In recent months, long-time SPAC structures that were spelled out in hundreds of registration statements reviewed by the Staff of Corp Fin have been called into question, most notably in a lawsuit filed by former SEC commissioner & NYU Law School professor Robert Jackson & Yale Law School professor John Morley. That lawsuit challenges Pershing Tontine’s compliance with the Investment Company Act, and calls into question underlying assumptions about the availability of an exemption from that statute that have been relied upon by SPACs for years.
That’s private litigation, not an enforcement proceeding – but its allegations concerning non-compliance with the Investment Company Act have been commented on favorably by current and former senior SEC officials. What’s more, in a recent article, one of those former officials, Harvard Law School professor John Coates, states that the SEC’s past inaction in the face of widespread belief in the availability of the exemption should not be an impediment to future enforcement proceedings:
Does the claim, then, reduce to a claim that a regulatory agency with a limited budget should be held to legally have given up authority if it does not bring an enforcement action when it could, even when the issue has been part of what even its promoters say was until 2020 a “backwater” of the capital markets?
No, I don’t think so. I think the claim reduces to a claim that an enforcement proceeding alleging that the typical SPAC structure violated the Investment Company Act would raise due process issues that could be avoided if the SEC opted to address these newly articulated concerns through rulemaking. I hope that’s the path that the agency will choose to take.
In addition to the SEC, the DOJ may find itself under pressure to use novel academic arguments to support enforcement activities – even in criminal proceedings. As I blogged last year, the DOJ has recently launched a major investigation into the business practices of short sellers. According to a recent NYT DealBook article, the legality of activist short sellers’ longstanding use of “short reports” has been called into question by Joshua Mitts, a professor at Columbia Law School:
Short sellers have long been told by their lawyers that as long as their reports contain no material inaccuracies and are not based on inside information, they have done nothing illegal. In the disclosure accompanying their reports, activist short sellers typically say they are short the stock but may cover at any time. And they add that they are not offering investment advice.
John Courtade, a former senior S.E.C. enforcement litigator who now represents short sellers, has designed some of these disclosures. “Scalping has to involve deception of some sort,” he said. “Just the fact that you’re going to close your position has never been held to be deception. If you look at the cases, they involve situations like not disclosing that you have a position at all.” But Mr. Mitts argues that whether the boilerplate disclosure is sufficient “has not been tested by the courts.”
The article says that the SEC is unlikely to move on a rulemaking petition submitted by Prof. Mitts, but that “it’s an open question as to whether the Justice Department will try to set a precedent by prosecuting short sellers for market manipulation under the scalping theory — or any other one not yet tested.”
I’m not a fan of SPACs or short sellers, but I am a fan of due process – and I think that there’s a legitimate risk that the SEC and the DOJ may cross the line in the upcoming months if they bring enforcement actions or criminal proceedings premised on conduct that has long been engaged in openly, with the advice of experienced counsel, and under the noses of regulators.
We’ve recently passed the 11,000-query mark in our “Q&A Forum.” Of course, as Broc would always point out when he wrote one of these Q&A milestone blogs, the “real” number is much higher since many queries have others piggy-backed upon them. When I first came on board, I never realized how much time I’d spend responding to these questions. Don’t get me wrong – all of my colleagues (and many of our members and advisory board members) have generously pitched in on the Q&A Forum, but everyone on the editorial team has their own set of responsibilities, and the way it turned out, addressing Q&A Forum questions is something that’s usually devolved to me.
I think there’s something in my background that may help explain why I’m usually the editor who responds to questions on the Q&A Forum. For the first 15 years or so of my career, I was essentially an outside in-house counsel for a pretty active regional investment bank. Among other things, that meant responding on a daily basis to multiple questions from investment bankers on securities law, state corporate law, directors’ fiduciary duties, M&A and capital markets deal processing issues, etc.
One banker even called me with a Lemon Law question on a Sunday afternoon when he got buyer’s remorse one hour after buying a new car. Like most bankers, they were a pretty laid-back bunch – in terms of when they wanted an answer, well, yesterday was just fine.
As you might imagine, this wasn’t my favorite part of the job and I didn’t miss it when it was taken almost entirely in-house after the investment bank was gobbled up by a big commercial bank in the late ’90s. But for better or worse, this experience implanted an almost Pavlovian reflex in me to try to respond promptly to questions. So, when I see a question on the Forum that I can answer, I have a pathological need usually try to respond pretty quickly.
I’m far from perfect, so trying to answer these questions is sometimes a humbling experience. But fortunately, when I’m off base on a response, our members have frequently – and invariably graciously – come to my rescue. So, over the years, we’ve collectively developed quite a resource. Combined with the “Q&A Forums” on our other sites, there have been well over 35,000 individual questions answered – including over 10,000 that Alan Dye’s answered over on Section16.net. No matter how many I answer, I’ll never catch Alan!
You are reminded that we welcome – in fact, we actively encourage – your input into any query you see that you think you can shed some light on for other members of our community. There is no need to identify yourself if you are inclined to remain anonymous when you post a reply (or a question). And of course, remember the disclaimer that you need to conduct your own analysis & that any answers don’t constitute legal advice.
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Much of the discussion on board diversity issues has focused on race, gender and sexual preference, but this recent “Race to the Bottom” blog says more attention needs to be paid to increasing the representation of people with disabilities on corporate boards. The blog recounts the unsuccessful efforts to persuade Nasdaq to include individuals with disabilities in the Diversity Matrix required by its new diversity rule. The blog says that this has left those individuals at a disadvantage when it comes to increasing their representation on corporate boards, but that their efforts appear to be receiving a more sympathetic reception at the SEC:
Even though Nasdaq did not include people with disabilities in its list of individuals that are considered to be diverse under its new diversity rule requirements, other groups are continuing to push forward and advocate on this front, and it appears that the SEC has heard their call. The SEC is considering its own board diversity rules and Commissioner Lee noted that “there’s merit to counting individuals with disabilities as diverse members of the boards, as women and ethnic minorities often are.” Commissioner Lee further stated that while it may be difficult to analyze this issue, it “does seem to [Commissioner Lee] potentially that disability is a group that makes a lot of sense to include” in SEC’s board diversity requirements. (Lydia Beyoud and Andrew Ramonas, Bloomberg Law).
The blog notes that the SEC has not released its proposed board diversity rules and that it remains to be seen whether persons with disabilities will be included in those rules. However, as I blogged a few months ago, in setting board diversity targets in its own voting policies, BlackRock specifically included individuals with disabilities in the category of “underrepresented groups.”
This Audit Analytics blog reviews the tenure of public company auditors, and notes that for Russell 3000 companies, the average tenure of their outside auditors depends a lot on their size. As of 2021, large accelerated filers in the Russell 3000 retain an outside audit firm for an average of 22 years, with a median of 17 years. Accelerated filers and non-accelerated filers both average about 12 years, but the medians differ pretty dramatically. Accelerated filers retain their audit firms for a median of 8 years, while non-accelerated filers retain their for a median of 3 years.
The more interesting data in the blog addresses the number of companies that have retained the same outside auditor for over 100 years. A total of 18 companies are members of this particular century club. Procter & Gamble leads the way – it has retained Deloitte since 1890. Another Buckeye State company, Goodyear, is right behind P&G. The tire giant has retained PwC since 1898.
In fact, I just noticed this as I was drafting this blog, but Ohio companies really have a thing for long relationships with their auditors. Five of the top ten members of the century club are headquartered in Ohio. In addition to P&G and Goodyear, Cleveland-based Sherwin Williams, Canton-based Timken, & Toledo-based Dana all have had the same auditor for more than a century. I guess I shouldn’t be surprised that my home state is so well represented – Audit Analytics says that 78% of the companies that have retained their auditors for more than 100 years are in manufacturing.
The SEC has proposed significant changes to Rule 10b5-1 that may make complying with its requirements much more challenging. But despite a lot of commentary to the contrary from the chattering classes, the existing rule is far from a “get out of jail free” card. In that regard, the Fourth Circuit’s decision inKBC Asset Management NV v. DXC Technology Co., 19 F.4th 601 (4th Cir. 2021), highlights some potentially significant limitations on the protection provided under Rule 10b5-1. This excerpt from “The 10b-5 Daily’s” recent blog on the decision indicates that one of those limitations may arise from the rule’s status as an affirmative defense:
The defendants also argued that any inference of scienter should be negated by the fact that all of the trades were done pursuant to Rule 10b5-1 trading plans. The Fourth Circuit concluded that it could not consider the impact of the trading plans because the record was “silent as to when [the CEO and CFO] entered their plans.” If the plans had been entered into during the class period, they would not “mitigate a suggestion of motive for suspicious trading.” Interestingly, the court also noted in a footnote that it was not clear whether it could consider the trading plans “as an affirmative defense at the motion-to-dismiss stage.”
The first statement by the Court isn’t surprising, given the fact that Rule 10b5-1 requires plans to entered into at a time when the insider does not have MNPI. However, the suggestion that Rule10b5-1’s status as an affirmative defense might preclude a court from considering it at the motion to dismiss stage is likely to raise a few eyebrows. Here’s the language of the footnote to which the 10b-5 Daily referred:
Although we have previously considered trading plans as an affirmative defense when reviewing an appeal from a dismissal for failure to state a claim under Rule 12(b)(6), see Yates, 744 F.3d at 891, Plaintiffs contend it would be inappropriate for us to do so here. See Opening Br. at 49 (citing Lefkoe v. Jos. A. Bank Clothiers, No. WMN-06-1892, 2007 WL 6890353, at *6 n.11 (D. Md. Sept. 10, 2007) (noting that “[r]aising the affirmative defense of trading under a 10b5–1 trading [plan] . . . is typically premature . . . in a motion to dismiss” (internal quotation marks omitted))).
They may have a point. It is well established that we only consider affirmative defenses at this stage when facts sufficient to rule on the defense are apparent “on the face of the complaint.” Goodman v. Praxair, Inc., 494 F.3d 458, 464 (emphasis omitted) (quoting Richmond, Fredericksburg & Potomac R.R. v. Forst, 4 F.3d 244, 250 (4th Cir. 1993)).
As courts often do, the Fourth Circuit punted on the issue – but the precedent it cited suggests that it (and other courts) might be amenable to prohibiting the assertion of the affirmative defense in a motion to dismiss. For many users of Rule 10b5-1 plans, that kind of prohibition might be a very big deal. That’s because plaintiffs will have the opportunity to conduct potentially extensive and costly discovery before defendants will be able to raise a Rule 10b5-1 defense in their summary judgment motions.
Speaking of Rule 10b5-1, the SEC’s proposed amendments to that rule and its proposed amendments to rules governing stock buybacks were finally published in the Federal Register yesterday – almost two months to the day after they were initially issued. That means the 45-day comment period has officially commenced and that comments on both proposals will be due on April 1, 2022.
I still haven’t seen an explanation for the delay in publication – although given the initial objections about the short comment period established for these proposals, I don’t think anyone’s likely to complain about it. In any event, commenters haven’t waited to weigh in on the proposals, particularly the 10b5-1 proposal, which is far outpacing its stock buyback companion in terms of the number of comments received.
As Liz blogged last week, the SEC may be getting a little frustrated with having to wait for the Federal Register, because it has changed its approach to calculating the comment period in its most recent series of rule proposals.
Tune in tomorrow for the webcast – “Audit Committees in Action: The Latest Developments” – to hear Deloitte’s Consuelo Hitchcock, Maynard Cooper’s Bob Dow, Tapestry Networks’ Eric Shor, and E&Y’s Josh Jones discuss the ever-expanding responsibilities of audit committees in today’s environment and provide practical guidance on navigating the challenges they face.
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I swear, I try to take crypto seriously – I really do. I mean, there are trillions of dollars being invested in it and lots of smart people think it’s the future. But it’s hard not to be dubious when so many of the crypto schemes I’ve seen people touting remind me of either the South Park underpants gnomes or episodes of the 1990s cartoon Pinky & the Brain. Last time we visited the world of crypto, we discussed a public offering of NFTs by a piece of conceptual art in corporate form. I didn’t think we could top that one – until I read this article about a DAO that’s pursuing a project that’s even more “out there”. Meet BitMouse DAO:
A new decentralized autonomous organization (DAO) wants to genetically engineer mice so that they carry Bitcoin inside them. BitMouseDAO launched on January 25. As of this writing, it has exactly two investors, almost no money, and no Discord. One investor, who put in .01 ETH, commented “Lmao,” while the other who put in the same amount said, “crazy.” The scheme, according to the DAO’s pitch, is to experiment with genetic technology to put Bitcoin inside a mouse.
The anonymous mind behind this project claims to be an artist who got the idea as they were going to sleep one night. They jotted the idea down and began to ponder its possibilities. “Over the next few weeks I started looking around to see if it was possible to carry out the experiment,” theys said in a blog post. “I was excited to imagine how this would affect us in the future.”
After namechecking artist Eduardo Kac’s genetically engineered phosphorescent rabbits, BitMouseDAO then rambles about how cool it will be to make a living thing into literal money. “We have tied the value of the mouse directly to Bitcoin, and it will fluctuate with the daily value of Bitcoin,” they said. “Maybe in ten years it will be worth $100 million, or maybe it will be worth nothing.”
I guess the way this is going to work is that the DAO will pay to have scientists figure out a way to edit the mouse’s genetic code to carry the private key that controls the bitcoins. Why would they do that? Look, don’t ask me. I’ve read the article and I still don’t know. Maybe you should check with the underpants gnomes or – since this is all about genetically engineered mice – the folks behind Pinky & the Brain.
In light of the increasingly sympathetic approach that Delaware courts have taken to Caremark claims in recent years, some commenters have observed that the risk of potential liability for directors’ breach of their oversight responsibility is much higher than it used to be. In that regard, this Proskauer blog says that one of the lessons of recent Delaware cases is that the growing demand for board oversight on ESG issues may increase the chances of viable Caremark claims:
Recent cases finding complaints to have sufficiently pled Caremark allegations may dovetail with the ever-increasing role of ESG in corporate policy and strategy. Corporate boards may be required to oversee corporate conduct with an eye towards how the company’s financial health intersects with and relies upon its commitment to sustainability, transparency and regulatory compliance. But with these added oversight obligations may come a higher risk of liability if the Caremark standards are not met.
In order to reduce this risk, the blog says that boards need identify “mission critical” aspects of the company’s business by focusing on its essential functions. Mechanisms for actively overseeing these functions should be evaluated and enhanced if necessary. In addition, the full board should regularly address mission critical aspects of the business and ensure that any complaints or significant issues concerning them find their way to the board.
