Yesterday’s WSJ had an article on what aspects of Rule 10b5-1 plans are being scrutinized by the SEC. Not surprisingly, the list generally lines up nicely with the priorities Gary Gensler identified in his June 2021 speech to the WSJ’s CFO Summit. Single-trade 10b5-1 plans weren’t addressed in that speech, but the article suggests that they may be on the SEC’s list as well. This excerpt provides some insight on the reasons why the SEC might be interested in this topic:
Many 10b5-1 plans steadily sell shares, whether the stock is up or down. Facebook’s Mark Zuckerberg, for example, has sold consistent volumes of shares at regular intervals since at least August 2019, according to InsiderScore data. “Those plans that are selling routine amounts of shares every month over multiple years; that’s what the plan was intended for, to sell shares slowly over time,” said Daniel Taylor, an accounting professor who runs the Forensic Analytics Lab at the University of Pennsylvania’s Wharton School and one of the authors of the January study of trading under plans.
But about a third of plans since 2004 involve just a single trade, according to InsiderScore data. (Because documentation is scant, researchers can’t differentiate between plans that intended to execute a single trade and those that planned for multiple trades but were terminated after the first sale.) Single-trade plans outperformed multi-trade plans regardless of the timing, according to Mr. Taylor’s research. “When it’s a single-trade plan, it’s abusive,” he says.
That “January study” referenced in the excerpt is this Stanford study, which included single-trade plans in its list of three “red flags” for opportunistic use of 10b5-1 plans (the other red flags were a short cooling-off period & adoption of plans in a quarter that begin trading prior to the announcement of earnings). Here’s what the study had to say in support of its recommendation to prohibit single-trade 10b5-1 plans:
In the extreme, if the plan is designed to execute only a single trade, it is economically equivalent to a traditional limit order (or date-triggered order). Single-trade plans are inconsistent with traditional financial advice for exiting a concentrated equity position over time. They are also inconsistent with the original expectation that Rule 10b5-1 would govern trades made under a “regular, pre-established program.”
Perkins Coie’s Allison Handy put together a nice graphic depiction of the various ESG “materiality” concepts floating around. Traditionally, we’re accustomed to thinking of materiality by reference to the TSC v. Northway “reasonable investor” test. But ESG disclosure advocates argue for conceptions of materiality that take into account matters beyond financial considerations and constituencies other than investors. This graphic provides a quick reference tool that will help you navigate this brave new world.
One of the emerging items on this year’s shareholder proposal agenda has been requests for companies to convert to benefit corporations. Here’s an excerpt from this Faegre Drinker memo on these proposals:
Fifteen public companies received and voted on proposals to convert to benefit corporations at their 2021 annual meetings of shareholders, a dramatic shift from the previous year, when not one of these companies received a proposal to convert. Shareholder proponents requested companies approve an amendment or take the necessary steps to amend their certificates of incorporation and, if necessary, bylaws to become a benefit corporation.
The Shareholder Commons, a nonprofit that states it is seeking to catalyze a movement of shareholders that insist on responsible business, assisted the shareholder proponents with these requests. Accordingly, although each proposal was uniquely tailored to the specific company, the proposals exhibited a common rationale — prioritizing stakeholder interests in addition to shareholder interests is vital.
The memo reviews how companies responded to these proposals, and provides a chart indicating the level of support that they received. It turns out that most didn’t fare too well.
The blog notes that only a handful of proponents were responsible for these proposals, and suggests that the small proponent group & limited support raises the question of whether this initiative will have staying power or is just a fleeting trend. Personally, I have the same question about about benefit corporations themselves.
By the way, don’t say we didn’t warn you that these proposals were coming – over on the “Proxy Season Blog“, Liz gave everyone a heads-up last fall, when she blogged about The Shareholder Commons’ offer of drafting assistance to proponents.
Late last month, the roof came crashing down on Nikola Corporation’s founder & former CEO Trevor Milton, when his indictment for securities fraud was announced by the U.S. Attorney for the SDNY & the SEC announced an enforcement action against him arising out of the same alleged conduct. The former CEO is alleged to have repeatedly misled investors about the status of the company’s electric vehicles & technology.
Both the SEC & SDNY claim that this guy engaged in a pretty massive fraud, and in situations involving a complete train wreck like this one, it’s usually hard to draw a lot of helpful insights for other public companies aside from “don’t do massive frauds.” However, this Locke Lord blog says that this case is an exception, and provides some valuable lessons for other public companies. This excerpt says that one of those lessons is that every word that comes out of a corporate officer’s mouth carries with it the potential for liability:
The actions against Milton are a reminder that public statements by corporate officers in relatively informal settings, outside of SEC filings, can be used as a basis for Rule 10b-5 sanctions. A company’s lawyers may scrutinize annual and quarterly reports to ensure that they contain appropriate cautionary statements. In contrast, private tweets, other social media postings and statements in podcasts or interviews are often made without compliance in mind.
In Milton’s case, he encouraged investors to follow him on Twitter to get “accurate information” about Nikola “faster than anywhere else.” In practice, he used Twitter to announce corporate initiatives that he had not vetted internally, to answer investor questions with misleading or outright false information, and even to double down on prior false statements.
Moreover, according to the allegations, Milton responded to other senior executives’ expressions of concern about his social media presence and his public statements by asserting that these other executives “did not understand current capital market dynamics or what he was trying to accomplish with retail investors, and that he needed to be on social media to put out good news about Nikola to support its stock price.” Retail investor frenzy driven by social media and retail-oriented trading platforms such as Robinhood does not give companies a pass from the application of the securities laws. The SEC has emphasized that it will monitor these situations for manipulation or other misconduct.
The blog also says that the case also provides a reminder of the importance of strong board oversight, as well as the importance of the “tone at the top” and a strong compliance culture.
I’ve been reviewing the Staff’s 2021 comments on non-GAAP disclosures. As you might expect, most of them fall under the heading of “blocking & tackling,” and focus on discrete compliance issues regarding the content and reconciliation of non-GAAP numbers. But “equal or greater prominence” issues also haven’t gone away, and in a couple of instances, the Staff asked companies to re-order the presentation of sections of their periodic reports in order to give greater prominence to GAAP information.
An example of this is Bill.com Holdings, which included a subsection in the forepart of the MD&A section of its 2020 10-K captioned “Non-GAAP Financial Measures.” As you might expect, this section included the required Reg G disclosures & reconciliations for the non-GAAP numbers that the company used in its MD&A discussion. The Staff’s comment letter included the following comment on this disclosure:
Please revise the first table on page 58 to disclose the comparable GAAP measure with greater prominence. Also, to avoid giving undue prominence to your non-GAAP financial measures, please move this section so that it follows the results of operations section. Refer to Item 10(e)(1)(i)(A) of Regulation S-K and Question 102.10 of the Non-GAAP Compliance and Disclosure Interpretations (“C&DIs”).
This was one of those Staff comments that didn’t mention whether an amendment to the prior filing was required. However, Bill.com indicated in its response that it would comply with the Staff’s comment in future filings. The Staff didn’t comment further.
A recent Watchdog Research blog reports that there’s been a dramatic uptick in the use of Form 10-K/As as the vehicle for making initial disclosures of internal control deficiencies, going concern qualifications, and restatements. According to the blog, over the past decade, an average of 19 ineffective internal controls disclosures, 3 going concern opinions and less than 1 non-reliance restatement were initially reported on Form 10-K/A filings during each year. In contrast, so far in 2021, there have been 80 ineffective internal controls disclosures, 31 going concern opinions and 5 non-reliance restatements initially reported on Form 10-K/As.
The blog says that SPACs are driving the increased reliance on Form 10-K/As as the vehicle for these disclosures. They have accounted for 70 of the 80 10-K/A internal controls disclosures, 30 of the going concern opinions and all of the restatements this year. The blog points to troubled electric vehicle start-up Lordstown Motors as the poster-child for this trend:
For public companies, it is not just about when the disclosure is made, but how it is made. We are seeing a concerning trend in 2021 where companies are waiting to make their initial disclosures of bad news such as going concern opinions, ineffective internal control disclosures, and financial restatements in an amended annual 10-K filings (10-K/As), instead of 8-Ks and other traditional methods and long after the original “clean” 10-K was filed with the SEC.
Lordstown Motors is an electric car company that went public via SPAC. On June 8th, Lordstown Motors filed a 10-K/A, more than two months after it released its annual report on March 25th. As reported by Francine McKenna in The Dig, Lordstown disclosed a going concern opinion, an ineffective internal control assessment by management, and two subpoenas from the SEC (indicating that the SEC was conducting a formal investigation, not an informal inquiry). Lordstown also disclosed that their restatement announced in May would include an additional charge of $23.5 million, perhaps what tipped it into the “going concern” warning range.
The blog characterizes SPACs approach to making initial disclosures of this “bad news” trifecta in 10-K/A filings as “novel” and “a bit sneaky.” The approach is definitely novel, but I’m not so sure that it’s sneaky. That’s because these disclosures were themselves prompted by a novel set of circumstances – namely, the SEC’s highly publicized guidance on the proper accounting treatment of SPAC warrants & the consequences of that guidance.
This guidance prompted almost 90% of SPACs to restate their financial results. I’m guessing that for most SPACs, the 10-K/A disclosures concerning internal controls deficiencies and the addition of going concern qualifications were a direct result of those warrant restatements. A conclusion that internal controls were deficient flows almost inevitably from a decision to issue a non-reliance restatement, and the going concern opinions may (as in the case of Lordstown Motors) have been prompted by the financial statement impact of the warrant restatements.
I can see why a company might not feel compelled to disclose an inevitable internal control deficiency when it filed an 8-K announcing a non-reliance restatement. A decision to defer disclosure of a going concern qualification would be more troubling, assuming the company knew that such a qualification would be required. But in the case of the warrant restatements, it’s not clear when many SPACs first became aware of this issue. The decision to add a going concern qualification sometimes turned on the results of a complex valuation process, and was likely the last piece of the puzzle to be completed before the 10-K/A was filed.
It does seem inappropriate to defer reporting a decision to restate financials until the filing of Form 10-K/A that includes those financials. If a company decides that its financial statements need to be restated & should no longer be relied upon, it has to file an Item 4.02 Form 8-K. Five SPACs apparently didn’t – but that’s out of a universe of more than 500 SPAC restatements and more than 300 non-reliance restatements.
We’ve previously blogged about Covid-19 related securities litigation, but this Proskauer blog flags something a little different – derivative litigation targeting comp awards that the plaintiffs essentially claim were “spring loaded” due to the pandemic-related market volatility:
While we are growing accustomed to pandemic-based shareholder actions relating to improper health and safety disclosures or misrepresentations relating to COVID-19 treatments and tests, this month brings a novel variant of the COVID-19 lawsuit. A Universal Health Services Inc. investor has filed a derivative suit against company officers and directors, claiming they took advantage of a pandemic-related drop in the company’s stock price to grant and receive certain stock options that were unfair to the company and its stockholders.
The plaintiff investor claims that “company insiders took advantage of the temporary drop in the company’s stock price to grant and receive options to buy the company’s stock at rock bottom prices, thereby showering themselves in excessive compensation.” The complaint alleges that the drop in stock price was “not caused by any changes in the company’s fundamentals or business prospects,” but instead was entirely attributable to the effect of the pandemic on the markets writ large.
The blog points out that the timing of the awards was pretty terrific from the recipients’ standpoint. The stock popped 25% the day after they were granted and by 47% within a week. According to the complaint, in just twelve days, the defendants reaped over $30 million in gains. The complaint alleges that the officers who received the grants unjustly enriched themselves and that the comp committee committed waste in making the awards.
General Electric recently completed a reverse stock split. That’s a pretty unusual transaction for an S&P 500 company – as this Barron’s article notes, GE’s only the 5th S&P 500 company to engage in a reverse split since 2012. For most people, that’s an interesting piece of corporate trivia, but for securities lawyers, it means we’ve got a fresh template for a reverse split that’s likely been vetted by some pretty high-powered lawyers. That’s gold!
Anyway, here’s the relevant language from GE’s proxy statement, the Form 8-K it filed in connection with the reverse split, the Certificate of Amendment to its charter, and the press release announcing the reverse split. If you’re looking for more information on reverse stock splits, check out our article, “Unpacking Stock Splits,” that appears on p. 4 of the July-Aug. 2019 issue of The Corporate Counsel.
On Friday, the SEC voted to approve Nasdaq’s board diversity listing standard. Here’s a copy of the SEC’s 82-page approval order. As usual, the SEC was divided, with Commissioner Peirce dissenting and Commissioner Roisman dissenting in part. SEC Chair Gary Gensler issued a brief statement in which he said that Nasdaq’s diversity disclosure rules “are consistent with the requirements of the Exchange Act,” and that they “reflect calls from investors for greater transparency about the people who lead public companies.”
If that sounds a little defensive, that’s probably because dissenting statements from Commissioners Peirce & Roisman contend that Nasdaq hasn’t satisfied its burden of showing that the rule is consistent with applicable Exchange Act requirements. Furthermore, as this excerpt from Hester Peirce’s lengthy dissenting statement points out, she questions the relevancy of the disclosure called for by the new standard to investors:
[T]his reasoning either begs the very question that needs to be asked—whether the information is relevant to investors in a way that matters under the Exchange Act—or suggests that an exchange may impose any obligation on issuers for which “commenters representing a broad array of investors” are clamoring. To the extent that it is begging the question, it fails under the D.C. Circuit’s decision in Susquehanna International Group LLC v. SEC, in which the Court held that the Commission’s “unquestioning reliance” on a self-regulatory organization’s analysis in approving a rule filing violated both the Exchange Act and the Administrative Procedure Act.
The Commission is obliged to critically assess the “self-serving views of the regulated entit[y],” and it cannot evade this obligation by assuming that the Proposal imposes disclosures and other obligations that are meaningful to investors (and “commenters representing” them) in a way that is relevant under the Exchange Act.
Commissioner Peirce raises a number of other legal issues in her statement (which reads like a brief), but her comments on the relevancy of information on board diversity to investors may be a preview of coming attractions. My guess is that we’ll likely hear similar arguments from dissenters when it comes to climate change & other ESG-related rule proposals that are likely to come down the pike over the next few years.
Commissioner Roisman issued a statement explaining why he supported the provisions of Nasdaq’s listing standard that would offer support to companies looking to add diversity to their boards, but dissented from the standard’s disclosure requirements for listed companies. Commissioners Crenshaw and Lee issued a brief joint statement in support of the approval order.
Be sure to check out this Goodwin memo on the new rules. We’ll be posting this and other memos in our “Nasdaq Guidance” Practice Area.
Shortly after the SEC issued its approval order, Nasdaq posted updated guidance on how the new listing standard’s disclosure requirements will work and the timeline for its implementation. This excerpt discusses the transition period for compliance with the new standard, which is generally based on a company’s listing tier:
– Nasdaq Global Select Market and Nasdaq Global Market companies will have, or explain why they do not have, one diverse director by the later of two years of the SEC’s approval date (August 7, 2023), and two diverse directors within four years (August 6, 2025), or the date the company files its proxy or information statement (or, if the company does not file a proxy, in its Form 10-K or 20-F) for the company’s annual shareholder meeting in that year.
– Nasdaq Capital Market companies will have, or explain why they do not have, one diverse director by the later of two years from the SEC’s approval date (August 7, 2023), and two diverse directors within five years (August 6, 2026), or the date the company files its proxy or information statement (or, if the company does not file a proxy, in its Form 10-K or 20-F) for the company’s annual shareholder meeting in that year.
Companies with five or fewer directors represent an exception to the tier-based transition period. Regardless of their listing tier, these companies will be required to have at least one diverse director or explain why they don’t by the later of August 7, 2023 or the date the company files its proxy statement for the company’s annual shareholder meeting in that year. For companies that don’t solicit proxies, the compliance date will be the date of filing their 10-K or 20-F for that year.