In our recent webcast on 2023 proxy disclosures, Mark Borges observed anecdotally that more companies appear to be permitting directors and officers to pledge shares. Mark said that these companies should disclose the safeguards they’ve put in place to prevent the pledge from backfiring and ending up with insider trading allegations. Those companies and their directors and officers should also check out this Orrick memo, which reviews some things insiders should consider before pledging shares. This excerpt addresses the risks associated with pledge arrangements:
Various risks may arise for both the insider and the company in connection with pledging shares since share pledging may be utilized as part of hedging or monetization strategies that limit an insider’s economic exposure related to their ownership of the company’s shares, even while the insider maintains voting rights.
The personal risk to the insider in connection with pledging shares is that, if the value of the shares falls below certain contractual minimums set in the agreement by which the shares are pledged, the insider may be subject to a margin call, in which case, the insider may be required to either sell the pledged shares, pledge additional shares, pay cash to make up for the shortfall or reduce the amount of the loan. If the insider sells shares that they are contractually or statutorily prohibited from selling as a result of the margin call, they may expose themselves to liability.
A margin call can have several negative consequences on a company and the affected insiders. The first is that if the insider is forced to sell the shares, the sale could cause the share price of the company to fall. The second is that the act of pledging shares and the risk of a margin call may create a misalignment of interests between the insider and the company’s shareholders, as the insider may be incentivized to take actions that limit his or her exposure to a margin call. Either scenario could potentially subject the company and its insiders to shareholder lawsuits, particularly in an environment of declining share prices.
The “worst case scenario” in the event of a margin call involving a large amount of an insider’s shares can be very bad – and if you remember the Green Mountain Coffee Roasters fiasco from about a decade ago, you know exactly what I mean by “very bad.”
We’ve posted the transcript from our recent webcast – “ISS Forecast for 2023 Proxy Season.” ISS’s Marc Goldstein provided a recap of what transpired during the 2022 proxy season and thoughts on the issues companies will face in the upcoming proxy season. Davis Polk’s Ning Chiu & Gunster’s Bob Lamm joined in the dialogue with Marc. The program was full of useful information, including this nugget about what ISS expects from companies with less than 70% say-on-pay support:
What we always tell companies is, “Go and talk to your shareholders.” We want to see in the proxy how many shareholders you spoke to. It can be a number, it can be a percentage. We want some indication of the breadth of the engagement program. What did you hear from shareholders and what did you do in response? It’s not rocket science, it’s fairly simple. If companies report in the proxy that shareholder feedback was on issues A, B, and C and ISS had identified a different set of issues in our report, we expect the company to be responsive to what shareholders said rather than what was in the ISS report.
If a company received low support and then claims that every shareholder they spoke to was supportive of the program, that raises some credibility issues. Clearly, you’re not talking to the right people if Say on Pay failed or got 50% support. Someone obviously wasn’t supportive. Go out and find them, talk to them, and figure out what was the basis of their opposition and what you can do about that.
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When I read Liz’s “Debbie Downer” blog last week about the disclosure implications of the “polycrisis,” I was so bummed out that I wanted to go back to bed and pull the covers up over my head. However, my wife decided there was zero chance I was going to get away with that stunt and accused me of using that as an excuse to avoid taking the trash & recycling out to the curb.
Okay, it turns out she was right about that, but the important thing is that I’ve recovered my equilibrium and feel that I need a “Gloomy Gus” blog to pair with Liz’s Debbie Downer offering. Thanks to this Morgan Lewis memo, I’ve found my topic. Liz catalogued a whole bunch of economic & geopolitical developments that might merit an updated risk factor or two, but this excerpt from the memo highlights one she didn’t address – the increasingly frosty relationship between the United States and China:
As geopolitical tensions between the United States and China continue, issuers should consider carefully tailoring their risk factors to address specific risks facing their businesses related to China, and should benchmark these risk factors against what their peers are disclosing. While the risk factors of Chinese-based companies publicly traded in the United States offer a catalog of China-related risks to consider, including those risks for which the US Securities and Exchange Commission (SEC) has requested explicit disclosure through staff comment letters, many of these will not be relevant to US issuers doing business in China.
Reliance on generic risk factors related to the risks of doing business internationally may fall short of properly informing investors of the specific risks an issuer may face when engaging in certain China-related activities, and the SEC discourages such boilerplate disclosure.
The memo says that while the SEC hasn’t put forward guidance on risk factor disclosure relating to the implications of significant exposure to China, companies should look to the disclosure guidance provided by the Staff on COVID-19 & the Staff’s sample comment letter on the business impact of Russia’s invasion of Ukraine as a framework. It goes on to provide a list of some specific areas of China-related risk that companies might want to address in their disclosures.
Thompson Hine recently released its second annual survey of corporate ESG programs. The survey addresses a variety of issues associated with those programs. Here are some of the highlights:
– The top current challenge for respondent private companies is Data Collection (20%) (but not Data Verification (only 2%)), followed by Green Initiatives and Staffing (12% each), and Talent Management/Human Capital and Regulatory Activity (10% each). Risk Management is also a concern (8%).
– Public companies report currently being most concerned with Green Initiatives (23%), followed by Data Verification (15%), Regulatory Activity (13%) and Talent Management/Human Capital (8%).
– Private company respondents reveal that their CEO usually has primary responsibility for ESG oversight (35%, compared to 31% last year). However, while 25% of public companies surveyed last year said their CEO had primary ESG responsibility, this year that number dropped to only 8%, with the Chief Sustainability Officer assuming that role 28% of the time.
– While the majority of respondent companies are not yet seeking ESG information or obligations through their contractual arrangements, 24% of private companies and 31% of public companies report they are doing so.
– 53% of respondent companies’ customers are not currently requiring them to report ESG information, but 34% of customers are asking for information on GHG emissions, 25% want DEI data and 21% are concerned about human capital.
Of course, the elephant in the room this year when it comes to corporate ESG programs is the looming adoption of the SEC’s proposed climate disclosure rules. That’s not lost on survey respondents – not only are 79% of public companies preparing to follow the mandates of the draft SEC rule, but so are 30% of private companies.
Tune in at 2pm Eastern tomorrow for the webcast – “The SEC’s Rule 10b5-1 Amendments: What Issuers & Insiders Need to Know” – to hear Brian Breheny of Skadden, Ning Chiu of Davis Polk, Meredith Cross of WilmerHale, Dave Lynn of Morrison Foerster and TheCorporateCounsel.net, and Ron Mueller of Gibson Dunn discuss the changes to Rule 10b5-1 & the adoption of disclosure obligations and provide insights about what companies and insiders should do to prepare for the new regime.
If you attend the live version of this 90-minute program, CLE credit will be available. You just need to fill out this form to submit your state and license number and complete the prompts during the program. All credits are pending state approval.
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Earlier this week, the SEC released its Fall 2022 Reg Flex Agenda. Based on the dates the agency has targeted for action on some major rule proposals, it looks like it’s going to have a very busy first quarter. Here are some of the more consequential rule proposals that the SEC says it wants to act on in the next few months:
Whenever we blog about these Reg Flex Agenda dates, we always point out that they are by no means etched in stone. That being said, the only major item on the last edition of the SEC’s Reg Flex Agenda where final action was postponed was the agency’s climate change disclosure proposal. So, it looks like could be in for a veritable “bomb cyclone” of rulemaking over the next few months.
The SEC’s effort to require some companies to provide disclosure about Scope 3 emissions is probably the most controversial part of its proposed climate change disclosure rules. Now, this PlanSponsor article reports that comments at a recent House Financial Services subcommittee hearing suggests that political support for a Scope 3 disclosure requirement among House Democrats may be getting a little wobbly:
At the December 8 hearing, Subcommittee Chairman Brad Sherman, D-California, said, “Scope 1 and Scope 2 being proposed by the SEC, I think, make a lot of sense. It is going to be hard to go into Scope 3, and that may be a bridge too far; it may give us effects far beyond what we are trying to achieve.”
Sherman is far from alone in this opinion. A letter by Representative Cynthia Axne, D-Iowa, signed by four other House Democrats in October, also expressed concern about Scope 3. In particular, the letter called for clarity and greater protections for farms and small businesses that would have to collect data for their publicly listed customers and suppliers.
The article points out that in light of strong opposition from Republicans to mandatory disclosure of Scope 3 emissions data, erosion in support among Dems may increase the likelihood that this disclosure requirement won’t make the final cut. The Reg Flex Agenda suggests that we’ll find out pretty soon. Stay tuned.
Liz’s change in status has prompted us to rethink how we email our blogs to you each morning. At the end of the month, we’re going to change over from our current practice of having our blogs come from the email address of one of our editors. Going forward, all of our blogs will be sent from Editorial@TheCorporateCounsel.net. Our objective is to establish a sender address that won’t need to be changed every time there’s a change on the editorial masthead, which hopefully means that this will be the last time we have to ask you to take the time to whitelist our email addresses.
We know that whitelisting is kind of a pain in the neck, so we’ve put together this whitelisting instruction page to help you and your IT department understand what actions you may need to take in order to ensure there’s no disruption in delivery. We’re going to begin to send blogs from the Editorial@TheCorporateCounsel.net address over the course of the next several weeks, so please be sure to whitelist the new address at your earliest convenience. We’re going to do this incrementally across our sites, and we’ll keep you apprised of when we plan to make the change for a specific site.
There are a couple of things that I also want to mention about this change. First, the name of the author of a blog will always appear in the email, so if you want to respond to the author, you can just click on the author’s name and their email address will pop up. Second, Editorial@TheCorporateCounsel.net isn’t a black hole. If you hit reply, your message will go to a folder that I’ll have access to. I’ll check that every few days and forward your email to the appropriate editor. Finally, thanks for your patience and cooperation.
I think most securities lawyers are a little paranoid when it comes to their public company clients’ interactions with securities analysts. After all, the 2nd Cir. famously compared these interactions to “a fencing match conducted on a tightrope” in SEC v. Bausch & Lomb, (2d. Cir. 9/77), and we’ve become accustomed to advising clients of the parade of horribles that can result when a discussion with securities analysts goes awry. However, a recent 4th Cir. decision provides a refreshing reminder that a company isn’t always on the hook for the spin that analysts put on its management’s remarks to them.
Boykin v. K12 Inc., (4th Cir. 11/22), arose out of statements made by a public company’s CEO concerning a potentially lucrative business relationship with the Miami-Dade School District. These comments were characterized by analysts as the CEO essentially confirming the existence of a “signed contract” between the parties. The potential deal subsequently unraveled, and the plaintiffs sued the company alleging that its CEO had made material misstatements about the status of the business deal. The Court disagreed, and this excerpt from the 10b-5 Daily’s blog on the decision explains the court’s reasoning:
On appeal from the district court’s dismissal of the complaint, the Fourth Circuit found that the company’s statements about the Miami-Dade deal “could well have factored into the run-up of K12 shares during the summer of 2020.” As to the falsity of the statements and the defendants’ scienter (i.e., fraudulent intent), however, the court was less convinced.
First, the falsity element is based on a reasonable investor’s view of the company’s statements, “not any individual investor’s reaction.” If the analysts believed that the CEO had confirmed the existence of a done deal, they were simply incorrect given that the CEO never “attested unambiguously to having a signed agreement.” And to the extent that the CEO “was gesturing to an extensive working relationship between K12 and Miami-Dade,” that was factually accurate at the time. Indeed, Miami-Dade’s superintendent even signed the completed contract in mid-August, but it was never returned to K12.
The Court also concluded that the plaintiffs’ failed to adequately allege scienter, noting both that the timeline was consistent with the CEO’s “anticipation in mid-August of a consummated deal with Miami-Dade” and that if the CEO’s goal had been to inflate K12’s stock price, “he could have chosen far less ambiguous language than he did.”
While this case’s result is somewhat reassuring, I suppose it’s still a bit of a cautionary tale about the risks of letting analysts’ mischaracterizations of management comments go unaddressed. After all, the company only got to this outcome after a couple of years of litigation involving a not insignificant amount of expense and distraction.
Will the fallout from 2022’s crypto meltdown lead to an SEC enforcement sweep targeting crypto exchanges in 2023? Former SEC Internet Enforcement Chief John Reed Stark says “you bet!” In fact, a looming enforcement sweep tops his list of 12 crypto predictions for 2023:
An Enforcement sweep carried out by the U.S. securities and Exchange Commission (SEC) of crypto-intermediaries is clearly coming in 2023. Senior SEC crypto-officials have promised as much too many times for a crypto-sweep not to happen. Just read the following recent quotes from the three most important SEC crypto-enforcement officials. In my experience, the SEC does not make idle threats and the “runway” no longer runneth over:
November 15, 2022: Per SEC Crypto Unit Chief David Hirsch at the SEC Enforcement Forum: “We want people to come in and register so that investors can decide on what risks they would like to take. There is a runway for crypto intermediaries and exchanges to come in and get registered, but I think that RUNWAY is growing shorter and SEC enforcement is willing to move forward and bring enforcement actions as appropriate.” (emphasis added)
December 8, 2022: Per SEC Chair Gary Gensler on Speaking with Yahoo!: “I’ve got one goal is that these platforms, the exchanges, the lending platforms come into compliance. They can do that appropriately working with the SEC. Or we can continue on the course with more enforcement actions. And I would have to say that the RUNWAY is getting shorter.” (emphasis added)
December 13, 2022: Per SEC Enforcement Director Gurbir Grewal at the DOJ FTX Press conference: “Grewal warned investors and customers to remain cautious on crypto platforms, which he said “don’t provide [customers] with the same robust level of disclosures and protections against fraud and conflicts of interest” as SEC-registered platforms do. As Chair Gensler has made clear, the RUNWAY is getting shorter for them to come in to register with us. And for those who do not, the Enforcement Division stands ready to take action.” (emphasis added)
Stark goes on to give the crypto industry a thorough – and quite entertaining – thrashing. Here’s an example:
Gensler, Gurbir and Hirsch could not say it any plainer. Fail not at your peril crypto-ecosystem, you are all squarely within the SEC’s sights. By calling themselves “exchanges,” “brokers,” and “market-makers,” crypto firms co-opt historically powerful nomenclature that implies trust, oversight and consumer protection, etc. This is a material ruse. It’s like if a drug dealing gang suddenly offered to perform brain surgery for customers, yet had never gone to med school, never done a hospital internship or residency and their only health training consisted of watching a few TikTok videos.
