Well, it was fun while it lasted. We now return to our regularly scheduled series of ESG-related lead blogs. Yesterday, the SEC released the agenda for tomorrow’s meeting of its Asset Management Advisory Committee. Topping that agenda is a discussion of the ESG subcommittee’s recommendations on improving “the data and disclosure used for ESG investing, in order to create better transparency for investors, and better verifiability of investment products’ ESG strategies and practices.”
The subcommittee’s recommendations address both issuer disclosure and ESG-themed investment products. On the issuer side, the subcommittee calls on the SEC to adopt a standardized framework for disclosing material ESG risks – a process that the subcommittee acknowledged would be “lengthy and complex.” On the investment products side, the recommendations start with asking “How can we avoid ‘greenwashing,’ that is, investment products bearing the name ESG but not actually engaging in meaningful ESG investment?”
That focus on greenwashing is timely, because the AMAC meeting will be held just a few days after the publication of a scathing opinion piece by Tariq Fancy, BlackRock’s former head of sustainable investments, on how ESG investment products are “duping” the public. This excerpt gives you a sense for the tone of the piece:
The financial services industry is duping the American public with its pro-environment, sustainable investing practices. This multitrillion dollar arena of socially conscious investing is being presented as something it’s not. In essence, Wall Street is greenwashing the economic system and, in the process, creating a deadly distraction. I should know; I was at the heart of it.
As the former chief investment officer of Sustainable Investing at BlackRock, the largest asset manager in the world with $8.7 trillion in assets, I led the charge to incorporate environmental, social and governance (ESG) into our global investments. In fact, our messaging helped mainstream the concept that pursuing social good was also good for the bottom line. Sadly, that’s all it is, a hopeful idea. In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community.
I’m not sure what to make of the fact that this appeared in – of all places – “USA Today.” That’s a publication I’m more accustomed to turning to for high school football rankings than for financial analysis & opinion, although I guess that’s beside the point. Anyway, if you read the whole thing, you come away with a feeling that the SEC’s new enforcement task force is going to find a target-rich environment when it comes to ESG themed mutual funds & ETFs.
Crowdfunding: Corp Fin Issues Guidance on EDGAR Filing of Form C
The SEC’s private offering simplification rule amendments became effective earlier this week, and as a follow-up to that, Corp Fin issued guidance yesterday on EDGAR filings of Form C for Regulation Crowdfunding offerings. The first part of the guidance addresses the fact that the form hasn’t caught up to the rule changes yet, and provides advice to companies that are taking advantage of the new $5 million size limit on how to fill out a form that only contemplates a $1.07 million maximum offering size.
The second part of the guidance contains 4 Q&As addressing how issuers taking advantage of their new ability to use a special purpose vehicle as a conduit in a Regulation Crowdfunding should complete & file Form C. The first Q&A addresses each party’s filing obligations:
Is a crowdfunding vehicle required to file its own Form C, separate from the Form C filed by the crowdfunding issuer?
Response: No. Under Regulation Crowdfunding Rule 203(a)(1), the crowdfunding issuer and crowdfunding vehicle are required to jointly file one Form C, providing all of the required Form C disclosure with respect to the offer and sale of the crowdfunding issuer’s securities to the crowdfunding vehicle and the offer and sale of the crowdfunding vehicle’s securities to investors.
However, if the crowdfunding issuer is offering securities both through a crowdfunding vehicle and directly to investors, Rule 203(a)(1) requires the crowdfunding issuer to file two Forms C: its own Form C covering the securities offered directly to investors, and a second Form C jointly with the crowdfunding vehicle for the securities offered through such vehicle.
Other Q&As address matters such as CIK numbers & access codes, how to furnish the XBRL information for the crowdfunding vehicle, and how the crowdfunding vehicle should comply with signature requirements.
Public Offerings: Financial Statement Requirements for US & Foreign Issuers
Latham recently published its annual memo on the financial statement requirements for public offerings. As usual, there’s a version for U.S. issuers and a separate version for non-U.S. issuers. These are always a good resource, but with the changes to acquired company financial information requirements that the SEC adopted last year, you may find them particularly useful this year.
In news that I’m delighted to say has nothing whatsoever to do with ESG, the SEC recently issued an Investor Alert about celebrity involvement with SPACs. Here’s the gist of it:
The SEC’s Office of Investor Education and Advocacy (OIEA) cautions investors not to make investment decisions related to SPACs based solely on celebrity involvement.
Celebrities, from movie stars to professional athletes, can be found on TV, radio, and social media endorsing a wide variety of products and services. Sometimes they are even involved in investment opportunities such as special purpose acquisition companies, or SPACs, as sponsors or investors. Those celebrities may even be well-known professional investors.
However, celebrity involvement in a SPAC does not mean that the investment in a particular SPAC or SPACs generally is appropriate for all investors. Celebrities, like anyone else, can be lured into participating in a risky investment or may be better able to sustain the risk of loss. It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.
I know that most of you likely had the same reaction to this that I did – How can the SEC issue something like this during this very difficult time for A Rod & J Lo?
America may not be #1 in a lot of stuff anymore, but I’ll match our celebrities against anybody in the world. During the past couple of weeks alone, Meghan & Oprah caused the British monarchy more heartburn than George Washington or Mahatma Gandhi ever did, Geraldo entertained the Buckeye State by almost simultaneously announcing that he was, and that he was not, considering a run for the Senate, and Kanye reportedly offered to buy Rye, New York for $100 million & rename it “Ye,” which is totally sane and very cool. Meanwhile, the biggest professional investor celebrity SPACer, Bill Ackman, has been busy trying to both cultivate & stay one step ahead of the “Stonks” crowd on Reddit.
I guarantee that an investment in a SPAC sponsored by any of these folks will provide much greater entertainment value than an investment in other SPACs. I also bet that when the dust settles, public investors in celebri-SPACs & public investors in more mainstream SPACs will achieve just about the same really crappy return on their investments. So, to paraphrase the great American patriot Patrick Henry, I say, “I know not what course others may take, but as for me, give me Shaq SPAC or give me death!”
Financial Reporting: Big Year for Goodwill Impairment
If your company took a big goodwill impairment charge last year, it probably won’t come as a big surprise to learn that you weren’t alone. According to this Duff & Phelps report, goodwill impairments in 2020 were at their highest level since the financial crisis:
At the time of writing, the disclosed top 10 GWI events for 2020 reached a combined $54 bn, far surpassing the top 10 in 2019. Although full 2020 calendar year-end results for U.S. public companies will not be known for some time, early reporting points to overall GWI already exceeding $120 bn in 2020. For perspective, in 2008, at the height of the global financial crisis, U.S. companies recorded a total GWI of $188 bn, according to our prior studies.
According to the report, the energy sector took the biggest hit – approximately 34% of energy companies with goodwill on their books recorded an impairment charge. Duff & Phelps says that if 2020’s impairment charges don’t top financial crisis levels, we can thank the Federal Reserve & federal government for repeatedly firing their cash bazookas.
Sold! Glass Lewis Moves From Activist to Private Equity Ownership
Yesterday, Glass Lewis announced that it had been sold to the Toronto-based private equity firm Peloton Capital Management & its Chairman, Stephen Smith. Here’s the press release. As most of you know, Glass Lewis’s previous majority owner was an activist investor, the Ontario Teachers Pension Plan. Now that it’s in the hands of private equity, you’ll have to decide for yourselves whether there’s been a disturbance in the Force.
Well, it looks like this blog has to continue with its “All ESG, All the Time” format for at least another day. The latest event that’s preventing me from taking my preferred approach & blogging about literally any other topic is yesterday’s announcement from Acting SEC Chair Allison Herren Lee that the agency is soliciting public comment on climate change disclosure.
The announcement identifies 15 specific climate disclosure-related questions on which the SEC would like public input. These range from the fairly mundane (What are the advantages & disadvantages of rules that incorporate or draw on existing frameworks?) to the downright hair-raising (How should the SEC’s rules address climate change disclosure by private companies?).
The final question notes that the Staff is evaluating a range of ESG disclosure issues & asks if climate-related requirements should be one component of a broader ESG disclosure framework. That’s a good segue into the speech that Acting Chair Lee also gave yesterday at the Center for American Progress, in which she outlined her views on the SEC’s climate change & ESG agenda. In case you haven’t already figured it out, this excerpt indicates that the SEC is going to be a very different place than it has been over the past several years:
Human capital, human rights, climate change – these issues are fundamental to our markets, and investors want to and can help drive sustainable solutions on these issues. We see that unmistakably in shifts in capital toward ESG investing, we see it in investor demands for disclosure on these issues, we see it increasingly reflected on corporate proxy ballots, and we see it in corporate recognition that consumers and investors alike are watching corporate responses to these issues more closely than ever.
That’s why climate and ESG are front and center for the SEC. We understand these issues are key to investors – and therefore key to our core mission.
While climate change & ESG may be front and center, Acting Chair Lee indicated that they aren’t the only items on the agenda. Others include potentially undoing last year’s changes to the shareholder proposal process, revisiting the SEC’s guidance on proxy voting by investment advisors and finalizing a universal proxy rule.
Non-GAAP: Companies Aren’t Pushing the “EBITDAC” Envelope
Throughout the pandemic, we’ve been keeping an eye on how companies have been reporting the financial impact of Covid-19. Early on, some companies were disclosing non-GAAP adjusted EBITDA that reflected pandemic-related expenses, such as PPE and other safety-related expenses and high comp for on-site employees.
This adjusted EBITDA presentation was derisively called “EBITDAC” by its critics. Last fall, the WSJ questioned how long companies could continue to characterize additional expenses like these as one-time charges justifying an “adjusted EBITDA” presentation. According to this CFO Dive article, it looks like companies are backing away from this approach in their Q4 disclosures:
Few companies are reporting adjustments to earnings before interest, taxes, depreciation and amortization (EBITDA) to account for COVID-19-related costs at this late stage of the pandemic. Some analysts say that’s not a bad thing. Adjustments to EBITDA, a non-GAAP performance measure, are intended to account for one-time events. The idea is to show that, but for these unique circumstances, the company’s sustained performance would show a different result.
In the first few quarters after the pandemic’s start, some companies were reporting adjusted EBITDA to account for purchases of personal protective equipment (PPE), higher pay to on-site employees and operational restructuring. Uber, for example, increased its adjusted EBITDA by $19 million in March to account for assistance payments to its drivers. Iron Mountain, an information management and storage company, included almost $10 million in expenses for PPE, plexiglass shields and facility cleaning in its second quarter financial results.
The article cites a Bass Berry blog which said that only 16% of large, public companies made COVID-related adjustments at the end of 2020. The blog says that most of the companies that presented adjusted EBITDA dumped the charges into a single “Covid-19 related charges” line item, but that 37% provided more granular detail on the nature of the charges.
“Technoking” & “Master of Coin”? Elon Strikes Again
Not too long ago, Tesla went through three General Counsels in a single year. My guess is that you need look no further than the Item 8.01 Form 8-K that Tesla filed yesterday if you want to know why the company finds it so hard to hang on to senior lawyers. Yesterday’s filing announced the following:
Effective as of March 15, 2021, the titles of Elon Musk and Zach Kirkhorn have changed to Technoking of Tesla and Master of Coin, respectively. Elon and Zach will also maintain their respective positions as Chief Executive Officer and Chief Financial Officer.
Ha Ha! Oh, that Elon – what a jokester! I’m not sure the Tesla board is laughing though, particularly since they were just sued again in Delaware for allegedly allowing Elon to continue to engage in “erratic” tweets that the plaintiffs contend violate the terms of the company’s settlement with the SEC.
One wit wondered via tweet if the 8-K filing also disclosed that the GC’s title had been changed to “He Who Sits In The Revolving Door Of Saying ‘No’ And Creating Forms?”
I was really hoping to lead with something other than an ESG-related topic this morning, but thanks to Acting Corp Fin Director John Coates, that’s not going to happen. Coates issued a statement on Thursday setting forth his views on ESG disclosure, and he had a lot to say. He addressed some of the key considerations in developing an ESG disclosure system, the costs of non-disclosure of ESG information, and, in this excerpt, called for the development of global disclosure standards:
On the issue of global comparability, in the first instance, arguments in favor of a single global ESG reporting framework are persuasive. ESG issues are global issues. ESG problems are global problems that need global solutions for our global markets. It would be unhelpful for multiple standards to apply to the same risks faced by the same companies that happen to raise capital or operate in multiple markets. In this regard, the work of the IFRS Foundation to establish a sustainability standards board appears promising.
This Davis Polk blog on the statement provides some additional color on the efforts to establish the sustainability standards board to which John Coates referred:
The IFRS is an international non-profit organization that has been steadily working on creating global sustainability reporting standards. By the end of September 2021, IFRS plans to release its definitive proposal, complete with a roadmap and timeline, on whether it will create a sustainable standards board to sit beside the International Accounting Standards Board, IFRS’s accounting standard-setting body.
In February 2021, the International Organization of Securities Commissions, or IOSCO, issued a public statement in support of IFRS’s work. IOSCO’s members include 34 international securities regulators, including the SEC and the CFTC, and the securities regulators of Brazil, China, France, Hong Kong, Spain and the UK, among others.
IOSCO said that it “sees an urgent need for globally consistent, comparable, and reliable sustainability disclosure standards and announces its priorities and vision for a Sustainability Standards Board under the IFRS Foundation.” However, despite the apparent consensus, the blog notes one particular challenge that needs to be confronted – getting all parties to agree upon a definition of “materiality” in the ESG context.
SEC Enforcement: Commissioner Crenshaw Throws a Grenade
Last week, Commissioner Caroline Crenshaw gave a speech at the CII’s spring meeting. She didn’t make much news – well, I mean unless you consider throwing a grenade at 15 years of SEC enforcement policy to be news. Over on Radical Compliance, Matt Kelly seemed to think this was kind of a big deal:
Compliance officers, clear your schedule and retreat to your reading nook! We have an important speech to consider on the future of enforcement at the Securities and Exchange Commission. Commissioner Caroline Crenshaw, a Democratic appointee who joined the SEC only seven months ago, spoke Tuesday at the spring meeting of the Council of Institutional Investors — and took a wrecking ball to longstanding assumptions about how large the penalties should be in cases of corporate misconduct.
Specifically, Crenshaw faulted an SEC enforcement policy in place since 2006 that says the agency should be careful not to impose a penalty that might unduly burden shareholders of the company in question. The logic behind that policy has been that a company’s current shareholders at the time of resolution might not have benefitted from the misconduct that happened earlier; and that those current shareholders would suffer because paying the penalty leaves that much less money for the company to put to good use.
Crenshaw’s response: what does any of that have to do with the need to, ya know, punish misconduct?
Commissioner Crenshaw said that in lieu of focusing on “amorphous concepts” like corporate benefits and shareholder harm, the SEC should set penalties based on the actual misconduct and the extent of cooperation with the Division of Enforcement staff. Higher penalties should be imposed for violations that cause more harm, and for those that are more difficult to detect. Stay tuned. . .
Tomorrow’s Webcast: “The Top Compensation Consultants Speak”
Tune in tomorrow for the CompensationStandards.com webcast – “The Top Compensation Consultants Speak” – to hear Blair Jones of Semler Brossy, Ira Kay of Pay Governance and Marc Ullman of Meridian Compensation Partners discuss what compensation committees should be learning about – and considering – evolving views of pay-for-performance, expanding roles for compensation committees, goal-setting and adjustments, and an early look & predictions for the 2021 proxy season.
If you attend the live version of this 60-minute program, CLE credit will be available! You just need to submit your state and license number and complete the prompts during the program.
Members of CompensationStandards.com are able to attend this critical webcast at no charge. If you’re not yet a member, subscribe now. The webcast cost for non-members is $595. You can renew or sign up online – or by fax or mail via this order form. If you need assistance, send us an email at info@ccrcorp.com – or call us at 800.737.1271.
Transcript: “Private Offerings – Navigating the New Regime”
We have posted the transcript for the recent webcast “Private Offerings – Navigating the New Regime.”
Activist hedge funds are usually considered a potential threat by public company management, but that’s not always the case. A recent study takes a look at the phenomenon of “validation capital,” where hedge funds take a position in a company and protect management from other activists as they implement the company’s strategy. Here’s an excerpt from the abstract:
Although it is well understood that activist shareholders challenge management, they can also serve as a shield. This Article describes “validation capital,” which occurs when a bloc holder’s—and generally an activist hedge fund’s—presence protects management from shareholder interference and allows management’s pre-existing strategy to proceed uninterrupted.
When a sophisticated bloc holder with a large investment and the ability to threaten management’s control chooses to vouch for management’s strategy after vetting it, this support can send a credible signal to the market that protects management from disruption. By protecting a value-creating management strategy that might otherwise be misjudged, providers of validation capital benefit all shareholders, including themselves.
These arrangements often involve side payments to the hedge funds providing the muscle, which the authors acknowledge creates the potential for a corrupt bargain – but they conclude that legal and market forces make that an unlikely outcome. They claim that empirical data from hedge fund activism events supports that conclusion. This “Institutional Investor” article discusses the study, and cites Trian’s 2014 investment in BNY Mellon as an example of validation capital.
Earlier this month, Sen. Pat Toomey (R-PA) & other Republican members of the Senate Banking Committee sent a letter to Acting SEC Chair Allison Herren Lee urging the SEC to reject Nasdaq’s board diversity listing proposal.
While acknowledging the potential benefits of board diversity, the letter contends that Nasdaq’s proposal would interfere with “a board’s duty to follow its legal obligations to govern in the best interest of the corporation and its shareholders,” violate the materiality principle that governs securities disclosure & harm economic growth by imposing costs on public companies and discouraging private companies from going public. Okay, those may be reasonable criticisms – but I rolled my eyes at this part of the letter:
The materiality doctrine prevents the development of an unstable, politicized securities regime that would be ripe for abuse of power. Without it, political factions could use securities regulations to advance the latest social policy fad, sidestepping democratic deliberation. Securities regulation would become a political football, as all sides of a social policy issue would fight to enshrine their perspective into regulation.
Sen. Toomey & his colleagues undoubtedly intended their statement about securities regulation becoming a “political football” as a warning about a future regulatory dystopia. Unfortunately, it seems more like a pretty accurate description of the past several years at the SEC, where the outcome of virtually all major regulatory proposals has been decided by a 3-2 vote along unbending partisan lines. That’s a situation that seems unlikely to change in the near future.
Contracts: SDNY Says the Pandemic is a “Force Majeure”
This Shearman blog reviews the SDNY’s recent decision in JN Contemporary Art v. Phillips Auctioneers, (SDNY; 12/20), in which Judge Denise Cote held that an auction house was permitted to terminate an agreement because the pandemic constituted a “natural disaster” within the meaning of the agreement’s force majeure clause. This excerpt discusses Judge Cote’s reasoning:
The Court held that the COVID-19 pandemic and related government restrictions on business activity were “squarely” within the agreement’s force majeure clause, which allowed the auction house to terminate the contract if the auction were postponed due to “circumstances beyond [the parties’] reasonable control.” First, the Court concluded that it could not be “seriously disputed” that COVID-19 constituted a “natural disaster” as the pandemic was an event “brought about by nature” and a “natural event that cause[d] great damage or loss of life.”
Second, the Court determined that the COVID-19 pandemic was the type of “circumstance” envisioned by the clause because the enumerated examples included environmental calamities and “also widespread social and economic disruptions.” The COVID-19 pandemic fell within that category, the Court noted, as it was “a worldwide public health crisis that has taken untold lives and upended the world economy.”
The blog says that this decision is among the first to explicitly hold that the pandemic qualifies as a “natural disaster” under a contractual force majeure clause.
In news that may throw an 11th hour monkey wrench into the finalization of a number of 10-K filings, Acting SEC Chair Allison Herren Lee issued a statement yesterday in which she directed Corp Fin to take a hard look at companies’ climate change disclosures. Here’s an excerpt:
Today, I am directing the Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings. The Commission in 2010 provided guidance to public companies regarding existing disclosure requirements as they apply to climate change matters.
As part of its enhanced focus in this area, the staff will review the extent to which public companies address the topics identified in the 2010 guidance, assess compliance with disclosure obligations under the federal securities laws, engage with public companies on these issues, and absorb critical lessons on how the market is currently managing climate-related risks. The staff will use insights from this work to begin updating the 2010 guidance to take into account developments in the last decade.
You may recall that a few years ago, the GAO took a look at the SEC’s actions since it issued climate change disclosure guidance. The GAO report expressed some concern with the Staff’s level of training on climate related disclosures, so that may present some challenges for everyone involved in the review process. Those training shortcomings may well have been addressed in the years following the GAO report, but there’s still the matter of the lack of uniformity in climate change disclosures that the GAO report also noted.
Finally, the SEC hasn’t exactly been cracking the disclosure whip on climate change in recent years, so the Staff’s likely to find a fairly target rich environment when it reviews existing climate disclosures. Add all of that up, and, well, in the words of Bette Davis, “fasten your seat belts, it’s going to be a bumpy night.”
Now is probably a good time to refresh yourself on the SEC’s 2010 guidance, and to review the other resources in our “Climate Change” Practice Area. If you want to get a sense for where the SEC may be heading in this area and the broader ESG disclosure category, check out this blog from Cooley’s Cydney Posner.
Disclosure: ESG Top Priority for Corp Fin’s Acting Director
Acting Chair Lee & Corp Fin’s Acting Director John Coates are clearly “singing from the same hymnal” when it comes to increasing the agency’s emphasis on climate change and other ESG disclosures. In fact, according to this Bloomberg Law article, ESG is Coates’ top disclosure priority. Here’s an excerpt:
A Harvard Law School professor who has pushed the SEC to update its corporate disclosure requirements on climate change and other ESG issues is now planning to turn his words into action as an agency insider. John Coates, who joined the Securities and Exchange Commission on Feb. 1 as acting director of its Division of Corporation Finance, is poised to play a leading role in any agency action to boost companies’ environmental, social, and governance disclosures, following his work on the issues at Harvard and on an SEC advisory panel.
Under his guidance, the SEC’s Division of Corporation Finance could enhance its focus on climate disclosures when it reviews companies’ filings. It also could start working on rules to mandate more corporate reporting on climate change and other ESG matters. He may even play a role in requiring disclosures on companies’ political spending, if Congress allows the SEC to act.
“If I were to pick a single new thing that I’m hoping the SEC can help on, it would be this area,” Coates said about ESG in an interview with Bloomberg Law.
A recent Reuters article also quotes Coates as saying that the SEC “agency ‘should help lead’ the creation of a disclosure system for environmental, social and governance (ESG) issues for corporations.”
Zoom Etiquette: No Jammies in Chancery Court!
It turns out that “Cat Lawyer” wasn’t the only member of the bar who fumbled a Zoom hearing in recent months. Francis Pileggi recently provided some guidance on his blog about “protocols & professionalism” for remote hearings. He included a number of helpful links to information from the Delaware courts, but it was a link to a recent letter from Vice Chancellor Slights that caught my eye. This excerpt from that letter suggests that one lawyer involved in a hearing would have been better off using a cat filter instead of taking a “come as you are” approach:
Mr. Weisbrot’s email states that I would not consider an application from him because he was “not wearing a tie.” That is true, as the record reflects. What the record also reflects is that Mr. Weisbrot appeared in court for trial (via Zoom) on Tuesday in either a printed tee-shirt or pajamas (it was difficult to discern).
Egads! Look, we long ago established that I don’t know much about fashion, but even I would think twice about showing up for a Chancery Court hearing in my “Dragnet” tee-shirt.
This Bryan Cave blog provides some helpful input about the SEC’s recently adopted electronic signature process – a topic that we’ve received a lot of questions about in our Q&A Forum. Here’s an excerpt addressing a common area of uncertainty: will the authentication requirements be met if a company emails a document for signature and asks that the recipient reply by email affirmatively indicating approval of the filing?
Many take the more conservative view that affirmative reply emails, without added features, are not sufficiently secure to authenticate the signer’s identity. For example, someone other than the signer may have access to his or her email account and the ability to send affirmative reply emails on his or her behalf. Similarly, someone could theoretically walk by an unoccupied computer and send a reply email.
Another view is that an affirmative reply email in and of itself should be a sufficient “logical or digital” authentication as long as the attestation form confirms the signatory’s email address to be used for that purpose.
We recommend that unless and until the SEC provides guidance, companies proceed with caution in using “affirmative reply” emails to authenticate signatures, and that, to the extent practicable, they consider adding features such as those discussed in Item 3 below.
As the blog’s response suggests, the details surrounding the authentication requirement are somewhat murky, and this is an area where experienced practitioners disagree on the right approach. Some guidance from the Staff on this and other electronic signature-related topics would be helpful. Sure, this is pretty mundane stuff – but worrying about the mundane stuff probably accounts for the vast majority of sleepless nights among securities lawyers.
Activism: The Pandemic as a Catalyst
Last year’s proxy season saw a decrease in the number of activist campaigns, as pandemic-related disruptions during the early spring early raised investor concerns about the potential for opportunistic behavior among activist hedge funds. This recent Deloitte report suggests that this year may be a different story – and that some of the changes brought about by the pandemic may serve as a catalyst for activism. Here’s an excerpt:
In another intriguing example of how dramatically things have changed in the past year, labor productivity in the United States jumped even as companies scrambled to adjust to the economic upheaval. Worker productivity growth in the United States had been essentially flat in the decade since the Great Recession, but through the first three quarters of 2020, it jumped.
This may be a macroeconomic clue that points to unexpected value in our new ways of doing business—increased digital interaction with their customers, or workforce changes such as work-from-home. Activists are likely to see in this and other “disconnects” new opportunities for boosting margins that can be added to their playbooks. As a result, we may see activists pushing companies to pursue digital transformation or change product mix based on the lessons of the crisis.
The report suggests that the typical advice to boards – “think like an activist” – is even more important this year. The focus on margin improvement is a case in point. Activists will typically look for opportunities to improve a company’s performance in three main areas: revenue growth, margin enhancement, or portfolio changes. Boosting margins is often a more attractive option than revenue growth, because smaller gains can have a bigger impact on the bottom line.
Transcript: “Shareholder Proponents Speak – 14a-8 Fallout & Other Initiatives”
We have posted the transcript for the recent webcast – “Shareholder Proponents Speak: 14a-8 Fallout & Other Initiatives.”
In response to the events of last summer, many companies announced actions designed to showcase their commitment to racial & ethnic diversity. Global private equity colossus The Carlyle Group was one of them. Last August, Carlyle announced a new policy calling for at least one candidate who is Black, Latino, Pacific Islander or Native American to be interviewed for every new position. Carlyle also committed to ensuring that that 30% of its portfolio companies’ boards were ethnically diverse.
Corporate commitments like these were a dime a dozen in the long, hot summer of 2020, but Carlyle looks like it just might mean business. This recent NYT article describes a new $4.1 billion credit facility that the firm established for its portfolio companies that ties pricing to the diversity of a company’s board:
The credit facility is an extension of Carlyle’s goal for the boards of the companies in its portfolio to have a diversity rate of at least 30 percent by next year. Nearly 90 percent of its companies now meet its 2016 goal of having at least one director who is a woman or ethnic minority for companies in the United States or, for companies outside the United States, one director who is a woman.
The firm says the effort is good for business: In a study of its portfolio companies, Carlyle found that firms with two or more diverse board members recorded annual earnings growth 12 percent higher than those with fewer diverse directors.
The Times article says that Carlyle’s effort to use the tools of private equity to promote diversity initiatives is part of a broader trend in ESG investments. It points out that debt issuance in support of sustainability efforts hit a record $732 billion last year – a 26% increase from the prior year.
ESG: The Rise of Sustainable Finance
If that $732 billion number caught your eye, check out this Wachtell Lipton memo, which highlights how rapidly the market for ESG-related debt financing is growing and broadening. Here’s the intro:
In the midst of the Covid pandemic, issuances of green, social, sustainable and sustainability-linked financing products have surged. Once solely available in the investment grade space, ESG-related debt issuance has expanded into the high-yield market. Likewise, sustainable finance is not just for European issuers anymore; it has jumped the pond and landed in the mainstream in the United States. Notably, private equity sponsors and their portfolio companies have recently joined strategic companies as ESG issuers.
As we expected, the credit markets have sent two unequivocal messages as companies increasingly signal their commitment to accountability on ESG issues: (i) ESG risk is credit risk and (ii) investors are willing to pay modest subsidies to support progress on ESG issues. Massive inflows into ESG-oriented investment funds and seemingly insatiable demand for ESG-related issuances have led to “greenium” pricing (i.e., a lower cost of capital for issuers) of many ESG-related issuances. Moreover, credit rating agencies are increasingly factoring ESG risks – including related regulatory risks – into their ratings, as are credit committees at banks into their determinations.
The memo reviews common sustainable finance product types and urges companies considering tapping into this financing to consider in advance what KPIs could form the basis for an ESG-related bond or loan. Those companies also need to consider how their existing sustainability reporting can support sustainable finance, because investors will want periodic disclosure on the relevant metrics & their drivers.
Key Performance Indicators: Recent Staff Comments
Early last year, the SEC issued an interpretive release providing guidance on disclosure of key performance indicators in MD&A. Just to make sure they had everyone’s attention, they quickly followed that up with an enforcement action targeting allegedly misleading KPI disclosures. KPI disclosures have remained the subject of close Staff scrutiny since that time, and this recent Bass Berry blog looks at recent Staff comments touching on these disclosures.
The blog focuses on comments directed at the determination of whether a KPI was a non-GAAP financial measure or an operational metric & on disclosure of KPI trends, and includes excerpts from Staff comment letters & responses. It’s definitely worth reading before your next SEC filing.
Compliance with the changes to Reg S-K’s financial disclosure rules doesn’t become mandatory until August 9th, but companies are permitted to early adopt the changes on a line item-by-line item basis as of the February 10th effective date. One of those changes eliminates Item 301 of S-K and its requirement to include selected financial data in a company’s 10-K filing. If you’re still trying to decide what to do about selected financial data in your 10-K, Jenner & Block has some help for you.
The firm surveyed 100 Form10-K filings made after the February 10th effective date of the rules by large accelerated filers & accelerated filers to see what companies were doing about selected financial data disclosure. This excerpt summarizes the survey’s findings:
Approximately 40% of the Sample Eliminated Item 301 Disclosure: On the balance, we found that companies were slightly more likely to include the selected financial data than to omit such information based on the sample we reviewed.
– 61 companies within the sample included the selected financial data in the Form 10-K
– 39 companies within the sample omitted the selected financial data in the Form 10-K
No Distinct Patterns within the Sample: We did not detect any concrete patterns with respect to industry or company size. Companies of all industries and sizes elected to include and omit the selected financial data.
For Companies that Early Adopted, Use of Disclosure Varied: Some companies elected to explain why the information was omitted, some omitted the item entirely from the Form 10-K, and some used “Reserved” or similar disclosure.
On this last point, I think that if you’re going to eliminate Item 301 disclosure, the better approach from a technical standpoint is to continue to include the caption “Item 6 – Selected Financial Data” in the 10-K. Here’s why – Item 6 is still included in Form 10-K, and Rule 12b-13 says that an Exchange Act report “report shall contain the numbers and captions of all items of the appropriate form. . .” It also says that unless the form provides otherwise, “if any item is inapplicable or the answer thereto is in the negative, an appropriate statement to that effect shall be made.”
So, while I doubt very much anybody will end up in SEC prison for just omitting Item 6 in its entirety, Rule 12b-13 indicates that you should continue to include it in your 10-K along with an appropriate statement about why you’re not disclosing the selected financial data that it calls for. Looking for an example? Check out Zillow Group’s 10-K.
Delaware Chancery: “You Do NOT Have the Right to Remain Silent. . .”
The last 12 months have certainly lent themselves to TV binge-watching. While most people binged on shows like “Tiger King” or “The Queen’s Gambit,” I took the road less traveled and binged on “Dragnet” reruns. Yeah, I know that’s a pretty eccentric choice, but I simply can’t get enough of Sergeant Joe Friday & his partners.
Sure, the acting’s wooden & the world view’s problematic, but the 1950s version of the show just may be TV’s greatest example of the film noir style. The preachy 1960s version wasn’t nearly as good as its predecessor, and was often absurdly campy, but whatever its faults, Dragnet remains the seminal police procedural. Like Jack Webb or loathe him, he’s an auteur, and you don’t get “Hill Street Blues,” “NYPD Blue,” “Law & Order” – or even “LA Confidential” – without him.
By now, you’re probably asking yourself – “Okay, how is this goofy boomer going to tie his odd Dragnet obsession into something corporate law related?” Well, hold my beer. . .
Back in the 1950s, Joe and his partners (of whom Frank Smith was indisputably the greatest) didn’t have to worry about niceties like Miranda warnings. That changed in the swingin’ 60s, and although you could always hear the edge in their voices when they did it, Joe & Bill Gannon never failed to advise a perp that he had “the right to remain silent.”
Now, unlike the perps Joe & Bill sent to San Quentin at the end of every show, a corporation doesn’t have a 5th Amendment right against self-incrimination. That’s because of something known as the “collective entity doctrine,” and a recent decision from – of all places – the Delaware Chancery Court makes it clear that’s the case even if you’re dealing with a single owner entity. The case involved a discovery dispute in which one of the parties, a single-member LLC, asserted the 5th Amendment in response to a document production request. Vice Chancellor Laster said no deal:
The overwhelming weight of federal decisions from the courts of appeals recognizes that the collective entity doctrine applies with equal force to a single-person entity. The United States Court of Appeals for the First Circuit has held that “the sole shareholder of a one-man corporation has no ‘act of production privilege’ under the [F]ifth[A]mendment to resist turnover of corporate documents.” The court explained that the choice to incorporate brings with it “all the attendant benefits and responsibilities of being a corporation,” including the responsibility “to produce and authenticate records of the corporation . . . .”
I just know that Joe Friday and Bill Gannon would have loved working a white collar beat. Dum-de-dum-dum. . .
Tomorrow’s Webcast: “Your CD&A – A Deep Dive on Pandemic Disclosures”
Tune in tomorrow for the CompensationStandards.com webcast – “Your CD&A: A Deep Dive on Pandemic Disclosures” – to hear Mike Kesner of Pay Governance, Hugo Dubovoy of W.W. Grainger and Cam Hoang of Dorsey discuss how to use your CD&A to tell your story and maintain high say-on-pay support, trends and investor expectations for COVID-related pay decisions, addressing “red flags” through storytelling, linking your CD&A to your broader ESG and human capital initiatives and ensuring consistency between your CD&A and minutes.
If you attend the live version of this 60-minute program, CLE credit will be available! You just need to submit your state and license number and complete the prompts during the program.
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A recent Olshan blog discussing what activists might expect from a Gary Gensler led SEC raised the possibility that Section 13(d) reform just might find its way on to the SEC’s agenda. This excerpt explains these efforts might garner bipartisan support:
At the CFTC, Mr. Gensler demonstrated an ability to balance progressive political pressures with competing industry interests. Should he take a similarly pragmatic approach if confirmed to lead the SEC, one of the areas where a coalition can be brokered between different interest groups is reform of Section 13(d) of the Exchange Act. Adopted in 1968 as part of the Williams Act, Section 13(d) instituted a rigorous beneficial ownership disclosure regime that requires stockholders to promptly notify issuers if they accumulate significant stock positions.
Ever since, corporations and their advisors have agitated for increasingly stringent investor reporting obligations. Likewise, progressives skeptical of hedge funds and activism in general have also trained their sights on parts of Section 13(d). As a testament to the appeal of this sentiment to both the business community and progressives, legislation (the “Brokaw Act”) was introduced in the Senate in 2017 to intensify oversight of activist hedge funds through Section 13(d) reform by Senator Tammy Baldwin (D-WI) and former Senator David Perdue (R-GA), each a member of the peripheral wing of their respective party.
The blog suggests that in addition to potentially shortening the reporting window, the SEC’s efforts could include expanding the definition of “beneficial ownership” to include derivative instruments that are not subject to settlement in the underlying security.
Rule 10b5-1 Plans: Glass Lewis Offers Up “Best Practices”
Rule 10b5-1 plans are one of the “great divides” between those of us who are lawyers for public companies and literally everyone else who follows public company issues. Most of us are borderline paranoid about crossing the t’s & dotting the i’s to make sure these plans provide the protection they’re supposed to provide (we even have an 87-page handbook devoted to that!). Most of them think these plans are a total scam – and point to the windfalls reaped by execs at Pfizer & Moderna for trades under 10b5-1 plans that seemed particularly well-timed to coincide with positive Covid-19 vaccine news.
That divide is one reason why I was kind of surprised by a recent Glass Lewis blog offering up some thoughts on “best practices” for 10b5-1 plans. These include typical suggestions like “cooling off” periods & public disclosure – but as this excerpt notes, the ultimate goal of these and other best practices is to provide transparency about the plan and its implications:
Other forms of best practice include avoiding the use of multiple, overlapping plans, avoiding short-term plans (most plans are six months to two years) and avoiding making changes to existing plans. All of these best practices help simplify the flow of publicly available information and present a clear way for insider trading rules to be followed. They help to avoid situations where executives are put into the spotlight, as was the case for Pfizer and Moderna – and ensure that when things do go public, the market has the information it needs to put things in context.
Now, since the blog’s title is “Operation Warp Pay,” I expected this discussion of best practices to be followed by a smackdown of the trading by the execs of these pharma companies. Surprisingly, that wasn’t the case. While the media reaction to Pfizer & Moderna’s 10b5-1 trading plans suggest that more could have been done on the transparency front, Glass Lewis concludes that the trades were essentially benign examples of lawful transactions under Rule 10b5-1.
Market Mania: History Doesn’t Repeat Itself, But It Often Rhymes
Have you ever heard of the Piggly Wiggly short squeeze? This FT.com article tells the story of the last time individual investors & Wall Street went toe-to-toe over a stock. It happened nearly a century ago, but it shows that Mark Twain was right when he said that “history doesn’t repeat itself, but it often rhymes.” (In case FT puts this behind their pay wall, this Of Dollars & Data blog also recounts the tale).
Also, check out Bruce Brumberg’s interview with former SEC enforcement lawyer John Reed Stark for a discussion of some of the legal issues involved in last week’s shenanigans.
