterly or annual earnings guidance and says recent data shows continued uncertainty. Recapping Q1, the blog notes there was an unprecedented number of companies that withdrew guidance due to market turbulence that resulted from Covid-19. After reviewing Q2 updates, the blog says some companies have begun reinstating previously withdrawn guidance, while others maintained their ambiguous position and declined to provide guidance – in other words, companies are still sitting amid uncertainty, although some sectors lean more one direction than the other. Here’s some takeaways:
– Since the huge spike in guidance withdrawals this Spring, companies have taken different approaches to providing guidance Q2 earnings, with a near even split between companies providing guidance and those declining to do so
– Consumer Discretionary companies declined to provide guidance most often, accounting for 19% of companies not providing guidance this quarter
– Information Technology companies account for 17% of companies declining to provide guidance and 24% of companies sharing guidance this quarter, showing a split in confidence across the sector
ESG Disclosure Trends: SEC Filings Increasingly Highlight Disclosures on Company Websites
A recent White & Case report summarizes ESG disclosure trends of the top 50 of Fortune 100 companies by revenue. It’s a good look at where disclosure is headed as all of the information was pulled from SEC filings and it’s notable how much human capital and environmental disclosure was included in the filings. When comparing 2020 data to 2019, it’s important to note the effect of the Covid-19 pandemic and the current social climate and how that has placed focus on companies’ management of ESG issues. Here’s some of the report’s highlights:
– In 2020, every company surveyed increased its ESG disclosures in at least one category in their proxy statements compared to 2019
– The largest increase in ESG disclosures came in human capital management, in fact 90% of the companies surveyed included some form of HCM disclosure in their 2020 Form 10-K or proxy statement, increasing 8% from 2019
– 29% of the 2020 filings increased their environmental disclosure from 2019, with a significant increase in the amount of quantitative disclosures, such as information on greenhouse gas emissions reductions and renewable energy use
– Other ESG categories on the rise in 2020 include company culture, ethical business practices, board oversight of E&S issues, social impact/community and E&S issues in shareholder engagement
The report provides a few things for companies to think about that includes beefing up disclosure on human capital management, environmental, and board oversight of E&S issues – if companies haven’t already done so. One tricky issue for companies is deciding where to include ESG disclosures – in SEC filings or on company websites. The report says 84% of the companies surveyed referred readers to disclosure on the company’s website from their 10-K or proxy statement with an increasing number using their SEC filings to high-light for investors that enhanced ESG reporting is available on the company website.
Bloomberg Joins Mix with Proprietary ESG Score
We’ve blogged before about the various ESG ratings – here’s an entry about Morningstar and Sustainalytics joining up and now we can add Bloomberg to the mix. Earlier this month, ThinkAdvisor reported that Bloomberg launched its own proprietary ESG score, available to Bloomberg Terminal subscribers. Initially, the score will cover E&S for over 250 companies in the oil and gas sector and it will also include board composition scores for over 4300 companies. For board composition, here’s an excerpt from Bloomberg’s press release:
The Board Composition scores enable investors to assess how well a board is positioned to provide diverse perspectives and supervision of management, as well as to assess potential risks in the current board structure. The quantitative model is designed by Bloomberg governance specialists and utilizes Bloomberg’s management and board level data. The scores rank the relative performance of companies across four key focus areas of diversity, tenure, overboarding and independence.
Wilson Sonsini recently came out with its risk factor trends report among Silicon Valley’s 150 largest public companies. One item the report delves into is the potential impact of SEC proposed rulemaking relating to risk factors that the Commission is slated to consider at its meeting tomorrow. Some may recall that the proposed amendments to Item 105 of Reg S-K would require summary risk factor disclosure if the risk factor section is greater than 15 pages and that companies organize risk factors with headings.
Wilson Sonsini’s report covers risk factor disclosures from Form 10-Ks filed from early 2019 through March 2020 and includes information of disclosure practices overall of the SV150. Given the timing of the disclosures that were reviewed, the report doesn’t indicate trends in Covid-19 risk factor disclosure but it does illustrate how Covid-19 related disclosures impacted the overall length of risk factor disclosures. Here’s an excerpt:
Wilson Sonsini’s report says that 74% of SV150 companies include at least one heading for risk factors, with most including only one to three headings. And, all companies that went public in the last five years include at least one heading in their risk factors – whereas companies that went public over 20 years ago only 39% include at least one heading in their risk factors.
As far as inclusion of summary risk factor disclosure, the report says none of the SV150 companies include an explicit summary risk factor disclosure in their 10-K filings. So although this practice is rare, the report references Walmart’s Form 10-K filed in March of this year as a notable example of a titled summary risk factor disclosure (see page 5).
Other trends noted in the report include the number of pages of risk factors decreases as more time elapses since a company’s IPO – companies that went public in the last five years average about 27 pages of risk factors compared to companies that went public at least 20 years ago that average about 15 pages of risk factors.
As annual sales increase, the average total number of pages of risk factors also decreases.
Companies in the technology industry average the highest total number of pages of risk factors disclosure – approximately 23 pages.
Mandatory D&O Insurer Rotation: Solution for Mitigating Governance Risks?
That’s what one law prof suggests. A recent entry on the Columbia Law School Blog asserts that mandatory rotation of D&O insurers could help control corporate governance risks. Professor Andrew Verstein of UCLA School of Law grounds that assertion on his 66-page academic study in which he concludes that mandatory rotation of D&O insurers would leave insurers with only a few years to recoup any losses thus leading the insurers to serve as governance gatekeepers to limit those losses.
Like many academic studies, the study is thought-provoking as the author suggests D&O insurance itself contributes to governance problems and that the way D&O insurance is bought and sold harms governance. The gist of the author’s argument in favor of mandatory rotation is based on a theory that companies rarely switch D&O insurers, leading insurers to be passive and not monitor risk because they can recoup losses over future years from their loyal customers. By time-limiting the client-insurer relationship, the author says insurers would need to evaluate and price risks in real time rather than recouping any losses for years into the future. Here’s an excerpt summarizing the author’s reasoning:
Insurers should be permitted no more than five years with a given client, at which time they must take their underwriting elsewhere. Mandatory rotation renders the passive insurance model impractical. Insurers can never hope to insure passively and then recoup their losses down the line. Every insurer will have to actively vet insureds for risks pending over the next few years, to monitor for abrupt changes during that period, and to take steps to limit a corporation’s slide toward increase risk; the result is that corporations and their managers will be more likely to internalize the expected cost of their harmful behaviors and, thus, take those harms more seriously.
Through 66 pages, the author acknowledges the complexity of the D&O insurance model. For a thorough critique of the study, Kevin LaCroix walks through a thoughtful series of observations about the author’s assumptions – and reasons for disagreement. Up front, Kevin notes D&O insurers and their policyholders would be surprised to hear of the perceived loyalty between companies and their insurers since the D&O insurance environment can at times be “prickly.” Among other things, Kevin also discusses how much chaos mandatory rotation of D&O insurers would cause.
Without getting into the weeds about the author’s assertion and assumptions, some might wonder how mandatory D&O insurer rotation would be enforced and one way the author suggests is for the SEC to require it. As the author notes, this would require Congressional action because there is no colorable basis for the SEC to impose such a requirement on companies – I don’t think I’m going too far out on a limb in saying it’s unlikely this is coming along anytime soon.
SRCs: Scaled Disclosures & Tools to Help Determine Filer Status
With recent economic volatility, some companies might find themselves evaluating whether they qualify as “smaller reporting companies.” Of course, companies qualifying as “smaller reporting companies” can take advantage of scaled disclosure requirements that are outlined in this BDO memo – it provides a quick summary for those able to take advantage of SRC filing status. For more on determining filer status, which can be confusing, check out our “Disclosure Deadlines Handbook” and our “Smaller Reporting Companies – Entering Status” and “Smaller Reporting Companies – Existing Status” checklists available to members on TheCorporateCounsel.net.
Late Friday afternoon, the SEC issued proposed amendments under Regulation S-T aimed at promoting reliability and integrity of EDGAR submissions. If adopted, the amendments could mark the end of an era for “fake SEC filings” that we enjoy blogging about so much. But there’s still cause for celebration. In addition to aiming to curtail fake filings, the proposal is also intended to improve administration of EDGAR – for example, filing delays arising in connection with EDGAR outages (which have been a problem lately). The proposed rule specifies the Commission can take the following actions to facilitate resolution of issues that arise in connection with EDGAR submissions:
– redact, remove, or prevent dissemination of sensitive personally identifiable information that if released may result in financial or personal harm;
– prevent submissions that pose a cybersecurity threat;
– correct system or Commission staff errors;
– remove or prevent dissemination of submissions made under an incorrect EDGAR identifier;
– prevent the ability to make submissions when there are disputes over the authority to use EDGAR access codes;
– prevent acceptance or dissemination of an attempted submission that it has reason to believe may be misleading or manipulative while evaluating the circumstances surrounding the submission; and allow acceptance or dissemination if its concerns are satisfactorily addressed;
– prevent an unauthorized submission or otherwise remove related access; and
– remedy similar administrative issues relating to submissions.
The proposed rule provides that in certain circumstances, such as a threat to EDGAR, the Commission may take corrective action without first communicating with the filer. In such instances, the proposed rule sets forth a process for the Commission to notify filers and other relevant persons of actions it takes as soon as reasonably practicable.
Filers still need to ensure the accuracy and completeness of information in their EDGAR submissions and in most cases, address any errors by submitting a filer corrective disclosure. The proposed rule will be subject to a 30-day comment period after publication in the Federal Register.
SEC Comment Letters Continue Downward Trend
SEC comment letters are still around and haven’t completely disappeared but if it seems like you don’t hear as much about them, it’s because they’re declining in number. As reported in a recent Audit Analytics blog, SEC comment letters on Forms 10-K, 10-Q and 8-K continued a downward trend in 2019, a trend spanning the last nine years. The decline in 2019 seems like quite a drop-off, although much of the decline is attributed to the government shutdown in early 2019. Between 2018 and 2019, the blog says the number of comment letters fell by 30% and this was after a 32% decline between 2017 and 2018. The blog also reports that the number of conversations declined and that most reviews were resolved after one round of comments. For something to watch, the blog notes ASC 842 – the lease accounting standard – became effective in 2019 for companies with calendar year-ends so keep an eye out for any comment letter trends relating to that.
July-August Issue of “The Corporate Executive”
The July-August issue of The Corporate Executive was just posted – & also sent to the printer. It’s available now electronically to members of TheCorporateCounsel.net who also subscribe to the print newsletter at each of their locations (try a no-risk trial). This issue includes articles on:
– SEC Adopts Rules to Regulate Proxy Advisory Firm Recommendations: Where Do We Go from Here?
The Unique Role of Proxy Advisory Firms
The SEC’s First Shot Across the Bow: The 2019 Interpretive Release
ISS Responds: See You in Court!
This Means War: The SEC’s Rule Proposal
The Final Rules: Proxy Advisory Firm Regulation is Born—After a Decade in Labor!
Supplemental Guidance for Investment Advisers
Status of the ISS Lawsuit
– Considerations for the Use of Private Air Travel During the COVID-19 Pandemic
Yesterday, the SEC scheduled an open meeting for August 26th. The meeting’s agenda features a couple of big potential rule amendments. This excerpt from the meeting’s Sunshine Act notice says that the first agenda item is:
Whether to adopt amendments to modernize the description of business, legal proceedings, and risk factor disclosures that registrants are required to make pursuant to Regulation S-K. These disclosure items, which have not undergone significant revisions in over 30 years, would be updated to account for developments since the rules’ adoption or last revision, to improve disclosure for investors, and to simplify compliance for registrants. Specifically, the amendments are intended to improve the readability of disclosure documents, as well as discourage repetition and the disclosure of information that is not material.
There have been so many S-K-related proposals floating around that it’s sometimes hard to keep track, but this one relates to potential changes to Item 101, 103 & 105 that were proposed almost exactly a year ago. It’s worth noting that this is the proposal that raised the idea of requiring some kind of “human capital” disclosures – and it will be interesting to see what any final rule has to say about that topic.
SEC Open Meeting: “Accredited Investor” & “QIB” Definitions Also Up to Bat
The second item on next week’s agenda is also significant – and controversial. The Sunshine Act notice says that the SEC will consider:
whether to adopt amendments to the definition of “accredited investor” in Commission rules and the definition of “qualified institutional buyer” in Rule 144A under the Securities Act to update and improve the definition to identify more effectively investors that have sufficient financial sophistication to participate in certain private investment opportunities. The amendments are the product of years of efforts by the Commission and its staff to consider and analyze possible approaches to revising the accredited investor definition.
The SEC split 3-2 on the decision to issue these proposals last November, with Commissioner Allison Herron Lee & then-Commissioner Robert Jackson dissenting. As proposed, the amendments to the “accredited investor” definition would expand the number of investors eligible for that status by allowing individuals to qualify based on their professional knowledge, experience or certifications. The proposed amendments also would expand the list of entities that may qualify as accredited investors.
Business Interruption Insurance: Covid-19 Plaintiffs Get a Win
We’ve previously blogged about the challenges facing companies trying to assert claims under business interruption policies for pandemic-related losses, and the early returns from court cases involving these claims weren’t encouraging. One of the biggest challenges that plaintiffs have faced is persuading insurers & courts that their claims involve “physical loss,” which is a necessity under most policies in order to trigger coverage.
However, Alison Frankel blogged about a recent decision by a federal judge in Kansas City involving claims against Cincinnati Insurance that gives plaintiffs some reason for hope – and may even provide a roadmap for these claims. Here’s an excerpt:
The Kansas City plaintiffs, unlike plaintiffs in some of the previous cases, argued that the coronavirus – as a widespread, airborne virus that was rampant in the community – had likely infected their properties. It was the presence of the virus, they argued, that had rendered their businesses unsafe and unusable, forcing the shutdowns that triggered their insurance coverage.
Cincinnati, represented by Litchfield Cavo and Wallace Saunders, argued that COVID-19 did not trigger business interruption insurance coverage because it did not cause tangible, physical damage like a fire or hurricane. The coronavirus, Cincinnati argued, can be cleaned from surfaces or will otherwise die naturally within days, leaving no physical trace. Moreover, the insurer argued, the salons and restaurants hadn’t even shown the virus was actually present within their properties.
Judge Bough, however, said that under the ordinary meaning of “physical loss,” the policyholders suffered a loss when the spread of coronavirus led to prohibitions or restrictions on their businesses.
In the Judge’s view, although the coronavirus may not have caused physical damage, the insurer’s business interruption policy also covered physical loss – and a business may suffer physical loss if its premises are rendered unusable. Here’s what Alison says is the key takeaway for potential plaintiffs:
Argue that your business was likely contaminated by the coronavirus as it spread across the country through unseen droplets – and that the presence of the virus led to a physical loss, even if the particles did not cause lasting physical damage.
If you’re an investment grade issuer & want to lower your cost of capital the next time you go to market, this Politico article says you’d be well advised to use the money to fund ESG related projects, as Alphabet and Visa have recently done. This excerpt says there’s simply not enough ESG product to meet market demand:
This is a big year for investment-grade corporate debt — fueled in part by actions the Federal Reserve took in March allowing large companies to borrow more cheaply from private lenders. But the vast majority is not aligned with environmental, social and governance principles, said Jonny Fine, head of Investment Grade Syndicate at Goldman Sachs who played an integral role in the Alphabet deal. “The proportion of ESG this year is no different. It’s a very small part of our market overall,” Fine said. “The only difference we’re seeing in 2020, because we’ve had health care crises and racial divisions across the U.S., is the S in ESG has become much more important.”
So far this year, companies have issued nearly $1.5 trillion in new investment-grade debt. Less than 2 percent of that adheres to ESG standards. This reflects a problem in financial markets, Fine added. Right now, there aren’t enough ESG assets to satisfy demand from investors, who clamored for the bonds issued by Alphabet and Visa. Companies need to develop sustainability frameworks so they don’t miss out on the wave of cheap financing. “There is a very clear cost of capital disadvantage for a company that doesn’t have strong ESG principles,” Fine said.
Granted, Alphabet & Visa are both premium credits, but the pricing on their ESG-related debt was pretty phenomenal. Alphabet issued $5.75 billion at 0.8%, while Visa raised $500 million at 0.75%.
Unicorn IPO Litigation: Hung Up by Happy Talk?
One of my favorite snarky things to do is to make fun of Unicorn IPO filings. I know the poor lawyers involved must pull their hair out over some of the over-the-top statements that the underwriters & business folks insist on including in the prospectus, but a federal court’s decision in Uber’s IPO litigation may give those lawyers more leverage when arguing to tone things down.
This excerpt from a recent Jim Hamilton blog on a California federal judge’s denial of Uber’s motion to dismiss the case explains how the company’s prospectus “happy talk” made the plaintiffs’ claims stickier than they might otherwise have been:
The purchaser alleged that Uber’s registration statement omitted material facts about the legality of Uber’s business model, its passenger safety record, and its financial condition. Uber countered that each of these three categories was adequately disclosed, and the court agreed that the disclosures were well beyond boilerplate. Given the facts alleged, however, the court also concluded that the offering documents created an impression of a state of affairs that was materially different from what actually existed.
Specifically, Uber represented that while it had faced trouble in the past, it was on “a new path forward.” Despite this optimistic impression, the purchaser plausibly alleged that Uber was still using its old “playbook,” continuing, for example to view pay fines for violating local laws as a cost of doing business and intentionally delaying layoffs and restructuring to mislead the markets. Thus, the court said, what was disclosed was not enough to render what was not disclosed not misleading.
Mind you, the court reached this conclusion despite the fact that Uber’s lawyers included a 48-page Risk Factors section addressing many of these issues.
What’s in a Name? Hester Peirce is Okay with “Crypto Mom” Moniker
SEC Commissioner Hester Peirce was just reconfirmed by the Senate – along with new Commissioner Caroline Crenshaw. On the occasion of her reconfirmation, one intrepid tweeter (@BarbarianCap) asked if she was okay with her “Crypto Mom” nickname. In response, she tweeted: “It’s better than a lot of other names I have been called.” Me too, Commissioner, me too.
The Center for Audit Quality recently issued a report on Covid-19’s potential implications for this year’s audit. While we’ve touched on things like going concern issues in prior blogs, one of the matters discussed in the report that I haven’t seen before is how the pandemic may influence the determination of “Critical Audit Matters,” or CAMs. Here’s what the report has to say on this topic:
While COVID-19 in and of itself, or going concern uncertainty, would not necessarily meet the definition of a CAM, the pandemic could increase the subjectivity and complexity of a specific audit area such that it meets the definition of a CAM, when it otherwise may not have prior to the pandemic. In addition, for audits of large-accelerated filers, COVID-19 also could result in CAMs that were previously identified and communicated in the auditor’s report being expanded to include new assumptions that were especially challenging or complex due to the pandemic and/or result in changes to the auditor’s response to a previously identified CAM.
Until now, the requirement to disclose CAMs in an auditor’s report has been limited to large accelerated filers, but all issuers will have to comply with it for audits covering fiscal years completed on or after December 15, 2020 – so this is one that needs to be on everybody’s radar screen.
Critical Audit Matters: Due Diligence Questions
While we’re on the subject of CAMs, this recent Mayer Brown blog notes that because CAMs provide information about audit matters that required complicated auditor judgments & how the auditor responded to those matters, they are particularly helpful for people who are conducting due diligence. If you’re looking for something to get you started, they’ve also provided this template for due diligence questions regarding CAMs.
Audit Committees: PCAOB’s Conversations With Committee Chairs
Earlier this month, the PCAOB issued a report on its conversations with audit committee chairs about how audit committees are thinking about the effect of COVID-19 on financial reporting and the audit as they perform their oversight duties. This excerpt from a recent Wilmer Hale memo provides an overview of the results of those discussions:
Increased risks associated with remote work. The most common theme among audit committee chairs that recently met with the PCAOB dealt with risks regarding remote work arrangements, with most audit committee chairs describing the rapid shift to remote work arrangements as “effective.” This was equally applicable to the company’s employees and outside auditors.
Given the greater reliance on cloud computing in remote work environments, a number of audit committee chairs noted that they have been discussing cyber-related controls within the scope of the audit and increasing the focus on the controls’ effectiveness. Based on insights shared from audit committee chairs, the Summary includes a list of example questions that audit committees may want to discuss with their auditors regarding risks related to remote work arrangements.
Increased audit committee communications with the auditor. The Summary notes that a majority of audit committee chairs cited COVID-19 as a basis for more frequent communication between auditors and audit committees. Among the topics audit committees may want to discuss with auditors, in light of COVID-19, the Summary lists a handful of considerations, including challenges to completion of the audit, the cadence of communication with auditors and management, changes in the audit plan and potential disclosure changes resulting from COVID-19.
The memo says that audit committee chairs reported three forms of auditor communication that they have found useful: discussions about trends auditors are seeing, particularly those pertaining to industry peers; presentations about audit areas that may require greater attention due to the pandemic, and audit firm resources and webinars with industry-specific content.
Last month, the SEC issued a rule proposal that would increase the reporting threshold for Schedule 13F filings from $100 million to $3.5 billion – and oh boy, do the commenters hate it! Here’s a comment that, while fiery, is also pretty representative:
This is complete bull. You are supposed to be protecting investors, not making it easier for billion dollar hedge funds to manipulate markets. This proposal is a terrible idea and runs directly counter to the principles upon which the SEC was founded. What is the SEC thinking? This reeks of corruption.
So far, it’s mostly been retail investors who have weighed-in – and I mean a lot of retail investors. (According to a piece in the NYT DealBook yesterday, more than 1,500 people have commented to date). Apparently, some outreach to Reddit users may help explain the volume of comments. The big guns may soon fire as well. NIRI is circulating a joint comment letter for public company issuers to sign (it’s available here), and other investor and business groups and public companies are expected to comment as the deadline approaches.
Supply Chains: SEC Reporting on China Forced Labor on the Horizon?
Companies with supply chains in China should be prepared to comply with enhanced due diligence & reporting requirements. That’s the conclusion of this Foley Hoag blog, which surveys recent legislative initiatives aimed at Chinese companies’ use of forced labor from Xinjiang and other regions of the country. One pending piece of legislation could even result in an SEC reporting requirement:
A measure with more serious potential repercussions for companies is H.R. 6210, the Uyghur Forced Labor Prevention Act. H.R. 6210 lists all companies found by the Congressional-Executive Commission on China to be suspected of using the forced labor of ethnic minorities in China. Most of the companies on the list are in the processed food and apparel industries. More importantly, the measure establishes a rebuttable presumption that all goods manufactured in Xinjiang are made with forced labor; accordingly, such goods are banned under the Tariff Act of 1930 unless the Customs Border and Protection Commissioner certifies otherwise.
The bill would also impose sanctions and visa restrictions on individuals and senior Chinese officials determined to be complicit in forced labor in Xinjiang. Additionally, H.R. 6210 requires companies to certify annually to the Securities and Exchange Commission that their products do not contain forced labor inputs from Xinjiang.
The prospects for the legislation’s passage are uncertain, but the Chinese government is taking it seriously enough to have imposed sanctions on one of the bill’s co-sponsors, Sen. Marco Rubio (R-Fla.) and on the Congressional-Executive Commission on China, for which he and another co-sponsor of the legislation, Rep. Jim McGovern (D-Mass.), serve as co-chairs.
EDGAR Problems: Now It’s Personal. . .
The technical problems plaguing the EDGAR system this summer became a full-blown crisis last night – and by that I mean they directly affected me for the first time. (We priced a debt deal last night & it took a couple of hours to get the term sheet filed.) I guess the problems have been so persistent that last week, the SEC decided that it needed to post a bit of an explanation:
The SEC staff has been deploying significant technical upgrades to the EDGAR system. While these upgrades follow extensive planning and testing, unexpected performance issues that have arisen have inconvenienced filers. We apologize for these difficulties and wish to assure filers that we are working diligently to resolve the issues.
The statement goes on to say that should you experience problems or have any questions or concerns, you may contact Filer Support at (202) 551-8900, option 3, or FilerTechUnit@sec.gov. I sometimes think it might be interesting to work for the SEC, but I’ll tell you what – I definitely wouldn’t want to be the poor soul you get connected to if you hit “option 3.”