If you attended our 2023 Practical ESG Conference or our 2023 Proxy Disclosure & 20th Annual Executive Compensation Conferences, you heard about two bills passed by California’s legislature in September that together comprise the state’s “Climate Accountability Package.” Here’s an important update that Lawrence shared yesterday with our Practical ESG blog subscribers:
This past Saturday, California Governor Gavin Newsom signed two sweeping climate disclosure bills into law as had been expected: SB253 – the Climate Corporate Data Accountability Act (see a summary here) and SB261 – Greenhouse gases: climate-related financial risk (see a summary here).
In almost identical letters to the state Senate announcing his action on SB253 and SB261, Newsom indicated that he has two significant concerns with the new law:
“… the implementation deadlines in this bill are likely infeasible, and the reporting protocol specified could result in inconsistent reporting across businesses subject to the measure. [Ed. note: Newsom’s comment about the reporting protocol was omitted in the letter on SB261]
Additionally, I am concerned about the overall financial impact of this bill on businesses, so I am instructing CARB [California Air Resources Board] to closely monitor the cost impact as it implements this new bill and to make recommendations to streamline the program.”
SB253 requires regulations to be developed and implemented by CARB, while SB261 is self-implementing with the first report due January 1, 2026. The concerns expressed by Newsom will likely be part of any legal challenge against the new laws. A lawsuit would also impact potential timing of the requirements as courts stay challenged language in situations like this until the suit(s) is/are resolved. The new laws could have an impact on the SEC’s climate disclosure as SEC Chair Gary Gensler hinted at two weeks ago. It’s going to be interesting to see how all the moving parts play out. We’re definitely tracking this from the legal, accounting, assurance and technical perspectives for you.
In March 2023, in the wake of the US Supreme Court decision in Slack Technologies v. Pirani, the Working Group on Investor Protection in Public Offerings, which includes academics, former SEC officials, and legal scholars, submitted a rulemaking petition urging the SEC to amend Rule 144 given the difficulties plaintiffs face in trying to trace their purchases to a registration statement. The petition notes that direct listings aren’t uniquely creating this issue, citing data showing the increasing frequency of lock-up waivers since 2010 — sometimes, even a few days post-IPO — causing tracing issues in the traditional IPO context as well. Here’s an excerpt regarding the proposed amendments:
Specifically, the Commission should amend Rule 144 such that, upon the effectiveness of a registration statement, holding periods are reset to the later of: (1) 90 days or (2) the next 10-Q or 10-K. Our proposed holding period is approximately half the length of the stated lockup period for most traditional IPOs—but gives ample time in which only registered shares trade, addressing the tracing problems modern offering practices have produced and retaining the deterrence that Congress designed Section 11 to achieve. At the same time, under our proposal issuers have the flexibility to effectively shorten the holding period by releasing post-offering financials.
Late last week, CII submitted a letter to the SEC supporting this rulemaking petition, and, while it doesn’t recommend a specific period, states the petition’s suggestion is a “useful starting point” for discussion. The working group argues that the proposed 90-day period balances the liquidity interests of early investors with the interests of public shareholders to maintain Section 11 protections.
In July, Dave blogged about the rise in the number of deficiencies identified in audits during PCAOB inspections in 2021 and 2022. He noted that PCAOB Chair Erica Williams released a statement on the Staff report calling the deficiency rate “unacceptable.” In a speech late last week at the PCAOB Conference on Auditing and Capital Markets, Chair Williams again called out these alarming trends in deficiencies:
This means audit opinions were signed without completing the audit work required to verify the accuracy of the financial statements. That is a serious problem at any rate, and 40% is completely unacceptable. I have challenged auditors to sharpen their focus and called on audit committees to hold their firms accountable. Of course, as our third pillar of strengthening enforcement suggests, the PCAOB has not hesitated to bring enforcement cases against auditors when appropriate.
In addition to discussing enforcement, she highlighted the PCAOB’s efforts to improve the transparency of inspection results:
In May, we announced enhancements to make our inspection reports more transparent with a new section on auditor independence and a range of other improvements to make more relevant, reliable, and useful information available for investors, researchers, and others.
In July, we rolled out new features on our website to help users compare inspection report data.
This was just the beginning of our work to increase transparency and make PCAOB data more accessible.
Transparency is one of the most powerful tools the PCAOB has to improve audit quality. Sharing our inspection results empowers audit committees and boards of directors – which are responsible for hiring auditors of public companies – to hold audit firms accountable directly.
So audit committees will soon have more information on their independent auditor’s performance. Dave’s blog noted questions audit committees should consider asking their independent auditors regarding inspection results, including whether the engagement partner has been inspected and what the firm is doing to address the increasing number of deficiencies.
Check out John’s latest “Timely Takes” Podcast featuring Orrick’s J.T. Ho. John and J.T. address these complex topics in 13 minutes:
– The EU’s Corporate Reporting Sustainability Directive
– Corp Fin’s New 10b5-1 and Buybacks CDIs
– Changes to Nasdaq’s listing rules on code of conduct waivers
– Claims that litigation is “without merit” can come back to bite you
– The SEC’s recent Form 12b-25 enforcement actions
As always, if you have insights on a securities law, capital markets or corporate governance issue, trend or development that you’d like to share in a podcast, we’d love to hear from you. You can email us at mervine@ccrcorp.com or john@thecorporatecounsel.net.
With all the new rules and their associated compliance & effective dates, it is getting difficult to keep track of what will need to change in your next Form 10-K. This memo from Bryan Cave Leighton Paisner is a helpful resource for doing that, with summaries for each of these new 10-K/proxy statement disclosures:
1. Annual cybersecurity disclosures
2. 10b5-1 plan quarterly disclosures
3. Clawback policy and disclosures
4. Share repurchase disclosures
The memo also runs through other “hot topics” that may warrant extra attention as you prepare your reports. And, it looks ahead to additional items that will be required in 2025! Also check out Meredith’s blog from earlier this week on our Proxy Season Blog about potential D&O questionnaire updates (visit our “D&O Questionnaire” Practice Area for our handbook, memos, and samples).
Earlier this week, I jokingly referenced the Commission’s “customary year-end enforcement spree” – a reliable addition to the government’s bottom line. On the final business day this year, the SEC raked in $218 million in fines!
New research in the Journal of Accounting & Economics looks at 20 years of data to figure out whether the “September Spike” is really a thing – and if so, whether it can be explained away by market or other factors. Here’s an excerpt about the case volume at the SEC’s FYE:
We find that the average number of cases (of any category) filed in September is almost double the average in other months, and that the median percentage of total annual cases filed in September is 16%. We refer to higher case volume in September relative to other months as the “September spike” and document variation in the size of this spike across time.
Our results are consistent with trends described in the financial press and examined by legal scholars. The Wall Street Journal, for example, reported an uptick in case volume in September 2013 (Eaglesham, 2013b), and subsequent legal research has shown similar upticks over longer sample periods (Velikonja, 2017; Choi, 2020). We extend the descriptive and graphical evidence in these articles by showing that the September spike is robust to controlling for various factors that may influence case volume, such as trailing securities class actions, SEC investigations, and other market factors.
The researchers found that the spike is larger when case totals are lagging the prior year, and smaller when the Chair is in their first year in office. It’s also larger when the SEC’s spending exceeds its budget authority and when the Enforcement Division has more resources. Does it matter? The authors suggest that in “high-spike” years, the resolutions of complex and possibly egregious cases are getting kicked down the road:
Regarding case selection, we create measures of case complexity and find that SEC staff prioritize less complex cases at fiscal year-end. Specifically, the standalone cases filed in September are significantly more likely to reference defendant cooperation and to only name companies as defendants, and are less likely to include a fraud allegation and to reference parallel criminal proceedings. For instance, September cases are approximately 11% less likely to include fraud allegations than cases filed in other months.
The annual year-end pressure might also give companies more leverage for settlements:
We find that defendants receive lower financial sanctions—both disgorgement and civil penalties—when they settle in September. On average, our results suggest the SEC discounts financial sanctions for cases filed as settled charges in September by approximately $132,000—an economically meaningful discount, given that the average financial sanction is $270,000. We also find an 11% lower likelihood of a large financial sanction in September.
As far as whether companies need to be on their best behavior in September, a graph on pg. 45 shows that the number of investigations remains steady year-round. Fiscal year end is just a good time to negotiate a settlement.
Speaking of disclosures to watch in your upcoming reports, we’ve posted the transcript for our recent “Corporate DEI Programs After Students for Fair Admissions v. Harvard” webcast featuring J.T. Ho, Partner at Orrick, Ngozi Okeh, DEI Editor of PracticalESG.com, and Travis Sumter, Labor & Employment Attorney at NextRoll. Our panelists offered their insights about how to navigate the increasingly complex surroundings in which corporate DEI programs operate.
The webcast covered:
– Overview of the Students for Fair Admissions v. Harvard Decision
– Legal Framework Governing Corporate DEI
– Potential Vulnerabilities of Corporate DEI Programs
– Mitigating DEI Legal Risks
– Dealing With Pro- and Anti-DEI Activism
This was a joint webcast with PracticalESG.com. If you are not a member of TheCorporateCounsel.net or PracticalESG.com, email sales@ccrcorp.com to sign up today and get access to the full transcript – or sign up online.
Programming note: In observance of the federal holiday on Monday, we will not be publishing a blog. We will be back on Tuesday!
This HLS blog details recent CEO succession trends among the Russell 3000 and S&P 500 – with data & analysis from The Conference Board, Heidrick & Struggles, and ESGAUGE. Here’s one trend that jumped out:
The rate of inside promotions to the CEO position in the Russell 3000 increased from the prior years, reaching 73.5 percent of incoming CEOs in 2022—the highest since The Conference Board and ESGAUGE began tracking these statistics. In the S&P 500, the rate of inside promotions is projected at 84.6 percent for 2023, one of the highest ever recorded and higher than the historical average (78.8 percent since 2011). In 2022, Real Estate, Utilities, and Financial companies reported the highest rate of internal promotions to the EO role (93.3 percent, 91.7 percent, and 86 percent, respectively), while Communication Services companies had the highest percentage of outside CEO hires (64.3 percent).
What’s more, companies aren’t just promoting internal executives, they are awarding the golden ticket a few years sooner than has been the case historically:
While a critical source of CEO talent continues to be long-serving executives promoted from within, data suggests that after the pandemic, boards fast-tracked inside promotions to the chief executive post. As of the end of 2022, the average tenure-in-company of internally promoted CEOs was 12 years in the S&P 500 and 10 years in the Russell 3000, lower than the historical averages of 16 years and 11 years, respectively. The share of “seasoned executives”—or those with at least 20 years of company service—was also lower than the historical averages (17.3 percent in the S&P 500, compared to a 32.2 percent 5-year average; and 15.0 percent in the Russell 3000, down from a 17.8 percent historical average).
The blog points out that there’s significant variance across industries but says the data could suggest changing perceptions of leadership. Specifically, boards might be embracing new leadership traits around innovation & adaptability. Lastly, the more rapid ascent of executives makes leadership development even more important. The blog gives these final thoughts:
The decline of tenure-in-company and “seasoned executives” in a year where the overall rate of CEO succession increased may also suggest that companies accelerated their leadership development process to expand their pool of CEO candidates. To help mitigate human capital risks, the entire board should review, at least annually, the leadership development process within their companies and scrutinize internal succession candidate lists.
A fun project that often accompanies board meeting preparation is “benchmarking.” This used to mean combing through peer SEC filings to find information from other companies on whatever specific data point your boss or the board had inquired about. If you were lucky, secondary commentary would exist and give you a starting point. Good news! While peer disclosures & trend summaries absolutely remain valuable as sources for context and analysis, there are new tools these days to add to your toolbox.
Here’s a handy dashboard from The Conference Board, ESGAUGE, and Heidrick & Struggles that is updated weekly with info on CEO succession announcements in the Russell 3000 and S&P 500. I’ve also recently been using these dashboards to track trends on compensation, board practices, shareholder proposals, and ESG. You can filter by index, company size, and business sector – and browse data about:
1. Succession Rates – generally, across performance quartiles, across age groups, and share of forced successions
2. CEO Profile – various demographic categories and tenure
3. Departing CEOs – similar demographic categories, tenure, reasons for departure, and number of forced CEO departures (and why)
4. Incoming CEOs – demographics
5. Placement Types & Other Practices – inside appointments, non-executive directors appointed as CEOs, interim CEOs, practices for announcement & effectiveness dates, outside hires, and more
Here’s a topic of interest that John blogged about last week on DealLawyers.com (visit that site for seasoned perspectives and practical guidance on all things deal-related):
One of the issues under Delaware law that has generated some uncertainty over the years is the extent to which the DGCL permits a corporation to create a mechanism in which shares of the same class differ in their share-based voting power depending on who holds them. Vice Chancellor Laster’s recent decision in Colon v. Bumble, (Del. Ch.; 9/23), may go a long way toward resolving that uncertainty.
Delaware courts have permitted tenure voting arrangements, in which the voting rights of holders of the same class vary depending on how long they’ve held the shares, and other limitations, such as per capita regimes, that limit a stockholder’s voting rights based on the number of shares owned, but in Colon v. Bumble, Vice Chancellor Laster addressed a situation in which the voting rights of particular shares expressly depended on the identity of their owner.
In order to facilitate its IPO, Bumble installed an “Up-C” structure, which resulted in a hybrid entity in which public stockholders’ enjoyed voting & economic rights through ownership of Class A shares, while pre-IPO insiders enjoyed voting rights through ownership of Class B shares and economic rights through the ownership of their pre-IPO LLC units, each of which were convertible, when accompanied by a Class B share, into shares of Class A Common Stock.
Bumble’s charter provides that each share of Class A Common Stock is entitled to one vote, unless that share is held by one of the company’s “Principal Stockholders,” in which case it is entitled to ten votes. The charter defines the term Principal Stockholders to include the two insiders who were party to a pre-existing stockholders’ agreement with the company. It also authorized a class of Class B Common Stock, which was issued exclusively to the company’s Principal Stockholders. Each share of Class B stock is entitled to a number of votes equal to the number of Class A shares that the holder would receive if all of its units in were converted into Class B shares at the Exchange Rate and with a Principal Stockholder receiving ten votes per Class A share.
The plaintiffs contended that the disparate voting rights enjoyed by the Principal Stockholders under this structure were invalid under Delaware law because those rights depended on the identity of the stockholder. In response, Vice Chancellor Laster conducted a detailed and thoughtful analysis of both the relevant statutory provisions and case law, and concluded that the disparate voting rights were valid:
As required by Sections 102(a)(4) and 151(a), the charter sets out a formula that applies to all the shares in the class and that specifies how voting power is calculated. As authorized by Section 151(a), the formula makes the quantum of voting power that a share carries dependent on a fact ascertainable outside of the certificate of incorporation, namely the identity of the owner. The Class A formula is a simple one. If a Class A share is held by a Principal Stockholder, then it carries ten votes per share. If not, then a Class A share carries one vote per share.
The Class B formula is complex but reaches the same result. As long as a Class B share is held by a Principal Stockholder, then it carries ten votes per share for each Class A share that it could convert into. If the Class B share is not held by a Principal Stockholder, then then it carries one vote per share for each Class A share that it could convert into.
Under Providence, Williams, and Sagusa, having the level of voting power turn on the identity of the owner is permissible. To apply the formulas in Providence, Williams, and Sagusa, the corporation had to determine which stockholder owned the share. True, the processes also had to take into account another attribute. In Providence and Sagusa, it was how many other shares the owner held. In Williams, it was when the owner acquired the share. But the starting point in each mechanism was the identity of the owner. That is the same mechanism that the Challenged Provisions use.
From my perspective, this is a very impressive opinion, and one that any lawyer called upon to draft charter documents will want to keep in mind. Vice Chancellor Laster provides a comprehensive seminar on Delaware statutory law and judicial opinions addressing the special attributes and limitations with respect to shares that Delaware corporations may establish in their charter documents. Most impressively, he accomplishes this in an opinion that’s less than 35 pages long. That’s practically a text message by the Vice Chancellor’s standards.
Check out this blog from Keith Bishop for a discussion of how California law addresses the issue of disparate voting rights based on the identity of the stockholder.
