Bass Berry’s Jay Knight recently blogged about a comment letter exchange in which the Staff objected to a company’s presentation of a non-GAAP measure adjusted for expenses incurred in transitioning to public company status. Here’s an excerpt:
We found particularly interesting this recent comment letter exchange (see here and here) where the SEC Staff took issue when a company, which had recently gone public, included an adjustment in its Adjusted EBITDA non-GAAP financial measure for “public company expenses” related to “additional headcount to build infrastructure and support the operations of a public company (i.e., public company directors & officers liability insurance, investor relation and public listing fees, additional legal and accounting fees, and additional independent board members).”
In the Staff’s view, these expenses were normal, recurring expenses associated with public company status and efforts to back them out of Adjusted EBITDA involved inappropriate “tailored accounting.” The company agreed to remove the adjustment in future filings.
On Tuesday, Coinbase announced disappointing first quarter earnings. In the midst of a crypto crash, that would’ve been enough by itself to result in a big hit to the company’s stock price, but to make matters worse, the addition of new language to an existing risk factor prompted a firestorm of negative media reports about the company’s prospects. What caught the eye of many analysts was an updated version of a risk factor relating to issues associated with safeguarding client assets that appeared on p. 40 of its latest Form 10-K. The company’s first quarter Form 10-Q tacked on the following sentences to the first paragraph of that risk factor, which appears on p. 83 of the filing:
Moreover, because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors. This may result in customers finding our custodial services more risky and less attractive and any failure to increase our customer base, discontinuation or reduction in use of our platform and products by existing customers as a result could adversely impact our business, operating results, and financial condition.
That language was added in response to the SEC Accounting Staff’s issuance of SAB 121, which addressed accounting for safeguarded digital assets and noted that “disclosures regarding the significant risks and uncertainties associated with the entity holding crypto-assets for its platform users may also be required outside the financial statements under existing Commission rules, such as in the description of business, risk factors, or management’s discussion and analysis of financial condition and results of operation.”
My guess is that Coinbase probably viewed this disclosure as not being particularly material. It likely concluded that it was simply making explicit something that was implicit in its existing risk factor disclosure or at least widely known among crypto investors. But the market freaked out after media reports suggested that the new language implied that the company was facing the risk of bankruptcy. To make matters worse, some of those reports accused the company of hiding this allegedly apocalyptic disclosure. Ultimately, Coinbase’s CEO felt compelled to respond with a Twitter thread explaining the fact that the disclosure was prompted by the adoption of SAB 121.
I think there are a couple of takeaways from the Coinbase situation. First, sometimes a perfect storm of negative events surrounding a company and its industry can transform what a company thinks is a non-controversial risk factor update into a five-alarm fire – and the possibility of that kind of perfect storm needs to be kept in mind when drafting disclosure and considering its possible impact.
Second, as we point out in the discussion on p. 9-10 of our Risk Factors Disclosure Handbook, companies take different approaches to updating risk factors. Some opt to simply set forth the risk factors that are being updated in the filing, while others, like Coinbase, include the entire set of risk factors that appeared in the 10-K. We recommend that companies that repeat the entire section highlight the updated language in some fashion. Highlighting the new language might not stop an unexpected firestorm from happening, but it might help avoid accusations of attempting to bury the disclosure if one does break out.
As the war in Ukraine rages on, the U.S. and its allies continue to ratchet up pressure on the Putin regime by expanding the scope of economic sanctions imposed on Russia. This Ropes & Gray memo summarizes the latest round of sanctions, which extend to accounting, trust, corporate formation and management consulting services. Here’s an excerpt:
Executive Order 14071, issued on April 8, 2022, prohibits “the exportation, reexportation, sale, or supply, directly or indirectly, from the United States, or by a United States person,” of any category of services subsequently identified by the U.S. government as impermissible. On May 8, OFAC, in consultation with the State Department, has now determined that the provision of accounting, trust, and corporate formation, as well as management consulting activities, to parties in the Russian Federation should be prohibited, effective June 7 (the “Services Determination”). In connection with the Services Determination, OFAC issued the following explanatory guidance:
– “Accounting services” includes any “services related to the measurement, processing, and transfer of financial data about economic entities.”
– “Trust and corporate formation services” includes “services related to assisting persons in forming or structuring legal persons, such as trusts and corporations; acting or arranging for other persons to act as directors, secretaries, administrative trustees, trust fiduciaries, registered agents, or nominee shareholders of legal persons; providing a registered office, business address, correspondence address, or administrative address for legal persons; and providing administrative services for trusts.”
– “Management consulting services” includes “services related to strategic advice; organizational and systems planning, evaluation, and selection; marketing objectives and policies; mergers, acquisitions, and organizational structure; staff augmentation and human resources policies and practices; and brand management.”
We’re continuing to post resources in our “Ukraine Crisis” Practice Area on a daily basis. One recent addition that you may find helpful is this Jones Day memo, which provides a cross-jurisdiction summary of key Russia-related sanctions imposed by Australia, the EU, Japan, the UK & the US.
Speaking of sanctions, the DOJ is extremely interested in companies’ efforts to comply with them. Here’s an excerpt from this Davis Polk memo:
At a recent New York City Bar Association event, Deputy Attorney General Lisa Monaco emphasized the centrality of national security to the Department of Justice’s white collar enforcement efforts. In particular, Monaco pointed to the enforcement of sanctions evasion and export control violations as key to the Department’s work to combat corporate crime. “One way to think about this is as sanctions being the new FCPA,” she said.
Although the Foreign Corrupt Practices Act (FCPA) has long been a focus of the Department’s corporate enforcement efforts, criminal enforcement of sanctions laws (the Trading With the Enemy Act and the International Emergency Economic Powers Act) has not been as widely publicized as a Department priority for corporate enforcement. Monaco’s remarks have thrown such enforcement under the spotlight.
The memo says that the DOJ appears poised to aggressively enforce sanctions evasion and export control violations, and it is possible that it seek harsher penalties and resolutions for violations of the sanctions laws. Because of the potential overlap between corruption and sanctions enforcement, the memo also says that the DOJ’s initiative could lead to increased collaboration with other agencies, including the State Department, the Commerce Department, and the Treasury Department’s Office of Foreign Assets Control. Involvement of multiple agencies and departments may make investigations and their resolution much more complicated.
The SEC’s climate change disclosure proposal was on the agenda at last Friday’s meeting of the SEC’s Small Business Capital Formation Advisory Committee. As you might expect, the various small business representatives who spoke at the meeting had plenty to say about the proposal, and Cooley’s Cydney Posner recently provided a detailed summary of the meeting and the recommendations the committee will pass along to the SEC. This excerpt lists those recommendations, which Cydney points out are subject to further amplification:
– Affirm that the committee believes that climate disclosure is important, including disclosure that is consistent across companies and agencies;
– Ask the SEC to perform a more detailed cost/benefit analysis, especially with respect to smaller companies;
– Provide more scaling and phase-ins for EGCs and smaller reporting companies (such as the phase-in for EGCs in the JOBS Act);
– Expand safe harbors from liability;
– Create an incentive structure rather than a penalty structure (such as through reduced fees);
– Address considerations that could deter companies from conducting IPOs;
– Address the potential impact on very small companies;
– Consider the impact on private companies of public companies’ potential reluctance to include them in the value chain;
– Consider industry-specific requirements, similar to the SASB framework;
– Eliminate the costly and slow attestation requirement;
– Treat the disclosure as “furnished,” not “filed”;
– Delay the disclosure due date; and
– Delay the general phase-in dates to allow more time to organize and prepare.
This list of recommendations isn’t really surprising, but I think it confirms the widely held belief that, in their current form, the proposed climate change disclosure rules will present enormous compliance challenges to smaller companies. It also suggests that the cost of those compliance efforts may have been underestimated by the SEC when it put forward the proposal.
I recently blogged about the role political risk insurance might play in helping companies recoup some of their losses arising out of Russia’s invasion of Ukraine. Yesterday’s WSJ included an article on the growing demand for political risk insurance since the Ukraine crisis began, but notes that it’s focused on another geopolitical nightmare scenario – a Chinese invasion of Taiwan. This excerpt quotes Daniel Riordan, who’s in charge of Vantage Group’s political risk business:
“They’re concerned about the potential for China getting even more aggressive with Taiwan, particularly in the wake of Russia’s invading Ukraine,” said Mr. Riordan, adding that his political risk business has seen an influx of new clients. “We’re seeing boards who are saying, ‘OK, where’s our political risk insurance?’” he said.
Mr. Riordan said his political risk business—measured in the volume of new insurance proposals submitted to underwriters—jumped about 25% from the last quarter of 2021 to the first quarter of 2022, driven in part by China-related concerns. The increase bucked a normal trend of business slowdown over that time frame, he said.
Beijing regards Taiwan as an integral part of the People’s Republic of China, while Taiwan views itself as a sovereign and independent state. Tensions between the two have risen in recent years, as China has suppressed Hong Kong’s democratic aspirations and repeatedly dispatched military aircraft into Taiwan’s air-defense zone.
The article says that Taiwan-related political risk insurance has been purchased to cover risks in the tech & power sectors, reflecting Taiwan’s dominance in semiconductors and its wind-power industry. In mainland China, it’s companies with manufacturing operations there that are the prime customers for political risk insurance. Not surprisingly, the article also says that pricing is on the rise and that the number of underwriters participating in the market is starting to decline.
If your company has significant exposure to either Taiwan or China – and who doesn’t? – then you may want to look into political risk insurance or other alternatives to mitigate the risk of an armed conflict. If war breaks out between China & Taiwan and your board hasn’t devoted serious attention to alternatives for mitigating political risk in those countries, they may well be setting themselves up for a Caremark claim. Of course, if China invades Taiwan, corporate director liability may be pretty far down the list of our concerns.
Last week, a member asked a question in the Q&A Forum about whether anyone else was experiencing a situation where an EDGAR filing had been made & accepted but wasn’t showing up on the SEC’s website for several days. Nobody responded – and I hadn’t heard anything – so I assumed that this might be an isolated problem. It turns out that’s not the case. Yesterday, I received the following heads up from a member confirming that multiple filers are experiencing this same issue with EDGAR:
We have had multiple clients in the past week that have experienced issues with EDGAR where a submission was made and accepted, but it doesn’t show up on EDGAR for several days. (When it shows up on EDGAR, it is placed in the correct time when accepted.) We’ve contacted the EDGAR office about this and they are aware of the issue and are working to resolve it. (For what it’s worth, we’ve heard that sometimes the filing show up on Westlaw or other third party vendor much sooner than it shows up on public EDGAR, so it is likely a glitch in the public EDGAR system.)
Apparently, some filings may show up on the “Latest Filings” page before appearing on the company’s page, and we’re told that if you keep refreshing the site, your filing will eventually show up.
Yesterday, the SEC extended the comment period for its controversial climate change disclosure proposal to June 17th. The comment period was scheduled to expire on May 20th, and as Dave blogged a few weeks ago, the SEC has been taking a lot of heat over the relatively brief length of the comment period originally established for the proposal. The SEC’s press release also announced the reopening of the comment period for the SEC’s proposed overhaul of private fund advisor rules & its recent proposal regarding the definition of an “exchange” and amendments to Regulation ATS (Reg ATS). The comment period for these proposals will expire 30 days following publication of the reopening release in the Federal Register.
These latter two proposals – which combined exceed 900 pages – originally provided for a 30-day comment period. As with the climate change proposals, the SEC took some heat here over the length of the original comment period. Check out this rather pointed excerpt from the American Securities Association’s comment letter on the private fund advisors proposal:
The Proposal is just one of the many complex and consequential rulemakings the SEC has proposed in recent months. To date, the SEC has proposed sixteen new rulemakings, in addition to several others that were proposed at the end of 2021. Most of these proposals run to hundreds of pages in length, and often include hundreds of questions that commenters must consider when assessing the impact of potential new rules.
The Proposal itself is 342 pages and includes several very specific questions, some of which hint at further mandates that are not fully explored or analyzed in the release. Yet the SEC provided the public only thirty (30) days to comment on the Proposal. This is simply an inadequate amount of time for the public to properly consider how the contents of the Proposal will affect the U.S. securities markets – particularly when many entities are simultaneously considering and developing comments on over a dozen other rulemakings from the SEC, trying to navigate unprecedented market volatility.
We haven’t covered the Reg ATS proposal here, but crypto-world is freaking out about it, and the ASA submitted an identical critique concerning the length of the comment period for that proposal.
It’s hard to say whether the SEC’s action represents a broad retreat from its recent preference for short comment periods, but it appears that the SEC recognized that adopting short comment periods for these lengthy, intricate & controversial rule proposals wasn’t a good look – and it deserves some credit for the decision to extend them.
I’m sure it won’t escape the watchful eye of conspiracy theorists that the expiration date of the climate change proposal’s comment period now coincides with the 50th anniversary of the Watergate break-in. However, as a Cleveland Browns fan, I prefer to note that it also coincides with the 28th birthday of the team’s recently acquired WR, Amari Cooper.
This Weil survey reviews governance & liquidity arrangements in 2021 sponsor-backed IPOs. The survey reviewed the terms of 15 U.S. IPOs by companies that had one or more private equity sponsors. Of these transactions, 10 were “club” deals involving more than one sponsor, while the remaining five were single-sponsor deals. Here are some of the conclusions on corporate governance arrangements:
– Consistent with previous years, in a significant majority of surveyed deals (87%), Sponsor-backed IPO companies availed themselves of at least some “controlled company” exemptions available under applicable listing requirements, which, among other things, exempt such companies from certain board and committee director independence requirements (other than with respect to the audit committee). Notably, even though companies are availing themselves of the controlled company exemptions, most Sponsor-backed companies are going public with a majority of independent directors.
– Consistent with previous years, Sponsors in the surveyed deals typically (93%) adopted a classified board structure for the newly public company in connection with an IPO. In one of the surveyed deals, the classified board structure established in connection with the IPO is subject to “sunset” (triggered upon the earlier of 5 years following the IPO or when Sponsor’s ownership drops below 50% of the voting power of the common stock necessary to elect directors) to address governance and proxy advisory firm concerns.
– In a significant majority of surveyed deals (80%), Sponsors secured contractual rights to nominate or designate directors to serve on the public company’s board of directors (in some cases, including committees) following an IPO. Such director nomination rights were secured in all “club” deals and in 40% of single-Sponsor deals. In 70% of “club” deals where Sponsors secured contractual rights to nominate or designate directors and in 100% of such single-Sponsor deals, Sponsors secured the right to elect a majority of the directors constituting the board.
The survey says that all of the transactions included provisions secured the ability of shareholders to act by written consent so long as sponsors held a specified ownership percentage. In addition, in 70% of “club” deals and in 20% single-sponsor deals, sponsors had the right to call special meetings of shareholders so long as they held a specified ownership percentage. All of the surveyed deals included a waiver of the corporate opportunity doctrine in favor of the sponsor in their post-IPO charter documents.
The validity and accuracy of the assessments and subsequent company decisions rests heavily on ensuring you have and use high quality ESG data and that there is accountability for progress on the company’s ESG strategy. The data must be credible, validated and reported as appropriate to the board. For more on this, join us today at 2pm Eastern for our PracticalESG.com webcast “Putting the ‘G’ First: Oversight of ‘E’ & ‘S’ in ESG”. Sunrun’s Sundance Banks, Orrick’s JT Ho, Delta Air Lines’ Stephanie Bignon and American Express’s Kristina Fink will share their insights on prioritizing governance and overseeing E&S issues.
You can attend the webcast for free if you are a PracticalESG.com member. Registration information is available on the webcast page – but remember that the incremental cost of a membership gets you much more bang for your buck. If you’re not already a member with access to our full suite of resources, sign up online or by emailing sales@ccrcorp.com or calling 800-737-1271. Our “100 Day Promise” allows you to try a subscription at no risk for 100 days – within that time, you may cancel for any reason and receive a full refund!
