The SEC did an interesting thing in the adopting releases for its long-anticipated Schedule 13D & 13G amendments and its overhaul of SPAC regulation. Instead of adopting the most controversial aspects of the rule proposals, the agency opted to issue guidance setting forth its views on the issues they addressed. It seems to me that in an unfriendly judicial environment, a strategy like this for dealing with controversial proposals may offer a lot of advantages for the SEC, at least in the short term.
First of all, SEC guidance statements are non-binding and as this excerpt from a CRS article notes, that makes them a much more flexible tool for the agency than rulemaking:
Guidance is subject to fewer procedural requirements than legislative rules. Legislative rules typically must undergo the informal rulemaking process set forth in the APA, which generally requires that agencies publish a notice of proposed rulemaking in the Federal Register and allow members of the public an opportunity to submit comments on the proposed rule. Final rules generally must be published in the Federal Register at least 30 days before becoming effective, and are then subject to judicial review immediately after taking effect. By contrast, the APA exempts guidance from the notice-and-comment and delayed effective date requirements.
The article also highlights a second advantage that guidance enjoys over rulemaking. The ability to avoid compliance with the APA makes guidance more difficult to challenge in court than new rules are – particularly when that guidance is positioned as “clarifying” existing SEC positions:
In deciding whether guidance is reviewable, courts have considered factors such as the consequences of the guidance, including whether it confers rights or imposes legal obligations beyond those in existing statutes or regulations, and the agency’s characterization and application of the guidance. Courts have also evaluated whether interpretive rules merely interpret or clarify preexisting requirements, or whether they effect a substantive change in existing law or policy.
Guidance may have advantages to the SEC in terms of flexibility and reduced risk of judicial second-guessing, but why come out with an aggressive rule proposal in the first place if guidance is going to be the end result? The market’s reaction to the SEC’s rule proposal on underwriter status in de-SPAC transactions may provide a clue.
If you’ve been following the SPAC saga, you know that as part of the SEC’s initial rulemaking proposal, it offered up a new Rule 140a, which the agency said was intended to “clarify” that an underwriter in a SPAC IPO is also on the hook for subsequent de-SPAC related financings. That prompted a lot of wailing & gnashing of teeth among industry participants about the effect of the proposed rule – but as this Davis Polk memo on the new SPAC rules points out, it also prompted a significant change in market practice:
[W]e think financial institutions participating in de-SPAC transactions are going to continue to take a conservative approach, as they largely have done since the announcement of proposed Rule 140a – treating these transactions more akin to a traditional IPO than a traditional public M&A transaction in terms of potential liability pitfalls.
So, even though the SEC backed away from the proposed rule and substituted guidance, in this case simply offering up the proposed rule was enough to prompt the kind of change in behavior the SEC sought. Since market participants know well that enforcement often follows closely on the heels of guidance, the guidance contained in the adopting release is likely to continue to reinforce this change in behavior.
The issuance of guidance in an adopting release isn’t unprecedented, but its potential benefits to the SEC in the current environment and the agency’s decision to take that approach to the most controversial aspects of two recent high-profile rulemaking initiatives makes me wonder if we may see it more frequently in the future.
While there are a lot of advantages for the SEC in issuing guidance documents instead of adopting the most controversial aspects of proposed rules, there’s also a downside. The ability to use agency guidance as a tool depends on the policy preferences of the folks running the agency, and those change with each change in administrations.
For instance, in 2018, former President Trump issued an executive order curbing the use of agency guidance by enhancing Congress’s ability to review and reject guidance documents. In turn, President Biden revoked that executive order on his first day in office. So, while guidance in lieu of rulemaking has its advantages, its downside is that it’s pretty easy to change with a change in the direction of the prevailing political winds.
Of course, the bigger issue is whether this is any way to run a railroad – but that one’s above my pay grade.
We’ve recently passed the 12,000-query mark in our “Q&A Forum.” Of course, as Broc would always point out when he wrote one of these Q&A milestone blogs, the “real” number is much higher since many queries have others piggy-backed upon them. Over the years, we’ve collectively developed quite a resource. Combined with the “Q&A Forums” on our other sites, there have been well over 35,000 individual questions answered – including over 10,500 that Alan Dye’s answered over on Section16.net.
As always, we welcome – in fact, we actively encourage – your input into any query you see that you think you can shed some light on for other members of our community. There is no need to identify yourself if you are inclined to remain anonymous when you post a reply (or a question). And of course, remember the disclaimer that you need to conduct your own analysis & that any answers don’t constitute legal advice. Also, please keep in mind that the Q&A Forum is not an outsourced research service – we all have day jobs and aren’t in a position do research projects!
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A recent Woodruff Sawyer blog highlights some of the factors that may make the SEC more likely to charge an individual executive when bringing an enforcement action against the company arising out of disclosure issues. One of the factors identified is media attention, and this excerpt points out that the more interested the media is in a particular situation, the more likely it is that the SEC will be looking for individuals to hold accountable:
There is a strong correlation between media scrutiny and government enforcement risk. Pretend you run an unsexy widget-making business. You tell the street that you will be releasing a new widget imminently. Then things go sideways, the widget is never released, and your company’s stock price declines by 35%. While the plaintiffs’ bar may be very interested, the media doesn’t bat an eyelash. Will you be investigated and sued by the SEC? It’s possible, but if there’s no article in The Wall Street Journal, it’s equally possible that the government may never focus on your issues.
Now assume that you run a super-sexy tech company disrupting the industry with WaaS (widgets-as-a-service). When your company’s problems emerge, a story appears on the front page of the Journal, and The New York Times does a deep dive on your corporate culture three weeks later. This virtually ensures the government will come sniffing around. In high-visibility cases, the government may be especially focused on showing that they are not being soft on senior executives (if they have the evidence to back it up).
A lot of this is out of your control. Typically, enterprise-facing companies simply don’t have the same media allure as consumer-facing companies. But if as a consumer-facing company you can achieve your public relations and marketing goals without also becoming an object of media obsession, when challenges emerge, you may be happy that you are not front-page material.
Other factors pointed to by the blog as increasing the likelihood of charges against an individual include evidence that senior officials pressured others to take improper actions and the presence of cooperating witnesses in addition to documentary evidence.
Another interesting fact that the blog points out is that the percentage of SEC enforcement proceedings in which individuals are named has remained relatively constant regardless of which party is in power. From 2017 to 2023, the percentage of cases involving charges against individuals has consistently been in the range of 70%.
If you work with public companies, it’s essential to keep up not only with what’s going on with the SEC, the FTC and any other federal regulator that’s relevant to the company’s business, but also with developments in the Delaware. Those often come fast & furious, so it’s helpful to have a resource like this Wilson Sonsini report addressing Delaware corporate law & litigation developments. Here’s an excerpt from the report’s discussion of oversight claims:
As to board obligations, some of the 2023 cases from Delaware reinforced the traditional approach that oversight claims against boards are difficult theories for plaintiffs, that directors will not face exposure merely for making risky business decisions, and that directors, even if confronted with a crisis, will not be liable if they have taken appropriate steps from a fiduciary duty standpoint.
In one case, the Delaware Court of Chancery concluded that the plaintiffs were “nowhere close” to pleading oversight claims against the directors of an insurance company. There, the insurance company had shifted its business practice of underwriting professional liability insurance policies for smaller, lower risk physician groups in favor of underwriting policies for larger, riskier physician groups and hospitals, which created difficulty in calculating the company’s required loss reserves.
After the shift, the company struggled with forecasting the number and severity of claims, which resulted in a significant drag on the company’s performance. The court dismissed the oversight claims, noting that the facts suggested the board and audit committee had indeed spent significant time evaluating the business risk associated with the strategy shift and there was no indication that any of the directors had acted in bad faith.
The memo also addresses decisions dealing with M&A issues, ESG & corporate purpose, dual-class structures and controlling stockholders, and advance notice bylaws and activism. It also covers the 2023 amendments to the DGCL.
Last summer, I blogged about an SEC Report to Congress that included an itemized list by filing type of which data must be tagged using inline XBRL. Orrick’s Bobby Bee recently let us know that this resource has been updated and will continue to be updated on a regular basis for the next several years. Here’s the skinny from Bobby:
The most recent flavor of the SEC’s “Semi-Annual Report to Congress on Machine Readable Data for Corporate Disclosures” (iXBRL summary report & checklist) was released back in December. Turns out the SEC has to “submit this report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives every 180 days until December 23, 2029, when the provision requiring the report sunsets.” So, we’ll get regular 6-month updates of this iXBRL form check tool from the SEC – which is pretty nice! Seems like these updates can be found via the “Reports and Publications” log.
Last month, the WSJ published a report on Elon Musk’s drug use which noted concerns among board members and company executives about his behavior’s potential implications for his companies. Since the report makes it clear that Musk’s directors & executive officers are aware of this behavior, a recent blog from UCLA’s Stephen Bainbridge discussed whether their oversight responsibilities under Caremark might be implicated if they fail to take action. As this excerpt from his blog explains, Prof. Bainbridge doesn’t believe that directors & executive officers would face liability in this situation:
[W]hat liability exposure does the board have when it is aware of a problem and decides to do nothing? I think the answer should be that the board would not be held liable. Granted, a board can be held liable for acting in bad faith not only for acting with “’subjective bad faith,’ that is, fiduciary conduct motivated by an actual intent to do harm” to the corporation, In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 64 (Del. 2006), “but also intentional dereliction of duty.” Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 240 (Del. 2009).
At least on these facts, however, I doubt whether a board decision to do nothing would rise to the level of “intentional dereliction of duty.” First, as VC Will explained, The Caremark doctrine is not a tool to hold fiduciaries liable for everyday business problems. Rather, it is intended to address the extraordinary case where fiduciaries’ “utter failure” to implement an effective compliance system or “conscious disregard” of the law gives rise to a corporate trauma. … Officers’ management of day-to-day matters does not make them guarantors of negative outcomes from imperfect business decisions.” Hence, even if the board’s decision not to act was “imperfect” that board cannot be held liable as “guarantors of negative outcomes.”
Second, as I discussed at considerable length in my post My Pillow, Inc. and the perennial question of whether Caremark claims should lie when boards fail to monitor the CEO’s personal life, the Delaware courts have held in several cases that ““directors of Delaware corporations generally have no duty to monitor the personal affairs of other directors and officers.” Granted, saying there is no duty to monitor such affairs is not the same as saying that there is no duty to intervene when such affairs are brought to the board’s attention, but it tends to support the proposition that the board has little liability exposure in this area.
Prof. Bainbridge also pointed out that, related to his first point, Delaware courts have held that while the business judgment rule doesn’t have any bearing on a claim that the directors’ inaction was the result of ignorance, it does apply to a conscious decision not to act, which he thinks this case would seem to involve.
About this time last year, the Delaware Chancery Court made it clear that Caremark claims could be brought not only against corporate directors, but also against corporate officers. Recently, in Segway v. Hong Cai, (Del. Ch.; 12/23), the Chancery Court held that Caremark claims against corporate officers were subject to the same high pleading standards as those targeting corporate directors.
The case involved allegations that a former VP of Finance had breached her duty of oversight because “she knew or should have known there were potential issues with some of [the Company’s] customers, which caused [the Company’s] accounts receivable to continuously rise” and that she failed to address these issues or bring them to the attention of the board. Vice Chancellor Will dismissed the complaint, and this excerpt from a Sheppard Mullin blog on the decision explains her reasoning:
The Court of Chancery sided with the Officer, noting that the Company’s allegations are “an ill fit for a Caremark claim.” A plaintiff may state a claim for failure of oversight against a director or officer where such person acted in bad faith by (i) utterly failing to implement any reporting or information systems or controls; or (ii) having implemented such a system or controls, consciously failing to monitor or oversee their operations, including by ignoring red flags. And, with respect to officers, the scope of an officer’s duty of oversight would need to fall within the officer’s sphere of corporate responsibility.
The Court found that generic financial matters such as learning of issues with unspecified customers, revenue decreases, and increases in receivables “are far from the sort of red flags” that could trigger liability. The Company failed to allege facts that would suggest bad faith; rather the Company sought to have the Officer “answer for a decrease in sales and an increase in receivables” with the benefit of “20/20 hindsight.”
Barker-Gilmore recently released its 2024 Aspiring General Counsel Report. Among other things, the report notes that if you want to be a GC, it sure helps to be anointed as a potential successor by your company’s management. According to the report, management-identified successors receive professional development in the form of expanded responsibilities, increased board exposure, leadership training and “stretch” assignments at higher rates than their peers generally. Here are some of the report’s other findings:
– 42% of Managing Counsel and 11% of Senior Counsel report being identified by management as potential successors to the sitting General Counsel.
– Being identified as a potential successor is more likely to keep Senior Counsel (60%) from pursuing other opportunities than it is for Managing Counsel (42%).
– In-house counsel that have received executive coaching (35%) are more likely to be identified as a successor than their counterparts without executive coaching (26%).
– Most identified successors are currently Deputy General Counsel (58%)
– 23% of potential successors identify as a race or ethnicity other than “white.”
The report also found that women are slightly more likely to be identified as a successor than men (53% vs. 47%), and that women are most likely to have been identified as a potential successor in the consumer (75%), industrial/manufacturing (60%) and financial services (56%) industries.
Allianz has issued its 13th annual “risk barometer,” which identifies the top 10 risks for the upcoming year based on a survey of 3,069 respondents from 92 countries including Allianz customers, brokers, industry trade organizations, risk consultants, underwriters, senior managers, claims experts, as well as other risk management professionals in the corporate insurance segment.
“Cyber incidents” tops the list again after taking the top spot last year, but for the first time by a clear margin and across all company sizes. The report described AI’s contributions to increasing cyber threats:
AI adoption brings numerous opportunities and benefits, but also risk. Threat actors are already using AI-powered language models like ChatGPT to write code. Generative AI can help less proficient threat actors create new strains and variations of existing ransomware, potentially increasing the number of attacks they can execute. An increased utilization of AI by malicious actors in the future is to be expected, necessitating even stronger cyber security measures.
Voice simulation software has already become a powerful addition to the cyber criminal’s arsenal. Meanwhile, deepfake video technology designed and sold for phishing frauds can also now be found online, for prices as low as $20 per minute.
ICYMI, even your annual meeting isn’t safe! On other happy topics, “business interruption” (including supply chain disruption), which has frequently been a top risk in years past, is now at no. 2 followed by “natural catastrophes.” I promise my intention was not to disrupt your sleep tonight when I started writing this blog…