Last week, a jury in a securities class action lawsuit found in favor of Elon Musk for his 2018 “funding secured” tweet – in which he said he was considering taking Twitter private at $420 per share and had locked in the funding. Here’s a NYT article about the outcome. The SEC had also taken issue with those tweets, resulting in a $40 million settlement and the “Twitter sitter” – plus a lot of animosity from Elon towards the Commission.
All I can say is that I’m nearly as happy as Elon that we can finally put this saga to bed. There’s no real takeaway for other companies because the jury’s verdict appeared to rest on the determination that nobody takes Elon Musk’s tweets all that seriously – and at the same time, they trust him to get things done when he really wants to.
So, investors truly may not have cared if instead of “funding secured,” the tweet had said “I might have a handshake deal for funding” – because it’s Elon Musk and he’ll either bring in the money when he wants to, or the whole thing was a joke in the first place. Did the statement really cause people to buy Tesla stock at an inflated price? The jury apparently was not convinced of that.
The reason this doesn’t translate well to other companies is that Elon Musk has carefully (or not-so-carefully?) cultivated a free-wheeling, Teflon persona and a cult-like following. It would be difficult & risky for other public company CEOs to emulate that. We don’t give legal advice in this blog, but common sense says it’s a bad idea for others to try “going private; funding secured” announcements without a commitment letter in-hand.
Yesterday, the SEC announced an open meeting to be held next Wednesday, February 15th. The Sunshine Act Notice says that the meeting will include consideration of whether to adopt rules & rule amendments under the Securities Exchange Act of 1934 to shorten the standard settlement cycle for most securities transactions.
Presumably, this relates to the Commission’s February 2022 proposal to shorten the settlement cycle to T+1 and make other “market plumbing” changes. The proposed rules and rule amendments would be applicable to broker-dealers and certain clearing agencies.
For those who are still refining their risk factors for this year’s Form 10-K, I’m happy to share this guest post from Orrick’s JT Ho, Carolyn Frantz, Bobby Bee and Hayden Goudy:
For companies with a fiscal year end on December 31, the drafting and review process for the annual report is well underway. Companies, however, should make sure they are considering emerging practices for disclosing environmental-, social-, and governance- (“ESG”) related risk factors.
Based on our review of companies in the S&P 500, having ESG-related disclosures in the risk factors is now a common practice. For companies which have already filed their annual report for fiscal year 2022, 89% had ESG-related risk factors. These risk factors spanned a range of ESG-related topics, primarily related to climate change, but also including diversity-, other environmental-, or general ESG-related risks. This graph shows the percentage of the S&P 500 with an ESG-Related Risk Factor in the annual report (by fiscal year):
As you can see, the number of companies with an ESG-related risk factor has increased year-over-year. Less than half of the S&P 500 had an ESG-related risk factor in their annual report for fiscal year 2019. Since then, a significant number of companies have added ESG-related risk factors to their annual report, and we expect this trend to be followed by small- and mid-cap companies.
When it comes to “general” versus “specific” risk factors, the Orrick team of JT Ho, Carolyn Frantz, Bobby Bee and Hayden Goudy share a reminder that “specific” is better.
In addition to the growing number of ESG-related risk factors, we’ve seen an increase in the number of ESG-related risks specific to the reporting company’s business, rather than “general” or “other” risks. The increase in specific ESG-related risk factors is consistent with guidance from 2019 in which the Securities and Exchange Commission (“SEC”) “eschewed ‘boiler plate’ risk factors that are not tailored to the unique circumstances of each registrant.” See below for an example ESG-related risk factor specific to the reporting company’s business compared with an example ‘general’ ESG-related risk.
Example Specific Risk Factor
Costs of Compliance with Environmental Laws are Significant, and the Cost of Compliance with New Environmental Laws, Including Limitations on GHG Emissions Related to Climate Change, Could Adversely Affect Cash Flows and Financial Condition
Our operations are subject to extensive federal, state and local environmental statutes, rules and regulations. Compliance with these legal requirements requires us to incur costs for, among other things, installation and operation of pollution control equipment, emissions monitoring and fees, remediation and permitting at our facilities. These expenditures have been significant in the past and may increase in the future. We may be forced to shut down other facilities or change their operating status, either temporarily or permanently, if we are unable to comply with these or other existing or new environmental requirements, or if the expenditures required to comply with such requirements are unreasonable.
Compare that to a “general” ESG risk factor:
Example General Risk Factor
Catastrophic events may disrupt our business which could have a material adverse effect on our business, financial condition, and results of operations.
Our business, financial condition, results of operations, access to capital markets and borrowing costs may be adversely affected by a major natural disaster or catastrophic event, including civil unrest, geopolitical instability, war, terrorist attack, the effects of climate change, or pandemics or other public health emergencies such as the recent COVID-19 outbreak, and measures taken in response thereto. In the event of a major disaster or event impacting any of our locations, we may be unable to continue our operations and may endure system interruptions, reputational harm, delays in our application development, lengthy interruptions in our services, breaches of data security and loss of critical data, all of which could have a material adverse effect on our business, financial condition, and results of operations.
To estimate the increase in the specificity of ESG-related risk factors, we reviewed the headings used to categorize each risk factor in the annual report and assumed that risk factors in the “General” or “Other” category were non-specific, while risk factors that were in other categories (such as “Legal and Regulatory Risks” or “Market and Industry Risks”) were specific to the reporting company’s business. This assumption is not true in every case, but we believe it is a good proxy. Following this methodology, for fiscal year 2019, 43% of the S&P 500 had a specific ESG-related risk factor, which increased to 80% for fiscal year 2021. This chart shows the percentage of the S&P 500 with a specific ESG-Related Risk Factor in the annual report (by fiscal year):
Rounding out the intel on ESG-related risk factors, the Orrick team of JT Ho, Carolyn Frantz, Bobby Bee and Hayden Goudy break down the variety of climate-related risk factors that are appearing in S&P 500 disclosures:
Climate-related risks accounted for most ESG-related risk factors in the S&P 500, with a significant increase in the number of companies reporting climate related risks since 2019. 82% of companies in the S&P 500 reported climate-related risks in fiscal year 2021, compared to just 45% for fiscal year 2019. For the 20% of companies in the S&P 500 which have already filed an annual report for fiscal year 2022, 85% had climate-related risk factors.
Most climate-related risk factors were specific to the reporting company’s business. The most common type of climate-related risks reported for fiscal year 2021 were physical risks related to business operations, with 45% of companies identifying operational risks including potential disruptions in the supply chain due to climate related events and the direct exposure of company assets and operations to more severe hurricanes and wildfires. 15% of the S&P 500 disclosed climate-related legal and regulatory risks for fiscal year 2021. We expect this percentage to increase for fiscal year 2022 given the SEC’s proposed climate-related disclosure rules (the “Proposed Rules”) which are expected to be finalized this year, and the European Union’s Corporate Sustainability Reporting Directive (the “CSRD”), which went into effect this year. Companies should engage with counsel to understand how the Proposed Rules and CSRD may affect their reporting practices and risk-related disclosures.
Climate-related risk factors are also becoming more prevalent across industries. For fiscal year 2019, only three industries had more than 50% of their companies report a climate-related risk; energy and transportation (82%), real estate and construction (63%), and manufacturing (56%). By fiscal year 2021, a large majority in every industry across the S&P 500 reported a climate-related risk. Here’s the percentage of the S&P 500 (by industry) with a specific Climate-Related Risk Factor in the annual report (by fiscal year):
Not every company will have ESG- or climate-related risk factors. But regardless of your industry, if you do not have a process in place to identify material company-specific ESG-related risks, especially climate-related risks, there is a potential that your risk management processes and disclosures will fall behind market practices.
On Friday, the SEC announced a $35 million settlement with Activision Blizzard for findings that it failed to maintain disclosure controls related to complaints of workplace misconduct – and separately, that it violated the whistleblower protection rule. The SEC’s 7-page order rests on two main allegations by the SEC. The press release summarizes:
According to the SEC’s order, between 2018 and 2021, Activision Blizzard was aware that its ability to attract, retain, and motivate employees was a particularly important risk in its business, but it lacked controls and procedures among its separate business units to collect and analyze employee complaints of workplace misconduct. As a result, the company’s management lacked sufficient information to understand the volume and substance of employee complaints about workplace misconduct and did not assess whether any material issues existed that would have required public disclosure.
Separately, the SEC’s order finds that, between 2016 and 2021, Activision Blizzard executed separation agreements in the ordinary course of its business that violated a Commission whistleblower protection rule by requiring former employees to provide notice to the company if they received a request for information from the Commission’s staff.
For the disclosure controls aspect of this settlement, the SEC focused on the company’s risk factors and cautionary language in Forms 10-K & 10-Q. The SEC didn’t allege that any particular statement was materially inaccurate or misleading – the problem in the SEC’s view was that shortcomings in how workplace-related information was collected and communicated to the company’s disclosure committee prevented the disclosure decision-makers from evaluating whether disclosure on this topic was needed. SEC Commissioner Hester Peirce dissented from both aspects of the order. Here’s her objection to the alleged “disclosure controls” violation:
In other words, the required disclosure controls and procedures must capture not only information that a company is required to disclose, but also an additional, vaguely defined category—information “relevant” to a company’s determination about whether a risk or other issue reaches the threshold where it is “required to be disclosed.”
She continues:
The requirement cannot be that a company’s disclosure controls and procedures must capture potentially relevant, but ultimately—for purposes of disclosure—unimportant information. As I read it, in this Order, the SEC once again has sat down at the gaming console to play its new favorite game “Corporate Manager.” Using disclosure controls and procedures as its tool, it seeks to nudge companies to manage themselves according to the metrics the SEC finds interesting at the moment. For Activision Blizzard, today, that metric is workplace misconduct statistics, but other issues will follow. In this level of the enforcement game, the SEC has added $35,000,000 to its point total despite the Order not identifying any investor harm.
The settlement comes at a time when the SEC has signaled that it may propose more prescriptive human capital disclosure rules in response to investors wanting more comparable info on that topic. Those rules are not yet in place, but the Enforcement Division already appears to be interested in the principles-based aspects of that topic.
Regardless of whether you find yourself nodding along with Commissioner Peirce, this settlement is another reminder that “workplace misconduct” continues to be a topic that requires board attention, appropriate oversight & information collection, and careful disclosures. The whistleblower component of the action also suggests you should take a fresh look at your separation terms. As this Cooley blog notes, this stuff is no longer just “employment lawyer” territory – you should have a cross-functional team.
Recall that last month, the SEC brought an enforcement action against McDonald’s to allege that the company mischaracterized the nature of the former CEO’s separation from service by not acknowledging that purported workplace misconduct was “cause.” (Commissioners Peirce & Uyeda dissented and said they believed the SEC was rewriting Item 402 disclosure requirements through an enforcement proceeding.) Two weeks later, the Delaware Court of Chancery allowed a fiduciary duty claim to proceed against McDonald’s HR head, finding at the motion to dismiss stage that if all the facts alleged by the plaintiff were true, the officer consciously ignored red flags and didn’t put in place reasonable information systems to report to the CEO & board. And while Activision settled an EEOC claim last year for a lower amount than this SEC matter, that company continues to face litigation in state court.
Many practitioners are taking the inclusion of the Dodd-Frank clawback checkboxes on the Form as confirmation that they are required on filings to be made this spring, and interpreting the SEC’s late-January CDI as guidance that you simply don’t need to mark the boxes. As I blogged on CompensationStandards.com, concerns linger – specifically, that including the checkboxes without marking them is a disclosure in and of itself and could be misleading. We heard informally last week that Corp Fin may issue additional guidance on this point, if it continues to cause consternation. But when it comes to “The Great Checkbox Debate of 2023,” one thing is pretty clear: you’re unlikely to face consequences from the SEC for any sort of perceived foot-fault this year.
Whenever the SEC issues a Form, it includes an “estimated average burden hours per response.” That’s because the Paperwork Reduction Act requires federal agencies – including the SEC – to estimate the compliance burden for any reporting or recordkeeping requirements. There’s always a section about this at the back of SEC proposals and adopting releases, although practitioners rarely comment on it. For the latest Form 10-K, the estimated burden is 2,255 hours!
1. The hours figure is intended to capture both internal & external hours, and isn’t limited to legal compliance (i.e., it also includes the compliance efforts of finance, treasury, auditors, etc.).
2. Although the Paperwork Reduction Act is a very important procedural requirement for SEC rulemaking, it’s difficult for companies to parse out the effort that goes into preparing a specific form – because it is just one component of a year-round integrated governance and disclosure process.
Dave blogged last week that you’ll need to make sure your insider trading policy is ready for “prime time” in light of the increased transparency that will result from the SEC’s recently adopted rules on on Rule 10b5-1 and insider trading (here are memos that lay out the requirements).
There’s been some confusion around when exactly a copy of these policies will need to be filed as an exhibit. With all of the other triage happening on securities compliance right now, people have been asking, “how urgent is this?”
At the Northwestern Pritzker School of Law’s Securities Regulation Institute last week, Corp Fin Director Erik Gerding said the Staff may issue additional guidance about the effective dates for disclosures under the new rules. He clarified that for annual disclosures, the phrase “the first filing that covers the first full fiscal period” would mean the first annual report that covers the 2024 year – which calendar-year companies will file in spring 2025. So, as John summarized in a recent post in our “Q&A Forum” (#11,400):
– Companies with a calendar year end will be required to disclose the information required by Item 408(a) of Regulation S-K beginning with their second quarter 2023 Form 10-Q filing (i.e., the 10-Q for the period ending June 30, 2023).
– Companies with a calendar year end will be required to provide the disclosures called for by Item 408(b) and 402(x) of Regulation S-K and Item 16J of Form 20-F in the Form 10-K filing for their 2024 fiscal year (i.e., the 10-K covering the year ended December 31, 2024, which will be filed in 2025). Copies of their insider trading policies will also need to filed as exhibits to that filing.
If this helps you breathe a sigh of relief, great – but don’t get too comfortable. Some folks still want to see a CDI from Corp Fin before planning for a 2025 exhibit. And even if we do have a two-year runway, the insider trading policy is a sensitive document – so it will take time to socialize and approve amendments. That means you need to dust it all off sooner rather than later. Don’t wait till the eleventh hour!
In his blog last week, Dave suggested several issues to consider. We’ll be providing even more guidance in the forthcoming issue of The Corporate Counsel newsletter. Email sales@ccrcorp.com if you want immediate access to that resource and aren’t already subscribed.
A WSJ article from late last week reported that the SEC is considering less onerous climate-related financial reporting after significant pushback to its proposal from companies – as well as investors. Here’s an excerpt:
The final version of the SEC rules, expected this year, will likely still mandate some climate disclosures in financial statements, according to the people close to the agency. But the commission is weighing making the requirements less onerous than originally proposed, the people said, such as by raising the threshold at which companies must report climate costs.
The article continues:
After the backlash to the climate proposals, officials are considering changes such as a higher trigger for disclosure, using different percentages depending on the financial item in question or eliminating a bright-line test altogether, the people close to the agency said.
Some of the groups pushing for the new climate-disclosure rules said they are open to changes.
The SEC doesn’t appear to be signaling that it’s giving up on the climate disclosure rule altogether – although that might be the preference of two of the Commissioners, based on public speeches like this one. At this point, the Staff is continuing to wade through thousands of comments on its way towards a final rule. They’re aiming for that rule to be more workable for companies – and survive anticipated legal challenges.
