Cooley’s Cydney Posner recently blogged about an SEC enforcement action targeting a lawyer who allegedly facilitated violations of Section 5 of the Securities Act by rendering legal opinions to transfer agents. Here’s the intro:
Attorneys who may think they can give short shrift to those pesky legal opinions to transfer agents might think twice after reading this complaint, SEC v. Frederick Bauman, filed on September 8, 2021, in the federal district court in Nevada. As described in the SEC’s litigation release, the SEC charged Bauman “with playing a critical role as an attorney who facilitated the unregistered sale of millions of shares of securities by two groups engaged in securities fraud.” According to the SEC’s complaint, between 2016 and August 2019, Bauman issued at least a dozen legal opinions to transfer agents advising that certain shares of four public companies were unrestricted and freely tradeable and that the holders of the shares were not affiliates of the public company issuers. However, the SEC alleged, the shareholders were actually part of groups that controlled those issuers, which made them affiliates under the securities laws.
The SEC alleged that the lawyer lacked a reasonable basis for representing that the shareholders weren’t affiliates, and alleged that their unregistered sales violated Section 5 of the Act, and that in rendering these opinions, the lawyer violated Sections 5(a) and 5(c) of the Securities Act.
The SEC has brought a number of these actions against lawyers over the years, and they’ve also attracted attention from the DOJ. For example, the SDNY indicted two lawyers last year for their role in cranking out allegedly fraudulent Rule 144 opinions for OTC companies.
The September-October issue of the Deal Lawyers newsletter was just posted – & also sent to the printer. Articles include:
– Recasting a Boilerplate Provision: Exclusive Forum Provisions for Private Delaware LLCs After a Decade of Public Corporate Developments
– Buyer Loses an MAE Claim (Again) in Delaware
– Discounted Cash Flow: “I’m Not Dead Yet!”
Remember that, as a “thank you” to those that subscribe to both DealLawyers.com & our Deal Lawyers newsletter, we are making all issues of the Deal Lawyers newsletter available online. There is a big blue tab called “Back Issues” near the top of DealLawyers.com – 4th from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.
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Earlier this year, Acting SEC Chair Allison Herren Lee issued a directive to the SEC’s Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings. Yesterday, Corp Fin posted a sample letter identifying some of the comments that companies should expect to receive during the filing review process. Not surprisingly, the sample letter includes comments seeking additional risk factor disclosure concerning climate change-related risks, but it’s also pretty clear that the Staff expects the MD&A section to do a lot of heavy lifting on climate change disclosure.
In fact, the bulk of the sample letter addresses MD&A disclosures. Specific areas where additional MD&A disclosure is sought include:
– the material impact of climate change-related legislation, regulation or international accords, historical and anticipated cap ex for climate-related projects;
– the indirect consequences of climate-related regulation or business trends, such as changes in demand for products and services, increasing competition to develop new lower-emission products, increases in demands for alternative energy & the reputational risks associated with operations or products that produce material greenhouse gas emissions;
– the physical effects of climate change on operations and results, including the impact of severe weather, quantification of weather-related damages and weather-related impacts on the cost of insurance;
– quantification of increased compliance costs and disclosure concerning the purchase and sale of carbon credits and any material effects on the company’s business, results of operations or financial condition.
Another topic addressed in the sample letter was discrepancies between the level of disclosure provided in corporate sustainability reports and in SEC filings. Companies should expect to be asked to what consideration they gave to providing the same type of climate-related disclosure in their SEC filings as they provided in their sustainability reports. Not to blow our own horn, but in our March issue, we told subscribers to The Corporate Counsel to keep an eye on this issue in preparing for Staff scrutiny of their climate change disclosures:
Look Beyond SEC Filings. Many companies have addressed climate change in sustainability reports and other publications beyond their Exchange Act reports. Those communications and third-party publications should be reviewed with an eye toward determining whether what is said in them is appropriately addressed in the company’s SEC filings.
Okay, so maybe the SEC did mention this issue back in its 2010 guidance, but I’m still calling this one a “W” for Dave & me.
While it’s helpful to know what kind of climate comments the Staff says companies should expect to receive, it’s also good to have some insight into what comments the Staff’s provided to date. My colleague Lawrence Heim addressed that topic in this recent PracticalESG.com blog, and it turns out that those comments are pretty consistent with what the Staff is telling companies to expect.
Lawrence cites this Gibson Dunn alert that reviews these comments & provides advice on how to prepare for them, but he also adds the following additional thoughts:
The alert walks through recommendations to prepare for the possibility of a comment on this topic. I would add to those – validate the data and assumptions on which you relied in (a) quantifying your emissions and (b) making future reduction commitments. At a minimum, consider using an internal team of environmental and internal audit staff, augmented with other internal functions as needed. Alternatively, it may be worth considering engaging a qualified external climate emissions quantification and/or risk management expert.
In response to the SCOTUS’s 2018 Cyan decision upholding the ability of plaintiffs to bring Securities Act claims in state court, many companies have adopted federal form bylaws providing that federal courts will be the exclusive forum for bringing claims arising under the Securities Act. Last year, the Delaware Supreme overruled the Chancery Court and held that these federal forum bylaws were permissible under Delaware law. Since that time, federal forum bylaws have served as the basis for several California state courts to dismiss Section 11 claims. Now, this recent blog from Kevin LaCroix reports that a New York court has joined them. Here’s the intro:
In an important development affirming the use of federal forum provisions (FFP) to avoid duplicative parallel state court securities lawsuits, a New York state court judge has granted the securities suit defendants’ motion to dismiss based on the FFP in the corporate defendant’s charter. The ruling appears to be the first in New York – indeed, the first outside of California – to enforce an FFP. The New York court’s enforcement of the FFP is a significant step in companies’ efforts to try to avoid the duplicative litigation problems caused by the U.S. Supreme Court’s March 2018 decision in Cyan.
Kevin points out that the decision is significant because the vast majority of the post-Cyan state court securities class action lawsuits were filed in either California or New York. If federal forum bylaws are enforceable in both of these jurisdictions, Section 11 plaintiffs may find themselves in a bit of a box.
According to a recent CFO Dive article, everybody’s largest shareholder is running out of patience with the pace of ESG disclosures. Here’s an excerpt:
BlackRock, the world’s largest asset manager, is losing patience with companies that are slow to disclose the details of their adherence to environmental, social and governance (ESG) principles, according to Jessica McDougall, a director for investment stewardship at BlackRock. “We don’t have patience much longer for these disclosures to be forthcoming,” McDougall said Tuesday in a webcast sponsored by Diligent, adding “we are increasingly seeing the impacts of climate change not only across our portfolios but also across the global economy.”
BlackRock, which manages $9 trillion in assets, has pressed for more disclosure in recent years, “but this was the year that we really started to take more concerted action based on what companies were providing us” before the 2021 proxy season, McDougall said. “Where we felt that companies were falling short for a variety of ESG issues, we were more inclined to support those [shareholder] proposals this year.”
Value Edge Advisors blogged that, during this same webcast, T. Rowe Price’s head of corporate governance said that the big asset managers are feeling the heat from their own clients, regulators & the media, so they’re ratcheting up the pressure on their portfolio companies. Specifically, they’re looking for inconsistencies between those companies’ stated ESG priorities and their political advocacy:
Large asset managers are feeling acute pressure on ESG from clients, the press and regulators, explained Donna Anderson, vice president and head of corporate governance at T. Rowe Price. She said the fund firm is developing analytical and tracking tools to help portfolio managers and stewardship teams identify gaps between companies’ stated ESG priorities that are undermined or canceled out by political spending or membership in trade associations that lobby state and federal legislators for regulations contrary to companies’ official positions.
“If you’re doing business as usual but your [corporate social responsibility] departments are generating tons of reports, assertively staking claim to these various goals, but they’re not being operationalized, it’s going to become evident,” said Anderson during the event. “That’s a real problem in our view.”
According to BlackRock’s recent Stewardship Report, its support for shareholder proposals doubled this year from 17% to 34%, and it voted against 10% of incumbent directors this year, up from 8.5% last year. These recent comments suggest that there’s more bludgeoning to come from the mega asset managers if companies don’t get religion when it comes to both ESG disclosure & operationalizing their stated ESG priorities.
While BlackRock & T. Rowe ramp up the heat, companies that dutifully churn out the kind of detailed ESG disclosure investors say they want may find themselves in for an unpleasant surprise from the ESG ratings industry, at least according to a new study discussed in this HBS newsletter:
Receiving more information can clarify the complex, but not when it comes to environmental, social, and governance (ESG) scores. A recent study shows that the more information a company discloses about its ESG practices, the more rating agencies disagree on how well that company is performing along these dimensions. According to the research, a 10 percent increase in corporate disclosure is associated with a 1.3 to 2 percent increase in ESG score variation among major ratings providers, which all interpret and process disclosures differently.
With more than $30 trillion in sustainable investment capital on the line, the stakes are high for companies and investors. Institutions, such as asset managers, pension funds, and endowments, often rely on ESG ratings to make investment decisions. Divergent scores hurt firms, investors, and markets, the research findings suggest, and these effects appear to be worsening over time.
“People are being sold on money being invested responsibly by using these ratings that nobody really understands,” says Harvard Business School Assistant Professor Anywhere “Siko” Sikochi, who co-authored the paper Why Is Corporate Virtue in the Eye of the Beholder? The Case of ESG Ratings with HBS professor George Serafeim and Dane Christensen of the University of Oregon. “That’s where the danger is in having all these different ratings not being aligned in some way.”
You know, there’s something about this problem that’s strangely familiar – where have I heard something like it before? Oh yeah, that’s right – in the Book of Genesis:
And the Lord said, Behold, the people is one, and they have all one language; and this they begin to do: and now nothing will be restrained from them, which they have imagined to do. Go to, let us go down, and there confound their language, that they may not understand one another’s speech. So the Lord scattered them abroad from thence upon the face of all the earth: and they left off to build the city. Therefore is the name of it called Babel; because the Lord did there confound the language of all the earth: and from thence did the Lord scatter them abroad upon the face of all the earth.
Remember way back in March 2020 when the SEC announced that employees at its DC headquarters would begin to work remotely due to the pandemic? Like many of us, they’re still remote – and last week an announcement on the Coronavirus page of the SEC’s website said that they’re going to stay remote until at least January 3, 2022.
On the one hand, I guess it’s a hopeful sign that the SEC thinks it will eventually be January 2022, but on the other hand, this is just another piece of evidence that today’s date is Wednesday, March 571, 2020.
Some commenters have suggested that one of the advantages of a direct listing might be the ability to insulate companies & other potential IPO defendants from Section 11 liability by making it impossible to satisfy the statutory requirement to trace the shares purchased to those sold in the offering. Last year, a California federal court rejected that argument and the 9th Circuit has affirmed the lower court’s ruling.
Section 11 provides that if the registration statement for a security contains an untrue statement or omission, any person acquiring “such security” may bring an action against the parties enumerated in the statute. Courts have generally interpreted the “such security” language to mean the securities issued under the particular registration statement, and have thus imposed an obligation on plaintiffs to “trace” their securities to those issued in the offering.
In Pirani v. Slack Technologies, (9th Cir.; 9/21), the 9th Circuit observed that the case involved an issue of first impression – “what does ‘such security’ mean under Section 11 in the context of a direct listing, where only one registration statement exists, and where registered and unregistered securities are offered to the public at the same time, based on the existence of that one registration statement?” It concluded that the term encompassed both the securities that were registered in connection with the direct listing and those that were unregistered:
Slack’s unregistered shares sold in a direct listing are “such securities” within the meaning of Section 11 because their public sale cannot occur without the only operative registration in existence. Any person who acquired Slack shares through its direct listing could do so only because of the effectiveness of its registration statement. Because this case involves only one registration statement, it does not present the traceability problem identified by this court in cases with successive registrations. . . All of Slack’s shares sold in this direct listing, whether labeled as registered or unregistered, can be traced to that one registration.
In her Twitter thread about the decision, Prof. Ann Lipton suggests that the case could have implications for Section 11 claims that go beyond direct listings. For instance, she says that “the same logic could equally be applied to companies that release shares from lockup early; those shares, too, are only trading on the exchange because of the earlier-filed registration statement.”
A few months ago, I blogged about a recent study suggesting that there was an epidemic of non-compliance when it came to crowdfunded offerings. So, maybe it isn’t surprising that in its first Regulation Crowdfunding enforcement proceeding, the SEC’s Division of Enforcement targeted not only alleged fraudsters, but a crowdfunding portal that the SEC claims ignored “red flags” and otherwise failed to comply with its obligations to protect investors. Here’s an excerpt from the SEC’s press release:
According to the SEC’s complaint, Robert Shumake, alongside associates Nicole Birch and Willard Jackson, conducted fraudulent and unregistered crowdfunding offerings through two cannabis and hemp companies, Transatlantic Real Estate LLC and 420 Real Estate LLC. Shumake, with assistance from Birch and Jackson, allegedly hid his involvement in the offerings from the public out of concern that his prior criminal conviction could deter prospective investors. The complaint alleges that Shumake and Birch raised $1,020,100 from retail investors through Transatlantic Real Estate, and Shumake and Jackson raised $888,180 through 420 Real Estate. Shumake, Birch, and Jackson allegedly diverted investor funds for personal use rather than using the funds for the purposes disclosed to investors.
As alleged, TruCrowd Inc., a registered funding portal, and its CEO, Vincent Petrescu, hosted the Transatlantic Real Estate and 420 Real Estate offerings on TruCrowd’s platform. Petrescu allegedly failed to address red flags including Shumake’s criminal history and involvement in the crowdfunding offerings, and otherwise failed to reduce the risk of fraud to investors.
In its complaint filed with a Michigan federal court, the SEC contends that portal’s alleged shortcomings violated Section 4A(a)(5) of the Securities Act and Rule 301(c)(2) thereunder, which obligates an intermediary to deny access to its platform if the intermediary “has a reasonable basis for believing that the issuer or the offering presents the potential for fraud or otherwise raises concerns about investor protection.”
