Our readers know that Delaware forum selection clauses have been enforced by courts in many states since Delaware Chancery’s 2013 decision in Boilermakers v. Chevron. Recently, the developments we’ve covered relating to forum selection have involved whether bylaws providing an exclusive forum for bringing claims under the Securities Act or the Exchange Act were permissible. The latest development is a bit different, although I can’t say unexpected, since Allen Matkin’s Keith Bishop predicted it just over a decade ago!
Last fall, Keith blogged about EPICENTERx, Inc. v. Superior Court (Cal. Ct. Appeal, 9/23) in which California’s Fourth District Court of Appeal refused to enforce the forum selection clause “in a Delaware corporation’s corporate documents” since it “would operate as an implied waiver of the plaintiff’s right to a jury trial—a constitutionally-protected right that cannot be waived by contract prior to the commencement of a dispute.”
This Sidley blog gives further background on the issue and explains that California is an outlier, although “other state courts could follow California’s approach.”
In California, forum selection clauses are typically enforced unless doing so would be unfair or unreasonable. But California courts will refuse enforcement if litigating in the selected forum would violate public policy. Normally the burden of proof to prove why the clause should not be enforced falls on the party opposing enforcement. Under California statutes, however, the burden is reversed when the issue bears on unwaivable rights. The right to a jury trial has been deemed “fundamental,” “inviolate,” and “sacred.” The Delaware Court of Chancery, as a court of equity, does not conduct jury trials. Therefore, the defendants must demonstrate that litigating in the Delaware Court of Chancery would not substantially diminish rights under California law. […]
California is an outlier in rejecting the enforcement of a Delaware Court of Chancery forum selection clause that is included in corporate documents. Most other state courts enforce Delaware forum selection clauses. Like California, nearly all state constitutions recognize the right to a jury trial. Yet California and Georgia appear to have the only courts that have expressly prohibited pre-dispute jury waivers. California courts point to the state’s constitution and Code of Civil Procedure that outlines only six actions that may waive the right to a jury trial, which do not include pre-dispute waivers, to demonstrate that forum selection clauses may not be enforced when they infringe upon such rights.
As Liz announced at our 2023 Conferences, we are absolutely thrilled that our 2024 Proxy Disclosure & 21st Annual Executive Compensation Conferences will be back in person! Since we lawyers are big planners, synchronize your (smart) watches for Operation 2024 Conferences & plug October 14 to 15 into your calendar.
We’ll gather in San Francisco to learn, plan for proxy season and commiserate (in person!) about our shared struggles. For extra credit, sign up here to be the first to get all the details. Or look out for future blogs about early bird registration and “sneak peeks” of topics & speakers.
And if you can’t make it in person, don’t panic! We will also offer a virtual option so you won’t miss out on the practical guidance our always excellent speaker lineup will share with attendees.
The transition to a T+1 settlement cycle pursuant to SEC Rule 15c6-1(a) will occur on May 28, 2024. The NYSE will adopt new rules to reflect regular way settlement as occurring on a T+1 basis and also will change the Exchange’s rules with respect to ex-dividend and ex-rights trading. Ex-dividend trading dates will be set during the transition period as follows:
– securities paying a dividend with a record date of May 28 will be traded ex-dividend on May 24; and
– securities paying a dividend with a record date of May 29 will be traded ex-dividend on May 29.
The Memo reminds listed issuers, to the extent practicable, to avoid consummation of corporate actions during the time of transition from T+2 to T+1.
In response to listed company inquiries, NYSE’s annual Listed Company Compliance Guidance letter also includes a reminder to debt-only issuers that they, too, are required to adopt a clawback policy. Here’s an excerpt:
In adopting Rule 10D-1, […] the SEC did not provide any such exemption for issuers whose only listed securities are debt securities, including issuers of debt securities guaranteed by a parent company whose common equity securities are typically listed on the Exchange. In response to inquiries from listed companies and their advisors, NYSE Regulation has sought clarification from the SEC regarding the treatment of debt-only issuers under Rule 10D-1 and Section 303A.14.
As a result of those conversations, NYSE Regulation confirms that all debt only issuers listed on the NYSE are required to adopt a Recovery Policy, including, without limitation, those with guarantees from listed parents and those that are exempt from disclosure requirements pursuant to Exchange Act Rule 12h-5. To the extent an issuer has not put in place relevant procedures, it is out of compliance with NYSE rules.
This Davis Polk memo from a few weeks ago has more on this and explains the mechanics (or lack thereof) for some debt-only issuers.
A subsidiary of a public company (including an operating company or finance subsidiary) can itself be the issuer of debt securities or a guarantor of debt securities issued by its parent company. […] Under SEC rules, where the parent guarantees the debt, the subsidiary is exempt from ongoing SEC reporting (in accordance with Rule 12h-5 under the Securities Exchange Act of 1934), and the parent reporting company is not required to provide separate financial statements to the SEC for the subsidiary (in accordance with the exemption under Rule 3-10 of Regulation S-X). […] Subsidiary securities are sometimes listed on an exchange.
Subsidiaries with listed securities should adopt a clawback policy to comply with the listing standards. The good news is that under both NYSE and Nasdaq listing standards, if the subsidiary is not itself subject to SEC financial reporting requirements, there should be no events that would trigger recovery of compensation under the policy.
This is because under the clawback rules, recovery of compensation is only triggered by a financial restatement that the issuer is required to prepare due to the issuer’s (i.e., the subsidiary’s) material noncompliance with financial reporting requirements under the U.S. federal securities laws. If the subsidiary issuer is not subject to such financial reporting requirements, then it should never be required to prepare a restatement due to material noncompliance with such financial reporting requirements.
The memo goes on to say that the clawback policy “could simply state that the parent company’s clawback policy applies to the subsidiary” and even includes a sample resolution that could be adapted for this purpose as an annex. Finally, it clarifies that, for any such subsidiary that does not file an annual report on Form 10-K, Form 20-F or Form 40-F, there would be no need to file the clawback policy as an exhibit.
A few weeks ago over on the Proxy Season Blog, Liz blogged about Exxon’s decision to take two shareholder proposal proponents to court over a “Scope 3” proposal and request a declaratory judgment that it could exclude the proposal from its proxy statement. Liz noted how unusual this “direct-to-court” strategy is — since shareholder proposals are non-binding, often don’t pass and there’s the option of seeking an SEC no-action letter. But she gave this background:
Back in 2017, one of the first climate proposals to receive majority shareholder approval was a request for a “2-degree scenario” analysis, which passed at ExxonMobil with 62% support. This emboldened proponents and gave credibility to the notion that investors want climate information. Looking back, it was one of the developments that launched the “E&S” tsunami. Over the ensuing 7 years, the volume of shareholder proposals increased to record numbers. Companies have been spending time, money, and energy on responding to proposals, negotiating with proponents, discussing the issues with institutional holders, and requesting no-action relief from the SEC.
The complaint, excerpted below, cites the difficulty in obtaining SEC no-action relief under current guidance:
The plain language of Rule 14a-8 supports excluding the 2024 Proposal, but current guidance by SEC staff about how to apply the rule can be at odds with the rule itself. Even though that guidance has no legal force or effect, Defendants and other similar activist organizations rely on it to pursue their personal preferences at the expense of shareholders. ExxonMobil seeks declaratory relief from this Court to stop this misuse of the current system.
On Monday, Liz shared that the proponents have now backed off by withdrawing their proposal (and promising not to refile it). But Exxon has not done the same. Here’s an excerpt from this Reuters article:
Exxon said it would continue with the suit, which questions the motivations of the investors and notes the rising number of resolutions being filed for corporate ballots.
“We believe there are still important issues for the court to resolve. There is no change to our plans, the suit is continuing,” Exxon said in an emailed statement.
In addition to seeking approval to skip a vote on the resolution, Exxon had sought attorneys’ fees and expenses and that the court enter “other and further relief as the Court may deem just and proper.”
This will be closely watched litigation that we’ll generally cover on our Proxy Season Blog where we continue to regularly post new items for TheCorporateCounsel.net members. Members can sign up to get that blog pushed via email whenever there is a new post. If you do not have access to the Proxy Season Blog or all the other great resources on TheCorporateCounsel.net, sign up today.
Yesterday, the SEC’s Office of Chief Accountant Paul Munter released this statement on the recent increase in deficiency rates found in audit inspections and the role of the auditor and audit committee in ensuring high-quality audits. The statement first addresses the role of auditors and suggests that auditors do more of the following:
– frequently and proactively engage with the audit committee, including on events that impact financial reporting and red flags arising from management responses;
– not agree to truncated or summary presentations with the audit committee regarding concerns with management or management responses;
– include specialists and other experts to assist in auditing complex areas or where specialized knowledge is needed to ensure adequate expertise;
– ensure engagement teams are trained on biases that affect auditor judgment and decision-making and undermine professional skepticism; and
– ensure that audit staff are empowered to exercise professional skepticism and challenge judgments of management by supporting audit staff in exploring areas of heightened risk and red flags, insulating audit staff from pressure to accept less than persuasive audit evidence and refusing management requests to replace audit team members.
Then the statement turned to the role of audit committees. First, it describes the importance of the committee’s role in assessing auditor performance, and suggests committees evaluate whether and how they consider the following:
– results of the auditor’s PCAOB inspections, the firm’s internal monitoring programs, or other firm audit quality reporting; – whether the engagement team has appropriate industry expertise, and whether the engagement partner is sufficiently engaged and provides leadership to the engagement team; – the engagement team’s total hours and staffing mix (such as, the use of specialists, the composition of experience within the engagement team, or portions of the engagement performed by other auditors); and – significant changes (or the lack thereof) in hours or staffing mix from previous audits.
It also encourages audit committees to build a strong professional relationship with the auditor independent of management and makes suggestions to further that goal.
Chief Accountant Munter has been sharing thoughts with the corporate and auditor communities regularly in recent months, having recently addressed the importance of the statement of cash flows, with consistent commentary at the Northwestern Securities Regulation Institute. He also recently joined this Q&A with KPMG where he highlighted the risk of what he called the “SALY” (same as last year) mentality, noting that audit committees need to pay attention to emerging risks, which are often communicated first outside of the financial statements, in risk factors or MD&A, and be thinking through what those risks mean for the financial reporting process.
Here’s something Liz shared on the CompensationStandards.com Advisors’ Blog yesterday:
It was the “moonshot” award that started it all. But last week, as you’ve probably heard, Elon Musk did not get the outcome he was hoping for in the Tornetta v. Musk litigation that has been winding its way through the Delaware Court of Chancery for several years.
The case challenged the record-breaking equity award that was granted to Musk in 2018 and – when the value of the company skyrocketed – came to be worth about $51 billion. Chancellor Kathaleen McCormick issued her 201-page opinion last Tuesday. As Tulane Law Prof Ann Lipton put it, “she took the extraordinary step of holding that Elon Musk’s Tesla pay package from 2018 was not ‘entirely fair’ to Tesla investors, and ordered that it be rescinded.” Mechanically, it looks like the options that the company had granted to Musk will now be cancelled (none of the options had been exercised). Ann’s blog walks through the complex legal standards – & burdens of proof – that led Chancellor McCormick to this outcome. Here’s an excerpt:
Formally, in Tornetta, the court concluded that Elon Musk was a controlling shareholder of Tesla, at least for the purposes of setting his compensation package. The court considered both his 21% percent stake, and his “ability to exercise outsized influence in the board room” due to his close personal ties to the directors and his “superstar CEO” status. She recounted the process by which the pay package was set, noting in particular that Musk proposed it, Musk controlled the timelines of the board’s deliberation, and he received almost no pushback – board members and Tesla’s general counsel seemed to view themselves as participating in a cooperative process to set Musk’s pay, rather than an adversarial one.
What about the stockholder vote? That, too, was tainted, because – McCormick concluded – the proxy statement delivered to shareholders contained material misrepresentations and omissions. It described Tesla’s compensation committee as independent when in fact the members had close personal ties to Musk, and it did not accurately describe the manner in which his pay package was set – again, with Musk himself proposing it and the board largely acquiescing. With those findings in hand, McCormick did not rule on the plaintiff’s additional arguments that the proxy statement was misleading for other reasons (namely, it falsely described the payment milestones as “stretches” when in fact the early ones were already expected within Tesla internally.)
Chancellor McCormick said that the process leading to the approval of the compensation plan was “deeply flawed.” Advisors will also find it interesting that she reviewed an early draft of Tesla’s proxy statement and found it to be the “most reliable (indeed, the only) evidence” of the substance of the discussion that established the terms of Musk’s equity grant. Over the course of several drafts, the existence of that conversation was edited out – so, it was not mentioned in the as-filed proxy. The judge also took issue with this statement:
The Proxy disclosed that, when setting the milestones, “the Board carefully considered a variety of factors, including Tesla’s growth trajectory and internal growth plans and the historical performance of other high-growth and high-multiples companies in the technology space that have invested in new businesses and tangible assets.” “Internal growth plans” referred to Tesla’s projections.
According to the court’s findings, the proxy was misleading because it didn’t disclose that the company had projections that would show that the milestones would be achieved. As Ann explained in her blog, the court also took issue with describing compensation committee members as “independent” when – according to the record – they in fact had relationships that gave rise to potential conflicts of interest that should have been disclosed, and a “controlled mindset.” So, Chancellor McCormick concluded:
The record establishes that the Proxy failed to disclose the Compensation Committee members’ potential conflicts and omitted material information concerning the process. Defendants sought to prove otherwise, and they generally contend that the stockholder vote was fully informed because the most important facts about the Grant—the economic terms—were disclosed. But Defendants failed to carry their burden.
The case shows that process, common-sense thinking, and disclosure matter. If you’re involved in the compensation-setting and/or proxy drafting process, you may not win friends if you read everything with a critical eye and ask unwanted questions. It can be hard to find a way to do that tactfully. But now you have a case to point to that shows why it’s important.
The latest issue of The Corporate Executive has been sent to the printer. It’s also available online to members of TheCorporateCounsel.net who subscribe to the electronic format. This issue is particularly timely as we head into proxy season and focus on proxy advisor policies:
– ‘Now What Do We Do?’ Dealing with Negative Proxy Advisor Recommendations
Read it now for practical tips for advance preparation and keep it handy for the future if you find yourself facing a surprise negative recommendation. Don’t miss out on all the practical guidance that The Corporate Executive has to offer. Email sales@ccrcorp.com to subscribe to this essential resource.
This post on the CS Blue Sky Blog highlights findings from “A Comparison of Direct Listings and Initial Public Offerings,” a study by Anna Bergman Brown of Clarkson University, Donal Byard of Baruch College, and Jangwon Suh of Queens College. Given suggestions by SEC commissioners and other regulators that direct listings present greater risk to investors than IPOs, the study assessed the types of companies that listed via IPO versus direct listing and the average price volatility post-listing.
The study used a sample of IPOs and direct listings on European stock exchanges given the historically few direct listings in US markets, despite their increasing popularity since Spotify’s in 2018. Here’s an excerpt summarizing the findings:
The first significant finding is that, on average, DL firms are significantly larger, more profitable, and less leveraged than IPO firms – all of which suggest that, on average, DL firms are less risky than IPO firms.
Our second significant finding is that, when we compare the post-listing price volatility of DLs with similar IPOs, consistent with some regulators’ suspicions, we find that DLs are riskier than IPOs in the immediate post-listing period: DLs have higher price volatility than similar IPOs in the immediate post-listing period. However, we find that this excess price volatility dissipates rather quickly: On average, it lasts for only 20 trading days.
We also find that, in industries with a richer “industry information environment” – i.e., where the existing listed firms in that industry already provide relatively high-quality public disclosures – there is no difference in post-listing price volatility across DLs and IPOs.
There is still the issue of traceability…and there’s more to come on that. For now, for more on direct listings, take a look at our “Direct Listings” Practice Area.
Last week, in Grabski v. Andreessen (Del. Ch.; 2/24), Chancellor McCormick denied a motion by directors and officers of Coinbase Global to dismiss claims that arose from Coinbase’s 2021 direct listing on Nasdaq. The plaintiff acquired stock in the direct listing and filed suit derivatively, alleging the defendants breached their fiduciary duties by selling $2.9 billion worth of stock in the direct listing based on MNPI and were unjustly enriched by the sales. A month after the listing, the company announced quarterly earnings and a capital raise through a notes offering and the stock price dropped.
Defendants sought to dismiss on the basis that the plaintiff failed to show the directors’ personal interest for demand futility purposes. Chancellor McCormick disagreed. After listing the amounts of sales by the director defendants, she states:
Plaintiff argues that it is reasonably conceivable that this amount of money was material to each Director Defendant such that none could impartially consider a pre-suit litigation demand attacking the sales. Plaintiff need not allege facts concerning each Director Defendant’s personal wealth to support this conclusion—$50 million is presumptively material. […] In the real world, the billions of dollars made by the Director Defendants constitutes a material personal benefit that would render a director incapable of impartially considering a demand attacking those sales. Demand is excused on this basis.
The opinion also found demand to be excused on the basis that the director defendants face a substantial likelihood of liability. The opinion only addresses one of the four categories of information plaintiff claims is MNPI — a 409A valuation approved by the board the same day as the direct listing. As to its materiality, the opinion declines to make any defendant-friendly inferences at the pleadings stage.
The defendants argued against the inference of scienter due to the proportion of their holdings represented by the sales and that they could have made more by selling more stock shortly after the initial sales but chose not to. To this, Chancellor McCormick said, “Plaintiff need not allege that Director Defendants maximized the value gained from their alleged impropriety” to infer scienter at the pleadings stage.
What does this mean for direct listings? The opinion says this:
Although the defendants’ briefs read like a philosophical apology for direct listings, the plaintiff’s claims do not place that relatively nascent transactional structure on the chopping block. Rather, this is yet another instance where a stockholder plaintiff calls on this court to deploy “well-worn fiduciary principles” to a new transactional setting.
