Okay, a few years ago, I blogged about research suggesting that the much-maligned staggered board was actually good for shareholders. That renaissance lasted about two days, at which point it became painfully obvious that investors were having none of it. Now, I’m again peeking out of my shell to highlight another study that says staggered boards may be beneficial. Here’s the abstract:
Staggered boards (SBs) are one of the most potent common entrenchment devices, and their value effects are considerably debated. We study SBs’ effects on firm value, managerial behavior, and investor composition using a quasi-experimental setting: a 1990 law that imposed an SB on all Massachusetts-incorporated firms. The law led to an increase in Tobin’s Q, investment in CAPEX and R&D, patents, higher-quality patented innovations, and resulted in higher profitability. These effects are concentrated in innovating firms, especially those facing greater Wall Street scrutiny. An increase in institutional and dedicated investors also accompanied the imposition of SBs, facilitating a longer-term orientation. The evidence suggests SBs can benefit early-life-cycle firms facing high information asymmetries by allowing their managers to focus on long-term investments and innovations.
No, I’m not exactly sure what “Tobin’s Q” is either. You know who does know though? Cooley’s Cydney Posner, who has taken a deep dive into the study and its conclusions over on her blog. To me, the big takeaway from all of this is that while we’re all in favor of good corporate governance, the evidence continues to suggest that nobody really knows exactly what that is.
The folks at Bass Berry recently held a webcast on the new universal proxy rules and have posted this blog summarizing the key takeaways from the program. Among other things, the blog includes a chart that briefly comparing the differences between the typical proxy access bylaw and the universal proxy rules. As you know, I can’t resist quick reference materials that I can quickly glance at and use to fake my way through a conference call, and this chart clearly makes the cut. Check it out!
Targets of SEC enforcement proceedings and advocacy groups have long complained about “regulation by enforcement.” Crypto evangelists have been particularly vocal with regulation by enforcement claims in recent years, but it looks like at least one of them may have effectively figured out how to use regulation by enforcement to its advantage, Check out Matt Levine’s take on the SEC’s recent enforcement action against BlockFi:
If a crypto startup went to the U.S. Securities and Exchange Commission and said “we want regulatory clarity about what we need to do to run crypto lending programs, so you should write some rules about it,” the SEC would say “sure, we’ll give that some thought in like 2036.” If it went to 50 different U.S. states and asked them for clarity it would get even more confused. If it went to the SEC and said “look, to speed this process along, why don’t we pay you $50 million to prioritize writing these rules,” that would be a very bad crime and it would go to prison. But BlockFi will give the SEC $50 million, and it will give some states another $50 million, and now it has clarity about crypto lending programs.
That’s a classic example of being handed a lemon and turning it into a very expensive glass of lemonade, and it’s also a unique twist on the problem of “regulation by enforcement.” BlockFi had the resources to use regulation by enforcement to its advantage, but that’s not typically the case.
Now, here’s where I should note that the current director of the SEC’s Division of Enforcement says that regulation by enforcement is a problem that doesn’t exist. That’s a view that he shares with many of his predecessors, but it’s one that’s not always shared by SEC commissioners or the courts. Here’s an excerpt from the 2nd Circuit’s 1996 opinion in SEC v. Upton:
Due process requires that “laws give the person of ordinary intelligence a reasonable opportunity to know what is prohibited.” Grayned v. City of Rockford, 408 U.S. 104, 108 (1972). Although the Commission’s construction of its own regulations is entitled to “substantial deference,” Lyng v. Payne, 476 U.S. 926, 939 (1986), we cannot defer to the Commission’s interpretation of its rules if doing so would penalize an individual who has not received fair notice of a regulatory violation. See United States v. Matthews, 787 F.2d 38, 49 (2d Cir.1986). This principle applies, albeit less forcefully, even if the rule in question carries only civil rather than criminal penalties.
In the current environment, it seems fair to say that regulation by enforcement concerns are by no means limited to issues surrounding digital assets. The SEC is under enormous pressure to move forward on its current regulatory agenda, and enforcement actions may be seen as an attractive shortcut in some areas. As I’ll explain with a couple of examples below, the risk of regulation by enforcement is heightened by the increasing influence on the SEC and other regulators of novel academic interpretations of what the securities laws require – interpretations that run counter to longstanding and well-known business practices.
– John Jenkins
Programming note: our blogs will be off Monday for Presidents’ Day, returning on Tuesday.
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.
Don’t miss out on the Q&A Forum or any of our other practical resources – checklists, handbooks, webcasts, members-only blogs and more – which so many securities & corporate lawyers know are critical to practicing in this space. If you’re not yet a subscriber, you can sign up for a membership today by emailing sales@ccrcorp.com or by calling us at 800-737-1271.
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.
