There’s been some back & forth over “who writes the rules” when it comes to dual-class shares: candidates for that job have included indexes, exchanges and institutional investors (whose objections to an extreme variation of this structure was one of many factors that played a role in the fall of WeWork). In a recent speech, the SEC’s “Investor Advocate” – Rick Fleming – even acknowledged that investors are part of the problem – but also called for heightened SEC disclosure requirements for dual-class shares and intervention from stock exchanges.
Now, CII is also moving the issue to the state level – via this letter to the Delaware State Bar Association. Here’s an excerpt (and here’s a Wilson Sonsini blog that responds to CII’s proposal):
A proposed new Section 212(f) of the DGCL is attached as Annex A to this letter. Pursuant to that language, no multi-class voting structure would be valid for more than seven years after an initial public offering (IPO), a shareholder adoption, or an extension approved by the vote of a majority of outstanding shares of each share class, voting separately, on a one-share, one-vote basis. Such a vote would also be required to adopt any new multi-class voting structure at a public company. The prohibition would not apply to charter language already existing as of a legacy date.
Non-GAAP: How to Avoid Staff Scrutiny
Last month, I blogged that this year’s “Top 10 List” for Corp Fin comments continues to include non-GAAP – no surprise there. This PwC memo highlights the 5 most common non-GAAP issues that draw Staff scrutiny:
1. GAAP measure not given enough prominence
2. Reconciliation between GAAP and non-GAAP measures is missing or does not start with the GAAP measure
3. Non-GAAP measure is not presented consistently between periods or the reason for changing a non-GAAP measure is not disclosed
4. Management’s explanation of why a non-GAAP measure is useful to investors is inconclusive
5. Use of an individually–tailored accounting principle (a company cannot make up its own GAAP)
We’ve blogged before about that last one – it’s a newer area of comment so there’s still some confusion about what it means. For those who subscribe to “The Corporate Counsel” print newsletter, we’ll take a deep dive into this topic in the forthcoming November-December Issue.
“Investors’ Exchange”: RIP
Three years ago, John blogged about a new national securities exchange, “IEX” – which was unique in that it wasn’t operated by Nasdaq or NYSE. Its run was short-lived – this WSJ article reports that it decided to exit the business after its only listed company went back to Nasdaq. But other new competitors remain optimistic – there are at least three hoping to break into the market next year…
In other “exchange” news, last week Nasdaq filed a rule change to modestly increase annual listing fees. Starting January 1st, fees for most equities will go up by about $1-$3k…
The gloves are off. Yesterday, ISS announced that it had filed this lawsuit against the SEC – which challenges the Commission-level guidance that was issued back in August. As Broc blogged earlier this week, CII had already sent a couple of comment letters to the SEC to complain about that guidance. This lawsuit also comes on the heels of the SEC announcing that it will hold an open Commission meeting next week to propose rule changes for proxy advisors.
These are the ISS allegations (also see this Cooley blog – and this Twitter thread from Wharton Prof David Zaring that speculates this case may be used as part of the bigger picture pushback on regulatory guidance that we’ve been seeing):
– The guidance exceeds the SEC’s statutory authority under Section 14(a) of The Securities Exchange Act of 1934 and is contrary to the plain language of the statute; the provision of proxy advice is not a proxy solicitation and cannot be regulated as such
– The guidance is procedurally improper because it is a substantive rule that the SEC failed to promulgate pursuant to the notice-and-comment procedures of the Administrative Procedure Act
– The guidance is arbitrary and capricious because, even though it marks a significant change in the regulatory regime applicable to proxy advice, the SEC has denied that it is changing its position at all. The agency has thus flouted the basic requirement of reasoned decision-making that it at least display awareness that it is changing its position
Director Survey: “Collegiality” & “ESG” Can Go Too Far
PWC is out with its annual survey of 700 directors. The main theme is that “collegiality” remains highly valued and important – but it can go too far if it keeps directors from speaking up or pursuing necessary refreshments. Here’s the key findings:
– 49% of directors (privately) say that one or more colleagues should be replaced (a record number)
– 43% of directors say it’s difficult to voice a dissenting view in the boardroom
– 72% of boards are conducting performance assessments (up from 49% in 2016) – but most focus on adding expertise or diversity, rather than counseling or not re-nominating underperforming incumbents
The survey also says that some directors are growing weary of diversity & ESG attention:
– After years of steadily climbing, the number of directors saying board diversity is “very important” fell by 10%
– 83% of directors say they don’t support state law diversity mandates – but around half say they support policies of including diverse candidates in recruitment slates
– 56% of directors say that investors devote to much attention to E&S issues (however, part of the frustration is that there’s still a lot of confusion among directors about what issues fall into this category)
– An increasing number of directors say that the board has a role in corporate culture (but still not as much as upper & middle management)
See this HBR article for a take on working with the “5 archetypes” of director approaches to ESG – the deniers, the hardheaded, the superficial, the complacent, and the true believers.
Our November Eminders is Posted!
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This 91-page report from EY – and the related 7-page summary – say that Corp Fin issued 34% fewer comment letters last year. While that was partially due to the long-lasting government shutdown, it follows a 25% drop in the prior year – so there appears to be a trend. Not surprisingly, revenue recognition & non-GAAP were the most frequent comment topics. Here’s the full top 10 (see the report for example comments in each category):
1. Revenue recognition
2. Non-GAAP financial measures
3. MD&A (in order of frequency: (1) results of operations (20%), (2) critical accounting policies and estimates (10%), (3) liquidity matters (8%), (4) business overview (6%) and (5) contractual obligations (2%) – many companies received MD&A comments in more than one category)
4. Fair value measurements (including comments on fair value measurements under Accounting Standards Codification 820 – as well as fair value estimates, such as those related to revenue recognition, stock compensation and goodwill impairment analyses)
5. Intangible assets and goodwill
6. Income taxes
7. State sponsors of terrorism
8. Segment reporting
9. Acquisitions and business combinations
10. Signatures/exhibits/agreements (new to this year’s “Top 10”)
Foreign Nations Might Be Delaware’s New Competition
While you may think of Nevada – or even federal law – as Delaware’s primary competitor in the “corporate law” space, a forthcoming law review article says that non-US jurisdictions are the real threat. Here’s an excerpt:
While Delaware continues to dominate the market with 48.1% of US-listed companies, foreign nations now account for 13.4% of incorporations – more than double the 5.5% of US-listed companies incorporated in Nevada, which has been identified as the only other state besides Delaware actively vying to draw corporations that physically operate outside of its borders.
As this Article will show, offshore incorporation havens in recent decades have built sophisticated legal infrastructures that enable them to compete with Delaware. For one, they have attracted a network of elite foreign lawyers who help lawmakers in these jurisdictions draft “cutting edge” corporate law statutes. These lawmakers also rely heavily on incorporation fees for government revenues, allowing them to credibly commit to retaining laws that are attractive to the private sector.
Because the population of offshore incorporation havens tends to be a fraction of even sparsely populated states in the United States (for instance, as of 2019, the population of the Cayman Islands is 59,613 compared to 961,939 in Delaware and 2,998,039 in Nevada), these jurisdictions can enact legislation swiftly in response to private sector demand. They also do not confront the type of democratic accountability facing large nation states (or large states like New York or California), in part because they specialize in producing laws for corporations that do not physically operate within their territories.
Delaware’s judicial system is often pointed to as a competitive advantage over other states. These jurisdictions compete not by carbon copying Delaware’s judiciary, but rather by offering dispute resolution for a functionally similar to modern commercial arbitration. Like arbitration, courts in offshore incorporation havens swiftly resolve disputes without juries. Judges serving in these courts, like arbitrators, are credentialed business law jurists including partners at major international law firms who fly in from overseas to preside over cases ad hoc. Many legal proceedings take place in secret, and full-length opinions are frequently unpublished or available only to insiders.
I’m admittedly biased due to interning in Wilmington for a Delaware Justice back in the day, but isn’t transparency & predictability still a pretty big advantage? I guess if you can opt out of derivative suits & fiduciary duties, which is the case with many of these incorporation havens, that may matter less.
Although we haven’t yet seen a Sunshine Act notice from the SEC, the Financial Times is reporting that the SEC could propose new rules for proxy advisors & shareholder proposal thresholds as soon as next Tuesday. For now, here’s what’s being reported as part of the proposal:
– Proxy advisors would be required to give companies two chances to review proxy voting materials before they are sent to shareholders
– Shareholder proposal resubmission threshold would increase to 6% approval in year one, 15% in year two and 30% in year three – if a shareholder proposal doesn’t hit those thresholds, companies would be able to exclude proposals on the same subject matter for the next three years
These things are always very speculative – both the substance & timing could change, and nothing’s certain till we see the proposal. The FT article emphasizes that too:
The Commission is expected to vote to put the changes out for comment on November 5, according to the people, who cautioned that the plans and the timing were still in flux and could change before the vote next month.
If the proposal is issued, you can bet we’ll be covering it in our upcoming webcast – “Shareholder Proposals: What Now” – on Thursday, November 21st. In that program, Davis Polk’s Ning Chiu, Morrison & Foerster’s Marty Dunn and Gibson Dunn’s Beth Ising will also be discussing Corp Fin’s new approach for processing shareholder proposal no-action requests and the expected impact of Staff Legal Bulletin 14K.
“Harmonization” of Private Offerings: NASAA Comments on SEC’s Concept Release
Right now, a “requirement” for relying on the Reg D private placement exemption is to file a Form D within 15 days of the date that securities are first sold under the exemption. “Requirement” is in quotes because filing a Form D isn’t a condition to the availability of the federal exemption – but it could disqualify the company from using the exemption in the future, and some state enforcement agencies say that a delinquent Form D kills the preemption the company would otherwise enjoy from state law registration requirements.
So it’s interesting that in its recent comment letter to the SEC’s “Concept Release on Harmonization of Securities Offering Exemptions,” the North American Securities Administrators Association – otherwise known as NASAA, the organization that represents state securities regulators – is recommending an amendment to Regulation D that would require pre-issuance as well as post-closing Form D filings. This Allen Matkins blog gives more details (and here are all the comments the SEC has received so far):
NASAA argues that a pre-issuance filing requirement will “alert regulators that the offering is forthcoming and to provide an opportunity for regulators to investigate the offering if any information in the Form D raises concern”. Form D was originally presented as a tool to “collect empirical data which will provide a basis for further action by the Commission either in terms of amending existing rules and regulations or proposing new ones”. It has evolved, however, into an enforcement tool for securities regulators. See “Is Form D Afflicted With Mission Creep?“
NASAA is also recommending amendments to the definition of “accredited investor” that would raise individual net worth & income requirements, and preserving Rule 504 in its current form. Our “Reg D Handbook” covers all the ins & outs of the current exemption – including the current Form D filing requirements and related “Blue Sky” impact.
“Climate-Change Accounting”: Not Adding Up?
Last week, as this WSJ article reports, Exxon began defending itself in New York state court about whether it improperly accounted for the cost of climate change regulations (they were also sued in Massachusetts). The NY suit was brought under New York’s sweeping Martin Act and arises out of a 4-year investigation – so of course there’s some controversy. According to the article, Exxon has denied wrongdoing – and said a reasonable investor wouldn’t expect to know these details. But then there’s this unrelated Reuters article about how investors want more transparent “climate-change accounting” so they can better understand & price risks. Here’s an excerpt:
Using a broad measure, global sustainable investment reached $30.1 trillion across the world’s five major markets at the end of 2018, according to the Global Sustainable Investment Review. This equates to between a quarter and half of all assets under management, due to varying estimates of that figure.
Condon said most investors were still more focused on returns than wider sustainability criteria but were becoming concerned that companies may expose them to possible future climate-related financial losses.
To try to price risk, the world’s biggest financial service providers are investing in companies which provide ESG-related data. This year alone, Moody’s bought Vigeo Eiris and Four Twenty Seven, MSCI bought Carbon Delta and the London Stock Exchange bought Beyond Ratings. S&P acquired Trucost in 2016. Independent climate risk advisors Engaged Tracking say they attracted two-thirds of their clients in the past year. All six companies provide data, assessments and consulting on the climate exposure of companies or bonds.
To reiterate, these investors weren’t reacting to Exxon’s disclosure specifically, or its court case. And we obviously don’t know what’ll happen there. But if there’s a scale weighing the pros & cons of a more standard disclosure framework for environmental costs & risks, the specter of this type of litigation – and investor appetite – seem to drop in on the “pro” side…
When I first saw this announcement from the SEC’s Enforcement Division about an emergency action to halt an unregistered ICO, I brushed it off as a takedown of yet another fraudulent “crypto” company. But this column from Bloomberg’s Matt Levine points out that this one is different.
In Matt’s words, the company here was doing the “best-practices-y thing” that had been blessed by several law firms. Its offering was structured as a “Simple Agreement for Future Tokens” – as John blogged last year, that’s an approach – based on the popular “SAFE” template for startup financing – that was starting to take off for Reg D token deals. Matt’s explanation of how it works:
1. Sell something—call it a “pre-token”—to accredited investors (institutions, venture capitalists, etc.) to raise money to build your platform. Concede that the pre-token is a security.
2. When the platform is built, it will run on a token, a cryptocurrency that can be used for transactions on the platform and that is not a security.
3. At some point — at or after the launch of the platform — the pre-token (the security) flips into the token (the non-security), and all the people who bought pre-tokens to finance the platform now have tokens to use on it. (Or to sell to people who will use them.)
This seems to honor the intention of securities law—you’re not selling speculative investments to retail investors to fund the development of a new business—while also honoring the intention of the ICO: Your platform is financed (indirectly, eventually) by the people who use it; the people putting up the money do so not in exchange for a share of the profits but for the ability to participate in the platform itself. In this model the pre-token will be called something like a “Token Purchase Agreement” or “Simple Agreement for Future Tokens”: It’s a security wrapper for the eventual utility token.
Unfortunately, the SEC’s complaint took issue with the fact that when the “pre-tokens” here were scheduled to flip into tokens, there would be no established ecosystem for them to trade as currency. Which would seem to be an obvious side-effect of financing a new form of cryptocurrency?
We’re not really sure what to make of this yet – there were some reports that early investors in this offering were flipping their tokens right away, which would be a problem in the SEC’s view. Matt also suggests that maybe the SEC would be more amenable if the pre-tokens didn’t flip until the ecosystem is running robustly. But probably not. John blogged recently on “The Mentor Blog” about how to do a Reg A token offering. So perhaps anyone considering an ICO should take a look at that…
“Reg D” ICOs: What’s the Harm in Trying?
This MarketWatch article notes there’s been a steep drop-off in the number of Reg D token offerings this year. If the Enforcement Division taking issue with a SAFT isn’t enough to put companies off that approach, keep in mind that the remedies in these actions go beyond just halting the current offering:
Until September 30, 2019, SEC enforcement actions in the crypto industry conveyed a consistent message: most crypto is a security, and if a token issuer does not follow the registration requirements of the 1933 Act, the issuer would face significant consequences in the form of substantial penalties, a mandated rescission offer to US investors, a requirement to register the tokens under Section 12(g) of the 1934 Act, and bad actor disqualifications preventing the issuer from future Regulation A and Regulation D offerings.
That’s the intro from this Wilson Sonsini memo – but it does note a recent “aberration” on the remedies front:
On September 30, the SEC announced a settlement with Block.one that did none of these things. Despite finding that Block.one issued tokens that were securities in the United States without complying with registration requirements of the 1933 Act, the SEC: imposed a financial penalty on Block.one that was minor in the context of the total size of Block.one’s capital raise; did not require Block.one to make a rescission offer to investors; did not require Block.one to register its tokens under the 1934 Act; and did not impose bad actor disqualifications under Regulation A and Regulation D.
And, as discussed below, the Block.one Settlement Order omitted any mention of key factual information necessary to support the SEC’s conclusion that the tokens were in fact securities. Equally surprising, the SEC did not address, in any respect, whether new tokens issued being used on a blockchain supported by Block.one are securities, and the SEC took no action (and offered no discussion) with respect to the issuance of those tokens.
What are we all to make from these mixed messages? This Eversheds Sutherland memo says that the most we can take away is that the SEC is evaluating facts in settlement proceedings on a case-by-case basis. If you’re doing an unregistered token offering right now, go document some good facts!
We just wrapped up “Lynn, Borges & Romanek’s 2020 Executive Compensation Disclosure Treatise” — and it’s been sent to the printers. This Edition includes updates to disclosure examples, info about the evolving link between ESG topics & executive pay, and a brand new chapter on hedging policy disclosure. All of the chapters have been posted in our “Treatise Portal” on CompensationStandards.com.
How to Order a Hard-Copy: Remember that a hard copy of the 2020 Treatise is not part of a CompensationStandards.com membership so it must be purchased separately. Act now to ensure delivery of this 1710-page comprehensive Treatise as soon as it’s done being printed. Here’s the “Detailed Table of Contents” listing the topics so you can get a sense of the Treatise’s practical nature. Order Now.
Here’s the latest “list” installment from Nina Flax of Mayer Brown (here’s the last one):
I believe none of us, regardless of the stage of our careers, should feel bad, shame or any other negative if we are unable to remain completely unemotional at work. We are human – and emotions make us human! There have been many times throughout my career, and of course in the past few years, that I have cried – including somewhere at work. How I know that I need that outlet as well as support from others in order to remain [more] composed in the inducing situation and after. I need it like the air I breathe.
This got me thinking about crying, how and when I cry, and how some people I work with (internally and externally) do not seem to think of me as being vulnerable for I am sure a plethora of reasons. So, here is a more vulnerable list… a list of Things That Make Me Cry.
1. My Son’s Love. It is a fact that I am a working mom. In fact, I do not think I would be a good mom if I did not work – I am just not cut from that cloth. However, I am in a service profession, which means I have to be available and can have intense hours. Which also means that I have to travel. When my son grabs on to my leg and starts crying hysterically, whether on a “normal” morning when I am going in to work or as I have a suitcase in hand waiting for a car to take me to the airport, I keep it together. Momentarily. The second I walk out of the house and he can no longer see me, remembering his dragon tears and “No, mommy, don’t go! Don’t go [to work] [to the airport]! Stay here! I want you to stay here with me!” – I cry.
2. My Son’s Rejection. See first three sentences above. Which also leads to my husband being the more stable figure who is always able to be there in the morning (no calls in the office from 6am), at night (no working until 3am) and on weekends (for all, no work travel). Which leads to my son at times (sometimes it feels like the vast majority of times) preferring my husband. Which leads to my son, sometimes, yelling “Go away!” or “I don’t want you” or “NO! Only Papa!”, etc. I know this is not atypical. And I know that in the next breath, I get an “I love you” or a hug or a kiss or a head leaning on my shoulder, or, as above, a “Mommy, no, don’t go to work!” These things don’t make the hurt go away. My son’s rejection cuts me to the core, including the guilt I feel that I have to prioritize work sometimes, and I always sneak away to cry by myself. I am saving for another day tag lines that really make me angry – like work-life balance, or lean in. Finally, before I move off of this point, I LOVE the relationship my son and husband have, and would not want their relationship to be any other way. Other than tempering the tone and words of my rejection. If my son said, “Mama, can you please have Papa come in?” or “Mama, I would prefer if Papa tucked me in.” in those moments, I swear I would not cry – I would not feel rejected. Thankfully, he has started heading in this direction.
3. Being Frustrated When I’m Tired. Not kidding. If I am tired and something occurs that I find particularly frustrating, I cry. It is truly a reflex for me. Any frustration.
4. Witnessing Artistic Accomplishments. When I see an amazing ballet, or even watch a moving piece on So They Think They Can Dance (when I watched this show before child), or someone sing beautifully a beautiful song, or someone receiving an award for a fantastic performance, I cry. When people perfect their craft, share it and exude peace and joy at the same time, I am moved. I must admit I am more emotional around the arts, but any deep recognition of achievement, scientific, professional or other non-arts focused, usually makes my eyes at least water.
5. Reading The News. I know I should not admit this in public, but I extremely dislike reading or staying up-to-date on the news. Because inevitably, there is a piece on conflict I seek out, a story about a crime or horrific accident involving a child, or a moving, random act of kindness. The majority of the time I read the news I read something that makes me cry.
6. Feeling Grateful. I have referenced this a bit in my other posts, but I try to remind myself of all that I have to be grateful for. And when I do I realize how much I am grateful for, how trivial some of the things that upset me are, and how there are so many with less. Including children who are hungry, without a roof over their heads, without feeling safe, without feeling loved and/or without books. And I cry.
This makes it seem like I always cry. Those who are closest to me are not at all surprised by my delicate flower status. Those that are not as close to me are probably floored by this post. But I felt compelled to be honest – I am not ashamed of crying, and have learned to temper my feeling of being “less” than anyone in a professional situation who comes across as perfectly composed. Because I love emotions, but maybe a little less than I love books.
Fake SEC Filings: Edgar Fights Back
I really can’t overstate how much we love “fake SEC filings” around here. So it’s with mixed feelings that I report on changes to Edgar that might make these an even rarer occurrence. Specifically, filers now need a longer & more complex password – this Gibson Dunn blog has more detail:
Filers, including Section 16 filers, will now be requested to provide twelve character passwords instead of eight character passwords when logging into both the EDGAR Filing Website and the EDGAR Online Forms Management Website. Current filers who do not update their password to twelve characters will be prompted to update it each time they log in. We have confirmed with the staff of EDGAR Filer Support that current filers who do not update their password when prompted will not be prevented from logging in successfully. However, EDGAR passwords expire annually and should be changed before the expiration date. Any filers who have not already updated their password by the time they otherwise expire will be required to create a password that satisfies the new requirements before being permitted to log in to EDGAR.
Even more interesting from a security perspective is that a “Last Account Activity” tab is being added to the filing & forms websites – so you can see a 30-day history of login attempts and spot any aspiring fakers. And on a more vanilla note, the changes also allow companies to include 150 characters in cover page tags for classes of registered securities (up from 100 characters), since some companies were having trouble fitting it all in.
New Podcast Series! “Women Governance Gurus” With Courtney Kamlet & Liz
Check out the new podcast series – “Women Governance Gurus” – that I’ve been co-hosting with Courtney Kamlet of Syneos Health. So far, these illustrious guests have joined us to talk about their careers in the corporate governance field – and what they see on the horizon:
– Stacey Geer – EVP, Chief Governance Officer, Deputy GC and Corporate Secretary at Primerica
– Kellie Huennekens – Head of Americas, Nasdaq Center for Corporate Governance
– Anne Chapman – Managing Director, Joele Frank
– Hope Mehlman – EVP, Chief Governance Officer at Regions Bank
Stacey’s President & GC even presented her with a new nameplate in honor of the occasion!
When Delaware Chief Justice Leo Strine announced that he’d be leaving the bench this fall, Broc speculated that grander things were yet to come. Now, the influential judge is kicking off his “retirement” with a bang – by publishing this proposal that would recommit to “New Deal” concepts. In particular, the proposal focuses on workers’ rights and a reformed shareholder voting/proposal process (e.g. requiring a “say-on-pay” vote only once every 4 years and changing shareholder proposal thresholds).
This isn’t a big surprise given some of Chief Justice Strine’s prior comments. But it’s more comprehensive. And while he doesn’t go as far as Senator Warren’s “Accountable Capitalism Act,” he does comment that companies are “societally chartered institutions” – notable for a Delaware judge! – and proposes requiring “workforce committees” for boards of all large companies (whether public or private). Here’s an excerpt on that point (and also see this Cooley blog):
To make sure that companies give careful consideration to worker concerns at the board level, the Proposal requires the Securities and Exchange Commission, the Department of Labor, and the National Labor Relations Board to jointly develop rules that would require the boards of companies with more than $1 billion in annual sales to create and maintain a committee focused on workforce concerns. By requiring these committees at all large corporations, not just public corporations, more accountability would be imposed on large private companies, such as those owned by private equity firms, to treat their workforce fairly.
These workforce committees would be focused on addressing fair gain sharing between workers and investors, the workers’ interest in training that assures continued employment, and the workers’ interest in a safe and tolerant workplace. These workforce committees would also consider whether the company uses substitute forms of labor—such as contractors—to fulfill important corporate needs, and whether those contractors pay their workers fairly, provide safe working conditions, and are operating in an ethical way, and are not simply being used to inflate corporate profits at the expense of continuing employment and fair compensation for direct company employees.
Offering a middle-ground between the current system and “codetermination”-style worker representation, the committees would be required to develop and disclose a plan for consulting directly with the company’s workers about important worker matters such as compensation and benefits, opportunities for advancement, and training. Finally, the National Labor Relations Act would be amended to ensure that companies can use dedicated committees to consult with their workers without running afoul of the Act’s prohibition on “dominating” labor organizations, provided that the company doesn’t interfere with, restrain, or coerce employees in the exercise of their rights to collective bargaining and self-organization. In essence, this would allow for European-style “works councils” without impeding union formation and representation.
Should the SEC Get Out of the “Stakeholder Disclosure” Business?
I think most securities practitioners can agree that it’s exhausting to shoehorn certain Congressional mandates for broader ’33 & ’34 Act reporting into the SEC’s mission to protect investors – and when these types of mandates come around, they also seem to be at odds with the Commission’s mission to facilitate capital formation. At the same time, a variety of stakeholders are clamoring for information, and the SEC runs the main disclosure game in town.
This paper by Tulane law prof Ann Lipton plays some of the same notes as Chief Justice Strine’s proposal (and it was actually published before his). For example, that it’s outdated to make disclosure requirements dependent on a company’s capital raising strategy. Here’s part of the abstract:
This Article recommends that we explicitly acknowledge the importance of disclosure for noninvestor audiences, and discuss the feasibility of designing a disclosure system geared to their interests. In so doing, this Article excavates the historical pedigree of proposals for stakeholder-oriented disclosure. Both in the Progressive Era, and again during the 1970s, efforts to create generalized corporate disclosure obligations were commonplace. In each era, however, they were redirected towards investor audiences, in the expectation that investors would serve as a proxy for the broader society. As this Article establishes, that compromise is no longer tenable.
Who would regulate this brave new world? Personally, I think that if the SEC’s mission was expanded, it would be well-suited to take on the challenge – but I’m not sure they’d want the job. Here’s what Ann suggests:
There is currently no federal agency with the skills to manage the system contemplated here. The SEC is not equipped to manage disclosures intended for noninvestors (which is another reason the securities laws should not be used for that purpose). The Federal Trade Commission has broad experience studying business activity, but has fewer disclosure mandates. That said, the SEC and the FTC both have skills and experience that would be useful in developing a new system: both study a wide range of industries, and the SEC in particular has expertise in developing standardized reporting for public audiences, balanced against the costs to businesses of complying with disclosure demands.
Therefore, it might be appropriate to create a joint initiative that draws on the resources and knowledge of both agencies. The initiative could begin its work by studying how public information about corporations is used by noninvestor audiences, including surveying local regulators, as well as advocacy and trade groups, for their input as to how existing disclosures are used and the weaknesses in the current system. Based on the results of this survey, the initiative could develop a standardized framework that would permit meaningful comparisons across reporting companies.
New! Quick Survey on Hedging Policy Disclosure
At our conference a few weeks ago a few weeks ago (which you can still register & watch via video archive), there were a lot of questions about how companies will handle the newly required hedging policy disclosure. Take a moment to participate in our 3-question “Quick Survey on Hedging Policy Disclosure” and see what others are planning to do.
Here’s something I recently blogged on CompensationStandards.com: As you can see from the studies posted in our “Director Pay” Practice Area, it’s become a pretty rare thing for public companies to pay director meeting fees. In fact, this Pearl Meyer blog reports that fewer than 25% of companies are doing it (though it’s still a majority practice at private companies). The blog gives these recommendations if your directors insist on being paid for attendance:
1. If your number of board or committee meetings is consistently above your peer group meeting, revisit whether your retainers account for that workload
2. If there’s a non-recurring situation, consider an ad-hoc retainer for affected directors
3. If directors are uncertain about their workload, consider conditional meeting fees if the number of meetings exceeds a pre-established threshold
SEC Enforcement: Check Your “Loss Contingency” Disclosure!
Ah, autumn. A time to relish the changing leaves, cooler temps and of course the deluge of press releases from the SEC’s Enforcement Division that drop before the end of the Commission’s September 30th fiscal year. Here’s an announcement about charges against the pharma company Mylan, which was the subject of a two-year DOJ probe and didn’t disclose any loss contingencies or accrue any estimated losses prior to announcing a $465 million settlement.
The SEC’s complaint also took issue with the company’s “hypothetical” risk factor disclosures about government authorities taking contrary positions to its Medicaid submissions, when CMS had already informed Mylan that a product was misclassified. Mylan agreed to settle the SEC matter for $30 million.
Things like this tend to seem pretty clear in hindsight – especially if you’re reading about them in an SEC announcement. But it really requires a thorough understanding of the rules and a lot of judgment. Don’t forget that we have handbooks to help you sort through it all. Here’s the one on “Legal Proceedings Disclosures” – and here’s the one on “Risk Factors.”
SEC Enforcement: Actually, Just Check All Your Disclosures
Here’s another recent settlement between the SEC’s Enforcement Division and a company that disclosed allegedly misleading customer metrics (the CEO was also charged). This one’s scary because it delves into the type of non-financial stuff that gets added to earnings releases (and occasionally periodic reports) without a lot of lawyerly checking. This Stinson blog explains the allegations:
In 2014 and 2015, Comscore disclosed its total number of customers and net new customers added in quarterly earnings calls. Comscore also disclosed its customer total in periodic filings with the Commission. According to the SEC the number of net new customers added per quarter was an important performance indicator for Comscore that analysts tracked and reported on. During this time, in an effort to conceal the fact that quarterly growth in Comscore’s customer total had slowed or was declining, a Comcast employee allegedly approved and implemented multiple changes to the methodology by which the quarterly customer count was calculated. These changes were neither applied retroactively nor disclosed to the public per the SEC order.
Coincidentally, a recent Corp Fin comment letter raised similar issues for a different company. Comments might be down overall, but don’t let anyone tell you that Corp Fin is “calling it in” for their reviews. They took issue with the number of customers disclosed by a gym in its annual report and – of all the things! – the viewership stats that the company cited for “Dick Clark’s Rockin’ Eve” (see this Bass Berry blog).
For those of us who want to save companies from fines & embarrassment, the question is how to vet non-financial metrics efficiently and without losing all your friends & clients. Some members have suggested putting a “stake in the ground” that describes how customer metrics are calculated – whether that’s a widely-available internal thing or actually in the 10-K would be up for debate (both shareholders & competitors would prefer the latter). Shoot me an email if you have other ideas…
Here’s something John blogged last week on DealLawyers.com: Don’t look now, but the Delaware Chancery Court just upheld another Caremark claim in the face of a motion to dismiss. In his 50-page opinion in In re Clovis Oncology Derivative Litigation, (Del. Ch.; 10/19), Vice Chancellor Slights held that the plaintiffs had adequately pled that the board breached its fiduciary duties by failing to oversee a clinical trial for the company’s experimental lung cancer drug and then allowing the company to mislead the market regarding the drug’s efficacy.
In declining to dismiss the case, the Vice Chancellor observed that Delaware courts are more likely to find liability under Caremark for oversight failures involving compliance obligations under regulatory mandates than for those involving oversight of ordinary business risks:
Caremark rests on the presumption that corporate fiduciaries are afforded “great discretion to design context- and industry-specific approaches tailored to their companies’ businesses and resources.” Indeed, “[b]usiness decision-makers must operate in the real world, with imperfect information, limited resources, and uncertain future. To impose liability on directors for making a ‘wrong’ business decision would cripple their ability to earn returns for investors by taking business risks.”
But, as fiduciaries, corporate managers must be informed of, and oversee compliance with, the regulatory environments in which their businesses operate. In this regard, as relates to Caremark liability, it is appropriate to distinguish the board’s oversight of the company’s management of business risk that is inherent in its business plan from the board’s oversight of the company’s compliance with positive law—including regulatory mandates.
As this Court recently noted, “[t]he legal academy has observed that Delaware courts are more inclined to find Caremark oversight liability at the board level when the company operates in the midst of obligations imposed upon it by positive law yet fails to implement compliance systems, or fails to monitor existing compliance systems, such that a violation of law, and resulting liability, occurs.”
VC Slights cited the Delaware Supreme Court’s recent decision in Marchand v. Barnhill, and noted that that case “underscores the importance of the board’s oversight function when the company is operating in the midst of ‘mission critical’ regulatory compliance risk.”
Caremark requires a plaintiff to establish that the board either “completely fail[ed] to implement any reporting or information system or controls” or failed to adequately monitor that system by ignoring “red flags” of non-compliance. While the board’s governance committee was responsible for overseeing compliance with regulatory requirements applicable to the clinical trial, the Vice Chancellor held that the plaintiff adequately pled that it knowingly ignored red flags indicating that the company was not complying with those requirements. Accordingly, he declined to dismiss the case.
Ann Lipton has some interesting perspectives on VC Slights’ distinction between business & legal compliance risks over on her Twitter feed. Check it out.
Caremark still may be, as former Chancellor Allen put it, “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” But after decades of routinely dismissing Caremark claims at the pleading stage, this marks the second time this year that the Delaware courts have declined to do so – and it’s the third case in the last two years in which they’ve characterized a Caremark claim as “viable.”
Is Caremark becoming a more viable theory of liability, or is board’s conduct in these cases just more egregious than in prior cases? It’s hard to say based on the limited evidence we have. For now, maybe the ’60s band Buffalo Springfield put it best – “There’s something happening here. What it is ain’t exactly clear. . .”
ISS Proposes Policy Changes: Comment By October 18th!
Yesterday, ISS announced a public comment period for proposed policy changes that would apply to next year’s annual meetings. For the US, the proposed changes are:
1. Clarifying a maximum 7-year sunset and other parameters for multi-class capital structures at newly public companies
2. Codifying ISS’s existing approach to “independent chair” shareholder proposals by identifying factors that will weigh in favor of a “For” recommendation – e.g. a “weak or poorly defined lead director role” – and moving some info into the “Policy FAQs”
3. Adding safeguards against “abusive practices” to the policy to vote “For” management proposals for buyback programs – e.g. the use of buybacks to boost EPS-based pay metrics
Submit comments to policy@issgovernance.com by next Friday – October 18th. Unless otherwise specified in writing, all comments will be disclosed publicly upon release of final policies – which is expected during the first half of November.
Ransomware: Preparing for a Growing Threat
According to a recent NYT article, more than 40 municipalities have been victims of ransomware attacks this year, including the 23 towns in Texas that were hit recently. This Wachtell Lipton memo predicts that ransomware is a growing threat for companies too – and offers these preparation & response tips (also see the suggestions in this “Accounting Today” article):
Before an attack:
– Reduce ransomware exposure by implementing reliable backup processes for IT systems & critical data
– Get cyber insurance that covers costs associated with ransomware incidents
– Implement incident response plans – including elevation procedures
– Foster pre-attack relationships with law enforcement
Responding to an attack:
– Protect attorney-client privilege by assigning legal counsel a leadership response role & engaging other advisers through counsel
– Assess disclosure obligations – e.g. state & international data breach notifications, SEC and industry-specific disclosure requirements
– Determine notice requirements for insurers, vendors and customers
– Approach the decision whether to pay a ransom with great caution & careful deliberation
On that last point about whether to pay a ransom, this ProPublica article outlines the pros & cons for victims – and suggests insurers have an incentive to accommodate the attackers even if (or because?) doing so leads to more incidents. According to the article, cyber insurance is now a $7-8 billion/year market, and insurers know that could fall apart if nobody is worried about getting hacked.
Recently, Lawrence Heim – himself the author of the book “Killing Sustainability” – sent me this 17-page essay on “greenwishing.” It’s written by Duncan Austin – a former investment manager at a large sustainable investment firm – and traces the rise in investor & consumer interest in sustainability. While it seems like that might be a good thing, Duncan opines that pushing sustainability as a cost-free endeavor – or a half-baked profit-driver – is hurting the cause. Of course, here’s the current problem with trying to do it any other way:
Today, companies can only pursue sustainable behaviors that are profitable. This rules out many sustainability actions that corporations are uniquely positioned to offer–and used to provide–though certain initiatives can make the grade as long-term investments, with characteristic extended payback periods. Yet, corporate pronouncements of such long-term investment plans are precisely the klaxon calls that bring activist investors running to restore short-term profit-maximizing order.
So here we have some evidence that deep down, even the most ardent proponents of sustainability reporting know that those metrics are always going to be “second class” compared to financial figures (even though financials don’t reflect external costs). In other words, reporting on sustainability metrics isn’t the answer. Duncan calls on people in the sustainable business community to take a more collaborative approach – e.g. by prodding their companies to disclose political contributions, not lobbying against environmental protection policies and adding disclosure – but not the type we’ve been focused on:
The disclosure now required is not more detail about a company’s own greenhouse gas emissions or water use, but rather what companies publicly stand for regarding the changes in rules and prices needed for a more sustainable world–and what, exactly, they are doing about it. This is the critical question we must now ask our portfolio managers and corporations.
It’s an interesting idea and aligns with the BRT’s recent statements. A few companies are even forming “public policy” board committees (see this Diligent video). Investors & lawmakers will probably have to take up the mantle on this before directors would do anything drastic…but some companies might actually benefit from supporting legislation that “levels the playing field.”
Better The Devil You Know? ISS ESG Business Keeps Growing
Most of us primarily think of ISS as a proxy advisor, but it’s also been not-so-quietly building its ESG business since acquiring oekom research last year. According to this announcement, ISS ESG (the “responsible investment arm of ISS”) now employs nearly 400 people and offers a slew of new products:
– Climate research & impact services – to help investors “reflect & vote their views on a company’s climate-change risks, disclosure & performance”
– Indexing services – for investors who want to build turnkey or custom indexes
– Publication of a broad range of data about 7800 companies on the “FactSet” marketplace – which aggregates data & analysis from many vendors for investors to access
– Absolute & relative ESG rankings of companies – see our “ESG” Practice Area for more info on the types of ratings & methodologies
I’ve blogged that State Street already uses ISS data in its “R-Factor” scoring. And to further appeal to investors, the press release says that ISS is showing how its ratings align with the SASB reporting framework:
ISS ESG has mapped its ESG Corporate Rating against the Sustainability Accounting Standards Board’s (SASB) industry standards to identify the degree of alignment and completion of accounting standards and performance ratings. The mapping shows meaningful alignment with the SASB view on the relevance of ESG performance information for investors and the status of ESG materiality within the rating.
Furthermore, a mapping of the ESG Corporate Rating methodology against the recent EU taxonomy proposal also showed great alignment, enabling investors to prepare and align their investments towards the EU taxonomy objectives.
ISS: “Climate Change” Voting & Research
Of course, ISS is also capitalizing on E&S interest through its proxy advisory services. The “climate research & impact services” offered by ISS ESG include a “climate change” voting service that scores disclosure, climate performance & sector-specific materiality. It’s marketed as a service that helps investors create & act on their own customized voting policies – in other words, it’s not a set of ISS-dictated voting recommendations. But it’s probably worth noting that ISS’s annual policy survey included questions about director accountability for climate change risk, so maybe that will be coming in some form.
This ISS blog says that select research reports will now also include the “ISS Climate Awareness Scorecard.” The blog gives some info on how the research report & voting service scoring will work – e.g. here are some of the TCFD-based disclosure topics that will win brownie points:
– Climate change strategy
– Climate change risk management – and how the processes are integrated into the overall risk management program
– Climate change targets & metrics
