April 6, 2021

April Fools’ Day? Materiality in the Age of “Stonks”

It wasn’t that long ago when discussions about the “materiality” concept focused on things like the efficient market hypothesis and the probability and financial magnitude of contingent events. Underlying all of these discussions was a core belief that the market prices of stocks generally moved for reasons that reflected investors’ rational assessments of the financial implications of new developments.  Yeah, well that was then & this is now.

Today, nothing seems to move the market for individual stocks quite like a rogue tweet, an internet meme, or – in the latest example of market mania – a dumb marketing department prank gone awry.  Of course, I’m talking about Volkswagen’s ill-conceived April Fools’ “Voltswagen” prank, which resulted in its stock popping by 10% before coming back to earth.  This CNN article says that the combination of the announcement & stock gyrations that followed may expose VW to liability under the federal securities laws:

Volkswagen of America says its “Voltswagen” name change was merely a joke “in the spirit of April Fools’ Day” to promote a new electric car. But even if it was meant as a lighthearted marketing gag, the move could land the carmaker in some serious trouble. The situation may have put the company at risk of running afoul of US securities law by wading into the murky waters of potentially misleading investors. “This is not the sort of thing that a responsible global company should be doing,” said Charles Whitehead, Myron C. Taylor Alumni Professor of Business Law at Cornell Law School.

Making a securities law issue out of this stunt seems kind of silly to me. Yes, I get the long-term importance to VW of moving to electric vehicles & how investors might be interested in a name change that signifies that importance – but c’mon, gimme a break! What I think this situation really does is illustrate the consequences of equating “materiality” under the securities laws with any information that might be “interesting” to an investor. That’s something courts have been concerned about for quite some time – for instance, here’s a quote from the 1st Circuit’s 1992 decision in Milton v. Van Dorn:

The mere fact that an investor might find information interesting or desirable is not sufficient to satisfy the materiality requirement. Rather, information is “material” only if its disclosure would alter the “total mix” of facts available to the investor and “if there is a substantial likelihood that a reasonable shareholder would consider it important” to the investment decision.

The reason for concerns about catering solely to investor desires when it comes to disclosure obligations is the risk that the Northway Court identified of setting materiality at such a low standard that companies will flood investors with “an avalanche of trivial information,” which obscures important data & doesn’t help a reasonable investor make an investment decision. In other words, courts are worried about creating what economists call “noise,” and I think those concerns are heightened during a period when the market seems to be a particularly noisy place.

Right now, we’re engaged in an important discussion about what non-financial information should be regarded as material under the securities laws.  If the SEC serves up new disclosure mandates intended to give investors “what they want”  without worrying about creating a lot of noise, its actions may end up lowering the overall quality & usefulness of corporate disclosures.

SEC Enforcement: Public Companies in the Cross-Hairs?

This Baker Donelson memo discusses expectations that the SEC will engage in intensified enforcement efforts on a number of fronts, and says that public companies are among other entities that should should expect greater scrutiny from the Division of Enforcement than they’ve received in recent years. Here’s an excerpt:

Chairman-designate Gensler testified at his March 2, 2021 confirmation hearing on several new areas of focus. Principal is the emphasis on new disclosure rules, which might require companies to report more about political contributions, workforce diversity, corporate governance, and the risks of climate change. Then, on March 4, 2021, the SEC created a Climate and ESG Task Force in the Division of Enforcement.

Another new focus would be on trading apps, like Robinhood, regarding whether investors get the best deals when such apps sell their trades for execution by market-making firms. Whereas former Chairman Jay Clayton emphasized cybersecurity issues and protecting retail investors under his Main Street investor initiative, more emphasis may now be placed on public companies (and possibly private equity and hedge funds, e.g., conflicts of interest) and issues such as inadequate disclosures, revenue recognition, and improper accounting.

The memo says that following the SEC’s COVID-19-specific pronouncements in March 2020 and thereafter about disclosure requirements and safe harbors for appropriate forward-looking statements, both SEC enforcement and private class actions can be anticipated. In addition, the memo suggests that companies in industries such as travel, health care, software, energy, and financial services, among others, may face enforcement actions similar to the proceeding that the SEC brought against The Cheesecake Factory late last year.

March-April Issue of “The Corporate Counsel” – New Podcast Coming Soon!

The March-April issue of “The Corporate Counsel” newsletter is in the mail (try a no-risk trial). It’s also available now online to members of who subscribe to the electronic format – an option that many people are taking advantage of in the “remote work” environment. The issue includes articles on:

– Climate Change Disclosures: Preparing for Staff Scrutiny
– The SEC’s Rule 144 Proposals: Our Suggestion to Combine the Form 144/Form 4 Filing Process Sees the Light of Day!
– SEC Eases Auditor Independence Rules

Dave & I have been doing a series of “Deep Dive with Dave” podcasts addressing the topics we’ve covered in recent issues (here’s the most recent one).  We’ll have a podcast for this issue up shortly, so be sure to check them all out!

John Jenkins