Sometimes there’s no specific 8-K item triggered and no item where disclosure neatly fits, but a company wants to get certain information out there and turns to Item 7.01 or 8.01. This general scenario is not new, but this Cleary alert suggests 7.01 or 8.01 might be more frequently utilized when companies discover cybersecurity incidents but have yet to make a materiality determination. As Dave recently blogged, “the Titanic effect is real in many cybersecurity breaches, in that one can easily misperceive that the giant iceberg lurking under the surface is just some harmless floating ice,” and the SEC will be looking at disclosures with the benefit of hindsight. Here’s an excerpt from Cleary’s alert:
Given the number of moving pieces and factors to consider, it is likely that it may take some time to reach a definitive conclusion around materiality for any given cybersecurity incident. If a registrant waits until it has come to a final conclusion around materiality, a significant amount of time may have passed since the initial discovery of the incident.
The SEC has been extremely focused on the timeliness of disclosure of cybersecurity incidents, and while an incident may appear to be immaterial for some period of time and non-disclosure at that time would be technically compliant with the disclosure rules, if the incident is later determined to be material, there is likely to be a tremendous amount of scrutiny around the timing of that determination. As a result, registrants will want to think carefully about the potential benefits of putting out disclosure on Form 8-K under Item 7.01 (Regulation FD Disclosure) or Item 8.01 (Other Events) (and/or in a press release or other Regulation FD-compliant channel) promptly after discovering a cybersecurity incident, while the materiality of the incident is still under consideration (including if they do not believe the incident will likely be deemed material).
The alert describes a number of potential benefits of using this approach initially:
[T]here is no preemptive concession by the registrant of the event’s materiality in a potential future litigation or otherwise. In some circumstances, disclosure more quickly than the usual four day Form 8-K deadline will be appropriate.
We have seen an increasing number of registrants adopt this practice, even ahead of the Item 1.05 requirement becoming effective, and believe it can be an effective communication tool, while also mitigating regulatory and other risk. By disclosing early, a registrant will give itself some breathing room to come to a materiality determination in an expeditious but methodical way that considers all necessary factors. In addition, providing prompt disclosure may provide some protection from stock-drop lawsuits following a potential later announcement that the incident has been determined to be material.
Additionally, registrants may need to alert and provide ongoing updates to certain external stakeholders. For example, registrants may need to coordinate logistics with vendors if their systems are inaccessible, or may be unable to meet their immediate obligations to customers due to production or operational issues. These types of issues will necessitate real-time engagement with impacted constituencies. Putting out public disclosure will facilitate this dialogue and alleviate any concerns around claims of selective disclosure in violation of Regulation FD.
It concludes this point by saying that this practice is expected to continue but “[w]hether Item 7.01 or Item 8.01 is appropriate (the latter of which carries with it an implicit element of materiality and is filed, not furnished) will be a facts and circumstances determination.”
We blogged last June about how corporate communications by public company employees may need to be retained due to generally applicable statutory recordkeeping obligations and that guidance from March clarified that the DOJ expects all companies to maintain and enforce policies to ensure that all “business-related” electronic data and communications are preserved. Ephemeral messaging and off-channel communications got a lot of attention this summer after the SEC settled numerous enforcement actions with broker-dealers and investment advisers. And, in fact, this blog was perfectly timed since the SEC announced a new sweep this morning.
A new development in late January underscores the dangers of business use of ephemeral messaging and off-channel communications beyond the broker-dealer and investment adviser space. The DOJ and FTC announced an update to their preservation notices and instructions for responding to discovery, and the FTC stated that it may even refer cases to criminal prosecutors when companies fail to preserve documents covered by an FTC investigation or action.
This Nelson Mullins alert says the added preservation language clarifies that preservation responsibilities extend to new methods of collaboration, defines “Collaborative Work Environments” and “Messaging Applications” and outlines in detail information that needs to be provided regarding policies and procedures for retention and destruction of documents, including “chats, instant messages, text messages, and other methods of communication.” The language will apply to second requests, voluntary access letters, and compulsory legal processes. The platforms mentioned in the updated guidance include Slack, Microsoft Teams and Signal, but the alert notes that it also covers any other collaboration tools or platforms used, plus social media accounts like X, Facebook, or Snapchat. The alert gives this example:
[I]f a company involved in a merger becomes aware that a second request will be issued but fails to suspend the “auto delete” function of its Microsoft Teams collaboration platform, it may find itself in hot water that runs deeper than the substance of the merger investigation itself.
– Consider implementing policies to prevent employees from using unapproved apps or personal accounts for business communications
– “Only approve platforms that give IT personnel admin-level control over data retention settings” rather than any that would permit employees to control their own data-retention settings
– Take steps to ensure data will be retained as soon as a litigation or investigation hold is issued on all necessary platforms, including by disabling any autodelete features immediately
Vanguard has issued its 2024 voting policies, which are now effective (for meetings held after February 1st) and apply to Vanguard-advised funds. This Alliance Advisors post discusses key updates and says: “Overall, Vanguard has enhanced its disclosure expectations related to board composition and provided more details on its approach to executive compensation programs, advance notice requirements and exclusive forum provisions.” Here’s an excerpt from the alert:
– Board and committee independence: Vanguard is relaxing its majority independence standard for the entire board at controlled companies (those in which a majority interest is held by company insiders or affiliates). However, it expects a majority of key committee members at controlled companies to be independent.
– Board composition: Vanguard has added a new section to its guidelines on board composition that replaces its discussion on diversity and qualifications disclosure. Vanguard looks to companies to disclose their perspectives on the appropriate board structure and composition and how these elements support the firm’s strategy, long-term performance and shareholder returns. It wants issuers to provide regular disclosure regarding their director nomination process, their process for evaluating board composition and effectiveness, and their identification of gaps and opportunities to be addressed through board refreshment and evolution. Vanguard expects disclosure of each director’s tenure, skills and experience in a skills matrix. Disclosure of directors’ personal characteristics (such as gender, race and ethnicity) may be done on an aggregate or individual director level.
– Escalation process for director and committee accountability: In certain instances, Vanguard will vote against directors as a means of expressing concern regarding governance failings or other issues that are unaddressed by a company. It has eased its policy of penalizing boards for not making sufficient progress on board diversity. Instead, absent a compelling reason, Vanguard will vote against the nominating/governance committee chair, or another relevant board member, if the board is not taking action to achieve board composition that is appropriately representative, relative to its market and the needs of its long-term strategy.
The summary also describes some clarifications or expanded discussions of poison pills, advance notice bylaws and exclusive forum provisions.
Over on the CompensationStandards.com blog yesterday, Liz shared tweaks made to Vanguard’s case-by-case approach to compensation-related ballot items (including say-on-pay). As she reminded readers, Wellington makes voting decisions for some Vanguard funds and also released its policies (see the full policies and a summary of changes on Wellington’s policy portal). And, as always, you now also need to keep track of policies that apply when investors are using “proxy voting choice.”
Yes, voting choice complicates things, but at least the proxy advisors and institutional investors seem to have mostly gone easier on public companies with their policy updates this season (knock on wood). I wonder how often descriptions of these summaries in prior years have used phrases like “relaxing its majority independence standard” or “eased its policy.” And, looking at how we’ve characterized other policy updates this season, we’ve used words like “a holiday miracle” and “a few reasonable updates.”
Our readers know that Delaware forum selection clauses have been enforced by courts in many states since Delaware Chancery’s 2013 decision in Boilermakers v. Chevron. Recently, the developments we’ve covered relating to forum selection have involved whether bylaws providing an exclusive forum for bringing claims under the Securities Act or the Exchange Act were permissible. The latest development is a bit different, although I can’t say unexpected, since Allen Matkin’s Keith Bishop predicted it just over a decade ago!
Last fall, Keith blogged about EPICENTERx, Inc. v. Superior Court (Cal. Ct. Appeal, 9/23) in which California’s Fourth District Court of Appeal refused to enforce the forum selection clause “in a Delaware corporation’s corporate documents” since it “would operate as an implied waiver of the plaintiff’s right to a jury trial—a constitutionally-protected right that cannot be waived by contract prior to the commencement of a dispute.”
This Sidley blog gives further background on the issue and explains that California is an outlier, although “other state courts could follow California’s approach.”
In California, forum selection clauses are typically enforced unless doing so would be unfair or unreasonable. But California courts will refuse enforcement if litigating in the selected forum would violate public policy. Normally the burden of proof to prove why the clause should not be enforced falls on the party opposing enforcement. Under California statutes, however, the burden is reversed when the issue bears on unwaivable rights. The right to a jury trial has been deemed “fundamental,” “inviolate,” and “sacred.” The Delaware Court of Chancery, as a court of equity, does not conduct jury trials. Therefore, the defendants must demonstrate that litigating in the Delaware Court of Chancery would not substantially diminish rights under California law. […]
California is an outlier in rejecting the enforcement of a Delaware Court of Chancery forum selection clause that is included in corporate documents. Most other state courts enforce Delaware forum selection clauses. Like California, nearly all state constitutions recognize the right to a jury trial. Yet California and Georgia appear to have the only courts that have expressly prohibited pre-dispute jury waivers. California courts point to the state’s constitution and Code of Civil Procedure that outlines only six actions that may waive the right to a jury trial, which do not include pre-dispute waivers, to demonstrate that forum selection clauses may not be enforced when they infringe upon such rights.
As Liz announced at our 2023 Conferences, we are absolutely thrilled that our 2024 Proxy Disclosure & 21st Annual Executive Compensation Conferences will be back in person! Since we lawyers are big planners, synchronize your (smart) watches for Operation 2024 Conferences & plug October 14 to 15 into your calendar.
We’ll gather in San Francisco to learn, plan for proxy season and commiserate (in person!) about our shared struggles. For extra credit, sign up here to be the first to get all the details. Or look out for future blogs about early bird registration and “sneak peeks” of topics & speakers.
And if you can’t make it in person, don’t panic! We will also offer a virtual option so you won’t miss out on the practical guidance our always excellent speaker lineup will share with attendees.
The transition to a T+1 settlement cycle pursuant to SEC Rule 15c6-1(a) will occur on May 28, 2024. The NYSE will adopt new rules to reflect regular way settlement as occurring on a T+1 basis and also will change the Exchange’s rules with respect to ex-dividend and ex-rights trading. Ex-dividend trading dates will be set during the transition period as follows:
– securities paying a dividend with a record date of May 28 will be traded ex-dividend on May 24; and
– securities paying a dividend with a record date of May 29 will be traded ex-dividend on May 29.
The Memo reminds listed issuers, to the extent practicable, to avoid consummation of corporate actions during the time of transition from T+2 to T+1.
In response to listed company inquiries, NYSE’s annual Listed Company Compliance Guidance letter also includes a reminder to debt-only issuers that they, too, are required to adopt a clawback policy. Here’s an excerpt:
In adopting Rule 10D-1, […] the SEC did not provide any such exemption for issuers whose only listed securities are debt securities, including issuers of debt securities guaranteed by a parent company whose common equity securities are typically listed on the Exchange. In response to inquiries from listed companies and their advisors, NYSE Regulation has sought clarification from the SEC regarding the treatment of debt-only issuers under Rule 10D-1 and Section 303A.14.
As a result of those conversations, NYSE Regulation confirms that all debt only issuers listed on the NYSE are required to adopt a Recovery Policy, including, without limitation, those with guarantees from listed parents and those that are exempt from disclosure requirements pursuant to Exchange Act Rule 12h-5. To the extent an issuer has not put in place relevant procedures, it is out of compliance with NYSE rules.
This Davis Polk memo from a few weeks ago has more on this and explains the mechanics (or lack thereof) for some debt-only issuers.
A subsidiary of a public company (including an operating company or finance subsidiary) can itself be the issuer of debt securities or a guarantor of debt securities issued by its parent company. […] Under SEC rules, where the parent guarantees the debt, the subsidiary is exempt from ongoing SEC reporting (in accordance with Rule 12h-5 under the Securities Exchange Act of 1934), and the parent reporting company is not required to provide separate financial statements to the SEC for the subsidiary (in accordance with the exemption under Rule 3-10 of Regulation S-X). […] Subsidiary securities are sometimes listed on an exchange.
Subsidiaries with listed securities should adopt a clawback policy to comply with the listing standards. The good news is that under both NYSE and Nasdaq listing standards, if the subsidiary is not itself subject to SEC financial reporting requirements, there should be no events that would trigger recovery of compensation under the policy.
This is because under the clawback rules, recovery of compensation is only triggered by a financial restatement that the issuer is required to prepare due to the issuer’s (i.e., the subsidiary’s) material noncompliance with financial reporting requirements under the U.S. federal securities laws. If the subsidiary issuer is not subject to such financial reporting requirements, then it should never be required to prepare a restatement due to material noncompliance with such financial reporting requirements.
The memo goes on to say that the clawback policy “could simply state that the parent company’s clawback policy applies to the subsidiary” and even includes a sample resolution that could be adapted for this purpose as an annex. Finally, it clarifies that, for any such subsidiary that does not file an annual report on Form 10-K, Form 20-F or Form 40-F, there would be no need to file the clawback policy as an exhibit.
A few weeks ago over on the Proxy Season Blog, Liz blogged about Exxon’s decision to take two shareholder proposal proponents to court over a “Scope 3” proposal and request a declaratory judgment that it could exclude the proposal from its proxy statement. Liz noted how unusual this “direct-to-court” strategy is — since shareholder proposals are non-binding, often don’t pass and there’s the option of seeking an SEC no-action letter. But she gave this background:
Back in 2017, one of the first climate proposals to receive majority shareholder approval was a request for a “2-degree scenario” analysis, which passed at ExxonMobil with 62% support. This emboldened proponents and gave credibility to the notion that investors want climate information. Looking back, it was one of the developments that launched the “E&S” tsunami. Over the ensuing 7 years, the volume of shareholder proposals increased to record numbers. Companies have been spending time, money, and energy on responding to proposals, negotiating with proponents, discussing the issues with institutional holders, and requesting no-action relief from the SEC.
The complaint, excerpted below, cites the difficulty in obtaining SEC no-action relief under current guidance:
The plain language of Rule 14a-8 supports excluding the 2024 Proposal, but current guidance by SEC staff about how to apply the rule can be at odds with the rule itself. Even though that guidance has no legal force or effect, Defendants and other similar activist organizations rely on it to pursue their personal preferences at the expense of shareholders. ExxonMobil seeks declaratory relief from this Court to stop this misuse of the current system.
On Monday, Liz shared that the proponents have now backed off by withdrawing their proposal (and promising not to refile it). But Exxon has not done the same. Here’s an excerpt from this Reuters article:
Exxon said it would continue with the suit, which questions the motivations of the investors and notes the rising number of resolutions being filed for corporate ballots.
“We believe there are still important issues for the court to resolve. There is no change to our plans, the suit is continuing,” Exxon said in an emailed statement.
In addition to seeking approval to skip a vote on the resolution, Exxon had sought attorneys’ fees and expenses and that the court enter “other and further relief as the Court may deem just and proper.”
This will be closely watched litigation that we’ll generally cover on our Proxy Season Blog where we continue to regularly post new items for TheCorporateCounsel.net members. Members can sign up to get that blog pushed via email whenever there is a new post. If you do not have access to the Proxy Season Blog or all the other great resources on TheCorporateCounsel.net, sign up today.
Yesterday, the SEC’s Office of Chief Accountant Paul Munter released this statement on the recent increase in deficiency rates found in audit inspections and the role of the auditor and audit committee in ensuring high-quality audits. The statement first addresses the role of auditors and suggests that auditors do more of the following:
– frequently and proactively engage with the audit committee, including on events that impact financial reporting and red flags arising from management responses;
– not agree to truncated or summary presentations with the audit committee regarding concerns with management or management responses;
– include specialists and other experts to assist in auditing complex areas or where specialized knowledge is needed to ensure adequate expertise;
– ensure engagement teams are trained on biases that affect auditor judgment and decision-making and undermine professional skepticism; and
– ensure that audit staff are empowered to exercise professional skepticism and challenge judgments of management by supporting audit staff in exploring areas of heightened risk and red flags, insulating audit staff from pressure to accept less than persuasive audit evidence and refusing management requests to replace audit team members.
Then the statement turned to the role of audit committees. First, it describes the importance of the committee’s role in assessing auditor performance, and suggests committees evaluate whether and how they consider the following:
– results of the auditor’s PCAOB inspections, the firm’s internal monitoring programs, or other firm audit quality reporting; – whether the engagement team has appropriate industry expertise, and whether the engagement partner is sufficiently engaged and provides leadership to the engagement team; – the engagement team’s total hours and staffing mix (such as, the use of specialists, the composition of experience within the engagement team, or portions of the engagement performed by other auditors); and – significant changes (or the lack thereof) in hours or staffing mix from previous audits.
It also encourages audit committees to build a strong professional relationship with the auditor independent of management and makes suggestions to further that goal.
Chief Accountant Munter has been sharing thoughts with the corporate and auditor communities regularly in recent months, having recently addressed the importance of the statement of cash flows, with consistent commentary at the Northwestern Securities Regulation Institute. He also recently joined this Q&A with KPMG where he highlighted the risk of what he called the “SALY” (same as last year) mentality, noting that audit committees need to pay attention to emerging risks, which are often communicated first outside of the financial statements, in risk factors or MD&A, and be thinking through what those risks mean for the financial reporting process.
Here’s something Liz shared on the CompensationStandards.com Advisors’ Blog yesterday:
It was the “moonshot” award that started it all. But last week, as you’ve probably heard, Elon Musk did not get the outcome he was hoping for in the Tornetta v. Musk litigation that has been winding its way through the Delaware Court of Chancery for several years.
The case challenged the record-breaking equity award that was granted to Musk in 2018 and – when the value of the company skyrocketed – came to be worth about $51 billion. Chancellor Kathaleen McCormick issued her 201-page opinion last Tuesday. As Tulane Law Prof Ann Lipton put it, “she took the extraordinary step of holding that Elon Musk’s Tesla pay package from 2018 was not ‘entirely fair’ to Tesla investors, and ordered that it be rescinded.” Mechanically, it looks like the options that the company had granted to Musk will now be cancelled (none of the options had been exercised). Ann’s blog walks through the complex legal standards – & burdens of proof – that led Chancellor McCormick to this outcome. Here’s an excerpt:
Formally, in Tornetta, the court concluded that Elon Musk was a controlling shareholder of Tesla, at least for the purposes of setting his compensation package. The court considered both his 21% percent stake, and his “ability to exercise outsized influence in the board room” due to his close personal ties to the directors and his “superstar CEO” status. She recounted the process by which the pay package was set, noting in particular that Musk proposed it, Musk controlled the timelines of the board’s deliberation, and he received almost no pushback – board members and Tesla’s general counsel seemed to view themselves as participating in a cooperative process to set Musk’s pay, rather than an adversarial one.
What about the stockholder vote? That, too, was tainted, because – McCormick concluded – the proxy statement delivered to shareholders contained material misrepresentations and omissions. It described Tesla’s compensation committee as independent when in fact the members had close personal ties to Musk, and it did not accurately describe the manner in which his pay package was set – again, with Musk himself proposing it and the board largely acquiescing. With those findings in hand, McCormick did not rule on the plaintiff’s additional arguments that the proxy statement was misleading for other reasons (namely, it falsely described the payment milestones as “stretches” when in fact the early ones were already expected within Tesla internally.)
Chancellor McCormick said that the process leading to the approval of the compensation plan was “deeply flawed.” Advisors will also find it interesting that she reviewed an early draft of Tesla’s proxy statement and found it to be the “most reliable (indeed, the only) evidence” of the substance of the discussion that established the terms of Musk’s equity grant. Over the course of several drafts, the existence of that conversation was edited out – so, it was not mentioned in the as-filed proxy. The judge also took issue with this statement:
The Proxy disclosed that, when setting the milestones, “the Board carefully considered a variety of factors, including Tesla’s growth trajectory and internal growth plans and the historical performance of other high-growth and high-multiples companies in the technology space that have invested in new businesses and tangible assets.” “Internal growth plans” referred to Tesla’s projections.
According to the court’s findings, the proxy was misleading because it didn’t disclose that the company had projections that would show that the milestones would be achieved. As Ann explained in her blog, the court also took issue with describing compensation committee members as “independent” when – according to the record – they in fact had relationships that gave rise to potential conflicts of interest that should have been disclosed, and a “controlled mindset.” So, Chancellor McCormick concluded:
The record establishes that the Proxy failed to disclose the Compensation Committee members’ potential conflicts and omitted material information concerning the process. Defendants sought to prove otherwise, and they generally contend that the stockholder vote was fully informed because the most important facts about the Grant—the economic terms—were disclosed. But Defendants failed to carry their burden.
The case shows that process, common-sense thinking, and disclosure matter. If you’re involved in the compensation-setting and/or proxy drafting process, you may not win friends if you read everything with a critical eye and ask unwanted questions. It can be hard to find a way to do that tactfully. But now you have a case to point to that shows why it’s important.