While the Staff hasn’t said much about MD&A requirements in recent years, I think most lawyers appreciate that it’s really one of the cornerstones of the entire disclosure system. This recent blog from Bass Berry’s Kevin Douglas offers up 12 things that you need to know when you’re preparing your company’s MD&A. Here’s an excerpt with some tips on Item 303 of S-K’s trend disclosure requirements:
A core disclosure component of Item 303 of Regulation S-K (which sets forth the SEC disclosure requirements applicable to MD&A) is the requirement to provide an analysis of known material trends, uncertainties and other events impacting a registrant’s results of operations, liquidity or capital resources. Practice varies widely among registrants regarding the extent to which the disclosure of forward-looking statements is included in the MD&A.
While there may be reticence among some registrants to include overly expansive forward-looking disclosure (for example, based on concerns about liability exposure if such forward-looking information is not ultimately accurate), countervailing considerations include the fact that such disclosure may result in more useful disclosure as well as the fact that the failure to disclose known trends can give rise to exposure from Rule 10b-5 allegations from private parties as well as SEC civil actions.
The blog also points out that when companies include trend disclosure in their MD&A, they need to keep in mind that this disclosure may need to continue to be included and updated in subsequent periodic reports. Other topics include presentation and readability of MD&A disclosure, the interaction between MD&A and risk factor disclosure, and the use of non-GAAP financial measures in the MD&A.
Del. Sup. Ct. Says Plaintiff Pled Viable “Caremark” Claim
Breach of fiduciary duty allegations premised on a board’s failure to fulfill its oversight obligations are notoriously difficult to establish. One reason that these Caremark claims are so tough to make is that a plaintiff needs to show “bad faith,” meaning that the directors knew that they were not discharging their fiduciary obligations. But last week, in Marchand v. Barnhill, (Del. Sup.; 6/19), the Delaware Supreme Court overruled the Chancery Court and held that – at least for purposes of a motion to dismiss – a shareholder plaintiff stated a viable Caremark claim.
The case arose from a 2015 listeria outbreak at Blue Bell Creameries. In addition to being implicated in the deaths of three people, the outbreak resulted in a recall of all of the company’s products, a complete production shutdown, and a lay-off involving 1/3rd of its workforce. Ultimately, the financial fallout from this incident prompted the company to seek additional financing through a dilutive stock offering.
As a result, the plaintiff brought a derivative action against the board & two of the company’s executives. The plaintiff alleged that the board failed in its oversight duties, but the Chancery Court rejected those allegations. The Supreme Court disagreed, holding that the plaintiff had alleged shortcomings in board level oversight sufficient to survive a motion to dismiss:
When a plaintiff can plead an inference that a board has undertaken no efforts to make sure it is informed of a compliance issue intrinsically critical to the company’s business operation, then that supports an inference that the board has not made the good faith effort that Caremark requires.
Since Marchand involved a motion to dismiss, it’s hard to tell whether the case suggests that Caremark may be a more viable path to imposing liability than it has been in the past – but it’s worth noting that this decision is the second case in the last two years in which a Delaware court has characterized a Caremark claim against directors as being “viable.”
Board Minutes: “Not Too Long, Not Too Short, But Just Right. . .”
Here’s a recent blog from Bob Lamm that has some terrific insights into preparing board minutes. This excerpt contains Bob’s take on the issue of whether to prepare “long-form” minutes or “short form” minutes:
I believe that the proper course is what I call “Goldilocks Minutes.” Not too long, not too short, but just right. Minutes can (and IMHO should) give an indication as to what was discussed. For example, if the board is considering an acquisition, it’s not only OK – it’s actually a good idea – to reflect that the board discussed the merits and risks of the transaction, along with some examples of the factors discussed.
If you’re looking for more of a deep dive into issues surrounding board minutes, check out the March issue of The Corporate Counsel.
Zoom Video Communications is one of the year’s better performing tech IPOs, & now the video conferencing software provider is earning kudos for its effective use of technology to liven up the typically lackluster quarterly earnings call ritual. Here’s an excerpt from this recent Quartz article:
Earlier this month, Zoom disclosed its first quarterly results as a public company. After its press release went out, founder and CEO Eric Yuan and other senior executives hopped onto a Zoom video call to discuss the earnings with analysts, press, and investors. The interactive webinar showed off the company’s technology—and reinvented notions of what a quarterly earnings call should be.
The format introduced a greater degree of transparency between the company and analysts. It wasn’t just the executives whose faces appeared on the screen; when asking questions, the analysts on the call could also be seen—both by the executives and by everyone else on the call.
“You’re not just sort of talking into a box or a handheld—you’re actually looking at each other in the eye and you’re actually talking to feel like we’re connecting with a lot more people,” says Tom McCallum, Zoom’s head of investor relations.
The dynamics transformed the call from a presentation to more of a conversation, with executives and analysts essentially chatting face-to-face via video screens (journalists on the call were in view-only mode). The ability to see each speaker’s face brought a distinctly human touch to something that, with other companies, often feels like an anonymous, formulaic encounter steered by barely-human-sounding teleconference operators reading from scripts and frequently betraying their lack of familiarity with either the presenters or the callers on the line.
Here’s the presentation, which – while not exactly Avengers: Endgame – is more interesting to look at than the standard call. The Q&A is what you want to see, and that starts around the 20 minute mark. My one beef is that you have to rummage around the IR website a bit to find the presentation – while a link to the earnings release appears on the home page, the earnings presentation itself does not. You have to click on the “events” link to find it.
Board Recruitment: Assessing First Time Director Candidates
Many companies are finding themselves moving beyond the traditional pool of current & former CEOs to identify new directors – and many of these non-traditional candidates have never served on a public company board. So, how do you assess their qualifications? This SpencerStuart article has some suggestions. Here’s an excerpt about questions that nominating committees should ask covering areas that are key to the success of a new director:
– Interpersonal skills — Has the person demonstrated an ability to build relationships with all kinds of people? To influence and to gain trust and support from others? Can the candidate use diplomacy and tact? Listen and adjust appropriately to others’ input?
– Intellectual approach — Can the candidate handle complexity, or simplify issues to the essence to make sound, logical decisions? What is their comfort level with ambiguity? Does he or she have the
ability to look ahead? To transfer knowledge and experience to different environments?
– Integrity — Will the candidate adhere to an appropriate and effective set of core values and live by them? Is she or he honest and truthful? Is the person authentic, self-aware and confident enough to “be oneself”?
– Independent mindedness — Can the candidate set out and defend a position, even when this means going it alone? What about the ability to maintain positive relationships amid conflicts about ideas?
– Inclination to engage — Is the candidate motivated to invest time and effort in learning about the organization and staying up to date with it? Is she or he diligent enough to follow through with commitments?
A prospective director’s financial competence is also an important issue, and the article suggests that companies include the chair of the audit committee in interviews of a prospective candidate, in order to better assess the financial sophistication revealed by the questions the candidate asks.
D&O for Unicorns: Insurers Move to Public Company Model
High value private companies – i.e., “Unicorns” – are making insurers nervous. These are private companies, but their huge and volatile valuations, significant financing and resale transactions & other characteristics make them appear much riskier to insurers than the typical private company.
As a result, insurers are increasingly moving to public company-style policies for these companies. This Woodruff Sawyer blog reviews the implications of that trend. This excerpt says the biggest issue is the reduced scope of entity coverage found in the typical public company policy:
To be clear, both public and private company forms provide for entity coverage if the corporation is named in a securities claim. The definition of “securities claim” typically includes breach of fiduciary duty suits. As a practical matter, these are the types of claims for which D&O insurance is being purchased for high-value private companies (and public companies, too).
What you lose, however, when you move to the public company form is the expanded coverage for the corporation for other suits that name the corporate entity. For example, on the private company form, defense costs coverage may exist for the corporate entity if a regulator decides to take an enforcement interest in a corporation. Another example is corporate entity coverage for antitrust claims. These scenarios are almost entirely excluded from the public company form.
On the other hand, public company policies may provide greater coverage for D&Os, enhanced ability for the company to select its own counsel, broader coverage for regulatory investigations, and other more favorable policy terms.
According to this recent Audit Analytics blog, the trend toward fewer comment letters from the Staff not only continued last year, but accelerated:
The total amount of comment letters stemming from 10-K and 10-Q filings has once again decreased (as shown in the chart below). From 2017 to 2018, total comment letters decreased by roughly 26%, which is slightly steeper than the decline we’ve seen in the past (13% from 2016 to 2017 and 10% from 2015 to 2016). Similarly, the number of conversations largely followed the same declining pattern.
The blog says that the decline in 8-K comment letters was even sharper. Comment letters on 8-K filings plummeted 54.5% between 2017 and 2018, in comparison to 31.5% between 2016 and 2017 and an increase of 112.4% between 2015 and 2016. The 2016 spike in comment letters is attributable to the Staff’s focus on the use of non-GAAP financial data following Corp Fin’s issuance of updated guidance.
Audit Analytics suggests that the reasons for the decline in comments include a nearly 50% decline in the number of reporting companies since the early 2000s and the Staff’s principles-based approach to issuing comments. Last year’s government shutdown may also have contributed, since reviews weren’t performed during that time. But that probably didn’t move the needle much – since only the last 2 weeks of December were affected by the shutdown.
KPMG/PCAOB: Worse Than We Thought?
I consider myself pretty jaded, but if you read my blog when news broke about the scandal involving KPMG personnel’s misappropriation of PCAOB data, you know I was pretty shocked by the magnitude of what was alleged to have happened. The SEC thought this was pretty serious stuff too. Last week, the agency announced that it had reached a settlement with the firm under the terms of which KPMG admitted wrongdoing & agreed to a $50 million civil monetary penalty – which matches the largest fine ever imposed against an audit firm.
As bad as the KPMG situation appeared when it was first revealed, this recent article by MarketWatch.com’s Francine McKenna notes that the SEC’s announcement suggests that the scandal is even worse than originally reported:
The SEC revealed Monday a much larger scandal than was previously known: KPMG auditors, including some senior partners in charge of public company audits, cheated on internal tests related to mandatory ethics, integrity and compliance training, sharing answers with other partners and staff to help them also attain passing scores. In addition, for a period of time up to November 2015, some audit professionals, including one partner, manipulated the system for their exams to lower the scores required to pass.
Twenty-eight of these auditors did so on four or more occasions. Certain audit professionals lowered the required score to the point of passing exams while answering less than 25% of the questions correctly, the SEC says.
Egads. The SEC’s announcement of the settlement indicated that the agency’s investigation was ongoing. Yeah, I bet it is.
SEC Revises Procedure for Authenticating Form ID
Here’s something that Alan Dye recently posted on his “Section 16.net” Blog:
The SEC has announced enhancements to the EDGAR system, one of which affects the submission of Form ID. New filers will now complete an updated online version of Form ID, which is accessible via a hyperlink from sec.gov. Filers will print out the completed version, for manual signature and notarization, and then upload the signed version for submission with the Form ID. The old “courtesy pdf copy” of Form ID previously available for use as an authenticating document has been removed from the SEC’s website.
PCAOB Rule 3526 requires auditors to communicate with audit committees concerning relationships that might impact their independence. Last week, the PCAOB issued guidance concerning the communications that are required under this rule when the auditor identifies one or more violations of applicable independence rules – but doesn’t think the violations disqualify it from continuing to serve as the auditor. The PCAOB also issued this summary of the guidance. This excerpt from the guidance document details the disclosures required by the rule:
The Firm would comply with Rule 3526 by:
a. summarizing for the audit committee each violation that existed during the year;
b. summarizing for the audit committee the Firm’s analysis of why, for each violation and notwithstanding the existence thereof, the Firm concluded that its objectivity and impartiality with respect to all issues encompassed within its engagement had not been impaired, and why the Firm believes that a reasonable investor with knowledge of all relevant facts and circumstances would have concluded that the Firm was capable of exercising objective and impartial judgment on all issues encompassed within the Firm’s engagement;
c. if more than one violation existed during the year, providing to the audit committee a separate analysis of why, notwithstanding all of the violations taken together, the Firm concludes that its objectivity and impartiality with respect to all issues encompassed within its engagement has not been impaired, and why the Firm believes that a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the Firm was capable of exercising objective and impartial judgment on all issues encompassed within the Firm’s engagement;
d. engaging in dialogue with the audit committee regarding the violation(s) and the Firm’s related analyses (as described in (a)-(c) above);
e. documenting the substance of the Firm’s discussion(s) with the audit committee (as described in (d) above); and
f. affirming in writing to the audit committee that, except for the violation(s) expressly identified, the Firm would be independent in compliance with Rule 3520.
In a nutshell, the auditor must consider the impact of the violation or violations on its objectivity and impartiality. It then communicates that analysis to the audit committee, which makes its own decision about whether to continue to retain the audit firm.
There are several other components to the guidance, and one of the more interesting is the PCAOB’s view that in this situation, the auditor “should not state in its required annual affirmation that the auditor is independent, but instead indicate that the auditor would be independent except for the violation or violations that it has identified and discussed with the audit committee.”
However, the auditor may issue its report without altering the required title: “Report of Independent Registered Public Accounting Firm.” The PCAOB views this as stating a legal requirement, and not a specific assertion of compliance with the applicable PCAOB rule.
Internal Controls: More ICFR Risk Factors in Wake of SEC Enforcement Action
I’ve blogged a few times (here’s the most recent) about the SEC’s enforcement action against a handful of companies that couldn’t get their acts together when it came to addressing material weaknesses in ICFR. Now, this Audit Analytics blog says that some companies with material weakness disclosures extending over multi-year periods are including “Risk Factor” disclosure specifically addressing the risk of SEC enforcement resulting from their inability to resolve those issues.
This excerpt suggests that we’re likely to see more disclosure along these lines as the year progresses:
It appears public companies are taking notice of the SEC’s January statement that merely disclosing ICFR material weakness is not enough. This year we may see more companies disclose ineffective controls, and this is meaningful because of the SEC’s scrutiny.
In conclusion, analysts and investors need to be on guard for more companies disclosing material weakness with ICFR. Further, they need to consider that admission of weak internal controls doesn’t necessarily mean 2018 was the first year the firm had problems. It’s possible historical filings could show years of ineffective ICFR.
Transcript: “How to Handle an SEC Enforcement Inquiry Now”
We have posted the transcript for our recent webcast: “How to Handle an SEC Enforcement Inquiry Now.”
Here are the results of our recent survey on drafting annual reports, proxy statements, glossy annual reports & Form 10-Ks:
1. At our company, the lead for drafting our proxy statement is (ie. running the master):
– Corporate secretary’s department – 20%
– Legal department – 70%
– Accounting department – 2%
– IR department – 0%
– Outside counsel – 8%
– None of the above – 0%
2. At our company, the lead for drafting our glossy annual report is:
– Corporate secretary’s department – 4%
– Legal department – 7%
– Accounting department – 6%
– IR department – 46%
– Outside counsel – 2%
– None of the above – 35%
3. At our company, the lead for drafting our 10-K is:
– Corporate secretary’s department – 2%
– Legal department – 6%
– Accounting department – 90%
– IR department – 0%
– Outside counsel – 1%
– None of the above – 1%
4. At our company, the lead group for conducting our disclosure committee meetings for our proxy statement is:
– Corporate secretary’s department – 14%
– Legal department – 48%
– Accounting department – 18%
– IR department – 0%
– Outside counsel – 4%
– None of the above – 16%
5. At our company, the lead group for conducting our disclosure committee meetings for our 10-K and 10-Q is:
– Corporate secretary’s department – 2%
– Legal department – 17%
– Accounting department – 73%
– IR department – 1%
– Outside counsel – 1%
– None of the above – 6%
Please take a moment to participate anonymously in these surveys:
Whistleblowers: Can In-House Lawyers Walk the Ethical Tightrope?
Under the attorney conduct rules adopted by the SEC following Sarbanes-Oxley, there are limited circumstances under which attorneys may be obligated to “report out” – i.e., blow the whistle to the SEC – on client misconduct. These obligations are not consistent with many states’ ethics rules, but the SEC brushed those concerns aside by saying that its rules preempted those standards. Now, according to this recent “Dimensions” article, the federal courts are starting to weigh in:
A California federal court held that in-house counsel could be a whistleblower under the federal statutes because the SEC rules preempt the state’s very strict duty of confidentiality. The case is on appeal and, the authors surmise, the holding will be limited because counsel reported internally, not to the SEC, before being fired (and thus falling outside the Dodd-Frank definition of a whistleblower).
Timing is also key to a case now pending in the Eastern District of Pennsylvania. In-house counsel seeks Dodd-Frank protection from retaliation for reporting to the SEC while still an employee. The company has counterargued that, prior to the report, it gave notice that counsel would be fired. A decision in the District of New Jersey denied Dodd-Frank protection to an attorney fired for reporting to FINRA, rejecting the argument that this was tantamount to reporting to the SEC, which supervises FINRA, while still employed.
The article notes that the 9th Circuit subsequently remanded the California federal court’s decision, affirming it in part and remanding it in part. This Sheppard Mullin blog has more details on the case.
Whistleblowers: Internal Whistleblower Rings the Bell for $4.5 Million
While lawyers may get tied-up in ethical knots for decades over whistleblower issues, for those who are unencumbered by such concerns, the SEC recently provided another example of just how lucrative whistleblowing can be. Late last month, it announced a $4.5 million award to a whistleblower, but as this excerpt from the SEC’s press release points out, this award had a unique fact pattern:
The whistleblower sent an anonymous tip to the company alleging significant wrongdoing and submitted the same information to the SEC within 120 days of reporting it to the company. This information prompted the company to review the whistleblower’s allegations of misconduct and led the company to report the allegations to the SEC and the other agency. As a result of the self-report by the company, the SEC opened its own investigation into the alleged misconduct.
Ultimately, when the company completed its internal investigation, the results were reported to the SEC and the other agency. This is the first time a claimant is being awarded under this provision of the whistleblower rules, which was designed to incentivize internal reporting by whistleblowers who also report to the SEC within 120 days.
As I blogged at the time, in 2018 the SCOTUS held that purely internal whistleblowers weren’t entitled to the protections of Dodd-Frank. Concerns were subsequently expressed that the decision would incentivize people to go to the SEC before the company was even aware of the potential problem.
That didn’t happen here – but because the whistleblower dropped a dime on the company to the SEC within 120 days of making an internal report, the person was credited with the results of the company’s investigation. As the SEC’s release noted, the policy establishing that 120 reporting period was intended to promote internal reporting, and in this case, it seems to have worked.
This WSJ article says that whistleblower lawyers are skeptical that this will be anything more than a one-off event, and that since internal whistleblowers are at risk for retaliation without Dodd-Frank’s protections, blowing the whistle to the SEC first is likely to remain the preferred path.
Yesterday, the SEC announced an enforcement proceeding against Kik Interactive, which allegedly has engaged in a $100 million unregistered token offering. Here’s the SEC’s complaint. Ordinarily, the SEC’s decision to bring an enforcement action is the big news, but I’ve kind of buried the lede here. Why? Because this Forbes article says that Kik & its affiliated entity, the Kin Ecosystem Foundation, are positively itching for a fight:
Two years ago, messaging app Kik raised about $100 million in an initial coin offering for the Kin token. Three days later, the SEC reached out, and after much back and forth, finally notified Kik last fall that it intended to pursue an enforcement action against both Kik and the Kin Ecosystem Foundation.
However, Kik and Kin made a surprise move: It published its response to the SEC, detailing what seems like a pretty strong case for why their token sale was not an offering of securities and why their token currently does not meet the definition of a security. They also announced in the Wall Street Journal their plan to fight this out in court.
In order to fund their defense, these crypto folks did a very crypto thing – they started a legal defense fund called “Defend Crypto” to which people can contribute bitcoin & other cryptocurrencies. What’s the sales pitch? In short, they say that “the future of crypto is on the line,” & they’re fighting Cryptomageddon:
For the future of crypto, we all need Kin to win. This case will set a precedent and could serve as the new Howey Test for how cryptocurrencies are regulated in the United States. That’s why Kin set up the Defend Crypto fund to ensure that the funds are there to do this the right way.
The message seems to be resonating with its intended audience. The fund raised over $4.5 million even before the SEC filed its action. What’s more, these guys seem positively thrilled that they’ve been sued. This WSJ article quotes KiK’s CEO as saying in reaction to the SEC’s complaint that what’s “exciting” to him “is that this industry is finally going to get the clarity it so desperately needs.”
“Clarity” is a word that crypto-evangelists use a lot when it comes to the securities laws. Sure, there are aspects of the SEC’s position on digital assets that are murky, but every time I hear somebody from the crypto crowd speak, I get the sense that they believe “clarity” means having regulators tell them what they want to hear. Anyway, enjoy the heck out of your enforcement proceeding. . .
Endangered Species: Quarterly Guidance on the Way Out?
It wasn’t all that long ago that most public companies seemed to view providing quarterly forecasts as just one of the costs of being public. That sure doesn’t seem to be the case anymore. In fact, this recent OZY article reports that the practice of providing quarterly guidance may be going the way of the Dodo:
The number of American companies releasing guidance every three months has dropped from 75 % in 2003 to 27% in 2017, according to a new report by the nonprofit FCLT Global, which advocates against quarterly earnings guidance. The phenomenon is even rarer outside the United States. Among listed companies on the Euro Stoxx 300, less than 1 percent issued quarterly guidance between 2010 and 2016.
Several publicly listed companies that release quarterly sales and revenue information are joining the chorus against short-term financial thinking. Large publicly traded companies such as Cisco, GSK, Barclays and Unilever, along with some state pension funds and global investment firms, are among the members of FCLT, an acronym for Focusing Capital on the Long Term. The group presents data showing that such forecasting does not, as many argue, reduce stock price volatility.
Despite this research and the calls of prominent investor & corporate advocates to end quarterly guidance, I suspect that the practice will remain pretty resilient at the lower end of the food chain. Smaller caps are often desperate to please analysts and maintain whatever coverage they may have, so until securities analysts jump on the bandwagon, some of these companies are likely to still keep sticking their necks out.
More On “NYSE Proposes to Tweak Equity Compensation Plan Rules”
Last week, I blogged about the NYSE’s proposed changes to the definition of “fair market value” in Rule 303A.08. Troutman Sanders’ Brink Dickerson points out that there seems to be a bit of a disconnect between the NYSE’s proposal & the approach taken by Item 402 of S-K:
The change to 303A.08 is interesting in that it does not reconcile nicely with S-K 402(d)(2)(vii), which requires a separate column when the exercise price is “les than the closing market price of the underlying security.” A lot of my clients now use the closing price on the date of grant (1) to avoid this extra disclosure, and (2) because they would prefer the stock price to be unknown at the time of grant to minimize bullet-dodging, etc. Surprising that the NYSE would not go with the SEC’s default approach. Under the NYSE construct, you can only avoid the extra column with certainty if you make a grant after the market closes but not on the next day.
You’ve got to hand it to college fraternities – their members have an uncanny knack for getting themselves into serious trouble. Most fraternity misconduct is the predictable result of their often over-the-top drinking culture & reckless hazing practices. But while that kind of stuff has become a cliché, it doesn’t mean that frat boys are incapable of more innovative misconduct.
Here’s a case in point: according to this SEC press release, one enterprising young man has allegedly been running a Ponzi scheme out of a University of Georgia frat house! This excerpt from the press release indicates that the Division of Enforcement decided that when it comes to dealing with this kind of alleged misconduct, Dean Wormer had it right – “the time has come for somebody to put his foot down, and that foot is me”:
The Securities and Exchange Commission today announced an emergency action charging a recent college graduate with orchestrating a Ponzi scheme that targeted college students and young investors. The SEC is seeking an asset freeze and other emergency relief.
The SEC’s complaint alleges that Syed Arham Arbab, 22, conducted the fraud from a fraternity house near the University of Georgia campus in Athens, Georgia. Arbab allegedly offered investments in a purported hedge fund called “Artis Proficio Capital,” which he claimed had generated returns of as much as 56% in the prior year and for which investor funds were guaranteed up to $15,000.
Arbab also allegedly sold “bond agreements” which promised investors the return of their money along with a fixed rate of return. The SEC’s complaint alleges that at least eight college students, recent graduates, or their family members invested more than $269,000 in these investments.
According to the SEC’s complaint, no hedge fund existed, Arbab’s claimed performance returns were fictitious, and he never invested the funds as represented. Instead, as money was raised, Arbab allegedly placed substantial portions of investor funds in his personal bank and brokerage accounts, which he used for his own benefit, including trips to Las Vegas, shopping, travel, and entertainment.
As noted in the press release, the SEC is seeking an asset freeze & a whole bunch of other emergency relief. Still, I was a little disappointed to find no reference to “double secret probation” in the SEC’s complaint.
SCOTUS Punts on “Duty to Update”
The SCOTUS has managed to dodge some pretty controversial issues in recent weeks, and according to this D&O Diary blog, the question of whether the securities laws impose a “duty to update” is another controversy that you can add to the list. Here’s an excerpt:
In a little noticed-development last week, the U.S. Supreme Court denied the petition for a writ of certiorari in Hagan v. Khoja, in which former officials of a bankrupt pharmaceutical company sought to have the Court review a decision by the Ninth Circuit to revive a securities class action lawsuit against them.
Had the petition been granted, the Court would have been called upon to consider the controversial question of whether public companies have a duty to update prior disclosures that were accurate when made. The Court’s cert denial leaves the Ninth Circuit’s ruling standing and the questions surrounding the existence and requirements of a duty to update remain unsettled.
Insider Trading: Don’t Look Now, But Here Comes Congress. . .
This NYT DealBook article reports on “The Insider Trading Prohibition Act,” which recently cleared the House Financial Services Committee. The proposed legislation is intended to eliminate some of the uncertainty surrounding insider trading law – and expand the government’s ability to bring insider trading cases. This excerpt provides an example of the greater flexibility the legislation would provide to prosecutors:
The legislation also would move insider trading law away from its focus on a duty to keep information confidential by more broadly describing what constituted “wrongful” trading or transmission of confidential information. There would be four ways to show that the information had been obtained wrongfully: by theft, bribery or espionage; by violation of any federal law protecting computer data; by conversion, misappropriation or unauthorized and deceptive taking of information; and by breach of a fiduciary duty or breach of “any other personal or other relationship of trust and confidence.”
By expressly including a breach of a federal data privacy law or theft of information, the legislation would eliminate some of the uncertainties surrounding the application of insider trading law to the kind of “outsider trading” schemes exemplified by the 2016 hack on the SEC’s Edgar database.
This WilmerHale memo suggests that prosecutors have already found a work-around for some of the issues that Congress is trying to address with this legislation – a federal statute that was added to their arsenal as part of the Sarbanes-Oxley Act.
Check out the latest report from BarkerGilmore – a boutique executive search firm – about in-house counsel compensation trends. Among the findings:
– The average annual salary increase rate for all positions across industries increased to 4.4%, up 0.6% from the previous year.
– 41% of all respondents believe their compensation is below or significantly below that of their peers in other organizations, with labor & employment lawyers and insurance reporting the greatest dissatisfaction.
– 38% of respondents indicate that they would consider a new position within the next year due to compensation issues, 3% less than the previous year.
– Public company lawyers make more than private company lawyers, and public company GCs make a lot more – 41% more to be precise.
– On average, female in-house counsel earn 85% of what male in-house counsel earn. The disparity is largest at the General Counsel level, with a 17% gap, 5% smaller than the previous year.
On a completely unrelated note, when I saw BarkerGilmore’s press release on the study, I noticed that they were headquartered in Fairport, NY. This charming canal town is the hometown of the late Philip Seymour Hoffman, who once described it as being “like Kansas, if Kansas was in New York.” Why do I know so much about this little upstate New York burg? Well, Mr. Hoffman isn’t the only one who grew up there. (Hi Mom!)
“Finders”: Lawsuit Pushes Back Against SEC on Broker Registration
The SEC has historically taken a very limited view of the role that “finders” who are not registered broker-dealers can play in financings. But this recent blog from Andrew Abramowitz notes that one company has filed a lawsuit that pushes back against the SEC’s position. Here’s an excerpt:
A company proposing to do business as an unregistered finder, Platform Real Estate Inc., has now filed suit in the Southern District of New York against the SEC, seeking a declaratory judgment to the effect that broker-dealer registration is not required for the plaintiff and similar companies acting as a finder on behalf of private companies.
The essence of Platform Real Estate’s argument is that the Exchange Act generally, and Section 15(a) (the section requiring registration of those acting as broker-dealers) in particular, are intended to protect investors in the secondary market, like those purchasing shares traded on an exchange. The transactions that Platform Real Estate would be involved in, in contrast, are primary transactions, where a company issues and sells new shares to accredited investors who represent as to their intent to hold the shares potentially indefinitely.
In discussing the case, Andrew makes a point that I think a lot of lawyers representing small companies would agree with – most registered broker-dealers don’t want to deal with this segment of the market. There’s just not enough money to be made in these financings to justify their commitment of resources. That means there’s a real market need that is being filled by finders, and makes it critical to get some clear rules governing what they can and can’t do.
Our June Eminders is Posted!
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Yesterday, Corp Fin Director Bill Hinman issued an exemptive order permitting a company that was unable to provide the audited financial statements required under Rule 14a-3(b) to nevertheless solicit proxies for its upcoming annual meeting. Companies that don’t have audited financials are in a tough spot if they need to hold an annual meeting. Rule 14a-3(b) requires them to provide an annual report containing that information along with the proxy materials, and if they can’t do that, they can’t solicit proxies.
Many companies in this position opt to delay their annual meeting until they can comply with the proxy rules, but that’s not a viable strategy if you’ve received a court order compelling an annual meeting. That’s the situation in which Mimedx Group found itself & what prompted it to seek the exemptive order. Companies finding themselves in this kind of a bind should note both the potential availability of exemptive relief & the existence of the following conditions upon which the Mimedx Group order was premised:
– MiMedx is required to hold the Delayed 2018 Meeting as a result of an action taken by security holders pursuant to Florida law and the Florida Court ordering such meeting to be held on June 17, 2019;
– The company has made good-faith efforts to furnish the audited financial statements required by Rule 14a-3(b) before holding the Delayed 2018 Meeting but is unable to comply with this requirement;
– MiMedx has made a determination that it disclosed to security holders all available material information necessary for security holders to make an informed voting decision in accordance with Regulation 14A;
– Absent the grant of exemptive relief, MiMedx would be forced to violate either Florida law or the rules and regulations administered by the Commission; and
– The company faces a proxy contest with respect to the matters to be presented at the Delayed 2018 Meeting, with certain MiMedx security holders filing a definitive proxy statement soliciting proxies for, among other things, the election of their own director nominees.
These conditions weren’t pulled out of thin air. With the exception of the reference to the proxy contest, they mirror the requirements of Rule 30-1(f)(18), which sets forth the circumstances under which the Director of Corp Fin has been delegated authority to grant exemptive relief from the requirements of Rule 14a-3(b).
Chief Accountant Wes Bricker to Leave SEC
The SEC announced yesterday that Chief Accountant Wes Bricker is leaving the agency. It also announced that Deputy Chief Accountant Sagar Teotia will serve as Acting Chief Accountant when Bricker leaves next month.
Enforcement: What’s in a Name?
I was kind of taken aback a few days ago when I saw the SEC’s litigation release announcing an enforcement proceeding against “Henry Ford.” Obviously, the SEC isn’t bringing an action against the long-dead father of the Model T, but as a Clevelander, the case made me think of the great Harvey Pekar & his famous “What’s in a Name?” story. I know the connection with securities law is pretty tenuous, but hey, it’s Friday.
Last week, the SEC published its latest Reg Flex Agenda, and it looks like the Commissioners may wade into some pretty controversial areas in the near future – including proposing rules relating to proxy advisory firms & shareholder proposals. This excerpt from a recent Gibson Dunn blog highlights the significant additions to the agenda:
Notably, the Reg Flex Agenda for the first time now identifies the following four rulemaking projects as among those that the SEC expects to address over the coming year:
– Proposing rule amendments regarding the thresholds for shareholder proposals under Rule 14a‑8;
– Proposing rule amendments to address certain advisors’ reliance on the proxy solicitation exemptions in Rule 14a-2(b);
– Proposing rule amendments to modernize and simplify disclosures regarding Management’s Discussion & Analysis (MD&A), Selected Financial Data and Supplementary Financial Information; and
– Proposing rule amendments to Securities Act Rule 701, the exemption from registration for securities issued by non-reporting companies pursuant to compensatory arrangements, and Form S-8, the registration statement for compensatory offerings by reporting companies (previously listed as a longer term project.).
The blog says that the SEC is generally expected to propose increases in the ownership & resubmission thresholds under Rule 14a-8. What the SEC is going to propose about the ability of proxy advisors to continue rely on exemptions from proxy solicitation rules is less clear – but some commenters have called for the SEC to reconsider those exemptions as part of a broader initiative to regulate the proxy advisory industry.
Potential changes to the shareholder proposal regime & the possible regulation of proxy advisors are likely to garner the most attention from the media, but my guess is that most of us will take an equal or greater interest in what the SEC proposes to do with MD&A, Rule 701 & Form S-8.
NYSE Proposes to Tweak Equity Compensation Plan Rules
Under NYSE rules, equity compensation plans are generally subject to shareholder approval. However, plans that allow participants to buy shares at a price equal to their “fair market value” are excluded from that requirement. Last week, the NYSE filed a proposed rule change with the SEC that would codify its long-standing practice for determining fair market value for purposes of this exclusion. This excerpt from a recent Steve Quinlivan blog summarizes the proposed change:
For purposes of the above exclusion from the definition of equity compensation plan, the Exchange has always interpreted “current fair market value” as requiring that the price used be the most recent official closing price on the Exchange. For the avoidance of doubt, the Exchange now proposes to include in Section 303A.08 text specifying how the fair market value of the issuer’s common stock should be calculated for this purpose. “Fair market value” will be defined as the most recent official closing price on the Exchange, as reported to the Consolidated Tape, at the time of the issuance of the securities.
The blog says that this means if the securities are issued after the close on a Tuesday, then Tuesday’s official closing price will be used. If they are issued at any time between the time of Monday’s close and Tuesday’s close, then Monday’s official closing price will be used.
Nasdaq Proposes to Tighten Initial Listing Standards
Since we’re on the topic of amendments to stock exchange rules, I confess that I somehow overlooked proposed rule changes that Nasdaq originally filed in March. In any event, Nasdaq wants to tighten its original listing standards and help assure adequate liquidity for listed securities. Here’s an excerpt from the proposal explaining what it’s proposing to do:
– First, Nasdaq proposes to revise its initial listing criteria to exclude restricted securities from the Exchange’s calculations of a company’s publicly held shares, market value of publicly held shares and round lot holders (“Initial Liquidity Calculations”). To do so, Nasdaq proposes to add three new definitions to define “restricted securities”, “unrestricted publicly held shares” and “unrestricted securities” and proposes to amend the definition of “round lot holder”.
– Second, Nasdaq proposes to impose a new requirement that at least 50% of a company’s round lot holders must each hold shares with a market value of at least $2,500.
– Third, Nasdaq proposes to adopt a new listing rule requiring a minimum average daily trading volume for securities trading over-the-counter (“OTC”) at the time of their listing.
No changes to continued listing standards are being proposed. I don’t feel too bad about missing this rule proposal when it was initially filed, because the SEC just extended the comment period to July 8th.
