The mandatory compliance date has arrived for the MD&A and financial disclosure rules that the SEC adopted late last year. Tune in tomorrow for the webcast – “MD&A and Financial Disclosures: What To Do Now” – to hear Sidley’s Sonia Barros, Skadden’s Raquel Fox, E&Y’s Mark Kronforst, Morrison & Forester & TheCorporateCounsel.net’s Dave Lynn, and Shearman & Stearling’s Lona Nallengara, all experienced former Corp Fin Staffers, continue the discussion from our January webcast of the many issues to watch out for when updating your disclosures.
If you attend the live version of this 60-minute program, CLE credit will be available. You just need to submit your state and license number and complete the prompts during the program.
We also acknowledge our oversight in scheduling the live program on Yom Kippur and profusely apologize. As always, the audio archive will be available shortly after the program airs, and the transcript will be available within 2-3 weeks. We respect and care for our Jewish community members and will not schedule future programs on this important holiday.
Programming Note: This blog will be off tomorrow in honor of the holiday; returning Friday.
– Liz Dunshee
You can still register for our popular conferences – the “Proxy Disclosure & 18th Annual Executive Compensation Conferences” – to be held virtually Wednesday, October 13th – Friday, October 15th. We’ll be covering the changing expectations from investors and other stakeholders – with practical guidance on how to use the annual reporting season to your advantage.
For more details, check out the agenda – 17 panels over 3 days. Our speakers are fantastic and this is truly a “can’t miss” event for anyone involved with proxy disclosures, corporate governance, and executive pay.
Conference attendees will not only get access to our unique & valuable course materials (coming soon) – we’ll also be making video archives and transcripts available after the conference, so that you can refer back to all of the practical nuggets when you’re grappling with your executive pay decisions, disclosures and engagements. Plus, our live, interactive format gives you a chance to earn CLE credit and ask real-time questions.
Register today! As an added benefit to our members, this year we are offering a discounted conference rate to those who have a paid subscription to any one of our sites.
– Liz Dunshee
Dave blogged last month about SEC Chair Gary Gensler publicly committing to protect investors from fraud in the crypto space – a signal that he would be open to the SEC playing a greater regulatory role in the world of digital assets. Last week, the CLO of Coinbase – the largest US crypto exchange – blogged that the company had received a Wells notice from the Staff about its crypto lending program. Coinbase’s CEO also took to Twitter about the exchange.
As we explain in our “SEC Enforcement” Handbook, a Wells notice is a statement by the Enforcement Division that they’ve reached a preliminary conclusion to recommend an enforcement action – but a majority of Commissioners still have to approve to institute the proceeding. Absent an extension, the Staff has 180 days after sending the Wells notice to decide whether to recommend enforcement to the Commissioners.
Some companies don’t disclose their receipt of a Wells notice, they wait until there’s an enforcement action. So it’s interesting here that Coinbase made the whole thing public right away. In a predictable argument that the regulatory crowd would say is against their own interests, crypto fans seem to be siding with the company in wanting the SEC to step away.
The company seems startled by the notice because it had been “proactively engaging with the SEC” about this product, which would allow Coinbase to lend out USD Coin (a stablecoin) from deposited funds in exchange for interest, a portion of which is paid to the depositors. Now, the SEC is saying it will bring an enforcement action if Coinbase offers the product without registration.
The Staff is taking the position that Coinbase’s “Lend” product may be a security that cannot be offered without registration or an exemption. Anne Lipton’s blog explains how the common law has developed to a point where the SEC is performing the test under both Howey and Reeves – and this blog from Adam Levitin analyzes how those tests apply to Lend. In short, he concludes that Lend fits one or both of the tests that define whether something is a “security.” Former SEC Enforcement Staffer John Reed Stark also took that stance in a popular LinkedIn post.
Yet, there could be a path out. Matt Levine pointed out that Section 3(a)(2) of the Securities Act – and the four-part Reeves test – could allow Lend to avoid regulation as a security. The catch is that Coinbase would then be subject to banking regulations, which it probably doesn’t want.
– Liz Dunshee
As expected, the SEC’s Investor Advisory Committee unanimously approved its recommendations on SPACs and Rule 10b5-1 reform at its meeting last week. This Cadwalader blog recaps the contrasting views that SEC Chair Gary Gensler and SEC Commissioner Hester Peirce expressed during the meeting on market regulation, technology and new financial products.
The remarks suggest that anticipated SEC rulemaking proposals will not be unanimously approved by the Commissioners. Here’s the summary:
In his address, Chair Gensler focused on investor protection, highlighting concerns raised by the behavioral design of online trading platforms, the insider trading enforcement regime, and special purpose acquisition companies (“SPACs”). As to current digital engagement practices (“DEPs”), Mr. Gensler described inherent conflicts of interest between financial intermediaries and investors, particularly when DEPs are optimized for revenues which could affect investment recommendations. Mr. Gensler discussed the SEC’s request for information and comment on the use of DEPs and asked for submissions from the Committee and other interested listeners. He noted the inherent biases of these business models should the underlying data reflect historical biases.
In addition, Mr. Gensler noted that the Committee’s recommendations for plans under SEA Rule 10b-5 (“Employment of manipulative and deceptive devices”) align with his previous request to SEC staff for proposed rulemakings. With regard to SPACs, Mr. Gensler stated that SPAC disclosures around dilution should be strengthened, and reported that the staff is developing rulemaking recommendations.
By contrast, Commissioner Peirce urged the Investor Advisory Committee to promote a regulatory process for digital platforms that considers investor opportunity as well as investor protection. Ms. Peirce contended that investors “at times may be willing to take on more risk than the regulator thinks is prudent,” and so the regulatory process should not undercut an investor’s ability to interact with the latest technologies, have access to new types of assets, and try new products and services. Ms. Peirce stated that a “healthy regulatory response” to such investor demand would not override investor decisions, but rather educate investors “using the same technologies through which they are investing.”
– Liz Dunshee
Last week, Vice Chancellor Zurn of the Delaware Court of Chancery determined that the shareholder derivative litigation against Boeing’s board of directors could proceed, based on allegations that the directors breached their duty of loyalty by not making a good faith effort to implement an oversight system and monitor it. The court dismissed the shareholders’ claims against the officers and the board for compensation decisions.
In light of the tragic loss of life that formed the basis for this lawsuit, the allegations here about the shortcomings in director decision-making are troubling, and that may have affected the opinion. The court noted that:
– Meeting minutes didn’t indicate rigorous director discussions of safety issues
– No board committee was charged with direct responsibility to monitor safety
– The board didn’t direct management to provide regular safety updates – it “passively” received updates at management’s discretion
– The Board publicly lied about whether & how it monitored the 737 MAX’s safety in order to preserve its reputation
Based on this, VC Zurn held that the board came up short on both Caremark prongs: it failed to establish a monitoring system and failed to respond to red flags. She also found that the plaintiffs adequately alleged scienter. Alarmingly for companies and their advisors, VC Zurn determined that the board’s remedial step of creating a safety committee after the crashes was evidence that, before the crashes, it had no oversight process at all – and knew it.
For 25 years, it was notoriously difficult for a Caremark claim to survive a motion to dismiss, even though the court has to accept the plaintiffs’ allegations as true at that stage of litigation. VC Zurn even acknowledged in her opinion that it’s extremely difficult to plead an oversight failure. Yet, a series of Caremark claims have proceeded past the motion to dismiss stage in just the past couple of years. As this Wachtell Lipton memo notes, that’s a big deal for the company and the board:
The company’s directors now face the prospect of intrusive document discovery, extensive depositions, and either an expensive settlement or a trial to defend the effectiveness of their oversight.
UCLA’s Stephen Bainbridge blogged that this case is another sign that Caremark claims are getting easier. He notes that the court took a much closer – and less favorable – look at board decisions than what you’d expect. Yet, as Kevin LaCroix blogged, the crashes at issue here “dramatically highlighted the critical importance of safety issues for Boeing.” And – hopefully – these types of events are rare. So, it’s too early to declare that every duty-of-oversight claim will proceed to the merits. But Kevin notes:
All of that said, I do think the recent spate of breach of the duty of oversight cases will encourage plaintiffs to pursue these kinds of claims and to include claims of breach of the duty of oversight in cases in which companies have experienced significant adverse circumstances in important operations. I suspect we are going to see an increase of claims of this type.
That makes it all the more important for other boards to review their risk management processes right now. Helpful steps could be:
– Document the board’s oversight of enterprise risk management, its process for asking questions & reviewing risks, and its evaluation of which functions are “mission critical”
– Ensure the board has a robust oversight process for key functions that create significant risk – and consider forming a dedicated board committee
– Document regular risk reporting to the committee & board, directors’ rigorous discussions & questions about risks, and board-directed risk reports
– Liz Dunshee
In her opinion last week, Vice Chancellor Zurn also made note of the lengthy tenure of many of Boeing’s directors and their skill-sets as “political insiders or executives with financial expertise.” She then discussed at length the transformation of the company from an organization run by engineers to one run by finance folks – recounting how the company moved its headquarters from Seattle 20 years ago in order to “escape the influence of the resident flight engineers.” The focus on cost-cutting allegedly impacted quality and resulted in more safety violations.
This is only the latest iteration of a story that keeps repeating. In his Radical Compliance blog, Matt Kelly highlighted that a cost-cutting culture was also to blame in last week’s SEC enforcement action. Here’s an excerpt:
Our point today, however, is that 3G made cost-cutting a strategic goal for the company. It tied employees’ performance metrics and compensation to their ability to cut costs. Procurement division employees said internally that the former COO “push[ed] like crazy” for them to meet cost savings goals, and increased cost savings targets to unreasonable levels.
Faced with that relentless pressure to cut costs, employees then engaged in the prebate chicanery we mentioned above, and lots more.
That’s the lesson for internal control and compliance officers. If your business is based on a misguided strategic goal, eventually it will warp your corporate culture to the point where misconduct is the only way to execute the strategy — and then, all the internal controls in the world won’t do you any good.
– Liz Dunshee
The topics of board composition and director skills are huge right now. Tune in tomorrow for the free webcast – “The 21st Century Board: Changing Expectations For Diversity, Human Capital & Risk Oversight” – co-hosted by ISS Corporate Solutions and CCRcorp – to hear Digimarc Board Chair Alicia Syrett, Russell Reynolds’ Rusty O’Kelley, ISS Corporate Solutions’ Ben Magarik, and our very own Lawrence Heim of PracticalESG.com. They’ll be talking about the changing expectations of investors & stakeholders – and how boards are responding.
– Liz Dunshee
On Friday, the SEC announced a $62 million settlement with The Kraft Heinz Company. The settlement resolved an alleged expense management scheme that the SEC says happened when the company was trying to aggressively cut costs after its 2015 merger.
The case underscores the importance of having strong internal controls that can catch irregularities. According to the SEC, the company had inadequate internal controls for its procurement division that caused gatekeepers to overlook warning signs of manipulated supply agreements and inaccurate reporting. The SEC also announced charges against the company’s former COO and former Chief Procurement Officer. Here’s more detail from the press release:
According to the SEC’s order, from the last quarter of 2015 to the end of 2018, Kraft engaged in various types of accounting misconduct, including recognizing unearned discounts from suppliers and maintaining false and misleading supplier contracts, which improperly reduced the company’s cost of goods sold and allegedly achieved “cost savings.” Kraft, in turn, touted these purported savings to the market, which were widely covered by financial analysts.
The accounting improprieties resulted in Kraft reporting inflated adjusted “EBITDA,” a key earnings performance metric for investors. In June 2019, after the SEC investigation commenced, Kraft restated its financials, correcting a total of $208 million in improperly-recognized cost savings arising out of nearly 300 transactions.
The company disclosed the investigation in an earnings release over two years ago. On Friday, it reported the settlement in a Form 8-K, under Item 8.01. The Form 8-K says that it recorded an accrual for the full amount of the penalty in the second quarter of this year.
For more details see this WSJ article, this NYT article and this Cooley blog.
– Liz Dunshee
In a statement published on Friday, SEC Commissioner Caroline Crenshaw says that the Kraft Heinz settlement shows why “corporate benefits” shouldn’t be part of SEC Enforcement’s penalty equation. She first caused a stir with this position at a March CII speech that called into question the 15-year enforcement policy.
Commissioner Crenshaw says that when Kraft announced the SEC investigation back in February 2019, it “bundled” that news with other negative information – a dividend cut and a $15.4 billion write down of goodwill. That makes it hard to tell whether any part of the resulting stock price drop was a reaction to the investigation news. She also says that the company initially estimated that the procurement issues would only increase cost of products sold by $25 million, but by mid-2019, the reporting errors ended up totaling $208 million.
Because this chain of events could make it more difficult for private litigants to recover damages, Commissioner Crenshaw believes that the SEC’s penalties should be more closely linked to misconduct & deterrence. Here’s her conclusion:
A recent analysis determined that it results in dramatically fewer successful recoveries by private securities litigants who, unlike the SEC, must prove that corporate stock price losses were directly attributable to the specific bad news. In this study researchers also concluded that information bundling resulted on average in $21.17 to $23.45 million lower recoveries for shareholders.
In considering the appropriate penalty to impose in actions brought by the SEC, I am concerned about corporate issuers benefiting from information bundling. To the extent corporations thereby make it more difficult to measure corporate benefit, that merely reinforces my inclination in setting penalties to focus more heavily on other factors, such as punishing misconduct and effectively deterring future violations.
– Liz Dunshee
The Center for Audit Quality recently published this analysis of S&P 500 ESG reporting. Here are some key takeaways:
– 95% of S&P 500 companies had detailed ESG information publicly available.
– The information the CAQ examined was primarily outside of an SEC submission in a standalone ESG, sustainability, corporate responsibility, or similar report. Of the remaining 5%, most companies published some high-level policy information on their website.
– A majority of companies referenced more than one reporting framework – CDP, SASB, GRI, TCFD and/or IR. Nearly 300 companies refer to using 3-5 frameworks.
– 264 companies said they had some form of assurance or verification over ESG metrics. Roughly 6% of S&P 500 companies received assurance from a public company auditing firm over some of their ESG information, and 47% had assurance from an engineering or consulting firm.
The CAQ goes on to compare different types of assurance and assurance terminology. This is definitely still an evolving area, and one that our colleague Lawrence will be continuing to write about on PracticalESG.com.
– Liz Dunshee
