A recent Woodruff Sawyer blog highlights some of the factors that may make the SEC more likely to charge an individual executive when bringing an enforcement action against the company arising out of disclosure issues. One of the factors identified is media attention, and this excerpt points out that the more interested the media is in a particular situation, the more likely it is that the SEC will be looking for individuals to hold accountable:
There is a strong correlation between media scrutiny and government enforcement risk. Pretend you run an unsexy widget-making business. You tell the street that you will be releasing a new widget imminently. Then things go sideways, the widget is never released, and your company’s stock price declines by 35%. While the plaintiffs’ bar may be very interested, the media doesn’t bat an eyelash. Will you be investigated and sued by the SEC? It’s possible, but if there’s no article in The Wall Street Journal, it’s equally possible that the government may never focus on your issues.
Now assume that you run a super-sexy tech company disrupting the industry with WaaS (widgets-as-a-service). When your company’s problems emerge, a story appears on the front page of the Journal, and The New York Times does a deep dive on your corporate culture three weeks later. This virtually ensures the government will come sniffing around. In high-visibility cases, the government may be especially focused on showing that they are not being soft on senior executives (if they have the evidence to back it up).
A lot of this is out of your control. Typically, enterprise-facing companies simply don’t have the same media allure as consumer-facing companies. But if as a consumer-facing company you can achieve your public relations and marketing goals without also becoming an object of media obsession, when challenges emerge, you may be happy that you are not front-page material.
Other factors pointed to by the blog as increasing the likelihood of charges against an individual include evidence that senior officials pressured others to take improper actions and the presence of cooperating witnesses in addition to documentary evidence.
Another interesting fact that the blog points out is that the percentage of SEC enforcement proceedings in which individuals are named has remained relatively constant regardless of which party is in power. From 2017 to 2023, the percentage of cases involving charges against individuals has consistently been in the range of 70%.
If you work with public companies, it’s essential to keep up not only with what’s going on with the SEC, the FTC and any other federal regulator that’s relevant to the company’s business, but also with developments in the Delaware. Those often come fast & furious, so it’s helpful to have a resource like this Wilson Sonsini report addressing Delaware corporate law & litigation developments. Here’s an excerpt from the report’s discussion of oversight claims:
As to board obligations, some of the 2023 cases from Delaware reinforced the traditional approach that oversight claims against boards are difficult theories for plaintiffs, that directors will not face exposure merely for making risky business decisions, and that directors, even if confronted with a crisis, will not be liable if they have taken appropriate steps from a fiduciary duty standpoint.
In one case, the Delaware Court of Chancery concluded that the plaintiffs were “nowhere close” to pleading oversight claims against the directors of an insurance company. There, the insurance company had shifted its business practice of underwriting professional liability insurance policies for smaller, lower risk physician groups in favor of underwriting policies for larger, riskier physician groups and hospitals, which created difficulty in calculating the company’s required loss reserves.
After the shift, the company struggled with forecasting the number and severity of claims, which resulted in a significant drag on the company’s performance. The court dismissed the oversight claims, noting that the facts suggested the board and audit committee had indeed spent significant time evaluating the business risk associated with the strategy shift and there was no indication that any of the directors had acted in bad faith.
The memo also addresses decisions dealing with M&A issues, ESG & corporate purpose, dual-class structures and controlling stockholders, and advance notice bylaws and activism. It also covers the 2023 amendments to the DGCL.
Last summer, I blogged about an SEC Report to Congress that included an itemized list by filing type of which data must be tagged using inline XBRL. Orrick’s Bobby Bee recently let us know that this resource has been updated and will continue to be updated on a regular basis for the next several years. Here’s the skinny from Bobby:
The most recent flavor of the SEC’s “Semi-Annual Report to Congress on Machine Readable Data for Corporate Disclosures” (iXBRL summary report & checklist) was released back in December. Turns out the SEC has to “submit this report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives every 180 days until December 23, 2029, when the provision requiring the report sunsets.” So, we’ll get regular 6-month updates of this iXBRL form check tool from the SEC – which is pretty nice! Seems like these updates can be found via the “Reports and Publications” log.
Last month, the WSJ published a report on Elon Musk’s drug use which noted concerns among board members and company executives about his behavior’s potential implications for his companies. Since the report makes it clear that Musk’s directors & executive officers are aware of this behavior, a recent blog from UCLA’s Stephen Bainbridge discussed whether their oversight responsibilities under Caremark might be implicated if they fail to take action. As this excerpt from his blog explains, Prof. Bainbridge doesn’t believe that directors & executive officers would face liability in this situation:
[W]hat liability exposure does the board have when it is aware of a problem and decides to do nothing? I think the answer should be that the board would not be held liable. Granted, a board can be held liable for acting in bad faith not only for acting with “’subjective bad faith,’ that is, fiduciary conduct motivated by an actual intent to do harm” to the corporation, In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 64 (Del. 2006), “but also intentional dereliction of duty.” Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 240 (Del. 2009).
At least on these facts, however, I doubt whether a board decision to do nothing would rise to the level of “intentional dereliction of duty.” First, as VC Will explained, The Caremark doctrine is not a tool to hold fiduciaries liable for everyday business problems. Rather, it is intended to address the extraordinary case where fiduciaries’ “utter failure” to implement an effective compliance system or “conscious disregard” of the law gives rise to a corporate trauma. … Officers’ management of day-to-day matters does not make them guarantors of negative outcomes from imperfect business decisions.” Hence, even if the board’s decision not to act was “imperfect” that board cannot be held liable as “guarantors of negative outcomes.”
Second, as I discussed at considerable length in my post My Pillow, Inc. and the perennial question of whether Caremark claims should lie when boards fail to monitor the CEO’s personal life, the Delaware courts have held in several cases that ““directors of Delaware corporations generally have no duty to monitor the personal affairs of other directors and officers.” Granted, saying there is no duty to monitor such affairs is not the same as saying that there is no duty to intervene when such affairs are brought to the board’s attention, but it tends to support the proposition that the board has little liability exposure in this area.
Prof. Bainbridge also pointed out that, related to his first point, Delaware courts have held that while the business judgment rule doesn’t have any bearing on a claim that the directors’ inaction was the result of ignorance, it does apply to a conscious decision not to act, which he thinks this case would seem to involve.
About this time last year, the Delaware Chancery Court made it clear that Caremark claims could be brought not only against corporate directors, but also against corporate officers. Recently, in Segway v. Hong Cai, (Del. Ch.; 12/23), the Chancery Court held that Caremark claims against corporate officers were subject to the same high pleading standards as those targeting corporate directors.
The case involved allegations that a former VP of Finance had breached her duty of oversight because “she knew or should have known there were potential issues with some of [the Company’s] customers, which caused [the Company’s] accounts receivable to continuously rise” and that she failed to address these issues or bring them to the attention of the board. Vice Chancellor Will dismissed the complaint, and this excerpt from a Sheppard Mullin blog on the decision explains her reasoning:
The Court of Chancery sided with the Officer, noting that the Company’s allegations are “an ill fit for a Caremark claim.” A plaintiff may state a claim for failure of oversight against a director or officer where such person acted in bad faith by (i) utterly failing to implement any reporting or information systems or controls; or (ii) having implemented such a system or controls, consciously failing to monitor or oversee their operations, including by ignoring red flags. And, with respect to officers, the scope of an officer’s duty of oversight would need to fall within the officer’s sphere of corporate responsibility.
The Court found that generic financial matters such as learning of issues with unspecified customers, revenue decreases, and increases in receivables “are far from the sort of red flags” that could trigger liability. The Company failed to allege facts that would suggest bad faith; rather the Company sought to have the Officer “answer for a decrease in sales and an increase in receivables” with the benefit of “20/20 hindsight.”
Barker-Gilmore recently released its 2024 Aspiring General Counsel Report. Among other things, the report notes that if you want to be a GC, it sure helps to be anointed as a potential successor by your company’s management. According to the report, management-identified successors receive professional development in the form of expanded responsibilities, increased board exposure, leadership training and “stretch” assignments at higher rates than their peers generally. Here are some of the report’s other findings:
– 42% of Managing Counsel and 11% of Senior Counsel report being identified by management as potential successors to the sitting General Counsel.
– Being identified as a potential successor is more likely to keep Senior Counsel (60%) from pursuing other opportunities than it is for Managing Counsel (42%).
– In-house counsel that have received executive coaching (35%) are more likely to be identified as a successor than their counterparts without executive coaching (26%).
– Most identified successors are currently Deputy General Counsel (58%)
– 23% of potential successors identify as a race or ethnicity other than “white.”
The report also found that women are slightly more likely to be identified as a successor than men (53% vs. 47%), and that women are most likely to have been identified as a potential successor in the consumer (75%), industrial/manufacturing (60%) and financial services (56%) industries.
Yesterday, the SEC announced an open meeting to held at 10:00 am eastern on Wednesday, January 24th. This excerpt from the meeting’s Sunshine Act notice indicates that the SEC is ready to act on the SPAC rule proposals that it teed up nearly two years ago:
The Commission will consider whether to adopt new rules and amendments to enhance disclosures and provide additional investor protections in initial public offerings by special purpose acquisition companies (SPACs) and in subsequent business combination transactions between SPACs and target companies (de-SPAC transactions), and to address investor protection concerns more broadly with respect to shell companies.
SPACs were red hot during the first few years of this decade, but they haven’t exactly covered themselves in glory in terms of public investor outcomes and the proposed rules are intended to rein them in by leveling the playing field between SPACs and other IPOs. That being said, I think many industry participants would argue that the rules as proposed wouldn’t just rein SPACs in – they would likely do them in. It will be interesting to see what next Wednesday brings.
If an officer exculpation charter amendment is on your agenda for this year’s annual meeting & you’ve got multiple classes of stock outstanding, I’ve got some good news for you. Last year, the Delaware Chancery Court held that companies with this capital structure didn’t have to hold a separate class vote on these charter amendments, and earlier this week, in In re Fox Corp./SNAP Inc. Section 242 Litigation, (Del.; 1/24), the Delaware Supreme Court affirmed that decision. This excerpt summarizes the court’s decision:
We affirm the Court of Chancery’s judgment. Based on long-standing precedent, which the Class A Stockholders have not asked us to overrule, the powers, preferences, or special rights of class shares in Section 242(b)(2) refers to the powers, preferences, or special rights authorized for a class by Section 151(a) and expressed in the charter as required by Sections 102(a)(4) and 151(a).
The powers, preferences, or special rights of class shares expressed in the charter include default provisions in the DGCL, which are part of every charter under Section 394. The ability to sue directors or officers for duty of care violations is an attribute of the Companies’ stock, but not a power, preference, or special right of the Class A common stock under Section 242(b)(2).
The annual Northwestern Securities Regulation Institute will be held next week in San Diego. I know that many of our members will be there and wanted to let you know that we’ll be there in force. Dave’s vice chairing the event, and Liz, Meredith & I will all be in attendance as well. We hope to have the chance to meet many of the members our community in person, so if you see us, please stop by and say hello!
We shouldn’t be hard to find – Dave will be at the podium, and if you’re looking for the rest of us, just keep your eyes peeled for two very professional looking young women standing next to an old guy who looks like Sir Topham Hatt.
A recent Morgan Lewis memo on white collar issues says that the DOJ is prioritizing corporate criminal enforcement for misconduct implicating national security issues. Here’s an excerpt:
Since the beginning of the Biden administration, the DOJ has loudly proclaimed an interest in increased corporate criminal enforcement in traditional white-collar spaces. However, in recent months, the DOJ has signaled an additional priority: corporate enforcement related to national security issues. In the fall of 2023, the DOJ announced the appointment of the National Security Division’s first chief counsel for corporate enforcement. Ian Richardson, a former federal prosecutor in the US District Court for the Eastern District of New York, was appointed to coordinate and oversee the prosecution of corporate crime relating to US national security. Additionally, Christian J. Nauvel was named as Deputy Chief Counsel for Corporate Enforcement.
Given some of the national security issues that have emerged in recent years, from trade secret theft to the visibility of non-state actors, the DOJ is looking for opportunities to send a message to companies that they need to crack down on misconduct that could have serious national security implications. The DOJ’s focus on national security extends to processes like the CFIUS regulatory process, which is focused on reviewing cross-border investments and not on criminal activity.
The memo says that this increased emphasis on enforcement means that the DOJ will likely increase the number of investigations and subpoenas, and that companies with activities in regions such as China, the Middle East, and Central Asia face the most significant risk of attracting the DOJ’s attention.
