A recent Spencer Stuart Survey of nominating/governance committee chairs sheds some light on their priorities during the current year. In early 2021, the firm surveyed 77 committee chairs to find out what this year’s “top of mind” issues are, how their recruitment efforts have changed, and where the composition of their boards is headed. Here are some of the highlights:
– The top five governance priorities reported by survey respondents were enhancing ESG oversight (69%), enhancing racial and ethnic diversity (44%), developing a board succession strategy (39%), enhancing board effectiveness (38%) and overseeing company wide DEI efforts (36%).
– The top five recruiting priorities reported by survey respondents were adding directors from an underrepresented group (58%), directors with global perspectives & experiences (43%), directors with technology expertise (40%), directors with financial expertise (39%) and directors with operational expertise (38%).
– Interestingly, gender diversity, which was last year’s fourth most highly rated governance priority, did not crack this year’s top five. In terms of recruiting profiles, the survey says it fell from 3rd place to 10th.
– The number of respondents reporting that their board had underperforming directors dropped from 35% in 2020 to 18% this year.
Many commenters have expressed concern about the ability of companies to identify qualified directors from underrepresented groups, but 83% of the committee chairs surveyed reported no issues with recruiting directors with diverse backgrounds.
Earlier this year, the DOJ announced the formation of a “Covid-19 Fraud Enforcement Task Force.” The task force is a joint effort between DOJ & other governmental agencies, and Attorney General Garland promises that it “will use every available federal tool—including criminal, civil, and administrative actions—to combat and prevent Covid-19 related fraud.”
This Woodruff Sawyer blog says that the task force is likely to result in a full-court press targeting potential fraud by recipients of government funds in pandemic-related programs. That likely means that many companies are going to be subjected to probes by the DOJ or other agencies looking for potential violations of the False Claims Act (FCA). These investigations may be disruptive, but at least you can count on your D&O policy to pick up the tab, right? Well, as this excerpt from the blog explains, the answer is complicated:
One area of frustration for many companies will be the lack of response from a D&O insurance policy for governmental investigations of corporate entities. While some D&O insurance policies may provide limited coverage for the governmental investigation of a corporate entity, this is increasingly unusual. As a result, very large legal fees for these investigations are likely to fall on the corporation.
D&O insurance policies, on the other hand, may respond to defend individuals who are the target of government enforcement actions. However, this coverage is typically only available after the government has made it very clear whom they are pursuing, something that often happens quite late in an investigation process.
Having said that, some polices provide limited coverage for “pre-claim inquiries.” This means insurance coverage for legal counsel for individuals asked to respond to government subpoenas. The cost of document production for documents under the control of the company, however, is typically not covered by D&O insurance.
If there is an FCA investigation that, when disclosed, causes your company’s stock price fall, you can typically expect to be able to rely on your D&O insurance. A modern D&O insurance policy usually covers a securities claim or a breach-of-fiduciary-duty suit related to disclosure concerning the government investigating the company under the FCA. However, the insurance would not cover any settlements with the government. This is because Side C of the D&O insurance policy only covers securities claims. An FCA claim is not a securities claim.
The blog also points out that most D&O policies have an exclusion for claims involving intentional fraud, and that fines and penalties are typically excluded from coverage. Even if coverage is potentially available, the blog provides a reminder that government agencies often demand that companies and individuals forgo any insurance or rights to indemnification when settling with the government.
August is always a strange “either/or” month – either nothing happens in the financial markets or something apocalyptic happens. I guess we’re fortunate that, so far at least, this August seems to have fallen into the former category. But that doesn’t help me out, because I’ve still got to come up with 3 blogs a day, and all the newsmakers are at the beach.
I was getting a little desperate to find a third blog for this morning when it occurred to me that it’s been several months since I took a look at what the Wu-Tang Clan has been up to. Last time we checked-in with them, the guys were getting into the non-fungible token game. At the time, it was a group effort, but according to this Rolling Stone article, Method Man now has a solo NFT project going:
Method Man is launching his own comics universe, titled Tical World, via NFT. The first installment of the rapper’s anthology series, “Part 1: The Origin,” features original characters, animations, artwork, apparel, and unreleased music available for sale as NFTs.
This includes a Killa Beez-inspired original artwork signed by Method Man and New York artist Alex Smetsky; a 3D-enabled digital animation depicting the origin story of Tical World; an unreleased audio recording with music and lyrics by Method Man; the sole copies of the first artistic renderings of the Tical World characters; and a gold VIP card for Tical Athletics, Method Man’s athleisure line. Tical World also represents the first “community owned crypto-characters” to use Flow Blockchain, developed by Dapper Labs and secured by the patented TuneGO Vault.
I don’t understand very much of the excerpt I just quoted, but whatever he’s doing sure sounds pretty cool. In other Wu-Tang Clan news, the U.S. government sold the only copy of the group’s “Once Upon a Time in Shaolin” album that it confiscated from the previous owner, fraudster Martin Shkreli, and the second season of “Wu-Tang: An American Saga” is set to premiere on Hulu on Sept. 8th.
Okay, my work here is done – now I just have to figure out what I’m going to do over on the DealLawyers.com Blog.
Our friends at WilmerHale tipped us off to this email message, which purports to be from the author of the hoax whistleblower emails received by a number of public companies over the past few months. The message says that the false reports were part of a research project led by a PhD student at the National University of Singapore. What’s this research project all about? This excerpt will give you the gist of its supposed purpose:
The purpose for the investigation was to see whether firms responded differently based on the identity of the sender and the route of the plane we send seemingly identical messages from both customers and employees raising concerns ranging from alleged bribery fraud and accounting mistakes. we varied the email to suggest that in some claims firms are perhaps benefiting from the alleged misbehavior whereas in others it is completely to their detriment.
We then compared the differences in response time the quality of the response and the language used. Importantly throughout our experiment, we’ve made sure no real names are used to not harm any real employee. The claims brought forth were completely fictitious and deliberately did not bare enough details to necessitate the launch of an investigation. Once the claim was made, we’ve only recorded your initial response and did not pursue the matter any further. Thereby interfering with your day-to-day business as little as possible.
Don’t you just love that these experts on the workings of U.S. public company whistleblower programs blithely state that their deception “did not bare enough details to necessitate the launch of an investigation”? Then they have the gall to pat themselves on the back for structuring their charade to “interfer[e] with your day-to-day business as little as possible.” If you ask me, there’s enough self-serving manure in this explanation to fertilize Nebraska.
There’s always the possibility that this communication is itself another hoax (it comes from a gmail account, not a university address). If it is, then the plot has thickened considerably. On the other hand, if it is legitimate, it’s either the most disingenuous CYA attempt I’ve ever read or an admission of breathtaking recklessness on the part of everyone involved in signing-off on this research project.
I’d be willing to wager that the aggregate fees and expenses recipient companies incurred in determining whether and how to investigate these false whistleblower allegations are easily in the hundreds of thousands of dollars. The cost could be even higher once you factor in the cybersecurity concerns raised after companies realized this was a hoax. The email says that companies are “free to withdraw their data” from the study, but must let the researchers know within a month. Frankly, if I received this, the only thing I’d be tempted to send to these folks within a month is an invoice.
If you do choose to reach out to the researchers, it’s probably best to contact the university by means of a hard copy letter, given the potential concerns about the authenticity of the email & the possibility that we might still be dealing with some kind of elaborate phishing scheme.
Yesterday’s WSJ had an article on what aspects of Rule 10b5-1 plans are being scrutinized by the SEC. Not surprisingly, the list generally lines up nicely with the priorities Gary Gensler identified in his June 2021 speech to the WSJ’s CFO Summit. Single-trade 10b5-1 plans weren’t addressed in that speech, but the article suggests that they may be on the SEC’s list as well. This excerpt provides some insight on the reasons why the SEC might be interested in this topic:
Many 10b5-1 plans steadily sell shares, whether the stock is up or down. Facebook’s Mark Zuckerberg, for example, has sold consistent volumes of shares at regular intervals since at least August 2019, according to InsiderScore data. “Those plans that are selling routine amounts of shares every month over multiple years; that’s what the plan was intended for, to sell shares slowly over time,” said Daniel Taylor, an accounting professor who runs the Forensic Analytics Lab at the University of Pennsylvania’s Wharton School and one of the authors of the January study of trading under plans.
But about a third of plans since 2004 involve just a single trade, according to InsiderScore data. (Because documentation is scant, researchers can’t differentiate between plans that intended to execute a single trade and those that planned for multiple trades but were terminated after the first sale.) Single-trade plans outperformed multi-trade plans regardless of the timing, according to Mr. Taylor’s research. “When it’s a single-trade plan, it’s abusive,” he says.
That “January study” referenced in the excerpt is this Stanford study, which included single-trade plans in its list of three “red flags” for opportunistic use of 10b5-1 plans (the other red flags were a short cooling-off period & adoption of plans in a quarter that begin trading prior to the announcement of earnings). Here’s what the study had to say in support of its recommendation to prohibit single-trade 10b5-1 plans:
In the extreme, if the plan is designed to execute only a single trade, it is economically equivalent to a traditional limit order (or date-triggered order). Single-trade plans are inconsistent with traditional financial advice for exiting a concentrated equity position over time. They are also inconsistent with the original expectation that Rule 10b5-1 would govern trades made under a “regular, pre-established program.”
Perkins Coie’s Allison Handy put together a nice graphic depiction of the various ESG “materiality” concepts floating around. Traditionally, we’re accustomed to thinking of materiality by reference to the TSC v. Northway “reasonable investor” test. But ESG disclosure advocates argue for conceptions of materiality that take into account matters beyond financial considerations and constituencies other than investors. This graphic provides a quick reference tool that will help you navigate this brave new world.
One of the emerging items on this year’s shareholder proposal agenda has been requests for companies to convert to benefit corporations. Here’s an excerpt from this Faegre Drinker memo on these proposals:
Fifteen public companies received and voted on proposals to convert to benefit corporations at their 2021 annual meetings of shareholders, a dramatic shift from the previous year, when not one of these companies received a proposal to convert. Shareholder proponents requested companies approve an amendment or take the necessary steps to amend their certificates of incorporation and, if necessary, bylaws to become a benefit corporation.
The Shareholder Commons, a nonprofit that states it is seeking to catalyze a movement of shareholders that insist on responsible business, assisted the shareholder proponents with these requests. Accordingly, although each proposal was uniquely tailored to the specific company, the proposals exhibited a common rationale — prioritizing stakeholder interests in addition to shareholder interests is vital.
The memo reviews how companies responded to these proposals, and provides a chart indicating the level of support that they received. It turns out that most didn’t fare too well.
The blog notes that only a handful of proponents were responsible for these proposals, and suggests that the small proponent group & limited support raises the question of whether this initiative will have staying power or is just a fleeting trend. Personally, I have the same question about about benefit corporations themselves.
By the way, don’t say we didn’t warn you that these proposals were coming – over on the “Proxy Season Blog“, Liz gave everyone a heads-up last fall, when she blogged about The Shareholder Commons’ offer of drafting assistance to proponents.
Late last month, the roof came crashing down on Nikola Corporation’s founder & former CEO Trevor Milton, when his indictment for securities fraud was announced by the U.S. Attorney for the SDNY & the SEC announced an enforcement action against him arising out of the same alleged conduct. The former CEO is alleged to have repeatedly misled investors about the status of the company’s electric vehicles & technology.
Both the SEC & SDNY claim that this guy engaged in a pretty massive fraud, and in situations involving a complete train wreck like this one, it’s usually hard to draw a lot of helpful insights for other public companies aside from “don’t do massive frauds.” However, this Locke Lord blog says that this case is an exception, and provides some valuable lessons for other public companies. This excerpt says that one of those lessons is that every word that comes out of a corporate officer’s mouth carries with it the potential for liability:
The actions against Milton are a reminder that public statements by corporate officers in relatively informal settings, outside of SEC filings, can be used as a basis for Rule 10b-5 sanctions. A company’s lawyers may scrutinize annual and quarterly reports to ensure that they contain appropriate cautionary statements. In contrast, private tweets, other social media postings and statements in podcasts or interviews are often made without compliance in mind.
In Milton’s case, he encouraged investors to follow him on Twitter to get “accurate information” about Nikola “faster than anywhere else.” In practice, he used Twitter to announce corporate initiatives that he had not vetted internally, to answer investor questions with misleading or outright false information, and even to double down on prior false statements.
Moreover, according to the allegations, Milton responded to other senior executives’ expressions of concern about his social media presence and his public statements by asserting that these other executives “did not understand current capital market dynamics or what he was trying to accomplish with retail investors, and that he needed to be on social media to put out good news about Nikola to support its stock price.” Retail investor frenzy driven by social media and retail-oriented trading platforms such as Robinhood does not give companies a pass from the application of the securities laws. The SEC has emphasized that it will monitor these situations for manipulation or other misconduct.
The blog also says that the case also provides a reminder of the importance of strong board oversight, as well as the importance of the “tone at the top” and a strong compliance culture.
I’ve been reviewing the Staff’s 2021 comments on non-GAAP disclosures. As you might expect, most of them fall under the heading of “blocking & tackling,” and focus on discrete compliance issues regarding the content and reconciliation of non-GAAP numbers. But “equal or greater prominence” issues also haven’t gone away, and in a couple of instances, the Staff asked companies to re-order the presentation of sections of their periodic reports in order to give greater prominence to GAAP information.
An example of this is Bill.com Holdings, which included a subsection in the forepart of the MD&A section of its 2020 10-K captioned “Non-GAAP Financial Measures.” As you might expect, this section included the required Reg G disclosures & reconciliations for the non-GAAP numbers that the company used in its MD&A discussion. The Staff’s comment letter included the following comment on this disclosure:
Please revise the first table on page 58 to disclose the comparable GAAP measure with greater prominence. Also, to avoid giving undue prominence to your non-GAAP financial measures, please move this section so that it follows the results of operations section. Refer to Item 10(e)(1)(i)(A) of Regulation S-K and Question 102.10 of the Non-GAAP Compliance and Disclosure Interpretations (“C&DIs”).
This was one of those Staff comments that didn’t mention whether an amendment to the prior filing was required. However, Bill.com indicated in its response that it would comply with the Staff’s comment in future filings. The Staff didn’t comment further.
A recent Watchdog Research blog reports that there’s been a dramatic uptick in the use of Form 10-K/As as the vehicle for making initial disclosures of internal control deficiencies, going concern qualifications, and restatements. According to the blog, over the past decade, an average of 19 ineffective internal controls disclosures, 3 going concern opinions and less than 1 non-reliance restatement were initially reported on Form 10-K/A filings during each year. In contrast, so far in 2021, there have been 80 ineffective internal controls disclosures, 31 going concern opinions and 5 non-reliance restatements initially reported on Form 10-K/As.
The blog says that SPACs are driving the increased reliance on Form 10-K/As as the vehicle for these disclosures. They have accounted for 70 of the 80 10-K/A internal controls disclosures, 30 of the going concern opinions and all of the restatements this year. The blog points to troubled electric vehicle start-up Lordstown Motors as the poster-child for this trend:
For public companies, it is not just about when the disclosure is made, but how it is made. We are seeing a concerning trend in 2021 where companies are waiting to make their initial disclosures of bad news such as going concern opinions, ineffective internal control disclosures, and financial restatements in an amended annual 10-K filings (10-K/As), instead of 8-Ks and other traditional methods and long after the original “clean” 10-K was filed with the SEC.
Lordstown Motors is an electric car company that went public via SPAC. On June 8th, Lordstown Motors filed a 10-K/A, more than two months after it released its annual report on March 25th. As reported by Francine McKenna in The Dig, Lordstown disclosed a going concern opinion, an ineffective internal control assessment by management, and two subpoenas from the SEC (indicating that the SEC was conducting a formal investigation, not an informal inquiry). Lordstown also disclosed that their restatement announced in May would include an additional charge of $23.5 million, perhaps what tipped it into the “going concern” warning range.
The blog characterizes SPACs approach to making initial disclosures of this “bad news” trifecta in 10-K/A filings as “novel” and “a bit sneaky.” The approach is definitely novel, but I’m not so sure that it’s sneaky. That’s because these disclosures were themselves prompted by a novel set of circumstances – namely, the SEC’s highly publicized guidance on the proper accounting treatment of SPAC warrants & the consequences of that guidance.
This guidance prompted almost 90% of SPACs to restate their financial results. I’m guessing that for most SPACs, the 10-K/A disclosures concerning internal controls deficiencies and the addition of going concern qualifications were a direct result of those warrant restatements. A conclusion that internal controls were deficient flows almost inevitably from a decision to issue a non-reliance restatement, and the going concern opinions may (as in the case of Lordstown Motors) have been prompted by the financial statement impact of the warrant restatements.
I can see why a company might not feel compelled to disclose an inevitable internal control deficiency when it filed an 8-K announcing a non-reliance restatement. A decision to defer disclosure of a going concern qualification would be more troubling, assuming the company knew that such a qualification would be required. But in the case of the warrant restatements, it’s not clear when many SPACs first became aware of this issue. The decision to add a going concern qualification sometimes turned on the results of a complex valuation process, and was likely the last piece of the puzzle to be completed before the 10-K/A was filed.
It does seem inappropriate to defer reporting a decision to restate financials until the filing of Form 10-K/A that includes those financials. If a company decides that its financial statements need to be restated & should no longer be relied upon, it has to file an Item 4.02 Form 8-K. Five SPACs apparently didn’t – but that’s out of a universe of more than 500 SPAC restatements and more than 300 non-reliance restatements.
