On Friday, the SEC announced that it had adopted two amendments to the rules governing its whistleblower program. Here’s the 46-page adopting release and the two-page fact sheet. This excerpt from the SEC’s press release summarizes the changes:
Specifically, the SEC amended Rule 21F-3 to allow the Commission to pay whistleblower awards for certain actions brought by other entities, including designated federal agencies, in cases where those awards might otherwise be paid under the other entity’s whistleblower program. The amendments allow for such awards when the other entity’s program is not comparable to the Commission’s own program or if the maximum award that the Commission could pay on the related action would not exceed $5 million.
Further, the amendments affirm the Commission’s authority under Rule 21F-6 to consider the dollar amount of a potential award for the limited purpose of increasing the award amount, and it would eliminate the Commission’s authority to consider the dollar amount of a potential award for the purpose of decreasing an award.
The amendments prompted much rejoicing from the whistleblower bar but left the two dissenting Republican commissioners scratching their heads about why the SEC felt the need to do this. Frankly, I find myself doing the same. Here’s an excerpt from Commissioner Uyeda’s dissenting statement, which picks up on some recent criticism concerning the program’s lack of transparency:
High-quality tips from whistleblowers represent an important tool in the Commission’s enforcement program. To the extent that the Commission seeks to improve the Whistleblower Program and its rules, it should perhaps consider promoting greater visibility into its claims and award determinations, and increasing the number of high-quality tips from unrepresented persons. Such a review could also evaluate the role played by lawyers representing whistleblowers on a contingency fee basis and how they present tips to the Commission.
The SEC’s surprise adoption of the pay for performance disclosure rules didn’t leave Dave room to address the universal proxy CDIs that the SEC issued last Thursday. Here’s what I had to say about them over on the DealLawyers.com Blog:
With the universal proxy compliance date less than a week away, the SEC yesterday issued three new Proxy Rules and Schedules 14A/14C CDIs addressing issues arising under Rule 14a-19. Unfortunately, the SEC didn’t include links to the individual CDIs, so you’ll need to scroll down to the new Section 139 in order to find them. Here’s a brief summary of the issues they address:
CDI #139.01 addresses the ability of a dissident shareholder to change its slate of nominees after the Rule 14a-19(b) notice deadline due to a nominee’s decision to withdraw or a change in the number of director seats up for election.
CDI #139.02 deals with the registrant’s obligation to comply with Rule 14a-19(b)’s notice requirements in the case of a contested election in which more than one dissident shareholder intends to present a slate of director nominees.
CDI #139.03 addresses the registrant’s obligation under Rule 14a-5 to disclose in its proxy materials Rule 14a-19(b)(1)’s requirement that a dissident provide notice of its nominees at least 60 calendar days before the anniversary of the prior year’s annual meeting in situations where the registrant’s advance notice bylaw provides for an earlier notification date.
On Friday, the PCAOB announced that it had reached an agreement with the China Securities Regulatory Commission and the PRC’s Ministry of Finance to permit the PCAOB to fully inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong. The PCAOB announced that the deal, which is embodied in a “Statement of Protocol,” is just a first step, and this excerpt from the comments of PCAOB Chair Erica Williams suggest a healthy degree of skepticism about whether China’s regulators will honor the accord in practice:
“On paper, the agreement signed today grants the PCAOB complete access to the audit work papers, audit personnel, and other information we need to inspect and investigate any firm we choose, with no loopholes and no exceptions. But the real test will be whether the words agreed to on paper translate into complete access in practice.
Today, I directed the PCAOB inspection team to finalize their preparations to be on the ground by mid-September so we can put this agreement to the test. The Statement of Protocol grants the PCAOB complete access in three important ways:
– The PCAOB has sole discretion to select the firms, audit engagements and potential violations it inspects and investigates – without consultation with, nor input from, Chinese authorities.
– Procedures are in place for PCAOB inspectors and investigators to view complete audit work papers with all information included and for the PCAOB to retain information as needed.
– The PCAOB has direct access to interview and take testimony from all personnel associated with the audits the PCAOB inspects or investigates.
Now we will find out whether those promises hold up.”
As Liz recently blogged, the tentative accord comes on the heels of increased activity surrounding the implementation of the Holding Foreign Companies Accountable Act, which could ultimately result in the wholesale delisting of China-based companies unless the PCAOB is provided with the kind of access to audit materials & personnel contemplated by the deal.
I see from recent media reports that meme stocks are back, which I guess means that people feel they didn’t lose enough money in crypto this year. Anyway, it’s Friday and it’s a slow news week at the SEC, so the resurgence of meme stocks gives me an excuse to recount the ongoing wild ride of a meme stock known as Vinco Ventures.
Vinco Ventures commercializes digital media and content technologies, and over the past month, it’s been the subject of some very bizarre boardroom shenanigans. They began with the filing of this Form 8-K announcing that the board had appointed Theodore Farnsworth to serve as Co-CEO alongside the company’s current CEO, Lisa King. But according to a subsequent press release, that’s not what happened. That press release – which you really need to read in its entirety – announced that Farnsworth & King had been terminated, and included this nugget:
On July 14, 2022, Ms. King authorized the filing of a Current Report on Form 8-K that incorrectly stated Mr. Farnsworth had been appointed as the Company’s Co-CEO despite being advised that the information contained in the Form 8-K was incorrect and based on an invalid Board meeting (the “First Incorrect 8-K”). The Company attempted to file a Current Report on Form 8-K by the end of the day on July 14, 2022 to correct the First Incorrect 8-K, but this attempted Securities and Exchange Commission (“SEC”) filing was blocked by certain members of the Farnsworth Group, even though Mr. Farnsworth was not legally appointed as the Company’s Co-CEO at the time.
The press release goes on to recount management reshufflings that occurred at two subsequent board meetings. When the dust settled, the press release says that Farnsworth remained a Co-CEO, but King was moved to another position and a new Co-CEO, John Colucci, was appointed to serve with him. The board purportedly directed the Co-CEOs to file a corrective 8-K, but the press release says that didn’t happen. Instead, the release claims that this happened:
On July 22, 2022, without informing anyone at the Company or the Board, the Company believes that certain members [of the] Farnsworth Group authorized the filing of a Current Report on Form 8-K signed by Mr. Farnsworth that, once again, materially misrepresented the facts and chain of events (the “Second Incorrect Form 8-K”).
Here’s that Form 8-K. In any event, the press release said that the board subsequently terminated Farnsworth and his pals & promised an 8-K filing. The only problem was that “[t]he Company’s SEC codes and SEC filings by the Company have been blocked by the Farnsworth Group,” so that Form 8-K couldn’t filed until those issues were resolved.
Apparently, they still haven’t been completely resolved, because the only 8-K filed after this press release relates to an announcement that the company’s shareholder meeting was being postponed. However, on Wednesday, the company announced that a Nevada court had entered a TRO barring the Farnsworth Group from, among other things, “holding themselves out internally or externally as employed by the Company or acting on its behalf in any capacity.” The court also ordered the Farnsworth Group to turn over the company’s SEC codes.
In its press release, the company claimed that it had “thwarted a hostile takeover attempt for no consideration by the Farnsworth Group.” Over the years, I’ve seen a lot of people try to take control of a lot of public companies in a lot of different ways, but allegedly swiping EDGAR codes as a hostile takeover strategy is a new one on me. If you find all of this very confusing, you’re not alone. I do too, and apparently, so does Nasdaq, which halted trading in the stock a week ago. The meme stock apes, however, continue to have faith that this particular stonk is “goin’ to the moon!”
We’ve blogged quite a bit over the past several years about the Delaware courts’ increasingly sympathetic approach to Caremark claims and their increasingly demanding view of what’s necessary for directors to fulfill their oversight responsibilities. This Wachtell memo addresses the implications of recent Caremark decisions. This excerpt discusses the role that books & records requests play in Caremark litigation and the resulting importance of properly structuring and documenting the board’s oversight efforts:
The increasing use of books and records demands by plaintiffs to plead their claims has been illustrated. Because the Delaware courts have long made clear—including inMarchandand Boeing—that Caremark requires a good faith effort by the board, not perfection, and that the board will only face liability if the evidence demonstrates that a board has not made a good faith effort to fulfill its duties, plaintiffs have sought books and records to sustain their difficult burden to plead a viable claim. When these books and records do not reflect that a company had in place a board structure that attended to core business and legal risks, the plaintiffs cite to that lack of effort in an effort to plead a complaint that cannot be dismissed on motion.
For these reasons, we have urged that companies ensure that their board-level committee structures address all mission critical risks and that the board’s efforts in holding meetings and receiving information in aid of its monitoring responsibilities are well documented. Taking these steps are beneficial on several levels. Most important, tone and involvement at the top on important compliance matters helps companies best position themselves to function safely and lawfully.
Because managing complex business entities invariably involves risks, these actions are also helpful in the event that something goes wrong despite the company’s good faith efforts at prevention. A documented board-level compliance system makes it much more difficult for a plaintiff to plead a viable Caremark claim. With increased attention to these subjects, two-thirds of the Caremark cases filed after Marchand have been dismissed on motion.
The blog goes on to discuss the role that proper structuring & documentation of the board’s oversight of mission critical played in Chancellor McCormick’s dismissal of Caremark claims in City of Detroit Police & Fire Retirement System v. Hamrock, (Del. Ch.; 6/22). It concludes by observing that Hamrock underscores the conclusion that directors face a very limited risk of personal liability if they “use their business judgment and work with management to put in place and attend in good faith to a sound compliance structure that addresses the company’s central risks, and documents its efforts in doing so.”
Wachtell Lipton will be well represented at our upcoming “Proxy Disclosure & 19th Annual Executive Compensation Conferences.” Former Delaware Chief Justice Leo Strine, who is currently Of Counsel at Wachtell, will participate in our “ESG Disclosures: Staying Out of Hot Water” panel & Wachtell Partner Sabastian Niles will participate in our “Next-Gen Activism: Are You Prepared?” panel. You won’t want to miss these or the other informative topics on our agenda, so be sure to sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
While we’re on the topic of Caremark and board oversight, be sure to check out this Bass Berry blog addressing the matters that should be considered when deciding how to provide board oversight of ESG initiatives and disclosures. The blog notes that approaches vary, and that many boards opt to have the full board provide that oversight. However, this excerpt says that there is a trend toward delegation:
For example, according to an EY study of Fortune 100 companies in 2021, 85% of the surveyed companies disclosed that a committee of the board oversaw environmental sustainability or corporate responsibility matters, compared to 78% in 2020. While these figures are likely higher among Fortune 100 companies than public companies as a whole, this increase between 2020 and 2021 reflects a trend toward greater board committee oversight of ESG matters occurring more generally among U.S. public companies.
Factors contributing to this trend include the SEC’s requirement for extensive board oversight under its proposed climate change disclosure rules, the increasing amount of time that boards are being required to devote to ESG issues, and the need in some cases for specialized expertise.
It’s not every day that the Delaware Chancery Court enjoins a company’s annual meeting of stockholders, but that’s what happened to UpHealth, a recently de-SPACed health care services company. According to this memo from Hunton Andrew Kurth’s Steve Haas, Vice Chancellor Will issued a bench ruling in late June enjoining the company’s annual meeting. Her decision was premised on her conclusion that the board’s likely breached its fiduciary duties by adopting a bylaw lowering the meeting’s quorum requirement.
The memo explains that stockholders allegedly holding a majority of the company’s voting power had entered into a voting agreement allowing a dissident to vote their shares, but the dissidents didn’t nominate a competing slate of directors before the deadline set by the company’s advance notice bylaw. The board’s co-chair, who was aligned with the dissident group, tried to have a special meeting called to repeal the bylaw, but that effort failed. In seeking to enjoin the annual meeting, the dissidents argued that argued that by lowering the quorum requirement from a majority to 1/3rd of the shares, the board prevented stockholders from blocking a quorum by refusing to attend the meeting, which in turn made it easier for the board to convene the meeting and elect its slate.
After rejecting the plaintiffs’ claims relating to the aborted effort to call a special meeting, the Court took up allegations that the board breached its fiduciary duties by enacting the quorum bylaw without a compelling justification. The Vice Chancellor held that the plaintiffs had a reasonable likelihood of success in proving these allegations and enjoined the meeting. This excerpt from the memo summarizes the Vice Chancellor’s reasoning:
The next issue was whether the board majority may have breached its fiduciary duties by amending the bylaws to lower the quorum requirement before the annual meeting. The court applied the Blasius test, which requires the board to show a compelling justification when it acts for the primary purpose of interfering with the stockholder franchise. Here, the court said the board majority was “changing the machinery of the election midstream . . . for the purpose of making it more difficult for the [majority] group of shareholders . . . from voting the incumbent slate down.” While the court did not question the board majority’s good faith, it nevertheless concluded that the plaintiffs had a reasonable probability of success in challenging the quorum change. As a result, the court entered a preliminary injunction against the meeting pending a trial on the matter.
The litigation ultimately settled, but the memo says that there are a number of key takeaways from it. These include the differing ways Delaware courts approach board actions taken “on a clear day” vs. those taken in the heat of a proxy contest & the importance those courts place on protecting stockholder voting rights – even if the exercise of those rights involving withholding shares from participating in a meeting. The memo also says that the decision is a reminder that Delaware’s demanding Blasius standard is alive and well when it comes to director actions that interfere with stockholder voting rights.
Yesterday, the SEC announced that it was proposing amendments to Form PF, which is a confidential reporting form that certain SEC-registered investment advisers to private funds are required to file. Here’s the 298-page proposing release and here’s the more manageable 2-page fact sheet. The SEC’s press release says that the proposed amendments, which are being proposed jointly with the CFTC, “are designed to enhance the Financial Stability Oversight Council’s (FSOC) ability to assess systemic risk as well as to bolster the SEC’s regulatory oversight of private fund advisers and its investor protection efforts in light of the growth of the private fund industry.”
This isn’t the type of SEC action we typically cover. Investment adviser regulation isn’t a high-priority topic for most of our members and – more importantly – what I know about it could fit inside a thimble. So, I wasn’t planning on blogging about the proposal until Liz flagged this WSJ article for me. The article says that, if adopted, the amendments would shed light on just how much exposure to crypto hedge funds have. That makes the proposal a little more interesting. Here’s an excerpt from the WSJ piece:
The collapse in cryptocurrency prices this year has left U.S. regulators scrambling to understand the risks that digital-asset markets could pose to the broader economy. They may soon enlist hedge funds in the effort.
The Securities and Exchange Commission issued a proposal Wednesday that would require large hedge funds to report their cryptocurrency exposure through a confidential filing known as Form PF. Created after the 2008 financial crisis, Form PF was designed to help regulators spot bubbles and other potential stability risks in the otherwise opaque ecosystem of private funds that manage money for wealthy individuals and institutions.
The potential addition of cryptocurrency data to the reporting requirements for hedge funds comes as the SEC and its sibling agency, the Commodity Futures Trading Commission, weigh a broader set of updates that would expand the scope of Form PF.
The proposing release suggests that currently, some filers apparently report crypto holdings as “cash or cash equivalents,” which makes no sense to me. The proposal would amend the term “cash and cash equivalents” to direct advisers to not include any digital assets under that category. Instead, the SEC proposes to define “digital assets” and require advisers to report them separately from other types of assets. Comments are due by the later of 30 days after the proposal is published in the Federal Register or October 11, 2022.
Earlier this year, I blogged about a 7th Cir. decision rejecting a claim that an exclusive forum bylaw could be used to preclude a plaintiff from filing a lawsuit premised on violations of Section 14(a) of the Exchange Act in federal court – which, since those claims can only be brought in federal court, would essentially preclude them from being brought anywhere. Recently, the 9th Cir. reached the opposite conclusion. Here’s what I recently said about that decision over on the DealLawyers.com Blog:
In Lee v. Fisher, (9th Cir.; 5/22), the 9th Circuit upheld a prior district court ruling dismissing federal disclosure claims and state law derivative claims on the basis of an exclusive forum bylaw designating the Delaware Court of Chancery as the exclusive forum for derivative suits. The Court reached that conclusion despite the fact that as a result of the application of the bylaw, the plaintiffs’ claims under Section 14(a) of the Exchange Act – which may only be asserted in federal court – would effectively be precluded.
This Troutman Pepper memo notes that the 9th Cir.’s decision creates a conflict with the 7th Cir., which recently held in Seafarers Pension Plan v. Bradway, (7th Cir.; 1/22), that the provisions of the DGCL authorizing exclusive forum bylaws did not permit Exchange Act claims to be brought in a Delaware court, since the Exchange Act gives federal courts exclusive jurisdiction over those claims. This excerpt from the memo summarizes the implications of the circuit split:
The circuit split created by the Ninth Circuit’s and the Seventh Circuit’s divergent rulings has injected some uncertainty into a common practice among Delaware corporations in the context of derivative claims brought under the Exchange Act. The Seventh Circuit’s decision, which is friendly to derivative plaintiffs, partially upsets standard practice in corporate affairs — that is, deciding where derivative internal corporate disputes should be heard.
The Ninth Circuit’s decision, which is friendly to Delaware corporations, generates uncertainty by splitting with the Seventh Circuit. Naturally, would-be plaintiffs and defendants will likely forum shop to the extent possible and gravitate toward their respective safe harbors. This issue could become exacerbated to the extent other circuit courts contribute to the circuit split. In that event, the uncertainty would likely continue unless and until the Supreme Court has the opportunity to, and chooses to, resolve the burgeoning circuit split.
In the course of his recent blog about Staff comments on the war in Ukraine, Dave also noted that the Staff has been seeking additional disclosure on inflation & supply chain issues. Yesterday, Olga Usvyatsky tipped us off via Twitter that the SEC released a number of comment letters addressing those topics. Most of the comments focused on disclosure in the Risk Factors & MD&A sections of the filings. Here are excerpts from some of those letters that should give you a flavor of the general nature of the Staff’s comments:
“We note your risk factor indicating that inflation could affect your margin performance and financial results. Please update this risk factor if recent inflationary pressures have materially impacted your operations. In this regard, identify the types of inflationary pressures you are facing and how your business has been affected.”
“We note your discussion here and on page 26 of your April 3, 2022 Form 10-Q related to inflation that it could affect your prices, demand for your products, your profit margins. We further note your disclosure that your test and industrial automation businesses will be impacted by supply constraints, which are in turn impacted by inflation. Please update this risk factor in future filings if recent inflationary pressures have materially impacted your operations. In this regard, identify the types of inflationary pressures you are facing and how your business has been affected.”
“We note your risk factor here and throughout the filing related to supply constraints. We further note from your Form 8-K dated April 27, 2022 that you continue to encounter material constraints in most product areas and that you provide wider than normal Q2 guidance range reflects those supply challenges. Specify in future filings and in more detail whether these challenges have materially impacted your results of operations or capital resources and quantify, to the extent possible, how your sales, profits, and/or liquidity have been impacted.”
“Please consider including disclosures in future filings to discuss known trends or uncertainties resulting from mitigation efforts undertaken, if any, from your supply chain disruptions. Explain whether any mitigation efforts introduce new material risks, including those related to product quality, reliability, or regulatory approval of products.”
“Please discuss in future filings whether supply chain disruptions or inflation have materially affected your outlook or business goals. Specify whether these challenges have materially impacted your results of operations or capital resources and quantify, to the extent possible, how your sales, profits, and/or liquidity have been impacted. Revise also to discuss in future filings any known trends or uncertainties resulting from mitigation efforts undertaken, if any. Explain whether any mitigation efforts introduce new material risks, including those related to product quality, reliability, or regulatory approval of products.”
A few common themes emerge from these comments. First, the Staff is focusing the need to keep risk factor disclosure up to date, and companies would be well advised to consider whether updates are necessary in order to avoid falling into the hypothetical risk factor trap. Second, the Staff wants more detail in disclosures about how a company’s business is being affected by inflation or supply chain disruptions. Finally, MD&A disclosure about these issues needs to address not only their current impact, but also any “known trends or uncertainties” that may result from them or from the company’s mitigation efforts.
