Here’s the results from our recent survey on director compensation in the wake of the 2015 Citrix decision:
1. When it comes to limits on our director pay:
– Yes, we have adopted limits since Citrix – 51%
– Yes, we had limits even before Citrix – 22%
– No, we don’t have limits – 26%
2. For those that have limits, our limits apply to:
– Cash only – 0%
– Equity only – 56%
– Both cash & equity – 44%
3. For those that have equity limits, our limits are based on:
– Dollar limit – 85%
– Share limit – 33%
4. For those that have limits, our limits are based on:
– Multiple of annual compensation – 35%
– Maximum number based on estimates of future compensation for a set period – 36%
– Other – 35%
5. For those that have limits, our limits are based on:
– Peer review – 43.6%
– What we could derive from the case law & settlements – 20.0%
– Our discretion – 58.2%
– Other – 16.4%
Privilege: “Oral Download” of Investigation Results to SEC May Waive Work-Product Protection
This Cleary memo addresses a recent decision by a Florida federal magistrate that could throw a monkey-wrench into a common method of informing the SEC’s Enforcement Division about information obtained in an internal investigation.
It’s not unusual for outside counsel retained to conduct that investigation to share factual information conveyed in witness interviews with the Division of Enforcement. That’s frequently done orally, and under the assumption that conveyance of this information won’t waive the protection of the attorney-work product doctrine for the underlying documentation of those interviews. The memo says this decision calls that assumption into question. Here’s the intro:
On December 5, 2017, Magistrate Judge Jonathan Goodman in the United States District Court for the Southern District of Florida held in SEC v. Herrera that the “oral download” of external counsel’s interview notes to the Securities and Exchange Commission (“SEC”) waived protection from disclosure under the attorney work product doctrine. In the same order, Magistrate Judge Goodman held that providing similar access to the client’s auditor did not result in a waiver.
As a result of the decision, the law firm was ordered to disclose to certain former employees of its client the interview notes that were orally conveyed to the SEC. The firm subsequently moved for clarification or reconsideration of the order – and an evidentiary hearing is scheduled for January 10th.
Coming Attractions: Securities Class Actions for Cyber Breaches
This Davis Polk memo says that securities class actions surrounding cybersecurity breaches are just a trickle now – but may soon become a wave:
The existence of securities fraud litigation following a cyber breach is, to some extent, not surprising. Lawyer-driven securities litigation often follows stock price declines, even declines that are ostensibly unrelated to any prior public disclosure by an issuer. Until recently, significant declines in stock price following disclosures of cyber breaches were rare. But that is changing. The recent securities fraud class actions brought against Yahoo! and Equifax demonstrate this point; in both of those cases, significant stock price declines followed the disclosure of the breach. Similar cases can be expected whenever stock price declines follow cyber breach disclosures.
The memo addresses emerging theories of liability in these cases & steps that companies can take to reduce their risk of a securities class action in the event of a cyber breach.
Last month, the WSJ published an investigative report that suggested that hundreds of corporate insiders frequently had uncanny timing when it came to gifts of company stock.
The WSJ examined 14,000 donations of stock to private foundations by insiders – and found that 3x as many were made before price declines of 25% or more than were made prior to comparably-sized price increases. It quoted a professor as saying that the chance that this kind of timing could result from random luck is “extremely small.” If luck’s not involved, what’s behind the fortuitous timing of these gifts? This excerpt speculates that this may be a case of old wine in new bottles:
Good luck or coincidence is one explanation for many of the well-timed stock gifts. Academic researchers say another possible explanation for some, given the outsize number of such gifts, is that some donors might be guided by inside information or backdating their stock gifts. Legal experts don’t agree on whether donating based on nonpublic information would be unlawful. Backdating a gift could be tax fraud, tax lawyers said.
When I first read this story, I thought the use of inside information was a more plausible explanation than backdating. Even after the Supreme Court’s decision in Salman, it’s not at all clear that a stock gift can give rise to insider trading liability. What’s more, some insider trading policies don’t apply to gifts of stock, it’s certainly plausible that insiders might capitalize on non-public information when it comes to gifting stock.
On the other hand, I was pretty skeptical about the idea that people are backdating gifts. I’ve been involved with a number of gifting situations involving insiders over the years – and large gifts usually involve pretty extensive planning by wealthy, well-advised individuals. So, I guess I wasn’t surprised that research showed that their timing is generally pretty good. But Broc reminded me that this is the kind of thing people said about options backdating a decade ago as well, so I did a little digging.
The most interesting thing I found was this study by an NYU professor referenced in the WSJ report. That study reached similar conclusions about the timing of CEO stock gifts almost a decade ago. It concluded that legal use of inside information could be part of the story, but also flagged evidence that strongly suggested that some insiders were backdating gifts as well:
Tests used to infer the backdating of executive stock option awards yield results consistent with the backdating of CEOs’ family foundation stock gifts. For instance, I find that the apparent timing of certain subsamples of family foundation stock gifts improves as a function of the elapsed time between the purported gift date and the date on which the required stock gift disclosure is filed by the donor with the SEC. This association between reporting lags and favorable gift timing does not hold for CEOs’ stock gifts to other recipients. Stock gifts of all types, including family foundation gifts, are also timed more favorably if they are larger and if they occur in months other than December, when many tax-driven charitable contributions ordinarily take place.
Ahem… well, it looks like my skepticism may just turn out to have been naivete. This could get interesting. . .
Insider Loans: SEC Brings a Rare Enforcement Proceeding
Since we’re sort of taking a stroll down memory lane today, I thought it was appropriate to flag this recent blog from Steve Quinlivan about a recent enforcement proceeding involving violations of Sarbanes-Oxley’s prohibition on loans to insiders. Here’s an excerpt summarizing the proceeding:
According to the SEC in an order settling an enforcement action, Alan Shortall was CEO and Chairman of Unilife Corporation, a Nasdaq listed issuer. According to the SEC, Shortall arranged for Unilife to make personal payments on his behalf aggregating approximately $340,000 over four years. The advances were outstanding for five to 36 days. According to the SEC, this violated provisions of the Sarbanes-Oxley Act which prohibits public companies from making loans to directors and executive officers, as codified in Section 13(k) of the Exchange Act.
In addition, an unnamed director of Unilife was going default on loans secured by a pledge of Unilife shares. Shortall agreed to arrange for Unilife to cover the loans. As Shortall understood Unilife could not loan money to the director, Shortall told the Chief Accounting Officer the loan was for the benefit of an external consultant. The SEC also found these transactions violated Section 13(k) of the Exchange Act.
Our more veteran readers may remember how much angst Sarbanes-Oxley’s prohibitions on loans to insiders caused at the time of their enactment. Interestingly though, it hasn’t resulted in a lot of enforcement activity. There may be a few others, but I’m only aware of one other enforcement proceeding dealing with loans to insiders – and that was way back in 2005.
First backdating & now loans to insiders – I think it may be time to get a MySpace account…
Audit Reports: PCAOB Staff Updates Guidance
I recently blogged about the PCAOB Staff’s implementation guidance on the new audit report regime. Last week, the Staff issued updated guidance providing additional information on determining auditor tenure – see page 4 of the updated document. We’re posting memos on the new audit report standard & the implementation guidance in our “Audit Reports” Practice Area.
– 37% of S&P 500 companies’ proxy statements present enhanced discussion of the audit committee’s considerations in recommending the appointment of the audit firm, up from 13% in 2014.
– 24% of mid-cap companies show enhanced discussion of the audit committee’s considerations in recommending the appointment of the audit firm (up from 10% in 2014) compared to 17% of small-cap companies (up from 8% in 2014).
– 38% of S&P 500 companies disclose criteria considered when evaluating the audit firm, a jump from 8% in 2014.
– 28% of mid-cap companies disclose criteria considered when evaluating the audit firm (up from 7% in 2014) compared to 27% of small-cap companies (up from 15% in 2014).
The report’s conclusions are consistent with the other studies on audit committee disclosure trends that we’ve blogged about in recent months. Investors want more information from audit committees – and audit committees seem to be responding.
Cannabizfile: “I’m From the Government, & Dave’s Not Here, Man”
California hasn’t always been recognized as a place that goes out of its way to attract new businesses – but this Keith Bishop blog flags a new state initiative trying to make life easier for one particular class of entrepreneur:
California Secretary of State Alex Padilla wants to help entrepreneurs in California by launching a new online business portal. According to Secretary of State’s press release, the new portal, coined “Cannabizfile”, provides useful information about cannabis-related business filings with the Secretary of State’s office. The Secretary of State has even published a public service announcement featuring actor Cheech Marin.
Casting Cheech Marin (of Cheech & Chong fame) in a PSA is inspired & shows a sense of humor that’s almost always lacking in government initiatives. The one disappointing aspect of the Cannabizfile website is that the FAQ section offers no insights into Dave’s whereabouts.
Our January Eminders is Posted!
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Brink Dickerson of Troutman Sanders sent in these thoughts about tax reform & MD&A: The corporate tax rate change will have three primary impacts on MD&A drafting:
– Prospectively, the impact of the lower rate. This is a “known trend or uncertainty” that needs to be discussed even where a company does not typically address future tax rates in its SEC filings.
– Historically, the impact of the change in the tax rate change on tax assets and liabilities, which will show up in the year-end financial statements.
– Prospectively, changes in repatriation plans, which again is “known trend or uncertainty.”
Brink expects non-GAAP disclosure regarding both. And he also expects that the amounts likely will be self-reconciling. For example, he would expect to see statements such as:
Our tax expense for 2017 was $ _million. This amount reflects a reduction in our Deferred Tax Asset of $_million as a result of a decrease in the value of our U.S. federal net operating loss carryforwards due to the rate decrease included in the Tax Cuts and Jobs Act, offset by a $_million decrease in our Taxes Payable, similarly resulting from the rate decrease. In the absence of the changes in the Act, our tax expense for 2017 would have been $_million.
For 2018 we expect an overall tax rate (including federal, state and foreign taxes) of _%, but in the absence of the Act would have expected an overall tax rate of _%. Historically, we have considered substantially all foreign profits as being permanently invested in our foreign operations, and we had no intent to repatriate those funds. We currently are reconsidering that policy in light of the changes contained in the Act.
Brink also expects a more granular discussion of future tax rates in earnings calls – and he suggests that since the analysts certainly will ask about it, many companies will want to include a slide on taxes & tax rates and probably a few sentences in their earnings release as well.
House Passes Proxy Advisor Reform Bill
Last week, the House passed proxy advisor reform legislation (H.R. 4015, “Corporate Governance Reform and Transparency Act of 2017”) by a 238-182 vote. As I blogged last week, this is a rehash of proposed legislation that has been floated in recent years…
Cybersecurity: NIST’s Re-Proposal
Recently, NIST issued a re-proposal to update its cybersecurity framework. The original proposal was published at the beginning of this year. Comments are due by January 19th…
Yesterday, I blogged about the SEC Staff’s new guidance on deferred tax assets and Form 8-Ks under Item 2.06. Note that a company may reach the conclusion that there is no impairment – or could rely on Item 2.06’s Instruction to defer the reporting of the impairment until the next quarterly report if the conclusion about the impairment is reached during a quarterly review. The bottom line is that after the Staff’s guidance, it’s unlikely that we’ll see many companies decide that an Item 2.06 8-K filing is required.
However, as this Gibson Dunn memo points out, companies need to keep in mind the possibility of an Item 2.02 filing if they discuss the impact of tax reform on their fourth quarter results after the new year:
Item 2.02 of Form 8-K applies to more than just a company’s earnings release, and instead is triggered by any public disclosure of material non-public information regarding a company’s results of operations or financial condition for a completed quarterly or annual fiscal period. Thus, any disclosures regarding material tax accounting effects of the Tax Act that relate to, but are made after the end of, the fiscal period that includes December 22, 2017 could trigger a required Item 2.02 Form 8-K. For example, if an executive of a calendar year company publicly comments on material tax accounting effects of the Tax Act during the first week of January 2018, the company may need to furnish such disclosures on a Form 8-K.
Item 2.02 8-Ks are “furnished,” not “filed” – and while they’re not optional, a stumble here won’t impact a company’s S-3 eligibility.
Speaking of that, the concerns that companies had before the Staff’s guidance about the possible need for an Item 2.06 filing suggest that it’s probably a good time for a reminder about the safe harbor that applies for certain 8-K items, including Item 2.06. For these 8-K items, there is no Rule 10b-5 liability for failure to file (under Rule 13a-11(c)), and the company does not lose Form S-3 eligibility if the disclosure is made by the due date of the next quarterly filing (under General Instruction I.A.3). The safe harbor covers 8-K line items that – like Item 2.06 – require materiality assessments, and while it doesn’t excuse willful failures to file, it does provide a bit of a cushion for companies that get their initial materiality analysis wrong.
Shareholder Proposals: Corp Fin Rejects Apple Despite SLB 14I
Here’s the intro from this blog by Davis Polk’s Ning Chiu:
The SEC Staff decided that a no-action letter by Apple citing the recently issued SLB 14I was not excludable based on the information presented. The Staff noted that “We are unable to conclude, based on the information presented in your correspondence, including the discussion of the board’s analysis on this matter, that this particular proposal is not sufficiently significant to the Company’s business operations such that exclusion would be appropriate. As your letter states, ‘the Board and management firmly believe that human rights are an integral component of the Company’s business operations.’ Further, the board’s analysis does not explain why this particular proposal would not raise a significant issue for the Company.”
Everyone is calling it a “holiday gift” (including this Cooley blog). One member wrote: “There are accounting departments throughout America who now know for sure that Santa’s full name is Santa EClaus. I have had clients absolutely freaking out about this – before the SEC’s guidance – because they felt they had no way to get their arms around the deferred tax valuation allowance number in time for an 8-K.”
Following up on my blog about the topic of deferred tax assets being impaired & the need to consider whether an Item 2.06 Form 8-K is required, the SEC issued this statement on Friday – along with a new Staff Accounting Bulletin No. 118 (from OCA & Corp Fin) and CDI 110.02 (from Corp Fin). These provide sorely-needed guidance about the impact of the signed tax legislation on financials – particularly deferred tax assets – including resolving some debated issues about how to handle disclosure (including Item 2.06 8-Ks).
This Steve Quinlivan blog notes some recent disclosures about the new tax law – and here is an example of a company filing a stand-alone Item 2.06 8-K in connection with the new law…
SEC Staff’s Tax Reform Guidance: The Open Issues (& Practical Considerations)
Many Tax Act accounting and disclosure issues remain to be addressed over the coming months during companies’ measurement periods, some of which may require guidance or consultations with regulators such as the Commission and the Treasury/Internal Revenue Service. For example, the Staff’s guidance does not expressly address the implications of filing a new Securities Act registration statement or conducting an offering off of an already effective registration statement during a company’s measurement period.
The Gibson Dunn blog also addresses “practical considerations” when it comes to Reg FD, Item 2.02 8-Ks and non-GAAP measures. Here’s their note about that last one:
Non-GAAP Financial Measures. To the extent that a company has not reflected the impact of the Tax Act in its financial statements (either on a provisional basis or as a result of having completed its assessment of such effect), and instead reports its financial results based on the tax laws as in effect immediately before enactment of the Tax Act, such disclosures continue to qualify as GAAP as a result of SAB 118.
However, to the extent that a company has completed or provisionally provided for its assessment of the tax accounting effects of an aspect of the Tax Act and reflected those effects in its financial statements, but then backs out that impact to address period-over-period comparability, the company should be mindful of the non-GAAP rules. For example, if a company has accounted for the impact of a provision of the Tax Act in its year-end financial results, but then states what its results would have been “excluding the impact of the Tax Act,” the company is presenting a non-GAAP financial measure that triggers the GAAP/non-GAAP presentation and reconciliation requirements of Regulation G and Regulation S-K Item 10(e).
In our “Regulatory Reform” Practice Area, we continue to post memos about how the tax legislation implicates a variety of business considerations outside of the SEC Staff’s guidance…
Last night, the Senate confirmed the nominations of Rob Jackson and Hester Peirce to serve as SEC Commissioners by unanimous consent. And before that happened, here was the news courtesy of Snell & Wilmer’s Jon Cohen (also see this Cooley blog):
I see that Senator Baldwin has backed off her threat to block the nominations of Robert Jackson and Hester Peirce after receiving their responses to the questions Senator Baldwin posed. It is also worth noting that Kara Stein’s term has ended and she is holding over. Mike Piwowar’s term will end this coming summer. And Robert Jackson, if confirmed, will take over a term ending June 5, 2019. This leaves a lot of room for this Administration to influence the composition of the SEC.
Many conservative groups have criticized federal agencies for allegedly using “guidance” as a substitute for the traditional “notice & comment” rulemaking process. In recent years, these complaints have gotten some traction in federal court & in Congress, but many agencies – including the SEC – continue to rely heavily on the use of guidance as part of their oversight activities.
That’s why this recent memo from Attorney General Jeff Sessions is big news – it basically says that the DOJ is out of the “rulemaking by guidance” business. Here’s an excerpt from the press release accompanying Sessions’ memo:
In the past, the Department of Justice and other agencies have blurred the distinction between regulations and guidance documents. Under the Attorney General’s memo, the Department may no longer issue guidance documents that purport to create rights or obligations binding on persons or entities outside the Executive Branch.
The press release says that the Attorney General’s Regulatory Reform Task Force will review existing DOJ documents and will recommend candidates for repeal or modification in the light of the memo’s principles.
It’s unknown whether the SEC or other agencies will feel compelled to follow the DOJ’s lead – but coming on the heels of the GAO’s recent decision that banking agencies’ leveraged lending guidelines were actually rulemaking subject to the Congressional Review Act, the AG’s action is another sign that agency guidance practices are being viewed with a jaundiced eye in DC.
Bye-Bye Buybacks? (Maybe Not)
Bad news for all you financial engineers out there – this WSJ article says that it looks like stock buybacks may be falling out of favor:
Companies in the S&P 500 are on pace to spend $500 billion this year on share buybacks, or about $125 billion a quarter, according to data from INTL FCStone. That is the least since 2012 and down from a quarterly average of $142 billion between 2014 and 2016.
Buybacks have been popular in recent years, in part because tepid economic growth limited perceived investment opportunities as well as expected returns on new plant and expanded operations. Adding to their appeal, repurchases can make shares more attractive to investors by lowering the share count and accordingly increasing earnings per share. The post crisis surge in buybacks has been frequently cited by stock-market bears as a sign that the market’s eight-year-long advance has been driven more by financial engineering than by long-term growth.
The article says that companies’ decisions to ease up on the throttle when it comes to buybacks are a result of an improving global economy, rising consumer & investor sentiment, and concerns about the staying power of this year’s stock market rally.
Wait a sec. . . According to this MarketWatch article, reports of buybacks’ demise may be greatly exaggerated. In fact, they appear to have exploded this month – perhaps hinting at what companies intend to do with the increased cash they expect to have on hand post-tax reform.
Bye-Bye CEOs? One in Three Gets Pushed Out
Earlier this year, I blogged about the research firm called “exechange” – and the “Push-out Score” model it uses to analyze the extent to which CEO departures were voluntary or involuntary. Based on the firm’s analysis of more than 200 changes in top management of public companies, a whole lot of CEOs are getting kicked to the curb. Here’s an excerpt from the firm’s recent study:
exechange uses a scoring system with a scale of 0 to 10 to determine the likelihood of a forced executive change. A Push- out Score of 0 indicates a completely voluntary management change, and a score of 10 indicates an overtly forced departure. The Push-out Score incorporates facts from company announcements and other publicly available data, including the age of the outgoing manager, time in office and share price performance. The system also interprets the sometimes-cryptic language in corporate communications, using a proprietary algorithm.
Around 36 percent of the Push-out Scores of CEO departures in the U.S. from the past 12 months reached values between 6 and 10, which suggest strong pressure on the outgoing CEO. Every third CEO in the U.S. steps down under pressure.
Mel Brooks’ version of Louis XVI said it was “good to be da King” – and a quick glance at any summary comp table says that there’s plenty of evidence for that. However, this report suggests that Shakespeare’s Henry IV also was on to something when he said, “uneasy lies the head that wears a crown.”
Last week, SEC Chair Jay Clayton issued another cautionary statement on cryptocurrencies & ICOs. The statement covers a lot of ground – and it zeroes in on the professionals involved in these deals & their actions following the SEC’s 21(a) Report:
Following the issuance of the 21(a) Report, certain market professionals have attempted to highlight utility characteristics of their proposed initial coin offerings in an effort to claim that their proposed tokens or coins are not securities. Many of these assertions appear to elevate form over substance. Merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security.
Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law. On this and other points where the application of expertise and judgment is expected, I believe that gatekeepers and others, including securities lawyers, accountants and consultants, need to focus on their responsibilities. I urge you to be guided by the principal motivation for our registration, offering process and disclosure requirements: investor protection and, in particular, the protection of our Main Street investors.
That boldface type isn’t from me – it’s from Jay Clayton. This is what a warning shot looks like, folks – and if you’ve been talking yourself into concluding that your client’s coin offering is different than all the rest, think again.
ICOs: SEC Halts ICO Offering
Just to make sure nobody missed the message, on the same day that Chair Clayton’s statement was issued, the SEC announced that it had entered a C&D order halting an ICO on the basis that it involved an unregistered public offering.
The SEC’s order is worth reading – if for no other reason than to drive home the point that a token can be a security even if it has some “utility”:
Even if MUN tokens had a practical use at the time of the offering, it would not preclude the token from being a security. Determining whether a transaction involves a security does not turn on labeling – such as characterizing an ICO as involving a “utility token” – but instead requires an assessment of “the economic realities underlying a transaction.” Forman, 421 U.S. at 849. All of the relevant facts and circumstances are considered in making that determination.
Interestingly, the issuer of the token contended in its offering materials that it had conducted a “Howey analysis” and that the tokens did not “pose a significant risk of implicating federal securities laws.” The SEC thought otherwise.
ICOs: Meanwhile, Over at the Plaintiffs’ Bar…
I recently blogged that the plaintiffs’ bar has jumped in on the ICO fun – and this recent blog from Kevin LaCroix at the “D&O Diary” highlights another new securities class action suit involving a coin offering. A company called Centra apparently raised $30 million in a token offering that was completed in October 2017. As this excerpt notes, that’s when things got interesting:
On October 27, 2017, shortly after the company completed its ICO, Centra was the subject of an unflattering profile in the New York Times entitled “How Floyd Mayweather Helped Two Young Guys From Miami Get Rich”). Among other things, the article disclosed that on Oct. 5, the company’s co-founders, Sam Sharma and Raymond Trapani, had been indicted by a Manhattan grand jury in connection with their testimony in a July trial involving drunk-driving charges against Sharma.
The article also detailed that Sharma and Trapani had no prior professional experience associated with the debit cards they hoped to build. Their prior business experience consisted of running a luxury rental car company. The Times was also unable to confirm with the major credit card companies the supposed business arrangement Centra had described on its website.
The company subsequently announced that the two founders were stepping aside – and a class action lawsuit was filed on December 13th…
