Last week on Section16.net, Alan Dye blogged about a recent decision regarding Rule 16b-3. Here’s the intro:
Peter Romeo and I have noted many times that neither the courts nor the SEC has ever addressed the question whether Rule 16b-3 exempts a transaction between the issuer and an officer or director if the transaction is approved while the person is an officer or director but occurs after termination of service. Uncertainty exists because the rule exempts transactions with an officer or director (not a former officer or director), and the question usually comes up in connection with such post-termination transactions as tax withholding upon the exercise of an option or a pay-out of stock units in a deferred compensation account. Most practitioners have gotten comfortable that the exemption should be available, and a recent decision by the SDNY dismissing a complaint appears to support that conclusion.
The blog continues with a discussion of the complaint and the decision. There have been lots of Section 16-related developments this summer that Alan has been covering over on Section16.net. As a member of Section16.net, you can subscribe to get Alan’s updates delivered right to your inbox so you don’t miss out on any timely reminders or related court decisions. If you’re not currently receiving other blogs by email, you can sign up here!
In March, John shared that the results of the PCAOB’s last inspection reports on the Big 4 accounting firms were…not great. New inspection reports are now out showing that the overall deficiency rate among the Big 4 has stabilized versus the prior year. The WSJ reports:
The firms collectively had an average deficiency rate of about 26%, the same as a year earlier. PCAOB Chair Erica Williams said the findings from the inspections released Thursday, which covered audits of 2022 financials, were still unacceptable.
Deloitte and PwC’s U.S. units had rates of 21% and 18%, respectively, both up from 17% and 9% a year earlier. EY continued to have the highest deficiency rate among the Big Four in the U.S., at 37%, down from 46% the year prior, which marked a surge from 21% the year before that. KPMG’s rate fell to 26% from 30%.
The WSJ subsequently reported on EY’s efforts to refresh its audit practice, including by “resigning from serving certain public-company audit clients and limiting new clients” starting about 18 months ago. It’s also focused on enhancing audit tools & methodology (investing “$1 billion over three years in part to strengthen artificial intelligence-enabled audit and tax platforms”) and improving training.
We’ve heard a lot from the PCAOB about the need to improve audit quality and reduce these deficiency rates, so it might seem surprising that rates only leveled out (without improving overall). But keep in mind that the results John covered in March were from 2022 inspections of 2021 audits, and the numbers reported by the PCAOB now are from 2023 inspections of 2022 audits. The PCAOB’s press release notes that these inspection reports were released “months sooner than reports have been released in recent years thanks to ongoing efforts to speed the release of reports.” It also highlights additional accompanying resources:
– The inspection reports are accompanied by a new staff Spotlight publication, which provides an overview of staff observations from the 2023 inspections.
– The PCAOB also published new charts on its website illustrating much of the data in the U.S. GNFandU.S. annual Non-Affiliate Firms (NAF)inspection reports for the first time as part of ongoing efforts to increase transparency in inspection data and make it easier for stakeholders to understand and compare inspection results both across firms and over time.
This additional transparency should allow audit committees to better evaluate auditor performance and monitor audit quality, in line with Chief Accountant Paul Munter’s statement on the recent increase in deficiency rates found in audit inspections and the audit committee’s role in ensuring high-quality audits.
In early July, John blogged about a rare SEC comment letter to Kimmeridge Energy Management LLC questioning the timing of a Schedule 13D filing and shared a newsletter from Olga Usyvatsky predicting “we will likely see more SEC comments on 13D and 13G filings.” Remember that in October 2023 the SEC adopted amendments shortening the deadlines.
It sounds like Olga’s prediction is coming to pass. Barnes and Thornburg recently blogged about a more recent SEC comment letter also challenging the timeliness of a Schedule 13D filing. Here’s the comment & response:
We note the date of the event reported as requiring the filing of the Statement was February 12, 2024. Rule 13d-1(a) of Regulation 13D-G requires the filing of a Schedule 13D within five business days after the date beneficial ownership of more than five percent of a class of equity securities specified in Rule 13d-1(i)(1) was acquired. Based on the February 12, 2024 event date, the Schedule 13D submitted on May 3, 2024 was not timely filed. Please advise us why the Schedule 13D was not filed within the required five business days after the date of the acquisition.
The Company respectfully advises the Staff that the Schedule 13D was not filed within five business days after the February 12, 2024 event date because the Company initially considered itself eligible to file on Schedule 13G with respect to its holdings in Kyverna Therapeutics, Inc. (“Kyverna”).
The Company was a stockholder of Kyverna since prior to its initial public offering (the “IPO”), which closed on February 12, 2024. At the closing of the IPO, based on its holding of an aggregate of 4,523,924 shares of common stock underlying shares of Series A-1 convertible preferred stock, all of which converted into shares of Kyverna’s common stock at the closing of the IPO, the Company believed that it is entitled to report its beneficial ownership of Kyverna’s equity securities on a Schedule 13G on a later date.
As disclosed in the Schedule 13D, Vida Ventures III, L.P. and Vida Ventures III-A, L.P., funds separately managed from, but affiliated with, the Company acquired a total of 253,136 shares of Kyverna’s common stock at the closing of the IPO. The Company disclosed its beneficial ownership of shares of Kyverna’s common stock, together with such affiliated entities, on a Form 4 promptly following the closing of the IPO, on February 14, 2024. However, the Company was not aware at the time that it was obligated to report such beneficial ownership on a Schedule 13D. Following a review of the affiliated position, including review of Staff guidance with respect to Section 13 filings, the Company determined a 13D was appropriate and filed the Schedule 13D on May 3, 2024. The Company respectfully advises the Staff that future filings by the Company with respect to its beneficial ownership in equity securities of Kyverna will be timely made in accordance with Rule 13d-1(a) of Regulation 13D-G.
The blog says no follow-up letters were made public, and the SEC Staff seems to have accepted this explanation, but warns of a “larger takeaway” — that “the SEC staff appears to be monitoring these filing deadlines as the new rules are implemented,” and “it could also indicate that the reported SEC enforcement sweep on violations of Section 16(a), Section 13(d) and Item 405 disclosure obligations is continuing.”
Last week, I blogged about Vice Chancellor Laster’s opinion in Seavitt v. N-Able, (Del. Ch.; 7/24). One of the more interesting aspects of his opinion addressed the permissibility of language in N-Able’s certificate of incorporation making certain of its provisions “subject to” the terms of the stockholders’ agreement that was at issue in the case. The defendants argued that this was permitted by Section 102(d) of the DGCL, which provides that:
“Any provision of the certificate of incorporation may be made dependent upon facts ascertainable outside such instrument, provided that the manner in which such facts shall operate upon the provision is clearly and explicitly set forth therein. The term “facts,” as used in this subsection, includes, but is not limited to, the occurrence of any event, including a determination or action by any person or body, including the corporation.”
Vice Chancellor Laster disagreed that the “ascertainable facts” language of Section 102(d) was broad enough to permit the incorporation by reference of a stockholders’ agreement into a corporate charter. This Paul Weiss memo summarizes the key points underlying his reasoning:
“Facts ascertainable” are not “provisions ascertainable.” The court reasoned that Section 102(d)’s reference to “facts” ascertainable outside a charter does not include outside “provisions” or other incorporation by reference of a broad, substantive nature. According to the court, “facts ascertainable” refers to specific inputs and are not a vehicle for introducing substantive provisions. According to the court, the examples of “facts” given in the statute (i.e., “the occurrence of any event” or “a determination or action by any person or body”) supported its conclusion. While the court distinguished and took no issue with references to private agreements for limited facts (e.g., the identity of parties or whether there has been a breach of the agreement) or references to laws and regulations (e.g., the definition of “affiliate” in the U.S. Securities and Exchange Act of 1934), a Delaware corporation cannot simply create substantive charter terms through an external, private document.
Public unavailability of private agreements. The DGCL requires charters to be publicly filed, but not a private agreement. The court reasoned that the public nature of charters makes basic information about the corporation available to both investors and third parties, but incorporating provisions by reference to non-public documents frustrates that statutory purpose. Furthermore, while federal securities laws might require public companies to file their governance agreements, that fact does not affect the interpretation of the DGCL applicable to all Delaware corporations.
Circumvention of stockholder vote on charter amendments. The court observed that DGCL Section 242 requires both board and stockholder approval of charter amendments, whereas incorporation by reference of private party agreement provisions permits the contracting parties to amend their agreement on their own and thereby amend the charter automatically. According to the court, this would circumvent Section 242, thereby depriving stockholders of their voting rights.
Members of TheCorporateCounsel.net can check out our “Delaware Law” Practice Area for more memos on this decision, the recent DGCL amendments and more.
Yesterday, the SEC issued an order to approve Nasdaq’s proposal to amend, or adopt new, corporate governance phase-in periods. My blog from May of this year (when the SEC posted the notice & request for comment) details the substantive rule changes. The changes will be reflected in Rules 5605, 5615 and 5810, so once they’re posted to the rulebook, read those for more detail.
A new survey commissioned by the folks behind the CPA-Zicklin Index shows widespread public support for improved governance of corporate political spending. Here are some stats from the survey summary:
– Nationwide, 87% believe that public corporations should be required to have a code of conduct to assess and govern their political spending.
– Similarly, 91% want procedures adopted that would ensure that corporate political contributions are lawfully spent and are consistent with public policies that benefit the company in which they are financially invested.
– Stockholders also feel that a code of conduct would improve a company’s political spending decisions (67%) and give them more confidence in their investment (79%).
– They also believe corporations need to consider the impact of their political spending on broader society (77%).
These survey responses make sense when looking at the Center for Political Accountability’s new report, Corporate Underwriters: Where the Rubber Hits the Road, focused on the impact of corporate political spending on politics — particularly at the state level. The report is intended to provide executives with a guide “for thinking about how to engage with the political process and how to spend corporate treasury funds.”
The report found that political spending by public companies plays “a major role in financing highly contested state political races through third-party 527 groups.” Public companies and their trade associations have contributed more than $1 billion (40% of all funds collected) to “527 Committees” (Republican & Democratic Governors Associations, Attorneys General Associations and State Leadership Committees) and influenced elections that have “reshaped policy and politics” and “had a major impact on our democracy” — including by state attorneys general using lawsuits and briefs to “drive national policy from the state level.” Gosh, that sounds familiar!
For further background, Cooley’s Cydney Posner did a deep dive on the report and risks to companies of public scrutiny of political spending. For companies looking to improve their governance in this area — or when controversies or other developments cause these risks to materialize — the report recommends the CPA-Zicklin Model Code of Conduct for Corporate Political Spending as a means to examine the full consequences of a company’s political spending and better understand the risks of political spending decisions.
The intro to a recent Covington alert made me thankful I’m not navigating political law issues in my day-to-day. Here it is:
With Election Day fast approaching, corporations face increasing pressure from both internal and external forces to make legal decisions about political activities. This can be a fraught area of law, with little understood, highly technical regulatory issues that vary significantly across jurisdictions. Corporate counsel should be mindful of common—and sometimes complicated—political law traps.
The alert lists seven areas for corporations to monitor and best practices to pursue in an election year. Here are two of the timely reminders:
Contribution Reimbursement
Almost every jurisdiction prohibits contributions that are made in the name of another. Therefore, a corporation (or any other person) should never fund a contribution made by one of its employees or any other person, whether through reimbursement, advance, “bonus,” or other funds given with an understanding or expectation they will pay for a contribution that has or will occur. Doing so exposes a company and its executives to criminal penalties. Corporations have sometimes inadvertently reimbursed employees’ political contributions through the corporate expense reimbursement system, and care should be taken to ensure that such systems do not allow for expensing of contributions.
Policies Around Voting
Any company policies regarding voting and elections should be reviewed by counsel to ensure they are consistent with current laws concerning political activity. For example, voter registration drives can be subject to complicated state regulations. Providing gifts or other things of value to encourage voting may raise issues under federal and state laws meant to prohibit vote buying or influence. Additionally, some state employment and labor laws, such as California’s Labor Code, include restrictions on an employer’s efforts to influence employee political behavior. Corporations that do not already have compliance policies governing corporate and employee political activity should consider adopting such policies now.
In mid-August, Liz shared Nasdaq’s proposed rule change to modify the delisting process for certain stocks that fail to regain compliance with the exchange’s bid price requirement. The Commission has since published the notice to solicit comments on the proposed rule change and will decide to approve or reject the changes within 45 to 90 days.
Bloomberg reports that AI and biotech startups are most at risk if the proposed rule change is approved. This Morrison Foerster alert describes the following potential consequences of delisting:
Involuntary delisting can lead to significant market disruptions, increased volatility, reduced access to capital, operational challenges, and damage to investor relations and market reputation. … Companies delisted from Nasdaq are generally relegated to trading on OTC markets. The specific OTC market depends on whether the company continues to file periodic reports and financial statements with the SEC. OTC markets typically have lower liquidity, are more volatile, and offer less visibility, often being perceived as a gray area in the capital markets that carries significant risk. Companies relegated to OTC markets usually cannot engage in traditional capital-raising activities without first securing a successful uplisting back with Nasdaq or the New York Stock Exchange, which generally involves a new listing application coupled with an underwritten offering.
[T]hese companies—or any company at risk of falling into penny stock status—should proactively consider strategic alternatives, such as a privatization, to avoid being quickly forced into delisting.
As Liz pointed out, this proposal comes on the heels of another proposal that would tighten the deficiency process for companies that effectuate a reverse stock split to regain a $1 bid price but, in doing so, trip up another continued listing requirement. Together, these proposals underscore how hard it can be when companies find themselves in a bid price deficiency and employ a reverse stock split. The stakes of missing the “sweet spot” — that is, the split ratio that gets the company into compliance for at least a year but doesn’t trip up other listing requirements — will be higher than ever.
A recent post on the HLS Blog claims that most Nasdaq-listed companies had no trouble disclosing that they met Nasdaq’s minimum number of diverse directors. But the blog goes on to describe what it calls the “interesting cases” — “the small number that have instead opted to explain why they do not meet” the minimum diverse director requirement. It shares example disclosures from 2024 proxy statements identified by Bloomberg’s Andrew Ramonas that you may find helpful if you find yourself with a client in this position.
Below are examples from the blog where a company finds itself temporarily without diverse directors and where company-specific factors might make director recruitment more difficult:
Groupon’s Transitional Phase. Groupon’s situation highlights a common issue where a company may temporarily fall short of diversity goals due to turnover. It “acknowledges and supports the general principles behind the diversity objectives,” but lost its one diverse board member this year. The company’s acknowledgment of the principles behind diversity objectives suggests a willingness to align with NASDAQ’s vision, yet it underscores the reality that board composition is dynamic and subject to change.
Red Rock Resorts’ Particular Constraints. The company says there is a:
relatively limited pool of potential directors who are willing to subject themselves, as well as their families, to the rigorous and intrusive process necessary to obtain a gaming license and the demand for qualified diverse candidates will continue to impact our ability to attract certain categories of diverse directors to serve on our Board.
Red Rock Resorts’ explanation illustrates challenges faced by companies in certain industries, such as gaming, where the process of obtaining a license can be a deterrent for potential directors. This highlights how external factors and industry-specific demands can significantly impact the ability to attract certain kinds of board members.
On the other end of the spectrum are boards that exceed the Nasdaq rule and are looking to promote and highlight the diversity of their board. For a standout example, check out e.l.f. Beauty’s social impact page “Changing the Board Game” highlighting their board diversity and their efforts to promote board diversity even outside the company — for example, by partnering with NACD to sponsor 20 diverse candidates through NACD’s Accelerator Program. The company’s proxy statement (page 2) doesn’t have the Nadaq table (it’s NYSE listed) but touts, “We are proud to be one of only four public companies in the U.S. (out of nearly 4,200 public companies) with a board of directors that is at least two-thirds women and at least one-third diverse.”
The July-August Issue of the Deal Lawyers newsletter was just posted and sent to the printer. This issue includes the following articles:
– Drafting of Corporate and M&A Documents for 2024 Delaware General Corporation Law Amendments
– Soft Earn-out “Promises” as Potential Fraud or Merely Puffery: Delaware Chancery Court Provides Guidance in Trifecta
– Watch Your Derivatives: The Role 13Fs Play in Detecting Shareholder Activism
– We’re Back In-Person – Register Today & Join Us in San Francisco!
The Deal Lawyers newsletter is always timely & topical – and something you can’t afford to be without to keep up with the rapid-fire developments in the world of M&A. If you don’t subscribe to Deal Lawyers, please email us at sales@ccrcorp.com or call us at 800-737-1271.
