Here’s a topic of interest that John blogged about last week on DealLawyers.com (visit that site for seasoned perspectives and practical guidance on all things deal-related):
One of the issues under Delaware law that has generated some uncertainty over the years is the extent to which the DGCL permits a corporation to create a mechanism in which shares of the same class differ in their share-based voting power depending on who holds them. Vice Chancellor Laster’s recent decision in Colon v. Bumble, (Del. Ch.; 9/23), may go a long way toward resolving that uncertainty.
Delaware courts have permitted tenure voting arrangements, in which the voting rights of holders of the same class vary depending on how long they’ve held the shares, and other limitations, such as per capita regimes, that limit a stockholder’s voting rights based on the number of shares owned, but in Colon v. Bumble, Vice Chancellor Laster addressed a situation in which the voting rights of particular shares expressly depended on the identity of their owner.
In order to facilitate its IPO, Bumble installed an “Up-C” structure, which resulted in a hybrid entity in which public stockholders’ enjoyed voting & economic rights through ownership of Class A shares, while pre-IPO insiders enjoyed voting rights through ownership of Class B shares and economic rights through the ownership of their pre-IPO LLC units, each of which were convertible, when accompanied by a Class B share, into shares of Class A Common Stock.
Bumble’s charter provides that each share of Class A Common Stock is entitled to one vote, unless that share is held by one of the company’s “Principal Stockholders,” in which case it is entitled to ten votes. The charter defines the term Principal Stockholders to include the two insiders who were party to a pre-existing stockholders’ agreement with the company. It also authorized a class of Class B Common Stock, which was issued exclusively to the company’s Principal Stockholders. Each share of Class B stock is entitled to a number of votes equal to the number of Class A shares that the holder would receive if all of its units in were converted into Class B shares at the Exchange Rate and with a Principal Stockholder receiving ten votes per Class A share.
The plaintiffs contended that the disparate voting rights enjoyed by the Principal Stockholders under this structure were invalid under Delaware law because those rights depended on the identity of the stockholder. In response, Vice Chancellor Laster conducted a detailed and thoughtful analysis of both the relevant statutory provisions and case law, and concluded that the disparate voting rights were valid:
As required by Sections 102(a)(4) and 151(a), the charter sets out a formula that applies to all the shares in the class and that specifies how voting power is calculated. As authorized by Section 151(a), the formula makes the quantum of voting power that a share carries dependent on a fact ascertainable outside of the certificate of incorporation, namely the identity of the owner. The Class A formula is a simple one. If a Class A share is held by a Principal Stockholder, then it carries ten votes per share. If not, then a Class A share carries one vote per share.
The Class B formula is complex but reaches the same result. As long as a Class B share is held by a Principal Stockholder, then it carries ten votes per share for each Class A share that it could convert into. If the Class B share is not held by a Principal Stockholder, then then it carries one vote per share for each Class A share that it could convert into.
Under Providence, Williams, and Sagusa, having the level of voting power turn on the identity of the owner is permissible. To apply the formulas in Providence, Williams, and Sagusa, the corporation had to determine which stockholder owned the share. True, the processes also had to take into account another attribute. In Providence and Sagusa, it was how many other shares the owner held. In Williams, it was when the owner acquired the share. But the starting point in each mechanism was the identity of the owner. That is the same mechanism that the Challenged Provisions use.
From my perspective, this is a very impressive opinion, and one that any lawyer called upon to draft charter documents will want to keep in mind. Vice Chancellor Laster provides a comprehensive seminar on Delaware statutory law and judicial opinions addressing the special attributes and limitations with respect to shares that Delaware corporations may establish in their charter documents. Most impressively, he accomplishes this in an opinion that’s less than 35 pages long. That’s practically a text message by the Vice Chancellor’s standards.
Check out this blog from Keith Bishop for a discussion of how California law addresses the issue of disparate voting rights based on the identity of the stockholder.
Last week was fiscal year end for the federal government, including the SEC and other agencies. In the face of the shutdown threat, the Commission plowed forward with its customary year-end enforcement spree, making every effort to add to the government’s bottom line. The WSJ reported that they brought in $218 million in fines last Friday alone – 10% of the Commission’s annual budget!
Included in the pile of settlements announced during the last 10 days of the month were two (!) instances of the SEC taking issue with non-disclosure provisions in separation or employment agreements that, in the SEC’s view, discouraged potential whistleblowers from voluntary contacting the SEC about potential securities law violations, and thereby violated Rule 21F-17.
For those who may not remember, Rule 21F-17 became effective as part of the Dodd-Frank Act in August 2011. In the big picture, that’s not that long ago. So, maybe it’s not too surprising that these provisions continue to linger on in forms – especially because stray language can appear in various overlapping policies, agreements, and acknowledgement pages that are handled by different departments. In the SEC’s view, that’s not a good excuse.
Anyway, these two actions followed a similar announcement earlier in the month (so that’s 3 total just this past month, for anyone counting at home). That brings the running total of Rule 21F-17 enforcement actions to “nearly 20” since 2015, according to one of the recent orders. In these instances, both companies added language and/or sent communications to employees following the first wave of enforcement actions in 2015 to clarify that the provisions shouldn’t be construed to prevent whistleblower claims. But in the SEC’s view, that didn’t fully address the problem. Here’s why:
1. In this case, the SEC viewed the new language as prospective in nature, and not a cure for restrictions on disclosure from 2011 to 2015. The Commission noted that it wasn’t aware of any specific instances in which a former employee was prevented from communicating with the Commission Staff about potential securities law violations, or in which the company took action against a former employee based on the non-disclosure representation. The company cooperated with the SEC’s investigation, initiated a remediation program, and agreed to a $375k fine as part of the settlement.
2. In this case, the company continued to use an employment agreement without a whistleblower carveout for years after revising other policies, and after that, continued to use a release at the time of separation that reminded employees of confidentiality requirements (without a carveout). The Commission didn’t like that severance and deferred comp were conditioned on signing the release, and also said it was aware of one former employee who was initially discouraged from submitting a whistleblower complaint. The company cooperated with the SEC on remedial steps. They were fined $10 million!
Enforcement Director Gurbir Grewal shared this warning in the SEC’s announcement about the second case:
“Entities employing confidentiality, separation, employment and other related agreements should take careful notice of today’s enforcement action,” said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. “The Commission takes seriously the enforcement of whistleblower protections and those drafting or using these types of agreements should take equally serious their obligations to ensure that they don’t impede whistleblowers from contacting the Commission.”
This week I’ve been re-reading Gulliver’s Travels, where shifts in scale make all the difference in Gulliver’s world. And because I also am on a journey with Dave to XBRL acceptance, it got me thinking that “scale” is a very important concept for data tagging requirements as well. So, with apologies to anyone whose enjoyment of Swift’s classic may now be ruined, I will spotlight an exchange on our “Q&A Forum” (#11,840), where a member posed this question about Corp Fin’s recent sample comment on XBRL cover page tagging:
Corp Fin’s sample comment says, “The common shares outstanding reported on the cover page and on your balance sheet are tagged with materially different values. It appears that you present the same data using different scales (presenting the whole amount in one instance and the same amount in thousands in the second). Please confirm that you will present the information consistently in future filings.”
The numbers are as of different dates (balance sheet date versus latest practicable date) and are in different scales. This seems compliant with the rules and not problematic so the comment seems errant.
An astute member responded:
I think the SEC may be looking for consistent scale when a filer includes the number of outstanding shares in the line-item description in the balance sheet, not the actual GAAP common stock amount. The relevant tags being:
dei:EntityCommonStockSharesOutstanding – used on cover page, scale should be zero
us-gaap:CommonStockSharesOutstanding – used by some filers in the line-item description (presumably what the SEC is targeting in the sample comment letter and believes should be presented in same scale as cover page)
us-gaap:CommonStockValue – actual GAAP amount in the balance sheet columns and is often in thousands or millions and wouldn’t make sense to be the same scale as the cover page
John weighed in as well:
I think you may be onto something when you note the possibility that filers weren’t using the proper “scale” when tagging the amounts. The SEC’s Office of Structured Disclosure issued this guidance in 2019 about scaling errors in public float.
I blogged a year ago that FASB was considering an accounting standard for digital assets. The Board’s technical agenda shows that they deliberated in early September and that a new ASU is scheduled to land in Q4. Here’s a summary of the tentative decisions.
The Center for Audit Quality says the new standard will require companies holding cryptocurrency to recognize losses & gains immediately – and shared this color:
According to a CAQ analysis as of September 5, 2023 83 comment letters had been submitted to FASB in response to their cryptocurrency proposal. Nearly all commenters across stakeholder groups (including the CAQ) expressed support for accounting for crypto assets within the scope of the Proposed ASU at fair value. Only two commenters specifically opposed accounted for crypto assets within the scope of the Proposed ASU.
Many commenters were supportive of the narrow scope of the Proposed ASU but recommend that additional standard setting on a wide range of topics will be needed in the future. These topics included wrapped tokens, NFTs, stablecoins, and other emerging crypto assets fall outside the scope of the Proposed ASU. However, according to this article from Accounting Today, we may need to wait a while for a project on wrapped tokens as a spokesperson for the FAF said “at this time there are no plans for a project specifically addressing NFTs or wrapped tokens.”
Commenters on the proposed ASU also requested further guidance on accounting for certain types of digital asset transactions (including, derecognition, crypto lending and borrowing, and crypto receivables and payables).
For more on digital assets, here’s a primer for audit committees and key questions for audit committees to consider, both from the CAQ.
According to the latest Spencer Stuart Board Index, 68% of S&P 500 boards included a director skills matrix in their proxy this spring. That’s up from 56% last year and just 38% in 2020! The trend is responsive to investors’ desires to better understand how each director’s expertise supports the company’s overall board composition.
This WSJ article likens the challenge of assembling a strong board – consisting of directors who have experience across all of the relevant categories – to solving a “Rubik’s Cube.” The article parses through the new Spencer Stuart Index and several other recent studies on board composition & diversity. Here’s one trend that jumps out:
Among last year’s newly appointed directors, CEO experience is less common, at just 43%, among the lowest figures since at least 2015, Heidrick & Struggles found.
The share of directors with CEO experience declined in 60% of companies and nearly every sector of the S&P 500 from 2019 to 2022, a Wall Street Journal analysis of data from BoardEx found.
That’s in part because more employers now let lower-level executives join the boards of other companies as boards simultaneously seek executives with specific experiences and skill sets, says John Wood, a Heidrick & Struggles vice chairman who recruits CEOs and directors.
Where in the past there was concern that such appointments would distract executives from their day jobs, Wood says, now “boards and management [are] saying: Can we give her some board experience? Because she could be in consideration for CEO succession.”
All that said, the Spencer Stuart analysis finds that boards continue to rely on retirement policies as their primary refreshment tool, so turnover is slow despite the rapidly changing business environment. I suppose that means that it’s more important than ever for directors to possess skills that can withstand the test of time.
Last week on CompensationStandards.com, I blogged about approaches that some companies are taking to incentivize compliance & ethics. But even “good” companies are regularly dealing with complaints, which may or may not be valid. Management & the board then face the difficult question of what to do – and recent experience shows that the decision can have important implications for officer & director liability.
This 4-page Skadden memo gives a roadmap that audit committees & boards can follow when deciding whether to launch an internal investigation, and what form it should take. Here are the key takeaways:
– When a complaint reaches a company’s board, directors need to assess how serious and detailed it is, and how credible it is at first glance, before deciding how to investigate it.
− If similar complaints have been lodged in the past, that could suggest systemic problems and greater risk for the company.
− An investigation will take on added urgency if the regulators or external auditors are aware of the allegations, or if those may affect pending financial or strategic transactions.
− Other complicating factors: any allegations against management, conduct the company has a duty to report and the potential for financial restatements.
If you find yourself answering “yes” to most of the questions in the memo, the Skadden team says that the board should strongly consider conducting an investigation, with help from outside experts.
The SEC has extended the comment period for Nasdaq’s proposal to require notice & disclosure of reverse stock splits, which John blogged about in July. This means that, under Exchange Rules, November 1st is the date by which the Commission will either approve or disapprove, or institute proceedings to determine whether to disapprove, the proposed rule change. You can use this form to submit comments.
Whether you spent the weekend as outside counsel frantically finalizing registration statements in order to claim your spot in “the backlog review queue,” a corporate employee worrying whether delayed regulatory approvals could cost you budget or even your job, or a federal employee attempting to plan for a month or more without pay, it likely was welcome news that, with mere hours to spare on Saturday, our legislators came to a last-minute compromise to keep our government running.
Unfortunately, the SEC’s operating plan and Corp Fin’s guidance on how the Commission and Staff will operate during a shutdown could still become relevant, because the resolution only funds the government for the next 45 days – through November 17th. Let’s all hope for the best!
On Friday, the SEC posted the notice & request for comment for a proposed listing standard from the NYSE that would create a new asset class for “Natural Asset Companies.” Here’s an excerpt that defines what an “NAC” is:
For purposes of proposed Section 102.09, a NAC is a corporation whose primary purpose is to actively manage, maintain, restore (as applicable), and grow the value of natural assets and their production of ecosystem services. In addition, where doing so is consistent with the company’s primary purpose, the company will seek to conduct sustainable revenue-generating operations. Sustainable operations are those activities that do not cause any material adverse impact on the condition of the natural assets under a NAC’s control and that seek to replenish the natural resources being used. The NAC may also engage in other activities that support community well-being, provided such activities are sustainable.
NYSE announced that it was working to develop this new asset class way back in 2021, so it’s been at least two years in the making. A lot has changed since then! ESG sentiment has become more discerning, and many companies have become more transparent over the past two years about environmental risks and emissions. But the proposal predicts that demand for this separate type of investment opportunity exists and will continue to grow because “investors still express an unmet need for efficient, pure-play exposure to nature and climate.”
Under the proposed standard, in addition to GAAP financial reporting provided in SEC filings, NACs would be required to periodically publish an “Ecological Performance Report.” Here’s more detail:
The EPR provides statistical information on the biophysical measures (e.g., tons of carbon, acre feet of water produced), condition, and economic value of each of the ecosystem services produced by the natural assets managed by the NAC. This will allow investors to gauge the effectiveness of management. The information will be consistently produced and periodically reported, following best practices from accepted valuation methodologies, as outlined in the Reporting Framework (as defined below).
The EPR produced by a NAC must follow IEG’s Ecological Performance Reporting Framework (the “Reporting Framework”). The Framework, in turn, is based on the natural capital accounting standards established in the United Nations System of Environmental- Economic Accounting – Ecosystem Accounting Framework (“SEEA EA”).
The EPR will measure, value, and report on the ecosystem services and natural assets managed by a NAC. Under the proposed amendments to the Manual, NACs will conduct a Technical Ecological Performance Study (“Technical EP Study”) annually, following the Reporting Framework. This Technical EP Study will generate the information used to prepare and publish the EPR. The EPR and Technical EP Study must be examined and attested to by a public accounting firm that is registered with the Public Company Accounting Oversight Board (“PCAOB”) and is independent from the NAC and NAC licensor, if applicable, under the independence standard set forth in Rule 2-01 of Regulation S-X (“Independent Reviewer”).
NACs would also be required to adopt policies on biodiversity, human rights, and other matters and post those on their website. The proposal gives more detail on the reporting framework, license, charter & policy requirements, corporate governance standards, and more. The standard, if adopted, will also come with a bunch of new terms to add to your “ESG glossary,” because it includes a whole section dedicated to definitions. The SEC is requesting comments on the proposal.
Also on Friday, the SEC posted notice & request for comment for a proposed NYSE rule change that would make it easier for companies to raise money from existing shareholders. Long story short, under the proposed amendment, companies would no longer have to get shareholder approval before issuing shares at a discount to “passive” (non-controlling) shareholders, even if the shareholder is buying more than 1% of currently outstanding shares and even if the shareholder owns 5% or more of the company’s outstanding stock or voting power at the time of the transaction – as long as they aren’t part of a control group. Here’s the rationale:
Certain NYSE listed companies are significantly dependent on their ability to regularly raise additional capital to fund their operations or acquire new assets. For example, pre-revenue stage biotechnology companies regularly seek additional capital to fund their research and development activities and real estate investment trusts seek to fund the acquisition of new properties by selling equity securities in private placements or direct registered sales priced at a small discount to the prevailing market price.
It is the Exchange’s understanding that, in many cases, existing shareholders of the listed company are willing purchasers of securities in such circumstances, as they already understand the company’s business and have a positive view of its future prospects. Sales to existing shareholders can also be advantageous to both the issuer and the shareholders because of the speed with which a direct sale to an existing shareholder can be completed if no shareholder approval is required.
However, the benefits of low transaction costs and speed of execution that typically exist when conducting these transactions with existing shareholders face countervailing factors if the counterparty is deemed to be a substantial securityholder for purposes of Section 312.03(b)(i). In such cases, to mitigate potential conflicts of interest, Exchange rules require that any sale below the Minimum Price can relate to no more than one per cent of the shares of common stock or one percent of the voting power outstanding before the issuance. Any such transaction that relates to more than one per cent of the common stock is subject to shareholder approval, which imposes significant delay and additional costs on the issuer, thereby often making the sale impracticable.
The NYSE notes that it is currently the only U.S. exchange with this requirement, which puts its listed companies at a disadvantage. The Exchange believes that transactions with these kinds of passive holders do not give rise to the potential conflicts of interest in the determination of transaction terms that exist where the purchaser has a role in the listed company’s board or management.
The shareholder approval requirement for issuances that exceed 1% of outstanding shares or voting power (other than cash sales for at least the “Minimum Price”) would continue to apply to issuances to officers or directors. In addition, it would apply to any controlling shareholder or member of a control group or any other substantial security holder of the company that has an affiliated person who is an officer or director of the company. The proposal emphasizes that other shareholder approval requirements also would continue to apply:
The Exchange notes that any listed company selling securities in a private placement that does not meet the Minimum Price requirement to a passive investor will remain subject to the shareholder approval requirement of Section 312.03(c) if such transaction relates to 20 percent or more of the issuer’s common stock. In addition, any such transaction would remain subject to shareholder approval under Section 312.03(e) if it resulted in a change of control. Finally, the Exchange notes that Section 312.03(b)(i) as proposed to be amended would continue to provide a significant protection to shareholders against conflicts of interest in sales of securities to related parties and that no other listing venue has such a protection in its rules.
The SEC is seeking comments on the proposal. We have resources in our “NYSE” Practice Area for anyone who is trying to navigate approval requirements or other compliance issues.
