According to this Reuters article, the NY AG is preparing to file an insider trading lawsuit against Eastman Kodak and its CEO. The allegations arose out of last summer’s debacle surrounding insider transactions in Kodak stock in advance of the announcement of a potentially transformational new loan from the federal government. Here’s an excerpt from the Reuters piece:
The New York attorney general’s office is preparing an insider-trading lawsuit against Eastman Kodak Co and its top executive, focusing on stock purchases that preceded an ill-fated deal with the Trump administration to finance a pharmaceutical venture during the COVID-19 pandemic, according to the company and people familiar with the matter.
The emerging civil case centers on Executive Chairman Jim Continenza’s June 23, 2020, purchase of nearly 47,000 Kodak shares, Kodak said in a quarterly Securities and Exchange Commission filing on Monday. Continenza, the company chairman starting in September 2013 and executive chairman since February 2019, took on the additional role of CEO in July 2020.
The trades occurred weeks before the Trump administration unveiled a tentative agreement to lend the company $765 million backing production of pharmaceutical components for help fighting the pandemic. Kodak’s stock experienced a roller coaster following the late-July announcement, skyrocketing more than 1,000% before falling.
As Lynn blogged last September, a report by independent counsel retained by a Kodak special committee concluded, among other things, that the company’s CEO did not trade while in possession of MNPI (see the discussion beginning at p. 36). Among other things, the report noted that the CEO traded during an open window, and pre-cleared his trades with the company’s GC, who indicated that he didn’t believe that discussions about the potential loan had risen to the level of MNPI at the time of the CEO’s transactions.
That combination of factors would appear to make it difficult to satisfy Rule 10b-5’s scienter requirement, but that’s not a problem for NY AG Letitia James. She has the Martin Act at her disposal – and there’s no need to prove scienter for civil or even misdemeanor criminal securities fraud claims under that nightmare of a statute.
As I’ve mentioned before, I grew up in Rochester, NY, and the parade of negative news about our fallen giant over the past several decades depresses me more than anybody who didn’t grow up there can begin to imagine. I remember how things used to be with Kodak, and it’s fair to say that I have a sentimental attachment to this company. As somebody once put it, “nostalgia – it’s delicate, but potent.”
Update: Here’s a statement on the matter I received from a spokesperson for Kodak:
“The Attorney General has threatened to file a lawsuit premised on an unprecedented and novel application of insider trading law that seeks to impose liability in the absence of evidence of intent. The threatened litigation would not be supported by legal precedent or the facts. Mr. Continenza did not engage in insider trading. He was not in possession of material non-public information when he made the trade at issue, and his small stock purchase fully complied with Kodak’s insider trading policies, was pre-approved by Kodak’s General Counsel, and was subsequently found to be compliant by outside counsel in an independent investigation. Importantly, Mr. Continenza has bought Kodak stock in virtually every open window period – and has never sold a single share. As we understand the Attorney General’s theory, the contemplated lawsuit would have a chilling effect on directors and executives of every public company, who could never invest in their own companies without fear of having good-faith decisions, pre-approved by counsel, second-guessed by regulators and charged as violations of law.”
PPP Fraud: Down the Shore, Everything’s Not Alright
Another place to which I have a pretty deep attachment is New Jersey. I was born there, still have lots of family there, and have been going “down the shore” for summer vacations on Long Beach Island for as long as I can remember. But it turns out – with apologies to Tom Waits – that down the shore, everything’s not alright. In fact, according to this ProPublica article, my favorite vacation spot is a target of opportunity for PPP fraudsters:
The shoreline communities of Ocean County, New Jersey, are a summertime getaway for throngs of urbanites, lined with vacation homes and ice cream parlors. Not exactly pastoral — which is odd, considering dozens of Paycheck Protection Program loans to supposed farms that flowed into the beach towns last year.
As the first round of the federal government’s relief program for small businesses wound down last summer, “Ritter Wheat Club” and “Deely Nuts,” ostensibly a wheat farm and a tree nut farm, each got $20,833, the maximum amount available for sole proprietorships. “Tomato Cramber,” up the coast in Brielle, got $12,739, while “Seaweed Bleiman” in Manahawkin got $19,957.
None of these entities exist in New Jersey’s business records, and the owners of the homes at which they are purportedly located expressed surprise when contacted by ProPublica. One entity categorized as a cattle ranch, “Beefy King,” was registered in PPP records to the home address of Joe Mancini, the mayor of Long Beach Township.
“There’s no farming here: We’re a sandbar, for Christ’s sake,” said Mancini, reached by telephone. Mancini said that he had no cows at his home, just three dogs.
Anyway, much of the problems arose out of loans initiated by an online lender, Kabbage, and the article says that they’re in large part the result of the program’s efforts to shove money out the door as quickly as possible during the height of the pandemic’s economic impact. The bottom line is that this is yet another data point indicating that there’s going to be quite a mess to clean up over the next several years.
More on “Corporate Governance Gaming”: ESG Crusaders or Gritty Gadflies?
Last Friday, Liz blogged about the potential shareholder voting implications of the “gamification” of the stock market. She noted a forthcoming study that suggests the new Gen Z & Millennial investors who’ve recently entered the market might coalesce around ESG issues and drive greater corporate accountability. Liz expressed some skepticism about this potential outcome. Given what usually happens when the Internet gets its hands on anything, I’m downright dubious.
For example, remember when the British government decided to let the Internet name a new research ship, and ended up – hilariously – with “Boaty McBoatface”? How about when PepsiCo decided to hold an online “Dub the Dew” contest to let the Internet come up with a name for a new flavor of Mountain Dew? The top choices were “Hitler Did Nothing Wrong” and “Diabeetus.”
The bottom line is that “gamers gonna game,” and that on the Internet, the anarchy is the point. My guess is that with the meme stocks crowd, we’re more likely to see a push to elect Gritty to GameStop’s board than we are to see a push for a socially conscious ESG agenda.
If you follow the SEC’s social media accounts, you know that almost anything the agency or commissioners post on any topic receives a deluge of responses from crypto fans ranting about the SEC’s enforcement actions targeting digital assets. Regardless of the merits of those rants, a recent Cornerstone Research report shows that the SEC has brought quite a few crypto-related enforcement actions over the years. Here are some of the highlights:
– Through December 31, 2020, the SEC has brought 75 enforcement actions and issued 19 trading suspension orders against digital asset market participants
– More than 70% of the SEC’s actions involved allegations of unregistered securities offerings, while 58% of its cases involved allegations of unregistered offerings combined with fraud. Over half (52%) of the actions involved unregistered securities offering allegations relating to ICOs.
– Other allegations include failure to register as a broker or an exchange, failure to register swap offerings to non-eligible contract participants, and failure to disclosure promoter compensation.
– 43 enforcement actions were initiated in federal court, while 32 were brought as SEC administrative proceedings. Of the 43 federal court cases, 34 involved a mix of individuals and firms as defendants. In seven cases, the defendants were individuals only, while two cases involved firms only. In 19 of the 32 administrative proceedings, the respondents were firms only. The SEC charged individuals only in six actions, or a mix of individual and firms in seven actions.
Many involved in the digital asset space have speculated that the SEC might be a more crypto-friendly environment with Gary Gensler as chair, under the assumption that his greater understanding of crypto would lead to a lighter regulatory touch. Based on his recent statements, however, while his tenure may see a push for greater clarity when it comes to regulation of digital assets as securities, that doesn’t necessarily translate into a “light touch.”
Staff Comments: “Hey, Where’s Your Earnings Release 8-K?”
For most companies, furnishing an Item 2.02 Form 8-K is a routine part of the earnings release process. But in a recent comment letter to CSW Industrials on its 2020 Form 10-K, the Staff noted that it had seen earnings releases on the company’s website, but that the company had not furnished any Item 2.02 8-Ks. Naturally, the Staff’s comment was “please tell us why you have not furnished these earnings releases under Item 2.02 of Form 8-K.” The company’s response was interesting. Here’s an excerpt:
For many years, the Company has issued earnings releases related to completed fiscal periods after the Company has filed with the SEC its Quarterly Reports on Form 10-Q and Annual Reports on Form 10-K relating to such fiscal periods. Further, the Company believes, based on reviews performed as part of the Company’s disclosure control procedures, that its earnings releases report substantially the same information contained in the applicable Form 10-Q or Form 10-K filings and have not disclosed any additional material non-public information related to the applicable completed fiscal period.
As a result, the company said that it “has not been required to furnish such earnings releases under Item 2.02(a) of Form 8-K.” After the Staff raised a further comment questioning whether certain disclosure in the earnings releases was contained in the company’s periodic reports, the company responded by pointing to the relevant language in those reports. The Staff did not comment further.
Risk Factor Disclosures: Before & After
Last year, the SEC adoptedamendments to Item 101, 103 & 105 of Regulation S-K. The amendments were effective in November, and this recent SEC Institute blog reports how one company responded to the changes to Item 105’s risk factor disclosure requirements in its recent Form 10-K filing. Here’s an excerpt:
In Lumen Technologies’ Form 10-K for the year-ended December 31, 2019, risk factors are on pages 20 to 48, 28 pages long. Risks described range from “Risks Affecting Our Business” to “Other Risks.” It would be fair to say that some of the risk factors, such as “We may not be able to compete successfully against current and future competitors” might be “risks that could apply generically to any registrant or any offering.”
After implementing the new disclosure requirements, and a major amount of work, in Lumen Technologies’ Form 10-K for the year ended December 31, 2020, risk factors are on pages 21 to 32. This is a reduction from 28 to 11 pages! The revised disclosures start with “Business Risks,” a simpler and more direct heading, and finish with “General Risks” as required by the new rule. Interestingly, the General Risks are less than one page. Competitive issues are addressed in a more tailored risk factor titled “We operate in an intensely competitive industry and existing and future competitive pressures could harm our performance.”
The blog quotes Associate GC David Hamm as saying that the company used the amendments to “take a fresh look” at its risk factor disclosure, which resulted in a more direct and more investor-friendly presentation.
Speaking before the SEC’s 8th Annual Conference on Financial Market Regulation, SEC Chair Gary Gensler reportedly stated that the Staff was working on a new rule addressing disclosure of human capital metrics. If you’re thinking, “didn’t they just do this?” the answer is “sort of.” Last year’s S-K modernization rules addressed human capital, but from a principles-based perspective only. Now, they’re talking about mandatory line-item disclosures focusing on specific metrics.
What might those metrics be? Commissioner Lee’s dissenting statement on last year’s rule adoption might provide some insight. In that statement, she cited favorably comments on the rule proposal received from the Human Capital Management Association, which called for a combination of a principles-based & line-item disclosures. In particular, the HCMA cited four specific metrics that should be required disclosure for all registrants:
1. The number of people employed by the issuer, broken down by full-time and part-time employees along with contingent workers who produce its products or provide its services (independent contractors, supplied through subcontracting relationship, temporary employees, etc.);
2. The total cost of the issuer’s workforce, including wages, benefits and other transfer payments, and other employee expenses;
3. Turnover or similar workforce stability metric; and
4. Workforce diversity data, concentrating on gender and ethnic/racial diversity across different levels of seniority.
These four metrics also have been cited in media reports concerning Gary Gensler’s remarks about a new human capital rule proposal, and given Commissioner Lee’s prior favorable reference to the HCMA comment letter, it’s probably a pretty good bet that they are likely to be included in any proposal forthcoming from the SEC.
Reg D: 2013 Amendment Proposals Back On The Table?
In her keynote speech at last week’s conference, Commissioner Caroline Crenshaw expressed concern that the SEC has taken actions in recent years to make it easier for issuers and investors to access the private markets without having a lot of information about those markets. Here’s an excerpt:
So do the actions the Commission took to expand access to private markets further our agency’s mission? It is a question that is harder than it should be to answer, because for the most part, we lack good data on private issuers and offerings. What we do know is that the private markets have increased in size over the years, both in absolute terms and relative to the public markets. The amount of capital raised via exempt offerings now far outpaces the amount raised on the public markets. Offerings under Regulation D alone accounted for $1.5 trillion of proceeds in 2019, compared with $1.2 trillion in the public markets.
And yet, while these markets have been expanding, the information we are collecting about them has not. For the most part, we do not know who invested in these private market offerings or how their investments performed.
Commissioner Crenshaw went on to call for the SEC to adopt amendments to Reg D that were proposed in 2013 & subsequently fell off the face of the earth. In case you’ve forgotten, these proposals would:
– require the filing of a Form D in Rule 506(c) offerings before the issuer engages in general solicitation;
– require the filing of a closing amendment to Form D after the termination of any Rule 506 offering;
– require written general solicitation materials used in Rule 506(c) offerings to include certain legends and other disclosures;
– require the submission, on a temporary basis, of written general solicitation materials used in Rule 506(c) offerings to the Commission;
– disqualify an issuer from relying on Rule 506 for one year for future offerings if the issuer, or any predecessor or affiliate of the issuer, did not comply, within the last five years, with Form D filing requirements in a Rule 506 offering; and
– amend Form D to require additional information about offerings conducted in reliance on Regulation D.
The rule proposals received a lot of pushback from commenters, including this letter from the ABA’s Federal Regulations of Securities Committee, which contended that they were “especially ill-suited” for small business issuers, “which often operate without the advice of sophisticated counsel that would be necessary to ensure compliance with the proposed rules’ detailed requirements, and avoid their pitfalls.”
Crowdfunding: Corp Fin Updates Guidance on Form C EDGAR Filings
In March, I blogged about guidance on EDGAR filings of Form C that Corp Fin issued shortly after the SEC’s private offering simplification rule amendments went into effect. The first part of the original guidance addressed the fact that the form hadn’t caught up to the rule changes, and provided advice to companies that are taking advantage of the new $5 million size limit for crowdfunded offerings on how to fill out a form that only contemplates a $1.07 million maximum offering size.
On Friday, Corp Fin updated that guidance to reflect the fact that the form’s been updated to reflect the higher maximum offering size limit. Here’s the relevant language:
Effective May 10, 2021, the changes to the XML-based fillable form have been implemented and issuers are now able to, and must, provide accurate offering amounts in the XML-based fillable form and in the offering document attached as an exhibit to the Form C. An issuer that previously completed the offering amount fields by including $1,070,000 in the XML-based fillable form in reliance on prior staff guidance must update its Cover Page to provide the actual offering amounts if it files an amendment to the Form C after May 10, 2021.
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Yesterday, the SEC announced enforcement proceedings against eight companies for alleged disclosure deficiencies in Form 12b-25 filings. Here’s an excerpt from the SEC’s press release:
Public companies are required to file the SEC’s Form 12b-25 “Notification of Late Filing,” commonly known as “Form NT,” when “not timely” filing a Form 10-Q or Form 10-K and seeking additional days to file their reports. Companies must disclose on the Form NT why their quarterly or annual report could not be filed on time, as well as any anticipated, significant changes in results of operations from the corresponding period for the last fiscal year.
The SEC orders find that each of the companies announced restatements or corrections to financial reporting within 4-14 days of their Form NT filings despite failing to provide details disclosing that anticipated restatements or corrections were among the principal reasons for their late filings. The orders also find that the companies failed to disclose on Form NT, as required, that management anticipated a significant change in quarterly income or revenue.
Without admitting or denying the SEC’s allegations, each company consented to C&D enjoining them from future violations of Section 13(a) of the Exchange Act & Rule 12b-25, and agreed to pay penalties ranging from $25,000 to $50,000.
It’s been a while, but these aren’t the first enforcement actions targeting 12b-25 filings. In 2003, the SEC brought an enforcement action against Spiegel for alleged shenanigans surrounding a Form 12b-25 filing, and it subsequently brought a separate action against the company’s former audit committee chair arising out of the same allegations. In 2005, the SEC brought an enforcement action against FFP Marketing (and the two employees responsible for preparing the filing) for deficient 12b-25 disclosure.
In the SEC’s press release, acting Enforcement Director Melissa Hodgman said that these actions were the latest in which the SEC used data analytics to identify difficult to detect disclosure issues. That’s something we blogged about last fall, when the SEC announced the first actions under its “EPS Initiative.”
Insider Trading Policies: Who Should be Subject to Your Blackout Period?
One of the questions that members frequently ask is which employees should be subject to a quarterly blackout period under an insider trading policies. There’s no “one size fits all” answer to that question, but this excerpt from WilmerHale’s new 2021 IPO Report (p. 22) provides a good summary of the reasons why some companies might answer this question differently than others:
Companies that have a relatively small number of employees or that have a corporate culture of broadly sharing information often apply these blackout periods to all employees. Many young public companies adopt this approach, particularly if they have only one principal facility and their employees have fairly open access to company information.
More established companies with large numbers of employees, multiple facilities and more restricted access to sensitive information typically apply blackout periods only to designated employees, such as management, finance, accounting and legal staff. Similarly, the company must decide which employees will be subject to the other provisions of the policy.
The memo cites surveys sponsored by our colleagues at NASPP & Deloitte concerning the scope of blackout period restrictions. The surveys, which were taken in 2014, 2017 & 2020, indicate that blackout prohibitions apply almost universally to Section 16 officers, directors, other members of senior management & employees with access to financial information or MNPI. However, only around 60% of those policies apply to middle management, and less than 50% apply to all exempt employees.
Securities transactions by companies & insiders are under increasing scrutiny from investors, regulators, and even Congress. Be sure to check out our July 20th webcast on “Insider Trading Policies & Rule 10b5-1 Plans” for insights on the latest developments from our panel of experts!
A Fond Farewell to Anne Triola
After more than 20 years of service, our webmaster, Anne Triola, is retiring today. Anne has handled posting of an often overwhelming volume of material on a daily basis, not to mention coding webcast transcripts, creating new practice areas, and performing 1,001 other tasks without which these sites would simply shut down. She’s always juggled the demands of multiple editors with good humor, great efficiency, and quiet competence.
Anne, thank you for everything. We will miss you, and we wish you and your husband a happy and healthy retirement. Bon voyage!
The Q&A process at last year’s virtual annual meetings didn’t get rave reviews from investors. Companies say they’re better prepared this year, but I’d still suggest you take a look at this article in “The Shareholder Service Optimizer,” which provides some helpful tips on handling the Q&A process.
The article makes several suggestions, starting with including language in your proxy materials prominently welcoming & soliciting shareholder questions, and carefully explaining exactly how they can be submitted and how they will be answered. Here’s an excerpt about what you should do next:
A very good step-two: Invite shareholders to submit questions in advance, via an e-mail to your Investor Relations site. Some institutional investors have pooh-poohed this, as leading to cherry-picked questions and canned answers. But this is the easiest way, by far, for all concerned – and we have found this to be a very good indicator of the issues that are on the minds of the savviest and most interested shareholders.
It’s also a quick and easy way to “get the Q&A ball rolling…and it provides excellent opportunities to have the questions answered by the best-qualified person…which conveys a welcome “openness” to shareholder questions, helps to showcase the management team as a whole and adds much needed variety to the webcast. But this should definitely NOT be the only way you allow questions to be asked.
The article includes a number of other practical suggestions to improve your Q&A period, and concludes by advising companies to commit – up-front – to answering all shareholder questions asked, prior to and during the meeting, and then to promptly post the answers on the investor page of the company’s website.
Shareholder proposals were another aspect of last year’s virtual annual meetings that didn’t always go smoothly, and this recent blog from Soundboard Governance’s Doug Chia provides some advice to companies about what not to do when dealing with a shareholder proponent at a virtual meeting. This excerpt discusses how companies have muzzled proponents by limiting their ability to talk about their proposal:
This leads me to the stories about issuers’ placing strict substantive limits on presenting shareholder proposals at VSMs. These instances involve issuers dictating what proponents can say:
(1) Requiring the proponent to provide a very short written statement (e.g., 100 words), to be read by management at the meeting in lieu of the proponent speaking in their own voice by phone or audio recording.
(2) Requiring proponent to stick to a prepared script provided by the company, based on the proposal and supporting statement in the proxy statement.
(3) Limiting the proponent to only the exact words of the proposal and supporting statement as printed in the proxy statement… and citing the SEC rules as the source of this limitation.
The blog acknowledges that abuses like these were outliers, particularly among large cap companies. But actions like this also risk alienating investors & making the company a corporate governance poster child – and while companies may not be seeking a governance “gold star” for their virtual meetings, they also don’t want to stand out from the pack in a negative fashion.
SEC Enforcement Chief Resigns
Last night, the SEC announced that Enforcement Director Alex Oh was resigning from the position that she was appointed to last week. This NYT article provides some background on her decision. Melissa Hodgman, who served as acting Director prior to Alex Oh’s appointment, will return to that role.
Last week, Liz blogged that the SPAC bubble was leaking. This week, S&P Global declared that the bubble has popped – and that SPACs have gone the way of tulips & dotcoms:
Even for a financial mania, SPACs didn’t last long. These highly speculative schemes have whipsawed from nowhere to everywhere and now back to nowhere – all in a matter of months. Live fast, die young.
Our obituary for the short-but-colorful life of special purpose acquisition companies (SPACs) is a bit facetious, of course. But there’s no denying, to use a metaphor favored by cynical Wall Streeters who have seen this sort of thing before, that the SPAC bubble is no longer being pumped up like it had been. Why the deflation? SPAC saturation.
In Q1, an average of more than 90 new US-listed blank-check companies each month successfully raised money from investors, according to S&P Global Market Intelligence. So far in April, the rate of issuance has plunged about 80%, with the full-month total tracking to just 14, our data indicates.
The article notes that instead of investors, the group that’s looking most closely at SPACs right now seems to be the SEC – and that’s a pretty clear signal “that a boom has gone bust.” That may be true when it comes to IPOs, but there’s a whole lot of money sloshing around in SPACs that are desperately chasing de-SPAC deals, so it’s likely that there’s another chapter in the SPAC boom story that has yet to be written.
NFTs: Playboy Hits the Jackpot
I really wasn’t planning to blog about “non-fungible tokens,” or NFTs, which in case you haven’t heard are the latest grift gift from the Blockchain crowd. As befits my grumpy boomer persona, I’m as dubious about the merits of NFTs as I am about the merits of crypto. But then I saw some news that made me think that if I were a little less jaded about innovations like these – and the prospects of certain adult-oriented SPACs – I’d have a few more dollars in the bank.
A few months ago, I blogged about how Playboy Enterprises was looking to merge with a SPAC. I dismissed Playboy’s business prospects as being out of step with the zeitgeist & the transaction as perhaps representing “peak SPAC.” As usual though, I was the one who was out of step. According to CNBC, Playboy’s stock is up over 80% this month alone & 173% since February. Why? Apparently dirty pictures & NFTs are a match made in heaven:
These days, announcing a new investment in a legacy media business is enough to draw a raised eyebrow. That is, of course, unless the company is reinvented nude magazine publisher Playboy — now PLBY Group — whose stock has surged more than 80% this month due in large part to excitement over how it can take advantage of the hot NFT market.
And Playboy certainly has unique offerings. “Look, we have an unbelievable archive, 68 years. It is the 5,000 pieces of art we have, it’s covers, it’s photography. It is so deep and rich in what’s in there,” CEO Ben Kohn said on the company’s earnings call last month.
Playboy, which went private in 2011 amid declining ad sales from its eponymous nude magazine, rejoined the public markets in February with a management laser-focused on modernizing a company once known for its leading market share of pubescent closets.
Yeah, I did not see that one coming. But I kind of saw this one coming – the Jim Hamilton blog recently flagged a petition for proposed rulemaking calling for the SEC to clarify the status of NFTs & NFT platforms under the federal securities laws. The petition was submitted by Arkonis Capital, and is a pretty sophisticated piece of work. If you’re working in this area, it’s definitely worth reading.
NFTs: Your Wu-Tang Clan Update
Since they’ve never been ones to sleep on a trend, I’m sure it will come as no surprise to regular readers of this blog that America’s most entrepreneurial hip-hop artists have already launched their own NFTs. This article from The Observer has the details on the Wu-Tang Clan’s move into the world of non-fungible tokens:
Within the music and recording industry, gimmicks are essential to keeping the wheel of capital and cultural production churning. In other words, gimmicks are nothing to be ashamed about because they tend to be extremely effective: back in March of 2014, the legendary rappers of the Wu-Tang Clan announced that they’d only be selling a single copy of their forthcoming album, Once Upon a Time in Shaolin.
The album eventually sold for around $2 million to the notorious “pharma bro” Martin Shkreli, but the stunt had proven that novel ways of selling music were still to be discovered. Now, that new frontier has arrived: recently, the Wu-Tang Clan announced that they’d be selling 36 copies of a 400 page coffee table book about their legacy in the form of NFTs, or non-fungible tokens.
Before you decide to turn to Ghostface Killah or RZA for investment advice, I would caution you that not all of their business ventures turn out to be as lucrative as Once Upon a Time in Shaolin. As for me, I’ve learned my lesson from Playboy & have given up on conventional investment strategies. I’m cashing in my 401(k) and putting it all in Dogecoin.
The rise of non-financial priorities in corporate governance and the focus on corporate purpose has attracted a lot of attention in recent years. Some have dismissed the increasing corporate emphasis on “stakeholder” interests & ESG issues as “woke capitalism,” which one pundit recently defined as the belief that “businesses ought to obey orders from the progressive elite, regardless of how thin its connection to any company may be.”
I’ll be the first to admit that some of this stuff is downright silly, but I don’t think this phenomenon can be tossed aside with a talk radio sound bite like “woke capitalism.” It seems to me that there’s something deeper going on, and that the recent Super League fiasco provides some insight into what that might be.
In case you’ve been living under a rock, last week, some of Europe’s wealthiest & most successful soccer teams decided to strike out on their own with an exclusive, multi-national “Super League.” While it was announced with great fanfare, the Super League imploded almost immediately. Fans, players, coaches, and even governments all expressed outrage over the attempted greed grab. The reaction appears to have caught the league’s organizers & financial backers by surprise. It shouldn’t have, and this excerpt from a recent Axios newsletter explains why:
A small group of 12 ultra-elite soccer clubs had access to the finest strategy, polling and public relations advice that money can buy. The deal they unveiled on Sunday night was years in the making. But they and their advisers missed something big — that society as a whole is now willing to forego wealth if it means more equality.
– Brexit made almost everybody in Britain worse off, for instance — but it also hit the rich London cosmopolitans and bankers the hardest.
– The Fed is openly embracing the prospect of higher inflation — something that erodes wealth and hits rich savers, while inflating away the debts of the poor.
The article sums up the current zeitgeist by stating that “when the source of a company’s profits is manifestly unfair, those profits are more likely than at any time in decades to be facing existential threats.” If you buy that conclusion, then business leaders aren’t falling in line with progressive elites – they’re just “reading the room.” Many appear to have decided that society’s decades-long embrace of “winner take all” capitalism is coming to an end, and that their companies need to think & act differently in order to continue to prosper in a more egalitarian environment.
Of course, so far this new attitude among business leaders hasn’t extended to their own compensation, but perhaps we can hope for a “Super League moment” there in the not too distant future as well.
#MeToo: Impact on CEO Employment Contracts
Speaking of executive comp, the Conflict of Interest Blog recently flagged a new study reviewing the impact of the #MeToo movement on the terms of executive employment agreements. This excerpt from the study’s abstract indicates that the growing public outcry about sexual misconduct has prompted companies to take a more aggressive approach when it comes to “for cause” termination provisions:
In the wake of MeToo, we find a significant and growing rise in the prevalence of contracts that allow companies to terminate CEOs without severance pay in response to harassment, discrimination, and violations of company policy. We discuss the implications of these “MeToo termination rights” for corporate governance, executive contracting, and gender equity. We conclude that our results offer promising evidence of increased corporate control of CEO behavior and greater accountability for sex-based misconduct in the wake of the MeToo movement.
The study reviewed over 400 CEO contracts and found that publicly traded companies are reserving greater discretion to terminate executives for sex-based misconduct in statistically significant numbers. The authors say that by “insisting on expanded contractual definitions of ’cause’ to terminate, these companies are signaling to CEOs that such behavior will not be tolerated, while ensuring that corporate boards are reducing the costs of penalizing wayward CEOs.”
The authors also suggest that the changes resulting from the #MeToo movement prove that the terms of CEO employment agreements aren’t immune from “exogenous shocks,” which gives some reason to believe that hopes for a Super League moment in executive comp may not be in vain.
PPP Loans: Seeking Forgiveness? If You’re a Gov Contractor, Think Twice!
For most companies, the decision to seek forgiveness of a PPP loan is the proverbial “no-brainer” – but this Hunton Andrews Kurth memo says that’s not necessarily the case if the borrower is a government contractor. Here’s an excerpt:
For government contractors, however, the rules are very different. If a government contractor received a PPP loan and thereafter obtains forgiveness of that loan, it is required to credit the amount of the forgiveness back to the government. For the reasons set forth below, a government contractor should carefully consider whether seeking forgiveness of a PPP loan makes good business sense. In some cases, government contractors might be worse off financially if they obtain forgiveness of that PPP loan than if they simply pay it back.
The problem is that the federal acquisition regulations make it clear that a contractor that has already received payment for contract costs cannot also receive PPP Loan forgiveness funds for those identical costs. The memo notes that this isn’t just an academic issue – the DOJ is aggressively prosecuting fraud in PPP loans, and while this issue hasn’t yet come up, there’s no reason that it couldn’t. What’s more, there are also potential issues under the False Claims Act that need to be taken into account.
PPP loans have pretty borrower-friendly terms, so although each company’s situation is different, for some government contractors, the economics of simply repaying the loan in accordance with its terms may be more favorable that seeking forgiveness.
On March 2, 2021, the Secretary of State designated various entities affiliated with Russia’s government, including the FSB, as parties subject to Executive Order 13382 for “having engaged, or attempted to engage, in activities or transactions that have materially contributed to, or pose a risk of materially contributing to, the proliferation of weapons of mass destruction.” This designation was prompted by the poisoning of dissident Alexander Navalny, and may result in some public companies that do business in Russia being required to provide the disclosure and accompanying “Iran Notice” filing contemplated by Section 13(r) of the Exchange Act.
This Bryan Cave blog reviews the scope & implications of the new sanctions designations, including the potential disclosure obligations for public companies with business in Russia:
Importantly, the additional sanctions designations pursuant to EO 13382 may trigger reporting to the SEC pursuant to Section 13(r)(1)(D) of the ’34 Act. Although Section 13(r)(1) of the ’34 Act is typically associated with the sanctions against Iran, some of the reporting triggers are broader than just transactions involving Iran. Among the broader triggers are any transactions or dealings knowingly conducted with “any person the property and interests in property of which are blocked pursuant to Executive Order No. 13382.”
Based on this, parties that engage in transactions with any of the parties now blocked pursuant to EO 13382 in connection with the Navalny poisoning must be cognizant of these reporting requirements if the party is an issuer or the affiliate of an issuer required to report on a periodic basis to the SEC.
There are a number of Russian entities subject to the sanctions, but the big kahuna is the FSB. As this Hogan Lovells memo notes, the FSB plays a prominent role in licensing the importation of IT and other encryption products into Russia. Notification to or approval by the FSB may be necessary for a variety of technology products, including “laptops and smartphones, connected cars, medical devices, software, or any other items that make use of ordinary commercial encryption.”
OFAC updated General License No. 1B to confirm United States persons may continue to interact with the FSB for purposes of qualifying their products for importation and distribution in Russia, but that license doesn’t include an exemption from providing the disclosure required by Section 13(r) of the Exchange Act or from filing the accompanying Iran Notice with any annual or quarterly report.
10b5-1 Plans: CII Calls for Mandatory Disclosure in Form 4s & 5s
One of the items included in the batch of Rule 144 amendments that the SEC proposed last December was a provision that would add a check box to Forms 4 and 5 to provide filers the option of disclosing that their sales or purchases were made pursuant to a Rule 10b5-1 plan. Last month, the CII submitted a comment letter on the proposal calling for that disclosure to be made mandatory. Here’s an excerpt:
We, however, would respectfully request that this provision be revised to require: (1) “Form 4 and Form 5 to indicate via a check box whether their reported transactions were made pursuant to Rule 10b5-1(c) rather than provide it as an option for the filer[;]” and (2) disclosure of the adoption date of the respective Rule 10b5-1 plan on the forms.
Our requested revision is consistent with our long-standing belief that providing greater transparency of Rule 10b5-1 transactions would provide useful information to investors and other market participants.
Don’t be surprised if this recommendation gets some traction. The CII’s comments come on the heels of other recent calls for more transparency about 10b5-1 plans – as well as proposed legislation passed by the House of Representatives last week that would direct the SEC to “study and report on possible revisions to limit the ability of issuers of securities and issuer insiders to adopt Rule 10b5-1 trading plans.”
Hertz: Who’s the Sucker Now?
Last summer I made fun of the “suckers” who were buying Hertz common stock while the company was in bankruptcy and after it disclosed that it would take a miracle for equity holders to realize any recovery. Well guess what? The bankruptcy process launched a bidding war, and now the equity’s in the money. Here’s an excerpt from this WSJ story on the deal:
Hertz proposed in a chapter 11 exit plan on Wednesday that current stockholders receive warrants to purchase up to 4% of the restructured business, the first time the company has said it is worth enough to distribute some value to its owners. The shareholder distribution would amount to a recovery of 60 to 70 cents per share, a “material return to equity,” Hertz lawyer Thomas Lauria said during a court hearing Wednesday.
If approved by the U.S. Bankruptcy Court in Wilmington, Del., that outcome would make Hertz a relative rarity in corporate bankruptcies, in which equity ranks behind debt and most often is wiped out.
In my defense, Hertz stock was trading at over $5 per share last June, so it was a sucker bet at that price – although this deal could still be topped, and there might even be more money on the table for the stockholders.
Shortly after the onset of the pandemic, many companies opted to discontinue providing quarterly EPS guidance for the remainder of 2020. This McKinsey article says that companies thinking about providing that guidance in 2021 may want to think again:
McKinsey compared the market performance of companies that offer quarterly earnings guidance with the performance of those that don’t. It found that the companies that did not provide EPS guidance did not generate lower total returns to shareholders (TRS). That same body of research revealed no difference in TRS between companies that regularly met the earnings consensus and those that occasionally missed it.
Lower TRS occurred only if companies missed consensus consistently over several quarters because of systematically lower performance. Further, McKinsey research showed that only 13 percent of investors surveyed thought that consistently beating EPS estimates was important for assessing a potential investment.
What’s the harm, then, in providing quarterly earnings guidance if investors don’t weigh such information heavily? One potential problem is the overemphasis of quarterly earnings to evaluate management teams’ performance, which can create unnecessary noise in corporate boardrooms. More important, EPS-focused companies are known to implement actions to “meet the number”—deferring investments or cutting costs excessively, for instance.
McKinsey’s views on quarterly guidance echo those of many business and investor groups. Instead of returning to the practice of providing quarterly EPS guidance, McKinsey says that the better approach is to provide long-term guidance, and that “For most companies, this would mean providing three-year targets (at a minimum) for revenue growth, margins, and return on capital.”
CARES Act Fraud: Whatcha Gonna Do When They Come for You?
I couldn’t resist using the lyrics of Inner Circle’s “Bad Boys” in the title of this blog. That’s because they ran through my head as I read this Womble Bond memo on the government’s investigations of CARES Act fraud. Unfortunately, as this excerpt dealing with the conclusions of the House Select Subcommittee on the Coronavirus reveals, it’s a target rich environment:
– Reviews of applications, records, and other data tend to show that there was around $84 billion in potential fraud from the PPP (more than $4 billion) and Economic Injury Disaster Loans (more than $79 billion) government payments;
– Over 1.3 million EIDL fraud referrals (over 700,000 of which involved identify theft) have been made to the SBA’s Inspector General’s Office;
– Nearly 150,000 hotline complaints related to potential PPP or EIDL fraud have been made to the SBA Inspector General’s Office;
– Financial institutions filed nearly 40,000 Suspicious Activity Reports related to potential PPP or EIDL fraud during May-October 2020 alone.
That’s quite a bit of potential fraud – but then again, these programs involved quite a bit of money that was moved out the door as quickly as possible. But the message is that if you’re a fraudster, Sherriff John Brown is most definitely coming for you. The memo says that the FBI has initiated hundreds of investigations into potential PPP fraud, and that they’ve been joined by more than 30 federal & state agencies investigating fraud in these programs.
Disclosure: Cybersecurity Breaches
This Audit Analytics blog summarizes its recent report on discovery and disclosure of cybersecurity breaches. One noteworthy aspect of the report is that the number of disclosed cybersecurity incidents actually declined in 2020. That was the first decline since Audit Analytics began reporting on cybersecurity disclosures in 2011, but the blog suggests that it is uncertain whether that decline reflects an actual decline in attacks or greater challenges monitoring cybersecurity incidents in a remote work environment. Here are some other key findings:
– The median number of days to discover a cyber breach was just 16 days in 2020, while the median number of days to disclose a breach was 37 days.
– The median number of days to discover a breach was the lowest since 2017. The decreasing number of days to discover a breach may be a sign that companies are implementing better controls to monitor for cyber incidents, which enables more timely discovery.
– The median number of days to disclose the breach was at its highest since at least 2016. The increase in the median time to disclose a breach could be a sign companies are prioritizing complete notification over quick notification. This can be seen in the percentage of companies that disclose a type of attack, which grew to 90% in 2020 from less than 60% between 2011 and 2019.
The blog also notes that nearly 30% of public companies with a cyber breach between 2011 and 2020 disclosed the breach in an SEC filing, and reviews the sections of SEC filings in which disclosures of cybersecurity breaches most commonly appear.
That’s it for me this week, folks. Our new colleague, Lawrence Heim, will take the helm of this blog tomorrow – and I think we can all agree that you’re getting an upgrade.
Fenwick & West recently published this report on board gender diversity among large public companies & the Silicon Valley 150. Here are some of the key findings:
– The representation of women on boards continued to increase between 2018 (the last year Fenwick published the gender diversity survey) and 2020 in the United States and at rates higher than in years past. The average percentage of women directors increased 8 percentage points in the SV 150 to 25.7% in 2020 and in the S&P 100 rose 4 percentage points to 28.7% (with the SV Top 15 increasing 4.5 percentage points to 30.3%).
– In the last few years in both the S&P 100 and the SV Top 15, 100% of companies have had at least one woman director. In the SV 150 overall, the percentage of companies with at least one woman director increased 16.4 percentage points to 98%.
– In the S&P 100, gender diversity has grown slowly but steadily at a cumulative rate of 61%, or a compound annual growth rate (CAGR) of 2.37%. The SV 150 has lower scores overall, but a greater cumulative growth rate of 216%, and more than double the CAGR, 5.42% (with more rapid growth over the past decade).
The report says that most SV 150 companies met the initial 2019 standard for board gender diversity mandated under California’s SB 826, but that 57% of those companies will need to add women to meet the law’s 2021 standard. Only 14% of S&P 100 companies would need to add women to their boards in order to satisfy the 2021 standard.
Board Diversity: Does Diversity Enhance Shareholder Value?
Most of the studies on board diversity that I’ve seen referenced have concluded that increasing the diversity of corporate boards enhances shareholder value. That conclusion is a cornerstone of Nasdaq’s justification for its board diversity listing proposal, which cites a number of these studies. But UCLA’s Stephen Bainbridge points to a recent paper by Harvard Law School Prof. Jesse Fried, which claims that the studies Nasdaq cites provide little support for that conclusion. Here’s the abstract:
In December 2020, Nasdaq asked the Securities and Exchange Commission to approve new diversity rules. The aim is for most Nasdaq-listed firms to have at least one director self-identifying as female and another self-identifying as an underrepresented minority or LGBTQ+. While Nasdaq claims these rules will benefit investors, the empirical evidence provides little support for the claim that gender or ethnic diversity in the boardroom increases shareholder value. In fact, rigorous scholarship—much of it by leading female economists—suggests that increasing board diversity can actually lead to lower share prices.
There are all sorts of good reasons to promote increased gender & ethnic diversity on public company boards, including (as the paper points out), data indicating that it results in improved oversight of executives & financial reporting. But if this study is correct, it appears that there isn’t much in the way of quality empirical research to support Nasdaq’s claims about the positive impact of board diversity on shareholder value.
Tomorrow’s Webcast: “ESG Considerations in M&A”
Tune in tomorrow for the DealLawyers.com webcast – “ESG Considerations in M&A” – to hear the Hunton Andrews Kurth’s Richard Massony, Seyfarth’s Andrew Sherman and K&L Gates’ Bella Zaslavsky discuss the ESG considerations that are increasingly “front and center” for both buyers and sellers in M&A transactions.
