The Delaware Court of Chancery, in Sciabacucchi v. Salzberg, C.A. No. 2017-0931-JTL (Del. Ch. Dec. 19, 2018), has declared “ineffective and invalid” provisions in three corporations’ certificates of incorporation that purported “to require any claim under the Securities Act of 1933 to be brought in federal court.” Ruling on cross-motions for summary judgment, the Court, by Vice Chancellor Laster, ruled that “[t]he constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law. In this case, the federal forum provisions attempt to accomplish that feat. They are therefore ineffective and invalid.”
Yesterday, ISS posted this updated set of FAQs for equity compensation plans, complete with 2019 burn rate benchmarks. There are 8 new or modified FAQs…
The World’s Largest Holiday Disclaimer
In what used to be an annual tradition, now-retired Cary Klafter shared this world’s largest holiday disclaimer – running for 21 pages – a few years back…
Yesterday, the SEC adopted the rules allowing ’34 Act reporting companies to rely on the Reg A exemption from registration for their securities offerings. This rulemaking was required by the “Economic Growth, Regulatory Relief and Consumer Protection Act” enacted earlier this year. Here’s the SEC’s press release – and here’s the 34-page adopting release.
Meanwhile, the SEC approved the PCAOB’s budget for next year…
The SEC Closed on Xmas Eve
As noted in this executive order, all federal agencies are closed on Monday for Christmas Eve…
By the way, if the government had partially closed due to a lack of approved funding by Congress and/or the President, the SEC would have been one of those agencies that could have been impacted (but SEC Chair Clayton said a few days ago that the agency has funds available to continue to operate for a little while – like the SEC has done in recent years when the government closed). Last night, the Senate passed a short-term spending bill to avert a shutdown and hopefully the House will pass it today & the President signs it – but when this short-term funding runs out on February 8th, this threat will re-emerge.
E&S Disclosures: SEC Chair Clayton Speaks
In this blog, Cooley’s Cydney Posner summarizes commentary recently provided by SEC Chair Jay Clayton about E&S disclosures. Here’s an excerpt:
Clayton contended that the current materiality disclosure framework (“materiality, comparability, flexibility, efficiency and responsibility (i.e., liability) are the lynchpins”) is the right one, but that what goes into it needs to reassessed. That is, we need to recognize when things have changed, and, Clayton maintained, what is important now is forward-looking information. For example, Clayton observed that, because the market reflects anticipated future performance, stocks tend to move at the time of the earnings release and analyst call—when guidance tends to be issued—not at the time of filing of the 10-Q. (Is that a harbinger of his view on the need for quarterly filings, now that it’s back on the agenda? See this PubCo post.)
Although KPIs are valued because they can presage future performance, they’re not part of the regulatory framework because there is little comparability across companies or industries. As a result, adding KPIs and NGFMs to GAAP is really difficult. What Clayton would like to see with regard to KPIs and NGFMs is a clear tie-back to GAAP and period-to-period consistency for each company. In addition, he indicated, these types of measures should track how management looks at its business, not just how management wants to present its business.
Yesterday, the SEC posted this 31-page “request for comment” about earnings releases & quarterly reports – and deleted consideration of this topic from the meeting agenda for today’s open Commission meeting. The SEC released its request for comments – and adopted the hedging rules – ahead of schedule to provide more time for the other rulemakings still on the agenda, which remains very full. We’re posting memos in our “Earnings Releases” Practice Area.
Here’s some analysis from John:
The number – and depth – of the questions the SEC raises about the relationship between Form 10-Q and earnings releases (29 out of 46) in comparison to those addressing reporting frequency suggests to me that the SEC may be more interested in tinkering with quarterly reporting requirements rather than seriously considering a move to semi-annual reporting.
Also, the SEC’s questions surrounding how a change to semi-annual reporting under the Exchange Act would impact Securities Act registration requirements suggest that even if they went to semi-annual reporting, the requirements for Securities Act filings are likely to remain unchanged. There are lots of good reasons why the SEC might do that – but if so, then changing the frequency of 10-Qs would be practically meaningless to any company that wants to preserve its ability to access the capital markets quickly.
SEC Adopts Hedging Rules
Yesterday, the SEC adopted the hedging rules required under Section 955 of Dodd-Frank. The SEC adopted the rules a day before they were supposed to be considered at today’s open Commission meeting – and deleted consideration of this topic from the meeting agenda. Except for “smaller reporting companies” and “EGCs” – which get a one-year pass to mid-2020 – the new hedging rules apply to proxies filed during fiscal years beginning after July 1, 2019.
Here comes another salvo in the battle over mandatory arbitration. Recently, John blogged about possible problems with “compelling shareholders to arbitrate” bylaws under Delaware law (here’s an article on that topic). Now comes news about the use of shareholder proposals to have companies adopt mandatory arbitration. Here’s the intro from this WSJ article by Dave Michaels:
Johnson & Johnson is being drawn into a battle over how much freedom shareholders have to sue companies, in a bid by lawsuit opponents to force regulators to pick sides over investors’ access to the courts. Hal Scott, a Harvard University professor who represents a trust that owns J&J shares, filed a shareholder proposal with the company that would push shareholder disputes into private arbitration hearings, instead of federal court. J&J doesn’t want to bring the proposal up for a shareholder vote, and this week the health-care products company asked the Securities and Exchange Commission for permission to reject it.
Supporters of mandatory arbitration say it would save companies money and time, arguing arbitration would be faster and less expensive than grinding out federal lawsuits involving thousands of investors. Proponents argue that class-action access to the courts is vital for holding corporations and executives accountable to shareholders. “This is an important issue for the capital markets,” Mr. Scott said in an interview. “It affects whether private companies want to go public, and whether foreign companies want to list [here].”
About 8.5% of all U.S. exchange-listed companies are projected to be targets of class-action lawsuits in 2018, according to Cornerstone Research, a litigation and economic consulting firm. That is well above the 20-year average of 2.9%, Cornerstone said. Securities class-action lawsuits typically focus on claims that public companies either misled investors about important facts or events, or failed to disclose important information that would have altered shareholders’ investment decisions.
Much of the expense is born by existing shareholders, with other shareholders sometimes benefiting from a settlement or judgment. Research into whether such judgments deter future wrongdoing has been inconclusive, said Donald Langevoort, a securities-law expert at Georgetown University. Mr. Scott is seeking to list his proposal for a bylaw change that would require mandatory arbitration on J&J’s 2019 proxy statement. J&J shareholders would vote on the measure next year.
J&J wrote the SEC this week asking permission to exclude the proposal from its ballot. Forcing investors into arbitration would violate parts of federal law that forbid asking investors to waive their legal rights, J&J’s attorneys wrote. The SEC rules every year on whether companies can omit different shareholder proposals. While public companies could benefit from arbitration, some fear it would offend investors if they were to push too aggressively for it. A J&J spokesman declined comment beyond the company’s letter.
SEC Chairman Jay Clayton has said he wants to avoid a brawl over mandatory arbitration that would pit business groups against investors and likely splinter the five-member commission along party lines. Some Republican commissioners say arbitration should be given a shot if stockholders agree with it.
SEC & PCAOB Revive Chinese Auditor Scare
This MarketWatch article by Francine McKenna says it all about this recent joint SEC/PCAOB statement about the lack of regulator access to audits of Chinese companies that are listed in the US. As the MarketWatch article notes, the SEC & PCAOB haven’t told us why they released this joint statement. Was it in reaction to something they know (that we should know)? Francine ponders whether there is some big China auditor fraud brewing and the US regulators will point to this statement as “we have a “disclosure regime” style here and well, we warned you, our hands are tied here.”
As noted in this article, the PCAOB recently published this “outlook” about it’s intended areas of inspection for next year – some of which impact areas that audit committees are responsible for…
Due to popular demand, we have posted the transcript for last week’s webcast – “Shareholder Proposals: Corp Fin Speaks” – featuring Corp Fin’s Matt McNair in record time…
Pay Ratio: Letter from Investor Group to Fortune 500
Companies preparing for Year 2 CEO pay ratio disclosures now have more questions to consider. Recently, Fortune 500 company compensation committees began receiving a letter from a group of 48 institutional investors requesting them to disclose more information on workforce compensation practices.
The letter posits that since “disclosure of the median employee’s pay provides a reference point for understanding the company’s workforce,” companies should move “to help investors put this pay information into the context of your company’s overall approach to human capital management” with more expansive disclosure.
IRS Issues Section 83(i) Guidance
A few days ago, over on CompensationStandards.com, I blogged about new Section 83(i) of the Internal Revenue Code – it allows private company employees to defer taxes for up to five years from the exercise of a stock option or settlement of a RSU. Recently, the Treasury Department & IRS issued this notice about this new provision. This memo from Davis Polk outlines the key takeaways (we’re posting memos in our “Restricted Stock” Practice Area on CompensationStandards.com):
– The measurement period to determine whether the employer satisfied the eligibility requirement that 80% of U.S. employees received grants is measured on a single calendar year basis and does not take into account grants made in prior years
– Employers must withhold taxes at the maximum individual rate in effect at the time the stock with respect to which a Section 83(i) election has been made (deferral stock) is treated as received in income and will be treated as a noncash fringe benefit, which will provide employers additional time to collect amounts required to be withheld from employees
– The employee and employer must agree to place deferral stock in escrow to ensure that applicable withholding taxes are deducted
– An employer may opt out of Section 83(i) by not establishing an escrow arrangement
We blogged several weeks ago about a scheduled open Commission meeting to consider a “request for comment” on the nature & content of quarterly reports & earnings releases. That meeting was cancelled due to President George H.W. Bush’s funeral. Yesterday, the SEC posted this Sunshine Act notice for the rescheduled meeting, to be held next Wednesday – December 19th. And at this meeting, the SEC will also consider adopting the long-pending hedging rules – as required by Section 955 of Dodd-Frank…
“Human Rights” Due Diligence
A growing number of investors are starting to ask companies how they manage human rights risks – but it’s a difficult thing to get your arms around. A recent report from the “UN Working Group on Business & Human Rights” says that the best thing to do is to just get started with the four-step diligence process (as outlined in this “Executive Summary”).
This 27-page annex provides a deeper dive on tools & resources, based on “lessons learned” from early adopters. Here’s an excerpt:
Enterprises should begin to consider the risks of adverse human rights impacts associated with the sector (or sectors) in which the enterprise is operating. For instance, the extractive sector must consider the human rights in communities affected by their projects, the garment sector must consider supply chain labour practices, and the information technology sector must consider the human rights affected when privacy is not adequately protected.
These examples are only some of the risks that are obvious in these sectors. Sector risks will be associated by the nature of the products and production processes as well as with the way the sector is organized. Some risks are common to almost all sectors. As part of the identification process, the enterprise should go through the list of internationally-recognized human rights.
Trading Suspensions: The Shareholder Perspective
This MarketWatch article looks at the consequences that shareholders face when a company’s stock is suspended or delisted – and follows the journey of one company, along with its shareholders and plaintiffs’ lawyers. Here’s the intro (and find more guidance on this topic in our “Delistings/Trading Suspensions” Practice Area):
You’re a thrill seeker, trading in highflying cannabis and crypto stocks, but you think you can get out any time. Suddenly there’s news of an unexpected trading stop or suspension and delisting by an exchange or by the Securities and Exchange Commission. Is all lost?
Unfortunately, according to the SEC, that may be the case. If there’s no exchange to trade that hot stock, the shares may become worthless, the SEC warns in an Investor Bulletin about the consequences of trading suspensions.
Earlier this year, Broc blogged about Bank of America’s campaign to increase retail voting – they were donating $1 to Habitat for Humanity for every shareholder account that votes and also featuring online director interviews. This issue of Carl Hagberg’s “Shareholder Service Optimizer” reports that the effort was a resounding success – a 41% increase in voters (on top of an 8% increase last year) and over $900k donated. And importantly, a 4% increase in pro-management votes – this can make a big difference, especially for say-on-pay. Here’s how BofA maximized its results:
– First and foremost is the marketing truism that to get results you need to “repeat, repeat and repeat” your message.
– Equally important, you need to position your messages prominently – so they will be noticed right off the bat. BofA did a masterful job of this last year with its inaugural “Special Olympics” campaign. And this year, the message was even more prominently and frequently displayed. It was the very first – and very attention-getting – thing that shareholders saw when they received & opened the proxy package.
– Of course, the message needs to be a compelling one. Here, BofA hit a bases-loaded home run by choosing excellent and non-controversial charities last year & this year.
– Most compelling, however, were the attention-getting numbers: BofA was able to report that $650,000 had been donated to the Special Olympics last year – and that, we think, was a major motivating factor behind the huge number of new people who got on the bandwagon this year. (Next year, a $1 million goal will keep voters on the ranch – and will generate a lot more new participation, we feel certain.)
Carl also notes that BofA worked to increase the always hard-to-get “Employee Plan” votes. Not only did they post an educational video and email voting reminders, but they created a single “landing platform” for all employee plan accounts. The platform allowed employees to vote all of their positions through a single set of voting actions.
Mobile-Friendly Director Interviews: Another Vote-Getter
Another article from Carl Hagberg’s “Shareholder Service Optimizer” also speculates that BofA’s online director interviews contributed to the company’s massive increase in retail voting. The link was appended to all of the e-deliveries & employee outreach materials – and was posted on the voting sites.
Carl’s hypothesis is borne out by the fact that the “Meet the Board” feature is the most-visited content page for mobile-friendly proxies at EZOnlineDocuments. We’ve blogged before about EZOnline’s work – and Carl notes that he was “absolutely bowled-over” by a recent product demo. Here’s more:
Particularly for retail investors, having an interactive, web- and mobile-friendly proxy statement makes it easier to read, search and actually digest the content – better than anything else we have seen. We urge you to visit www.ezonlinedocuments.com and to zero-in on the “Clients” tab for a quick and easy-to-absorb look at how it works for clients like Coca-Cola, Mastercard, Xcel Energy and others.
Transcript: “This Is It! M&A Nuggets”
We have posted the transcript for the recent DealLawyers.com webcast: “This Is It! M&A Nuggets.”
Tune in tomorrow for the webcast – “Shareholder Proposals: Corp Fin Speaks” – with Corp Fin’s Matt McNair, who has headed the Division’s “Shareholder Proposal Task Force” for the past five years. Tune in to learn the experiences with implementing Staff Legal Bulletin 14I from this past proxy season – and learn the intricacies of new SLB 14J.
SEC Enforcement: Number of Actions Tripled in Last Six Months
Last month, John blogged about the Enforcement Division’s annual report on its activities – and how the SEC disputed calculations that showed a significant decline in actions over the last couple of years. This annual study from Cornerstone Research & NYU, which was released yesterday and breaks out the numbers for public companies, seems to support the SEC’s view – it shows that SEC enforcement actions more than tripled in the second half of the fiscal year, reversing the decline that began in 2017. In announcing the results of their study, the researchers highlighted these findings (also see this “D&O Diary” blog):
– The last quarter of FY 2018 saw the highest number of public company and subsidiary actions that also named individuals as defendants in a single quarter tracked by the Securities Enforcement Empirical Database (SEED).
– The SEC continued to bring the substantial majority (85 percent) of actions against public companies and subsidiaries as administrative proceedings in FY 2018. In contrast, the majority (55 percent) of actions without public companies or subsidiaries were filed as civil actions in FY 2018.
– Almost half (45 percent) of public company and subsidiary actions involved Broker Dealer or Investment Advisor/Investment Company allegations. This is consistent with the SEC’s focus on retail investors and the launch of its Retail Strategy Task Force at the end of FY 2017.
– More than half (61 percent) of public company and subsidiary defendants cooperated with the SEC during the fiscal year. This marked the fourth fiscal year in a row in which more than half of public company and subsidiary settlements noted some form of cooperation.
– The SEC imposed monetary penalties in nearly all (89 percent) of its FY 2018 settlements with public companies and subsidiaries. This percentage is consistent with the FY 2010–FY 2017 average of 84 percent.
This Audit Analytics blog reiterates that the overall number of comment letters has been declining for nearly a decade – but companies should stay attuned to perennial favorites (MD&A, non-GAAP) & trending topics (revenue recognition). The blog is particularly helpful because it includes sample comments – like these, which deal with revenue recognition:
– We note your disclosure regarding three performance obligations under your franchise agreements. It appears that you have concluded that these items are not distinct and therefore are not separate performance obligations given your conclusion that they are highly interrelated. Please revise your disclosure to clarify your conclusions. Reference 606-10-25-22.
– Please revise your disclosure to provide your accounting policy on revenue recognition as a result of your implementation of FASB ASC 606. Please refer to the guidance in FASB ASC 606-10-50 and Article 10 of Regulation S-X.
– Please revise your disclosure to provide your conclusion on the effectiveness or ineffectiveness of your Disclosure Controls and Procedures. In addition, please provide a detailed discussion on how the non-disclosure of your revenue recognition policy in the Form 10-Q affected your conclusion.
In connection with yesterday’s AICPA conference, SEC Chief Accountant Wes Bricker provided this statement on financial reporting & auditing issues that he’s been discussing with SEC Chair Jay Clayton and others. As you’d expect, a lot of the statement is aimed toward auditors – e.g. what they should be doing to improve quality. But the statement also emphasizes the role of companies in the financial reporting process – with plenty of recommendations for audit committees and management:
– Internal controls – particularly where there are close calls as to a significant deficiency or material weakness, audit committees should pay extra attention to the adequacy of & basis for the company’s ICFR assessment, and seek training if necessary (citing this enforcement action). It’s vital to focus not just on actual misstatements but also whether it’s reasonably possible that a material misstatement won’t be prevented or detected in a timely manner.
Also remember that it’s the company’s responsibility to develop, maintain & assess ICFR – and that the thresholds for auditor attestation don’t change these requirements (it’s not obvious whether this remark is intended to foreshadow a change to the attestation requirement, which was discussed as a future possibility when the SEC increased the smaller reporting company threshold and in today’s Senate testimony by SEC Chair Jay Clayton). This blog from Cooley’s Cydney Posner reports that several members of the OCA Staff also discussed internal controls issues at yesterday’s AICPA Conference – with tips on how to assess controls and how to adequately disclose a material weakness.
– CAMs – conduct a “dry run” so that the auditors & audit committee can discuss issues. It’s also important to understand that CAMs aren’t intended to duplicate management’s MD&A disclosure of critical accounting estimates.
– Continuing education for audit committees – audit committee members must have time, commitment and experience to do the job well. Just possessing financial literacy may not be enough to understand the financial reporting requirements fully or to challenge senior management on major, complex decisions. Audit committees must stay abreast of these issues through adequate, tailored, and ongoing education.
– Audit committee agendas – must be balanced toward understanding accounting, ICFR and reporting requirements. For example, as business, technology, accounting, and reporting requirements change, it is crucial that the audit committee understand management’s approach for designing and maintaining effective internal controls.
– Voluntary disclosure – OCA Staff encourages audit committees for listed public companies of all sizes to communicate how the listing requirements related to the “appointment, compensation, and oversight of the work of any registered public accounting firm. . .” are carried out, especially among smaller companies. There are positive disclosure trends among S&P 1500 companies when it comes to disclosing considerations in appointing the audit firm, fee negotiations and evaluations – but there are opportunities for more progress among mid- and small-cap companies.
– Company processes to ensure auditor independence – emphasizing the role of companies to promote compliance by regularly monitoring corporate structural changes or other operational events that may result in new affiliates or business relationships and timely communicating these changes to the auditor, as well as evaluating the sufficiency of these monitoring processes & practices. Also note that the OCA Staff is assessing comments on the auditor independence “loan” rule – final rulemaking is expected in 2019.
– Auditor communications – to enhance oversight, audit committees should consider requesting additional voluntary information from the auditor to understand their level of investment in quality control functions, the connection of technology to audit quality and how audit firm performance compares to others.
– New GAAP standards – continue to focus on implementing & refining compliance with new standards on revenue recognition, leases & current expected credit losses
“Accredited Investor” Verification: SEC Enforcement is Watching
Last week, the SEC issued a cease-and-desist order against CoinAlpha Advisors for a Reg D offering gone wrong – which shows that Enforcement will take issue with relying on self-completed questionnaires to verify accredited investor status under Rule 506(c). Here’s an excerpt from Steve Quinlivan’s blog:
The SEC alleged CoinAlpha did not have pre-existing substantive relationships with nine of the fund’s investors and engaged in a general solicitation of public interest in the securities offering through CoinAlpha’s website, which was generally accessible without password protection. Additionally, CoinAlpha engaged in general solicitation through blog postings, and media interviews and digital asset and blockchain conferences, accessible both via live attendance and through the Internet. Despite collecting accredited investor questionnaires and representations from investors certifying to their accredited investor status, Respondent did not take reasonable steps to verify that investors in the Fund were accredited investors.
During the subsequent SEC investigation, CoinAlpha retained a third party who determined that all 22 investors were accredited investors.
The SEC found CoinAlpha engaged in an unregistered public offering. CoinAlpha did not admit or deny the SEC’s findings.
– What led you to write “The Governance Revolution”?
– What are the most important messages in the book?
– When it comes to some of the hazards of the board process, what is “The State Dinner” all about?
– What about “Bullying”?
– What has been the biggest surprise for you in reaction to the book?
Last week, SEC Chair Jay Clayton delivered this speech, where he outlined where the SEC stands on its rulemaking agenda – as well as the priorities for 2019. See Exhibits A & B of the speech for handy charts (and this blog from Davis Polk’s Ning Chiu and WSJ article). Key initiatives include:
– Reviewing ownership & resubmission thresholds for shareholder proposals – including whether there are factors in addition to the amount of money invested and length of holding period that would reasonably demonstrate the shareholders’ interests are aligned with those of long-term investors
– Proxy advisor reforms – including transparency, conflicts, whether certain matters should be analyzed on a company-specific basis (rather than market-wide), and investor access to issuer responses to reports
– Proxy plumbing – focusing on improvements to the current system, rather than a major overhaul
– Cybersecurity – including disclosure controls & procedures, insider trading policies, risk factor disclosures, and the SEC’s own cyber-risk profile
– Brexit & LIBOR disclosures – SEC is monitoring these risks and whether their impact is adequately disclosed
– ICOs – continuing 2018 efforts to protect investors
– Quarterly reporting & guidance – studying the current regime to determine whether it can be improved
– Capital formation & access to investment opportunities (Jobs Act 3.0) – expanding testing-the-waters and making Regulation A available to public companies
Senate Banking Committee’s Hearing on Proxy Voting Process
SCOTUS Oral Argument: Anti-Fraud Liability – Is Janus Dead-Letter Law?
Back in 2011, the Supreme Court rejected the idea that distribution of allegedly false statements by a broker-dealer was enough to create anti-fraud liability under Rule 10b-5(b) – explaining that because they didn’t have “ultimate responsibility” over the statement, they weren’t the “maker” described in the rule. Broc blogged about the case – Janus Capital Group v. First Derivative Traders – at the time. But he also later blogged that the SEC wasn’t giving up its expansive view of Rule 10b-5 – arguing that a different test applied to subsections (a) and (c).
Now, that theory has also made its way to the Supreme Court – which held its oral argument last week. In Lorenzo v. SEC, the SEC is pursuing a former broker who says that at the request of his boss, he copied & pasted a message and distributed it to potential investors – and come to find out, that message contained misleading information about a troubled company.
This Simpson Thacher memo provides notes about SCOTUS’ oral argument, as well as explains the circuit split – and its potential impact on SEC enforcement & private litigation. Here’s their prediction about what could happen:
The justices appear split on the issues of this case, with Justices Ginsberg, Breyer, Sotomayor and Kagan (the original dissenters in Janus) appearing sympathetic to the government and Chief Justice Roberts and Justices Thomas, Alito and Gorsuch seemingly skeptical of expanding SEC enforcement abilities. With Justice Kavanaugh recused, this could leave open the possibility of a split decision, which, while affirming the D.C. Circuit’s decision below as to Lorenzo, would fail to resolve the circuit split, potentially encouraging forum shopping by private plaintiffs.
If the Court does reach a majority in favor of the government’s position, however, this case stands to have broad implications for private securities litigants. If Rule 10b-5(a) and (c) can be used to circumvent the “maker” requirement of Rule 10b-5(b) under Janus, private plaintiffs could potentially bring securities fraud actions against individuals who are otherwise only minimally connected to the misstatement.
