Monthly Archives: April 2021

April 30, 2021

Enforcement: SEC Targets 12b-25 Disclosure Deficiencies

Yesterday, the SEC announced enforcement proceedings against eight companies for alleged disclosure deficiencies in Form 12b-25 filings. Here’s an excerpt from the SEC’s press release:

Public companies are required to file the SEC’s Form 12b-25 “Notification of Late Filing,” commonly known as “Form NT,” when “not timely” filing a Form 10-Q or Form 10-K and seeking additional days to file their reports. Companies must disclose on the Form NT why their quarterly or annual report could not be filed on time, as well as any anticipated, significant changes in results of operations from the corresponding period for the last fiscal year.

The SEC orders find that each of the companies announced restatements or corrections to financial reporting within 4-14 days of their Form NT filings despite failing to provide details disclosing that anticipated restatements or corrections were among the principal reasons for their late filings. The orders also find that the companies failed to disclose on Form NT, as required, that management anticipated a significant change in quarterly income or revenue.

Without admitting or denying the SEC’s allegations, each company consented to C&D enjoining them from future violations of Section 13(a) of the Exchange Act & Rule 12b-25, and agreed to pay penalties ranging from $25,000 to $50,000.

It’s been a while, but these aren’t the first enforcement actions targeting 12b-25 filings. In 2003, the SEC brought an enforcement action against Spiegel for alleged shenanigans surrounding a Form 12b-25 filing, and it subsequently brought a separate action against the company’s former audit committee chair arising out of the same allegations. In 2005, the SEC brought an enforcement action against FFP Marketing (and the two employees responsible for preparing the filing) for deficient 12b-25 disclosure.

In the SEC’s press release, acting Enforcement Director Melissa Hodgman said that these actions were the latest in which the SEC used data analytics to identify difficult to detect disclosure issues. That’s something we blogged about last fall, when the SEC announced the first actions under its “EPS Initiative.”

Insider Trading Policies: Who Should be Subject to Your Blackout Period?

One of the questions that members frequently ask is which employees should be subject to a quarterly blackout period under an insider trading policies. There’s no “one size fits all” answer to that question, but this excerpt from WilmerHale’s new 2021 IPO Report (p. 22) provides a good summary of the reasons why some companies might answer this question differently than others:

Companies that have a relatively small number of employees or that have a corporate culture of broadly sharing information often apply these blackout periods to all employees. Many young public companies adopt this approach, particularly if they have only one principal facility and their employees have fairly open access to company information.

More established companies with large numbers of employees, multiple facilities and more restricted access to sensitive information typically apply blackout periods only to designated employees, such as management, finance, accounting and legal staff. Similarly, the company must decide which employees will be subject to the other provisions of the policy.

The memo cites surveys sponsored by our colleagues at NASPP & Deloitte concerning the scope of blackout period restrictions. The surveys, which were taken in 2014, 2017 & 2020, indicate that blackout prohibitions apply almost universally to Section 16 officers, directors, other members of senior management & employees with access to financial information or MNPI. However, only around 60% of those policies apply to middle management, and less than 50% apply to all exempt employees.

Securities transactions by companies & insiders are under increasing scrutiny from investors, regulators, and even Congress. Be sure to check out our July 20th webcast on “Insider Trading Policies & Rule 10b5-1 Plans”  for insights on the latest developments from our panel of experts!

A Fond Farewell to Anne Triola

After more than 20 years of service, our webmaster, Anne Triola, is retiring today.  Anne has handled posting of an often overwhelming volume of material on a daily basis, not to mention coding webcast transcripts, creating new practice areas, and performing 1,001 other tasks without which these sites would simply shut down. She’s always juggled the demands of multiple editors with good humor, great efficiency, and quiet competence.

Anne, thank you for everything.  We will miss you, and we wish you and your husband a happy and healthy retirement. Bon voyage!

John Jenkins

April 29, 2021

Virtual Annual Meetings: Handling the Q&A

The Q&A process at last year’s virtual annual meetings didn’t get rave reviews from investors. Companies say they’re better prepared this year, but I’d still suggest you take a look at this article in “The Shareholder Service Optimizer,” which provides some helpful tips on handling the Q&A process.

The article makes several suggestions, starting with including language in your proxy materials prominently welcoming & soliciting shareholder questions, and carefully explaining exactly how they can be submitted and how they will be answered. Here’s an excerpt about what you should do next:

A very good step-two: Invite shareholders to submit questions in advance, via an e-mail to your Investor Relations site. Some institutional investors have pooh-poohed this, as leading to cherry-picked questions and canned answers. But this is the easiest way, by far, for all concerned – and we have found this to be a very good indicator of the issues that are on the minds of the savviest and most interested shareholders.

It’s also a quick and easy way to “get the Q&A ball rolling…and it provides excellent opportunities to have the questions answered by the best-qualified person…which conveys a welcome “openness” to shareholder questions, helps to showcase the management team as a whole and adds much needed variety to the webcast. But this should definitely NOT be the only way you allow questions to be asked.

The article includes a number of other practical suggestions to improve your Q&A period, and concludes by advising companies to commit – up-front – to answering all shareholder questions asked, prior to and during the meeting, and then to promptly post the answers on the investor page of the company’s website.

Virtual Annual Meetings: Mishandling Shareholder Proposals

Shareholder proposals were another aspect of last year’s virtual annual meetings that didn’t always go smoothly, and this recent blog from Soundboard Governance’s Doug Chia provides some advice to companies about what not to do when dealing with a shareholder proponent at a virtual meeting.  This excerpt discusses how companies have muzzled proponents by limiting their ability to talk about their proposal:

This leads me to the stories about issuers’ placing strict substantive limits on presenting shareholder proposals at VSMs. These instances involve issuers dictating what proponents can say:

(1) Requiring the proponent to provide a very short written statement (e.g., 100 words), to be read by management at the meeting in lieu of the proponent speaking in their own voice by phone or audio recording.

(2) Requiring proponent to stick to a prepared script provided by the company, based on the proposal and supporting statement in the proxy statement.

(3) Limiting the proponent to only the exact words of the proposal and supporting statement as printed in the proxy statement… and citing the SEC rules as the source of this limitation.

The blog acknowledges that abuses like these were outliers, particularly among large cap companies. But actions like this also risk alienating investors & making the company a corporate governance poster child – and while companies may not be seeking a governance “gold star” for their virtual meetings, they also don’t want to stand out from the pack in a negative fashion.

SEC Enforcement Chief Resigns

Last night, the SEC announced that Enforcement Director Alex Oh was resigning from the position that she was appointed to last week.  This NYT article provides some background on her decision.  Melissa Hodgman, who served as acting Director prior to Alex Oh’s appointment, will return to that role.

John Jenkins

April 28, 2021

SPACs: Pop Goes the Bubble?

Last week, Liz blogged that the SPAC bubble was leaking. This week, S&P Global declared that the bubble has popped – and that SPACs have gone the way of tulips & dotcoms:

Even for a financial mania, SPACs didn’t last long. These highly speculative schemes have whipsawed from nowhere to everywhere and now back to nowhere – all in a matter of months. Live fast, die young.

Our obituary for the short-but-colorful life of special purpose acquisition companies (SPACs) is a bit facetious, of course. But there’s no denying, to use a metaphor favored by cynical Wall Streeters who have seen this sort of thing before, that the SPAC bubble is no longer being pumped up like it had been. Why the deflation? SPAC saturation.

In Q1, an average of more than 90 new US-listed blank-check companies each month successfully raised money from investors, according to S&P Global Market Intelligence. So far in April, the rate of issuance has plunged about 80%, with the full-month total tracking to just 14, our data indicates.

The article notes that instead of investors, the group that’s looking most closely at SPACs right now seems to be the SEC – and that’s a pretty clear signal “that a boom has gone bust.”  That may be true when it comes to IPOs, but there’s a whole lot of money sloshing around in SPACs that are desperately chasing de-SPAC deals, so it’s likely that there’s another chapter in the SPAC boom story that has yet to be written.

NFTs: Playboy Hits the Jackpot 

I really wasn’t planning to blog about “non-fungible tokens,” or NFTs, which in case you haven’t heard are the latest grift gift from the Blockchain crowd. As befits my grumpy boomer persona, I’m as dubious about the merits of NFTs as I am about the merits of crypto.  But then I saw some news that made me think that if I were a little less jaded about innovations like these – and the prospects of certain adult-oriented SPACs  –  I’d have a few more dollars in the bank.

A few months ago, I blogged about how Playboy Enterprises was looking to merge with a SPAC.  I  dismissed Playboy’s business prospects as being out of step with the zeitgeist & the transaction as perhaps representing “peak SPAC.” As usual though, I was the one who was out of step.  According to CNBC, Playboy’s stock is up over 80% this month alone & 173% since February.  Why? Apparently dirty pictures & NFTs are a match made in heaven:

These days, announcing a new investment in a legacy media business is enough to draw a raised eyebrow. That is, of course, unless the company is reinvented nude magazine publisher Playboy — now PLBY Group — whose stock has surged more than 80% this month due in large part to excitement over how it can take advantage of the hot NFT market.

And Playboy certainly has unique offerings. “Look, we have an unbelievable archive, 68 years. It is the 5,000 pieces of art we have, it’s covers, it’s photography. It is so deep and rich in what’s in there,” CEO Ben Kohn said on the company’s earnings call last month.

Playboy, which went private in 2011 amid declining ad sales from its eponymous nude magazine, rejoined the public markets in February with a management laser-focused on modernizing a company once known for its leading market share of pubescent closets.

Yeah, I did not see that one coming. But I kind of saw this one coming – the Jim Hamilton blog recently flagged a petition for proposed rulemaking calling for the SEC to clarify the status of NFTs & NFT platforms under the federal securities laws. The petition was submitted by Arkonis Capital, and is a pretty sophisticated piece of work. If you’re working in this area, it’s definitely worth reading.

NFTs: Your Wu-Tang Clan Update

Since they’ve never been ones to sleep on a trend, I’m sure it will come as no surprise to regular readers of this blog that America’s most entrepreneurial hip-hop artists have already launched their own NFTs. This article from The Observer has the details on the Wu-Tang Clan’s move into the world of non-fungible tokens:

Within the music and recording industry, gimmicks are essential to keeping the wheel of capital and cultural production churning. In other words, gimmicks are nothing to be ashamed about because they tend to be extremely effective: back in March of 2014, the legendary rappers of the Wu-Tang Clan announced that they’d only be selling a single copy of their forthcoming album, Once Upon a Time in Shaolin.

The album eventually sold for around $2 million to the notorious “pharma bro” Martin Shkreli, but the stunt had proven that novel ways of selling music were still to be discovered. Now, that new frontier has arrived: recently, the Wu-Tang Clan announced that they’d be selling 36 copies of a 400 page coffee table book about their legacy in the form of NFTs, or non-fungible tokens.

Before you decide to turn to Ghostface Killah or RZA for investment advice, I would caution you that not all of their business ventures turn out to be as lucrative as Once Upon a Time in Shaolin.  As for me, I’ve learned my lesson from Playboy & have given up on conventional investment strategies. I’m cashing in my 401(k) and putting it all in Dogecoin.

John Jenkins

April 27, 2021

Stakeholder Capitalism: Lessons From The Super League Fiasco

The rise of non-financial priorities in corporate governance and the focus on corporate purpose has attracted a lot of attention in recent years.  Some have dismissed the increasing corporate emphasis on “stakeholder” interests & ESG issues as “woke capitalism,” which one pundit recently defined as the belief that “businesses ought to obey orders from the progressive elite, regardless of how thin its connection to any company may be.”

I’ll be the first to admit that some of this stuff is downright silly, but I don’t think this phenomenon can be tossed aside with a talk radio sound bite like “woke capitalism.”  It seems to me that there’s something deeper going on, and that the recent Super League fiasco provides some insight into what that might be.

In case you’ve been living under a rock, last week, some of Europe’s wealthiest & most successful soccer teams decided to strike out on their own with an exclusive, multi-national “Super League.”  While it was announced with great fanfare, the Super League imploded almost immediately. Fans, players, coaches, and even governments all expressed outrage over the attempted greed grab. The reaction appears to have caught the league’s organizers & financial backers by surprise. It shouldn’t have, and this excerpt from a recent Axios newsletter explains why:

A small group of 12 ultra-elite soccer clubs had access to the finest strategy, polling and public relations advice that money can buy. The deal they unveiled on Sunday night was years in the making. But they and their advisers missed something big — that society as a whole is now willing to forego wealth if it means more equality.

– Brexit made almost everybody in Britain worse off, for instance — but it also hit the rich London cosmopolitans and bankers the hardest.

– The Fed is openly embracing the prospect of higher inflation — something that erodes wealth and hits rich savers, while inflating away the debts of the poor.

The article sums up the current zeitgeist by stating that “when the source of a company’s profits is manifestly unfair, those profits are more likely than at any time in decades to be facing existential threats.”  If you buy that conclusion, then business leaders aren’t falling in line with progressive elites – they’re just “reading the room.”  Many appear to have decided that society’s decades-long embrace of “winner take all” capitalism is coming to an end, and that their companies need to think & act differently in order to continue to prosper in a more egalitarian environment.

Of course, so far this new attitude among business leaders hasn’t extended to their own compensation, but perhaps we can hope for a “Super League moment” there in the not too distant future as well.

#MeToo: Impact on CEO Employment Contracts

Speaking of executive comp, the Conflict of Interest Blog recently flagged a new study reviewing the impact of the #MeToo movement on the terms of executive employment agreements.  This excerpt from the study’s abstract indicates that the growing public outcry about sexual misconduct has prompted companies to take a more aggressive approach when it comes to “for cause” termination provisions:

In the wake of MeToo, we find a significant and growing rise in the prevalence of contracts that allow companies to terminate CEOs without severance pay in response to harassment, discrimination, and violations of company policy. We discuss the implications of these “MeToo termination rights” for corporate governance, executive contracting, and gender equity. We conclude that our results offer promising evidence of increased corporate control of CEO behavior and greater accountability for sex-based misconduct in the wake of the MeToo movement.

The study reviewed over 400 CEO contracts and found that publicly traded companies are reserving greater discretion to terminate executives for sex-based misconduct in statistically significant numbers. The authors say that by “insisting on expanded contractual definitions of ’cause’ to terminate, these companies are signaling to CEOs that such behavior will not be tolerated, while ensuring that corporate boards are reducing the costs of penalizing wayward CEOs.”

The authors also suggest that the changes resulting from the #MeToo movement prove that the terms of CEO employment agreements aren’t immune from “exogenous shocks,” which gives some reason to believe that hopes for a Super League moment in executive comp may not be in vain.

PPP Loans: Seeking Forgiveness? If You’re a Gov Contractor, Think Twice!

For most companies, the decision to seek forgiveness of a PPP loan is the proverbial “no-brainer” – but this Hunton Andrews Kurth memo says that’s not necessarily the case if the borrower is a government contractor. Here’s an excerpt:

For government contractors, however, the rules are very different. If a government contractor received a PPP loan and thereafter obtains forgiveness of that loan, it is required to credit the amount of the forgiveness back to the government. For the reasons set forth below, a government contractor should carefully consider whether seeking forgiveness of a PPP loan makes good business sense. In some cases, government contractors might be worse off financially if they obtain forgiveness of that PPP loan than if they simply pay it back.

The problem is that the federal acquisition regulations make it clear that a contractor that has already received payment for contract costs cannot also receive PPP Loan forgiveness funds for those identical costs. The memo notes that this isn’t just an academic issue – the DOJ is aggressively prosecuting fraud in PPP loans, and while this issue hasn’t yet come up, there’s no reason that it couldn’t. What’s more, there are also potential issues under the False Claims Act that need to be taken into account.

PPP loans have pretty borrower-friendly terms, so although each company’s situation is different, for some government contractors, the economics of simply repaying the loan in accordance with its terms may be more favorable that seeking forgiveness.

John Jenkins

April 26, 2021

New Russia Sanctions May Prompt “Iran Notice” Disclosure

On March 2, 2021, the Secretary of State designated various entities affiliated with Russia’s government, including the FSB, as parties subject to Executive Order 13382 for “having engaged, or attempted to engage, in activities or transactions that have materially contributed to, or pose a risk of materially contributing to, the proliferation of weapons of mass destruction.”  This designation was prompted by the poisoning of dissident Alexander Navalny, and may result in some public companies that do business in Russia being required to provide the disclosure and accompanying “Iran Notice” filing contemplated by Section 13(r) of the Exchange Act.

This Bryan Cave blog reviews the scope & implications of the new sanctions designations, including the potential disclosure obligations for public companies with business in Russia:

Importantly, the additional sanctions designations pursuant to EO 13382 may trigger reporting to the SEC pursuant to Section 13(r)(1)(D) of the ’34 Act. Although Section 13(r)(1) of the ’34 Act is typically associated with the sanctions against Iran, some of the reporting triggers are broader than just transactions involving Iran. Among the broader triggers are any transactions or dealings knowingly conducted with “any person the property and interests in property of which are blocked pursuant to Executive Order No. 13382.”

Based on this, parties that engage in transactions with any of the parties now blocked pursuant to EO 13382 in connection with the Navalny poisoning must be cognizant of these reporting requirements if the party is an issuer or the affiliate of an issuer required to report on a periodic basis to the SEC.

There are a number of Russian entities subject to the sanctions, but the big kahuna is the FSB.  As this Hogan Lovells memo notes, the FSB plays a prominent role in licensing the importation of IT and other encryption products into Russia. Notification to or approval by the FSB may be necessary for a variety of technology products, including “laptops and smartphones, connected cars, medical devices, software, or any other items that make use of ordinary commercial encryption.” 

OFAC updated General License No. 1B to confirm United States persons may continue to interact with the FSB for purposes of qualifying their products for importation and distribution in Russia, but that license doesn’t include an exemption from providing the disclosure required by Section 13(r) of the Exchange Act or from filing the accompanying Iran Notice with any annual or quarterly report.

10b5-1 Plans: CII Calls for Mandatory Disclosure in Form 4s & 5s

One of the items included in the batch of Rule 144 amendments that the SEC proposed last December was a provision that would add a check box to Forms 4 and 5 to provide filers the option of disclosing that their sales or purchases were made pursuant to a Rule 10b5-1 plan. Last month, the CII submitted a comment letter on the proposal calling for that disclosure to be made mandatory. Here’s an excerpt:

We, however, would respectfully request that this provision be revised to require: (1) “Form 4 and Form 5 to indicate via a check box whether their reported transactions were made pursuant to Rule 10b5-1(c) rather than provide it as an option for the filer[;]” and (2) disclosure of the adoption date of the respective Rule 10b5-1 plan on the forms.

Our requested revision is consistent with our long-standing belief that providing greater transparency of Rule 10b5-1 transactions would provide useful information to investors and other market participants.

Don’t be surprised if this recommendation gets some traction. The CII’s comments come on the heels of other recent calls for more transparency about 10b5-1 plans – as well as proposed legislation passed by the House of Representatives last week that would direct the SEC to “study and report on possible revisions to limit the ability of issuers of securities and issuer insiders to adopt Rule 10b5-1 trading plans.”

Hertz: Who’s the Sucker Now?

Last summer I made fun of the “suckers” who were buying Hertz common stock while the company was in bankruptcy and after it disclosed that it would take a miracle for equity holders to realize any recovery.  Well guess what? The bankruptcy process launched a bidding war, and now the equity’s in the money. Here’s an excerpt from this WSJ story on the deal:

Hertz proposed in a chapter 11 exit plan on Wednesday that current stockholders receive warrants to purchase up to 4% of the restructured business, the first time the company has said it is worth enough to distribute some value to its owners. The shareholder distribution would amount to a recovery of 60 to 70 cents per share, a “material return to equity,” Hertz lawyer Thomas Lauria said during a court hearing Wednesday.

If approved by the U.S. Bankruptcy Court in Wilmington, Del., that outcome would make Hertz a relative rarity in corporate bankruptcies, in which equity ranks behind debt and most often is wiped out.

In my defense, Hertz stock was trading at over $5 per share last June, so it was a sucker bet at that price – although this deal could still be topped, and there might even be more money on the table for the stockholders.

John Jenkins

April 23, 2021

The Returning Influence of Retail Investors: This Year’s “Sleeper Issue”?

The retail segment of shareholders had been holding steady around 30% the last couple of years, well below the 85% levels of the 1960s, before the dawn of huge asset managers. But now we’re in the age of stonks – and no-fee trading platforms. Although some are noticing that retail trading is slowing, there’s no denying that the number of retail accounts has swelled in the last year. Kris Veaco wrote me last week to say that it’s the fastest growing group of investors – some proxy intermediaries have noticed an uptick of 50% in email accounts compared to last year!

As I’ve noted a couple of times on our Proxy Season Blog, companies need to anticipate higher proxy distribution costs if they’ve seen a jump in retail holders. You may also need to brace yourselves for less predictable voting outcomes – especially with TD Ameritrade’s elimination of broker discretionary voting.

But there’s also an opportunity here – retail investors can be long-term, loyal supporters of management, and may also be enthusiastic participants in capital raises. This NYT article reports that some companies are rolling out the red carpet to welcome them – even changing the earnings release process to allow for more interaction with individuals. Here’s an excerpt (also see this Axios article):

After reported its quarterly results last month, executives at the company, which sells replacement auto parts, did what many of their ilk do: They held a conference call with Wall Street analysts, fielding questions about inventory levels, profit margins and corporate strategy.

Roughly 30 minutes later, the same executives were on Clubhouse, hosting an entirely different kind of audience. Their 2,000 or so guests had gathered at the buzzy online meeting spot to learn about the company. Their questions were far more straightforward. How did the business work? Why was able to offer lower prices than brick-and-mortar rivals? Were shares worth buying? isn’t the only company to do this – Restaurant Brands International also invited “customers & guests” to discuss Q4 earnings with its leaders on Clubhouse, and other companies are using podcasts and YouTube to reach the retail audience. Tesla has also been using the interactive “Say” platform for earnings calls for a while now – I blogged a couple of years ago about the impact that was having on the Q&A portion of the call.

The thought of extra conversations with different groups of investors makes me a little skittish – but as long as execs comply with Reg FD, it seems like it’s probably fine to do. Please correct me if you disagree!

New Director of SEC Enforcement: Alex Oh

Yesterday, the SEC announced that Alex Oh has been appointed Director of the Division of Enforcement. Alex was most recently a partner at Paul, Weiss – where she co-chaired the firm’s Anti-Corruption & FCPA Practice Group and had an extensive pro bono practice. She also has prior experience as an AUSA in the Criminal Division of the U.S. Attorney’s Office for the Southern District of New York, where she was a member of the Securities & Commodities Fraud Task Force and the Major Crimes Unit. Thank You – And More Trees!

I want to give a huge “thank you” to those of you who subscribed to our new blog on its very first day – we are so excited to begin this journey with you.

Our Earth Day launch offer of planting a tree for the first 422 subscribers was way more popular than we anticipated! We actually ran out of the allotted trees.

So we got more. Now, the first 1000 subscribers will have a tree planted on their behalf! Click here for your subscription and tree.

Liz Dunshee

April 22, 2021

It’s Here: “” – Sign Up Today! is here! To celebrate our Earth Day launch, we’re planting a tree in the name of the first 422 people who sign up to receive the free blog in their inbox. Sign up now and get your honorary tree!

As I blogged a few weeks ago, I’m thrilled that Lawrence Heim has joined our team to lead this new ESG platform. With Lawrence being a longtime ESG professional, you’ll be able to use his daily updates and more than 30 years of experience to get practice pointers and real talk on developments that affect your sustainability programs – including how to manage ESG data tracking and reporting.

Eventually, will be home to membership-based portals that take a deeper dive into environmental, social & governance issues. We’ll be unveiling those features in the coming months, and of course we’ll also continue to cover corporate governance, proxy season issues and SEC rulemaking here on

Remember, help us celebrate by signing up for Lawrence’s free daily blog and getting a tree planted in your name!

More on “Senate Confirms Gary Gensler as SEC Chair”

Lynn blogged last week that the Senate had confirmed Gary Gensler’s nomination as the next SEC chair. He’s now been sworn in, meaning all 5 Commissioners are now in place! And while the original confirmation ran only through June 5th of this year, the Senate has now also approved (54-45) his nomination for the succeeding 5-year term that ends June 5th, 2026.

Transcript: “Shareholders Speak: How This Year’s Expectations Are Different”

We’ve posted the transcript for our recent webcast: “Shareholders Speak: How This Year’s Expectations Are Different.” If you’re gearing up for your annual meeting – or shareholder engagements – you’ll want to check this out. Sustainable Governance Partners’ Rob Main led a program with Yumi Narita of the Office of the NYC Comptroller, Ryan Nowicki of State Street Global Advisors, and Danielle Sugarman of BlackRock. Among the topics covered:

– Key 2021 Priorities

– Voting Expectations

– Changes to In-Season Engagements

Liz Dunshee

April 21, 2021

Materiality: Traditional, New, Double or Dynamic?

As if “materiality” under the securities laws wasn’t a difficult enough concept, investors supporting various ESG frameworks and standards have been adding to the complexity. Responsible Investor published a short piece that summarizes comments submitted by six global asset managers on the IFRS 2020 Consultation on sustainability reporting. Unfortunately for those working on the company side, it means having to play “mix and match” with ESG reporting frameworks to try to satisfy multiple investor mandates.

To break it down, we have:

1. Traditional materiality, which relates matters that are directly linked to financial impacts from the viewpoint of the “reasonable investor”. As has been long established. traditional materiality focuses on financial risks TO the company. SASB takes this approach with its standards.

2. What I call “new materiality,” reflecting the perspective of stakeholders and impacts of a company. New materiality goes beyond a pure financial perspective and compels companies to evaluate their impact ON stakeholders and the communities in which they operate. This is the direction GRI takes in its reporting framework.

3. “Double materiality,” which encompasses both traditional and new materiality matters. Under the EU Non-Financial Reporting Directive (EU NFRD), companies are required to assess and report on both financial and non-financial matters. The European Financial Reporting Advisory Group (EFRAG), which advises the European Commission, follows the double materiality path.

4. “Dynamic materiality” – a concept acknowledging that materiality is a moving target, stemming from the idea that “stakeholders of companies have the capacity to determine what is material for a company” enabled by technology and social media. Some see this as similar to traditional materiality (in that as new information becomes known, it adds to what is important to investors in the total mix of information); others may liken it to The Blob of materiality.

Traditional Materiality: Financial Costs and Risks

This is using the old-school materiality lens (i.e., TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976)) to a company’s ESG matters. The archetypal approach would be to gather and evaluate input from a variety of corporate departments/functions to reflect the multidisciplinary nature of ESG. However, counsel should assess potential liabilities to disclosing as newly material an activity or matter that is itself not new. In other words, why was something not considered financially material previously? Given that the SEC issued guidance on climate change disclosures in 2010, some may question why climate matters were not disclosed in the past.

New Materiality: Non-Financial Impacts Beyond the Fenceline

The two critical elements of new materiality that radically differ from traditional materiality are:

– Assessment and consideration of things that don’t directly affect corporate finances, or may be contingent/not estimable.

– Assessment and consideration of external stakeholders beyond investors. There is a hidden recursive double-whammy here as it requires understanding both what information external stakeholders consider important, and how the stakeholders will react (which rather depends on the extent and nature of the information made available to them).

A good overview of new materiality is here.

Double Materiality: What Does Commissioner Peirce Think?

Acting Corp Fin Director John Coates suggested last month that global comparability would be a desirable thing for ESG reporting. Although he laid out some advantages to doing that, it doesn’t seem like people are rushing to embrace the idea.  SEC Commissioner Hester Peirce made a statement last week to caution against a move toward global sustainability reporting framework. In particular, she took issue with the “double materiality” – here’s an excerpt:

The European concept of “double materiality” has no analogue in our regulatory scheme and the addition of specific ESG metrics, responsive to the wide-ranging interests of a broad set of “stakeholders,” would mark a departure from these fundamental aspects of our disclosure framework. The strength of our capital markets can be traced in part to our investor-focused disclosure rules and I worry about the implications a stakeholder-focused disclosure regime would have. Such a regime would likely expand the jurisdictional reach of the Commission, impose new costs on public companies, decrease the attractiveness of our capital markets, distort the allocation of capital, and undermine the role of shareholders in corporate governance.

Let us rethink the path we are taking before it is too late.

Dynamic Materiality: “Anything You Say Can and Will Be Held Against You”

The idea of dynamic materiality has potential significant legal uncertainty and complexity, but may also be an accurate reflection of where things stand today. As John pointed out a couple weeks ago, what is “material” took a recent odd (perhaps scary) turn when a supposed April Fool’s day joke by VW didn’t go as planned.

Richard Levick has long helped companies with crisis communication strategies (he also spoke on a webcast for us a couple years ago about “Politics as a Governance Risk” – even more relevant now).  Richard recently wrote about companies being stuck between Scylla and Charybdis on responding to social issues of the day:

Brand neutrality is dead… Political contributions have become the new supply chain liability. But so is your DEI, environmental footprint, labor practices and more.

In the past, companies feared consumer boycotts. Today, the speed, ubiquity and ease of global social media – combined with intangible assets (including brand value) making up 90% of current company market valuation – make reputational risk a material matter regardless of which materiality you choose. And that could make an argument validating dynamic materiality.

– Lawrence Heim

April 20, 2021

Biden to Issue Executive Order for Climate Disclosure

President Joe Biden is set to issue an executive order on climate disclosure within capital markets, according to John Kerry, the US Presidential Special Envoy for Climate. Details are not available yet, but that one sentence pretty much says it all.

Theranos Redux? Why Governance Needs to Underpin E&S Commitments

Meeting greenhouse gas emissions/climate challenges will be a monumental undertaking for years to come and will require an array of solutions, some of which haven’t even been invented yet. Solutions will offer technological advances, social/environmental benefits and huge business opportunities. Fortunately for everyone, some will be successful and beneficial. Others may do more harm than good.

This Bloomberg article about a carbon capture company caught my attention for several reasons. One is that some form of ambient CO2 capture may be necessary to achieve reduction targets. But another reason is that in my years of auditing and fraud training, I’ve become somewhat competent in spotting patterns/trends in data and behavior. And – based solely on that piece – I see eerie similarities here to Theranos. And there is more reason this is top of mind given this week is the 20th anniversary of the Enron failure. This company is painting itself as a savior, but is it realistic?

Most companies know that chasing “E” goals needs to include using internal “G” processes and staff (indeed, the SEC’s recent Risk Alert on The Division of Examinations’ Review of ESG Investing points out this very thing). Here’s another reminder to proceed with caution. If you’re making public commitments of environmental/social progress based on third-party performance, you need to vet the service and qualify your statements. You may wind up with more risks & liabilities than you bargained for, especially if the third party doesn’t make good on their own promises.

Environmental Solutions & “The Law of Unintended Consequences”

Let’s look at an interesting element of technical solutions (such as carbon capture) that companies could end up getting dinged for: secondary impacts. Newton’s Third Law (with some poetic license) holds true in environmental solutions – a solution that solves one problem may create a secondary problem.

What is a “secondary impact”? In my view, a secondary impact is a meaningful environmental effect (or risk) that is created as a result of the intended benefit. Two examples of this are:

– I once visited a client site that had spent quite a bit of money to reduce their Scope 2 emissions (those that are associated with power purchased from the utility). The centerpiece of the reduction strategy was an on-site company owned and operated fuel cell. What the company had overlooked is that the fuel cell chemistry resulted in CO2 emissions that drastically increased the site’s Scope 1 (direct) emissions. I don’t recall the absolute emissions numbers and whether this resulted in an overall CO2 emissions reduction given the electricity production, but it had a real impact on how emissions were reported.

– An article on the Japan shipping industry’s evaluation of capturing and converting CO2 into methane as a fuel points out implementing the technology “would mean developing special vessels to transport the CO2. Key to commercialization would be the viability of shipping CO2 long distances.” So… transporting large volumes of CO2 in ocean vessels to reduce CO2 emissions from other ocean vessels? That’s a head scratcher.

This article from the Yale School of Environment also describes negative latent impacts of large scale tree planting.

… planting programs, especially those based on large numerical targets, can wreck natural ecosystems, dry up water supplies, damage agriculture, push people off their land — and even make global warming worse.

Unintended consequences can also show up as product issues that affect the business. More examples:

– Increasing the water recycling/reuse rate at one paper mill I audited years ago saved water and money, but made the paper turn brown. The mill was unable to remedy the problem and ended up reducing their water reuse.

– In order to reduce waste and save on raw material costs, one company dramatically increased their used product recovery and repair rates. Because the used products had to be washed before being put back into circulation, the more they upped their recovery, the more water they used.

The moral of the story is that companies should thoroughly evaluate identified solutions in advance. Use a wide angle “life cycle” view to eliminate surprises – and encourage directors to ask difficult questions.

– Lawrence Heim

April 19, 2021

SEC Reopens Comment Period for Universal Proxy!

On Friday afternoon, the SEC announced that it voted to reopen the comment period for the 2016 “universal proxy” proposal – which would amend Schedule 14A and related rules to require the use of a single proxy card in all non-exempt solicitations for contested director elections.

Last summer, it looked like this rule was nearing the finish line – and Acting SEC Chair Allison Herren Lee noted just last month that it was still on the near-term agenda. But – and this might be the greatest understatement to ever appear in this blog – a lot has happened since these amendments were proposed in October 2016. The 15-page reopening release says that the Commission wants more input in light of corporate governance developments that could affect how universal proxy cards work, such as:

– There have been several contests where one or both parties have used a universal proxy card

– Increased adoption of proxy access bylaws

– Use of virtual shareholder meetings

– New forms of advance notice bylaws that require dissident nominees to consent to being named in the company’s proxy statement and on its proxy card

The release identifies 25 topics on which the Commission would appreciate input – about half relate to fund-specific issues. The formal comment period will be open for 30 days after the release is published in the Federal Register, which often takes about a month. Here are all the comments submitted to-date. For even more background, see this Cooley blog.

The SPAC Bubble Is Leaking

The SEC’s recent scrutiny of SPACs (which we’ve blogged about repeatedly) appears to be sidelining some deals. According to this WSJ article, there were only 12 SPAC offerings in the past 3 weeks. That compares to about 25 per week from January – March!

Last week, the CII Research & Education Fund also released this 17-page memo to investors. While it doesn’t expressly advocate against the SPAC model of going public, it does identify several reasons why the SPAC/de-SPAC process is particularly risky.

The memo notes that at particular risk are SPAC investors who elect not to redeem their shares in the de-SPAC transaction, especially if the combined company adopts weak shareholder rights provisions – like a dual-class share structure. It suggests that these investors may be better off by either selling or redeeming before the de-SPAC, or by negotiating a favorable subscription through a PIPE.

Although the memo is aimed at investors, it’ll also be helpful to companies and advisors who are considering SPAC deals. Not only does it foreshadow investor demands that could be coming in the future, it also examines & pokes holes in some perceived SPAC benefits. Here are a couple that caught my eye:

Speed to Market: From the standpoint of the private company entering the public markets through a de-SPAC, the process is sometimes touted for beingfaster than a traditional IPO. But is that speed meaningful, and does that speed benefit investors? The typical timeline for a de-SPAC is 10 weeks, while a traditional IPO usually takes 19 weeks, but preparation for IPOs tends to extend this difference. Investors should be aware that a speedier time frame may attract a pool of operating companies that is disproportionately focused on capitalizing on a hot market, a hot sector or “short-term fads.”

Underwriting Costs: Underwriting fees for SPAC IPOs are based on a percentage of the proceeds raised, as with traditional IPOs. However, it is important to keep in mind that due to a SPAC’s redemption phase, cash raised can be different from cash received. The nominal fee percentage is often lower for SPACs than the usual 7% fee for traditional IPOs. It is unusual for SPAC underwriting fees to be adjusted for redemptions at the time of the de-SPAC. Without adjustment, that “attractive” 5% underwriting fee with a redemption rate of 50% is the equivalent of the merged company paying 10%.

Voting Statements: Can Anything Be “Non-Partisan”?

As I blogged a few months ago, businesses are now the most trusted institution in society. Unfortunately, that also means that 86% of people now expect CEOs to speak out on social challenges. Last week, hundreds of executives, companies, law firms and non-profits did just that – by signing their names to this 2-page ad in the WaPo and NYT.

The statement at the top of the ad is only 8 lines long and speaks of the importance of democracy. The two lines that drew the most attention (and were reportedly the most difficult to agree upon) were:

We all should feel a responsibility to defend the right to vote and to oppose any discriminatory legislation or measures that restrict or prevent any eligible voter from having an equal and fair opportunity to cast a ballot.

Voting is the lifeblood of our democracy and we call upon all Americans to join us in taking a nonpartisan stand for this most basic and fundamental right of all Americans.

Of course, the statement and the reporting on it was immediately criticized as partisan. People were looking to see whether or not their employers and local companies had signed, etc. I’ve been waiting for a statement from the Center for Political Accountability – haven’t seen one yet – about whether and how they’ll use companies’ endorsement/lack of endorsement in political spending proposals. (As this ICCR release notes, 81 institutional investors did send a statement on the risks of political spending to members of the Business Roundtable back in February.)

What’s clear is that this type of thing is very difficult for companies and their leaders to navigate. You’re bound to anger some people regardless of what you say. You’re bound to anger some people if you remain silent (contrary to some opinions that that’s typically the safer choice). And then, whatever choice you make is viewed through a lens of suspicion. Are you grandstanding? Who are you trying to appeal to? Have you said or done anything contradictory in the past?

This Perkins Coie memo outlines a framework for deciding when to speak out. It also lists a few factors that could trigger lobbying or ethics rules that you need to watch out for:

– Is the topic in which the company is engaging related to an election or ballot measure? If yes, the laws in many jurisdictions limit election-related activity but do not bar it entirely. For example, federal law provides corporations a number of opportunities to engage in voter registration, get out the vote, and other civic engagement activities as long as they do so on a nonpartisan basis. (Federal Election Commission regulations have specific requirements for what counts as nonpartisan in this context.)

– If the company is speaking out on legislation, is the bill still pending, or has the bill been passed and signed into law? Speaking out about a bill that has already been enacted will rarely be regulated (though companies will also have to weigh whether such after-the-fact statements are effective in addressing their strategic goals).

– If the legislation is still pending, does the communication or other activity include a call to action? A call to action is a statement urging employees, customers, or members of the public to contact their government official to support or oppose legislation or some other government action. Some jurisdictions do not regulate statements that don’t include a call to action.

– If the legislation is still pending, is the company paying to promote the communication in any way, such as by taking out a print or digital ad campaign or paying to boost social media posts? Some jurisdictions treat paid and unpaid content differently for ethics and compliance purposes.

At a bigger-picture level, this Korn Ferry memo makes the case that defining core values is now more important than ever. It sounds a little “woo-woo,” but clear values can give you something to lean on and return to when a novel issue arises. The devil’s in the details, though, because you have to make sure these values are consistently applied, and consistently articulated internally & externally. And while CEOs may have their own personal values that drive decisions, remember that CEO tenure averages about 7 years. Company values should be tied more to stakeholders than who is currently at the helm.

It’s also important to note that, at least for now, shareholders don’t appear to be making buy/sell decisions based on the statement or the ensuing commentary. This Economist article points out that after the ad was published, stocks performed almost identically for companies that did and didn’t sign.

Liz Dunshee