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.
It wasn’t that long ago when discussions about the “materiality” concept focused on things like the efficient market hypothesis and the probability and financial magnitude of contingent events. Underlying all of these discussions was a core belief that the market prices of stocks generally moved for reasons that reflected investors’ rational assessments of the financial implications of new developments. Yeah, well that was then & this is now.
Today, nothing seems to move the market for individual stocks quite like a rogue tweet, an internet meme, or – in the latest example of market mania – a dumb marketing department prank gone awry. Of course, I’m talking about Volkswagen’s ill-conceived April Fools’ “Voltswagen” prank, which resulted in its stock popping by 10% before coming back to earth. This CNN article says that the combination of the announcement & stock gyrations that followed may expose VW to liability under the federal securities laws:
Volkswagen of America says its “Voltswagen” name change was merely a joke “in the spirit of April Fools’ Day” to promote a new electric car. But even if it was meant as a lighthearted marketing gag, the move could land the carmaker in some serious trouble. The situation may have put the company at risk of running afoul of US securities law by wading into the murky waters of potentially misleading investors. “This is not the sort of thing that a responsible global company should be doing,” said Charles Whitehead, Myron C. Taylor Alumni Professor of Business Law at Cornell Law School.
Making a securities law issue out of this stunt seems kind of silly to me. Yes, I get the long-term importance to VW of moving to electric vehicles & how investors might be interested in a name change that signifies that importance – but c’mon, gimme a break! What I think this situation really does is illustrate the consequences of equating “materiality” under the securities laws with any information that might be “interesting” to an investor. That’s something courts have been concerned about for quite some time – for instance, here’s a quote from the 1st Circuit’s 1992 decision in Milton v. Van Dorn:
The mere fact that an investor might find information interesting or desirable is not sufficient to satisfy the materiality requirement. Rather, information is “material” only if its disclosure would alter the “total mix” of facts available to the investor and “if there is a substantial likelihood that a reasonable shareholder would consider it important” to the investment decision.
The reason for concerns about catering solely to investor desires when it comes to disclosure obligations is the risk that the Northway Court identified of setting materiality at such a low standard that companies will flood investors with “an avalanche of trivial information,” which obscures important data & doesn’t help a reasonable investor make an investment decision. In other words, courts are worried about creating what economists call “noise,” and I think those concerns are heightened during a period when the market seems to be a particularly noisy place.
Right now, we’re engaged in an important discussion about what non-financial information should be regarded as material under the securities laws. If the SEC serves up new disclosure mandates intended to give investors “what they want” without worrying about creating a lot of noise, its actions may end up lowering the overall quality & usefulness of corporate disclosures.
SEC Enforcement: Public Companies in the Cross-Hairs?
This Baker Donelson memo discusses expectations that the SEC will engage in intensified enforcement efforts on a number of fronts, and says that public companies are among other entities that should should expect greater scrutiny from the Division of Enforcement than they’ve received in recent years. Here’s an excerpt:
Chairman-designate Gensler testified at his March 2, 2021 confirmation hearing on several new areas of focus. Principal is the emphasis on new disclosure rules, which might require companies to report more about political contributions, workforce diversity, corporate governance, and the risks of climate change. Then, on March 4, 2021, the SEC created a Climate and ESG Task Force in the Division of Enforcement.
Another new focus would be on trading apps, like Robinhood, regarding whether investors get the best deals when such apps sell their trades for execution by market-making firms. Whereas former Chairman Jay Clayton emphasized cybersecurity issues and protecting retail investors under his Main Street investor initiative, more emphasis may now be placed on public companies (and possibly private equity and hedge funds, e.g., conflicts of interest) and issues such as inadequate disclosures, revenue recognition, and improper accounting.
The memo says that following the SEC’s COVID-19-specific pronouncements in March 2020 and thereafter about disclosure requirements and safe harbors for appropriate forward-looking statements, both SEC enforcement and private class actions can be anticipated. In addition, the memo suggests that companies in industries such as travel, health care, software, energy, and financial services, among others, may face enforcement actions similar to the proceeding that the SEC brought against The Cheesecake Factory late last year.
March-April Issue of “The Corporate Counsel” – New Podcast Coming Soon!
The March-April issue of “The Corporate Counsel” newsletter is in the mail (try a no-risk trial). It’s also available now online to members of TheCorporateCounsel.net who subscribe to the electronic format – an option that many people are taking advantage of in the “remote work” environment. The issue includes articles on:
– Climate Change Disclosures: Preparing for Staff Scrutiny
– The SEC’s Rule 144 Proposals: Our Suggestion to Combine the Form 144/Form 4 Filing Process Sees the Light of Day!
– SEC Eases Auditor Independence Rules
Dave & I have been doing a series of “Deep Dive with Dave” podcasts addressing the topics we’ve covered in recent issues (here’s the most recent one). We’ll have a podcast for this issue up shortly, so be sure to check them all out!
What if everything we’ve taken for granted about good corporate governance is wrong? According to a recent study, that just may be the case. As one of the authors, UVA Law School’s Cathy Hwang, discusses in this article, the study revisited a 2003 study that introduced the influential “Governance Index” or “G-index,” which measures how much governance rules protect shareholders.
That 2003 study has been cited nearly 10,000 times, and many other governance indices are based on the G-index it created. That study used the G-index to support its finding that stronger shareholder rights are correlated with higher value, profits & firm growth. There’s just one teensy-weensy problem with the G-index – it’s replete with errors. In fact, the authors found an astonishing 80% error rate in the G-index! What’s more, they concluded that “correcting these errors substantially weakens one of the most well-known results in law and finance, which associates good governance with higher investment returns.”
Ain’t that a kick in the head? The good news is that the authors decided to build their own dataset, called “Cleaning Corporate Governance,” that includes the 25 years of corporate charters from S&P 1500 companies that have been indexed across numerous governance metrics. This dataset will be free and open access, and hopefully will provide a better set of data for examining how governance affects shareholder value.
The governance industrial complex may find this news disconcerting, but those cynics (like me) who maintain that ideas about what constitutes “good governance” have a lot more to do with ideology than empirical data likely find it rather amusing.
Non-GAAP: Alternatives To EBITDAC
Earlier this week, I blogged about how relatively few companies are presenting adjusted EBITDA numbers that attempt to back-out expenses associated with Covid-19. That raises the question – how are companies getting the impact of the pandemic across to investors? This excerpt from a recent Lincoln International article says that companies appear to be adopting one of three alternative approaches:
– Annualizing Earnings. For some, business during Q4 2020 returned to more normal conditions than in April to June when COVID-19 was at its height. As such, for businesses disrupted by COVID-19 in the spring, annualized earnings either in the form of Last Quarter Annualized (LQA) or annualizing post June performance may be a more accurate measure of business performance than metrics from 2020.
– 2021 EBITDA. CFOs are more comfortable assessing 2021 EBITDA because they have better visibility into the full year’s budget, including contracted revenues and full implementation of cost-cutting measures, and as a result would prefer to focus on 2021 performance and underweight 2020 results.
– The Swap Out. Another twist to LTM EBITDA is to replace the months most impacted by COVID-19 with the earnings results of those same months from 2019. Swapping out those months with 2019 performance is an easy way to reflect actual levels that were once earned.
The article says that it is critical that the particular metric chosen is as defensible as possible – and that companies should evaluate KPIs to ensure the metric they select is one that market participants would actually rely upon.
Securities Litigation: 2020 Class Action Settlements
Cornerstone Research recently released its annual report on securities class action settlements. Over on The D&O Diary, Kevin LaCroix provides an in-depth review of the report. Here’s an excerpt summarizing the numbers:
According to the report, there were 77 securities class action settlements in 2020, compared to 74 in 2019. (The settlement date). The 77 settlements in 2020 was also slightly above the 2010-2019 average number of settlements of 72.
The total value of settlements in 2020 was $4.2 billion, which is double the 2019 total settlement amount of $2.0 billion. The increase in total settlements in 2020 was largely the result of the significant number of mega settlements in 2020. (At the end of this post, I have identified the largest of these mega-settlements.) If the 2020 settlements over $1 billion are excluded, the total settlement dollars actually declined 4% in 2020 compared to 2019
As a result of the number of very large settlements in 2020, the average securities settlement in 2020 doubled to $54.5 million from $27.8 million in 2019. Though the average settlement increased in 2020 relative to 2019, the 2020 average was below the 1996-2020 average of $58.1.
There are all sorts of other interesting tidbits in Kevin’s blog, including the fact that D&O insurance covered 90% of the settlement amounts in 1933 Act claims, and that the average case took 3.3 years to resolve. Unfortunately, Cornerstone believes that relatively high settlement amounts are likely here to stay, given the significantly increased volume of class action filings in recent years.
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.
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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.
