Check out this truly wild “Institutional Investor” article about hedge funds’ use of private investigators to dig up dirt on executives of potential targets. Some of the tactics these investigators use definitely push the envelope – but “hokey smoke, Bullwinkle” what they sometimes find!
The article tells one story involving the president of a large U.S. asset manager who was discovered by investigator Peter Barakett to have been arrested twice for art theft. The guy even had one of the stolen paintings hanging in his office. He avoided prison only because the statute had run, but is still managing $2 billion of other people’s money. This excerpt reveals a few other eye-opening discoveries:
Another case involved a Bear Stearns executive whose murder conviction had previously gone undetected because, Barakett suspects, a casual background check either did not look at records in every state he had lived in or checked the wrong name or date of birth. “Our client [an asset manager who was considering hiring the man for an IR position] could not believe it, and we showed him the proof,” he recalls.
Work for activist hedge funds is a particularly revealing task, according to Barakett. “I’m never surprised by what we find,” he says, mentioning a public company executive who had a “wife and kids in one city, and another wife and kids in another city in another — nonadjacent — state.”
The article also makes it pretty clear that hedge funds won’t hesitate to use the information they find as leverage. I guess the takeaway is that when people say certain activist hedge funds take no prisoners, they aren’t kidding around. So, if you’re a public company CEO with any skeletons in your closet, you’ve now got something else to worry about when one of these hedge funds comes knocking. And I’m sure they wouldn’t have it any other way.
ESG: New York Comptroller Releases Decarbonization Panel Report
Okay, I served dessert as the first course this morning – now you’ve got to eat your vegetables. And by that I mean it’s time for a couple of very earnest ESG blogs that may make your eyes glaze over. That’s ESG’s problem in a nutshell isn’t it? Some people think that the future of humanity may hinge on what nations & companies do about some of this stuff, but so help me, the nuts & bolts of it are often more boring than C-SPAN.
Anyway, it’s my duty to report that New York’s Comptroller recently released a 38-page report containing the recommendations of the “Decarbonization Advisory Panel” that the Governor convened last year. The panel was composed of experts from a variety of fields and was tasked with offering strategies for NYS’s Common Retirement Fund to use to identify, assess & manage the investment risks and opportunities of climate change. The Comptroller issued a press release summarizes the panel’s recommendations, and this excerpt lays out some of the specifics:
– The Fund should establish a new climate solutions investment program and increase its funding of investments with a proactive approach to climate risk and opportunity.
– The Fund should establish minimum standards to measure the readiness of its investments for climate change impacts and the transition to a low-carbon economy. These standards may vary by asset class, sector of the economy or geography, but could be used to construct indices, evaluate managers, direct engagement and define exclusion from the Fund’s portfolio.
The press release also said that the panel did not recommend divestment of specific stocks, but said that setting minimum standards could guide subsequent divestment decisions and provide guidance to help the Fund avoid investment managers with non-sustainable operations and strategies. The panel recognized that its recommendations would take time to implement, but encouraged the Fund to start working on a plan “with urgency.”
ESG: Not Just for Institutional Investors
ESG issues are usually considered to be priorities for certain institutional investors, but this Corporate Secretary article reviews a recent Allianz survey that says some of those issues move the needle with retail investors too. Here’s an excerpt:
Respondents were asked to rate the importance of a range of factors when deciding whether to invest in a company. The two highest-rated issues both fall under the ‘social’ section of the ESG umbrella, with 84% of respondents pointing to ‘the impact of [the company’s] product/service on people’s health or well-being’ and 84% pointing to ‘workplace safety/working conditions of employees.’
The next two highest-rated factors are both governance-related. ‘Transparency in business practices and finances’ is cited by 81% of respondents, while ‘wages provided to their employees’ is important to 80% of those taking part. The top two highest-rated environmental issues are ‘natural resource conservation (such as water conservation, species conservation)’ at 76% and ‘[the company’s] carbon footprint/impact on climate change’ (69%).
The article acknowledges that companies face challenges in communicating information about ESG issues to investors. There are no uniform disclosure standards, an assortment of intangible factors to assess & often an avalanche of data to sort through. It didn’t say anything about the need to tackle the “more boring than C-SPAN” issue though.
This Steve Quinlivan blog summarizes a recent derivative action filed against Facebook’s directors in connection with alleged insider trading involving sales of stock by Facebook’s CEO Mark Zuckerberg, its COO Sheryl Sandberg, and its former director & WhatsApp co-founder Jan Koum. Here’s an excerpt from the blog addressing the insider trading allegations:
In a wide ranging derivative action, a Facebook shareholder has filed a 193 page complaint in the Delaware Court of Chancery alleging three Facebook directors sold a total of $1.5 billion of stock while in possession of inside information. Specifically, the complaint alleges that at the time of the stock sales Facebook faced a looming crisis over privacy concerns and that the value of Facebook equity shares did not reflect such “inside information.” According to the complaint, when the directors sold their respective shares of Facebook stock, Facebook had been aware of the activities of Cambridge Analytica and the other misconduct referred to in the complaint.
The complaint also alleges violations of the proxy rules and breaches of fiduciary duty by the board in connection with Facebook’s repurchases of stock during the relevant period. In addition to 10b-5 claims against the three directors who traded during the relevant period, the complaint also alleges that “The sales of defendants Zuckerberg, Sandberg and Koum’s shares of Facebook common stock while in possession and control of this material adverse non-public information was a breach of their fiduciary duties of loyalty and good faith.”
Bringing fiduciary duty claims based on insider trading may seem somewhat incongruous given the pervasiveness of federal law in this area, but Delaware has recognized these so-called “Brophy claims” ever since the Delaware Supreme Court’s 1949 decision in Brophy v. Cities Service.
After a long period of relative dormancy, Brophy claims have become increasingly popular among plaintiffs in recent years. Part of the reason for that is a 2011 Delaware Supreme Court decision holding that disgorgement of all gains from insider trading is a potential remedy for the breach of fiduciary duty. But as this 2014 Business Law Today article suggests, there’s more to its increasing popularity than that:
The incentives of stockholder plaintiffs and their counsel to bring Brophy claims would seem to have increased with the confirmation that disgorgement of all gain by the alleged wrongdoer is a potential measure of damages. And, not only are the potential awards higher, but in certain circumstances, successfully pleading a Brophy claim will be less of a burden than a federal securities claim which is subject to the heightened pleading standards imposed by PSLRA.
Like other derivative claims, Brophy claims are generally subject to the heightened standard of pleading demand futility. But when it comes to the demand futility requirement, one of the interesting aspects of the Facebook complaint is that the plaintiffs allege that they made a demand on Facebook’s board – and received no response to that demand letter during the more than 10 months preceding the filing of the complaint.
IPOs: Founder’s Letters Get Some Love
If you’ve read my recent blog on Uber’s IPO, you know that I’m not a fan of founder’s letters in IPO prospectuses. I think they’re one of the many tech IPO clichés that investors could do without. But others hold them in much higher esteem than I do. This recent Olshan blog mounts a spirited defense of the founder’s letter & also reviews how the SEC looks at them during the comment process:
Based on our review of publicly available SEC comments, the SEC has frequently remarked in its comment letters that IPO letters need to serve a supplementary purpose that is meaningful to investors and directly relevant to the public offering. Given that the SEC’s prescriptive disclosure regime is designed to capture all material disclosures necessary for an investment decision, the SEC staff appears to have carefully reviewed the content and bounds of IPO letters.
Without specific rules applicable to such letters, however, the SEC appears to look primarily to the closest regulatory guidance, which is Item 503 of Regulation S-K. Item 503 requires a brief, clear and plain English business overview for the prospectus summary and risk factors touching on the most significant aspects of the company’s business and the offering.
In its reviews of IPO filings, the SEC has commented that IPO letters should be limited to a discussion of the company’s current business (particularly if the issuer is in its preliminary stage of development) and the risks of investing in the offering. The IPO letter must present a balanced summary of the business including, if presented, its current financial condition, future prospects and challenges.
The blog also discusses specific SEC comments on founder’s letters – including directives to discuss topics addressed only in those letters in other relevant prospectus sections, such as MD&A, as well as comments focusing on perceived inconsistencies between those letters and the other information in the filing.
IPOs: Here’s Why Founders Like High Vote Stock
Speaking of both Uber & founders, this recent letter from CtW Investment Group to Uber’s Board Chair Ronald Sugar is “Exhibit A” when it comes to why founders are so fond of sticking the public with low vote stock. After first acknowledging that “the company has a single voting structure, annual director elections, and a separate Chair and CEO,” the letter goes on to demand sweeping changes to its board over the course of the next 3 single-spaced pages.
Specific demands include the removal of John Thain as a director & that Sugar reduce his outside board commitments “prior to Uber’s stock being listed on the NYSE.” CtW also wants an overhaul of the board so that it is “more representative of its potential investor base.” I guess that’s not as urgent as the other stuff though – CtW gives the company until September 1, 2019 to get its act together on this.
It’s not lost on founders that while Uber’s shareholder-friendly governance structure is rewarded with investor ultimatums even before the IPO launches, a dual class company that received a letter like this could simply crumple it up & throw it in the waste basket. Investor advocates may find that appalling. Many entrepreneurs find it very reassuring.
As Liz blogged last week, the SEC & Tesla resolved their latest bit of unpleasantness late last month. The revised settlement gets pretty granular about what types of information Musk has to run by an “experienced securities lawyer.”
Statements that need to be run by this lawyer include those addressing the company’s financial results, including earnings of guidance, potential M&A activity, production, sales & delivery information, new business lines, previously undisclosed projections about the company’s business, and information relating to “events regarding the Company’s securities,” including Musk’s own transactions in them.
The settlement’s reference to the need to run all this past an “experienced securities lawyer” raises the question of “who will bell the cat?” According to this Law.com story, that particular position hasn’t been filled yet. I bet. It’s not exactly a plum assignment. After all, here’s what I think is a pretty realistic summary of the job description:
“The position involves telling our supervillain CEO who tweets at all hours and at a Trumpian pace that he can’t say what he wants to say on a regular basis. Oh, and just so you know, it’s entirely possible that he’ll be baked out of his gourd when you’re called upon to try to talk him into putting down his phone. Thoughts & prayers!”
And when Elon inevitably does fire off a non-compliant tweet, who wants to sign-up to be on the receiving end of the fire-breathing telephone calls from the Division of Enforcement, the Tesla board – and just maybe a federal judge?
Putting aside the job’s inherent undesirability, what makes anybody think that some lawyer is going to have any more success in keeping Elon’s fingers off the keyboard than his board, the plaintiffs’ bar and the SEC have had? Yeah, this is not gonna end well. . .
Quick Poll: How Does the SEC v. Musk Saga End?
Please take part in this anonymous poll on how the SEC v. Musk situation plays out.
Tune in tomorrow for the DealLawyers.com webcast – “M&A Stories: Practical Guidance (Enjoyably Digested)” – to hear Mayer Brown’s Nina Flax, Baker Bott’s Sam Dibble, Shearman & Sterling’s Bill Nelson and our own John Jenkins share M&A “war stories” designed to both educate and entertain.
On Friday, the SEC issued this 224-page proposing release that would make significant changes to the rules governing the financial information that public companies must provide for significant acquisitions and divestitures. Here’s the SEC’s press release – and we’ll be posting memos in our “Accounting Overview” Practice Area.
The “fact sheet” that the SEC included with its press release summarizes the changes that it proposes to make. As this excerpt indicates, they are fairly extensive and, in some cases, quite significant:
The proposed changes would, among other things:
– Update the significance tests under these rules by revising the investment test and the income test, expanding the use of pro forma financial information in measuring significance, and conforming the significance threshold and tests for a disposed business;
– Require the financial statements of the acquired business to cover up to the two most recent fiscal years rather than up to the three most recent fiscal years;
– Permit disclosure of financial statements that omit certain expenses for certain acquisitions of a component of an entity;
– Clarify when financial statements and pro forma financial information are required;
– Permit the use in certain circumstances of, or reconciliation to, International Financial Reporting Standards as issued by the International Accounting Standards Board;
– No longer require separate acquired business financial statements once the business has been included in the registrant’s post-acquisition financial statements for a complete fiscal year;
The changes would also impact financial statements required under Rule 3-14 of Regulation S-X (which deals with acquisitions of real estate operations), amend existing pro forma requirements to improve the content and relevance of required pro forma financial information, and make corresponding changes in the rules applicable to smaller reporting companies under Article 8 of Regulation S-X.
Interestingly, while Commissioner Jackson voted in favor of moving forward with the rule proposal, he also issued a statement in which he expressed concern that the proposals seem to proceed from the assumption that mergers and acquisitions are “an unalloyed good.” He expressed some skepticism about that, contending that the proposals ignore “decades of data showing that not all acquisitions make sense for investors.”
Ultimately, Jackson urged investors “to help us engage more carefully and critically with longstanding evidence that corporate insiders use mergers as a means to advance their private interests over the long-term interests of investors.”
For more detail on the rule proposals, check out this blog from Cooley’s Cydney Posner.
Exclusive Forum Bylaws: Fertile Ground for Corp Fin Comments
This Bass Berry blog says that companies that have adopted exclusive forum provisions in their charter or bylaws shouldn’t be surprised to receive comments on their disclosures about them in SEC filings. The blog includes links to a handful of recent comment letters touching on various aspects of exclusive forum provisions. Check it out!
Tomorrow’s Webcast: “Termination – Working Through the Consequences”
Tune in tomorrow for the CompensationStandards.com webcast – “Termination: Working Through the Consequences” – to hear Orrick’s JT Ho, Pillsbury’s Jon Ockern, Equity Methods’ Josh Schaeffer and PJT Camberview’s Rob Zivnuska discuss how the timing of when an executive officer becomes entitled to severance benefits can impact accounting, SEC disclosures, taxes, say-on-pay and shareholder relations. Please print out these “Course Materials” in advance.
Yesterday, the SEC posted this Sunshine Act notice of an open Commission meeting next Thursday – May 9th – to consider whether to propose amendments to the “accelerated filer” & “large accelerated filer” definitions and related transition thresholds (the Commission will also be discussing the cross-border application of rules for security-based swaps). The agenda says that any proposed amendments would be intended to promote capital formation for smaller reporting companies that are currently included in the larger filer categories.
When the SEC adopted the higher $250 million definition for “smaller reporting company” last year, the definitions of “accelerated filer” and “large accelerated filer” didn’t change. As a result, companies with $75 million or more of public float that qualify as SRCs are still subject to the requirements that apply to accelerated filers, including the timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal control over financial reporting – and I blogged that that was a point of contention among the Commissioners.
We’ve blogged a few times since then about SEC Chair Jay Clayton’s desire to promote capital formation – and his view that the SOX 404(b) thresholds play into that. So a proposal to amend the definitions wouldn’t come as a surprise.
Audit Committee Independence: Still Important
We get a pretty regular stream of questions on our “Q&A Forum” to the effect of, “Is it really *that* important for our audit committee members to avoid any potentially conflicting relationships with the company?” And we know our members aren’t just making up these questions for fun – let’s just say, the enhanced independence requirements aren’t always front of mind for every director. If I had a dime for every time one of my clients discovered a consulting agreement that had some sort of tie to an audit committee member…well, anyway:
In remarks yesterday, SEC Chief Accountant Wes Bricker called out independence of committee members as one of the main drivers of audit committee effectiveness – along with time, information quality and training & experience.
So yes, it’s still important to at least one influential person, even as we debate whether the overall trend of “supermajority” director independence is worthwhile. Wes also suggested that the auditor’s understanding of the company’s business & audit risks should be something the audit committee considers when evaluating their performance. And he implied that the idea of mandatory auditor rotation remains pretty dead in the US, despite some European regulators requiring it:
As relevant information for the audit committees’ oversight, I believe it is also essential for the committee members to familiarize themselves with relevant research evidence. For example, existing academic research has not been conclusive on the relationship between an auditor’s tenure and either audit quality or auditor independence. Some studies document that mandated rotation may worsen an auditor’s efforts to be skeptical and may mask company “opinion shopping.” There is also some evidence suggesting that professional skepticism can, in some cases, benefit from a long-term auditor-client relationship.
ESG Ratings: The Field Gets More Crowded
There’s some consensus that ESG ratings are impacting investment decisions – but it’s getting very difficult to keep up with all the offerings. S&P recently jumped into the mix with this “ESG Ratings Tool,” which allows companies to participate in the ratings process from start to finish. Assessments are conducted at the request of & in consultation with a company, and the company can then also decide whether & how to disclose the rating.
Meanwhile, State Street Global Advisors is fed up with the ESG ratings free-for-all and is now applying its own scoring system – “R-Factor.” This Davis Polk blog has the details:
An April 2019 SSGA article provides further insight into which resources SSGA is actually using to generate its R-Factor score for any company. For environmental and social scoring, R-Factor leverages the Sustainability Accounting Standards Board (or SASB) Materiality Map as the key framework for materiality.
SSGA writes that, “The R-Factor scoring model is powered by multiple best-in-class ESG data providers — Sustainalytics, Vigeo EIRIS, Institutional Shareholder Services (ISS) Governance and ISS Oekom — as well as SASB meta-data for categorizing and weighting.” SSGA uses another in-house proprietary tool for governance scoring that takes into account region- or country-specific norms. State Street has stated in other publications that it utilizes the Task Force on Climate-related Financial Disclosures Framework (known as TCFD) and that CDP’s (formally the Carbon Disclosure Project) Framework is another possibility.
It’s a safe bet that the SEC still takes social media more seriously than Elon Musk – whose recent Twitter bio was “Meme Necromancer.” But last week they called a truce in their ongoing battle by filing an amended settlement for court approval (although this WSJ article says that SEC Commissioner Rob Jackson wasn’t happy with the deal). The earlier version required a Tesla lawyer to give advance approval for any tweets that “contain, or reasonably could contain, information material to the company or its shareholders.”
I wrote about how the original settlement didn’t work out so well in practice, when Elon tweeted production numbers without getting pre-approval and the two sides couldn’t agree on whether those numbers were “material.” So, page 3 of the amended settlement attempts to be more specific – it says pre-approval is required for communications that contain information on any of the following topics:
– the Company’s financial condition, statements, or results, including earnings or guidance;
– production numbers or sales or delivery numbers (whether actual, forecasted, or projected) that have not been previously published via pre-approved written communications issued by the Company (“Official Company Guidance”) or deviate from previously published Official Company Guidance;
– new or proposed business lines that are unrelated to then-existing business lines (presently includes vehicles, transportation, and sustainable energy products);
– projection, forecast, or estimate numbers regarding the Company’s business that have not been previously published in Official Company Guidance or deviate from previously published Official Company Guidance;
– events regarding the Company’s securities (including Musk’s acquisition or disposition of the Company’s securities), credit facilities, or financing or lending arrangements;
– nonpublic legal or regulatory findings or decisions;
– any event requiring the filing of a Form 8-K by the Company with the Securities and Exchange Commission, including:
A. a change in control; or
B. a change in the Company’s directors; any principal executive officer, president, principal financial officer, principal accounting officer, principal operating officer, or any person performing similar functions, or any named executive officer; or
– such other topics as the Company or the majority of the independent members of its Board of Directors may request, if it or they believe pre-approval of communications regarding such additional topics would protect the interests of the Company’s shareholders
To anyone involved with insider trading, disclosure, Reg FD or social media compliance, this list looks similar to the materiality examples that those policies typically provide – i.e. info that’s not to be selectively shared, or publicly announced unless it’s fully-vetted. Hopefully there are controls to make sure those policies are followed!
While it’s not a bad idea to cross-check your own policies against this list, if you work with a limit-testing exec, you also might need to remind them it’s a baseline deriving from a (heavily) negotiated settlement – not an exhaustive list. So a principles-based approach remains best for most companies. As this article points out, it’s even hard to determine whether the tweet that caused this scuffle would require pre-approval, since Musk’s lawyers argued that the info was consistent with what was previously published in the company’s Form 10-K. This saga will likely continue.
Still More on “10-K/10-Q/8-K ‘Cover Page’ Changes: Courtesy of the Fast Act”
Yesterday, I blogged that the SEC had (very promptly) posted updated cover pages for Forms 10-K, 10-Q and 8-K – which companies now need to use due to the “Fast Act” rules being effective – and pondered why the Form 10-K cover page seemed to require companies to make redundant disclosure about the title & class of securities registered under Section 12(b). Now the SEC has moved the new “trading symbol” disclosure to a more logical location. The zombie Item 405 checkbox remains, for the time being…
More on “Human Capital: Investor Coalition Sends 45-Page Survey”
Last summer, I blogged about a lengthy survey sent to 500 companies by a 120-member investor coalition called the “ShareAction Workforce Disclosure Initiative.” The initiative stems from the UN’s Sustainable Development Goals and aims to get companies to disclose comparable workforce information. Now the coalition is reporting the results.
First off, 90 companies responded to the survey – which is honestly more than I expected – and apparently more companies plan to report human capital information to WDI in future years. But in most cases, the info they shared wasn’t as specific or transparent as WDI wanted. For example, here’s what the investors say about governance descriptions that were shared in the survey:
Although almost all (98%) companies reported extensively on their governance of workforce issues, the quality of these responses was highly varied and often missing key information. For example, while all companies named an individual or committee responsible for workforce issues, only 40% referred to specific areas of oversight – some companies referred to the credentials of individual board members or the composition of a committee rather than what they were tasked with delivering, while others did not even mention workers in their response. 10% of companies disclosed information on the regularity of oversight mechanisms and internal review of workforce issues (including Lloyds Banking Group).
There were significant weaknesses in the reporting of governance related to the workforce. Around half reported how overall responsibility for workforce issues is filtered down from the board to the rest of the organisation (including AIA Group, BAE Systems, Enel, Pearson, SSE, and Svenska Handelsbanken), and less than half provided specific examples of workforce-related performance indicators (including BHP, Cranswick, Inditex, Intel, Pearson, Veolia, and VW). Most companies only discussed corporate responsibility in general terms rather than linking workforce issues with performance-related remuneration.
The 13-page report summarizes five primary findings. WDI plans to post more analysis – and recommended disclosure & workforce practices – on its website in coming months.
The SEC’s “Fast Act” rules go effective tomorrow – which means you need to start using new cover pages for Form 10-K, Form 10-Q and Form 8-K. I blogged last month about our Word versions – and we’ve updated those to match the format that the SEC has now posted.
Also note that the way the trading symbol disclosure is set up for Form 10-K, companies will now need to identify the title(s) & class(es) of Section 12(b) securities twice on the cover page. That seems a little odd since page 82 of the adopting release acknowledged that the Form 10-K cover page already required that info and implied that the new rules would just add the trading symbol. Some of our members are speculating that this was done to facilitate tagging requirements and others think it was an oversight. Drop me a line if you know!
Fast Act: More FAQs on Expanded Hyperlinking Requirement
With the effective date looming for the Fast Act changes, we’ve been fielding tons of questions in our “Q&A Forum” about the new exhibit and hyperlink requirements. Here’s one (#9868):
Do the recently-adopted FAST Act disclosure simplification rules require registrants to include hyperlinks for the reports that are incorporated by reference into Part II, Item 3 of Form S-8? The adopting release does not mention Form S-8, but the amendments to Rule 411 could impact Form S-8 through general application of Regulation C (per Instruction B.1). Arguably, Item 3 should not be subject to the hyperlinking requirement, because the incorporation by reference required by Item 3 serves a different purpose than the incorporation by reference permitted under Rule 411, and because Item 3 also contemplates forward incorporation by reference (as to which hyperlinking is, obviously, impossible), but I haven’t seen any guidance on this.
John answered:
I think in the absence of guidance from the Corp Fin Staff to the contrary, people should assume that the hyperlink requirement does apply to S-8s, for the reasons you suggest. People raised the issue about forward incorporation by reference for other registration statements during the comment process, but the SEC wasn’t persuaded. See the discussion on pg. 77 of the adopting release.
In addition, John blogged last week about informal Staff guidance that suggests a link isn’t required if you’re incorporating by reference from one item to another within the same filing. Now, Bass Berry’s Jay Knight has followed up with thoughts on another common situation:
Question: How does this new hyperlinking requirement apply when the registrant cross-references the reader to other information that is contained either within the same filing or in a prior filing, without explicitly incorporating the information by reference?
For example, is a hyperlink required if the registrant in the legal proceedings item in Form 10-Q says that no material updates have occurred since the last Form 10-K and cross-references the reader to such prior disclosure, without explicitly incorporating the information by reference?
Here’s Jay’s answer:
Answer: Based on a review of the rules as well as the SEC’s adopting release, we believe it is reasonable to conclude that a “cross-reference” to other information, whether in the same or prior filing, should not be treated the same as the disclosure by a registrant that such other information is “incorporated by reference.” We believe this view is supported by the language in the new rules where incorporation by reference and cross-referencing are mentioned separately.
For example, new Rule 12b-23(b) states, “In the financial statements, incorporating by reference, or cross-referencing to, information outside of the financial statements is not permitted unless otherwise specifically permitted or required by the Commission’s rules or by U.S. Generally Accepted Accounting Principles or International Financial Reporting Standards as issued by the International Accounting Standards Board, whichever is applicable.” (emphasis added) We believe the phrase “or cross-referencing to” demonstrates that the SEC views incorporating by reference and cross-referencing differently.
In contrast, Rule 12b-23(d), which is the operative rule related to hyperlinking in the Form 10-Q context, omits any reference to cross-referencing. Rule 12b-23(d) states, “You must include an active hyperlink to information incorporated into a registration statement or report by reference if such information is publicly available on the Commission’s Electronic Data Gathering, Analysis and Retrieval System (“EDGAR”) at the time the registration statement or form is filed.”
Therefore, unless the registrant specifically incorporates by reference the information (perhaps even using that language explicitly), we believe it is reasonable to conclude that a hyperlink is not required by the new rules.
Our May Eminders is Posted!
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Following up on John’s blog about whether “non-IPOs” will become the new IPOs, on Friday, Slack Technologies filed a Form S-1 for its anticipated direct listing on the NYSE. Slack is the second big company to go this route (the first being Spotify). There are no lock-ups and no new shares being issued – but will this fundamentally change how IPOs get done? After delving into the unique parts of Slack’s “Plan of Distribution,” Bloomberg’s Matt Levine notes:
There is a sense of a sort of shadow-bookbuilding process: Slack’s banks are not underwriting an IPO, they’re not marketing stock to potential investors on behalf of Slack and its existing investors. But they are having chats with the existing private investors in Slack to see what their interest is in selling, and they’re having chats with potential public investors to see what their interest is in buying, and at what price, and those chats are all being relayed to the designated market maker, who will … just take binding bids and offers for the stock and set a price that clears the market? That last part seems pretty mechanical, which makes it not entirely clear why you need the first part, but I guess it is hard to let go of the IPO process entirely.
At any rate, there seems to be no shortage right now of “unicorn IPOs” – in one form or another. Yesterday, The We Company (otherwise known as “WeWork”) announced that it’s confidentially submitted an amended draft Form S-1. The WSJ reported that the filing was made without the assistance of bankers, but that doesn’t mean they won’t be hired eventually. If you’re a cynic, you’re not alone…
More on “Regulation G: Coming to a CD&A Near You?”
A couple weeks ago, John blogged that SEC Commissioner Rob Jackson wants the SEC to require explanations & reconciliations when non-GAAP numbers are used in the CD&A. Yesterday, the Council of Institutional Investors announced that it agrees with that suggestion – and it’s filed this petition with the SEC to recommend rule changes. Specifically, the petition requests that the SEC:
1. Amend Item 402(b) of Reg S-K to eliminate Instruction 5 (which says that disclosure of target levels that are non-GAAP financial measures won’t be subject to Reg G and Item 10(e))
2. Revise the Non-GAAP CDIs to provide that all non-GAAP financial measures presented in the CD&A are subject to Reg G and Item 10(e) – and that the required reconciliation must be included within the proxy statement or through a link in the CD&A
CII says it isn’t seeking a ban on using non-GAAP measures in compensation plans. However, it says that its members are concerned about the complexity in executive pay structures – and the challenges in understanding the link between pay & performance.
Lease Accounting: Compliance Still Costing a Pretty Penny
Late last year, “Accounting Today” reported that companies expected to spend $1-5 million to implement the new lease accounting standard, ASC 842. And a recent Deloitte poll is showing that, for many companies, compliance efforts will continue to require time & money for the rest of this year. Here’s the intro from Deloitte’s press release:
Nearly half of public company executives see no slowdown ahead in the time and effort to be spent on compliance with the new lease accounting standards issued by the Financial Accounting Standards Board and the International Accounting Standards Board, according to a new Deloitte poll conducted in February 2019. In fact, after they file Q1 2019 earnings, one-quarter (25 percent) expect to spend the same amount of time and effort on lease implementation related activities and nearly as many (23.9 percent) plan to spend more.
It’s no wonder that people are working so hard to get implementation right – Audit Analytics predicts that the standard will have a material balance sheet impact on 80% of companies.
It’s no secret that a small group of giant institutional investors exercise significant voting control over almost all large companies. One suggestion that’s been floated to “re-democratize” the proxy process – including in this research paper and in this WSJ op-ed from Vanguard’s founder John Bogle – is for funds to give up some voting power.
Last week, Vanguard announced that it’s doing just that. Starting later this year, the external firms who make investment decisions for 27 Vanguard funds – representing about 9% of its total assets – will also be making voting decisions for those funds. The practical takeaway is that you’ll now need to look more closely at which Vanguard funds own your shares – and you may need to familiarize yourself with the voting policies of these 25 firms. This WSJ article discusses the background & impact of the change:
Wellington Management Co., a Boston firm that serves as Vanguard’s biggest external manager, will gain the most voting power from the shift. Wellington oversees roughly $230 billion of the roughly $470 billion affected by the move. Twenty-four other outside firms control votes on the remaining amount.
“We are passing the baton to give active managers direct control over voting the shares of companies in which they invest,” said Glenn Booraem, who heads investment stewardship at Vanguard. “It’s to integrate their voting and engagement processes with their investment decisions.”
Wellington, in a rare public rebuke this year, said it opposed Bristol-Myers Squibb Co.’s deal to buy Celgene Corp. Wellington, however, wasn’t able to cast votes for all shares it managed. Vanguard retained control over a chunk of votes. Wellington had voting control over roughly 28 million shares of its some 126 million shares earlier this year. Shareholders ultimately approved the Bristol-Myers deal. Vanguard voted most of its shares in favor of the deal, said a person familiar with the matter.
The first Vanguard fund where an outside active manager has the power to vote shares will be launched in late May to early June. The fund will target companies with strong environmental, social and governance practices, and Wellington will manage it.
CEO Succession: Trends
Recently, Spencer Stuart released its annual report on CEO transitions in the S&P 500. Here’s the key takeaways:
– In 2018, the number of CEO transitions fell slightly, to 55 from 59 in 2017
– 69% of CEOs retired or stepped down; 22% of CEOs resigned under pressure, 5% left for health reasons, 2% left as a result of a company acquisition/merger and another 2% for other reasons
– 73% of new CEOs were promoted from inside the company, compared to 69% in 2017 and 90% in 2016
– Of the 12% of CEOs to resign under pressure, only 42% of candidates who took the role were internal promotions
– 1 of the 55 new CEOs is a woman and 20% had prior public company CEO experience
– 15% of new CEOs were also named board chair, compared to 7% in 2017 – and 35% of outgoing CEOs stayed on to serve as board chair, compared to 51% in 2017
CEO Succession: Why Boards (Not CEOs) Should Own the Process
CEO succession is a collaborative process involving the board, CEO, senior management and outside advisors. Although the CEO should be a productive partner in the process, the board – not the CEO – should drive the process, and clearly define and manage all participants’ roles& expectations.
This WSJ article gives a bunch of reasons why that’s the case. Here’s an excerpt (also see this Korn Ferry memo about the benefits of continuous “CEO progression” planning):
CEOs might not have the right perspective to evaluate successors. At the end of a long career, many CEOs are concerned about their legacy. This can bias them toward favoring candidates who will guide the company in the same direction—and in the same manner—that they themselves led it. Research bears this out: When powerful CEOs play a role in the succession process, they steer the choice toward someone with similar characteristics to themselves. However, the future is rarely like the past, and if the company’s success going forward requires a change in strategy or a different mix of skills, duplicating the old CEO—even a very successful one—can be a costly mistake.
CEOs can also distort the process through their behavior. Because they generally control top talent development in their companies, they control the flow of information that the board receives about how internal candidates are progressing, as well as shaping the board’s assessment of that information. In addition, they control access—the opportunity for directors to meet face-to-face with the people they will be evaluating. Subtle actions can serve to block a disfavored candidate or promote a favored one, biasing the board’s understanding of the candidates’ strengths and weaknesses, skewing the evaluation process, and ultimately leading to the incorrect choice.
Broc recently blogged about SEC Commissioner Robert Jackson’s concerns that insiders were using buybacks as an opportunity to cash out. Well, it turns out that they aren’t alone – buybacks are providing a frightening amount of the overall demand for corporate equities. This excerpt from a recent Bloomberg article on the effects of a ban on corporate buybacks just blew me away:
With political scrutiny of stock buybacks growing, Goldman Sachs started assessing an extreme scenario: “a world without buybacks.” The picture doesn’t look pretty. That’s because corporate demand has far exceeded that from all other investors combined, according to strategists led by David Kostin. Since 2010, net buybacks averaged $420 billion annually, while buying from households, mutual funds, pension funds and foreign investors was less than $10 billion for each, Federal Reserve data compiled by Goldman showed.
The article says that corporate repurchases represent the “largest source of U.S. equity demand,” and says that because other potential buyers are pretty saturated with equity investments, they’re unlikely to step in if companies pull back. According to Goldman, “aggregate equity allocation totals 44% across households, mutual funds, pension funds and foreign investors — and that ranks in the 86th percentile relative to the past 30 years.”
So, on the one hand, if buybacks stop, the market will lose its largest source of demand for equities, which is really bad news. But on the other hand, the market’s dependence on buybacks to provide demand cannot possibly be healthy – or sustainable – over the long term. And that may be even worse news.
According to this recent WSJ article, shareholders continue to gain clout in public companies, and the latest sign of that is increasing support for ESG shareholder proposals. Here’s an excerpt:
The median level of support for environmental and social shareholder proposals as a percentage of votes cast rose from the middle single digits from 2000 until 2008 to 24% in 2018, representing record levels of support, according to proxy-advisory firm Institutional Shareholder Services Inc.
But the real measure of success is the record 48% of proposals characterized as social or environmental that were filed and then withdrawn in 2018, according to ISS. That’s up from an average of 38% over the prior seven years. Such proposals are often withdrawn after a company accedes to at least some of the shareholder demands.
That’s all interesting, but to me, the best example of how much things have changed when it comes to shareholder clout is another WSJ piece from an earlier time that’s referenced in the article. That 1996 piece describes the response of ever-combative former Cypress Semiconductor CEO T.J. Rodgers to a letter from Sister Doris Gormley pressing for women to be represented on the company’s board.
While Rodgers’ letter was praised by some at the time as a strike against “political correctness,” today it reads as both condescending & more than a little misogynistic. For instance, can you imagine a CEO today responding to a shareholder seeking board gender diversity by saying that only a person with an advanced technical degree or CEO experience was qualified – and that few women or minorities “fit the bill?”
Fast Act Rules: Informal Staff Guidance on Expanded Hyperlinking Requirement
As part of the new Fast Act disclosure simplification rules, companies will be required to hyperlink to information incorporated by reference into a registration statement or report if the information is publicly available on EDGAR “at the time the registration statement or form is filed.”
This recent blog from Bass Berry’s Jay Knight discusses some informal Staff guidance on how this new requirement applies to information incorporated by reference from one item to another within the same filing. Here’s an excerpt:
The SEC staff has provided informal interpretive guidance that they believe it is reasonable for registrants to interpret the phrase “at the time the registration statement or form is filed” to mean that such information would need to be on EDGAR prior to the time the registration statement or form is filed.
In other words, an active hyperlink would not be required by the new rules if such hyperlink would be to information within the same filing. The SEC Staff noted that companies are permitted, if technically feasible, to include such hyperlinks to information within the same filing, but that they do not view the rule as requiring this.
