Issuers of securities in private offerings are sometimes inclined to downplay the risk of paying fees to unlicensed “finders” in connection with those deals, because they view the failure to appropriately register as a broker-dealer under federal or state law as being the finder’s problem. That’s not the case, and this Dorsey blog provides a reminder of the potentially calamitous consequences to the issuer associated with paying an unlicensed finder:
The Securities and Exchange Commission (SEC) has taken the position that a person receiving a finder’s fee with respect to a purchase of securities by a U.S. investor will, in many cases, be treated as having acted as a “broker” within the meaning of federal securities laws.[1] In those cases, the unregistered finder has violated the federal securities laws. Similarly, the issuer may have violated the federal securities laws (under an agency theory, or otherwise) by having paid such fee. In many states, state regulators take similar positions under applicable state law.
The filing of post-closing notices of sale with the SEC and the states disclosing such a fee may result in federal and state regulatory enforcement actions to seek injunctions, monetary penalties or criminal sanctions against the issuer and/or finder. Perhaps more importantly, the payment of the fee may provide the relevant investor(s) with a right to rescind their investment, and create uncertainty about whether and the extent to which such rights should be reflected in the issuer’s financial statements. Such disclosures may adversely affect the issuer’s ability to raise funds, and may further increase the risk of such a rescission claim or regulatory enforcement action.
The blog goes on to recount the story of a company that paid finders fees to unlicensed brokers in a series of offerings. After the SEC came knocking, the uncertainties concerning recission rights led the company’s auditors to withhold their opinion on its financial statements, which precluded it from obtaining further financing and ultimately led to its bankruptcy. Yikes!
Last month, Stanford’s Rock Center for Corporate Governance published a report addressing seven questions about the proxy advisor industry. One of them involves a topic that’s been discussed quite a bit over the years among boards, management teams and their advisors: “Are these folks really independent?” The report says that the jury’s still out on that one:
Institutional investors rely on proxy advisors to provide an independent assessment of proposed corporate and shareholder actions. However, whether proxy advisory firms are independent is an unresolved question. Some proxy advisors receive consulting fees from the same companies whose governance and ESG practices they evaluate, and the potential exists that they alter their voting recommendations to gain or retain business. Ma and Xiong (2021) show, using a theoretical model, that conflicts of interest can bias voting recommendations and decrease firm value.
Some evidence suggests this might be occurring. Li (2018) examines voting recommendations and finds that ISS shifts its positions to make them more favorable to the preferred position of the client company when Glass Lewis initiates coverage of that company. He concludes “conflicts of interest are a real concern.”
The report goes on to discuss possible policy responses to these concerns about proxy advisor independence. However, given the current regulatory climate and the outcome of recent litigation involving the SEC’s efforts to regulate the industry, it doesn’t look like there’s much inclination among policy makers to dig much deeper into this issue.
If you’re interested in reading more about the questions raised by the Rock Center about the proxy advisor industry and the implications of its report, check out Cydney Posner’s recent blog, which takes a deep dive into these issues.
When I was in practice, I was proud of the way that my old flyover state law firm managed to more than hold its own when it came to capital markets transactions. My colleagues and I were involved in some pretty complex offerings and knew our way around a bunch of different financing structures. That being said, whenever I worked on a “modern” convert deal, I felt like a complete rube. One reason for my discomfort was that I cut my teeth on traditional converts back in the 80s and 90s, and those straightforward deals bear little resemblance to the masterpieces of financial engineering that converts have morphed into over the past couple of decades.
If you feel the same discomfort with these deals that I did, this Latham memo on “Demystifying Modern Converts” may be helpful to you. Here’s an excerpt from the memo’s discussion of one of the more complex features of a modern convert – the fundamental change make-whole provision:
Make-whole fundamental changes include the classic example of a cash merger, but they also include other events, such as the delisting of the underlying common stock, which reduces time value by decreasing liquidity and, accordingly, the ability to quickly sell the stock at fair value. As described below, calling the notes for redemption can also trigger make-whole fundamental change provisions. Importantly, a business combination event pursuant to which the notes become convertible into consideration 90% or more of which consists of listed stock of another issuer is usually excluded from the definition of make-whole fundamental change.
The theory behind this exclusion is that the convertible notes will continue to have meaningful time value following the business combination because a substantial part of the consideration due upon conversion will be based on the value of a price-volatile asset — listed stock. This is rough justice, obviously, since the new underlying security could be significantly more or less volatile than the original underlying security. Nonetheless, this is the current market compromise on the issue.
The temporary increase to the conversion rate is usually designed to result in the consideration due upon conversion having a value that, except as described below, approximates the theoretical value of the notes immediately before the make-whole fundamental change. Accordingly, converting noteholders that are entitled to the increased conversion rate will, in theory, be “made whole” for the loss of time value resulting from the make-whole fundamental change. The amount of the increase is determined by reference to a table and is based on the effective date of the make-whole fundamental change and a measure of the value of the underlying common stock as of that effective date.
The memo goes on to describe how the pricing information in the “make-whole table” is determined. I triple-dog dare you to read that discussion once and tell me with a straight face that you understand it. If you can’t do that, don’t feel bad, because my experiences with make-whole tables were what made me realize that I wasn’t the only rube on the deal team. For instance, we once priced a deal right after the market closed and then waited until almost 10:00 pm for the pricing term sheet to be completed, because none of the Wall Street bankers on the deal could figure out the make-whole table either.
Don’t miss PracticalESG.com’s next free virtual event – “Developments in EU Policy and ESG Disclosure Assurance.” You can register here for this 3-hour program, which will kick-off at 12:00 pm eastern on Tuesday, May 14th. This virtual event features three panels of experts who will provide insights into the intricate policy landscape shaping EU regulations, strategies for ensuring compliance, and what to expect in ESG/climate report assurance and how to prepare for it.
These events are free to all – you don’t have to be a member of PracticalESG.com to attend. But if you’re attending events like these, you need the resources that PracticalESG.com provides. Become a member today by clicking here, emailing sales@ccrcorp.com or by calling (800) 737-1271.
The Hoover Institution and other Stanford-affiliated entities recently published the results of a survey of senior decision-makers at 47 of the largest institutional investment firms and asset managers in North America, Europe & Asia on sustainable investing priorities. The survey found that when it comes to ESG issues, there’s climate change and corporate governance, and then there’s everything else. This excerpt summarizes some of the key findings:
– When asked which ESG factors fund managers explicitly consider as part of an investment decision, climate change ranks as the most important, selected by 78% of respondents. After this, the next four factors are all governance-related: board structure (72%), ownership structure (72%), board diversity (65%), and quality of financial reporting (57%).
– The least important ESG factors according to respondents are the ratio of CEO pay to the pay of the average worker (20%), pollution and waste byproducts (24%), packaging and product waste (24%), and raw material sourcing (26%).
– Most investors (67%) consider ESG quality as one of many factors when making an investment decision; 2% use it to screen out potential investments, while 11% do not rely on it at all. Overall, 59% say ESG is important, while 41% say it is not.
Since investors appear to be most interested in governance and climate-related issues, I found another one of the survey’s conclusions a little surprising. The survey found that 98% of investors believe that governance risks are appropriately reflected in stock prices and 76% believe that climate risks are mostly or somewhat reflected in those prices. In contrast, only 50% said environmental risks (other than climate change) and 46% said social risks are reflected in stock prices. If that’s what these investors think, shouldn’t the risks that aren’t appropriately reflected in the market price for company stocks be more of a priority to them?
Last month, Dave blogged about the SCOTUS’s decision in the Macquarie case, in which the Court held that a company’s “pure omission” to disclose information concerning known trends required by Item 303 of Regulation S-K could not serve as the basis for a private securities fraud claim. The decision may have some companies wondering whether they’re off the hook for known trends disclosures, but a recent Weil memo makes it clear that they aren’t.
The memo points out that the decision doesn’t affect the SEC’s ability to bring an enforcement action for failure to comply with Item 303’s disclosure requirements, and that any protection that it provides against private claims may turn out to be very limited:
As the Court itself stated: “For one thing, private parties remain free to bring claims based on Item 303 violations that create misleading half-truths.” A half-truth by its nature is an affirmative statement that may be literally accurate, but it is nonetheless misleading due to the failure to provide additional qualifying information. “In other words, the difference between a pure omission and a half-truth is the difference between a child not telling his parents he ate a whole cake and telling them he had dessert.”
So following Macquarie, a claim that was once asserted as a pure omission of required SEC disclosure may instead be recast as a claim that other affirmative statements in the disclosure were rendered misleading by such omission. The practical result is that companies may continue to face litigation and liability exposure as a result of such omission.
For instance, consider the SEC’s examples of currently known trends and uncertainties that may require disclosure in the MD&A, such as a reduction in the company’s prices, an erosion in its market share and the likely non-renewal of a material contract. It would seem that a plaintiff in such cases would seek to identify affirmative statements in a company’s public disclosures that were rendered misleading (i.e. “half-truths”) as result of the failure to disclose the known trend or uncertainty. For example, if a company makes statements regarding the impact on revenues of a material contract, knowing that the material contract is not likely to be renewed, a plaintiff might argue that these statements are actionable “half-truths” under Rule 10b-5 if the company omits to disclose the potential non-renewal of that contract.
The memo also notes that while Rule 10b-5 may not be available to private plaintiffs in a pure omissions case, Section 11 of the Securities Act does provide for liability based on material omissions of information required to be included in a Securities Act registration statement.
Check out our latest “Timely Takes” Podcast featuring Orrick’s J.T. Ho & his monthly update on securities & governance developments. In this installment, J.T. reviews:
– Climate disclosure rules developments
– New DEI case law from the 4th Circuit
– AI developments on the disclosure & enforcement front
– Cybersecurity guidance and Corp Fin staff comments
-ISS & Glass Lewis developments
As always, if you have insights on a securities law, capital markets or corporate governance issue, trend or development that you’d like to share in a podcast, we’d love to hear from you. You can email me and/or Meredith at john@thecorporatecounsel.net or mervine@ccrcorp.com.
On Friday, the SEC’s Division of Enforcement announced enforcement proceedings against the BF Borgers CPA PC accounting firm and its sole partner, Benjamin Borgers, for alleged “deliberate and systemic failures” to comply with PCAOB standards in audits and reviews incorporated in more than 1,500 SEC filings from January 2021 through June 2023. As this excerpt from the SEC’s press release illustrates, the allegations are jaw-dropping:
The SEC’s order finds that, among other things, the Respondents failed to adequately supervise and review the work of the team performing the audits and reviews; did not properly prepare and maintain audit documentation, known as “workpapers;” and failed to obtain engagement quality reviews, without which an audit firm may not issue an audit report. According to the SEC’s order, of 369 BF Borgers clients whose public filings from January 2021 through June 2023 incorporated BF Borgers’s audits and reviews, at least 75 percent of the filings incorporated BF Borgers’s audits and reviews that did not comply with PCAOB standards.
The SEC’s order further finds that, at Benjamin Borgers’s direction, BF Borgers staff copied workpapers from previous engagements for their clients, changing only the relevant dates, and then passed them off as workpapers for the current audit period. As a result, the order finds, BF Borgers’s workpapers falsely documented work that had not been performed. Among other things, the workpapers regularly documented purported planning meetings – required to discuss a client’s business and consider any potential risk areas – that never occurred and falsely represented that both Benjamin Borgers, as the partner in charge of the engagement, and an engagement quality reviewer had reviewed and approved the work.
The SEC’s order in this case reads like a litany of every SEC rule & statutory provision that an auditor could conceivably violate (or cause its client to violate) in connection with an audit or review engagement. The case was settled on a neither admit nor deny basis, but not surprisingly, the SEC absolutely clobbered both respondents in terms of the sanctions it imposed. In addition to hefty monetary penalties, the SEC essentially put an end to both respondents’ public company practice by issuing an order under Rule 102(e) denying them the privilege of appearing or practicing before the SEC as an accountant.
BF Borgers may not have been well known to many of our readers before last Friday, but the firm has been a fairly significant player, particularly among small cap issuers. The firm ranked 8th in overall market share for public company audits last year & ranked 6th in market share for non-SPAC initial public offerings. It also was the auditor for a particularly high-profile public company, Trump Media, and . . . umm. . . [This marks the point where I stopped writing and bit my tongue so hard I had to go to the ER for stitches.]
It’s hard to overstate the mess that the BF Borgers scandal creates for its public company clients. In an effort to provide some guidance to those clients, Corp Fin’s Office of the Chief Accountant issued a statement highlighting their disclosure and reporting obligations. In addition to flagging the Item 4.01 8-K report required in connection with a change in accountants, the statement highlights the impact on companies with respect to their future SEC filings:
– Form 10-K filings on or after the date of the Order may not include audit reports from BF Borgers. Each fiscal year presented must be audited by a qualified, independent, PCAOB-registered public accountant that is permitted to appear or practice before the Commission.
– Form 10-Q filings on or after the date of the Order may not present financial information that has been reviewed by BF Borgers. Each quarterly period presented must be reviewed by a qualified, independent, PCAOB-registered public accountant that is permitted to appear or practice before the Commission.
– Form 20-F filings on or after the date of the Order may not include audit reports from BF Borgers. Each fiscal year presented must be audited by a qualified, independent, PCAOB-registered public accountant that is permitted to appear or practice before the Commission.
That means that companies are going to need to re-audit all of the years covered by a BF Borgers audit report for their next 10-K and re-do prior interim reviews for periods presented in upcoming 10-Qs. Unfortunately, for some of those companies, that may be the least of their problems.
For instance, the timing of the SEC’s action means that former Borgers clients face a looming 10-Q deadline, and even with a Rule 12b-25 extension, it may be practically impossible to retain a new accountant and complete the required review by the extended 10-Q deadline. Under the circumstances, I expect that any new accounting firm will need to do a lot of additional work before it will issue a review report and that audit committees will want to have those numbers scrubbed very hard before signing off on a 10-Q filing containing them. The bottom line is that many of these companies are going to be late filers.
What’s more, given all the work that Borgers apparently didn’t do on hundreds of audits, once new auditors start poking around, my guess is we’re likely to see a fair share of these companies conclude that restatements of prior audits are necessary – which will open up a “whole ‘nother bag of snakes.”
By now, BF Borgers’ audit clients and their lawyers may feel like their heads are spinning, and with good reason. This is a mess, and there are going to be a lot of challenging issues for those companies and their advisors to address during the coming weeks. My guess is that the Staff will have more to say at some point about this situation, but in the meantime, we have resources that can help. These include:
