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.”
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
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.
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.
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.
Tomorrow marks the twentieth anniversary of the September 11, 2001 terrorist attacks on the United States. It is hard to believe that twenty years have passed since that terrible day. I can still remember that morning so vividly – the sky was a crisp blue, the temperature was just right for a post-Labor Day morning and everyone was busy getting back into the swing of work after the end of the summer season.
I was in my office on the phone with a client when American Airlines Flight 11 crashed into the North Tower of the World Trade Center, and so I did not immediately know what was happening. My mother called while I was on the line and my assistant sent her to my voicemail – she was concerned because at the time I regularly traveled to New York and she wanted to see if I was OK. When I emerged from my office after the call, a group had gathered around a television to watch the events unfold, and it was then that we all watched in horror as United Airlines Flight 175 crashed into the South Tower. Having vividly remembered the 1993 World Trade Center attack, it was clear to me at that moment that this was no accident.
Within the hour, word came that American Airlines Flight 77 had crashed into the Pentagon, and the call was made to evacuate the building. At the time, I was working in the tallest office tower in Baltimore, and there was a concern that attacks could be unfolding in cities up and down the east coast. I distinctly remember exiting the fire stairs into a world that was transformed – the traffic was gridlocked as panicked office workers fled the city, cell phones did not work because the network was overwhelmed and there was a constant threat of the invisible enemy that could fall out of the sky at any moment.
After a taking circuitous route home, I was so relieved to be reunited with my family, but devastated to hear about the horrific loss of life that was unfolding as the Twin Towers fell, the Pentagon burned and United Airlines Flight 93 crashed in Pennsylvania. It was – and still is today – unthinkable that this despicable act of evil could be carried out against so many people who were simply trying to go about their lives and do their jobs.
We must always remember those who lost their lives on that day, and to this day – the flight crews, the passengers, the office workers, the incredibly brave first responders and many others who stepped in to help on the day of the attack and in the months after, as well as the members of our military who were killed or injured fighting the war on terror which followed that tragic day.
Please take a moment tomorrow to reflect on what it was like on that day twenty years ago, and please remember the fallen. I think that is the best way that we can all honor their sacrifice and secure their legacy.
I know my friends at the SEC had similar experiences on September 11, 2001. They were getting their work day started when the news of the crash of American Airlines Flight 11 broke, and when it became clear that New York and Washington were under attack, the agency evacuated the old office building at 450 Fifth Street and the staffers began a long trek home in a city that was in complete lockdown.
The New York attacks struck at the heart of the financial district, and so many financial firms were located in the Twin Towers and surrounding buildings that were impacted by the attack. As noted in this press release from then SEC Chair Harvey Pitt, the markets did not open for trading in New York on September 11. In fact, the devastation was so great that markets would not open again until the following Monday, September 17. As noted in this press release, the SEC took bold steps and used, for the first time, its emergency powers to ease certain regulatory restrictions so that the markets could open in an orderly manner. Amazingly, the markets did reopen thanks to the hard work of the SEC staff, the exchanges and all of the financial firms who pulled together in their darkest hour to show the world that the United States would not be defeated by terror. We should remember their efforts as one of the many ways the United States came together to demonstrate our strength and resilience in the face of these attacks.
The July-August issue of The Corporate Executive has been sent to the printer (sign up and order this essential resource today). It’s also available now online to members of TheCorporateCounsel.net who subscribe to the electronic format – an option that many people are taking advantage of in the “remote work” environment. In this issue, I am pleased to bring you articles on preparing for employee activism, the potential issues that could be addressed in a Rule 10b5-1 rulemaking and our compliance guide for the Nasdaq’s new diversity listing requirements.
As we roll into (and through) September, the attention of some non-listed issuers will inevitably turn to an impending SEC rule change that could cause the quotation of their securities in the over-the-counter markets to abruptly cease. Back in September 2020, the SEC adopted a number of amendments to Rule 15c2-11 that the Commission believed were necessary to protect investors in securities that are traded over-the-counter, and compliance with the amendments must generally be achieved by September 28, 2021. As this Baker & Hostetler memo notes:
The Amendment adds additional investor protections by mandating that investors have access to the current and publicly available information of issuers whose securities trade on the OTC markets, and it further requires broker-dealers to confirm that certain information about the issuer and its security is current and publicly available before quoting that security.
As amended, Rule 15c2-11 provides a broker-dealer with two ways to satisfy this obligation: (i) independently obtaining such information from issuers (or their agents) and reviewing it for material accuracy and reliability or (ii) relying on a publicly available determination by a qualified interdealer quotation system (an “IDQS”). OTC Link LLC (which is owned by OTC Markets Group, Inc., formerly known as Pink OTC Markets Inc.) is an IDQS, and the old OTC Bulletin Board (which is a facility of FINRA) is an IDQS (FINRA filed with the SEC to shutter the OTCBB back in September 2020, after the SEC adopted the Rule 15c2-11 amendments.
For the so-called “catch-all issuers” that are not subject to disclosure and reporting requirements under the federal securities laws, broker-dealers and the IDQSs will have to review an expanded list of financial and nonfinancial information about the catch-all issuers that is likely difficult for many such issuers to provide. Further, Rule 15c2-11 requires broker-dealers to be able to provide such information upon the request of any person who expresses an interest in a proposed transaction in the issuer’s security with the broker-dealer. SEC-reporting issuers that are delinquent in their filing obligations (and therefore without current, publicly available information) are also treated as catch-all issuers, but only for purposes of initiating or resuming a quoted market in such issuers’ securities.
With the compliance date of the rule fast approaching, catch-all issuers without current and publicly available information that broker-dealers and the IDQSs can review will find themselves in a position of no longer being quoted in the over-the-counter markets (unless some exception to Rule 15c2-11 applies), and the investors in such issuers will be in for a rude awakening when they are unable to get quotes such issuers’ securities.
Following adoption of the Rule 15c2-11 amendments, OTC Link LLC — responding to suggestions made by the Commission itself that a so-called “expert market” could “enhance liquidity for sophisticated or professional investors in grey market securities” — submitted a request on behalf of certain broker-dealers for an exemption from certain of Rule 15c2-11’s requirements for quotations made on electronic platforms where the distribution of such quotations is limited to sophisticated or professional investors. In December 2020, the SEC proposed to grant OTC Link LLC’s request for exemptive relief and issue a conditional exemptive order, and solicited public comment on that proposal.
The hopes for an expert market alternative were dashed last month, when the staff of the Division of Trading & Markets put out a statement which said:
This proposed order is not on the Chair’s agenda in the short term. Accordingly, on September 28, 2021, the compliance date for the amendments to Rule 15c2-11, we expect that broker-dealers will no longer be able to publish proprietary quotations for the securities of any issuer for which there is no current and publicly available information, unless an existing exception to Rule 15c2-11 applies.
Without the expert market alternative available, those issuers who fall into the category of “OTC Pink – No Information” (i.e., those issuers who cannot or will not provide current and publicly available information) will fall off the Rule 15c2-11 cliff later this month, with nowhere to land.
The present day electronic platform for over-the-counter stock quotations operated by OTC Link had its origins back in the early 1900s, when the National Quotation Bureau printed a weekly inter-dealer quotation service on pink paper. This paper publication continued through the years until the late 1990s, when an electronic quotation service was launched. I can still remember looking at the actual pink sheets, because the SEC subscribed to the service back in the day. It is hard to believe in today’s environment, where traders seek to exploit information imbalances lasting milliseconds, that there was actually a time when broker-dealers would wait a week for updated bid and ask quotes on over-the-counter securities!
