Here’s something John shared last week on DealLawyers.com:
Stockholders’ agreements are a common feature in a variety of transactional settings, and the rights and obligations they impose are often an essential part of the deal. That’s why the Delaware Chancery Court’s recent decision in West Palm Beach Firefighters v. Moelis & Company, (Del. Ch.; 2/24) voiding key provisions of a “new-wave” stockholders’ agreement merits close review by everyone involved in the dealmaking process.
The case focused on pre-approval rights for key corporate decisions and director designation rights granted by Moelis to the company’s founder in a stockholder agreement. The transactions requiring the founder’s prior approval included stock issuances, financings, dividend payments and senior officer appointments. The director designation rights & related governance provisions were intended to ensure that the founder could designate a majority of the members of the board and, among other things, required the company to recommend shareholders vote for any candidate designated by the founder.
Vice Chancellor Laster concluded that the pre-approval and governance rights contained in the agreement ran afoul of Section 141(a) of the DGCL, which says that “the business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.” This excerpt from Goodwin’s memo on the decision summarizes the basis for the Vice Chancellor’s decision:
[P]laintiff argued that the challenged provisions in the Stockholder Agreement violate Delaware law because they effectively remove from directors “in a very substantial way” their duty to use their own best judgment on matters of management. Meanwhile, the Company argued that Delaware corporations possess the power to contract, including contracts that may constrain a board’s freedom of action, and the Stockholder Agreement should not be treated any differently.
After a painstaking analysis of applicable Delaware cases, the court found that several of the Board Composition Provisions, and all of the Pre-Approval Requirements, were facially invalid under Delaware law. The court decided that each of the Pre-Approval Requirements went “too far” because they forced the Board to obtain Moelis’s prior written consent before taking “virtually any meaningful action” and, thus, “the Board is not really a board.”
The Goodwin memo also points out that the key problem here was that the rights at issue weren’t contained in the company’s certificate of incorporation. It also contends that the biggest takeaway from the case is that investors are likely to insist on including these provisions in charter documents, rather than in the agreement itself.
Importantly, VC Laster did not hold that all of the contractual investor rights challenged by the plaintiff were invalid on their face. For example, he said that a director designation right didn’t necessarily violate Section 141(a) of the DGCL. Instead, the problem in this case was that it was coupled a recommendation requirement compelling the board to support the designated candidate no matter what:
“The Designation Right does not violate Section 141(a) because it only permits Moelis to identify a number of candidates for director equal to a majority of the Board. The Company can agree to let Moelis identify a number of candidates. What the Board or the Company does with those candidates is what matters. The Recommendation Requirement improperly compels the Board to support Moelis’ candidates, whomever they might be. But there is nothing wrong with a provision that lets Moelis identify candidates.”
Traditionally, I think companies haven’t been completely insensitive to this issue, and many stockholders’ agreements include some sort of a fiduciary out when it comes to a recommendation requirement. But as Meredith blogged last summer, when it comes to activist settlements, boards haven’t always been cognizant of the limitations imposed by their fiduciary duties when negotiating the terms of those agreements. Moelis should serve as a reminder that those agreements don’t just have to satisfy Unocal, they also need to avoid running afoul of the limitations imposed by Section 141(a).
Hughes Hubbard attorneys represented the NSBA in the case and the firm describes the lawsuit and the decision in this announcement.
On Nov. 15, 2023, NSBA filed suit in the Northern District of Alabama, alleging that the Corporate Transparency Act exceeded Congress’ Article I constitutional powers and infringed upon individual constitutional rights by forcing ordinary Americans to hand over sensitive, personal information to a Financial Crimes Enforcement Network (FinCEN) law-enforcement database. NSBA sought an immediate injunction against the implementation of the CTA and FinCEN reporting rules.
The order found that the CTA exceeds Congress’ authority under Article I of the Constitution and did not address the NSBA’s other challenges under the First, Fourth, and Fifth Amendments:
The court acknowledged that the ultimate policy goals of the statute, in terms of countering money laundering and terrorism financing, are laudable. But the court concluded that Congress cannot attempt to achieve laudable goals through means that are outside its powers under the Constitution—either because (as the court found) Congress is legislating activities like entity formation that the Constitution leaves to the states, or because (as NSBA also contended) Congress is forcing ordinary and innocent Americans to hand over personal and sensitive information to a database dedicated to criminal investigations even though those citizens have done nothing wrong and there is no reason to suspect that they have.
An appeal seems highly likely, so stay tuned!
Thanks to my former colleague Angela Gamalski of Honigman for sharing this update on LinkedIn over the weekend!
In late December, Dave shared the first Form 8-K filed under the new cyber incident reporting regime. He noted “someone always must be first” to file. This unlucky company was also first to receive a comment. Hat tip to Emily Sacks-Wilner of Fenwick for sharing these first SEC comment and company response letters on disclosures under Item 1.05 of Form 8-K.
In its 8-K, the company disclosed that “the incident has had and is reasonably likely to continue to have a material impact on the Company’s business operations until recovery efforts are completed.” Relying on Instruction 2 to Item 1.05, it also stated that “the full scope, nature and impact of the unauthorized occurrences were not yet known” and the company hadn’t yet “determined whether the incident is reasonably likely to materially impact the Company’s financial condition or results of operations.”
It seems the SEC took this first filing as an opportunity to send a reminder that the amended 8-K (which must be filed to report the information called for by Item 1.05 that was not determined or available when the initial 8-K was filed) must describe the scope of the business operations impacted and the known material impacts the incident has had and those likely to continue. The comment letter continues:
In considering material impacts, please describe all material impacts. For example, consider vendor relationships and potential reputational harm related to stolen data and unfulfilled orders, as well as any impact to your financial condition or results of operations.
The company simply acknowledged the comment and noted that the amended 8-K will address these items.
The January-February issue of The Corporate Executive has been sent to the printer (email sales@ccrcorp.com to subscribe to this essential resource). It’s also available now online to members of TheCorporateCounsel.net who subscribe to the electronic format.
The issue includes the timely article “Cybersecurity: What Do the New Form 10-K Disclosures Look Like?” summarizing observations on how companies are approaching new Form 10-K cybersecurity disclosures based on a review of 25 Form 10-K filings from a group of large accelerated filers from a broad cross-section of industries.
Yesterday, the Council of Institutional Investors sent this letter to the SEC to request that the Commission initiate rulemaking to require a technological solution to the issue of “traceability.”
The rulemaking petition says that the 2023 decision in Slack Technologies, LLC v. Pirani has jeopardized investor protection. In the Slack case, the SCOTUS held that an investor plaintiff who is seeking a remedy under Section 11 of the Securities Act must prove that the shares that they hold are traceable to a registration statement. That is particularly difficult to do in the direct listing context because unregistered shares enter the market and begin trading alongside registered shares. If there are lockup waivers, traceability may also be an issue in a traditional IPO.
The letter acknowledges that a working group has already urged rulemaking to amend Rule 144 to address this issue (which CII also supported, but it hasn’t gone anywhere). CII says that alternatively, the Commission should consider a technological solution. Here’s an excerpt:
Two potential approaches have been recently identified by former SEC Chair Jay Clayton and former Commissioner Joseph A. Grundfest. In a brief filed as amici curiae in the Slack case they stated that the Commission could:
1. Require that registered and exempt shares offered in a direct listing trade with differentiated tickers, at least until expiration of the relevant Section 11 statute of limitations; or
2. Migrate the entire clearance and settlement system to a distributed ledger system or to
other mechanisms to allow the tracing of individual shares as individual shares, and not as fractional interests in larger commingled electronic book entry accounts.
We note that the second more ambitious approach is aligned with the recommendation CII submitted to the SEC in connection with its 2018 Roundtable on the Proxy Process.
The letter also notes a third alternative that was the subject of a recent study from Columbia Law Professor & Director of the Center on Corporate Governance John Coffee and his colleague Joshua Mitts: adapting the detailed trading records that broker-dealers already maintain as part of the consolidated audit trail – and requiring production of these records to private plaintiffs in Section 11 litigation.
I don’t know enough about broker-dealer record-keeping requirements to gauge whether this would be as minimal a lift as the cited study makes it out to be. I do know that broker-dealers generally aren’t clamoring for more recordkeeping requirements….
It’s a busy week for the Commissioners next week. On Thursday, March 7th, there will be a meeting of the SEC’s Investor Advisory Committee meeting, which was the subject of a Sunshine Notice because a majority of the Commissioners may attend. Here’s what’s on the agenda:
1. Panel: Discussing the U.S. Securities and Exchange Commission’s Proposals to Improve Equity Market Structure (this includes “payment for order flow”)
2. Panel: Examining the use of Materiality as a Disclosure Standard — Can the Definition be Improved to Better Serve Investors? (Dave’s panel for the SEC Historical Society could be a good “pre-read” for this one)
In this 12-minute episode of the “Women Governance Trailblazers” podcast, Courtney Kamlet & I interviewed Locke Lord’s Allison O’Neil, who co-chairs the firm’s White-Collar Defense & Investigations Practice Group. We discussed:
1. Allison’s career path, and her favorite part of leading internal investigations and white-collar defense matters.
2. How Allison has seen internal investigations evolve over the past 5-10 years.
3. The top 3 things companies and advisors should do right now in light of current SEC enforcement trends.
4. Suggestions for those advising boards and making compliance and disclosure decisions, from a litigator’s perspective.
5. What Allison thinks women in the corporate governance field can add to the current conversation on the societal role of companies.
To listen to any of our prior episodes of Women Governance Trailblazers, visit the podcast page on TheCorporateCounsel.net or use your favorite podcast app. If there are “women governance trailblazers” whose career paths and perspectives you’d like to hear more about, Courtney and I always appreciate recommendations! Shoot me an email at liz@thecorporatecounsel.net.
And if you want more info on SEC Enforcement’s priorities & trends (which are important to know in order to stay out of trouble), check out the transcript from our webcast a few months ago. Allison was part of our excellent panel of speakers!
The rumors panned out. Yesterday, the SEC posted the Sunshine Notice for an open meeting to be held next Wednesday, March 6th at 9:45am ET. Climate is one of the two agenda items:
The Commission will consider whether to adopt rules to require registrants to provide certain climate-related information in their registration statements and annual reports.
The timing of next week’s meeting allows the SEC to dodge the risk of a government shutdown (just in case the latest deal doesn’t go through). It likely also helps avoid the specter of a new Administration unraveling the rule under the Congressional Review Act. This blog from Hunton Andrews Kurth says that agency rules will be at risk if they are published in the Federal Register after May 22nd this year. Typically it takes about 30 days for rules to show up in the Federal Register, so that will probably not be an issue here. All that said, we will almost certainly see litigation that challenges the new requirements, assuming they are adopted.
I expect a final rule to be adopted in some form next week, although we may see 1 or 2 Commissioners dissent from the decision. What’s unknown is how exactly the record number of comments to the proposal have been considered and reflected in the final rule. The meeting will be webcast on the SEC’s website if you want to watch the drama unfold in real time.
Welcome to the 2024 Edition of Leap Day. It is always exciting to get a bonus day, and perhaps you’re marking the occasion with a time capsule or an energizing game of leapfrog. But it is also important to remember the impact that February 29th will have on your SEC filing calendar. Here’s a note from a member about the Leap Year deadline for forward incorporation by reference:
The deadline for forward incorporation by reference of information from a company’s definitive proxy or information statement into its previously-filed Form 10-K, which is 120 days after the end of the company’s fiscal year, falls one day earlier than usual in leap years, such as 2024. If the company isn’t going to be able to file its definitive proxy or information statement on or before the 120th day, it must amend its Form 10-K to include the Part III information omitted from the Form 10-K at the time the report was filed by filing a Form 10-K/A not later than the 120th day. The 120-day deadline cannot be extended by filing a Form 12b-25.
Because 2024 is a leap year, the 120th day after December 31, 2023 will be Monday, April 29, 2024, rather than April 30 (as it would be in other years). Failure to file the definitive proxy or information statement or a Form 10-K/A amendment to the Form 10-K within this period will result in the Form 10-K being untimely filed, which has a variety of consequences, including loss of eligibility to use Form S-3.
I’m beginning to think that Leap Day isn’t all fun & games. Not only do we need to consider its impact on forward incorporation by reference, this WSJ article reminds us that we also may need to give extra thought to the presentation of financial results for this quarter. The article calls out these things to watch:
Employee benefits: Companies need to make sure payroll benefits and certain employee pay reflect the extra day. Banking firm UMB Financial projects that its first-quarter salary and benefits expense will increase with the leap-year day, CFO Ram Shankar said on a Jan. 31 earnings call. Businesses with a large base of hourly workers could see a jump in expenses from the previous year.
Depreciation and amortization: Businesses will want to make sure they are booking the correct amount of depreciation and amortization for 29 days instead of 28, said Steve Hills, who heads up the accounting and reporting practice at Stout Risius Ross, an advisory firm. For some companies, that may be a manual adjustment, while at others it may be automated, he said.
Comparable metrics: If companies calculate key data such as same-store sales on a monthly basis and an extra day is material, investors could find it difficult to compare year-over-year sales and need to consider that day, said Olga Usvyatsky, an accounting consultant.
Interest rates: Certain industries will see greater effects from the added day. Banks and other lenders have to calculate interest rates on a daily basis for 366 days, not 365.
Or…just ignore it: Retailers have to examine the extra day of sales to see if it is material enough to warrant a footnote saying 2024 might not be comparable to the previous year. When calculating comparable metrics of a leap year versus a non-leap—a percentage change in sales, for instance—companies can omit the extra day in its comparisons and will generally explain it to investors separately if it is deemed material.
The article goes on to say that companies rarely mention the effect of Leap Day in their financial reports, but companies, auditors, and lawyers must analyze the impact regardless. Don’t begrudge Leap Day, though. This extra effort is worth it, since it means that our holidays stay in the seasons where they belong.
