Last Friday, Nasdaq filed a proposed rule with the SEC that would establish listing standards related to notification and disclosure of reverse stock splits. According to the filing, Nasdaq has seen a significant increase in reverse splits over the past two years, most of which involve small cap issuers trying to maintain the $1.00 minimum bid price required to keep their stock listed. These issuers typically don’t receive a lot of media or analyst coverage, and that seems to be driving Nasdaq’s push for notification & disclosure requirements. This excerpt from the rule proposal explains the reasons for it & provides a general overview of what would be required:
Nasdaq believes that the increase in companies effecting reverse stock splits warrants amendments to the listing rules to enhance the ability for market participants to accurately process these events, and thereby maintain fair and orderly markets. As such, Nasdaq is proposing amendments to its rules regarding notification and disclosure of reverse stock splits and regulatory halts.
Specifically, Nasdaq is proposing to adopt additional listing rules requiring a company conducting a reverse stock split to notify Nasdaq about certain details of the reverse stock split at least five (5) business days (no later than 12:00 p.m. ET) prior to the anticipated market effective date, and make public disclosure about the reverse stock split at least two (2) business days (no later than 12:00 p.m. ET) prior to the anticipated market effective date.
As part of the rule proposal, references to a reverse stock split currently contained in Listing Rule 5005(a)(44) would be deleted and new provisions added to set forth the timeframe and requirements for the new notification and disclosure requirements. The comment period for the proposal will expire 21 days after publication in the Federal Register, which hasn’t happened yet. Check out Cydney Posner’s blog for more details on the proposal.
What alternatives do companies have if they disagree with their auditors concerning an accounting issue? This recent blog from Perkins Coie’s Ben Dale – himself a recovering auditor – discusses some of the options. Here’s an excerpt:
AS 1301.22 states in relevant part: “The auditor should communicate to the audit committee any disagreements with management about matters, whether or not satisfactorily resolved, that … could be significant to the company’s financial statements or the auditor’s report.” Importantly, disagreements with management don’t include differences of opinion based on incomplete facts or preliminary information that are later resolved by the auditor after obtaining additional relevant facts or information prior to the issuance of the auditor’s report.
In the four years I worked as an auditor, I never saw a disagreement with management make it to the audit committee. Rather, they were kept within the management ranks for several days or weeks while the auditors and management performed additional procedures, reviewed all relevant information and sought resolution of their disagreement. Only if the disagreement persisted at the end of the audit after all efforts were made to resolve it, would it be elevated to the audit committee (assuming it was significant to the financials or audit report).
If a disagreement remains unresolved after escalation to the audit committee, the company or auditor could choose to seek advice directly from the SEC Staff. While the SEC Staff may provide interpretive guidance on issues arising under GAAP or certain securities regulations, they are highly unlikely to referee disputes between companies and auditors – and notably, communications with the SEC may not remain confidential.
The blog says that, ultimately, you could also go nuclear and fire the auditor, but that’s a “whole ‘nother bag of snakes.” As a practical matter, the big problem with a potential disagreement is that the issue typically arises when the clock is ticking on your next SEC filing. If the auditor won’t sign off on the financials in your 10-K or provide a consent for your registration statements, then you ultimately don’t have a lot of good alternatives except to see things their way – and that may be the biggest reason why these seldom even make it to the audit committee.
Check out the latest edition of our “Timely Takes” Podcast featuring my interview with Sidley’s Beth Berg, Paul Choi & Jim Ducayet on issues associated with earnings pre-releases. In this 19-minute podcast, Beth, Paul and Jim addressed the following topics:
– Legal issues that might compel an earnings pre-release
– Typical voluntary pre-release scenarios
– Key business and investor relations considerations
– Legal risks and compliance obligations around the pre-release decision
– Participants in the decision-making process
– Earnings pre-release “dos and don’ts”
Our discussion was based on Sidley’s recent memo, “Earnings Pre-Release Considerations”, which members of TheCorporateCounsel.net can access in our “Earnings Guidance” Practice Area. If you have insights on a securities law, capital markets or corporate governance issue, trend or development that you’d like to share, I’m all ears – just shoot me an email at john@thecorporatecounsel.net.
Over on The10b-5 Daily, Lyle Roberts recently blogged about the Third Circuit’s decision in City of Warren Police & Fire v. Prudential Financial, (3rd. Cir.; 6/23). One aspect of the Court’s opinion addressed whether the defendants could be liable for comments of its CEO that were paraphrased in an analyst’s report. This excerpt discusses the Court’s analysis:
In its Janus decision, the Supreme Court held that for a person or entity to have “made” a false statement that can lead to Rule 10b-5 liability, that person or entity must have “ultimate authority over the statement, including its content and whether and how to communicate it.” The attribution of a statement “is strong evidence that a statement was made by – and only by – the party to whom it is attributed.” But how does this analytical framework apply to a paraphrased statement from a corporate officer contained in an analyst report?
The Third Circuit held, contrary to the district court’s decision, that the corporate officer could still be deemed a “maker” of the statement. Even though the statement was indirect (paraphrased) and contained in a non-corporate document (analyst report), the court found that “because the report attributed the statement to the [corporate officer] and the context of the statement indicates that he exercised control over its content and the decision to communicate it to the [analyst], the statement cannot, at least at the pleading stage, be considered to have been ‘made’ by [the analyst] for purposes of Rule 10b-5.” In other words, the corporate officer had “ultimate authority” to speak about the topic on behalf of the company, so he was still the “maker” of the statement even though it was republished by the analyst.
This decision illustrates the fine distinctions that courts sometimes draw in these cases. The Third Circuit held that a company could be liable for its CEO’s “paraphrased” statements in an analyst report, while in another recent decision the Fourth Circuit declined to impose liability on a company for the way that an analyst “characterized” a CEO’s comments. I’m not exactly sure what the distinction is between characterizing and paraphrasing, but it looks like it might matter.
To be fair, the two decisions aren’t necessarily inconsistent – the Fourth Circuit focused on the “falsity” of the CEO’s statements while the Third Circuit focused on whether the CEO could be regarded as the “maker” of the challenged statements – but they do show the kind of thicket companies and executives confront when dealing with cases alleging that a company is responsible for information in analyst’s reports.
Late-stage pre-IPO companies looking for financing alternatives may want to consider issuing convertible securities. This Cooley blog reviews “pre-IPO converts” and discusses the key considerations that companies thinking about issuing these securities should keep in mind. This excerpt provides an overview of the terms of a typical pre-IPO convert:
A pre-IPO convert is a debt instrument issued by a private company, typically as the last financing round before an IPO. While public company convertible bonds are fairly standardized debt securities, pre-IPO converts tend to have a variety of negotiable structures and features, which also make them more complex than a traditional equity financing or convertible note bridge round.
The key feature of a pre-IPO convert is that, upon some future date or event, such as 2-3 years after issuance or upon an IPO which meets certain size and liquidity criteria, the debt becomes convertible at the option of the noteholder (or, in some cases, is mandatorily converted) into shares and/or cash based on the stock price at the time of the conversion event. Until the conversion event or maturity, the convertible note (or “convert”) is effectively a straight debt instrument. Some pre-IPO converts may be redeemed by the company in cash in limited circumstances (typically at a substantial premium).
In addition, pre-IPO convert structures tend to provide for an increasing interest rate and decreasing conversion price as the time to IPO or other conversion event increases. Features, such as cash interest vs. PIK, incurrence covenants, information rights, boards seats, subsidiary guarantors, collateral, guaranteed minimum internal rate of returns, valuation cap, conversion price resets and registration rights are much more common in pre-IPO converts.
The blog goes on to discuss the type of investors who are typically interested in these securities, the pros and cons for investors in these transactions, and the key considerations in negotiating a pre-IPO convert. It also includes a chart comparing and contrasting the terms of public converts and pre-IPO converts.
Speaking of IPOs, according to a recent WSJ article, the long IPO drought may be coming to an end. In fact, this excerpt says that investors are so eager for new issues that the only thing that might hold the market back may be the reluctance of private companies to take the plunge:
In the past several weeks, the major barriers to a resurgence in initial public offerings have lifted. U.S. stocks are climbing toward new 52-week highs, volatility is down, inflation has eased and, perhaps most important, investors are making speculative bets again.
What will determine whether the IPO market returns to a roar is now more about whether stewards of private companies want to make the transition to public ownership.
“It’s supply crimping the IPO market, not demand,” said Daniel Burton-Morgan, head of Americas Equity Capital Markets Syndicate at Bank of America. “Does that mean post Labor Day we see a more normal IPO market? Maybe. Or it could take another quarter. But at this juncture, investor demand is not the issue.”
The article notes that there are some potentially big deals in the queue for the fall, but nobody expects the market to quickly return to the scorching demand for new issues experienced during 2020-2021.
When Delaware amended Section 102(b)(7) of the DGCL last year to permit charter amendments exculpating officers from damages liability for breaches of the duty of care, people wondered whether many companies would propose amendments during the 2023 proxy season and, more importantly, how stockholders would react to those proposals. This excerpt from a Weil memo on this year’s officer exculpation proposals provides some answers to those questions:
Between August 1, 2022, when the amendment to DGCL Section 102(b)(7) became effective and July 5, 2023, 279 Delaware corporations included a proposal in their proxy statement requesting stockholder approval for a charter amendment to adopt an exculpatory provision for officers. Stockholders approved such proposal at 221 (79.2%) companies and did not approve the proposals at 42 of the 279 companies (15.1%). The results of the votes at 17 companies remain outstanding at the time of this publication.
Generally, pursuant to Section 242 of the DGCL, a charter amendment requires the vote of a majority of the outstanding stock entitled to vote on the matter. For companies that require supermajority approval under their governing documents, the higher vote threshold proved to be a hurdle to stockholder approval. Specifically, 18 of the 42 proposals that failed required a supermajority vote, 13 of which would have passed had the Delaware default standard applied.
People also wondered how the proxy advisors would react to these proposals. The memo says that ISS generally supported them, while Glass Lewis usually opposed them. It says that as of July 5, 2023, ISS supported 80% of these officer exculpation proposals. Another interesting tidbit is that 38 of the 47 proposals that ISS recommended against passed anyway. The memo didn’t provide any hard data on Glass Lewis’s recommendations, but since Glass Lewis’s superpower appears to be opacity, that’s not a huge surprise.
A recent Wilson Sonsini blog provides another interesting data point for how officer exculpation proposals fared with investors this proxy season. The blog looked specifically at Silicon Valley 150 companies, and while it found that relatively few companies asked stockholders to approve officer exculpation charter amendments, those that did enjoyed a fairly high rate of success:
Of the 143 SV150 companies that are incorporated in Delaware, only nine companies, or approximately 6.3 percent, included an officer exculpation proposal in their proxy statement.[3] Of those nine proposals, five required the affirmative vote of a majority of the voting power of the outstanding stock entitled to vote on the proposal (the default voting requirement under the DGCL for an amendment to the charter), and four required the affirmative vote of a supermajority (generally, 66 2/3 percent) of the voting power of the outstanding stock entitled to vote on the proposal.
Seven of the nine proposals, or approximately 78 percent, passed. The failed proposals were comprised of two of the four proposals that required a supermajority vote and, although they both received significantly more affirmative votes than “against” votes, they failed to attain the affirmative vote of a supermajority of the voting power of the outstanding stock entitled to vote thereon.
The blog says that while only a handful of SV 150 companies asked their stockholders to approve officer exculpation amendments this year, the success those companies enjoyed will likely prompt a much larger number to take this step next year. Based on the data in Weil’s memo, I think that it’s probably going to be the case beyond Silicon Valley as well.
Last week, Dave blogged about the PCAOB’s rather dismal assessment of audit deficiencies. With the PCAOB’s Chair very publicly ripping auditors a new orifice about shortcomings in their performance, investors also must be up in arms about audit quality issues, right? Yeah, well, apparently not so much. According to Audit Analytics, the capital markets’ trusty “arbiters of materiality” continue to vote overwhelmingly in favor of auditor ratification proposals – and by “overwhelmingly,” I mean in proportions that rival Joseph Stalin’s performance at the Soviet polls. Here’s what Audit Analytics found:
Throughout the last four years, our analysis on shareholder votes reveals that, on average, nearly 98% of total votes are cast in favor of auditor ratification. Shareholder votes filed between January 1, 2020 and December 31, 2022, continued that trend for a fifth consecutive year. Votes against auditor ratification comprised nearly 2% of the total votes; abstained votes account for the remaining 0.4% of total shareholder votes cast.
Audit Analytics says that fewer than 5% of shareholder votes were cast against the auditor, 93% of the time for proposals made during 2020-2022, although the frequency of votes in which more than 5% were cast against ratification increased. It also highlights the handful of situations in which a high percentage of shareholders voted against ratification.