Last month I blogged about a shareholder proponent that sued a Montana energy company seeking to force the company to include the proponent’s proposal on the company’s proxy ballot. Well, last week, the court ruled in the company’s favor and said the proposal could be excluded. What implications might this case have for shareholder proposal litigation? A timely Jones Day memo helps walk through that analysis. Here’s an excerpt from the memo:
The Court determined that under the Auer doctrine it should defer to the SEC’s formal releases, but that informal SEC staff interpretations, such as Staff Legal Bulletins and no-action letters, were entitled to “consideration” but not “persuasive weight.” Drawing on the Third Circuit’s analysis in Trinity Wall Street, a decision that the SEC staff had disavowed in a prior Staff Legal Bulletin, the Court held that the proposal could be excluded under the “ordinary business” exclusion of SEC Rule 14a-8.
Looking Ahead: The ruling may impact shareholder proposal litigation in two ways. First, the decision’s approach to Auer deference may breathe renewed life into certain Rule 14a-8 exclusions that were previously interpreted narrowly by informal SEC staff pronouncements. Second, the Court’s reliance on Trinity Wall Street reinforces the Third Circuit’s issuer-friendly analysis of the “ordinary business” exclusion.
Future of the PCAOB
As reported in various news outlets (here’s one from Accounting Today), President Trump’s 2021 budget includes a proposal that would consolidate the PCAOB into the SEC. Consider me a skeptic as to the likelihood of this actually happening, but then again it’s up to Congress so we’ll see. This blog from Baker Botts discusses some of what this might mean for issuers and auditors if it really happens. Here’s some considerations:
– Would the monitoring of public accounting firms be carried out in the same manner as it has been under the PCAOB? Would the SEC replicate the scope, magnitude, and rigor of the PCAOB’s regulatory activities?
– The proposed budget raises the possibility that funding will be reduced, does this mean auditor oversight activities would be reduced under the SEC—or would consolidation truly save millions without a reduction in oversight activities?
– Would the SEC would assume the PCAOB’s standard-setting function?
– Would audit firms and auditors lose confidentiality protections, which were explicitly required when Congress created the PCAOB, that aren’t necessarily available for charges brought by the SEC?
As alluded to in the blog, perhaps even if the consolidation doesn’t happen, there may be other changes in store for the PCAOB.
Managing Data Privacy Compliance
With 2020 bringing the effectiveness of the California Consumer Privacy Act and the New York Stop Hacks and Improve Electronic Data Security Act (otherwise known as the “SHIELD Act”) – and other state legislatures preparing to advance their own data privacy laws – this Jackson Lewis blog provides a list of 10 steps to help manage data privacy compliance. The list is a helpful reminder for managing any program but especially helpful as many compliance departments may be feeling overwhelmed with the proliferation of data privacy laws. Here’s an excerpt:
– Set expectations – remember staying on top of privacy laws will be an on-going effort
– Build interdisciplinary teams – include not only IT, but also HR, legal, operations and other business area representatives
– Evaluate new technologies carefully – not all technologies may have been developed or designed with an eye toward data privacy or security
– Remember to manage data retention – retain data and information strategically and deliberately
As for the CCPA, California’s Attorney General proposed two rounds of amendments to the regulations in February. This Cleary memo provides a summary of the proposed changes and we’re posting additional memos in the “state law” section of our “Cybersecurity/Privacy/Data Governance” Practice Area.
Yesterday, the SEC issued this 341-page proposing release intended to “simplify, harmonize, and improve certain aspects of the exempt offering framework.” The SEC’s press release summarizes the changes. Among other changes, the SEC proposes:
– Revisions to current offering and investment limits for certain exemptions for Reg A, Regulation Crowdfunding and Rule 504 of Reg D
– Amendments relating to offering communications, including:
New rule permitting issuers to use generic solicitation of interest materials to “test-the-waters” for an exempt offer of securities prior to determining which exemption it will use
Rule amendment permitting Regulation Crowdfunding issuers to “test-the-waters” before filing an offering document with the Commission in a manner similar to Reg A
New rule providing that certain “demo day” communications would not be deemed a general solicitation or general advertising
– Amendments to eligibility restrictions in Regulation Crowdfunding and Reg A, which would permit use of certain special purpose vehicles to facilitate investing in Regulation Crowdfunding issuers, and would limit the types of securities that may be offered and sold in reliance on Regulation Crowdfunding
– Changes to the Securities Act integration framework by providing a general principle of integration that looks to the particular facts and circumstances of the offering, and focuses the analysis on whether the issuer can establish that each offering either complies with the registration requirements of the Securities Act, or that an exemption from registration is available for the particular offering
– Four non-exclusive safe harbors from integration
– A change in the financial information that must be provided to non-accredited investors in Rule 506(b) offerings to align with financial information issuers must provide to investors in Reg A offerings
– A new item in the non-exclusive list of verification methods in Rule 506(c)
– Simplification of certain requirements for Reg A offerings
– Harmonization of bad actor disqualification provisions of Reg D, Reg A and Regulation Crowdfunding
The comment period on the proposing release will remain open for 60 days following publication of the release in the Federal Register. It’s hard to say whether these amendments will make everyone happy but with all the confusion caused by the current rules, one would think the amendments will bring some improvement.
SEC Issues COVID-19 Coronavirus Exemptive Order
Yesterday, the SEC took steps to address COVID-19 concerns and issued an unprecedented COVID-19 exemptive order. The SEC’s order provides publicly traded companies, subject to certain conditions, an additional 45 days to file certain disclosure reports that would’ve otherwise been due between March 1 and April 30, 2020. Companies seeking to rely on the order, need to furnish a Form 8-K – or 6-K – by the later of March 16th or the original reporting deadline.
The SEC filing relief isn’t available for all companies though as companies seeking to avail themselves to the SEC’s filing relief need to satisfy certain conditions, which are listed in the order and include among other things, a company’s inability to meet its filing deadline due to circumstances relating to COVID-19. The order also lists the information requirements for the Form 8-K or 6-K.
The order also provides relief for furnishing of proxy and information statements to shareholders “when mail delivery isn’t possible” and the order lists conditions for that relief.
In addition to providing filing relief to certain companies, the SEC’s press release reminds companies of their disclosure obligations:
For example, where a company has become aware of a risk related to the coronavirus that would be material to its investors, it should refrain from engaging in securities transactions with the public and to take steps to prevent directors and officers (and other corporate insiders who are aware of these matters) from initiating such transactions until investors have been appropriately informed about the risk.
When companies do disclose material information related to the impacts of the coronavirus, they are reminded to take the necessary steps to avoid selective disclosures and to disseminate such information broadly. Depending on a company’s particular circumstances, it should consider whether it may need to revisit, refresh, or update previous disclosure to the extent that the information becomes materially inaccurate.
Companies providing forward-looking information in an effort to keep investors informed about material developments, including known trends or uncertainties regarding the coronavirus, can take steps to avail themselves of the safe harbor in Section 21E of the Exchange Act for this information.
As stated in its press release: the “Commission may extend the time period for the relief, with any additional conditions it deems appropriate, or provide additional relief as circumstances warrant. Companies and their representatives are encouraged to contact SEC staff with questions or matters of particular concern.”
The development of COVID-19 has certainly made this year’s annual meeting season more complicated and has everyone watching for the latest guidance addressing a host of issues. To help – we’re posting memos about COVID-19 implications in our “Risk Management” Practice Area.
More on “Annual Meetings: Planning for COVID-19 Developments”
Yesterday, I blogged about possible COVID-19 implications for annual shareholders’ meetings and said maybe interest in virtual annual meetings would pick up. Thanks to Brooke Goodlett of DLA Piper for pointing us to Starbucks. Just yesterday, Starbucks filed an amendment to its proxy statement changing its annual shareholders’ meeting to a virtual-only meeting. Last year, Starbucks held an in-person meeting along with a webcast and according to this year’s original proxy statement, the company had been planning for the same format again this year.
Starbucks annual meeting is coming up in just a couple of weeks, so this is a pretty late-breaking development. It’s worth noting that Starbucks is a Washington company, not Delaware. DLA Piper’s memo on coronavirus considerations suggests companies consider, to the extent permissible by the company’s charter documents and state law, virtual board and shareholder meetings.
Last month we included a guest blog from Rhonda Brauer, and we’re excited to bring another post from Rhonda to you:
Since my last guest blog on the sustainability reporting frameworks, UK-based Aviva Investors published a thoughtful inhouse article on “Climate data: Seeing through the fog”, as part of a larger climate-related series. Many of us interviewed for this article agreed that required, not voluntary, reporting would be the best solution to the problem of not having comparable, relevant and transparent corporate ESG disclosures. The article goes on to explore how “big data” — which is too complex to be analyzed using traditional processing applications — and artificial intelligence (AI) could help solve this problem in the interim, particularly when applied to climate change and similar issues.
Highlights include:
Although the use of satellites, sensors and big data analytics to measure emissions and inform investment decisions is just beginning, much of the data and computer programmes that make it possible exist and are constantly improving.
Whether to measure direct emissions from factories, across a company’s supply chain, or at a country level, an increasing number of options are emerging including mobile data, big data analytics from online sources, satellite measures and data available from a plethora of sensors scattered around the world.
This type of approach allows analysts and researchers to find and assess relevant data that does not feature in companies’… disclosure reports… through scraping (compiling information from online and offline sources) and crawling (using programmes to search across online sources)… Using AI to sort and analyse the mass of information gathered could make sense of it without deploying armies of researchers.
One cited example of how big data and AI can help reduce carbon emissions: Deforestation can now be predicted and detected through digital solutions, which form the basis for proactive action through monitoring and improving agriculture, reforestation and peatland restoration.
The article also includes examples of data gleaned from government satellites that make their data public versus commercial satellites and drones, how such data can be used and influenced by both equity and debt investors to inform financial decisions and to better detect “greenwashing” or manipulation of data, gaps that remain when using such data, how investors can play a critical role, and how companies should be using similar analyses for their business models.
Annual Meetings: Planning for COVID-19 Developments
In case you missed it, here’s something I blogged yesterday on our Proxy Season blog: This memo from Davis Polk walks through some of the things you might want to think about if you’re worried about the COVID-19 coronavirus and how it might affect where or when you hold your annual shareholders’ meeting. The memo looks at these considerations in context of SEC proxy rules and Delaware law. With COVID-19 developments moving quickly, the memo is timely and helpful because someone is bound to ask what your plan is in case you need to move the meeting location, etc.
For those that have already mailed the proxy statement:
In the event you have a last minute change in your meeting location or date, the memo discusses whether you would need to re-mail the proxy statement – the answer is “no” except for special circumstances described in the memo. Even though you likely wouldn’t need to re-mail the proxy statement, the memo says you should disclose the change as soon as possible by issuing a press release and filing the press release with the SEC as supplemental proxy materials.
For those that are still working on your proxy statement:
If you’re still working on your proxy statement and haven’t mailed it yet and you’re considering the possibility of a last minute change in venue or date, the memo suggests disclosing the possibility of a change in your proxy statement but says a change to the proxy card itself is likely unnecessary.
I often worried about what we would do if our meeting venue was suddenly unavailable, not to mention worries about technical snafus and our team had back-up plans “just in case”. To help you prepare and hopefully avoid any annual meeting surprises, here’s a reminder to visit our “Checklists” Portal – especially this one on “Annual Meeting Surprises.”
Virtual Meetings
A few weeks ago, I blogged about things to consider if you’re thinking of holding a virtual annual meeting. Maybe interest will pick up but again, it’s not for everyone. If you want to look into this further, here’s another comprehensive resource about virtual meeting considerations sent to us from the folks at Veaco Group.
Also, it has been reported that in advance of Apple’s shareholder meeting last week, Apple warned those planning to attend to take extra health and safety precautions due to the ongoing development of COVID-19.
Really? SEC Cancels Another Open Meeting
It happened again, the SEC has cancelled an open meeting scheduled for today about proposed changes to rules on private offerings. Broc blogged last fall about how the SEC was cancelling open meetings on what was turning out to be a regular basis. Unclear what led to the cancellation this time, maybe a Commissioner is unavailable at the last minute or perhaps the Commissioners will take action in seriatim and still get something done, we’ll see and stay tuned!
Yesterday, the SEC voted to adopt amendments that significantly change the financial disclosure requirements for guaranteed debt offerings under Regulation S-X Rule 3-10 and Rule 3-16. The changes are intended to improve the quality of disclosure and increase the likelihood that issuers register debt offerings and provide investors with protections they wouldn’t receive in unregistered offerings.
Here’s the 265-page release. The SEC’s press release summarizes amendments to Rule 3-10, which will be amended and partly relocated to new Rule 13-01, high-lights include:
– 100% ownership replaced by consolidation
– Condensed consolidating financial information reduced
– Disclosure may be made outside the financial statement footnotes
– Disclosure ends when Exchange Act reporting ends
Here’s the SEC’s press release summary of the new Rule 13-01 high-lights:
– Replace the condition that a subsidiary issuer or guarantor be 100%-owned by the parent company with a condition that it be consolidated in the parent company’s consolidated financial statements
– Replace condensed consolidating financial information, as specified in existing Rule 3-10, with certain new financial and non-financial disclosures. The amended financial disclosures will consist of summarized financial information, as defined in Rule 1-02(bb)(1) of Regulation S-X, of the issuers and guarantors, which may be presented on a combined basis, and reduce the number of periods presented. The amended non-financial disclosures, among other matters, will expand the qualitative disclosures about the guarantees and the issuers and guarantors. Consistent with the existing rule, disclosure of additional information about each guarantor will be required if it would be material for investors to evaluate the sufficiency of the guarantee
– Permit the amended disclosures to be provided outside the footnotes to the parent company’s audited annual and unaudited interim consolidated financial statements in all filings
– Require the amended financial and non-financial disclosures for as long as an issuer or guarantor has an Exchange Act reporting obligation with respect to the guaranteed securities rather than for as long as the guaranteed securities are outstanding
The SEC’s press release also summarizes amendments to Rule 3-16, which will be replaced with requirements in new Rule 13-02, high-lights for these amendments include:
– Separate financial statements for each affiliate whose securities are pledged replaced by financial & non-financial disclosures
– Disclosure required unless immaterial
Here’s the SEC’s press release summary of the new Rule 13-02 high-lights:
– Replace the existing requirement to provide separate financial statements for each affiliate whose securities are pledged as collateral with amended financial and non-financial disclosures about the affiliate(s) and the collateral arrangement as a supplement to the consolidated financial statements of the registrant that issues the collateralized security. The registrant will be permitted to provide the amended financial and non-financial disclosures outside the footnotes to its audited annual and unaudited interim consolidated financial statements in all filings
– Replace the requirement to provide disclosure only when the pledged securities meet or exceed a numerical threshold relative to the securities registered or being registered with a requirement to provide the proposed financial and non-financial disclosures in all cases, unless they are immaterial
If it seems like these amendments were a long time coming, they kind of were – John blogged about the proposed amendments back in July 2018. The amendments will be effective January 4, 2021 but voluntary compliance is permitted starting now.
SEC Calendars ‘Open Meeting’: Private Offerings on Agenda
Last week, the SEC issued a Sunshine Act notice for an open meeting scheduled for tomorrow – March 4th. Here’s the agenda saying:
The Commission will consider whether to propose rule amendments that would facilitate capital formation and increase opportunities for investors by expanding access to capital for entrepreneurs across the United States. Specifically, the proposed amendments would simplify, harmonize, and improve certain aspects of the framework for exemptions from registration under the Securities Act of 1933 to promote capital formation while preserving or enhancing important investor protections. The proposed amendments seek to address gaps and complexities in the exempt offering framework that may impede access to investment opportunities for investors and access to capital for issuers.
In December, I blogged about the proposed amendments to expand the definition of accredited investors and last summer Liz blogged about the SEC’s concept release that included discussion of a lot of topics, including among other things, whether there should be any changes to streamline capital raising exemptions, especially Rule 506 of Reg D, Reg A, Rule 504 of Reg D, the intrastate offering exemption, and Regulation Crowdfunding and the accredited investor definition. Since then, the concept release generated a lot of comment letters.
So, we’ll see what’s all included with the proposed amendments tomorrow and whether they can truly satisfy everyone. We’ll be blogging about the meeting’s outcome and will post memos as they come in.
Regular Compliance Reporting Boosts Director Confidence
A recent study from FTI Consulting and Corporate Board Member found that director confidence in internal ethics and compliance programs is declining. The study – based on interviews with over 300 public company directors – found that only 35% of survey respondents said they were “very confident” in their company’s internal compliance programs compared to 46% a year earlier. The study lists several reasons that may have contributed to declining confidence such as increased complexity of rules and regulations, pace of change and disruption and uncertainty introduced by advanced technologies.
All is not lost though, the study also found that of directors who say they receive regular ethics or whistleblower reports, only 5% of those directors reported low confidence in the company’s internal ethics and compliance programs. The study lists steps an organization can take to help bolster confidence among their directors, here’s an excerpt:
Take a hard look at the organization’s internal ethics and compliance programs and ensure they meet high standards in the following areas:
– Establish direct and autonomous reporting by the head of compliance to the board, or the audit committee
– Set formal metrics for the board to measure the effectiveness of the compliance program
– Ensure effective hotline and whistleblower processes and report activity to the board regularly
– Enhance compliance functions by using advanced technology
According to this report, Chief Audit Executives (CAEs) don’t think that companies are doing a very good job evaluating corporate governance. The report was issued by the Institute of Internal Auditors and the Neel Center for Corporate Governance at the University of Tennessee. The report says that IIA and the Neel Center partnered to develop what they call the “American Corporate Governance Index” (ACGI) that’s based on eight guiding principles of corporate governance.
The report is based on survey responses from 128 Chief Audit Executives of publicly traded U.S. companies. Survey respondents answered questions anonymously, so scores aren’t assigned to individual companies, by indicating their level of agreement or disagreement with specific statements and scenarios.
Emphasizing the difficulty in overseeing corporate governance across all levels of an organization, the report’s survey questions were designed to capture the effectiveness of corporate governance enterprise wide. Key findings include:
– 10% of Index companies scored an F
– Many companies are willing to sacrifice long-term strategy in favor of short-term interests
– More than one-third of board members are not willing to offer contrary opinions or push back against the CEO
– Boards fail to verify the accuracy of information they receive
– Independent boards drive stronger governance
– Companies are vulnerable to corporate governance weaknesses or failures – the report says that the majority of respondents reported no formal mechanism for monitoring or evaluating the full system of corporate governance
– Regulation does not correlate with stronger governance
Aside from the report’s key findings, it also said that CAE’s reported when corporate governance is formally evaluated, internal audit completes the evaluation 75% of the time, and when not, it’s often done by the GC’s office or under the direction of the board governance committee, at which point “it is more likely to be a compliance ‘check-the-box’ exercise”. Reading that CAE’s say regulation doesn’t correlate with stronger governance, regulations aside, I suspect many wouldn’t support dropping ‘check-the-box’ governance evaluations.
Insider Trading: Ex-Legal Department Employee Gets Caught
Last year, John blogged about how lawyers seemed to be getting caught in the cross-hairs of insider trading cases. It can be a little unnerving to read of these cases, especially when lawyers know better and company legal departments have policies and safeguards in place to mitigate insider trading risks.
But, here we are again. I recently saw this story about a SEC settlement involving a now ex- in-house legal department employee. According to the story, the employee, who was a legal assistant, got his hands on an update to the company’s board about a pending acquisition – the update was marked “strictly confidential”. The ex-employee then purchased shares in the target company and tipped his 86-year old father who also purchased the target’s shares. The story says the ex-employee got cold feet and sold his shares in the target but his father hung on for the acquisition announcement and resulting gain. Both the son and father agreed to pay civil penalties of about $20,000 with the father also giving up the illicit profit.
Bottom line – just don’t do it! For anyone wanting to brush-up on insider trading considerations, check out the “Insider Trading” Handbook available on our website that includes a sample insider trading policy as well as discussion of the scope and content for insider trading policies.
Our March Eminders is Posted!
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Yesterday, the SEC announced that it had instituted a settled enforcement action against actor, musician, environmentalist, martial arts master & Russian special envoy Steven Seagal for allegedly violating the anti-touting provisions of the Securities Act in connection with a digital asset offering. Here’s an excerpt from the SEC’s press release:
The SEC’s order finds that Seagal failed to disclose he was promised $250,000 in cash and $750,000 worth of B2G tokens in exchange for his promotions, which included posts on his public social media accounts encouraging the public not to “miss out” on Bitcoiin2Gen’s ICO and a press release titled “Zen Master Steven Seagal Has Become the Brand Ambassador of Bitcoiin2Gen.” A Bitcoiin2Gen press release also included a quotation from Seagal stating that he endorsed the ICO “wholeheartedly.”
These promotions came six months after the SEC’s 2017 DAO Report warning that coins sold in ICOs may be securities. The SEC has also advised that, in accordance with the anti-touting provisions of the federal securities laws, any celebrity or other individual who promotes a virtual token or coin that is a security must disclose the nature, scope, and amount of compensation received in exchange for the promotion.
According to the SEC’s order, in addition to consenting to a C&D on a neither admit nor deny basis, Vladimir Putin’s BFF agreed to disgorge all of the $157,000 in promotional payments that he received (plus interest) and to pay a $157,000 penalty. He also agreed not to promote any securities for three years.
If it’s any consolation to Louisiana’s most Googled d-lister, he’s not the first celebrity to run afoul of Section 17(b) of the Securities Act for touting a digital deal. Back in 2018, boxer Floyd Mayweather & music impresario DJ Khaled were tagged by the SEC for the same conduct.
D&O Insurance: Dealing with a Tough Market
Lynn recently blogged about the tightening market for D&O insurance. This Goodwin memo reviews some of the things that companies can do to put themselves in the best position to deal with current market conditions. In addition to careful advance planning with the company’s insurance brokers & coverage counsel, this excerpt highlights some alternatives for managing increased premiums:
Given daunting premium increases, insureds are also increasingly considering alternative ways to structure their insurance programs. For example, insureds may consider increasing the amount of their deductibles in order to reduce insurer risk, and thereby reduce the amount of premium charged (or reduce the size of a premium increase). In certain situations, insureds have also considered “captive insurance” programs to replace or supplement traditional insurance programs. (Captive insurance programs are in essence self-insurance programs owned and controlled by insureds rather than insurance companies).
Insureds may also consider reallocating more of their insurance program to so-called “Side A Difference-in Conditions (DIC)” coverage, which is less expensive coverage that is for the dedicated benefit of directors and officers only, excess of all other insurance and indemnification available to those individuals. Care should be taken with respect to any of these changes, however, in order to avoid unduly reducing important insurance protections in the event of claims.
Note the reference to “daunting” premium increases – the memo says that some companies are seeing premiums double without any change in risk profile. Deductibles for securities claims are also doubling in some cases, with IPO companies facing as much as a $10 million deductible. Yikes!
D&O Insurance: The Importance of Indemnification Agreements
With deductibles rising significantly, the importance of supplemental arrangements like “Side A” policies are well understood. But this recent blog from Woodruff Sawyer’s Priya Cherian Huskins says that the importance of individual indemnification agreements shouldn’t be overlooked – particularly given the risk that companies may opt for coverage that proves to be inadequate as premiums escalate. Here’s an excerpt:
An indemnification agreement in this context is a contract between individual director or officer and the company the director or officer serves. These agreements promise to (1) advance legal fees, and (2) pay loss (indemnification) on behalf of an individual should he or she be named in a lawsuit in his or her capacity as a director or officer of the company.
When properly structured, these agreements provide broad protection so that individuals have the right to hire a lawyer at the company’s expense from the moment they need protection, be it because they’re being investigated (including informally) by a regulator, accused of wrongdoing in a suit, or called as a witness in a case.
Directors & officers may think that they’re appropriately protected by corporate bylaws, but those often provide the company with discretion when it comes to advancement of expenses – and people can’t always rely on that discretion being exercised in their favor after they’ve departed. Indemnification agreements provide the individual with contractual rights obligating the company to defend an indemnitee, and will ensure that there’s a source of funding for those expenses so long as the company remains solvent.
Warren Buffett’s annual letter to Berkshire Hathaway shareholders came out last Saturday. It attracted the usual avalanche of media attention, but I recommend that you check out Kevin LaCroix’s particularly good write-up about it over on the “D&O Diary.” The letter contained its customary mix of insight & folksy charm, but it also once again featured a lot of griping about the Oracle of Omaha’s favorite hobby-horse, generally accepted accounting principles – specifically ASC Topic 321.
The fact that ASC 321 requires Berkshire Hathaway to mark many of its minority investments to market really frosts Buffett. He’s spilled a lot of ink on the topic – and its impact on the company’s bottom line – in each of his last 3 annual letters. Here’s an excerpt from the latest:
The adoption of the rule by the accounting profession, in fact, was a monumental shift in its own thinking. Before 2018, GAAP insisted – with an exception for companies whose business was to trade securities – that unrealized gains within a portfolio of stocks were never to be included in earnings and unrealized losses were to be included only if they were deemed “other than temporary.” Now, Berkshire must enshrine in each quarter’s bottom line – a key item of news for many investors, analysts and commentators – every up and down movement of the stocks it owns, however capricious those fluctuations may be.
Berkshire’s 2018 and 2019 years glaringly illustrate the argument we have with the new rule. In 2018, a down year for the stock market, our net unrealized gains decreased by $20.6 billion, and we therefore reported GAAP earnings of only $4 billion. In 2019, rising stock prices increased net unrealized gains by the aforementioned $53.7 billion, pushing GAAP earnings to the $81.4 billion reported at the beginning of this letter. Those market gyrations led to a crazy 1,900% increase in GAAP earnings!
Buffett’s position is that Berkshire’s a buy & hold investor, and he doesn’t think fluctuations in the value of its enormous stakes in Apple, Coca-Cola and other companies should run through its income statement. He says that just doesn’t reflect business reality for a company like his.
If GAAP Doesn’t Reflect Reality, Then Why You Mad, Bro?
It’s easy to understand Buffett’s beef with GAAP, because mark-to-market fluctuations in Berkshire’s investments add a huge amount of volatility to its bottom line. But here’s the thing – Berkshire made a business decision to take multi-billion dollar minority stakes in enormous companies. What if it had to sell one or more of those positions? That’s what ASC 321 is getting at – it shows users of the financial statements what that would look like.
That fire-sale mentality reflects GAAP’s conservative bias, and yes, it doesn’t necessarily reflect current business reality for a company sitting on a pile of cash that could fund the federal deficit, but Buffett’s allowed to tell people that – and he does, constantly. The fact that Buffett points this out doesn’t bother me, but the fact that he trashes GAAP to do it kind of does.
Of course, GAAP has its limitations, but GAAP disclosures usually provide insights into a business that shouldn’t be ignored. I’ve been practicing law long enough to know that when people constantly harp on the dirty deeds that GAAP’s doing to their company’s financial statements, it’s usually a sign that those financials are highlighting something that makes them uncomfortable.
In Buffett’s case, that “something” is likely the magnitude of the investments that Berkshire’s size compels it to make in order to move the needle – as well as the magnitude of the market risks to which those investments expose it. ASC 321 gives Berkshire no place to hide on this issue & highlights an even more fundamental question: does the Berkshire Hathaway conglomerate make sense anymore?
Restatements: A Quick Reference
When you’re as old as I am, you really develop a fondness for anything that you can quickly grab to remind you of all the things you’ve forgotten about stuff that any corporate lawyer should know. That’s why I really like this 12-page BDO guide on the fundamentals of restatements. There’s definitely enough in there on accounting changes, error corrections & reclassifications to let you fake your way through a conference call or two. Check it out!
If you’re a trend chaser, forget about canned booze or intermittent fasting – all the cool kids are now getting their own stock exchange. This Axios article discusses The Members Exchange, or MEMX, which is backed by the likes of Goldman Sachs, BofA & Morgan Stanley. It’s expected to go live this summer & compete with the NYSE and Nasdaq based on lower fees.
Meanwhile, not to be outdone by Wall Street’s brahmins, Silicon Valley bigwigs are backing the Long Term Stock Exchange, or LTSE. We’ve blogged about this one before, but according to this Marker article, the LTSE’s backers include Andreessen Horowitz, Peter Thiel’s Founders Fund, LinkedIn co-founder Reid Hoffman, & AOL founder Steve Case. CEO Eric Ries & his backers have big ambitions for the exchange:
When it launches — sometime late in the first quarter of this year, Ries hopes — the LTSE will be the 14th U.S. exchange registered for trading securities, but only the third active exchange that is approved for both trading and listing of public companies. That means, instead of IPO’ing on the NYSE or Nasdaq, companies will now have the option of listing shares, aka “going public,” on the LTSE.
DFS: New York’s New Regulatory King Kong?
Armed with the formidable Martin Act, the NY Attorney General’s office has long been one the most powerful state regulators in the country – but this WilmerHale memo says that if legislation introduced by NY Gov. Andrew Cuomo is enacted, the AG won’t be The Empire State’s only regulatory colossus:
In legislative language accompanying his proposed budget, New York Governor Andrew M. Cuomo proposes to significantly expand the powers of the New York Department of Financial Services (DFS), the state’s banking and insurance regulator. The Governor’s proposal would enlarge the department’s mission beyond banking and insurance oversight, transforming DFS into perhaps the most powerful state regulator in the nation, with new and broad jurisdiction and substantial enforcement powers over consumer products and services, business to business arrangements, and securities and investment advice.
Though significant in its scope, the Cuomo proposal is in many respects unsurprising. The Governor created DFS in 2011 upon merging the state’s Banking Department and Insurance Department; he initially sought to give DFS powers under the Martin Act, the state’s broad “blue sky” securities statute, but the Legislature declined to do so. Governor Cuomo has, however, expanded DFS’s jurisdiction in other ways in the years since its creation, including by granting it powers to police the state’s student loan servicing industry.
Among other things, the proposal would amend New York’s Financial Services Law to add securities to the definition of “financial product or service” and give DFS the power to regulate the provision of investment advice. As a result, the memo says that the proposal would effectively make DFS another securities regulator. There are a number of other provisions that would enhance DFS’s power to protect consumers, and would also grant DFS jurisdiction over fraud or misconduct in business-to-business transactions.
Lease Accounting Impact: Holy Cow!
We’ve blogged several times in recent years about the implementation of the new FASB lease accounting standard. Now that the standard’s in place for public companies, a recent article from “Accounting Today” says that the balance sheet impact has been staggering:
The new lease accounting standard caused lease liabilities for the average company to increase a whopping 1,475%, skyrocketing from $4.4 million before the transition to $68.9 million post transition, as operating leases were recorded on the balance sheet for the first time, according to a new study.
The study, from the lease accounting software provider LeaseQuery, analyzed more than 400 companies in its customer base and found that the increase was particularly striking in certain industries, such as financial services, where the amount of the average lease liability increased 6,070%. Similarly, in the health care industry, average lease liability liabilities went up 1,817 %, in the restaurant industry 1,743%, in the energy industry 1,542%, in retail 1,012%, and in manufacturing 495%.
Not surprisingly, the article says that companies found the transition to the new standard more difficult and more time consuming than they initially thought. Feedback from public companies prompted FASB to delay the new standard’s application to private companies in order to give them an extra year to get their act together.
With everybody’s 401(k) plan smarting from the stock market’s belated realization that the coronavirus epidemic was actually a thing, this Nelson Mullins memo seems particularly timely. It takes a deep dive into the potential disclosure issues that the ongoing outbreak may raise for public companies. As this excerpt demonstrates, the memo is a great resource for issue spotting:
The impact of CV may have repercussions on a number of disclosure areas, including liquidity and capital resources, sources and uses of funds, gross and net revenues in the short, medium and long term, and other economic and noneconomic, personal and ESG considerations. Enhanced or additional risk factor disclosure related to CV pursuant to Regulation S-K Item 105 may be needed if it is or becomes one of the most significant factors that make an investment in the company or any offering speculative or risky.
Since SEC disclosure is increasingly principles-based, even if there is not a rule specifically dealing with a situation that a company may find itself in related to CV, the principles of full and fair disclosure apply. Companies should be mindful that their planning for uncertainties that may arise as a result of CV and their response to events as they unfold may be material to an investment decision, and should plan accordingly.
Consider other situations where disclosure of material nonpublic information may be necessary, such as if senior management or boards become impaired and are unable to serve or whether a “material adverse change” in “prospects” has occurred or is reasonably likely to occur. Business interruption insurance policies may be triggered. “Act of God” provisions may be applicable. Contract disputes may occur over CV related matters. Professionals should review and update insider trading policies, blackout periods and trading activity monitoring in light of new information related to CV.
As if that wasn’t enough, the memo also addresses a variety of other legal issues that may arise as a result of the outbreak, including potential labor and employment law, privacy, and even cybersecurity considerations.
Coronavirus: Implications for Contracts
It really is difficult to get your arms around the sweeping legal & business implications of the coronavirus epidemic. This Cleary Gottlieb memo picks up on one of the topics alluded to in the Nelson Mullins memo – the potential inability of companies to perform their contractual obligations due to the impact of the epidemic on supply chains. This excerpt addresses the potential availability of the “force majeure” clause to provide relief from contractual liability:
Force majeure clauses seek to define circumstances beyond the parties’ control which can render performance of a contract substantially more onerous or impossible, and which may suspend, defer or release the duty to perform without liability. They can take a variety of forms but most list a number of specific events (as well as more general ‘catchall’ wording to make clear the preceding list is not exhaustive) which may constitute a “Force Majeure Event” and excuse or delay performance, or permit the cancellation of the contract.
Matters such as war, riots, invasion, famine, civil commotion, extreme weather, floods, strikes, fire, and government action (i.e. serious intervening events that are outside the control of ordinary commercial counterparties) are typically included within the scope of Force Majeure Events.
The memo reviews how courts in the U.K., the U.S. & France have interpreted these clauses, and also discusses how common law doctrines of frustration and impossibility of performance may come into play in situations involving U.K. or U.S. contracts. It also touches on the right of parties to contracts entered into after October 1, 2016 under French civil law right to renegotiate those contracts based on a change in circumstances.
EU Blacklists The Cayman Islands & My Wife’s Book Club Gets Skunked
All this coronavirus stuff has made this morning’s blog pretty depressing, so I want to close on a lighter note. My wife is part of a neighborhood book club. Last week, it was hosted by a woman who lives across the street. At one point in the evening, she let one of the family dogs – “Hank” – outside. Hank is a very good boy, but he’s about as smart as you’d think a dog named Hank might be. So, he quickly ended up on the losing end of an encounter with a skunk.
Being a dog, Hank promptly retreated back into the house, whereupon he shared his “Eau de Pepe le Pew” with all the book club members in attendance. Regrettably, all of those women, including my beloved, returned home to their spouses reeking of skunk. As the neighborhood Facebook page lit up with late night tips on how to launder skunk out of clothing, it dawned on me that I live in a sitcom.
It’s at times like these when I fantasize of escaping from my suburban Ohio sitcom life – this week’s episode written & directed by Larry David – to an exotic location like The Cayman Islands. So, it kind of bummed me out to learn that according to this Debevoise memo, the EU just added my fantasy island to its “tax blacklist.” The memo discusses the implications of this action, which are most relevant for investment funds.
Okay, so that’s probably not real relevant to most of you, but I was just looking for an excuse to tell you about the skunking of the Wyndgate Farms book club. Have a good day, everybody!
Well, it didn’t take long for the Division of Enforcement to focus everybody’s attention on the SEC’s recent guidance on the use of key performance indicators in MD&A, did it? This Fried Frank memo focuses on how that guidance may influence the use of ESG metrics in MD&A. While the guidance itself only references ESG metrics in a footnote, this excerpt says that what it had to say about them is consistent with recommendations of some well-known sustainability frameworks:
Although the Metrics Guidance is largely silent with respect to ESG metrics as a specific category, it does note that some companies “voluntarily disclose environmental metrics, including metrics regarding the observed effect of prior events on their operations.” In a footnote, the Metrics Guidance provides examples of metrics to which the guidance is intended to apply, which include a number of ESG metrics, such as total energy consumed, percentage breakdown of workforce, voluntary and/or involuntary employee turnover rate and data security breaches.
While the Metrics Guidance addresses ESG metrics only via footnote, it is consistent with the recommendations in certain voluntary sustainability frameworks that require both qualitative and quantitative disclosure associated with ESG metrics. For example, SASB’s Conceptual Framework notes that sustainability metrics should be accompanied by “a narrative description of any material factors necessary to ensure completeness, accuracy, and comparability of the data reported.”
In addition, the TCFD recommendations note that reporting companies should provide metrics on climate-related risks for historical periods to allow for trend analysis and, where not apparent, should provide a description of the methodologies used to calculate the climate metrics. Similarly, both SASB and TCFD emphasize the importance of having effective disclosure controls and governance, as well as verifying ESG data (by third-party auditors, if possible).
As the memo also points out, many companies have been criticized by stakeholders for using ESG metrics that aren’t “easily comparable, decision-useful, and verifiable.” The new guidance on MD&A key performance indicators heightens the stakes for these ESG disclosures, and companies that don’t respond appropriately may face a bigger downside than complaints about “greenwashing.”
ESG: Building Value Through Good Disclosure
This Latham memo says that companies have an opportunity to build value through their ESG initiatives & disclosure. The memo says that clear and transparent ESG disclosures can “build trust and demonstrate the company’s thoughtful management of ESG risks and opportunities.” This excerpt offers some specific suggestions for preparing ESG disclosures:
– Companies should take steps to ensure the consistency of disclosures in financial and sustainability reports.
– Even if information is included in the sustainability report, ESG information should be included in financial reports if material and called for by the regulations underpinning the disclosure documents.
– Information disclosed in sustainability reports is subject to the antifraud provisions of the securities laws even if not filed with the SEC. The information in companies’ sustainability reports should be scrutinized and verified to ensure its accuracy and completeness as if it were filed with the SEC.
– Companies should explain the importance of the ESG factors in their disclosures to help the reader to understand why the information is meaningful to the company and how it fits within the company’s strategy.
In today’s environment, I don’t think companies that want to address their ESG performance have any alternative to real transparency. The audience for ESG disclosures is increasingly sophisticated & extremely skeptical, so the historically preferred alternative of having the marketing department “put lipstick on the pig” when it comes to describing corporate ESG performance is likely to get you clobbered.
Transcript: “Conflict Minerals – Tackling Your Next Form SD”
We have posted the transcript for our recent webcast: “Conflict Minerals – Tackling Your Next Form SD.”
