We’ve previously blogged about the Corporate Transparency Act, which requires non-exempt entities to disclose information about their beneficial owners to FinCEN. Well, the New York LLC Transparency Act, which is currently awaiting Gov. Hochul’s signature, could impose beneficial ownership disclosure obligations that go beyond those contemplated by the CTA. This excerpt from a BakerHostetler memo explains:
If it becomes law, the NYTA will require all LLCs formed or registered to do business in New York to disclose to the New York Department of State the same beneficial ownership information that such LLCs will need to disclose to the Financial Crimes Enforcement Network (FinCEN) under the CTA.
While both pieces of legislation have similar goals and impose similar disclosure obligations, they differ drastically in terms of the use and availability of the information submitted. Under the CTA, the beneficial ownership database is kept confidential and may be accessed only by law enforcement agencies and financial institutions in limited circumstances. But under the NYTA, the names and business addresses of the beneficial owners of LLCs will be made publicly available in a searchable database.
The New York Legislature passed this bill in June, and it’s been waiting on the Governor’s desk since then. The memo says that it is unclear whether she will sign it, but that if she vetoes it, the Legislature can override that action by a 2/3rds vote of both houses.
When I’m reduced to blogging about things like pending NY LLC transparency legislation, you know we’ve reached the end of a slow news week here at TheCorporateCounsel.net. Since that’s the case, I thought it might be fun to might close things out today by checking in with America’s most entrepreneurial hip-hop artists, The Wu-Tang Clan, to see whether they’re up to anything interesting on the business front.
That’s a dumb question to ask when it comes to The Wu-Tang Clan, because they’ve always got some interesting business deals going on. In recent years, the group’s entrepreneurial ventures have focused on digital assets, and I’ve blogged about things like Method Man’s NFT venture & Ghostface Killah’s ill-fated ICO deal. Now, however, it looks like the burgeoning legal cannabis market has caught the eye of at least a couple of Wu-Tang members.
According to this article, the Newark, NJ City Council has signed-off on Raekwon’s application to open a branch of his “Hashstoria” cannabis dispensary in the city, and Raekwon promises big things to potential customers:
When it’s complete, Hashstoria’s newest location in Newark will have “the finest greenery on the planet.” That’s the pledge from Raekwon, the Wu-Tang Clan rapper who is bringing a cannabis dispensary and smoking lounge to New Jersey’s largest city.
Raekwon previously posted a message on Instagram about the planning board’s approval of Hashstoria in Newark, saying that it will be a “culture-shifting endeavor” and it is “guaranteed to be the top tier consumption lounge / dispensary to hit the east coast period.”
Not to be outdone by his colleague, Method Man recently announced that his own cannabis-related venture would be expanding into New York State:
TICAL Official, the cannabis brand spearheaded by Wu-Tang Clan’s Method Man, has officially graced New York State’s adult-use cannabis shelves. Collaborating with Central Processors NY and Adirondack Hemp Company, the brand’s entrance into the market has been both highly anticipated and symbolically significant. Rapper, actor and entrepreneur, Method now hopes to bring a different kind of soothing relief with his TICAL Official cannabis brand to his home turf. The initial offering features Central Processors’s prerolls and edibles, with indications that the product line is set to expand over the subsequent months.
The potential upside of a vertical merger involving Method Man’s chronic brand and Raekwan’s smoke shops seem obvious enough to me that I expect that it won’t be too long before we add a conflict with FTC Chair Lina Khan & her antitrust enforcement team to the “Beefs” section of our “Wu-Tang Clan” Practice Area.
We’ve previously blogged about the split between the circuits over whether deficiencies in MD&A disclosures, standing alone, are sufficient to give rise to a private Rule 10b-5 claim & efforts to persuade the SCOTUS to address the issue. Late last month, the Court granted cert in Macquarie Infrastructure Corp. v. Moab Partners, L.P., a case from the 2nd Cir. where the ability to rely on non-compliance with Item 303’s requirements to state a securities fraud claim is front and center. This excerpt from Debevoise’s recent memo on the Court’s decision to review the case discusses what’s potentially at stake:
The Supreme Court’s decision could have a significant impact on private securities fraud litigation, should Item 303 omissions be allowed to serve as a basis for Section 10(b) liability. This change would enable plaintiffs to establish a duty to disclose when they otherwise may not be able to plead an omission case, potentially expanding Rule 10b-5 liability to more closely resemble Section 11 and 12(a)(2) liability for omissions of “a material fact required to be stated.”
Although expanding the private cause of action under Section 10(b) and Rule 10b-5 in this way could incentivize issuers to over-disclose in an effort to prevent costly shareholder suits, issuers are already subject to SEC review and enforcement action regarding omissions in MD&A, so the practical impact of the Supreme Court’s decision on issuer activity may be negligible.
However, if the Court determines that Item 303 violations can serve as a basis for Rule 10b-5 liability, the ruling may raise questions about whether other disclosure obligations under Regulation S-K should be afforded similar treatment. In light of the upcoming changes to Regulation S-K, including significant new requirements related to cybersecurity risk management and climate change disclosures, the Court’s decision in Macquarie could have broader implications for issuer liability.
The memo also provides background on the Macquarie litigation and reviews the divergent positions that the 9th Cir. and 2nd Cir. have taken on whether there is a private right of action for MD&A disclosure shortcomings, so it’s a great way to get up to speed on the issues before the SCOTUS.
A recent Audit Analytics blog discussed the results of its review of situations in which companies have repeatedly disclosed that their internal control over financial reporting, or ICFR, was ineffective. As this excerpt indicates, repeat negative ICFR assessments happen a lot more than you may have thought:
A repeat adverse disclosure is when a company that filed an adverse ICFR disclosure the prior year, files another for the current year. Over the 19-year period, we found that there were 4,892 companies that had at least one repeat adverse ICFR disclosure. Between 2004 – 2022, 3,636 companies filed between one and four repeat adverse disclosures each. On the other hand, 81 companies filed a repeat adverse disclosure between 13 and 16 times over the period.
The blog says that accounting documentation, policy and/or procedures was cited as a deficiency in 98% of repeated adverse disclosures between 2004 and 2022. Unspecified FASB/GAAP issues were the most common accounting issue, cited in 73% of repeated adverse disclosures. The blog goes on to identify the other commonly cited internal controls and accounting issues cited in repeated adverse disclosures.
Woodruff Sawyer recently published its annual D&O Market Update, which discusses the roller coaster ride that public companies have experienced when it comes to D&O insurance premiums over the past few years. The report notes that during the second half of 2021, 71% of public companies renewing the same year-over-year program experienced a price increase, while just a year later, 87% of public companies achieved a decrease in the cost of their renewal program.
Favorable market trends accelerated into the first half of 2023, and this excerpt suggests that in the short term at least, those favorable pricing trends will continue:
As we move into the second half of 2023 and look ahead to 2024 and beyond, 63% of underwriters predict that D&O rates will stay the same, with another 30% expecting that rates will continue to fall. Our own forecast is that public companies will continue to see savings—but on a more moderate basis—compared to the sizeable savings achieved in the second half of 2022 and so far in 2023.
The publication provides some color on the reasons for the significant price increases that D&O insurance buyers experienced during 2021 and the first half of 2022, and cautions that some underwriters are concerned that continued price decreases may lead to a “whipsaw” effect on premiums in a few years.
Senior officials at the SEC’s Division of Enforcement have long touted the potential benefits that companies may derive by cooperating with its investigations, but it’s not always clear what companies have to do to move the needle. This K&L Gates memo looks at the terms of recent settlements and identifies some of the cooperation factors that are likely to contribute to reduced penalties – or even a decision not to impose penalties. Here’s an excerpt:
First, an important driver in whether a penalty is imposed is whether the entity promptly self-reports potential misconduct upon learning it or not. In each of the actions described above that did not impose a penalty, the entity self-reported the conduct to the SEC.
A second factor cited in the orders is the extent to which the entity provides information to the staff as it investigates the matter. Among the actions cited favorably are hiring outside counsel to conduct an independent internal investigation, providing the SEC with facts developed in that internal investigation (including presentations of interim findings and highlighting key documents and witnesses), promptly making witnesses available, providing detailed explanations of factual issues, facilitating testimony of former employees, providing relevant documents without requiring subpoenas, and providing translations of foreign-language materials.
Third, the SEC has highlighted that the entities voluntarily took remedial measures in response to the issues discovered. Such measures have included replacing management and board members, commencing an audit of compliance programs, revising procedures, holding compliance trainings with employees, creating employee guides or toolkits with commonly asked questions regarding the federal securities laws, and voluntarily ceasing the at-issue conduct.
If this sounds familiar, it probably should, because the memo points out that these are the same type of actions that the DOJ looks for when it assesses whether cooperation credit is appropriate.
Despite the SEC’s statements and the evidence provided by recent settlements, many companies are still skeptical about whether there’s much upside in going above and beyond in cooperating with the SEC. The memo acknowledges that this isn’t an irrational concern. That’s because the SEC isn’t exactly a model of consistency, and sometimes imposes significant penalties notwithstanding a high degree of cooperation by the company involved in the enforcement action.
There’s been a lot of discussion in recent months about generative AI and its implications for, well, everything. In keeping with that, we’ve added an avalanche of resources to our “Artificial Intelligence” Practice Area since the beginning of the year. There are two new additions that I think will give you a taste for the kind of really helpful materials that we’re posting in that practice area. The first is this 49-page Foley memo that takes a deep dive into the legal & operational issues associated with generative AI. This excerpt highlights some of the legal risks:
Another of AI’s most significant legal risks is the potential for bias. AI systems are as good as the data they are trained on. If that data is biased, the AI system will also be biased. This can lead to outcomes that violate anti-discrimination laws. For example, an AI hiring system trained on historical data that reflects biased hiring practices may perpetuate that bias and result in discrimination against certain groups.
Another legal risk of AI is the potential for violating privacy laws. AI systems often require access to large amounts of data. If that data includes personal information, businesses must comply with relevant privacy laws, such as the General Data Protection Regulation (GDPR) in the European Union or the California Consumer Privacy Act (CCPA) in the United States.
The second new resource is this Mayer Brown memo, which addresses the emerging legal frameworks for governing AI in jurisdictions throughout the world & their implications for corporate boards. Here’s the intro:
Currently, there are artificial intelligence (“AI”)-related legal frameworks pending or proposed in 37 countries across six continents. Even within each particular country, multiple governmental agencies are claiming AI as within their jurisdictional reach. For example, in the United States, the Consumer Financial Protection Bureau, Department of Justice, Equal Employment Opportunity Commission, Food and Drug Administration, Federal Trade Commission and the Securities and Exchange Commission each has issued guidance or otherwise indicated through enforcement activity that they view AI as within their respective purview of current regulatory and enforcement authority.
The memo goes on to discuss the policy rationale behind these legal frameworks & the importance of acquainting boards with their requirements. It also offers guidance on ways to help ensure that directors are prepared to provide appropriate oversight in this area.
The SEC has been pretty active over the past year in adopting new disclosure requirements, many of which companies are going to be required to comply with in their Form 10-Q and Form 10-K filings over the course of the next year. This Weil memo identifies these new disclosures, provides a snapshot of the compliance dates for calendar year end companies, and offers some guidance on how to prepare to comply with them. Not surprisingly, the memo’s recommendations focus on the need for companies to take a hard look at their disclosure controls and procedures:
Companies should confirm that disclosure controls and procedures have been updated and evaluated as they prepare to meet the timely disclosure of information required by the new rules. Companies also should be reviewing and updating various policies that will be required to be either filed or described publicly for the first time, such as the company’s insider trading policy, share repurchase processes and procedures, and cybersecurity risk management, strategy, and governance
The memo goes on to identify some specific actions that companies should take regarding their disclosure controls and procedures for each of these new disclosure mandates, if they haven’t already done so.
Like most Americans, I have a soft spot in my head heart for conspiracy theories. Generally, the kookier they are, the more intriguing I find them to be. But I’ve got to admit that I’m having a hard time buying into one that the Chair of the House Oversight Committee, Rep. James Comer (R-KY), appears to be peddling. Check out this excerpt from a recent letter he wrote scolding SEC Chair Gary Gensler for dragging his feet in complying with Republican legislators’ demand for information about the SEC’s efforts to coordinate with EU regulators:
Senator Tim Scott and I wrote you on June 5, 2023, seeking documents and information on your agency’s involvement in the development of European social engineering initiatives disguised as disclosure and due diligence directives being developed by the European Union (EU). This Administration has hidden behind “interoperability of disclosure regimes” as its justification for global coordination. However, it is not clear that the law provides such authority and we must determine whether legislation is necessary to ensure our government works for the American taxpayer and not on behalf of foreign interests.
So, the distinguished gentleman & his Senate colleague are apparently concerned that the SEC may be conspiring with the EU to engage in a “social engineering initiative disguised as disclosure”? Well, I suppose Gary Gensler could be part of a globalist conspiracy to deprive us of our liberty, destroy our economy, make us trade in in our F-150s for electric Vespas & force us to watch soccer instead of the NFL.
On the other hand, given the US reluctance to embrace concepts like “double materiality” when it comes to financial regulation, the simpler explanation may be that the SEC’s efforts to coordinate with the EU have been motivated in part by a desire to prevent regulators there from implementing disclosure standards that the US will find unacceptable. Personally, in choosing between the two alternative explanations, I’d opt for the one that conforms with “Occam’s razor.”
As Meredith blogged back in August, disclosures concerning the impact of inflation have been getting increased attention in Staff comment letters. Now, it looks like plaintiffs’ lawyers are scrutinizing those disclosures pretty closely as well. Over on “The D&O Diary,” blog Kevin LaCroix recently blogged about a purported class action lawsuit filed against Advance Auto Parts last week premised on alleged shortcomings in the company’s disclosure about the impact of inflation and other macroeconomic factors on its business. This excerpt highlights the statements that gave rise to the lawsuit:
On November 16, 2022, in its quarterly earnings call, the company announced its “strategic pricing initiatives” aimed to help grow margins in 2023. The company’s CEO said that “our goal overall is to cover cost increases.” The CEO said that these initiatives were based on the company’s research showing that in the professional category, availability rather than prices was the more important factor in sales.
On its quarterly earnings call on February 28, 2023, the company said that it was continuing to execute “disciplined inventory and pricing actions.” During the call, the company’s CEO dismissed the impact of the U.S. economy and other macroeconomic factors on sales and margins. While acknowledging that the company remains “cautious surrounding the macroeconomic backdrop, including with respect to the pressure on low-to-middle income consumers,” the CEO confirmed the company’s 2023 guidance.
However, in its quarterly earnings call on May 31, 2023, the CEO said that “our financial results in the first quarter were well below expectations, noting that the company’s pricing initiatives produced “less price realization than plans,” and that the company had been “unable to price to cover product costs in the quarter.”
In their lawsuit, the plaintiffs allege that the company’s statements violated Rule 10b-5. They contend, among other things, that these statements misrepresented the efficacy of the company’s strategic pricing initiative and “created the false impression that inflation and macroeconomic factors had an insubstantial impact on the Company’s margins.”
Kevin addresses the issues likely to be raised by the company in its motion to dismiss and seems to think the plaintiffs may face an uphill battle to establish that the statements at issue were made with scienter. But he also points out that as companies continue to face economic headwinds associated with inflation and higher interest rates, more of them may face lawsuits like this one.
