Apparently, SEC Chair Gary Gensler had a brief media availability last week in which he shared some thoughts on the status of potential reforms to the beneficial ownership reporting rules under Section 13(d) of the Exchange Act. The financial media doesn’t appear to have picked up on this, although CNBC’s Eamon Javers did tweet out a report on Gensler’s comments. According to that report, the SEC chair’s primary concern is addressing information asymmetries created by the 10-day lag between the acquisition of a 5% or greater stake and the deadline for reporting it:
Gensler said he is considering tightening the deadline to disclose such large holdings, which is currently set at 10 days. Large active traders are likely to hate this, because it’s harder for them to make money if they have to reveal strategies to the public too soon. Still, Gensler said “I would anticipate we’d have something on that.” He said he is worried about “information asymmetry,” because the public doesn’t know there’s a big player buying up shares during the 10-day period.
He said: “Right now, if you crossed the 5% threshold on day 1, and you have 10 days to file, that activist might in that period of time, just go up from 5 to 6% or they might go from 5 to 15% but there’s nine days the selling shareholders in the public don’t know that information.” More Gensler: “And that’s what motivates me, is some of that information asymmetry. So, we’re looking at that. I would anticipate that we’d have something on that.”
Unfortunately, Gary Gensler didn’t provide any insight as to the timing of a rule proposal, but it clearly remains on his “to do” list.
Section 27(a) of the Exchange Act vests federal courts with exclusive jurisdiction over claims arising under that statute. So, what happens when a company adopts a bylaw mandating a state court as the exclusive forum for all derivative claims? As I blogged over on DealLawyers.com last year, a pair of California federal court decisions indicate that such a bylaw provision is enforceable, even though it would effectively preclude a plaintiff from asserting derivative claims under Section 14(a) of the Exchange Act. Recently, however, the 7th Cir. reached a different conclusion.
In Seafarers Pension Plan v. Bradway, (7th Cir.; 1/22), a divided 7th Circuit panel held that an exclusive forum bylaw could not be used to preclude a plaintiff from filing a lawsuit premised on violations of Section 14(a) of the Exchange Act in federal court. Here’s an excerpt from this Shearman blog reviewing the Court’s decision:
The Court began by holding that the Company’s choice-of-forum provision violated Delaware law because it was “inconsistent with the jurisdictional requirements of the Exchange Act.” According to the Court, Section 115 [of the DGCL] was “not intended to authorize a provision that purports to foreclose suit in a federal court based on federal jurisdiction,” which is exactly what application of the Company’s choice-of-forum provision would do. The Court then explained that, while Section 115 expressly authorizes choice-of-law provisions that require shareholders to file derivative suits “in” the state of Delaware, it does not authorize bylaws that restrict such suits to courts “of” the state of Delaware. The Court held that Delaware law “does not authorize application of [the Company’s] forum bylaw to close all courthouse doors to this derivative action.”
Next, the Court held that enforcing the Company’s choice-of-forum provision would violate federal law. “Because the federal Exchange Act gives federal courts exclusive jurisdiction over actions under it, applying the bylaw to this case would mean that plaintiff’s derivative Section 14(a) action may not be heard in any forum.” The Court emphasized that “[b]oth federal [Securities] Acts contain anti-waiver provisions that prevent parties from opting out of the federal laws in favor of state law, no matter how similar or strong the state-law rights and remedies are.”
Over on The Business Law Prof Blog, Ann Lipton finds the Court’s opinion to be a bit of a head scratcher:
This entire discussion, to me, is baffling, because it’s almost an afterthought that the Seventh Circuit concludes the bylaw as applied here violates the anti-waiver provisions of the Exchange Act. Normally, you’d expect that to end the matter; whether Delaware does or doesn’t authorize the bylaw is beside the point, because the Supremacy Clause beats Delaware. Instead, the primary focus of the Seventh Circuit is what Delaware thinks of such bylaws – and whether, amazingly, a Delaware Chancery court thinks they violate the Exchange Act.
Delaware courts have become more accommodating to Caremark claims in recent years and this recent Sidley blog cautions that the claims, which are premised on a board’s failure to fulfill its oversight responsibilities, may become increasingly attractive to plaintiffs in situations involving data breaches. Here’s an excerpt:
To successfully allege a Caremark claim, a plaintiff must plead facts demonstrating that either “(a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.” Put differently, the directors must have acted in bad faith in failing to oversee. Furthermore, this failure must be related to some aspect of the business that is “essential and mission critical.”
As our “data economy” has fed an increase in data security incidents, failures in data security have in turn created significant risks to corporations. These risks take many forms, including loss of access to business-critical data and IT infrastructure, successful consumer class action lawsuits, regulatory liability, or loss of commercial counterparties or liability to those counterparties. Not surprisingly, shareholder lawsuits have also followed, seeking to hold corporate boards responsible for lax oversight that results in harm to the corporation following a data security incident.
To date, Caremark claims based on data security incidents have mostly failed to gain traction; the vast majority have been dismissed at the motion to dismiss stage and a smaller portion have settled, as our colleagues noted in an article for Bloomberg Law back in 2017. Several recent cases have confirmed that Caremark claims remain difficult to bring (much less win), even when those claims are based on data security incidents. But these cases also reveal potential avenues that shareholder plaintiffs may pursue when bringing data security-related Caremark claims.
The blog highlights recent Caremark claims against Solar Winds & T-Mobile arising out of data breaches. The Solar Winds complaint focuses on Caremark’s first prong, and alleges that the Solar Winds board failed to implement necessary controls. In support of that allegation, the plaintiffs point to, among other things, the board’s failure to respond to an outside consultant’s warnings about data system vulnerabilities.
The T-Mobile case focuses on the second prong, and alleges that the company’s data security shortcomings involved violations of law – which in recent years have proven to be a fertile ground for Caremark claims. In particular, the complaint points to an FCC investigation and resulting fine to support allegations that the Board was “long aware of” yet “failed to heed . . . red flags” related to the company’s cybersecurity inadequacies.
The SEC recently scored a big win on the insider trading front, when a California federal court endorsed its novel “shadow trading” theory as the basis for a Rule 10b-5 enforcement proceeding. Here’s the intro to Cleary’s memo on the decision:
On January 14, 2022, the United States District Court for the Northern District of California issued a decision in SEC v. Matthew Panuwat validating the legal theory advanced by the Commission that trading in the securities of a competitor company could form the basis of an insider trading violation where the defendant learned that an acquisition of his employer was imminent.
In denying the defendant’s motion to dismiss the complaint, the court ruled that the SEC had sufficiently pled a claim, marking the first judicial decision concerning alleged insider trading in securities of a company based on material, nonpublic information (“MNPI”) about another company, a practice that has sometimes been referred to as “shadow trading.”
The court’s refusal to dismiss the SEC’s novel legal theory that trading on the basis of MNPI of one company to profit on a securities transaction involving a competitor constitutes actionable insider trading should be considered by companies and individuals as they assess trading decisions and policies.
The defendant allegedly traded stock of a direct and close competitor in a small market, and the memo points out that the straightforward facts of the case provided the SEC with an optimal setting for asserting its novel theory. This except says that the SEC might find other cases provide tougher sledding:
Other shadow trading fact patterns will likely have to grapple with more complicated determinations, including how material information about one company is for the value of securities of other companies in larger markets or less direct competitors (e.g., an insider at a company trading in the securities of a supplier or customer of the company).
When last we dropped in on Nasdaq, it had amended its proposal to permit direct listings with a capital raise in order to tweak the price range limitations contained in the rule. That amendment came only weeks after the SEC had approved the original version of the rule. Now this Fenwick memo reports that Nasdaq recently filed another amendment to its proposal:
On January 6, 2022, Nasdaq filed an amended rule proposal with the U.S. Securities and Exchange Commission to address the SEC’s questions and concerns related to the prior proposal filed by Nasdaq on May 25, 2021, which sought increased pricing flexibility in a Direct Listing with a Capital Raise.
Among other things, the amended proposal includes additional requirements for pricing a Direct Listing with a Capital Raise at more than 20% above the price range, adds certain notification requirements and a price volatility constraint, eliminates market orders (other than by the company) from the opening of the offering, requires a company to specify the quantity of shares registered in the S-1 registration statement and aligns the 20% price range deviation calculation with the SEC’s rules.
The memo has additional details on the amended proposal, and notes that the comment period will run until February 2, 2022, and the SEC will make a final decision on the proposal by February 25, 2022.
Liz recently blogged on the topic of how “homeless” public companies – those that claim not to have a principal executive office in their SEC filings – may create regulatory puzzles. Keith Bishop recently blogged a couple of specific examples of those puzzles under California law:
The designation of a corporation’s principal executive offices, of course, is one factor in determining whether a publicly held corporation is subject to California’s board quota laws. Cal. Corp. Code §§ 301.3, 301.4, 2115.5 & 2115.6. In addition, a domestic or foreign corporation required to file an annual statement of information (Form SI-550) must disclose the address of its principal executive office (no “s”). Cal. Corp. Code §§ 1502(a)(5) & 2117(a)(3).
Those corporations that have decided that they have no principal executive office may want to revisit their bylaws. Some corporate bylaws provide impose advance notice requirements on shareholders wishing either to submit a proposal for a shareholder vote or to nominate candidate(s) for election to the board. Often these provisions require that the notice be received at the corporation’s principal executive offices within a specified timeframe before the meeting. This is problematical if the corporation is taking the position that no such office exists in its filings with the Securities and Exchange Commission.
I know all the cool kids only want to exist in cyberspace or the metaverse or whatever this week’s variation on cloud cuckoo land is, but I think it’s kind of preposterous that the SEC permits companies to get away with offering securities without providing a physical address, particularly since they almost certainly have one. In that regard, this Olshan blog notes that “securities law commentators have suggested that the term “principal executive offices” would mean the place where the CEO and most other executive officers work most of the time.”
It’s no secret that rule amendments to enhance cybersecurity disclosure are on the SEC’s agenda, but in a speech yesterday at Northwestern Law School’s annual Securities Regulation Institute, SEC Chair Gary Gensler provided a little more color as to what public companies might expect to see in a rule proposal. Here’s an excerpt:
Disclosure regimes evolve over the decades. Cybersecurity is an emerging risk with which public issuers increasingly must contend. Thus, I’ve asked staff to make recommendations for the Commission’s consideration around companies’ cybersecurity practices and cyber risk disclosures. This may include their practices with respect to cybersecurity governance, strategy, and risk management.
A lot of issuers already provide cyber risk disclosure to investors. I think companies and investors alike would benefit if this information were presented in a consistent, comparable, and decision-useful manner.
In addition, I’ve asked staff to make recommendations around whether and how to update companies’ disclosures to investors when cyber events have occurred.
Make no mistake: Public companies already have certain obligations when it comes to cybersecurity disclosures. If customer data is stolen, if a company paid ransomware, that may be material to investors. As recent cases show, failure to make accurate disclosures of cybersecurity incidents and risks can result in enforcement actions.
Chair Gensler’s speech also addressed cybersecurity regulatory initiatives addressing broker-dealers, investment advisors, mutual funds and other participants in the financial sector – as well as service providers to those businesses.
The inaugural post on Goodwin’s new Public Company Advisory Blog shares some helpful tools on navigating the legal and practical aspects of the earnings release process. This 18-page Earnings Release Compliance Guide provides an overview of the legal issues that companies need to keep in mind when preparing their earnings releases, as well as guidance on dealing with potential problem areas. For example, this excerpt addresses the use of KPIs:
– Review key performance measures/indicators (KPIs) for consistency across quarters and other disclosure documents.
– KPIs are used by management to manage or evaluate the performance of the business. Certain KPIs may not meet the definition of a non-GAAP financial measure and thus may not be subject to Regulation G or Item 10(e) of Regulation S-K. Nevertheless, you need to consider what additional information may be necessary to provide adequate context for an investor to understand the KPI metric presented. In this regard, the SEC generally expects the following disclosures to accompany any KPI metric:
– a clear definition of the metric and how it is calculated,
– a statement indicating the reasons why the metric provides useful information to investors, and
– a statement indicating how management uses the metric in managing or monitoring the performance of the business
This publication is accompanied by a 6-page Earnings Release Compliance Checklist that provides a bullet-point summary of many of the topics covered in more depth in the Guide.
This Woodruff Sawyer blog lays out 20 questions that a prospective director should ask before agreeing to join a corporate board. Each question is accompanied by an explanation of why it’s important. Here’s an example:
What skill sets are represented on the board?
A diversity of skills and experience among board members is one of the best ways to ensure that the board can address unexpected issues. Does the board you are considering have this? If everyone on a board has a similar background—everyone has a technical or finance background, for instance—the board is less likely to be able to proactively identify new risks or recognize innovative solutions and strategies.
Consider, too, the advantage of having at least one board member who has the skill set to be the director who will deal with difficult legal situations, such as an internal investigation or thorny litigation. A board that has no one capable of making independent legal judgments is a board that is at risk for blindly agreeing to do whatever outside counsel tells them to do.
I’ve previously blogged about some of the uncertainties involved in how to account for digital assets. In light of those uncertainties & Bitcoin’s volatility, it’s not surprising that companies with investments in Bitcoin or other digital assets might want to present non-GAAP financial data that backs out the impact of swings in the value of those assets on their financial results.
Yeah, well good luck with that, because the Corp Fin Staff apparently is having none of it. Here’s an excerpt from this Bloomberg Tax article detailing the back & forth between the Staff and MicroStrategy on that company’s unsuccessful efforts to back out Bitcoin from its non-GAAP income statement:
For the quarter ending Sept. 30, 2021, MicroStrategy reported a net loss of $36.1 million. Adding back in its share-based compensation expense and the impairment of its digital assets made the company’s unofficial, or non-GAAP, income flip to $18.6 million, its filing shows. MicroStrategy did not immediately respond to a request for comment.
The company told the SEC it used non-GAAP measures to give investors a fuller picture of its finances. If the company only showed declines in value, it would give “an incomplete assessment” of its Bitcoin holdings that would be “less meaningful to management or investors” in light of the company’s strategy to acquire and hold Bitcoin. “We further believe that the inclusion of bitcoin non-cash impairment losses may otherwise distract from our investors’ analysis of the operating results of our enterprise software analytics business,” the company wrote.
The SEC disagreed. In a letter dated Dec. 3, the market regulator told MicroStrategy it objected to the adjustment and told the company to remove it from future filings. In its Dec. 16 response, MicroStrategy said it would comply.
Speaking of Bitcoin, as a very bitter Cleveland Browns fan, I admit that this report brightened my day just a little.
