Companies and their auditors must periodically assess whether there is substantial doubt about the company’s ability to continue as a “going concern.” In normal times, this evaluation at major public companies usually results in the conclusion that the company doesn’t face going concern issues. But as this Gibson Dunn memo points out, these aren’t normal times, and going concern questions are on the front burner at many more companies than in years past.
The memo walks through the AICPA, FASB & PCAOB standards that apply to the going concern analysis, and the differences in the obligations imposed on issuers & outside auditors under them. It also addresses the implications that Covid-19 uncertainties may have for the analysis:
The list of adverse events set out in AS 2415 and Subtopic 205-40 that could potentially call a company’s viability into question includes items such as negative operating trends, work stoppages, and loan defaults. In some cases, the ultimate outcome of those events or circumstances will be uncertain at the time of management’s or the auditor’s assessment. The COVID-19 pandemic, however, raises a set of global uncertainties—concerning areas from public health to financial markets—whose complexity is an order of magnitude greater than that of the circumstances that may drive an entity’s going-concern analysis in normal times.
While Subtopic 205-40 requires only that an entity assess its ability to meet its obligations based on “relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued,” and AS 2415 similarly requires only that the auditor consider “his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor’s report,” both issuers and auditors should be aware that regulators and private plaintiffs will later assess their actions with twenty-twenty hindsight.
The memo says that in an environment like this, management & auditors should make, document & disclose their going concern evaluation process, the factors that could affect its ability to meet its obligations, and what is known and unknown about those factors and their implications. Finally, they need to make and document a good-faith assessment of how likely it will be that one or more of those factors will cause the company to be unable to meet its obligations during the relevant assessment period.
Going Concern: Covid-19’s Toll So Far
While Gibson Dunn’s memo focuses on issues companies and auditors must address when making a going concern assessment This recent Audit Analytics blog provides some input on the toll that Covid-19 has already taken when it comes to “going concern” conclusions:
As of May 20, 2020, there have been 30 audit opinions for SEC-registered public companies that have cited the COVID-19 pandemic as a contributing factor to substantial doubt about a company’s ability to continue as a going concern for the next twelve months. Of the 30 companies that received a going concern audit opinion citing COVID-19 as a contributing factor, 14 were issued their first going concern opinion within the last five years. This means that more than half of the companies receiving a going concern modification in their audit opinion citing COVID-19 were previously experiencing difficulties that could impact their ability to continue operating prior to the pandemic.
The blog reviews the disclosures made by companies that have cited Covid-19 as a contributing factor to a going concern qualification. Interestingly, for most of these companies, Covid-19 “unknowns” haven’t been the primary trigger for going concern issues. Instead, the blog says that going concern qualifications have been triggered primarily by the pandemic’s impact on other areas, such as a company’s inability to operate & subsequent liquidity concerns.
Cheat Sheet: Acquired Company Financials
If you’ve followed my blogs over the years, you know that aside from finding something that gives me an excuse to blog about celebrities, there’s nothing I like more than a good cheat sheet. This handy 2-pager from Latham & KPMG walks you through the process of determining whether you need to include acquired company financial statements in your registration statement – and yes, it’s been updated to reflect the SEC’s recent rule changes. Check it out!
I really don’t know how to lead things off today. It just doesn’t seem appropriate to jump into my usual spiel without acknowledging the events of the past several days. It’s been an awful weekend, at the end of terrible week, which wrapped up another dreadful month in an abominable year. I want to say something hopeful, and that’s hard right now, but I’m going to give it a shot.
I’m mindful that the epicenter of the latest crisis is Minneapolis, the beautiful city that my colleagues Liz and Lynn call home. But I’m from Cleveland, and when I saw a peaceful protest turn violent on the streets of my own city, I was struck by the fact that the unrest began just a couple of blocks from the old federal courthouse in downtown Cleveland. As I watched the news coverage, I thought about something that happened in that courthouse one day in 1918, and it reminded me that, no matter how bad things get, we seem to have been blessed throughout our history with more than our share of men and women who – to paraphrase Edward Kennedy’s eulogy for his brother Robert – “see things that never were, and say why not?”
It may surprise you to learn that a corporate tool like me thinks that the old lefty Eugene Debs was one of those people. Although I don’t agree with his politics, I still think he’s one of American history’s most interesting figures. He was a socialist, yet received over 6% of the popular vote in the 1912 presidential election. Debs also managed to get nearly 1 million votes in the 1920 presidential election – despite running from a prison cell. He was sent to that cell by a federal judge in that old federal courthouse in Cleveland.
To make a long story short, during the First World War, Debs gave an anti-war speech in Canton, Ohio and was convicted of violating the Espionage Act. He asked to address the court at his sentencing, and his speech that day has gone down in history. In the words of the journalist Heywood Broun, “he was for that one afternoon touched with inspiration. If anyone told me that tongues of fire danced upon his shoulders as he spoke, I would believe it.”
Debs stood up in the Cleveland courtroom, and began: “Your Honor, years ago I recognized my kinship with all living beings, and I made up my mind that I was not one bit better than the meanest on earth. I said then, and I say now, that while there is a lower class, I am in it, and while there is a criminal element I am of it, and while there is a soul in prison, I am not free.”
He went on to deliver a harsh critique of the American economic system, but also pledged his faith in the idea that the nation would change for the better, through non-violent means. He saved his best – and most poetic – rhetorical flourish for last:
“When the mariner, sailing over tropic seas, looks for relief from his weary watch, he turns his eyes toward the southern cross, burning luridly above the tempest-vexed ocean. As the midnight approaches, the southern cross begins to bend, the whirling worlds change their places, and with starry fingerpoints the Almighty marks the passage of time upon the dial of the universe, and though no bell may beat the glad tidings, the lookout knows that the midnight is passing and that relief and rest are close at hand. Let the people everywhere take heart of hope, for the cross is bending, the midnight is passing, and joy cometh with the morning.”
The judge was apparently unmoved by Debs’ eloquence, and sentenced him to 10 years in prison. President Harding commuted his sentence to time served in 1921. Please don’t misunderstand me – this isn’t meant to be a political statement. I don’t have a lot in common with Gene Debs when it comes to politics. But I don’t find that to be an impediment to admiring his fearlessness, idealism, and defiant belief that better days were ahead for the nation.
Those are qualities that Americans have always admired in our greatest leaders, regardless of their political affiliation. In trying times like these, I find hope in the knowledge that we can usually count on people with these qualities to step up, appeal to the better angels of our nature, and remind us of who we are supposed to be. If you take the time to look, you’ll see that lots of people like this are with us even now.
SPACs: Will More IPOs Mean More Lawsuits?
Last month, I blogged about the recent prominence of SPAC IPOs. While many traditional IPO candidates have put their deals on hold during the Covid-19 crisis, SPACs have prospered. But this recent Woodruff Sawyer blog cautions that the rise in SPAC IPOs may be followed by a rise in post-deal litigation. The blog says that it isn’t the IPO that SPACs have to worry about – it’s the M&A deals that come next that often trigger litigation. Here’s an excerpt addressing a recent SPAC-related M&A lawsuit:
Consider the 2019 case of Welch v. Meaux. The plaintiffs in this case brought both Section 11 and Section 10(b) claims against officers and directors of the publicly traded company in connection with a de-SPAC transaction. The case also included a claim concerning the subsequent follow-on offering. The SPAC in question, Landcadia, had raised $250 million in its 2016 IPO. Landcadia had 24 months to complete its business combination before being forced to return the proceeds to its investors. With two weeks to go before the deadline, Landcadia agreed to buy a mobile food ordering and delivery company.
Things did not go well with the target company after it became publicly traded. Plaintiffs ultimately brought suit, alleging material deficiencies in the proxy statement and subsequent registration statement. Their allegations included the charge that when the target company began publicly trading, investors were not told of all the risks being foisted onto them. Moreover, the plaintiffs alleged that they were deceived as to the company’s prospects for profitability. This case is still pending.
The blog also addresses securities class actions targeting SPAC-funded operating companies, and reviews some of the difficult issues that D&Os may face in bankruptcy proceedings due to the structure of SPAC transactions.
Our June Eminders is Posted!
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Yesterday, the SEC announced that it had adopted amendments overhauling the rules governing the financial information that public companies must provide for significant acquisitions & divestitures. Here’s the 267-page adopting release. Highlights of the rule changes include:
– Updating the significance tests in Rule 1-02(w) and elsewhere by revising the investment test to compare the registrant’s investments in and advances to the acquired or disposed business to the registrant’s aggregate worldwide market value if available; revising the income test by adding a revenue component; expanding the use of pro forma financial information in measuring significance; and conforming, to the extent applicable, the significance threshold and tests for disposed businesses to those used for acquired businesses;
– Modifying and enhancing the required disclosure for the aggregate effect of acquisitions for which financial statements are not required or are not yet required by eliminating historical financial statements for insignificant businesses and expanding the pro forma financial information to depict the aggregate effect in all material respects;
– Requiring the acquired company financial statements to cover no more than the two most recent fiscal years;
– Permitting disclosure of financial statements that omit certain expenses for certain acquisitions of a component of an entity;
– Permitting the use of, or reconciliation to, IFRS standards in certain circumstances;
– No longer requiring separate acquired business financial statements once the business has been included in the registrant’s post-acquisition financial statements for nine months or a complete fiscal year, depending on significance;
The changes also impact financial statements required under Rule 3-14 of Regulation S-X (which deals with acquisitions of real estate operations), amend existing pro forma requirements to improve the content and relevance of required pro forma financial information, and make corresponding changes in the rules applicable to smaller reporting companies under Article 8 of Regulation S-X.
I suppose you’re wondering if the SEC split along partisan lines once again – well, of course they did! Here’s Commissioner Allison Herren Lee’s dissenting statement. We’ll be posting memos in our “Accounting Overview” Practice Area.
The Financial Times recently reported that some companies have presented non-GAAP metrics – such as “EBITDAC” – that effectively adjust away the effects of the Covid-19 pandemic on their operations. Maybe I’m too cynical, but presenting “as adjusted” numbers that back out an event of the pandemic’s magnitude seems akin to asking a question like, “Other than that, Mrs. Lincoln, how did you enjoy the play?”
Just how prevalent are presentations of non-GAAP Covid-19 adjusted numbers? According to a recent Bass Berry survey, not very. The firm reviewed 55 public companies that presented Adjusted EBITDA in earnings releases during the period from April 1, 2020, to May 14, 2020. This excerpt says that only a handful included Covid-19 related adjustments in their Adjusted EBITDA presentations, but a number did narratively disclose the impact Covid-19 had on that metric:
Of the surveyed companies, five companies, or 9%, included an adjustment in their calculation of Adjusted EBITDA related in some form to the COVID-19 pandemic, and 91% did not. Certain surveyed companies within this 91% group, while not including an adjustment for COVID-19 in the definition of Adjusted EBITDA, noted the impact that the COVID-19 pandemic had on Adjusted EBITDA at either the consolidated or the segment level (for example, by noting that the COVID-19 pandemic had a specified percentage impact on Adjusted EBITDA as the result of the shutdown of a manufacturing facility as the result of the COVID-19 pandemic).
That seems to me to be a better way to present this information than adjusting it away. Covid-19’s impact on key performance indicators is clearly relevant information, but including it in the Adjusted EBITDA metric itself implies that it should be regarded as a one-time event. Unfortunately, it appears that the pandemic is more like the “new normal,” and may impact operations in future periods even more significantly than it did during the first quarter.
Virtual Meeting Admission Practices: Public Companies Respond
We’ve run a couple of blogs in recent weeks that have aired investor criticism of admissions practices for virtual annual meetings. That has prompted responses from some of our members. This one is representative:
I’m the Assistant Secretary of a company that held its first virtual meeting this year. We have two service providers – Corporate Election Services mails to our registered holders and Broadridge mails to most of the beneficial holders. When we switched our meeting to a virtual meeting, we had two options. Have Broadridge host the virtual meeting so most could have a control number to access the meeting. This would have required us to re-mail to the registered holders a new proxy card. This would have canceled their votes and required re-voting.
The second option was to have Corporate Election Services run the virtual meeting using the model we use for attendance at our in-person meeting. Registered shareholders all have access to the in-person meeting in normal years because they receive an admission card with their proxy card or they can come to the meeting and check in using the registered shareholder list we keep on hand. Beneficial holders are not on the registered roles so to attend the in-person meeting they need to provide a legal proxy from their broker. Sometimes we accept a brokerage statement for a beneficial holder to attend in person.
Rather than re-mail, we choose to hold the virtual meeting the same way we would have held the in-person meeting – the same method described in the post above. We did have a couple of complaints. Note that Computershare hosted virtual meetings are also using this same access model. Also note that not all brokers use Broadridge so if Broadridge hosts, some beneficials still do not have access.
Admission practices for physical annual meetings vary, but it isn’t unusual to require some proof of beneficial ownership. As the member’s comments suggest, there’s usually some flexibility when it comes to the credentials required for admissions that doesn’t necessarily translate to a virtual platform. But the bottom line is that many companies that are being criticized for their virtual admissions policies aren’t doing anything that hasn’t been standard practice at their physical meetings in prior years.
Earnings Season: Trends During the Covid-19 Crisis
In their recent statement on Covid-19 disclosures, SEC Chair Jay Clayton & Corp Fin Director Bill Hinman said that this earnings season would not be routine. In that same vein, “Investor Relations” magazine recently published an article about trends that IR professionals have identified from companies’ recent earnings reports & calls. This excerpt points out that the crisis has “softened” some of the commentary from executives:
Given the current circumstances, corporate leaders have understandably focused less on market performance and more on their Covid-19 response. ‘While mitigating actions in most cases include cost cutting, the current crisis has provided an opportunity for leadership to show its human side and demonstrate genuine affection and respect for employees,’ says Sandra Novakov, head of IR at Citigate Dewe Rogerson, who is based in London. As an example, she points to the personal CEO message delivered by ABF, a Citigate client, in its interim results announcement.
The article identifies several other trends, including detailed scenario planning, intraquarter updates, and increased use of prerecorded comments.
Yesterday, I blogged about the SEC’s apparent initiation of an enforcement sweep targeting public companies that borrowed money under the Paycheck Protection Program. Public company borrowers have been sharply criticized by the media, lawmakers, and the Secretary of the Treasury himself. But is it fair to lump all public companies together as the bad guys – or are some just convenient scapegoats for a program that simply hasn’t been well administered?
This NY Times article provides a more nuanced picture of public company PPP borrowers and the plight many of them face than has been presented in other media reports. While the SBA’s guidance says that the government will be skeptical when it comes to need certifications from public companies with “substantial market value” and “access to capital markets,” it still isn’t entirely clear what those terms mean. Furthermore, this excerpt from the article about a small cap called RealNetworks suggests that – no matter how you define the terms – it’s hard to conclude that a lot of small caps have either substantial market value or access to the capital markets at this time:
RealNetworks struggled, too, as the pandemic transformed American life. The company went public during the dot-com boom of the 1990s, only to see its stock fall in the subsequent bust. In recent years, it has marketed a facial recognition product to casinos and airports, among other venues. But its share price has fallen. At the end of February, it was hovering just above a dollar. Then the virus crippled travel and hospitality businesses. Companies that had been possible clients before the pandemic made it clear that they wouldn’t engage its services this year.
Rob Glaser, RealNetworks’ chief executive, said the pandemic had put a “bull’s-eye” on the company’s facial recognition offering. He said it was “not as devastating to our company as if we were a cruise ship company or an airline or a restaurant chain, but we were directly affected.”
RealNetworks qualified for $2.9 million and got its loan. According to the article, it has apparently decided to keep it. That doesn’t seem unreasonable to me. The company’s market cap is $44 million, its stock closed on Tuesday at $1.18 per share, and it received a delisting notiice from Nasdaq the day before it received its PPP loan. In terms of access to capital, the company’s most recent financing came entirely from the pockets of its CEO.
Some public companies that received PPP loans clearly shouldn’t have, but the same is also true for some private companies. I mean c’mon – the Lakers? In any event, it’s hard for me to see a small cap public company like this one being anybody’s idea of poster child for abusive conduct. Lumping all “public company borrowers” together as being unworthy participants in the program just doesn’t reflect reality.
PPP Loan Forgiveness: It’s Complicated. . .
The SBA issued its PPP loan forgiveness application last week, and it’s apparently pretty complicated. Here’s an excerpt from Crowell & Moring’s memo on the application:
On May 15, 2020, the Small Business Administration (SBA) released the Paycheck Protection Program Loan Forgiveness Application which is comprised of a PPP Loan Forgiveness Calculation Form (SBA Form 3508), including related certifications, and worksheets to assist in making the calculations. Although the SBA has yet to release further guidance on PPP Loan forgiveness, the Loan Forgiveness Application does provide some guidance on elements of forgiveness that were not clear from either the text of the Cares Act, or the SBA’s Interim Final Rules and FAQs. However, the complexity of the application and the onerous submission requirements present challenges for small businesses and create a further need for guidance and legal/accounting support.
I took a look at the application, and it does appear to be fairly daunting. For example, there’s an entire page of instructions devoted solely to the payroll, FTE, & non-payroll documentation that must be submitted with the application or retained by the borrower. In keeping with the government’s “Ready. . . FIRE!. . .Aim” approach to this program, now that the SBA has published the application, it will eventually tell people how they are supposed to complete it.
Tomorrow’s Webcast: “Middle Market M&A – The Latest Developments”
Tune in tomorrow for the DealLawyers.com webcast – “Middle Market M&A: The Latest Developments” – to hear to hear Citizens M&A Advisory’s Charles Aquino, Mintz Levin’s Marc Mantell and Duane Morris’s Richard Silfen discuss the state of the middle market and issues dealmakers are confronting in 2020, including bridging valuation gaps, Covid-19’s implications for deal structure and process, and the evolution of deal terms in the Covid-19 environment.
Public company borrowers under the Paycheck Protection Program have received plenty of criticism. Now, according to this Bryan Cave blog, their hot seat just got even hotter, because these companies appear to be targets in an SEC enforcement sweep. Here’s the intro:
We understand that several issuers and regulated entities that publicly disclosed their receipt of funds from the SBA’s Paycheck Protection Program (PPP), established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, have received requests for information from the SEC’s Division of Enforcement. In general, the requested information appears to concern the recipients’ eligibility and need for PPP funds, the financial impact on recipients of the pandemic and government response, and recipients’ assessment of their viability and access to funding.
This SEC outreach is rumored to be part of a sweep styled In the Matter of Certain Paycheck Protection Program Loan Recipients. The SEC is reportedly investigating whether certain recipients’ excessively positive or insufficiently negative statements in recent 10-Qs may have been inconsistent with certifications made in PPP applications regarding the necessity of funding. These information requests are voluntary at this time, and it appears that not all PPP loan recipients are receiving document requests.
There may be a correlation between large funding amounts and SEC scrutiny, both in terms of attracting interest and avoiding the impact of the SBA’s announced safe harbor for loans less than $2 million (though the safe harbor does not explicitly affect the SEC). Recent news reports indicate that the Department of Justice Fraud Section also is investigating possible misconduct by PPP loan applicants. Initial DOJ actions have focused on potential overstatement of payroll costs and/or employee headcount, as well as misuse of PPP proceeds.
In addition to public company borrowers, we have heard anecdotally that investment advisors and brokerage firms that received PPP loans are also targeted in the sweep. The blog says that while existing allegations appear to focus on “extreme behavior,” it is expected that less egregious borrowers may be caught up in the dragnet.
SEC Enforcement: Covid-19 Steering Committee Established
News of a potential enforcement sweep came only a few days after co-director of the SEC’s Division of Enforcement Steve Peikin gave a speech announcing that the Division had formed a steering committee to coordinate Covid-19 related enforcement activities:
In late March my co-Director, Stephanie Avakian, and I formed a Coronavirus Steering Committee to coordinate the Division of Enforcement’s response to coronavirus-related enforcement issues. The Steering Committee comprises approximately two dozen leaders from across the Division, including representatives from our various specialized units, from our Home Office and various regional offices, and from our Office of Market Intelligence.
The Steering Committee’s mandate is to proactively identify and monitor areas of potential misconduct, ensure appropriate allocation of our resources, avoid duplication of efforts, coordinate responses as appropriate with other state and federal agencies, and ensure consistency in the manner in which the women and men of the Division address coronavirus-related matters.
While the speech didn’t specifically identify PPP loan recipients as potential targets, it did identify a number of other areas of emphasis, including microcap fraud and insider trading.
Steve Peikin also said that the Division has developed a “systematic process to review public filings from issuers in highly-impacted industries, with a focus on identifying disclosures that appear to be significantly out of step with others in the same industry” and “disclosures, impairments, or valuations that may attempt to disguise previously undisclosed problems or weaknesses as coronavirus-related.” Stay tuned.
NYSE Temporarily Eases Approval Requirements for Covid-19 Share Issuances
Earlier this month, I blogged about Nasdaq’s adoption of a temporary rule easing the shareholder approval requirements applicable to listed companies looking to raise private capital during the Covid-19 crisis. Last week, the SEC approved a similar NYSE rule proposal. This Stinson memo has the details. Here’s an excerpt:
The SEC has approved, effective immediately, new Section 312.03T of the NYSE Listed Company Manual. Section 312.03T provides a limited, temporary exception from the shareholder approval requirements in Section 312.03(c), accompanied, in certain narrow circumstances, by a limited exception from Sections 312.03(a) and (b) and Section 303A.08. The exception in Section 312.03T is available until and including June 30, 2020.
Among other things, and subject to certain exceptions, Section 312.03(c) of the Manual requires shareholder approval for certain issuances of over 20% of outstanding shares or voting power. Section 312.03(a) references the requirement for shareholder approval of equity compensation plans set forth in 303A.08 of the Manual. Section 312.03(b) requires shareholder approval for issuance of equity securities to certain related parties.
Listed companies may take advantage of the temporary rules only in limited circumstances arising out of Covid-19’s impact on their results of operations and financial condition. Companies must also jump through a number of other hoops, including audit committee and NYSE approval. Additional conditions apply for issuances under the other temporary rules.
As the U.S. slowly reopens for business, we’re already hearing warnings that a second wave of the pandemic is likely heading our way in the fall. Since that’s the case, a recent Gartner survey finding that 42% of CFOs have not addressed a potential second wave in their planning for the remainder of the year is a little disconcerting. Here’s an excerpt:
A Gartner, Inc. survey of 99 CFOs and finance leaders taken April 14-19, 2020 revealed that 42% of CFOs are not incorporating a second wave outbreak of COVID-19 in the financial scenarios they are building for the remainder of 2020. Additional survey data showed that only 8% of CFOs have a second wave factored into all their planning scenarios, and only 22% have a second wave factored into their “most likely” scenario. The lack of planning comes even as CFOs express a cautious approach as to when they will fully reopen their operations and bring employees back to their normal office routines.
“As CFOs are attempting to project revenue and profits for 2020, it’s surprising that 42% are not baking a second wave of COVID-19 into any of their scenarios” said Alexander Bant, practice vice president, research, for the Gartner Finance practice. “Our latest CFO data also reveals that most executive teams are still trying to decide what factors they should use to determine how and when to reopen their offices and facilities.”
In fairness, this survey was taken a full month ago, and a lot has changed since then. But with the Covid-19 pandemic already spawning securities litigation, the potential lack of preparedness for a second wave presents governance and disclosure issues that may make attractive targets for plaintiffs.
IPOs: SPACs Ride High in April & Don’t Get Shot Down in May
The Covid-19 related turmoil in the stock markets during the past few months has put a damper on IPO activity, but this WSJ article says that April was a boom time for SPAC IPOs. Here’s an excerpt:
The companies raising the most money in the IPO market right now have no revenue, aren’t profitable and lack long-term business plans. That is by design: They are blank-check companies, whose purpose is to raise money for acquisitions. So far this year, these special-purpose acquisition companies, or SPACs, have raised $6.5 billion, on pace for their biggest year ever, according to Dealogic. In April, 80% of all money raised for U.S. initial public offerings went to blank-check firms, compared with an average of 9% over the past decade.
SPACs accounted for $2.2 billion of the $2.6 billion raised in IPOs last month, and they’ve raised another $575 million so far this month. The article suggests that investors’ fondness for SPACs arises from their belief that “there will be good deals to scoop up when the coronavirus subsides.”
Tomorrow’s Webcast: “Political Spending – What Now?”
Tune-in tomorrow for the webcast – “Political Spending: What Now?” – to hear DF King’s Zally Ahmadi, Skadden’s Hagen Ganem and Wilmer Hale’s Brendan McGuire discuss an overview of the current climate for political spending, corporate governance/board oversight, key considerations for political spending policies, political spending disclosure, shareholder engagement and shareholder proposal trends and voting behavior.
Earlier this year, I blogged about the possibility that the use of direct listings instead of traditional IPOs might allow companies to avoid the Section 11 claims that so often accompany IPOs. This Orrick memo says that a recent California federal court decision suggests that this hope may be misplaced:
On April 21, 2020, Judge Susan Illston of the U.S. District Court for the Northern District of California denied defendants’ motion to dismiss a securities class action complaint brought by a shareholder of Slack Technologies, Inc. following the company’s 2019 direct listing. Pirani v. Slack Technologies, Inc. , No. 19-cv-05857-SI (N.D. Cal. Apr. 21, 2020).
Rejecting defendants’ argument that the plaintiff lacked standing to pursue claims under Section 11 of the Securities Act, the court held, in a matter of apparent first impression, that in the unique situation of a direct listing in which shares registered under the Securities Act become publicly tradeable on the same day that unregistered shares become publicly tradeable, a plaintiff does not lack standing to sue under Section 11 even though the plaintiff cannot show that her shares were registered.
The memo goes on to summarize the judge’s reasoning, which appears to be based almost entirely on policy considerations underlying Section 11. We’re posting memos in our “Securities Act Liability” Practice Area.
“No Respect at All”: Are Dual Class Companies Undervalued?
Dual class companies are the Rodney Dangerfield of corporate governance – “No respect. . .I’m tellin’ ya, I don’t get no respect at all!” It’s hard to find any love for them among investor advocates, who’ve made “one share, one vote” a central underpinning of their good governance creed. But does their zeal for this revealed truth result in the undervaluation of dual class companies? That’s the conclusion of a recent study by a Cambridge University law prof. Here’s the abstract:
Dual-class stock enables a company’s controller to retain voting control of a corporation while holding a disproportionately lower level of the corporation’s cash-flow rights. Dual-class stock has led a tortured life in the US. Between institutional investor derision and the exclusion or restriction of dual-class stock from certain indices, one may assume that dual-class structure must be harmful to outside stockholders.
However, in this article, the existing empirical evidence on US dual-class stock will be reassessed by contrasting studies that use different measures of performance. It will be shown that although dual-class firms are generally valued less than similar one-share, one-vote firms, they perform as well as, and, in many cases, outperform, such firms from the perspective of operating performance and stock returns. When it comes to dual-class stock, more than meets the eye, and a presumption that dual-class stock is harmful for outside stockholders should not guide policy formulation.
The study argues that the market discounts dual-class stock to protect itself against the potential that the downsides of the structure will outweigh the benefits, but that those downsides seldom emerge. As a result, outside stockholders are not harmed by dual-class stock. Instead, they invest in dual-class stock at a discounted price which organically protects them against the potential for future abuses, and that, if anything, discounts dual-class stock too much.
Capital Markets: Time to Dust-Off the Alternative Equity Offering Playbook?
In times like these, many public companies that otherwise might be good candidates for a traditional equity offering may need to look at alternative strategies. That means ATMs, PIPEs, registered directs, and even equity lines are on the table for companies that haven’t previously considered them. If you haven’t done one of those deals since the last time the world ended, you should take a look at this Proskauer memo on alternative equity offerings. It provides a detailed overview of each of these alternative equity financing options.
If you’re considering tapping the capital markets, be sure not to miss our upcoming webcast – “Capital Raising in Turbulent Times” – which will address the current state of the new issues market for debt and equity, and explore financing and liability management alternatives.
Yesterday, I blogged about the bind that some Delaware companies find themselves in when it comes to switching their annual meetings from a physical location to a virtual only meeting. The problem stems from the fact that public companies that first gave notice of their annual meeting after the date of Gov. Carney’s April 7th order providing relief from DGCL notice requirements for such a switch aren’t eligible to rely on it.
That means that these companies can’t be certain that merely complying with the SEC’s guidance on providing notice of a change to a virtual meeting will be compliant with the DGCL’s notice requirements. Many are concerned about their ability to provide the formal notice of a change required by the DGCL in a timely manner.
Help for these companies may be on the way in the form of proposed 2020 amendments to the DGCL recently endorsed by the Corporate Law Section of the Delaware Bar. While the legislature needs to act on the proposal, Section 4 of the proposed legislation would amend Section 110 of the DGCL to provide the board of a public company with the authority during an emergency to:
Notify stockholders of any postponement or a change of the place of the meeting (or a change to hold the meeting solely by means of remote communication) solely by a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to § 13, § 14 or § 15(d) of [the Exchange Act] and such rules and regulations.
Section 23 of the proposed legislation would make this authority retroactive to January 1, 2020 “with respect to any emergency condition occurring on or after such date and with respect to any action contemplated by Section 4 of this Act and taken on or after such date by or on behalf of the corporation with respect to a meeting of stockholders held . . . during the pendency of such condition.”
I’m told that the Delaware Bar is seeking immediate consideration of these emergency amendments, but that the legislature has not yet reconvened from its Covid-19 imposed hiatus.
Nasdaq Temporarily Eases Approval Requirements for Covid-19 Share Issuances
Earlier this week, the SEC approved a temporary Nasdaq rule that would provide listed companies with a temporary exception from certain shareholder approval requirements through June 30, 2020 in order to streamline issuers’ access to capital. Here’s an excerpt from Nasdaq’s issuer alert summarizing the rule:
The exception is limited to circumstances where the delay in securing shareholder approval would:
– Have a material adverse impact on the company’s ability to maintain operations under its pre COVID-19 business plan;
– Result in workforce reductions;
– Adversely impact the company’s ability to undertake new initiatives in response to COVID-19; or
– Seriously jeopardize the financial viability of the enterprise.
In order to rely on the exception, among other requirements, the company would also have to demonstrate to Nasdaq that the need for the transaction is due to circumstances related to COVID-19 and that the company undertook a process designed to ensure that the proposed transaction represents the best terms available to the company.
No prior approval of the exception by Nasdaq is required if the maximum issuance of common stock (or securities convertible into common stock) issuable in the transaction is less than 25% of the total shares outstanding and less than 25% of the voting power outstanding before the transaction; and the maximum discount to the Minimum Price at which shares could be issued is 15% (the “Safe Harbor Provision”).
Companies that fit within this Safe Harbor Provision must notify Nasdaq as promptly as possible, and at least two days before issuing shares, but aren’t required to wait required 15 calendar days after filing the listing of additional shares notification. If a transaction falls outside of the Safe Harbor Provision, Nasdaq must approve the company’s reliance on the exception before the company can issue any securities in the transaction. Here’s a Nasdaq FAQ on the rule as well as its supplemental instructions to listed companies.
PPP Loans: Borrowers Get Another Week to Decide to Whether to “Hold’em or Fold’em”
In the latest chapter of the Paycheck Protection Program saga, the SBA issued FAQ #43, which extends the deadline for borrowers to take advantage of the safe harbor for repayment of PPP loans from May 7th to May 14th. The SBA says that it will provide additional guidance on the PPP’s need certification requirement prior to that deadline. Yeah, sure, that should clear things up. . .
A number of companies have transitioned to virtual annual meetings as a result of the Covid-19 crisis, and according to the CII’s recent letter to the SEC’s Investor Advisory Committee, it has been kind of a bumpy ride from an investor perspective. Companies that are looking for ways to make their own virtual meetings more investor friendly should take a look at the CII’s letter. Here’s an excerpt summarizing some of the anecdotal concerns that the CII has heard from investors about the virtual meeting process:
– Shareholders struggling to log in for meetings.
– Inability to ask questions in some cases if the shareholder has voted in advance by proxy. We understand that one virtual meeting platform provides that for a beneficial owner to ask questions, the record holder must transfer a legal proxy to the beneficial owner. This would require the record holder to withdraw its vote if it already had voted before executing the required legal proxy because the voting would transfer to the beneficial holder. These rules unnecessarily hamper the ability of beneficial owners to participate in meetings, even at companies that use effective technology and rules for participation by shareholders who get into the meeting.
– Shareholders unable to ask questions during the meeting. In some cases, questions are limited to those that can be submitted in writing in advance, which interferes with the potential for interplay between meeting content and questions or comments.
– Lack of transparency on questions asked by shareholders, making it possible that company officials cherry-pick questions to which to respond. This obviously is an issue if time limits for a meeting prevent responses to all questions. At one large company at which shareholder questions went unanswered, we understand the company provided only 10 minutes for Q&A.
– Conflicting channels for shareholder participation, with shareholder resolution proponents required to be on a line that is different than that used for general shareholder Q&A.
– At least one company prohibiting a shareholder proponent from speaking on behalf of their proposal.
– Snafus with control numbers not working to permit shareholders to log into a meeting.
The CII acknowledges that some of these problems may be attributable in part to the speed with which many companies have shifted to virtual-only meetings, but it is concerned about the precedents that may be set this year.
Virtual Annual Meetings: Delaware’s Relief Order Leaves Some Companies Uncovered
Last month, I blogged about Delaware Gov. John Carney’s order permitting public companies that had previously noticed physical annual meetings to switch to virtual annual meetings simply by complying with the SEC’s guidance, without the need to provide further notice under applicable provisions of the DGCL. That order was extremely helpful for companies covered by it, but it turns out that a number of companies weren’t – and some of them find themselves in a bind.
As this Morris Nichols memo points out, the order only applies to companies that provided notice of a physical meeting prior to the April 7th date of the order. Companies that first mailed their proxy materials after that date apparently are not covered by it. One of our members recently posted a comment in our Q&A forum about a tragic situation that’s compounding the problems companies that aren’t covered by the order face:
This is really unfortunate. I understand that Broadridge is struggling right now to get materials mailed to shareholders. If reports are to be believed, they had an outbreak at a warehouse in NY resulting in several deaths. Their staffing levels have been drastically reduced as they are trying to comply with social distancing efforts. And they are notifying clients of delays in mailings of material and fulfilling requests for hard copy materials. Requiring notices of changes to a virtual meeting format (rather than just press release/SEC filing) will only compound the problem.
One workaround that’s been suggested to handle mailing delays resulting from the critical need to prioritize worker safety is to bypass Broadridge and mail any new notice to record holders only. Since only those holders are entitled to receive notice under state law, it seems to me that this may be a viable solution for companies that don’t have large numbers of record holders.
On the other hand, many of the orders issued by other states permitting deviations from statutory practice due to Covid-19 are prospective in nature, while Delaware’s applied only to actions taken prior to the order. Perhaps Delaware’s order could be revised to take the same approach?
Virtual Annual Meetings: Doug Chia’s Attending Them So You Don’t Have To. . .
Soundboard Governance’s Doug Chia attended Wells Fargo’s virtual annual meeting and posted a detailed summary that’s a must read for anyone considering going virtual this year. His write-up provides plenty of insights into how the meeting was conducted – including commentary on the virtual meeting platform, the manner in which the Q&A was conducted, and how shareholder proposals were presented.
Doug’s attending other meetings and posting similar summaries (here’s one about Berkshire Hathaway’s meeting that he posted earlier this week), so stay tuned.
