I know that Delaware’s Chief Justice Leo Strine is the kind of guy who could make his breakfast order sound provocative, but you’ve really got to check out his recent interview with “Directors & Boards.” The Chief Justice has all sorts of interesting things to say about the role of independent directors – including suggesting that perhaps we’d be better off with a few less of them. Here’s an excerpt:
We have a lot of unrealistic expectations for independent directors, and I think it would be better to rebalance boards a little bit. We need folks who are genuinely independent directors, but we also need directors with expertise, and we need directors who were active in business and who understand the industry. And some of the rules and incentives can get so tight that we actually discourage people with the right kind of qualities from serving on boards.
It doesn’t really matter if you’re independent if you don’t have expertise. But can you be independent and also have the expertise and the knowledge? I’m sure you can. We just independent director-ized the world. We went from having a bare majority of them to having a supermajority of them. We don’t actually empower them. We take away their ability to think long term because we put in place Say on Pay. We don’t do Say on Pay every four years or five years, where you would really have a long-term pay plan, we do it every year as a vote on generalized outrage.
Corporate management and employees are the most important thing to corporate success, especially employees — who, frankly, boards of directors, managers and institutional investors have undervalued for 30 years — which is part of why there are the tensions we have in society right now.
It’s refreshing to hear somebody with influence in the corporate governance debate finally say something like this. As I’ve blogged previously, my guess is that in 50 years people may really wonder why we thought it was a good idea to demand that the boards of the world’s largest corporations be comprised overwhelmingly of people with no ties to or experience with the company. Who knows? Maybe Chief Justice Strine’s remarks are a signal that we won’t have to wait 50 years for people to start asking that question.
Insider Trading: Another Lawyer in the Cross-Hairs
Earlier this year, I blogged about the SEC’s insider trading enforcement action against a former Apple lawyer who exploited his access to the company’s draft earnings releases. The SEC recently brought another proceeding against an in-house lawyer for SeaWorld who allegedly engaged in similar conduct. Here’s an excerpt from the SEC’s press release announcing the action:
The SEC alleges that Paul B. Powers had early access to key revenue information as the company’s associate general counsel and assistant secretary, and he purchased 18,000 shares of SeaWorld stock the day after he received a confidential draft of the 2018 second quarter earnings release that detailed a strong financial performance by the company after a lengthy period of decline. According to the SEC’s complaint, Powers immediately sold his SeaWorld shares for approximately $65,000 in illicit profits after the company announced its positive earnings and the company’s stock price increased by 17 percent.
“As alleged in our complaint, Powers blatantly exploited his access to nonpublic information by misusing SeaWorld’s confidential revenue data to enrich himself,” said Kurt Gottschall, Director of the SEC’s Denver Regional Office. “Investors should feel confident in the integrity of corporate officers, particularly attorneys. The SEC is committed to swiftly pursuing insiders who breach their duties to investors.”
According to the SEC, the defendant consented to a permanent injunction and disgorgement in an amount to be determined by the court. As seems to be almost standard operating procedure in these cases, parallel criminal proceedings were also filed. Sigh. Don’t insider trade.
Insider trading cases involving corporate officials who trade ahead of good or bad news are like shooting fish in a barrel for the SEC. Whenever I read about one, I’m reminded of the story of a buddy of mine, who while he was in college at Georgetown got good & liquored up one night and decided to jump into the Tidal Basin with a few equally inebriated cohorts. Upon pulling himself out of the water, he found himself at the feet of a very large & completely unamused member of the National Park Police. The officer looked down at my friend, shook his head, and inquired – “How stupid can you be?”
Tesla Tweets: Will The D&O Carriers Ultimately Rein in Elon Musk?
This recent article from MarketWatch’s Francine McKenna tries to answer the question: “how do you handle a problem like Elon?” Several notables weighed in with their views, but the response that I found most intriguing came from Betsy Atkins, a Wynn Resorts director:
Atkins believes that market forces will cause the correction needed before any regulatory sanction, even a bigger fine for Musk, does. “If I were on that board, I would be very concerned and want the company to buy additional liability insurance for directors,” Atkins told MarketWatch. “Plaintiffs attorneys are already circling and at some point the current directors and officers insurance carrier may become fatigued and potentially unwilling to immunize the board from the public and private litigation.”
It’s a truism that there’s always somebody out there who will provide some kind of D&O insurance if you’re willing to pay enough for it – but whether that price is something that an increasingly independent Tesla board would be willing to stomach in order to allow Elon Musk to keep on tweeting is another issue.
I’ve always been very skeptical about whether most institutional investors really care about “corporate governance” when it comes to decisions to part with their investment dollars – and the continued willingness of non-index funds to buy into IPOs for dual class companies is a big reason for that skepticism. But this article from TheStreet.com suggests that institutional investors may finally be pushing back:
Much has been written about the advantages and pitfalls of the multi-class system, which grants founders who own relatively small stakes in the company disproportionate control of votes. On one hand, founders can drive growth unencumbered by squabbling activists; on the other, it can be extremely difficult to remove founders who underperform.
In the case of Uber, it took the dramatic ouster of founder and ex-CEO Travis Kalanick by the company’s board in August 2017 to ditch the dual-class structure it favored in its earlier days. Once the founder-knows-best mentality collides with institutional money, companies are increasingly facing pushback from institutional investors or would-be activists whose authority to push for changes is kneecapped.
Once dual-class stocks are traded publicly, unicorns can find themselves “instantly unpopular” among those constituencies, said Wei Jiang, a Chazen Senior Scholar at Columbia Business School. “I certainly think they will need to get used to it,” Jiang said of the growing pushback, some of which was codified in a 2018 letter co-signed by Blackrock, pension plans and other long-term investors, which condemned the dual-class model as poor corporate governance.
So, that’s it? Dual class companies will be “unpopular” & won’t be able to sit at the cool kids table during lunch at investor conferences? If that’s the sanction, my guess is that most of these companies will tough it out & see how much more popular they become if they beat their growth forecasts. (Spoiler alert: they will become very popular).
Do you know what makes me dubious about claims that dual class companies are “increasingly facing pushback” from institutions? TheStreet.com wrote the exact same story a year and a half ago. And yet, here we are. . .
Activism: A Watershed Moment for Active Fund Managers?
According to this Barron’s article, active fund managers are becoming. . . well. . . more “active” – and Wellington Management’s recent decision to publicly oppose Bristol-Myers Squibb’s acquisition of Celgene may represent a watershed moment for them:
In the past, fund managers simply sold a stock if they didn’t like what a company was doing. Today, more and more are nudging companies whose shares are trading far less than they should be to make changes that will close the valuation gap. Why ghost a company when you can help it become the investment you need it to be? These new voices are being heard: Whether they shout or they whisper, the market listens.
Consider Wellington Management, the venerated, press-shy $1 trillion firm that, for the first time ever, has publicly opposed management. In late February, Wellington, which runs $359 billion for Vanguard, announced it would oppose Bristol-Myers Squibb ’s plan to acquire Celgene. Celgene shares fell 8% in a matter of hours. Wellington’s protest coincided with a behind-the-scenes critique by Dodge & Cox, another old-school money-management firm with $300 billion in assets. In every story about the Celgene deal, Dodge & Cox was described as a detractor.
“If I were asked to rank the most important moments of this era and name the one event that figures to have the most lasting impact, I would save the top spot for Wellington and its decision to become a public shareholder activist,” says Don Bilson, head of event-driven research at Gordon Haskett. “Corporate America had better take note, because the folks who actually pick stocks have finally decided to flex their muscles.”
I’m a lot less skeptical about institutions speaking up when it comes to opposing deals they don’t like than putting their money where their mouths are when it comes to dual class structures. As I’ve previously blogged over on DealLawyers.com, there’s some pretty good evidence that this kind of buy-side M&A activism pays tangible dividends for investors.
Wells Fargo Annual Meeting: “That Went Well . . .”
According to this Dallas Morning News report, it sounds like yesterday’s Wells Fargo annual meeting was kind of a train wreck. Here’s an excerpt:
C. Allen Parker was interrupted more than a dozen times during Wells Fargo & Co.’s annual meeting by activists who called executives “frauds” and “criminals” and demanded the interim chief executive officer turn the scandal-plagued bank around. “Frauds, all of you,” one heckler shouted as Parker tried to deliver his opening remarks in Dallas on Tuesday. “Wells Fargo, you cannot be trusted,” yelled another.
In what will likely turn out to be 2019’s least sincere CEO statement, Parker responded to the heckling by saying, “One of the wonderful things about shareholder democracy in this country is that we have meetings like this. . .”
In the “all’s well that ends well” department, Wells Fargo announced that the board was reelected, say-on-pay was approved & a new comp plan passed.
There’s no love lost for corporate CEOs on Capitol Hill these days – particularly among Democratic lawmakers. Here’s a case in point – Sen. Elizabeth Warren (D – Mass.) has introduced “The Corporate Executive Accountability Act,” which would impose criminal liability on any executive officer who negligently permits or fails to prevent a violation of law by their company. Yup, she said “negligently.” Here’s an excerpt from this Cleary Gottlieb blog:
If enacted, the bill would constitute a dramatic departure from the typical requirements for a criminal conviction. Traditionally, crimes require both a wrongful action and a particular mental state—the mens rea, or guilty mind. The required mental state is usually (at a minimum) knowledge with respect to the actions that constitute the crime.
The Supreme Court has observed that “[t]he contention that an injury can amount to a crime only when inflicted by intention . . . is as universal and persistent in mature systems of law as belief in freedom of the human will and a consequent ability and duty of the normal individual to choose between good and evil.” Negligence—which is the mental state required for conviction under the Corporate Executive Accountability Act—is a much lower threshold, requiring only that a person act unreasonably, and is usually reserved for the context of civil liability.
The blog notes that there’s precedent for imposing criminal liability on executives who aren’t directly involved in or aware of wrongdoing – the “Responsible Corporate Officer Doctrine” has made that possible under a handful of federal statutes. The blog points out that this doctrine has been applied narrowly to offenses against public health & welfare.
In contrast, Sen. Warren’s proposed legislation – which could not conceivably have anything to do with the fact that she’s running for president – would expand the doctrine’s reach to any crime committed by a company with at least $1 billion in revenue, “regardless of whether the crime affects the public health or welfare or impacts the general public at all.”
China IPO Pig Outs: Credit Where It’s Due
Last fall, I blogged about the new standard in management pig-outs being set by Chinese tech IPOs – apparently, several newly public companies were giving their CEOs $1+ billion bonuses for their role in taking the companies public.
According to this recent article from The Guardian, one of the recipients of that corporate largesse – Xiaomi founder & CEO Lei Jun – has opted to give his bonus to charity. At a measly £750 million, it doesn’t even amount to $1 billion at current exchange rates, but it’s the thought that counts.
Inside the SEC’s Investor Advisory Committee
If you’re looking for insight into the role that the SEC’s Investor Advisory Committee plays in the agency’s regulatory initiatives, check out this recent “Dimensions” interview of IAC member & UVA law professor Paul Mahoney. Here’s what Prof. Mahoney says about why you should keep an eye on IAC findings & recommendations:
The statute mandates that the SEC review any findings or recommendations that the IAC brings it. Moreover, the SEC must respond publicly to those findings and recommendations and disclose what action, if any, it intends to take in response. So, of course, securities lawyers and financial-reporting professionals should want to know what the IAC is doing because we have, at a minimum, the power to draw the SEC’s attention to an issue.
Beyond that, the IAC has a statutorily mandated consultative role in the SEC’s ongoing work to modernize and simplify the ongoing disclosure requirements for public companies under Regulations S-K and S-X, which the SEC calls the Disclosure Effectiveness Project.
As we’ve previously blogged, much of the clamor for proxy advisor regulation on the part of “main street” investors has been coming from the “Main Street Investors Coalition” – an organization that is essentially a sock puppet for the U.S. Chamber of Commerce & the National Association of Manufacturers.
It looks like we may finally have some data on what real retail investors actually think. That’s because Spectrem Group recently surveyed over 5,000 retail investors to get their views on proxy advisors. And guess what? If you buy into the survey’s results – which not everybody does – it appears that the sock puppet may have had its finger on the pulse of retail investors all along. Here’s an excerpt from the intro:
The results of an extensive survey of 5,159 retail investors points to a growing disconnect between the expectations of those everyday investors and the increasing influence of proxy advisors, companies that provide voting services to the investment firms managing retail investor money. The survey presented here directly asks retail investors about issues raised in the debate over proxy advisory firms, revealing retail investors’ level of concern with fundamental flaws in the proxy advisor industry, including, but not limited to, conflicts of interest, robo-voting and insufficient transparency.
The increased focus of fund managers and proxy advisors on political and social activism, rather than maximizing returns, is out of sync with the expectations of ordinary investors. This practice has the potential to negatively impact returns for all retail investors by increasing the burden on public companies with no clear link to shareholder value. The absence of the inclusion of retail investors in the proxy process – as demonstrated by the participation levels and their inability to influence institutional shareholder voting – means that the voice of retail investors, who own 30 percent of public corporations in the United States, is being drowned out.
In terms of specific issues, 36% of investors cited conflicts of interest as their top concern with proxy advisors, 23% named lack of transparency & 20% identified errors in proxy advisor reports. Enabling robo-voting was named as the top concern by only 13% of investors – but 40% ranked it in their top 3.
Reminder: Your 10-Q Needs a Statement of Changes in Shareholders’ Equity!
Since a lot of companies are closing the books on Q1 of 2019, here’s a timely reminder from this SEC Institute blog on a new requirement for your Form 10-Q:
As a quick reminder for first quarter-end, the SEC’s Disclosure Update and Simplification Rule last fall added a requirement to the Form 10-Q to include a statement of changes in stockholders’ equity. This requirement was added via this addition to Article 10-01(a) of Regulation S-X:
(7) Provide the information required by §210.3-04 for the current and comparative year-to-date periods, with subtotals for each interim period.
Article 3.04 referred to in the paragraph above is the requirement to provide a statement of changes in stockholders’ equity.
When the disclosure simplification changes went into effect last fall, the Staff issued Exchange Act Forms CDI 105.09 indicating that companies wouldn’t be required to provide this disclosure in their 10-Qs for the 3rd quarter, but that the disclosure would be required in subsequent 10-Q filings – and for most companies, that means the upcoming Q1 filing.
Transcript: “Activist Profiles & Playbooks”
We have posted the transcript for the recent DealLawyers.com webcast: “Activist Profiles & Playbooks.”
Disdain for the “Administrative State” is an article of faith among conservatives – and this Politico article discusses a recent OMB memo that’s likely to be music to their ears. Here’s an excerpt:
The White House on Thursday moved to curb the power of federal regulators by directing them to submit nonbinding guidance documents to the budget office for review, a step that could slow down the enactment of any rule with a potentially large impact on the economy. A memo from acting Office of Management and Budget Director Russell Vought would vastly broaden Congress’s ability to reject such guidance, subjecting the documents to the same scrutiny as regulations that carry the force of law.
The move is the latest salvo in a war waged by corporations and their Republican allies in government against what they view as backdoor rulemaking: agencies issuing regulatory documents that don’t go through the formal notice-and-comment process but can still be used as a cudgel against certain behavior.
The memo will have a potentially sweeping impact on agencies throughout the government including independent regulators like the Federal Reserve and the SEC. It calls on the agencies to regularly notify the Office of Information and Regulatory Affairs of upcoming guidance, along with determinations of whether it qualifies as “major” — the threshold for notifying Congress under the Congressional Review Act. Any guidance document deemed major by OIRA would need to be sent to Congress, which would then have the ability to strike it down under the review act, a law that gives lawmakers a short window to roll back a rule.
Compliance professionals should be very wary of what the Trump White House is trying to do here. In theory, restrained rulemaking is a reasonable idea — but time and again, we’ve seen this president and his sycophants in the White House playing with forces they’re too ignorant to use, bollixing up life for the rest of us.
For example, compliance officers of a certain age can remember the summer of 2008, and the feverish, improvisational rulemaking banking regulators tried back then to stave off the financial crisis. You’d really want OIRA review in the middle of something like that? You’d want Congress slowing down the process with 60-day approval windows?
In the real world, of course, if another crisis were to come along, you could bet your mortgage payment that the Trump Administration and Congress would grant some emergency stay of OIRA review, so regulators could move more quickly — and be left as the scapegoats, should the crisis explode anyway.
This isn’t the first time the Trump Administration has moved to curtail what it views as “rulemaking by guidance” – in 2017, former AG Jeff Sessions banned the DOJ from issuing guidance purporting to “create rights or obligations binding on persons or entities outside the Executive Branch.”
ESG: Trump Executive Order May Signal ERISA Fiduciaries to Watch Their Step
Last week was a big week for corporate America. In addition to the OMB memo, President Trump issued an executive order that contains a section directing the Secretary of Labor to “complete a review of available data filed with the Department of Labor by retirement plans subject to the Employee Retirement Income Security Act of 1974 (ERISA) in order to identify whether there are discernible trends with respect to such plans’ investments in the energy sector.”
That sounds innocuous enough, but this Davis Polk blog suggests that something more significant may be afoot:
While the section does not directly address environmental, social and governance (ESG) disclosure, it restates the definition of materiality from the U.S. Supreme Court case, TSC Industries, Inc. v. Northway, Inc., and reiterates a company’s fiduciary duties to its shareholders to strive to maximize shareholder return, consistent with the long-term growth of the company.
This order comes on the heels of last week’s U.S. Senate Committee on Banking, Housing, and Urban Affairs hearing on ESG Principles in Investing and the Role of Asset Managers, Proxy Advisors and Other Intermediaries, as well as ongoing activity at the U.S. Securities and Exchange Commission level, with certain institutional investors agitating for additional ESG disclosure requirements.
The blog says that while the order is silent about how the study might be used, it may well serve as the starting point for a crackdown on plan fiduciaries’ ESG activism. One “obvious use” of the study’s results could be to enforce the DOL’s April 2018 guidance prohibiting plan fiduciaries from focusing on ESG factors “solely to benefit the greater societal good.”
SEC Staff Guidance: A “Secret Garden” of Private Law?
You know who else has some issues with regulatory guidance? SEC Commissioner Hester Peirce. In a recent speech, Commissioner Peirce expressed concern about the extent to which the SEC Staff provides non-public guidance about unresolved regulatory questions. Here’s an excerpt:
Some requests for clarification or guidance are inappropriate for handling through a time-consuming process that results in a published response. Indeed, as a Commissioner, I hope that the staff is engaging productively and responsively with market participants. I would not want to see this engagement become so burdensome to either staff or market participants that it discourages people from seeking informal guidance or the staff from providing it.
However, when staff provides non-public guidance, Professor Davis’s concerns become much more pronounced, and I believe that there is a line that can be crossed where non-public staff guidance goes from being merely helpful “l-o-r-e” lore to something that is more akin to secret law that, for all practical purposes, binds at least some (though perhaps not all) market participants without any opportunity for review or appeal.
Commissioner Pierce suggests that private interactions between the Staff and private parties in certain areas have created a “secret garden” of guidance that raises questions of fairness & transparency. Peirce isn’t suggesting eliminating the practice of providing private guidance, but does see a need to “take down the walls of the secret gardens at the SEC, or at least to make doorways into these gardens, so that the public can get a glimpse inside, assess the quality of what is growing within, and hold us accountable for what is found there.”
Yesterday, Corp Fin announced a streamlined procedure for extending previously granted confidential treatment orders covering information in material contracts. The announcement notes that, when it comes to extensions, simply filing the redacted exhibit as contemplated by the new Fast Act rules will not provide confidential treatment for information in the previously filed CTR. This excerpt from the announcement summarizes the new procedure:
We have developed a short form application to facilitate and streamline the process of filing an application to extend the time for which confidential treatment has been granted. It is a one-page document by which the applicant can affirm that the most recently considered application continues to be true, complete and accurate regarding the information for which the applicant continues to seek confidential treatment. With that affirmation, the applicant indicates its request that the Division extend the time period for confidential treatment for an additional three, five or 10 years and provides a brief explanation to support the request.
Companies don’t have to refile the unredacted contract with the extension request, and if the supporting analysis remains the same as presented in the most recent CTR, they won’t have to refile that either. If the applicant reduces the redactions, the revised redacted version of the contract must be filed with the short form extension application.
The short form application may only be used if the contract has already been the subject of an order granting a CTR, and it can’t be used to add new exhibits to the application or make additional redactions. For a deeper dive into the new process, check out this Cydney Posner blog. We’ve also updated our “Checklist on Confidential Treatment Requests” to reflect this new procedure.
Cybersecurity: Beware Cyberinsurance’s War Exclusion
This recent NYT article says that the cyberinsurance policy you pay big bucks for may have a big hole in it – thanks to the standard “war exclusion” contained in most policies. Here’s an excerpt:
Mondelez, owner of dozens of well-known food brands like Cadbury chocolate and Philadelphia cream cheese, was one of the hundreds of companies struck by the so-called NotPetya cyberstrike in 2017. Laptops froze suddenly as Mondelez employees worked at their desks. Email was unavailable, as was access to files on the corporate network. Logistics software that orchestrates deliveries and tracks invoices crashed.
Even with teams working around the clock, it was weeks before Mondelez recovered. Once the lost orders were tallied and the computer equipment was replaced, its financial hit was more than $100 million, according to court documents. After the ordeal, executives at the company took some solace in knowing that insurance would he lp cover the costs. Or so they thought.
Mondelez’s insurer, Zurich Insurance, said it would not be sending a reimbursement check. It cited a common, but rarely used, clause in insurance contracts: the “war exclusion,” which protects insurers from being saddled with costs related to damage from war.
The U.S. government said that Russia was responsible for the cyberattack, which made Mondelez & other companies “collateral damage in a cyberwar” & gave insurers an opening to deny coverage under the war exclusion. Mondelez & Merck, which was also denied coverage, sued their insurers & the issue is working its way through the courts. The stakes are high – given the prevalence of state-sponsorship when it comes to big cyberattacks, the article suggests that the outcome could go a long way to determining whether cyberinsurance is worthless.
ICOs: Reg D Remains the Preferred Route
I blogged last year about a MarketWatch article highlighting coin offerings’ increased reliance on Regulation D following the Staff’s 2017 guidance on coin offerings. This recent MarketWatch article says that while the volume of coin offerings is down, Reg D still seems to be the preferred route. Here’s an excerpt addressing the number of Form D filings for token deals:
MarketWatch counted 33 ICO-related fundraisings accepted by the SEC in the first quarter of 2019, with a total stated value of $1.9 billion. That is down from a peak of 99 in the second quarter of 2018. MarketWatch estimated there were 287 ICO-related fundraisings accepted by the SEC with a total stated value of $8.7 billion in 2018. That was a significant increase from 44 fundraisings filed with a total stated value of $2.1 billion in 2017.
Now that I’ve seen both Lyft’s prospectus & Uber’s recent filing, I’ve reached the conclusion that we here at TheCorporateCounsel.net need our own mission statement. Here’s what I’ve come up with: “Our mission is to end global warming, poverty & tooth decay by publishing online and print resources for corporate and capital markets lawyers.”
Does that mission statement seem a bit unrealistic given the nature of our business? Well, I think ours is arguably more tightly tethered to reality than what either of these two high profile tech companies cab dispatchers are peddling.
Lyft says its mission is to “Improve people’s lives with the world’s best transportation,” while Uber says that “our mission is to ignite opportunity by setting the world in motion.” Both companies extensively embellish on their mission statements, with Lyft contending that it is at the forefront of a “massive societal change,” while Uber counters with a statement that it “believes deeply” in its “bold mission” and has a “massive market opportunity.”
This is heady stuff for companies with core businesses based on an app that does what Danny DeVito did in the ’80s sitcom “Taxi” & whose financials suggest that they spend a lot of time shoveling money into a furnace. Although to be fair, Uber will also deliver your Pad Thai order, and it’s . . .you know. . . sorry about the other stuff.
These messianic mission statements & the puffery that accompanies them have become a cliché in tech deals. But it seems to me that they do little to aid investors and a lot to obfuscate what companies actually do. The whole approach reminds me of nothing so much as “The Great & Powerful Oz” exhorting Dorothy to “pay no attention to the man behind the curtain” – only what’s frequently behind the curtain in tech deals is an endless string of huge losses, and a path to future profitability that is far from certain.
By the way, there’s plenty of disclosure about what’s behind the curtain in these prospectuses, if you take a moment to look for it. For instance, Uber accompanies its announcement of the new millennium with a 46-page “Risk Factors” section, while Lyft’s “Risk Factors” section is 41 pages long. So investors who get carried away with the hype have only themselves to blame. Read the prospectus.
Regulation G: Coming to a CD&A Near You?
SEC Commissioner Robert Jackson recently co-authored a WSJ opinion piece calling for increased transparency about the use of non-GAAP numbers in setting executive pay. The article notes that Reg G generally requires companies to provide comparable GAAP information & a reconciliation, but acknowledges that this doesn’t apply to the CD&A discussion. The authors think it should:
Unfortunately, those requirements do not apply to the reports that compensation committees of corporate boards disclose to investors each year. Thus, committees choosing to use adjustments when deciding on payouts need not explain why an adjusted version of earnings is the right way to determine incentive pay for the company’s top managers. This increases the risk that adjustments will be used to justify windfalls to underperforming managers.
The SEC’s disclosure rules have not kept pace with changes in compensation practices, so investors cannot easily distinguish between high pay based on good performance and bloated pay justified by accounting gimmicks. That’s why we’re calling on the SEC to require companies to explain why non-GAAP measures are driving compensation decisions—and quantify any differences between adjusted criteria and GAAP. A few public companies already provide investors with this kind of transparency. Others can too.
Transcript: “The Top Compensation Consultants Speak”
We have posted the transcript for the recent CompensationStandards.com webcast: “The Top Compensation Consultants Speak.”
Last week the market inched closer to peak “Unicorn” frenzy when – after what felt like a decade of speculation – Uber filed the Form S-1 for its IPO. Reuters reported that it’s seeking to raise $10 billion, which would be the largest offering since Alibaba went public in 2014. John will give his take on the prospectus tomorrow. For today, we’re looking back on IPO trends leading up to this enormous deal.
As Proskaur’s 6th Annual IPO Study shows, Uber’s IPO would build on trends from last year. Nearly half of the 94 IPOs in the study were conducted by companies with a market cap of at least $1 billion – with many of those deals coming from tech & health care behemoths. The 168-page study looks at a subset of IPOs that had an initial base price of $50 million or more. It offers all kinds of data points – and analyzes trends over the last six years. Here’s a few takeaways (also see this “D&O Diary” blog and Proskauer’s press release):
– 46% of analyzed deals were in the $100-250 million range, 48% of companies had a $1 billion+ market cap at pricing, 86% were EGCs
– 82% of IPOs priced in or above range, and the over-allotment was at least partially exercised in 77% of deals
– 99% of companies used the confidential submission process
– Average number of days from initial filing to pricing was 139, up slightly from the year before
– Average number of first-round SEC comments was down to 20 – and the study looks at the prevalence of “hot-button” comment topics, comments by sector, etc.
– 26% of companies included “flash results” for a recently-completed period – that number jumped to 50% for companies that priced within 45 days of quarter-end
– 47% of companies issued stock in a private placement within a year of going public
– 46% of companies disclosed a material weakness and 22% had a going concern qualification
– 15% of companies had multiple classes of stock – mostly in the tech sector – and 92% had a classified board
– 88% of US IPO issuers were incorporated in Delaware, 16% of IPOs came from Chinese companies
Unicorn IPOs: The More The Merrier
With companies staying private much longer these days than they did even five years ago, there’s a lot of pent up demand for “Unicorns” – venture capital-backed companies valued at $1 billion or more before going public (in Uber’s case, 90-100x more). The reason investors are itching to buy stock is because the companies are considered “high growth.” That’s bank-speak for “losing money” – one study even showed that the less profitable unicorns are, the more people like them! And that’s just one way these offerings can differ from those conducted by “regular” companies.
This “Unicorn IPO Report” from Intelligize takes a look at last year’s trends in this space, concluding that these “wild & independent creatures” actually demonstrate a “herd mentality” on some data points – not just on pricing, which is something that’s been written about a lot in the last few weeks & months – but also on things like (lack of) board diversity and the speed of their IPO process. Here are a few takeaways from this Mayer Brown blog (also see Intelligize’s press release):
– There were 20 unicorn IPOs last year, compared to 13 the year before
– A 7% underwriting fee remained the norm – despite concerns of an SEC Commissioner and legislators that smaller and medium-sized companies are paying higher fees
– About 30% of unicorns had multi-class share structures
– Other than Dropbox, all 2018 unicorns went public as EGCs – and took advantage of those scaled disclosure accommodations
– Excluding one outlier, the average time from draft registration statement filing to IPO was 132 days (shortest was 61 days) – about 140 days was spent between filing the draft and the Form S-1, with 28 days from S-1 to effectiveness (for the broader market, the average time from filing the S-1 to trading was 49 days)
Audit Committees: Auditor Assessment Template
Is your audit committee asking the right questions when it reengages your independent auditor each year? As detailed in this Cooley blog, the CAQ recently announced an updated version of its “External Auditor Assessment Tool” – with sample questions that are organized by category:
– Quality of services and sufficiency of resources provided by the engagement team
– Quality of services and sufficiency of resources provided by the audit firm;
– Communication and interaction with the external auditor; and
– Auditor independence, objectivity, and professional skepticism
The tool also includes a sample form and rating scale for obtaining input from company personnel about the external auditor, as well as resources for additional reading.
Here’s something I blogged yesterday on CompensationStandards.com: When the SEC adopted the pay ratio rule four years ago, it repeatedly stressed that company-to-company comparisons would be meaningless. The adopting release said:
As we noted in the Proposing Release, we do not believe that precise conformity or comparability of the pay ratio across companies is necessarily achievable given the variety of factors that could cause the ratio to differ. Factors that could cause pay ratio to differ from one company to the next include differences in business type, variations in the way the workforces are organized to accomplish similar tasks, differences in the geographical distribution of employees, reliance on outsourced workers, and the variations in methodology for calculating the median worker. Consequently, we believe the primary benefit of the pay ratio disclosure is to provide shareholders with a company-specific metric that they can use to evaluate the PEO’s compensation within the context of their company.
That message stuck: most people seemed to understand that the ratio would be company-specific, and there was a pretty “ho-hum” reaction to the first year of pay ratio disclosure. But, you might say, “What about tracking changes to a particular company’s ratio over time, to monitor how CEO pay increases compare to everyone else’s? Won’t that be useful?” More than a few people predict that pay ratio will garner more attention going forward, because shareholders & others will compare a company’s current year number to prior years.
The problem with that, as this WSJ article points out, is that the same factors that make comparisons among different companies meaningless are also things that can change from one year to the next at a single company. And as I’m sure you can guess, those changes cause big swings in the ratio. So for many companies, pay ratio doesn’t even provide meaningful year-over-year info (at least, about the relationship between CEO & employee pay). Here’s a couple of examples from the article:
Median pay at Jefferies Financial jumped to $150,000 last year from $44,584 in 2017 after the holding company sold most of its stake in its National Beef meat-processing unit in June 2018, cutting its workforce to about 4,600 from 12,600. The 2017 median employee at the company, formerly called Leucadia National, was an hourly line worker at National Beef, while last year’s was a senior research associate in the company’s Jefferies LLC financial-services operation.
Coca-Cola slashed its median pay figure by two-thirds after it finished shifting North American bottling operations to franchisees and acquired a controlling interest in African operations. The 2017 median worker was an hourly full-timer in the U.S. making $47,312, while last year’s made $16,440 as an hourly full-timer in South Africa. In its proxy statement, Coca-Cola said it intends to shed the African operation again after making improvements and offered an alternative median employee excluding that unit: an hourly full-timer in the U.S. making $35,878, about 25% less than his or her 2017 counterpart.
I will say, companies are making the most of what they have to work with (thanks in large part to the flexibility the SEC incorporated into the rule). And for better or worse, the “median employee” data point might illustrate to people how company policies & strategies play out in the workforce. But a single data point can’t tell the whole story – and the pay ratio itself remains pretty useless.
Internal Auditors Worry Boards Aren’t Using Them Enough
This survey of chief audit executives & directors, compiled by the Institute of Internal Auditors, suggests that enhancing internal audit’s role could help directors identify & mitigate emerging risks. Here’s a few of their recommendations (also see this and this CFO.com article and this Cooley blog):
– While cyber and IT issues have grown to represent nearly 20% of the average audit plan, CAOs still think there’s a shortage in the resources and skills that would allow them to protect the company from significant cyber incidents. Audit committees should ask about obstacles to internal audit’s performance in this area.
– At about 60% of companies, internal audit either never reviews board materials, or does so only for unusual situations. Copying the CAO on board materials would allow them to provide negative assurance on its accuracy, completeness, timeliness, transparency, and reliability. According to this WSJ article, the lack of corroboration worries auditors, who feel that audit committees aren’t exercising “professional skepticism,” and aren’t ensuring that necessary controls are in place.
– Organizational monitoring of third-party relationships is viewed by nearly half of CAOs as ad hoc or weak. CAOs must elevate concerns about weak controls on third-party risks to the audit committee. These relationships require the same level of risk management as any that affect the organization directly.
– 75% of CAOs report to the CFO – which is concerning because they may focus disproportionately on financial risks and overlook areas such as reputational & cyber risk. Internal audit can take on a greater role in oversight of emerging risks by monitoring “key risk indicators” for the company.
– Variances in audit committee structure and responsibility create the real possibility that in some organizations internal audit is not involved with committees that handle critical issues, such as cybersecurity and overall risk governance. For example, in many organizations, risk and IT committees, not audit committees, are tasked with overseeing cybersecurity and cyber preparedness. Such conditions could handicap internal audit’s ability to deliver perspectives about those vital risk domains. CAOs should be present and able to share information at these committee meetings.
“Changes in Accounting Estimates” Linked to Low-Quality Financial Reporting
Accounting isn’t as “black & white” as people sometimes think. This Audit Analytics blog highlights the tendency for people to overlook the significant judgment calls that are involved in financial reporting – and it takes a look at what it can mean when those judgments change. Here’s an excerpt:
Changes in Accounting Estimates (CAEs) are a normal part of periodic reviews of both current and future benefits and obligations. These estimates are recorded as new information appears. From an accounting perspective, the disclosure is governed by ASC 250, which requires all material changes in estimates to be disclosed.
The PCAOB proposed amendments to ASC 250 a couple of years ago, because it views this area as one of the riskiest parts of an audit. The blog walks through three studies that lend support to the PCAOB’s belief – and encourages auditors to be very skeptical of CAEs. Here’s the conclusion:
All three working papers found evidence that CAEs can lead to lower quality of financial reporting. Whether it may be from opinion shopping, managerial opportunism or an unintentional misstatement, these CAEs have been positively associated to subsequent restatements. This can lead to poorer financial quality which, in turn, can impede the assessment of earnings quality making it harder to accurately assess a company’s performance.
It was twenty years ago today
Sgt. Pepper taught the band to play
They’ve been going in and out of style
But they’re guaranteed to raise a smile
So may I introduce to you
The act you’ve known for all these years
Sgt. Pepper’s Lonely Hearts Club Band
Can’t believe it’s been twenty years since I last left the SEC as a Staffer. At the time, I was working for a SEC Commissioner. So my “going away” party was held in the SEC’s “Closed Commission Room.” That’s the room where the Commissioners meet to discuss & vote upon the agency’s enforcement actions. Very cool.
That party was quite different than when I left the SEC after my first tour of duty – that one was morning juice & coffee for the dozen or so people in my “branch.” Both types of parties were beautiful in their own way. Anyway, I thought I would excerpt a blurb from this blog about why working at the SEC is such a special experience:
Although some aspects of each ‘going-away’ party at the SEC varies depending on the circumstances, the constant is that a supervisor(s) makes some kind remarks – and then the person leaving speaks. That alone is quite powerful and something that I haven’t experienced at my numerous other jobs during my career. These are not big drinking events. In fact, they traditionally are done on the SEC’s premises at the end of the workday and they end by 6 pm. So they are short & simple – they are a stark reminder that everyone that works at the SEC is on the same team…
Always Have a Vacation on the Calendar
Thought I would borrow the title from my blog yesterday on “Broc Tales” to note that I’m starting a 5-week sabbatical this Monday – completely unplugged. Starts to make up for all the missed vacations over the years to my dear wife…
SEC IDs: Old School Style
Just found my SEC ID from my 1st tour of duty at the SEC back in the late ’80s:
