Last week, the SEC announced several enforcement actions as it wrapped up its fiscal year – here’s John’s blog about an alleged MD&A “Known Trends” violation. Earlier though, another SEC enforcement settlement slipped under the radar – in which the SEC alleged that a Nasdaq-traded company in the business of “live-adult entertainment clubs” and “military-themed Bombshells restaurants” failed to disclose a variety of perks and related party transactions and that a former director failed to disclose personal bankruptcies.
With the mix of allegations, the action provides a good case study on disclosure controls & procedures – and the SEC Enforcement folks took care to lay out in striking tables the value of perks allegedly received by execs versus what the company had disclosed in its proxy statements, including a Valentine’s Day trip by the CEO’s girlfriend to meet him when he was away on business. The press release summarizes the actions, and the 11-page order provides more color:
From FY 2014 through FY 2019, RCI failed to disclose a total of $615,000 in executive compensation in the form of perquisites. According to the order, these undisclosed perquisites included the cost of the personal use of the company’s aircraft and company provided vehicles, reimbursement for personal airline flights, charitable corporate contributions to the school two of the CEO’s children attended, and housing costs and a meals allowance for the CFO. In addition, the order finds that RCI failed to disclose related party transactions involving the CEO’s father and brother and a director’s brother. The order further finds that RCI failed to keep books and records that allowed it to report, and lacked sufficient internal controls concerning, these executive perquisites and related party transactions.
The former director served on the company’s audit committee and had filed two personal federal bankruptcy petitions that he failed to disclose to the company. The order involving the former director states that he also served as the audit committee financial expert and that he didn’t disclose the bankruptcy filings due to embarrassment and he didn’t want to embarrass the company. Once the company learned of the bankruptcy filings, the company asked him to step down from the board.
Without admitting or denying the SEC’s findings, RCI, the CEO and CFO consented to a cease & desist order and agreed to pay civil penalties in the amounts of $400,000, $200,000, and $35,000, respectively. With regard to the former director, he also consented to a cease-and-desist order and to pay a $30,000 civil penalty. The former director further agreed to be suspended from appearing or practicing before the SEC as an accountant, with the right to apply for reinstatement after three years.
These cases provide a good synopsis of how important it is to have internal controls and checks & balances in place. The SEC’s order sheds light on RCI’s internal control issues – for instance, the company identified personal use of company aircraft as a tax issue by reporting income on the executives’ W-2 forms but then didn’t disclose the value of personal aircraft use in the company’s SEC filings. In another instance, the company didn’t properly account for the full value of automobile perquisites because the value disclosed only included depreciation amounts as incremental costs and didn’t include other costs such as fuel, maintenance, registration and insurance. And as this excerpt shows, the company took the inadvisable approach of relying on personal judgment when it came to reimbursement requests:
The company did not have internal controls or policies and procedures concerning expense reimbursement requests approvals because management never got down to that specific detail. In the absence of expense reimbursement controls, persons approving reimbursement requests would use their “judgment,” resulting in undisclosed compensation to officers.
Here’s an entry I blogged about last week on CompensationStandards.com: The SEC’s Division of Enforcement announced another perquisites enforcement action. The latest action involves Hilton Worldwide Holdings and is the second third perks-related enforcement action in just the last few months. We list perks cases in our CompensationStandards.com “Perks” Practice Area and you can see they aren’t too frequent – so to see two three in just the last few months is surprising.
The SEC’s order provides some of the details and says the company failed to disclose $1.7 million worth of travel-related benefits to its CEO and NEOs.
Items that Hilton incorrectly viewed as business expenses and paid for on behalf of its Named Executive Officers, but did not disclose, include, in the case of the CEO, expenses associated with personal use of corporate aircraft, and in the case of Named Executive Officers, expenses associated with hotel stays, as well as taxes related to such items. As a result, Hilton understated “All Other Compensation” portion of its Named Executive Officers’ compensation by an annual average of approximately $425,000 in the company’s 2016 – 2019 proxy statements.
According to the SEC’s order, Hilton’s system for identifying, tracking and calculating perquisites incorrectly applied a standard whereby a business purpose would be sufficient to determine that certain items were not perquisites or personal benefits that required disclosure.
The SEC’s order acknowledges that Hilton took prompt remedial acts and cooperated with the Commission:
Among other things, the order says after receipt of a written document and information request from the Commission staff, Hilton conducted an internal review of its perquisite disclosures and its system for identifying, tracking and calculating perquisites. On April 24, 2020, Hilton filed a definitive proxy statement, which, among other things, provided revised disclosures regarding perquisites and personal benefits provided to its CEO in 2017 and 2018 and to other Named Executive Officers for the same time period.
Without admitting or denying the SEC’s findings, Hilton consented to the SEC’s cease-and-desist order, which requires Hilton to pay a $600,000 civil penalty.
Perks can be tricky – to help guard against this type of action, we have a 102-page chapter on Perks & Other Personal Benefits as part of Lynn & Borges’ “Executive Compensation Disclosure Treatise” posted on CompensationStandards.com. Also, if you missed the perks session at our “2020 Proxy Disclosure” and “17th Annual Executive Compensation” conferences, you can access the video archives or if you didn’t register to attend, you can register now to watch any and all sessions.
Transcript: “Non-GAAP Measures & Metrics: Where Are We Now?”
We’ve posted the transcript for our recent webcast: “Non-GAAP Measures & Metrics: Where Are We Now?” – it covered these topics:
– Background to SEC’s 2020 MD&A Guidance
– Operating Metrics vs. Non-GAAP Financial Measures
– Presenting the Impact of COVID-19: Acceptable & Unacceptable Adjustments
Yesterday, the SEC scheduled an open meeting for Wednesday, October 7th. The topic is one that’s likely to be of interest to anyone involved with small cap companies – a proposal to provide some relief from broker-dealer registration for “finders” involved in capital raising. Here’s an excerpt from the Sunshine Act notice:
The Commission will consider whether to issue a Notice, proposing to grant a conditional exemption, pursuant to Sections 15(a)(2) and 36(a)(1) of the Securities Exchange Act of 1934 (“Exchange Act”), from the broker registration requirements of Section 15(a) of the Exchange Act to permit natural persons to engage in certain limited activities on behalf of issuers, subject to conditions. The Commission would solicit comment on the proposed exemption, which seeks to assist small businesses in raising capital and provide regulatory clarity.
Specifically, observers have noted that small businesses frequently encounter challenges connecting with investors in the exempt market, particularly in regions that lack robust capital raising networks. So-called “finders,” who may identify and in certain circumstances solicit potential investors, often play an important and discrete role in bridging the gap between small businesses that need capital and investors who are interested in supporting emerging enterprises.
The securities laws don’t define the term “finder,” and the SEC’s guidance on distinguishing between a finder and a person who should be registered as a broker-dealer has been provided informally, through various no-action letters and other guidance. Action by the SEC in this area would finally address one of the key recommendations in the final report that the SEC’s Advisory Committee on Small and Emerging Companies issued more than three years ago. As noted in that report, the SEC’s current approach has resulted in “significant uncertainty” in the marketplace about what activities a finder may engage in without registering under the Exchange Act as a broker-dealer.
Some sort of formal relief for finders would also come as welcome news for many small companies that need capital, but whose financings aren’t large enough to attract interest from traditional investment banks. Finders address this market need, but the ground rules under which they may lawfully assist a company in raising capital are both restrictive and opaque. As the Advisory Committee’s final report observed, this has put companies seeking to comply with the rules in a situation where they “find it hard to determine under what circumstances they can engage a “finder” or online platform that is not registered as a broker-dealer.”
Stock Exchanges: Long-Term Stock Exchange Debuts
We’ve previously blogged about efforts to get the LTSE off the ground – and earlier this month, they culminated with the official opening of the exchange. Here’s an excerpt from the LTSE’s press release announcing its debut:
The Long-Term Stock Exchange (LTSE), the only national securities exchange built to serve companies and investors who share a long-term vision, has opened for business. The exchange went live on Wednesday with the trading of all U.S. exchange-listed securities and a mission to offer companies in every industry a public-market option designed to sustain long-term growth. To list their shares on the exchange, companies are required to publish and maintain a series of policies that are designed to provide shareholders and other stakeholders with insight into their long-term strategies, practices, plans and measures.
The policies are based on five underlying principles, which hold that long term-focused companies consider a broad group of stakeholders, measure success in years and decades, align compensation of executives and directors with long-term performance, engage directors in long-term strategy (and grant them explicit oversight of this strategy), and engage long-term shareholders.
This Davis Polk blog has additional information on the LTSE, including the fact although no companies are yet listed on the exchange, it “allows shares of companies, regardless of whether they are listed on the LTSE or another exchange, to trade simultaneously and in real time across all U.S. exchanges, alternative trading systems and platforms operated by securities dealers.”
This market status information from the NYSE suggests that the LTSE has gotten off to a bit of a bumpy start when it comes to its trading activities, but this PitchBook article highlights the exchange’s big plans to develop an alternative market for IPO companies.
Peak SPAC? Playboy Enterprises to Go Public Through Reverse Merger
When I was in college, I won a raffle in which my prize was a “key” to the luxurious Buffalo Playboy Club. Quite a score, eh? I’m a big fan of Buffalo, but I must admit that this prize was even less impressive than it sounds to those of you who aren’t familiar with the city.
The original Playboy Club was located on the “Magnificent Mile” in Chicago, but this one was located across from the Buffalo airport in Cheektowaga, NY. Still, the college kid version of me was pretty impressed with the idea of having a key to any Playboy Club, even if I was too chicken to ever pay the club a visit.
Anyway, that’s kind of a rambling introduction to the news I wanted to share with you today – according to this article from TheStreet.com, Playboy Enterprises is re-entering the public market by way of a reverse merger with a SPAC:
Playboy is joining the super-hot special acquisition company club, with official plans to go public in a SPAC deal that values the storied brand at $415 million, the company said Thursday. The SPAC deal, which will make the iconic adult-entertainment brand public for the second time in its history, involves being acquired by a blank-check firm, in this case Mountain Crest Acquisition Corp. (MCAC) , which was set up earlier this year and trades on the Nasdaq exchange.
I’m not sure about this one. Putting aside the company’s extended decline prior to its 2011 take-private deal & the recent demise of the print version of its magazine (which I only ever read for the articles anyway), the Playboy brand & legacy just don’t seem in-tune with the current zeitgeist.
In the company’s defense, it has reinvented itself as a “lifestyle brand” and has apparently built a $3 billion business, so maybe its return to the public market will have a happy ending. Still, there are a lot of SPACs chasing deals right now, and I wouldn’t be shocked if we looked back on this one as signifying the moment when the SPAC craze jumped the shark.
The last day of the SEC’s fiscal year included the announcement of a settled enforcement proceeding against HP, Inc. Among other things, the proceeding involved HP’s alleged failure to comply with Item 303’s “known trends” disclosure requirement regarding the implications of certain sales practices. This excerpt from the SEC’s press release summarizes the agency’s allegations:
According to the SEC’s order, from early 2015 through the middle of 2016, in an effort to meet quarterly sales targets, regional managers at HP used a variety of incentives to accelerate, or “pull-in” to the current quarter, sales of printing supplies that they otherwise expected to materialize in later quarters. The order further finds that, in an effort to meet revenue and earnings targets, managers in one HP region sold printing supplies at substantial discounts to resellers known to sell HP products outside of the resellers’ designated territories, in violation of HP policy and distributor agreements.
The order finds that HP failed to disclose known trends and uncertainties associated with these sales practices. The order further finds that HP failed to disclose that its internal channel inventory ranges, which it described in quarterly earnings calls, included only channel inventory held by channel partners to which HP sold directly and not by channel partners further down the distribution chain, thereby disclosing only a partial and incomplete picture of HP’s channel health.
The HP proceeding is the second enforcement action involving trend disclosure that the SEC has brought against a major public company this year. This excerpt from the SEC’s order summarizes the company’s alleged shortcomings:
In its 2015 Form 10-K, HP failed to disclose the known trend of increased quarter-end discounting leading to margin erosion and an increase in channel inventory, and the unfavorable impact that the trend would have on HP’s sales and income from continuing operations, causing HP’s reported results to not necessarily be indicative of its future operating results. The failure to disclose that material trend caused HP’s 2015 Form 10-K to be materially misleading.
The SEC’s order also focused on HP’s disclosure controls & procedures, and alleged that the company’s disclosure process “lacked sufficient interaction with operational personnel who reasonably would have been expected to recognize that the known trends” attributable to these discounting practices. Without admitting or denying the SEC’s findings, HP consented to a cease & desist order and agreed to pay a $6 million penalty.
NYSE Again Extends Temporary Shareholder Approval Relief
In April 2020, the NYSE adopted a temporary rule easing the shareholder approval requirements applicable to listed companies looking to raise private capital during the Covid-19 crisis. That temporary rule, which was originally set to expire at the end of June, was extended through the end of September. Earlier this week, the SEC approved the NYSE application to extend it again.
In case you’ve forgotten what the temporary rule is all about, here’s an excerpt from this Wilson Sonsini memo on the latest extension:
Generally, Section 312.03 of the NYSE Listed Company Manual requires listed companies to obtain shareholder approval prior to the issuance of common stock, or securities convertible into or exercisable for common stock, in certain circumstances. This temporary relief provides for a waiver, subject to the satisfaction of several conditions, from certain of the limitations and approval requirements set forth in Section 312.03 of the NYSE Limited Company Manual, including relating to (1) private placements involving 20 percent or more of a company’s outstanding shares of common stock or voting power at a price that is lower than the “minimum price” and (2) related party transactions.
The temporary rule is now scheduled to expire on December 31, 2020. However, since there’s a good chance that either a plague of locusts will descend upon us or the sea will turn to blood before then, my guess is another extension may be on the horizon.
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Earlier this week, the SEC announced settled enforcement proceedings against Fiat-Chrysler arising out of allegedly misleading disclosures about its compliance with emissions standards. Here’s an excerpt from the SEC’s press release:
The SEC’s order found that in February 2016, FCA represented in both a press release and an annual report that it conducted an internal audit which confirmed that FCA’s vehicles complied with environmental regulations concerning emissions. As found in the order, FCA’s statements did not sufficiently disclose the limited scope of its internal audit, which focused only on finding a specific type of defeat device, or that the audit was not a comprehensive review of FCA’s compliance with U.S. emissions regulations. In addition, at the time FCA made these statements, engineers at the U.S. Environmental Protection Agency (EPA) and California Air Resource Board (CARB) had raised concerns to FCA about the emissions systems in certain of its diesel vehicles.
Under the terms of the SEC’s order, Fiat-Chrysler consented to a cease & desist order enjoining it from committing or causing future violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-16 thereunder. The company also agreed to a $9.5 million civil monetary penalty.
The announcement of this proceeding follows on the heels of a significant setback in the SEC’s enforcement action against Volkswagen arising out of that company’s use of a “defeat device” to thwart emissions tests. As discussed in this Mintz memo, a California federal court recently dismissed a significant portion of the SEC’s securities claims against Volkswagen on the grounds that they were previously released by the DOJ.
I’m inclined to be a little more forgiving toward Fiat-Chrysler than I am toward Volkswagen. Sure, this conduct seems to be less egregious, but the real reason is that I have a sentimental attachment to the company. My first car was a 1972 Dodge Polara, and my current dream car is an Alpha-Romeo Stelvio Quadrifoglio – both of which are currently under the Fiat-Chrysler corporate umbrella. Of course, in the real world I still drive a 2012 Equinox that eats oil and has a broken tail light that I busted when I accidentally hit it with a garbage can I was dragging in from the curb a few months ago.
By the way, if it seems like there are more high-profile enforcement actions this week than usual, don’t forget that the SEC’s fiscal year ends today, so Enforcement needs to put cases to bed now if they’re going to count in this year’s stats.
Board Diversity: The Impact of Geography
Improved oversight and risk management are some of the advantages often associated with board gender diversity. However, a recent study suggests that the advantage that boards with female directors have when it comes to improved oversight doesn’t derive from the gender of those directors, but from their location.
The study says that what makes the difference is that fact that female directors are generally more geographically distant from the companies that they serve than their male counterparts. According to the study, this makes them more reliant on hard data and less reliant on things like CEO schmoozing when it comes to making tough decisions. Here’s the abstract:
Using data on residential addresses for over 4,000 directors of S&P 1500 firms, we document that female directors cluster in large metropolitan areas and tend to live much farther away from headquarters compared to their male counterparts. We also reexamine prior findings in the literature on how boardroom gender diversity affects key board decisions.
We use data on direct airline flights between U.S. locations to carry out an instrumental variables approach that exploits plausibly exogenous variation in both gender diversity and geographic distance. The results show that the effects of boardroom gender diversity on CEO compensation and CEO dismissal decisions found in the prior literature largely disappear when we account for geographic distance.
Overall, our results support the view that gender-diverse boards are “tougher monitors” not because of gender differences per se, but rather because they are more geographically remote from headquarters and hence more reliant on hard information such as stock prices.
Check out this episode of the @DenselySpeaking podcast, in which Greg Shill leads a discussion with one of the study’s authors about its implications and some of the other ways geography influences governance. I’ve never really considered the impact of geography on corporate governance, but the discussion makes an interesting case for the idea that geographic considerations can play a big role in a wide range of governance concerns.
ICFR: Newly Public Companies & Material Weaknesses
This Audit Analytics blog takes a look at how newly public companies have fared when it comes to internal control over financial reporting. This excerpt summarizes the results of its analysis:
To get a sense of how prepared new IPOs are in terms of ICFR, this analysis looks at the effectiveness of controls as disclosed by SEC registrants in the first management report on ICFR after the IPO year. The amount of reports disclosing ineffective ICFR after an IPO has increased from 12% in 2010 to 21% in 2018, with a high point of 24% in 2016.
As an important note, 2019 is excluded from the above longitudinal analysis on ineffective ICFR after an IPO due to incomplete data; less than 20% of IPOs conducted in 2019 have subsequently filed a management’s report on ICFR. However, based on the reports currently available, 39% have disclosed a weakness in internal controls.
For comparative purposes, a 2019 study referenced in this FEI blog found that 23% of all SEC filers reported a material weakness in 2018. However you slice it though, the trend line for new public companies is not good – and remember, most IPO companies aren’t required to have their auditors vouch for management’s assessment of ICFR.
Ernst & Young recently issued its annual review of Staff comment letters. The number of comment letters issued during the year ended June 30, 2020 declined by 15% over the prior year. That represents the continuation of a four-year trend that has seen the number of comment letters decline by nearly 2/3rds since 2016.
EY attributes the decline to the Staff’s continued use of a “risk-based” approach to the review process, which involves concentrating on larger filers and reviewing their filings more frequently. Here’s a list of the 10 topics that were most frequently the subject of SEC comments:
1. Non-GAAP financial measures
2. Management’s discussion and analysis
3. Revenue recognition
4. Segment reporting
5. Fair value measurements
6. Intangible assets and goodwill
7. Contingencies
8. Inventory and cost of sales
9. Income taxes
10. Signatures/exhibits/agreements
The list is pretty similar to last year’s, although revenue recognition comments led the way in 2019. Contingencies and inventory & cost of sales were the only additions to this year’s top 10 list, while comments on state sponsors of terrorism and acquisitions and business combinations failed to make the cut this year.
SEC Enforcement: “EPS Initiative” Snares First Two Companies
Corp Fin isn’t the only SEC division that takes a risk-based approach to its work. Yesterday, the Division of Enforcement announced settled enforcement proceedings against two companies for allegedly manipulating their reported earnings per share. Here’s an excerpt from the SEC’s press release announcing the proceedings:
The Securities and Exchange Commission today filed settled actions against two public companies for violations that resulted in the improper reporting of quarterly earnings per share (EPS) that met or exceeded analyst consensus estimates. The actions are the first arising from investigations generated by the Division of Enforcement’s EPS Initiative, which utilizes risk-based data analytics to uncover potential accounting and disclosure violations caused by, among other things, earnings management practices.
The proceedings, which were settled on a “neither admit nor deny” basis, involved allegedly inappropriate accounting adjustments that enabled the companies to present misleading earnings performance. Both companies consented to cease and desist orders and civil monetary penalties. Two accounting executives at one of the companies also consented to cease & desist orders, civil monetary penalties and temporary bars to practicing before the SEC.
This is the first I’ve heard about an “EPS Initiative,” but the Enforcement Division’s increasing emphasis on data analytics is something that the agency has publicized for some time. For example, this BakerHostetler memo discusses comments made by the Enforcement Division’s Chief Accountant, Matthew Jacques, at a conference last fall:
Mr. Jacques disclosed that the Division of Enforcement has also invested time and energy in technology to better detect fraud, such as the increased use of data analytics, to allow the SEC to detect complex fraud faster and catch bad actors more quickly. Mr. Jacques stated that the SEC will evaluate potential accounting cases brought to its attention based on considerations such as the egregiousness of the conduct, the size of the company and the SEC’s priorities.
My guess is that we’ll be hearing more from Enforcement’s EPS Initiative in the coming months. Cases targeting earnings shenanigans seem like a nice fit with the SEC’s current focus on violations that impact “Main Street investors,” and they also highlight the agency’s ability to leverage its resources through the application of technology.
Sustainability: CII Calls for Companies to Use Standard Reporting Metrics
Last week, the CII adopted a statement a statement urging companies to report on their sustainability performance using standardized metrics established by independent private sector standard-setters. In its press release announcing the adoption of the new statement, the CII provided some insight about why it decided to adopt the statement now:
The CII statement comes at a pivotal time for the future of sustainability reporting, with five leading sustainability standard setters recently releasing a document declaring intent to work together toward comprehensive reporting, and the International Federation of Accountants recently proposing the creation of a sustainability standards board that would exist alongside the International Accounting Standards Board. While CII does not endorse any particular framework or independent standard setter, these developments clearly indicate momentum toward the broad objectives described in the statement.
The CII’s statement says that “standards that focus on materiality, and take into account appropriate sector and industry considerations, are more likely to meet investors’ needs for useful and comparable information about sustainability performance.” The statement also endorses the idea that, over time, companies should obtain external assurance of the sustainability performance disclosures.
Last week, ISS released the results of its 2020 policy benchmark survey. Here are some of the highlights:
Pandemic-Related Issues
1. ISS policy guidance in response to COVID-19 pandemic: With respect to ISS’s policy guidance issued in response to the pandemic, a significant majority of both investor (62%) and non-investor respondents (87%) indicated that ISS should carry this or similar guidance into 2021 and continue to apply flexible approaches where warranted through at least the 2021 main proxy seasons.
2. Annual Meetings: Regarding the question on the preferred shareholder meeting format, absent continuing COVID-19 health and social restrictions, almost 80% of investor respondents chose “Hybrid” meetings, with the possibility for shareholders to attend and participate in the meeting either in-person or via effective remote communications. On the other hand, a plurality of non-investor respondents (42%) indicated a preference for in-person meetings, with virtual meetings used only when there is a compelling reason (such as pandemic restrictions).
3.Expectations regarding compensation adjustments: When asked about executive compensation in the wake of the pandemic, 70% of investor respondents indicated that the pandemic’s impact on the economy, employees, customers and communities and the role of government-sponsored loans and other benefits must be considered by boards, incorporated thoughtfully into decisions to adjust pay and performance expectations, and be clearly disclosed to shareholders. Among non-investor respondents, 53% indicated that many boards and compensation committees will need flexibility to make reasonable adjustments to performance expectations and related changes to executive compensation.
4.Adjustments to short-term/annual incentive programs: Regarding short-term/annual incentive programs and the respondents’ views on what is a reasonable company response under most circumstances, 51% of investors and 54% of non-investors indicated that both (1) making mid-year changes to annual incentive metrics, performance targets and/or measurement periods to reflect the changed economic realities and (2) suspending the annual incentive program and instead making one-time awards based on committee discretion could be reasonable, depending on circumstances and the justification provided.
Non-Pandemic-Related Issues
5. Director accountability to assess and mitigate climate risk: Investors ranked the top three actions that appropriate for shareholders to take at a company that isn’t effectively not effectively reporting on or addressing its climate change risk as follows: (1) engage with the board and company management (92%); (2) consider support for climate-related shareholder proposals (87%); and (3) consider support for shareholder proposals seeking greenhouse gas reduction targets (84%).
Notably, three-quarters of investors responded that they would consider a vote against directors who are deemed to be responsible for poor climate change risk management. Non-investors overwhelmingly favored engagement with the board and company management as the most appropriate action (93%) while other possible actions were far less popular.
6. Sustainable development goals: When asked whether the UN’s SDG framework to be an effective way for companies to measure environmental and social risks and to commit to improving environmental and social disclosures and actions, 44% of non-investors said “yes,” while 51% said “no.” Investor responses were “yes” (44%) and “no” (56%).
7.Auditors and audit committees: ISS often considers the relative level of non-audit services and fees compared to audit-related services and fees when assessing auditor independence of the external auditor. When asked what other factors (when disclosed) they considered relevant to the evaluation of auditor independence & performance, 88% of investors said significant audit controversies. That edged out significance/frequency of material restatements, which was cited by 83% of investors. Significance/frequency of material restatements (67%) topped the list for non-investors.
When asked what information should be considered by shareholders in evaluating a company’s audit committee, the most popular response among investors was significant controversies relating to financial reporting, financial controls or audit (93%). Skills and experience of audit committee members (97%) topped the list for non-investors.
8. Racial and ethnic diversity: When asked should all corporate boards provide disclosure of the demographics of their board members including directors’ self-identified race and/or ethnicity, 73% of investors indicated all boards should disclose this information to the full extent permitted under relevant laws. Only 36% of non-investors gave the same response, while 32% said boards should only disclose this information where it is mandated in jurisdictions where they operate.
9. Independent board chairs: 85% of investors said that an independent chair is their preferred model, but 47% said that company-specific circumstances may justify other models. On the other hand, 38% said that non-independent chairs should only be allowed in emergency or temporary situations. Nearly half of non-investor respondents indicated that there was no single preferred model for board leadership.
PPP Loans: The SBA is MIA On Loan Forgiveness
According to this recent “American Banker” article, the SBA isn’t off to a great start when it comes to acting on PPP loan forgiveness applications. In fact, this excerpt suggests that it hasn’t gotten off to any start at all:
More banks, weary of waiting on legislative fixes, are moving ahead with processing Paycheck Protection Program forgiveness applications. Many of those lenders have become more frustrated by a lack of communication from the Small Business Administration.
The $1.6 billion-asset NexTier Bank in Kittanning, Pa., submitted the first of 95 applications on Sept. 15, while the $2.2 billion-asset First Choice Bancorp in Cerritos, Calif., has processed about 200 applications in recent weeks. The $1.4 billion-asset IncredibleBank in Wausau, Wis., has submitted 50 loans since the forgiveness portal opened on Aug. 10. Each is still waiting for a response from the SBA.
“We have not yet had a single one validated,” said Robert Franko, First Choice’s president and CEO. “To our knowledge, no one has yet received forgiveness,” Franko added. “There’s no question borrowers are tired of waiting. We have an automated system and everything can be done online.”
Lenders and borrowers aren’t the only ones dissatisfied with the SBA’s performance. According to this recent GAO report, the SBA’s guidance on the loan forgiveness process leaves some remaining uncertainty about some aspects of the lenders’ role in the process, and its plans for overseeing the loan forgiveness process are still incomplete.
The GAO report said that the SBA had received approximately 56,000 forgiveness applications as of Sept. 8. According to the American Banker article, “The GAO report did not mention any approvals, and other lenders said they know of no applications that have made their way through the review process.”
Fantasy “Stockball”? Score a TD & Get Stock for Free!
A member tipped us off to a new twist on “fantasy football.” Apparently, the online financial services & investment platform SoFi is offering a promotion where you can win up to $100 in stock for every touchdown your NFL team scores in one game. When I first saw this, I immediately thought about all of those enforcement actions that the SEC brought against companies that gave away securities for “free” during the late 90s. The SEC has also had occasion to crack down on this practice more recently, in the context of ICO “airdrops.”
This free stock promotion is different from the ones that have given the SEC heartburn. Instead of using its own stock, SoFi is giving away shares (or fractional shares) of other companies that it holds in its inventory. It turns out that SoFi isn’t the only online investment platform that gives away stock as a promotion – apparently Robinhood does something similar.
I like fantasy football, but I’m not into online trading. I’m also a Cleveland Browns fan, which means that it’s far from a sure thing that my team is going to score a touchdown on any given Sunday. So, I think I’ll take a pass on “fantasy stockball” and stick to my fantasy football league, where my team – “Myles Garrett’s Helmet Helpers” – is off to a 3-0 start. And yes, this entire blog was just an excuse to tell you that.
Last week, the Business Roundtable released these “Principles & Policies Addressing Climate Change” – a 16-page statement that declares the US should adopt a “market-based approach” to reduce emissions in line with the Paris Agreement. The BRT is careful to note that carbon should be priced only where it is environmentally and economically effective and administratively feasible, and in a way that continues to foster innovation & competitiveness. This Politico article summarizes the BRT’s positions. Here’s an excerpt:
A “market-based mechanism” is a broad term, and the Business Roundtable did not recommend any one particular design. It called for putting a price on carbon as a means to reduce emissions since “a clear price signal is the most important consideration for encouraging innovation, driving efficiency, and ensuring sustained environmental and economic effectiveness.”
Examples include direct taxation of carbon dioxide emissions as well as cap-and-trade schemes, such as legislation that passed the House in 2009 but fizzled in the Senate.
Any revenues that come from any market-based system should be used to support economic growth, reduce societal impact, and aid people and companies that are the most negatively affected, the goups said. And it should be linked with “at least a doubling of federal funding for research, development and demonstration of (greenhouse gas) reduction technologies.”
As this WaPo article notes, it’s looking like corporate interests may be more likely to claim a seat at the table the next time climate change legislation is considered, versus trying to kill those efforts outright, and that might help us all. However, the BRT’s principles envision reducing emissions by at least 80% from 2005 levels by 2050 and come at a time when the BRT is still drawing scrutiny of last year’s “stakeholder capitalism” pledge – the latest shot being this letter last week from Senator Elizabeth Warran (D-Mass.).
I suspect that a 30-year goal for reducing emissions is not what investors have in mind when they refer to “long-termism” – so if companies are hanging their hats on the BRT timeline, they probably also need to have some convincing talking points for engagements. As illustrated by this “open letter” issued last week by PRI, investors also continue to want companies to reflect climate-related risks in financial reporting.
Director Information Rights: The Latest “WeWork” Gift
We don’t get to blog much about The We Company since its IPO imploded, but their ongoing litigation recently brought us a nugget of corporate governance case law out of the Delaware Court of Chancery. In this opinion, Chancellor Bouchard decided as a matter of first impression that management cannot unilaterally preclude a director from obtaining the company’s privileged information.
The directors who were being kept in the dark here were members of a special committee formed last fall who were opposing the company’s motion to dismiss a complaint that the company filed in April against SoftBank, and they wanted privileged info that had been shared among company management, in-house counsel and outside counsel. The motion to dismiss was brought by a new committee consisting of two temporary directors, which was formed in May.
The info at issue isn’t the info that was shared between the new committee and its counsel, but between the company and its counsel – info about how the new committee was established, etc. Here’s the holding:
This decision holds, under basic principles of Delaware law, that directors of a Delaware corporation are presumptively entitled to obtain the corporation’s privileged information as a joint client of the corporation and any curtailment of that right cannot be imposed unilaterally by corporate management untethered from the oversight and ultimate authority of the corporation’s board of directors. Accordingly,the Special Committee is entitled to receive the privileged information of the Company it is has requested, which, to repeat, does not concern privileged communications between the New Committee and its own counsel.
This opinion is of interest because isolating director factions or underperforming directors through the use of special committees is one avenue that companies use to minimize those directors’ activities when they can’t otherwise be removed and won’t resign – but as this case emphasizes, director information rights must be honored. This blog from Frank Reynolds explains that there is a situation in which a board or committee can withhold privileged information – which exists when there’s sufficient adversity that the director could no longer have an expectation that they were a client of the board’s counsel. Here, the court found that management acted unilaterally – so the exception didn’t apply.
Venture Capital: New NVCA Forms Include Market Term Analysis
The National Venture Capital Association (NVCA) published on July 28, 2020 an updated suite of model venture capital financing documents that reflect the current events shaping the investment climate, and for the first time, embedded analysis of market terms directly in the NVCA’s model term sheet. Venture capital funds, professional investors, emerging companies and their respective advisors will benefit from the summary analysis contained in this article which highlights the most significant changes to the primary model financing documents.
The NVCA’s updates are timely because venture capital investing remains strong despite the challenges of 2020. Pitchbook reports 2,893 U.S. venture capital deals with an aggregate of $45.20B of capital raised as of the second quarter of 2020, representing approximately a 17% reduction in deal count and a 2% increase in aggregate dollars raised over the same period in 2019. Economic uncertainty looms in the market, as does the specter of increased governmental interest in foreign investments in certain emerging businesses.
As we covered in real-time yesterday at our “Executive Compensation Conference,” (archives will be available soon – and you can still register for on-demand viewing of those), after a high-drama “pause” last week, the Rule 14a-8 amendments are finally here. The Commissioners voted 3-2 to adopt the amendments – which include the first revisions to the submission threshold in over 20 years, and the first revisions to the resubmission threshold since 1954. For companies that focus on keeping proposals out of the proxy statement (not all companies, but many!), this is a big deal. Here are the highlights from the SEC’s Fact Sheet:
Submission Thresholds – amend Rule 14a-8(b) by:
– Replacing the current ownership threshold, which requires holding at least $2,000 or 1% of a company’s securities for at least one year, with three alternative thresholds that will require a shareholder to demonstrate continuous ownership of at least:
– $2,000 of the company’s securities for at least three years;
– $15,000 of the company’s securities for at least two years; or
– $25,000 of the company’s securities for at least one year.
– Prohibiting the aggregation of holdings for purposes of satisfying the amended ownership thresholds;
– Requiring that a shareholder who elects to use a representative for the purpose of submitting a shareholder proposal provide documentation to make clear that the representative is authorized to act on the shareholder’s behalf and to provide a meaningful degree of assurance as to the shareholder’s identity, role and interest in a proposal that is submitted for inclusion in a company’s proxy statement; and
– Requiring that each shareholder state that he or she is able to meet with the company, either in person or via teleconference, no less than 10 calendar days, nor more than 30 calendar days, after submission of the shareholder proposal, and provide contact information as well as specific business days and times that the shareholder is available to discuss the proposal with the company.
– Applying the one-proposal rule to “each person” rather than “each shareholder” who submits a proposal, such that a shareholder-proponent will not be permitted to submit one proposal in his or her own name and simultaneously serve as a representative to submit a different proposal on another shareholder’s behalf for consideration at the same meeting. Likewise, a representative will not be permitted to submit more than one proposal to be considered at the same meeting, even if the representative were to submit each proposal on behalf of different shareholders.
– Revising the levels of shareholder support a proposal must receive to be eligible for resubmission at the same company’s future shareholder meetings from 3%, 6% and 10% for matters previously voted on once, twice or three or more times in the last five years, respectively, with thresholds of 5%, 15% and 25%, respectively. For example, a proposal would need to achieve support by at least 5% of the voting shareholders in its first submission in order to be eligible for resubmission in the following three years. Proposals submitted two and three times in the prior five years would need to achieve 15% and 25% support, respectively, in order to be eligible for resubmission in the following three years.
The amendments will be effective 60 days after publication in the Federal Register – but there’s an important transition period in that the final amendments will first apply to any proposal submitted for an annual or special meeting to be held on or after January 1, 2022. The final rules also provide for a transition period with respect to the ownership thresholds that will allow shareholders meeting specified conditions to rely on the $2,000/one-year ownership threshold for proposals submitted for an annual or special meeting to be held prior to January 1, 2023.
We’ll be posting the inevitable flood of memos in our “Shareholder Proposals” Practice Area, and will continue to provide guidance on how practice evolves. One thing is already clear – investor groups aren’t happy. CII’s press release says that the amendments will “muzzle the voice of small investors” and lists several benefits of the current proposal process – asserting that it is a cost-effective way for shareholders to communicate with companies. ICCR’s press release takes it a step further, with this quote from Andy Behar of As You Sow:
“The SEC has intervened to disrupt a system that has worked with fairness and integrity for over 50 years,” said Andy Behar, CEO of As You Sow. “Companies have gained deep insight into potential material risks to their businesses, courtesy of their shareholder engagements. Investors have had a forum to raise their concerns, assisting companies to outperform. This is an ecosystem based on mutual respect and a common goal; helping companies be as good as they can be. The new SEC rules will not stop this relationship, they will simply force shareholders to escalate to litigation and other means. This will ultimately cost companies valuable time and resources.”
But Wait, There’s More! SEC Updates Whistleblower Awards Program
Yesterday, the SEC also tackled amendments to the rules governing its whistleblower program – another controversial proposal that was initially scheduled for a few weeks ago but postponed. The final amendments were adopted 3-2 and were accompanied by guidance from the SEC’s Office of the Whistleblower about the process for determining award amounts for eligible whistleblowers. This blog from Matt Kelly of Radical Compliance gives a good overview. Here’s an excerpt:
Among the changes: a presumption toward more generous awards at the lower end of the pay scale, restrictions on people who abuse the tipster process too often, and faster disposal of would-be tips that don’t meet the awards program criteria.
And the controversial idea to cap large awards at $30 million — technically killed, although the SEC’s two Democratic commissioners still objected that the agency could use other measures to achieve that same end of whittling down large awards.
A few years ago, Broc blogged about a “request for comment” on Guide 3 – the industry guide for banks and bank holding companies. That effort has now come to fruition as the SEC (unanimously!) adopted amendments on September 11th, which update & expand statistical disclosure requirements and move “Guide 3” requirements into Reg S-K. We’re posting memos in our “Financial Institutions” Practice Area.
Today is our “17th Annual Executive Compensation Conference” – Monday & Tuesday were our “Proxy Disclosure Conference.” For those who haven’t been attending the conferences – or for those who have and want to watch again – we ran a special tribute video yesterday to honor Marty Dunn. Marty was a legend in our community and is deeply missed.
You can still register online to get immediate access to these virtual events. Both conferences are paired together and they’ll also be archived for attendees until next August. That’s a huge value. Here’s more info:
– How to Attend: Once you register, you’ll receive a Registration Confirmation email from mvp@markeys.com. Use that email to complete your signup for the conference platform, then follow the agenda tab to enter sessions. All sessions are shown in Eastern Time – so you will need to adjust accordingly if you’re in a different time zone. Here’s today’s agenda. If you have any questions about accessing the conference, please contact Victoria Newton at VNewton@CCRcorp.com.
– How to Watch Archives: Members of TheCorporateCounsel.net or CompensationStandards.com who register for the Conferences will be able to access the conference archives until July 31, 2021 by using their existing login credentials. Or if you’ve registered for the Conferences but aren’t a member, we will send login information to access the conference footage on TheCorporateCounsel.net or CompensationStandards.com.
– How to Earn CLE Online: Please read these “CLE FAQs” carefully to confirm that your jurisdiction allows CLE credit for online programs. You will need to respond to periodic prompts every 15-20 minutes during the conference to attest that you are present. After the conference, you will receive an email with a link. Please complete the link with your state license information. Our CLE provider will process CLE credits to your state bar and also send a CLE certificate to your attention within 30 days of the conference.
OTC: SEC Amends Information Requirements
Last week, the SEC closed the loop on a proposal from last year and adopted amendments to Rule 15c2-11 to modernize the type of information that needs to be available for broker-dealers to quote securities on the OTC markets. In keeping with the SEC’s current focus on outdated rules, this one was last amended about thirty years ago. Here’s an excerpt from the SEC’s fact sheet about the amendments (and here are statements from SEC Chair Jay Clayton & Commissioner Hester Peirce):
The amendments facilitate transparency of OTC issuer information by:
– Requiring to be current and publicly available certain specified documents and information regarding OTC issuers that a broker-dealer or qualified IDQS must obtain and review for the broker-dealer to commence a quoted market in an OTC issuer’s security (“information review requirement”);
The amendments provide greater investor protections when broker-dealers rely on the piggyback exception by:
– Providing a time-limited window of 18 months during which broker-dealers may quote the securities of “shell companies.”
The amendments reduce unnecessary burdens on broker-dealers by:
– Allowing broker-dealers to initiate a quoted market for a security if a qualified IDQS complies with the information review requirement and makes a publicly available determination of such compliance; and
– Providing new exceptions, without undermining the Rule’s important investor protections, for broker-dealers to:
– Quote actively traded securities of well-capitalized issuers;
– Quote securities issued in an underwritten offering if the broker-dealer is named as an underwriter in the registration statement or offering statement for the underwritten offering, and the broker-dealer that is the named underwriter quotes the security; and
– Rely on certain third-party publicly available determinations that the requirements of certain exceptions are met.
The rule will have a general compliance date that is 9 months after the effective date – and a compliance date that is 2 years after the effective date for the provisions that require a company’s financial info for the last 2 fiscal years to be current and publicly available.
How to Successfully Uplist
This blog from the Small Cap Institute points out that uplisting is a transformative event that is more than just a single transaction – it requires months of planning, and nearly perfect post-closing execution to assure investors that the company will be profitable investment. Here’s one tip for success:
Sell Stock to the Right Audience: Most companies that uplist have predominantly retail shareholder bases (i.e., their investors are mostly nonprofessional investors). Most companies that uplist also have stocks that trade less than $250,000 of stock per day. For reasons we cover in this piece about trading volume, most institutional investors are mathematically foreclosed from buying stocks that trade less than $250,000 per day, whether they like your company or not.
Unfortunately, due to either ignorance or disingenuous advice, myriad uplisted companies with daily trading volume less than $250,000 waste enormous amounts of time and money endlessly meeting around the country with institutional investors, who simply can’t buy their stock – and won’t.
As John blogged last week on DealLawyers, SPACs have been having a “moment” due to this year’s market volatility. Yesterday afternoon, Corp Fin issued a new “Securities Act Forms” CDI #115.18 to address the Form S-3 eligibility of companies that go public via merger into a SPAC.
Question 115.18
Question: Following the merger of a private operating company or companies with or into a reporting shell company (for example, a special purpose acquisition company), may the resulting combined entity rely on the reporting shell company’s pre-combination reporting history to satisfy the eligibility requirements of Form S-3 during the 12 calendar months following the business combination?
Answer: If the registrant is a new entity following the business combination transaction with a shell company, the registrant would need 12 calendar months of Exchange Act reporting history following the business combination transaction in order to satisfy General Instruction I.A.3 before Form S-3 would become available. If the registrant is a “successor registrant,” General Instruction I.A.6(a) would not be available because the succession was not primarily for the purpose of changing the state of incorporation of the predecessor or forming a holding company. General Instruction I.A.6(b) also would not be available because the private operating company or companies would not have met the registrant requirements to use Form S-3 prior to the succession.
Where the registrant is not a new entity or a “successor registrant,” the combined entity would have less than 12 calendar months of post-combination Exchange Act reporting history. Form S-3 is premised on the widespread dissemination to the marketplace of an issuer’s Exchange Act reports over at least a 12-month period. Accordingly, in situations where the combined entity lacks a 12-month history of Exchange Act reporting, the staff is unlikely to be able to accelerate effectiveness under Section 8(a) of the Securities Act, which requires the staff, among other things, to give “due regard to the adequacy of the information respecting the issuer theretofore available to the public,…and to the public interest and the protection of investors.” [September 21, 2020]
219.05 In reporting compensation for periods affected by COVID-19, questions may arise whether benefits provided to executive officers because of the COVID-19 pandemic constitute perquisites or personal benefits for purposes of the disclosure required by Item 402(c)(2)(ix)(A) and determining which executive officers are “named executive officers” under Item 402(a)(3)(iii) and (iv). The two-step analysis articulated by the Commission in Release 33-8732A continues to apply when determining whether an item provided because of the COVID-19 pandemic constitutes a perquisite or personal benefit.
– An item is not a perquisite or personal benefit if it is integrally and directly related to the performance of the executive’s duties.
– Otherwise, an item that confers a direct or indirect benefit and that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, is a perquisite or personal benefit unless it is generally available on a non-discriminatory basis to all employees.
Whether an item is “integrally and directly related to the performance of the executive’s duties” depends on the particular facts. In some cases, an item considered a perquisite or personal benefit when provided in the past may not be considered as such when provided as a result of COVID-19. For example, enhanced technology needed to make the NEO’s home his or her primary workplace upon imposition of local stay-at-home orders would generally not be a perquisite or personal benefit because of the integral and direct relationship to the performance of the executive’s duties. On the other hand, items such as new health-related or personal transportation benefits provided to address new risks arising because of COVID-19, if they are not integrally and directly related to the performance of the executive’s duties, may be perquisites or personal benefits even if the company would not have provided the benefit but for the COVID-19 pandemic, unless they are generally available to all employees.
Today: “Proxy Disclosure Conference – Part 2”
Today is the second day of our “Proxy Disclosure Conference” – tomorrow is our “17th Annual Executive Compensation Conference.” You can still register online to get immediate access to these virtual events! Both conferences are paired together and they’ll also be archived for attendees until next August. That’s a huge value.
– How to Attend: Once you register, you’ll receive a Registration Confirmation email from mvp@markeys.com. Use that email to complete your signup for the conference platform, then follow the agenda tab to enter sessions. All sessions are shown in Eastern Time – so you will need to adjust accordingly if you’re in a different time zone. Here’s today’s agenda. If you have any questions about accessing the conference, please contact Victoria Newton at VNewton@CCRcorp.com.
– How to Watch Archives: Members of TheCorporateCounsel.net or CompensationStandards.com who register for the Conferences will be able to access the conference archives until July 31, 2021 by using their existing login credentials. Or if you’ve registered for the Conferences but aren’t a member, we will send login information to access the conference footage on TheCorporateCounsel.net or CompensationStandards.com.
– How to Earn CLE Online: Please read these “CLE FAQs” carefully to confirm that your jurisdiction allows CLE credit for online programs. You will need to respond to periodic prompts every 15-20 minutes during the conference to attest that you are present. After the conference, you will receive an email with a link. Please complete the link with your state license information. Our CLE provider will process CLE credits to your state bar and also send a CLE certificate to your attention within 30 days of the conference.
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