Yesterday, the SEC announced that it was reopening the comment period for the Dodd Frank-mandated pay-for-performance disclosure rules that the agency proposed way back in 2015. Here’s the 29-page reopening release & the 2-page fact sheet. This excerpt from the fact sheet summarizes the reasons for the SEC’s decision to reopen comments as well as some changes to the initial proposal that are being contemplated:
The Commission received numerous comment letters on the 2015 proposing release. In light of the regulatory and market developments since 2015, the Commission is providing the public the opportunity to submit additional comments on the 2015 proposal, and to address the additional requirements the Commission is considering in the reopening release issued today. These additional requirements include, among other things:
– Whether registrants should be required to disclose additional performance measures beyond total shareholder return;
– Whether, if required, pre-tax net income and net income would be useful additional financial measures;
– Whether registrants should be required to disclose the measure that in the registrant’s assessment represents the most important performance measure used by the registrant to link compensation actually paid during the fiscal year to company performance (which is called the “Company-Selected Measure”); and
– Whether registrants should also be required to disclose a tabular list of a registrant’s five most important performance measures used to determine compensation actually paid.
Commissioner Peirce issued a brief dissenting statement in which she contended that “the additional requirements raised in this release go well beyond the statutory mandate of Section 953(a), are not responsive to the comment file, and do not seem warranted in light of current executive compensation practices related to company performance.” Commissioner Lee weighed in with a supporting statement and Commissioner Crenshaw provided one as well.
The reopened comment period will expire 30 days after publication of the release in the Federal Register. However, the SEC hasn’t exactly been rocketing into print with its recent rule proposals – the10b5-1 & buybacks proposals still haven’t been published – so it’s possible that the reopened comment period actually may be quite a bit longer than that.
Pardon me for using this blog to share some personal news, but it’s kind of a big deal – at least for me. You see, today is my final day at Calfee, Halter & Griswold LLP, the law firm I’ve worked at since I graduated from law school 35 years ago. They say that “time flies,” and while I’ve had many days that seemed to drag on forever during my legal career (I’m looking at you, Bowne & Donnelley), that expression sure seems apt when you’re looking through the rearview mirror.
I guess I expected to feel a little more wistful about resigning, but I think I don’t feel that way primarily because this is my second try at it. When Broc & Nathan Brill offered me a position here back in 2016, I actually resigned, but the firm was going through some other transitions and asked me to stay on. Now, I think we’ve both agreed that I’ve reached my expiration date!
Anyway, I’ll certainly miss my colleagues at Calfee. It’s a great firm, and I wish them all the best. But I am not sad to go. Through no fault of my own, I stumbled onto the best job in the world five and a half years ago. I’m incredibly grateful to Nathan and Broc for giving me that opportunity, and to all of my colleagues, past and present, for making this such a great place to work. I hope to have the chance to work with everyone here for a long time to come.
There’s something else I’m looking forward to as I leave my law firm, and that’s saying goodbye to the knot in my stomach that’s been there for 35 years. I think most of you know exactly what I’m talking about. If you’re a securities lawyer, you learn fast that you’re working without a net. Your entire career is based on your reputation, and when it comes to preserving it, you’re only as good as the last thing you screwed up.
You get used to making high-stakes judgment calls on a shot clock, even though you often don’t have all the information you need. It comes with the job, but it also comes with a price – and the knot in your stomach that never completely goes away is a big part of that price. Hopefully, my colleagues and I are able to come up with some things that help loosen the knot in your stomach every now and again.
So, what are my parting words for my friends and colleagues at the law firm where I’ve spent my entire professional career? Heh-heh, you know, I’ve always wanted to do this, and I know they’d all be disappointed in me if I didn’t – take it away, Edith!
Apparently, SEC Chair Gary Gensler had a brief media availability last week in which he shared some thoughts on the status of potential reforms to the beneficial ownership reporting rules under Section 13(d) of the Exchange Act. The financial media doesn’t appear to have picked up on this, although CNBC’s Eamon Javers did tweet out a report on Gensler’s comments. According to that report, the SEC chair’s primary concern is addressing information asymmetries created by the 10-day lag between the acquisition of a 5% or greater stake and the deadline for reporting it:
Gensler said he is considering tightening the deadline to disclose such large holdings, which is currently set at 10 days. Large active traders are likely to hate this, because it’s harder for them to make money if they have to reveal strategies to the public too soon. Still, Gensler said “I would anticipate we’d have something on that.” He said he is worried about “information asymmetry,” because the public doesn’t know there’s a big player buying up shares during the 10-day period.
He said: “Right now, if you crossed the 5% threshold on day 1, and you have 10 days to file, that activist might in that period of time, just go up from 5 to 6% or they might go from 5 to 15% but there’s nine days the selling shareholders in the public don’t know that information.” More Gensler: “And that’s what motivates me, is some of that information asymmetry. So, we’re looking at that. I would anticipate that we’d have something on that.”
Unfortunately, Gary Gensler didn’t provide any insight as to the timing of a rule proposal, but it clearly remains on his “to do” list.
Section 27(a) of the Exchange Act vests federal courts with exclusive jurisdiction over claims arising under that statute. So, what happens when a company adopts a bylaw mandating a state court as the exclusive forum for all derivative claims? As I blogged over on DealLawyers.com last year, a pair of California federal court decisions indicate that such a bylaw provision is enforceable, even though it would effectively preclude a plaintiff from asserting derivative claims under Section 14(a) of the Exchange Act. Recently, however, the 7th Cir. reached a different conclusion.
In Seafarers Pension Plan v. Bradway, (7th Cir.; 1/22), a divided 7th Circuit panel held that an exclusive forum bylaw could not be used to preclude a plaintiff from filing a lawsuit premised on violations of Section 14(a) of the Exchange Act in federal court. Here’s an excerpt from this Shearman blog reviewing the Court’s decision:
The Court began by holding that the Company’s choice-of-forum provision violated Delaware law because it was “inconsistent with the jurisdictional requirements of the Exchange Act.” According to the Court, Section 115 [of the DGCL] was “not intended to authorize a provision that purports to foreclose suit in a federal court based on federal jurisdiction,” which is exactly what application of the Company’s choice-of-forum provision would do. The Court then explained that, while Section 115 expressly authorizes choice-of-law provisions that require shareholders to file derivative suits “in” the state of Delaware, it does not authorize bylaws that restrict such suits to courts “of” the state of Delaware. The Court held that Delaware law “does not authorize application of [the Company’s] forum bylaw to close all courthouse doors to this derivative action.”
Next, the Court held that enforcing the Company’s choice-of-forum provision would violate federal law. “Because the federal Exchange Act gives federal courts exclusive jurisdiction over actions under it, applying the bylaw to this case would mean that plaintiff’s derivative Section 14(a) action may not be heard in any forum.” The Court emphasized that “[b]oth federal [Securities] Acts contain anti-waiver provisions that prevent parties from opting out of the federal laws in favor of state law, no matter how similar or strong the state-law rights and remedies are.”
Over on The Business Law Prof Blog, Ann Lipton finds the Court’s opinion to be a bit of a head scratcher:
This entire discussion, to me, is baffling, because it’s almost an afterthought that the Seventh Circuit concludes the bylaw as applied here violates the anti-waiver provisions of the Exchange Act. Normally, you’d expect that to end the matter; whether Delaware does or doesn’t authorize the bylaw is beside the point, because the Supremacy Clause beats Delaware. Instead, the primary focus of the Seventh Circuit is what Delaware thinks of such bylaws – and whether, amazingly, a Delaware Chancery court thinks they violate the Exchange Act.
Delaware courts have become more accommodating to Caremark claims in recent years and this recent Sidley blog cautions that the claims, which are premised on a board’s failure to fulfill its oversight responsibilities, may become increasingly attractive to plaintiffs in situations involving data breaches. Here’s an excerpt:
To successfully allege a Caremark claim, a plaintiff must plead facts demonstrating that either “(a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.” Put differently, the directors must have acted in bad faith in failing to oversee. Furthermore, this failure must be related to some aspect of the business that is “essential and mission critical.”
As our “data economy” has fed an increase in data security incidents, failures in data security have in turn created significant risks to corporations. These risks take many forms, including loss of access to business-critical data and IT infrastructure, successful consumer class action lawsuits, regulatory liability, or loss of commercial counterparties or liability to those counterparties. Not surprisingly, shareholder lawsuits have also followed, seeking to hold corporate boards responsible for lax oversight that results in harm to the corporation following a data security incident.
To date, Caremark claims based on data security incidents have mostly failed to gain traction; the vast majority have been dismissed at the motion to dismiss stage and a smaller portion have settled, as our colleagues noted in an article for Bloomberg Law back in 2017. Several recent cases have confirmed that Caremark claims remain difficult to bring (much less win), even when those claims are based on data security incidents. But these cases also reveal potential avenues that shareholder plaintiffs may pursue when bringing data security-related Caremark claims.
The blog highlights recent Caremark claims against Solar Winds & T-Mobile arising out of data breaches. The Solar Winds complaint focuses on Caremark’s first prong, and alleges that the Solar Winds board failed to implement necessary controls. In support of that allegation, the plaintiffs point to, among other things, the board’s failure to respond to an outside consultant’s warnings about data system vulnerabilities.
The T-Mobile case focuses on the second prong, and alleges that the company’s data security shortcomings involved violations of law – which in recent years have proven to be a fertile ground for Caremark claims. In particular, the complaint points to an FCC investigation and resulting fine to support allegations that the Board was “long aware of” yet “failed to heed . . . red flags” related to the company’s cybersecurity inadequacies.
The SEC recently scored a big win on the insider trading front, when a California federal court endorsed its novel “shadow trading” theory as the basis for a Rule 10b-5 enforcement proceeding. Here’s the intro to Cleary’s memo on the decision:
On January 14, 2022, the United States District Court for the Northern District of California issued a decision in SEC v. Matthew Panuwat validating the legal theory advanced by the Commission that trading in the securities of a competitor company could form the basis of an insider trading violation where the defendant learned that an acquisition of his employer was imminent.
In denying the defendant’s motion to dismiss the complaint, the court ruled that the SEC had sufficiently pled a claim, marking the first judicial decision concerning alleged insider trading in securities of a company based on material, nonpublic information (“MNPI”) about another company, a practice that has sometimes been referred to as “shadow trading.”
The court’s refusal to dismiss the SEC’s novel legal theory that trading on the basis of MNPI of one company to profit on a securities transaction involving a competitor constitutes actionable insider trading should be considered by companies and individuals as they assess trading decisions and policies.
The defendant allegedly traded stock of a direct and close competitor in a small market, and the memo points out that the straightforward facts of the case provided the SEC with an optimal setting for asserting its novel theory. This except says that the SEC might find other cases provide tougher sledding:
Other shadow trading fact patterns will likely have to grapple with more complicated determinations, including how material information about one company is for the value of securities of other companies in larger markets or less direct competitors (e.g., an insider at a company trading in the securities of a supplier or customer of the company).
When last we dropped in on Nasdaq, it had amended its proposal to permit direct listings with a capital raise in order to tweak the price range limitations contained in the rule. That amendment came only weeks after the SEC had approved the original version of the rule. Now this Fenwick memo reports that Nasdaq recently filed another amendment to its proposal:
On January 6, 2022, Nasdaq filed an amended rule proposal with the U.S. Securities and Exchange Commission to address the SEC’s questions and concerns related to the prior proposal filed by Nasdaq on May 25, 2021, which sought increased pricing flexibility in a Direct Listing with a Capital Raise.
Among other things, the amended proposal includes additional requirements for pricing a Direct Listing with a Capital Raise at more than 20% above the price range, adds certain notification requirements and a price volatility constraint, eliminates market orders (other than by the company) from the opening of the offering, requires a company to specify the quantity of shares registered in the S-1 registration statement and aligns the 20% price range deviation calculation with the SEC’s rules.
The memo has additional details on the amended proposal, and notes that the comment period will run until February 2, 2022, and the SEC will make a final decision on the proposal by February 25, 2022.
Liz recently blogged on the topic of how “homeless” public companies – those that claim not to have a principal executive office in their SEC filings – may create regulatory puzzles. Keith Bishop recently blogged a couple of specific examples of those puzzles under California law:
The designation of a corporation’s principal executive offices, of course, is one factor in determining whether a publicly held corporation is subject to California’s board quota laws. Cal. Corp. Code §§ 301.3, 301.4, 2115.5 & 2115.6. In addition, a domestic or foreign corporation required to file an annual statement of information (Form SI-550) must disclose the address of its principal executive office (no “s”). Cal. Corp. Code §§ 1502(a)(5) & 2117(a)(3).
Those corporations that have decided that they have no principal executive office may want to revisit their bylaws. Some corporate bylaws provide impose advance notice requirements on shareholders wishing either to submit a proposal for a shareholder vote or to nominate candidate(s) for election to the board. Often these provisions require that the notice be received at the corporation’s principal executive offices within a specified timeframe before the meeting. This is problematical if the corporation is taking the position that no such office exists in its filings with the Securities and Exchange Commission.
I know all the cool kids only want to exist in cyberspace or the metaverse or whatever this week’s variation on cloud cuckoo land is, but I think it’s kind of preposterous that the SEC permits companies to get away with offering securities without providing a physical address, particularly since they almost certainly have one. In that regard, this Olshan blog notes that “securities law commentators have suggested that the term “principal executive offices” would mean the place where the CEO and most other executive officers work most of the time.”
It’s no secret that rule amendments to enhance cybersecurity disclosure are on the SEC’s agenda, but in a speech yesterday at Northwestern Law School’s annual Securities Regulation Institute, SEC Chair Gary Gensler provided a little more color as to what public companies might expect to see in a rule proposal. Here’s an excerpt:
Disclosure regimes evolve over the decades. Cybersecurity is an emerging risk with which public issuers increasingly must contend. Thus, I’ve asked staff to make recommendations for the Commission’s consideration around companies’ cybersecurity practices and cyber risk disclosures. This may include their practices with respect to cybersecurity governance, strategy, and risk management.
A lot of issuers already provide cyber risk disclosure to investors. I think companies and investors alike would benefit if this information were presented in a consistent, comparable, and decision-useful manner.
In addition, I’ve asked staff to make recommendations around whether and how to update companies’ disclosures to investors when cyber events have occurred.
Make no mistake: Public companies already have certain obligations when it comes to cybersecurity disclosures. If customer data is stolen, if a company paid ransomware, that may be material to investors. As recent cases show, failure to make accurate disclosures of cybersecurity incidents and risks can result in enforcement actions.
Chair Gensler’s speech also addressed cybersecurity regulatory initiatives addressing broker-dealers, investment advisors, mutual funds and other participants in the financial sector – as well as service providers to those businesses.
The inaugural post on Goodwin’s new Public Company Advisory Blog shares some helpful tools on navigating the legal and practical aspects of the earnings release process. This 18-page Earnings Release Compliance Guide provides an overview of the legal issues that companies need to keep in mind when preparing their earnings releases, as well as guidance on dealing with potential problem areas. For example, this excerpt addresses the use of KPIs:
– Review key performance measures/indicators (KPIs) for consistency across quarters and other disclosure documents.
– KPIs are used by management to manage or evaluate the performance of the business. Certain KPIs may not meet the definition of a non-GAAP financial measure and thus may not be subject to Regulation G or Item 10(e) of Regulation S-K. Nevertheless, you need to consider what additional information may be necessary to provide adequate context for an investor to understand the KPI metric presented. In this regard, the SEC generally expects the following disclosures to accompany any KPI metric:
– a clear definition of the metric and how it is calculated,
– a statement indicating the reasons why the metric provides useful information to investors, and
– a statement indicating how management uses the metric in managing or monitoring the performance of the business
This publication is accompanied by a 6-page Earnings Release Compliance Checklist that provides a bullet-point summary of many of the topics covered in more depth in the Guide.
