An almost universal question when a company is subject to a formal or informal SEC investigation is: “Do we need to disclose the investigation?” The traditional advice is: “No, unless the underlying facts in themselves necessitate disclosure.” Comments by the Corp Fin Staff at seminars and elsewhere always have been consistent with this – but the SEC never has issued any formal guidance, which can lead to companies & audit committees second-guessing the soundness of the traditional advice.
In 2012, in Richman vs. Goldman Sachs, the SDNY held that so-called Wells notices – the SEC notice to a potential defendant that the SEC intends to proceed with formal charges unless the potential defendant can convince it otherwise – do not in themselves need to be disclosed. A fortiori, there should be no duty to disclose an investigation either, but that was not the focus of the opinion. More recently, in January 2016, in In re Lions Gate Entertainment Corp. Securities Litigation, the SDNY reached the same conclusion again. What is particularly helpful about Lions Gate is that, in concluding that no disclosure of an investigation or a Wells Notice was required, the Court systematically went through each of the potential disclosure triggers under Section 10, Regulation S-K and GAAP and ruled each out.
This is not to say that there are not plenty of situations when a company might prefer to disclose an SEC investigation – e.g., where the overall situation already has been widely discussed and there is a general desire to shorten the news cycle – but it is to say that companies can rest comfortably that they do not have a disclosure duty unless either (i) the facts underlying the matter being investigated trigger a disclosure obligation independent of the SEC investigation (or Wells notice), or (ii) they make statements about their situation that necessitate discussion of the SEC investigation (or Well notice) in order for their statements not to be misleading.
New Lease Accounting Standard: FASB Balloons Balance Sheets
As noted in these memos, the FASB recently issued ASU 2016-02, Leases (Topic 842) that ushers in a new era in which lessees will recognize most leases on their balance sheets (beginning for fiscal years after 2018) – which will increase their reported assets and liabilities – in some cases, quite significantly. Lessor accounting remains substantially similar to current US GAAP.
This analyst report notes that the accounting change may increase debt reported by companies by a staggering $1 trillion…
Transcript: “How to Get Your Equity Plan Approved By Shareholders”
We’ve posted the transcript for the recent CompensationStandards.com webcast: “How to Get Your Equity Plan Approved By Shareholders.”
1. Spousal/family member tag-along on corporate plane where executive is flying for business reasons (assume no incremental cost of tag-along):
– Definitely a perk – 52%
– Leaning toward a perk – 20%
– Leaning toward not a perk -14%
– Definitely not a perk – 15%
2. Spousal/family member tag-along on corporate plane where executive is flying for personal reasons (assume no incremental cost of tag-along):
– Definitely a perk – 87%
– Leaning toward a perk – 5%
– Leaning toward not a perk – 2%
– Definitely not a perk – 6%
3. Executive use of corporate plane for outside board meetings (i.e., director of another company):
– Definitely a perk – 60%
– Leaning toward a perk – 20%
– Leaning toward not a perk – 14%
– Definitely not a perk – 7%
4. Outside director’s use of corporate plane to attend company’s board meeting (i.e., picking up directors for meetings):
– Definitely a perk – 7%
– Leaning toward a perk – 5%
– Leaning toward not a perk – 25%
– Definitely not a perk – 64%
5. Executive use of corporate plane to attend a meeting of the board/trustees of a charitable organization:
– Definitely a perk – 59%
– Leaning toward a perk – 22%
– Leaning toward not a perk – 16%
– Definitely not a perk – 3%
B. Other Spousal/Family Member Issues
1. Travel costs associated with spouse attendance with directors at annual board retreat/meeting where all spouses are invited:
– Definitely a perk – 43%
– Leaning toward a perk – 24%
– Leaning toward not a perk – 21%
– Definitely not a perk – 12%
2. Travel costs associated with spouse attendance with directors at a board meeting where spouses are welcome, but not formally invited, and only a few spouses attend:
– Definitely a perk – 70%
– Leaning toward a perk – 21%
– Leaning toward not a perk – 6%
– Definitely not a perk – 4%
3. Spousal golf and other extra services, such as day travel or spa services, for when the board is in a formal meeting:
– Definitely a perk – 85%
– Leaning toward a perk – 9%
– Leaning toward not a perk – 4%
– Definitely not a perk – 2%
C. Mixed Business & Personal Use
1. Country club membership paid by company that is not used exclusively for business purposes, if the membership is used a few times by the executive or a family member for personal reasons:
– Entire amount of country club expenses is a perk – 22%
– Allocate incremental cost of those few personal uses as a perk – 52%
– Allocate all expenses, including a portion of the membership cost on some basis, as a perk – 24%
– Not a perk – 3%
2. Luxury box paid by company that is not used exclusively for business purposes, if the box is used a few times by the executive or a family member for personal reasons:
– Entire amount of ownership expenses is a perk – 6%
– Allocate incremental cost as a perk (eg. cost of refreshments) – 50%
– Allocate all expenses, including a portion of the membership cost on some basis, as a perk (eg. by dividing number of events box is paid for in order to allocate the cost on a per event basis) – 36%
– Not a perk – 7%
3. Membership in airline club paid by company that provide facilities at airports, if the club is also used by executive during personal travel:
– Entire amount of club expenses is a perk – 11%
– Allocate incremental cost as a perk (eg. cost of refreshments) – 40%
– Allocate all expenses, including a portion of the membership cost on some basis, as a perk (eg. valuation based on percentage of personal use) – 17%
– Not a perk – 32%
4. Relocation expenses for existing executive that the company has required to relocate:
– Definitely a perk – 25%
– Leaning toward a perk – 11%
– Leaning toward not a perk – 9%
– Definitely not a perk – 55%
5. Relocation expenses for newly hired executive, extended to induce the executive to accept an employment offer:
– Definitely a perk – 35%
– Leaning toward a perk – 29%
– Leaning toward not a perk – 24%
– Definitely not a perk – 12%
6. CEO’s assistant (whose compensation is paid for entirely by company) who spends 60% of his time taking care of personal tasks (such as maintaining the CEO’s personal calendar, paying personal bills, etc.) and the other 40% is work-related:
– Definitely a perk – 35%
– Leaning toward a perk – 29%
– Leaning toward not a perk – 24%
– Definitely not a perk – 12%
7. Would your answers change to the above questions if the executive paid the full incremental cost to the company?
– Yes to most – 60%
– Yes to a few – 19%
– Maybe for a few – 10%
– No – 11%
New Nasdaq Staff FAQ on the 20% Rule
In this blog, Morrison & Foerster’s Anna Pinedo alerts us to a new Nasdaq FAQ relating to the issuance by Nasdaq-listed companies of warrants with cashless exercise features.
Webcast: “Key Steps to an Effective Compensation Committee”
Tune in tomorrow for the CompensationStandards.com webcast – “Key Steps to an Effective Compensation Committee” – to hear Pay Governance’s Diane Lerner, Shearman & Sterling’s Doreen Lilienfeld & Global Governance Consulting’s Susan Wolf untangle the complex issues that compensation committees face in exercising their fiduciary duties against a backdrop of increased shareholder activism, potent proxy advisor policies, an active plaintiff’s bar and heightened media scrutiny.
Over the past few weeks, I keep reading tweets – mostly from Michelle Leder of @footnoted – that Edgar is down. This includes yesterday, which was the deadline for many companies to file their Form 10-Ks. I’ve always known that Edgar goes down occasionally – but it appears that it’s happening more frequently lately. But then again, maybe it has always has gone down an average of once per week. We really don’t know because the SEC doesn’t let us know when Edgar is down. This has been one of my pet peeves – that the SEC doesn’t have a blog that is Edgar-focused, which would be the perfect vehicle to inform the public when Edgar is down – and then when it’s back up. Or at least, the SEC could tweet this valuable information. The SEC now has a total of 9 Twitter handles – perhaps add one more for “Edgar News”?
I’m loving a new social media app called “Anchor,” which essentially is Twitter with voice. It’s much more personal – and quite fun to have a time-shifted conversation. Download the free app on your phone and record your own 20-second reply to my first “wave”: “The SEC’s EDGAR is down. Chronic problem?” [Of course, you can email me a response instead – I never post with attribution unless I gain permission.] You’ll see that there is a reply already at the end of my clip – please add yours. It’s simple to do (but I’m happy to help if you experience technical difficulties).
More on “The SEC’s Home Page Redesign: Less Color”
Last Friday, I blogged about the SEC’s new site redesign. Here’s two observations from members that I missed:
– Did you notice that the links to the company’s “Insider Filings” is now missing on the new Edgar site? One has to literally open up every Form 4 to see who filed it and for what amount & type.
– Noticed an “Edgar Search Results Beta” tab on the company page, which takes you to a slightly different index of filings (which unfortunately doesn’t identify the item number for 8-K filings).
– Now lists the votes of Commissioners on actions/orders in a chart that is current.
Webcast: “Hot Issues for Your Annual Meeting”
Tune in tomorrow for the webcast – “Hot Issues for Your Annual Meeting” – to hear Allen Matkins’ Keith Bishop, Independent Inspector Carl Hagberg, Potter Anderson’s Roxanne Houtman and Broadridge’s Jill Whitney discuss the latest developments – including how to handle tricky issues – related to annual shareholder meetings.
Our March Eminders is Posted!
We have posted the March issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
Here’s an excerpt from this great piece by Morgan Lewis’ Linda Griggs, Rani Doyle & Sean Donahue (also see this blog by Mike Gettelman):
Companies’ management should consider whether to add a materiality carve-out to the related party representations now being included in management representation letters as a result of the PCAOB’s Auditing Standard No. 18 (AS 18). AS 18 established “requirements regarding the auditor’s evaluation of a company’s identification of, accounting for, and disclosure of relationships and transactions between the company and its related parties” and is effective for audits of fiscal years ended after December 14, 2015.
The sample management representation letter for auditors to consider, which is set forth in Appendix A to AU Section 333, includes the following specific representations as a result of AS 18:
– Management has made available to auditors the names of all related parties and all relationships and transactions with related parties
– There are no side agreements or other arrangements (either written or oral) that have not been disclosed to the auditors
These representations are broad given the definition in the accounting literature of the term “related party,” which is applicable to AS 18 and the related management representation letter. The definition of “related party” included in the Master Glossary of the FASB’s Accounting Standards Codification includes affiliates of an entity, principal owners of an entity and members of their immediate families, management of an entity and members of their immediate families, and other parties that can influence an entity’s management or operating policies.
On Friday, CII announced that it hired Ken Bertsch to replace Ann Yerger as the Executive Director. Ken has served as head of the Society of Corporate Secretaries before his current job at CamberView…
Nasdaq’s Golden Leash Proposal: Commentary From In-House Counsel
As I’ve blogged, Nasdaq recently proposed a rule that would require listed companies to disclose third-party compensation arrangements of their directors/ nominees (while the proposed rule was rejected on technical grounds, Nasdaq plans to resubmit the proposal soon). I recently received this note from an in-house counsel:
Snapshot Summary
In short, this proposal would require Nasdaq-listed companies to publicly disclose (on their websites or in their proxy statements) compensation arrangements between activist stockholders and their director/director nominees. The proposal indicates that often times, such compensation arrangements are structured such that the director receives certain amounts from the activist if the company’s stock price increases by a certain amount over a specified time period. The concern of course is that undisclosed arrangements like these raise conflicts of interest and could interfere with those directors fulfilling their fiduciary obligations because they are incented to focus on short-term stock price results at the expense of long-term sustainable growth. The proposal recognizes that the company will only be able to disclose information that is provided to it (for example, in D&O questionnaires).
Observations
1. Overlap with Current SEC Rules
Arguably, third party compensation to directors for board service is already required to be disclosed under the SEC’s rules — and if clarification is needed on that, it could easily be provided by the SEC rather than being addressed in stock exchange rulemaking.
First of all, Reg SK, Item 402(a)(2) [entitled “All Compensation Covered”] requires “disclosure of all plan and non-plan compensation awarded to, earned by, or paid to …. directors.” Similarly, the specific provision requiring director compensation disclosure – Reg S-K, Item 402(k) – has no language limiting the disclosure to director compensation paid by the company. I don’t think it’s a stretch to say that the SEC provision covers compensation from whatever sources – i.e. the company and any other third parties. But presumably, an issue may be that the SEC’s rules are focused on compensation for the previous fiscal year – and these undisclosed activist arrangements (focused on stock price increase) could run past the fiscal year (and not result in any payment during that year).
But to that I say, let’s look at Form 8-K, Item 5.02(d)(2) that requires disclosure of “any arrangement or understanding between the new director and any other persons.” Wouldn’t that pick up the stock-price increase scenario? In case you say, “Not always – because that provision has a carveout for directors elected at an annual or special meeting,” I would point out that my understanding is that when companies settle with activists, they agree to put the directors on the board right away, and then they stand for re-election at the next annual meeting. So the Form 8-K would seem to pick up those arrangements.
I would also direct your attention to Reg S-K, Item 601(b)(10) [material contracts]. Even though most of us think this is limited to contracts to which the company itself is a party, the provision has more expansive language, picking up contracts in which the company “has a beneficial interest.” I don’t think it’s a stretch to argue that the company has a beneficial interest in a contract by a third party with a company director that rewards the director for an increase in the company stock price over a specified period of time, which would mean it would have to be disclosed under Item 601(b)(10)(ii)(A) or 601(b)(10)(iii).
Bottom line: I think it’s somewhat disingenuous for Nasdaq to have issued this proposal without any discussion about the existing SEC’s rules requiring disclosure of all compensation paid to directors. I think the better approach would just be for the SEC to clarify that its existing proxy statement rules regarding disclosure of director compensation cover third arrangements. Under that route, investors reading the proxy statements for NYSE- or Nasdaq-listed companies would be receiving comparable information when it comes to director compensation matters.
2. CII Letter – It’s not often I agree with CII, but they recently submitted a letter to the SEC asking that the proxy statement rules be clarified to require disclosure about compensation arrangements between nominees and those who nominated them. I agree with CII’s implicit suggestion that this subject matter falls within the purview of the SEC and should not be the subject of separate rulemaking by stock exchanges.
3. Sleeper Footnote #5 – Footnote #5 is a bit of a bombshell. It suggests that Nasdaq may propose to modify its director independence rules to provide that if a director receives compensation from third parties, s/he would not be considered independent. Whether it’s appropriate to adopt such a bright-line test would obviously be a very sensitive issue. My two cents worth is that it doesn’t make sense to establish this a bright-line test for director independence – but instead, the specific facts and circumstances of such arrangements should be considered by the Board when it’s making its independence determinations. The Nasdaq recently put out a survey to solicit input on this issue.
Nasdaq’s Survey: Third-Party Payments to Directors & Independence
As noted above, Nasdaq is running this survey that’s different – but clearly related to – to its Golden Leash proposal. The Golden Leash proposal relates to how companies will be required to provide disclosure about third-party director compensation arrangements. In contrast, Nasdaq’s survey is focused on the next part of this equation: the impact that these arrangements could have on director independence, with the Nasdaq asking for input on whether it should adopt rules to either prohibit directors that receive third-party payments from being considered independent directors under Nasdaq rules – or from serving on the Board at all. Nasdaq has not yet put out a proposal on this – and presumably will use the survey results to help form their opinion on this topic…
For the 1st time since 2012, the SEC has redesigned its home page – and the home pages for each of the Divisions. The site’s underlying pages haven’t changed – including the important item of the URLs not changing (which would kill millions of links over the Internet if that happened). As noted in this blog, the redesign four years ago was the first since the SEC’s site was launched 20 years ago.
Overall, I like the redesign – it’s clean and simple, as the tabs with the dropdown menus have been kept. For what I can tell, the principal difference is that there is less color than the old home page. Personally, I’m not a big fan of moving pictures on home pages (usability principle: gratuitous graphics can distract users from critical content) – nor do I like “all caps” for the home page title & the tab captions (I’m a big plain English fan). But overall, it’s a winner…
By the way, I recently celebrated 15 years since I first launched a website – RealCorporateLawyer.com in 2001. Talk about simple…
NYSE to Require FPIs to File Semiannual Financials on Form 6-K
The SEC has approved an NYSE rule change which will require foreign private issuers to file semiannual financial statements on Form 6-K. Foreign private issuers are not currently subject to any SEC rule that specifically requires the filing of interim financial information.
New Section 203.03 of the Listed Company Manual provides that each listed foreign private issuer must, at a minimum, submit to the SEC a Form 6-K that includes:
– an interim balance sheet as of the end of its second fiscal quarter; and
– a semi-annual income statement that covers its first two fiscal quarters.
The Form 6-K is required to be submitted no later than six months following the end of the company’s second fiscal quarter. The financial information included in the Form 6-K would be required to be presented in English, but would not be required to be reconciled to U.S. GAAP.
As noted in this Cooley blog, the deadline for filing a cert petition has been extended again in conflict minerals case…
Transcript: “Activist Profiles & Playbooks”
We have posted the transcript for the recent DealLawyers.com webcast: “Activist Profiles & Playbooks.”
In this blog, MoFo’s Anna Pinedo writes up a brief summary from recent speeches by SEC Chair White and Commissioner Stein. This excerpt of Kara’s comments caught my eye:
Commissioner Stein also raised interesting considerations regarding the increased reliance on private placements and other exempt offerings. She observed that “Studies have shown that a sizable amount of capital is now raised in the private markets. In fact, amounts raised through unregistered offerings have outpaced the level of capital raising via registered offerings in recent years. More than $2 trillion, in fact, was raised privately in 2014. Regulation D offerings accounted for more than $1.3 trillion of this amount. In comparison, registered offerings amounted to approximately $1.35 trillion in 2014.” She also commented on the unicorn phenomenon and the need for some level of transparency and accountability in private markets.
Here’s an excerpt from this WSJ article regarding the battle over whether Jim Doty will get another term as PCAOB Chair:
The Securities and Exchange Commission has decided not to decide on the leadership of the government’s audit regulator, at least for now. SEC Chairwoman Mary Jo White on Friday said her agency is waiting until it has a full complement of five commissioners before picking a head for the Public Company Accounting Oversight Board. The commission is currently down to just three members. Meanwhile, James Doty, the current PCAOB chairman whose term officially expired last October, can remain at the agency indefinitely until he’s either reappointed or the SEC taps a successor.
“It’s a decision I think should be left to the full commission, as in the past,” Ms. White told reporters, after remarks at a securities conference here. She added that Mr. Doty and the current PCAOB board were doing “quite well, without missing a beat.”
SEC Enforcement Lays Out Approach to Cybersecurity Cases
If you’ve ever attended the annual SEC Speaks conference, you know that the official program is an intensely uninteresting collection of short speeches by SEC officials who don’t have a lot of incentives to say groundbreaking things. But occasionally there are exceptions. I think Deputy Enforcement Director Stephanie Avakian’s discussion of cybersecurity cases on Friday was one of those.
Avakian broke those cases down into three categories.
1. Failures of registered entities to safeguard information. She cited the T. Jones Capital Equities Management case from September of last year (covered here) as an example of those.
2. Electronic thefts of material nonpublic information, and illicit securities trading following the thefts. Avakian cited the Dubovoy case filed in the District of New Jersey last August and updated on Thursday as an example of these.
3. Cyber-related disclosure failures by public companies. The SEC hasn’t brought any cases in this category yet, and much of Avakian’s discussion focused on why that is the case and how the SEC might get to the point of bringing one.
Assuringly for companies that are investing resources in cybersecurity and trying to do the right things for its customers and shareholders, Avakian said, “A company that has been a victim of an intrusion is just that: a victim.” She also said in several different ways that the Division understands that when attacks happen, critical facts can change and develop very quickly. These developing facts can make any necessary disclosures a moving target. Along these lines, the Enforcement Division will appreciate the difficulty of the circumstances, Avakian says. She added that the SEC is not looking to second guess well-thought decisions in this area.
With all of that said, the Enforcement Division very much wants companies that are victims of cyber attacks to involve appropriate law enforcement authorities as quickly as they reasonably can. It will also examine (1) whether companies have policies and procedures that are reasonably designed to protect customer information; and (2) whether companies with potential liability have self-reported issues to the Division. Regarding the second factor, the SEC’s Seaboard Report from 2001 continues to include the guideposts the Division will consider.
While no cases have yet been brought against public companies in this third category, Avakian can imagine circumstances in which the Commission does file a case to penalize inadequate cybersecurity disclosures. I can, too. Be careful out there.
Institutional investors will seek to “trust, but verify” the performance and governance of their portfolio companies in 2016, according to this recent Russell Reynolds report, which is based in large part on interviews with numerous asset managers, pension funds, shareholder organizations, proxy advisors and activist investors world-wide.
US-specific take-a-ways include:
There will be a focus on improving the quality of engagement between investors and boards, including through individual meetings between investors and board leaders.
Investors are pushing to have boards designate one or two directors as point people who will engage with investors meaningfully and appropriately about the board’s role in strategy development, executive compensation, and CEO succession planning.
Boards will start to look for more investor-savvy directors, whether from the investment community or from the ranks of current and former CEOs and CFOs who have dealt with investors regularly. At the same time, investors will be under pressure to improve the quality of their own engagement with boards—for example, by limiting “gotcha” questions.
Some very large institutional investors will push harder for regular (every third year) external board assessments, following the British and French models.
Board leaders, whether chairmen or lead directors, will see a new focus on their precise roles and responsibilities for board oversight of management (with requests that this be publicly disclosed).
Since the DOL has clarified fiduciaries’ ability to consider ESG factors (see this release), we expect to see more interest from all types of investors in disclosure of environmental and social risks.
See this related Forbesarticle and King & Spalding memo.
New Climate Disclosure Task Force
Late last month, the Financial Stability Board announced the initial membership of its industry-led task force on climate-related financial disclosures including four Vice Chairs to work alongside Task Force Chair, former NYC Mayor Michael Bloomberg – who currently serves as Chair of SASB and United Nations Secretary-General’s Special Envoy for Cities and Climate Change. Members include “data users” JPMorgan Chase and BlackRock and “data preparers” BHP Hilton and Air Liquide, as well as experts associated with Mercer, KPMG, S&P and HSBC. SASB director and former SEC Chair Mary Schapiro is identified on the Task Force website as Secretariat and Special Advisor to the Chair.
The Task Force, which met for the first time earlier this month, reportedly plans to deliver its first report re: current levels of disclosure and the scope of its work in March, and the second report suggesting voluntary disclosure guidelines by year-end.
See my earlier blog regarding this new Task Force.
More on “The Mentor Blog”
We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:
– Study: Experience With Board Gender Quota Increases Director Support
– FEI Disclosure Effectiveness Review: A Preview
– Survey: Progress Slowing on Board Gender Diversity
– Username/Password Breaches: Notification & Other Considerations
– Social Media & the Securities Laws
This paperdocuments the not insignificant psychological effects of M&A transactions on employees, which – left unaddressed – can correspondingly undermine productivity, realization of expected benefits from the transaction and shareholder value.
According to the paper, research shows that more than half of merger failures are due to failure to attend to the “people factors” – which are often neglected due to management’s focus on the myriad operational-related issues inherent in the merger process. While the percentage of mergers deemed to be “failures” varies depending on, e.g., the source and definition of what constitutes a failure, this paper asserts that most commentators agree that between 50% and 70% of mergers fail to achieve their objectives.
Psychological Impacts of “Merger Syndrome”
Anxiety – Employees face uncertainty about job prospects and impact on career
Social Identity – Employees lose their old organizational identity
Acculturation – Employees must adjust to a new culture and form new relationships
Role Conflict – Employees face uncertainty about where they stand in the post-merger organization
Job Characteristics– Employees must adjust to changes in their jobs as certain functions are changed to eliminate redundancies
Organizational Justice– Employees lose trust if the company is unfair or not transparent about who they promote or lay off
While each of these psychological issues and suggested antidotes are discussed in detail, the table on the last page does a nice job of summarizing each issue, its sources, predicted outcomes, and suggested management actions to avoid or mitigate the potential for undesirable consequences.
An Attack on the Hedge Fund Activism/Positive Long-Term Value Link
This recent paper investigates the association of hedge fund activism and long-term firm value, concluding that:
Positive long-term association between hedge fund activism and long-term firm value documented in prior studies is likely affected by selection bias – as activist hedge funds tend to target poorly performing companies.
Once such selection bias is incorporated into the analysis, evidence shows that companies targeted by activist hedge funds improve less in value after their campaigns than ex-ante similarly poorly performing control companies that are not subject to hedge fund activism – suggesting that the hedge fund activism decreases – rather than increases – a company’s long-term value relative to comparably situated non-targeted control companies.
Findings are consistent with the authors’ hypothesis that the ability of activist hedge funds to substantially influence a firm’s investment policy exacerbates a company’s “limited commitment” problem toward long-term value creation and stable stakeholder relationships. The “limited commitment” problem (discussed further in the paper) purportedly arises out of the inability of public shareholders vested with strong exit rights and exposed to informational inefficiencies to credibly commit to long-term investment strategies or engage in long-term cooperation with other firm stakeholders.
See also this noteworthy Short-Term Thinking infographic from the New York Times.
More on “The Mentor Blog”
We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:
– Director Exit Interviews
– Data Breach Derivative Suit Protection: Action Items
– How to Calmly Effect Emergency Succession
– Non-GAAP Disclosure Compliance Tips
– Redefining the Board’s Role in Strategic Planning
The seemingly positive SEC press release touting improvements in credit rating agency processes based on 2015 annual examinations (summary report) and reporting (annual report) notwithstanding, this NY Times article portrays the progress of the Big 3 rating agencies (S&P, Moody’s and Fitch) in particular in a much less favorable light based on a close read and analysis of the same underlying information contained in the SEC’s December 2015 reports.
By way of background, in August 2014, in response to the alleged role of flawed credit ratings on asset-backed and other securities in the financial crisis, the SEC adopted Dodd-Frank-mandated rules aimed at improving the quality of credit ratings by addressing, e.g., agency internal controls, conflicts of interest, procedures designed to protect the integrity of rating methods, and their transparency/accountability.
Contrary to the outwardly reassuring picture conveyed by the SEC release, the NY Times recounts these concerning findings from the SEC reports:
Two of the larger companies “failed to adhere to their ratings policies and procedures, methodologies, or criteria, or to properly apply quantitative models.” These failures occurred on numerous occasions.
Errors seem common. Because of a coding mistake, a structured finance deal made by one larger ratings agency didn’t reflect its actual terms. It took some time for this error to be detected and when it was, the transaction’s rating took a substantial hit.
A larger ratings agency employee noticed an error in the calculations used to determine certain ongoing ratings, but in subsequent publications, the company disclosed neither the mistake nor its implications. This ratings agency also inaccurately described the methodology it used to determine some of its official grades.
The analysts at one larger ratings agency learned of flaws in outside models used to determine ratings. But no one at the company assessed the impact of the errors or told others about them as required under its procedures. The SEC also identified instances where substantive statements made by this agency in its rating publications directly contradicted its internal rating records.
Policies and procedures at one larger credit ratings agency did not prevent “prohibited unfair, coercive or abusive practices.” As a result, the agency gave an unsolicited rating to an issuer that was “motivated at least in part by market-share considerations.” Such a practice would allow an agency to gain an issuer’s business by offering a better rating than a competitor.
At the same agency, two grades assigned by ratings committees were changed at the urging of “senior ratings personnel.” This not only violated the unnamed firm’s policies and procedures, but also resulted in a misapplication of the company’s ratings criteria.
Consumer Federation of America’s Micah Hauptman made these remarks: “These failures are eerily familiar, right? Sales and marketing concerns influencing the production of ratings. Credit ratings agencies that didn’t have policies and procedures in place to manage issuer-pay conflicts. These are the exact same deficiencies that caused the 2008 financial crisis, and that the Dodd-Frank Act was supposed to address.”
See these August 2014 statements from SEC Chair White and Commissioner Stein upon adoption of the new credit agency requirements.
Credit Rating Agencies: Random Selection
Under Presidential candidate Bernie Sanders’ plan to reform Wall Street, companies would no longer be allowed to select their rating agency:
Reforming Credit Rating Agencies
We cannot have a safe and sound financial system if we cannot trust the credit agencies to accurately rate financial products. And, the only way we can restore that trust is to make sure credit rating agencies cannot make a profit from Wall Street. Investors would not have bought the risky mortgage backed derivatives that led to the Great Recession if credit agencies did not give these worthless financial products triple-A ratings – ratings that they knew were bogus. And, the reason these risky financial schemes were given such favorable ratings is simple. Wall Street paid for them. Under my administration, we will turn for-profit credit rating agencies into non-profit institutions, independent from Wall Street. No longer will Wall Street be able to pick and choose which credit agency will rate their products.
Senators Al Franken (D-Minn.) and Roger Wicker (R-Miss.) reportedly offered a proposed amendment during the deliberation of Dodd-Frank to effect random assignment of rating agencies to companies – with an incentive for more business based on ratings accuracy, but the proposal morphed into a study. The two since have continued to push for reform.
Moody’s Evaluation of Cyber Risk: Credit Rating Impacts
In this podcast, Christian Plath, VP – Corporate Governance Analyst at Moody’s, discusses the credit rating impacts associated with companies’ cyber risks with reference to Moody’s recent cyber risk report (see this overview), including:
– How has Moody’s view of cyber risks vis a vis its credit analysis evolved over the past few years?
– How does Moody’s evaluation of cyber risk in its analysis differ from its evaluation of other types of risks – if at all?
– What can companies do to mitigate the potential for cyber risk to adversely affect their rating?
– Could a lack of preparedness or an acute vulnerability for a cyber attack ever be a justification to downgrade an issuer?
Ongoing challenges to the constitutionality of the SEC’s administrative proceedings ranks at the top of Baker Hostetler’s informative Top 10 list of SEC Enforcement Highlights of 2015.
According to the latest Cornerstone report, the SEC reportedly filed 76% of its enforcement actions against public companies as administrative proceedings in 2015 – more than triple the number and percentage of actions filed as administrative proceedings since 2010. This controversial issue – namely, the Appointments Clause constitutionality of the appointment of the arguably “inferior officer” administrative law judges who preside over the administrative proceedings, and the related constitutionality of the proceedings themselves – simply refuses to go away pending definitive resolution by the courts.
Here is the complete Top 10 list:
SEC Administrative Proceedings Challenged as to Constitutionality
SEC Claims Against Compliance Officers
Policing Manipulative High-Frequency Trading
First SEC Action to Enforce Cybersecurity Policies
SEC Presses Insider Trading Actions With Mixed Success In Post-Newman Era
SEC Charges Private Equity Giant With Misallocating Broken Deal Expenses
SEC Brings Enforcement Actions Over “Spoofing”
CFTC Brings Action against “Flash Crash” Trader
SEC Actions Protecting Whistleblowers
First Circuit Court of Appeals Vacates SEC Order Not Based on “Substantial Evidence”
See also the OIG’s recently issued final report of investigation into allegations of bias on the part of the SEC’s ALJs – concluding that there is no evidence to support the allegations.
Is the Yates Memo Unconstitutional?
This recent Corporate Counsel article authored by Paul Hastings Paul Monnin and Eric Stolze – Everything Old Is New Again: Why the Yates Memo is Constitutionally Suspect – does a convincing job of pointing out the several aspects and implications of the DOJ corporate cooperation policies espoused by the September 2015 so-called Yates Memo that raise potential constitutionality issues. Aside from potential constitutional challenges, the memo identifies the not unlikely adverse effects of the policy on internal corporate dynamics. It’s definitely worth a read.
See Broc’s and my earlier blogs on the Yates Memo and our oodles of memos about it in our “White Collar Crime” Practice Area.
Marsh: Cyber Insurance Trends
In this podcast, Marsh Cyber Practice leader Tom Reagan discusses key cyber insurance trends in the context of Marsh’s recent benchmarking report, including:
– Can you describe the overall trends in frequency of acquisition of cyber coverage?
– What are the top reasons companies are purchasing cyber coverage?
– What are the overall trends in terms of coverage limits?
– Are there any industry-specific trends?
– Can you describe the current state of knowledge – or perhaps confusion – about cyber insurance coverage?
– What are the overall pricing and insurance market trends?
– Is there anything companies can do to better position themselves before they seek to acquire or renew coverage?
