If you’ve ever worked on a public offering, you know that as part of those transactions issuer’s and underwriters’ counsel routinely provide a statement in their closing opinions to the effect that nothing has come to their attention that would lead them to believe that the prospectus contains an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. This statement is sometimes referred to colloquially as a “10-5 letter” or even a “10b-5 opinion”, but a recent New York trial court decision provides a reminder that a 10b-5 letter isn’t a legal opinion, and that some pretty significant consequences result from that conclusion.
In Camelot Event Driven Fund v. Morgan Stanley, (NY Cty.; 9/24), the plaintiff sought discovery of materials provided by the underwriters to their counsel in connection with that counsel’s 10b-5 opinion. In rejecting the defendants’ efforts to avoid producing those documents, the Court observed:
Because the 10b-5 letter is not legal advice or a legal opinion, the documents delivered to [underwriters’ counsel] (and both the written and oral communications with [such counsel]) for the purpose of obtaining the 10b-5 letter were not delivered to or had with [underwriters’ counsel] for the purpose of obtaining or facilitating legal advice. They are thus not privileged and must be produced. Stated differently, the facts and communications that the defendants chose to have [underwriters’ counsel] review and rely on (or not rely) on for the purposes of the 10b-5 letter are validly within the purview of discovery and are not privileged because they are given for the purposes of a business document needed for the transaction and not for the purpose of obtaining a legal opinion or legal advice.
The Court went on to say that non-privileged facts that were communicated from the underwriters to underwriters’ counsel in connection with the preparation of the 10b-5 letter did not become privileged on that basis, and the plaintiff was entitled to “fulsome discovery” concerning information that was disclosed to or withheld from counsel for that purpose. However, the Court said that the plaintiff was not entitled to ask underwriters’ counsel to disclose why the underwrites chose to disclose or not disclose certain facts for purposes of the 10b-5 letter, because that information was privileged.
Last week, Liz blogged about a recent NACD report on technology governance. I thought that an article in the most recent issue of The Boardroom Insider discussing the top AI trends that boards should keep in mind as they perform their oversight responsibilities might be a nice follow-up to that blog. The article follows up a roundtable discussion on this topic that included IBM CTO Khwaja Shaik and Gartner CFO Jackie Lyons. This excerpt highlights the need for boards to change the way they look at risk management of AI issues:
The board should refresh its views on risk management for AI projects. “Set up the governance of AI as a business risk rather than just an IT risk,” says Lyons. This will push management and the board to shape an overall AI integration and risk policy, rather than random AI trials throughout the company, where, as Shaik says “the left hand doesn’t know what the right hand is doing.” Still, a good risk oversight policy should allow for plenty of AI innovation throughout the system. Bottom-up experiments and projects offer a far more productive ecosystem than top-down policies. Shaik says even large, established companies will need to take a more fatalistic, venture capital approach with AI projects. “Nine out of ten will fail, but the one that wins pays for all the rest.”
Other trends identified in the article include the need to appropriately identify the impact of AI energy consumption on a company’s stated ESG and carbon footprint goals and directors’ personal vulnerability to AI-enhanced spoofing or similar scams.
We’re kicking things off today in San Francisco with our “Proxy Disclosure Conference” and we’ll follow that up tomorrow with our “21st Annual Executive Compensation Conference.” The agendas for our conferences include 15 substantive panels over 2 days – as well as an interview with Erik Gerding, the Director of the SEC’s Division of Corporation Finance. Here’s what’s on tap for today.
We’re very excited to be back in-person for the first time since the pandemic, but if you can’t be here in person, you can still register to attend today’s program and tomorrow’s “21st Annual Executive Compensation Disclosure Conference” online by visiting our online store or by calling us at 800-737-1271. Our conferences are bundled together into a single two-day event for registration and pricing, so your purchase will cover both events.
– How to Attend Online: Our conferences are hosted online through the RingCentral Events platform. When you register for the conferences, you’ll receive a registration confirmation email that will contain your personalized “Magic Link.” Just click on that link to be instantly directed to the event. The Magic Link acts as an “access pass” into the event. It is unique to you and cannot be shared with others. It bypasses the need for registered users to sign into RingCentral Events and brings you directly into your RingCentral Events account and into the event.
Once in the event, click the “Stage” button from the menu on the left of the webpage. In order to view the session currently playing on stage, you will need to press the play button on the video. If you need technical assistance, members of our team will be available within the platform and via email at info@ccrcorp.com to assist you throughout the conferences. If you need technical assistance, members of our team will be available via email at info@ccrcorp.com to assist you throughout the conferences.
– Access to Archives & On-Demand CLE: Your registration includes access to the conference archives, which will be available until October 15, 2025 – but you’ll need your confirmation email to access them so be sure to retain it! One big reason to make sure you do that is that if you can’t attend the conferences live, you may earn on-demand CLE credit by viewing the archives. See these “CLE FAQs for Archived Conference Sessions (ON DEMAND)” for more information.
– Thanks to Our Sponsors! A huge “thank you” to our sponsors who have helped make these events possible. Our platinum sponsor for this year’s conferences is Goodwin, our gold sponsors are Fredrikson and Kirkland & Ellis, our silver sponsors are Alliance Advisors, Cooley, Fintool, King & Spalding, Latham & Watkins, Morrison & Foerster, The Nuvo Group, and Wilson Sonsini. Our digital partner is Aon. Our media partner is Newsfile, and those of you who are attending in-person should be sure to check out our exhibitor, DragonGC. We are extremely grateful for the support of our sponsors!
Last week, ISS published the results of its most recent benchmark policy survey, and this year, respondents had quite a bit to say about poison pills. The survey is part of ISS’ annual global policy development process and was open to all interested parties to solicit broad feedback on areas of potential ISS policy change for 2025 and beyond. The survey’s results reflect responses from investors and non-investors. This latter group is comprised primarily of public companies & their advisors. Not surprisingly, the survey found that they differ when it comes to what’s acceptable when it comes to poison pills. Here are some of the highlights:
– When asked if the adoption by a board of a short-term poison pill to defend against an activist campaign was acceptable, 52% of investor respondents replied “generally, no”, while 65% of non-investor respondents replied “generally, yes”.
– When asked whether pre-revenue or other early-stage companies should be entitled to greater leeway than mature companies when adopting short-term poison pills, 56% of investors and 43% of non-investors said that such companies should be entitled to greater leeway on the adoption of a short-term poison pill, as long as “their governance structures and practices ensure accountability to shareholders.”
– When asked about whether a short-term poison pill trigger set by a board below 15 percent would be acceptable, the most common response among investor respondents was “No” (39%), while the largest number of non-investor respondents (38%) said “yes, the trigger level should be at board’s discretion.”
– When asked whether a “two-tier trigger threshold, with a higher trigger for passive investors (13G filers) would be considered a mitigating factor in light of a low trigger, 78% of non-investor respondents said “yes, it should prevent the pill from being triggered by a passive asset manager who has no intention of exercising control.” On the investor, while 41% agreed with the majority of non-investor respondents, 48% considered that “no, all investors can be harmed when a company erects defenses against activist investors whose campaigns can create value, so the lowest trigger is the relevant datapoint.”
Also, it turns out that investors like their pills to be “chewable.” The survey found that nearly 60% of investors found a qualifying offer clause in a pill to be important and a feature that should be included in every pill. A small majority (52%) of non-investors said that this feature was “sometimes important” depending on the trigger threshold and other pill terms.
Check out the latest edition of our “Timely Takes” Podcast featuring my interview with Remy Nshimiyimana and Oderah Nwaeze of Faegre Drinker regarding Delaware’s process for ratifying defective corporate acts. In this 10-minute podcast, Remy & Oderah covered the following topics:
– Overview of Delaware’s statutory procedure for ratifying defective corporate acts
– Examples of the types of defective acts that can be ratified under this statutory procedure
– Limitations on a corporation’s ability to ratify defective acts
– Shareholder approval requirements
– The Role of the Chancery Court
Our discussion was based on Faegre’s recent memo, “Ratification of Defective Corporate Acts: An Overview”, which members of TheCorporateCounsel.net can access in our “Delaware Law” Practice Area. If you have insights on a securities law, capital markets or corporate governance issue, trend or development that you’d like to share, we’re all ears – just shoot me an email at john@thecorporatecounsel.net or send one to Meredith at mervine@ccrcorp.com.
Yesterday, the SEC announced a settled enforcement proceeding against DraftKings arising out of the use of its CEO’s social media accounts to disseminate material non-public information. This excerpt from the SEC’s press release announcing the proceeding lays out the factual background of the case:
The order finds that, on July 27, 2023, at 5:52 p.m., DraftKings’ public relations firm published a post on the personal X account of the DraftKings CEO. The post, according to the order, stated that the company continued to see “really strong growth” in states where it was already operating. DraftKings’ public relations firm posted a similar statement that same day on the CEO’s LinkedIn account. At the time of the posts, DraftKings had not yet disclosed its second quarter 2023 financial results, nor had it otherwise publicly disclosed certain information contained in the posts.
Shortly after the public relations firm published the posts, it removed both posts at the request of DraftKings. According to the order, even though Regulation FD required DraftKings to promptly disclose the information to all investors after it was selectively disclosed to some, DraftKings did not disclose the information to the public until seven days later when it announced its financial earnings for the second quarter of 2023.
The SEC’s cease and desist order says that publication of these social media posts violated the company’s social media and Reg FD policies, which prohibited the use of social networks to disseminate MNPI and barred the company’s authorized spokespersons from discussing financial or operational results or guidance during the pre-earnings release “quiet period” specified in its Reg FD policy.
In addition to consenting, on a neither admit nor deny basis, to an order to cease and desist from future violations of Section 13(a) of the Exchange Act and Regulation FD thereunder, the company agreed to pay a $200,000 civil penalty and comply with certain undertakings, including Reg FD training for employees who have corporate communications responsibilities.
Earlier this month, a divided SEC approved the PCAOB’s new audit quality control standard, QC 1000 – A Firm’s System of Quality Control. Over on The Audit Blog, Dan Goelzer has a recent post that says public companies are going to feel the impact of the new standard.
On the plus side, he suggests that audit quality may improve, and that audit committees may have more visibility into audit deficiencies and audit firm quality controls. Unfortunately, those benefits may be accompanied by some fairly significant costs, including higher audit fees and, as this excerpt explains, an increase in “CYA” behavior by auditors:
Auditing requires the exercise of judgment, and the line between permissible judgments that in hindsight appear flawed and auditing standard violations is not always clear. QC 1000 seems to assume that an audit deficiency identified by the PCAOB’s inspectors is evidence of a potential QC lapse. In turn, a QC breakdown potentially raises questions about whether the individuals responsible for the operation of the system properly performed their responsibilities.
As a result, firm leadership will have strong new personal incentives to avoid inspection deficiency findings. This could of course be viewed as one the benefits of QC 1000. But it could also create a dynamic under which auditing becomes more focused on the mechanics of compliance and documentation at the expense of a big-picture understanding of the company’s financial reporting risks and the exercise of judgment concerning how best to address those risks in the audit.
The blog also echoes concerns expressed by Commissioner Peirce that the compliance costs associated with the new standard may drive some audit firms out of the public company market, thus providing smaller public companies with fewer audit firms to choose from.
Last week, the SEC announced that it had obtained a judgment against one of the defendants in an insider trading case. But this isn’t just any insider trading case, because this one may involve the silliest piece of MNPI ever to result in illicit profits. Here’s an excerpt from the SEC’s litigation release on developments in SEC v. Watson:
On September 20, 2024, the Securities and Exchange Commission obtained a final judgment against defendant Oliver-Barret Lindsay, a Canadian citizen, whom the SEC previously charged with insider trading in advance of an announcement by Long Blockchain Company (formerly known as Long Island Iced Tea Co.) that it was going to “pivot” from its existing beverage business to blockchain technology, which caused the company’s stock price to soar.
The SEC’s complaint was filed on July 9, 2021, in federal district court in the Southern District of New York. The complaint alleged that Lindsay’s co-defendant Eric Watson, a Long Blockchain insider who had signed a confidentiality agreement not to disclose the company’s business plans, tipped Lindsay about Long Blockchain’s unannounced plans to pivot to blockchain technology. The complaint further alleged that Lindsay then tipped his friend and co-defendant, Gannon Giguiere, who purchased 35,000 shares of Long Blockchain stock within hours of receiving confidential information about Long Blockchain from Lindsay. According to the complaint, the company’s stock price skyrocketed after a press release was issued announcing its shift to blockchain technology. The complaint further alleged that within two hours of the announcement, Giguiere sold his shares for over $160,000 in illicit profits.
The SEC’s complaint provides more details. Apparently, the company announced that it was “shifting its primary corporate focus towards the exploration of and investment in opportunities that leverage the benefits of blockchain technology” compared to “the ready-to-drink segment of the beverage industry,” as well as changing its name to “Long Blockchain Corp.” in place of “Long Island Iced Tea Corp.”
That announcement was apparently enough to send the stock price skyrocketing by nearly 400% and to increase its trading volume by 1,000%. Seriously? C’mon, the idea that a microcap soft drink company could suddenly become 400% more valuable because it issues a press release announcing a pivot to “opportunities that leverage the blockchain” seems like it could only come from the mind of an underpants gnome.
Nevertheless, a lot of people seem to have bought into it, which makes complete sense if you proceed under the assumption that everyone in the market is as dumb as a bag of hammers. Unfortunately, cases like this one demonstrate that P.T. Barnum’s supposed statement that “there’s a sucker born every minute” frequently explains how markets work a lot better than the Efficient Market Hypothesis does.
Yesterday, the SEC announced settled enforcement proceedings against 23 entities and individuals arising out of late beneficial ownership reports (and yes, there are some very big names here). Two public companies were also charged for contributing to their insiders’ violations and failing to disclose the delinquent filings as required. Here’s an excerpt from the SEC’s press release announcing the proceedings:
The charges announced today stem from SEC enforcement initiatives focused on Schedules 13D and 13G reports and Forms 3, 4, and 5 that certain corporate insiders are required to file. Schedules 13D and 13G provide information about the holdings and intentions of investors who beneficially own more than five percent of any registered voting class of public company stock. Forms 3, 4, and 5 are reports used to provide information about public company stock transactions by corporate officers, directors, or certain investors who beneficially own more than 10 percent of the stock. These reporting requirements apply irrespective of whether the trades were profitable and regardless of a person’s reasons for the transactions. SEC staff used data analytics to identify the charged individuals and entities as filing required reports late.
Each of the parties consented, on a neither admit nor deny basis, to an order to cease and desist from future violations and to pay civil penalties. Those penalties ranged from $10,000 to $200,000 for the individuals involved in the proceedings and from $40,000 to $750,000 for the entities involved. The two public companies targeted by the SEC each paid a civil penalty of $200,000.
Earlier this year, Corp Fin Director Erik Gerding announced that compliance with beneficial ownership reporting requirements was one of the priorities for this year’s disclosure review program, and we’ve blogged about Staff comments targeting the timeliness of beneficial ownership filings. We’ve also seen at least one high-profile 13D enforcement proceeding prior to those announced yesterday. With that background, the SEC’s decision to conduct an enforcement sweep probably shouldn’t come as a surprise to anyone.
While we’re on the topic of potential consequences for violating Section 16 of the Exchange Act, did you ever wonder what would happen if somebody tried to dodge paying over short swing profits under Section 16(b)? Would you believe handcuffs? Here’s something Alan Dye recently posted on his Section16.net blog:
This is my fifth blog about Avalon Holdings v. Gentile, a long-running and bitterly fought action filed by David Lopez and Miriam Tauber against a Bahamian broker-dealer (MintBroker) and its sole owner (Guy Gentile, a resident of Puerto Rico) based on their high-frequency trading in the securities of two microcap companies, Avalon Holdings and New Concept Energy. Earlier this year, the district judge found the defendant’s liable to each company for short-swing profits of $6 million plus pre-judgment interest, currently amounting to a total of $16 million. In my blog about that decision, I noted that “recovering the amount of the judgment may not be easy, given that the Bahamian Securities Commission has forced MintBroker into liquidation proceedings.”
That prediction is proving to be true. The plaintiffs subpoenaed the defendants to produce records and provide testimony regarding their assets, but the defendants didn’t respond and didn’t show up for a hearing on the motion. The defendants’ counsel appeared, though, and told the judge that he hadn’t heard from Gentile since May and had no information regarding how to effect service on Gentile. After post-hearing attempts to serve Gentile did not elicit a response, the plaintiffs renewed their motion to compel and also submitted an application for a bench warrant for Gentile’s civil arrest for contempt of court.
Last week the judge granted the motion, in language that makes startlingly clear the consequences of failing to comply with a court’s order. The judge directed the U.S Marshals Service to effect service on Gentile in any U.S. district in which he may be found, and ordered that:
– the U.S. Marshall “will be permitted to use the minimum degree of non-deadly force necessary to arrest and detain Gentile and bring him before this Court, and will be permitted to enter any premises of Gentile’s if he is reasonably believed to be inside and if requested access to such premises is withheld” and
– “Gentile shall be incarcerated until he responds to Avalon’s post-judgment subpoenas or until further Order of this Court.”
Gentile may decide it’s not worth stepping foot in the U.S. ever again, but there is a big fee at stake for Lopez and Tauber, so I suspect collection efforts will continue.