On March 12, 2014, the SEC updated its guidance regarding the framework it will follow in reviewing a “WKSI waiver” request. Such a waiver – which, if granted, allows an issuer to continue to qualify as a WKSI despite otherwise disqualifying misconduct – is critical to the affected issuer’s ability to access the capital markets. These waivers have become particularly important for bank and other financial holding companies with large networks of subsidiaries, one or more of which may have been charged with mortgage securities fraud or other crimes arising out of the recent financial crisis. Under the revised guidance, the SEC will consider many of the same factors in a waiver request as before, but will no longer highlight certain aspects of the underlying offense as threshold issues, as under the prior guidance. As a result, issuers will need to take greater care in their waiver requests to address all of the various considerations raised by the SEC in its guidance and apply them to the issuer’s particular facts and circumstances.
As publicly traded companies consider potential risks to their assets from a changing climate, the chorus of individuals and institutions advocating for public disclosures of these risk assessments continues to grow. In this post, originally featured on Akin Gump’s Speaking Energy Blog, we discuss the idea of “stranded assets” and recent developments involving ExxonMobil’s response to such shareholder petitions regarding risk analysis and disclosure.
Arjuna Capital, a sustainable wealth management platform, and As You Sow, an environmental corporate responsibility advocacy group, have been advocating for publicly traded companies to assess and disclose the risks that their assets will be “stranded” as a result of changing regulatory regimes designed to address climate change. The rationale underlying these efforts derives from the notion that a “carbon bubble” exists. Author and climate activist Bill McKibben is often credited with introducing the notion, basing it on a U.K. research group’s contention that upwards of 80 percent of the world’s oil, gas and coal reserves would become “stranded” if GHG emissions were controlled sufficiently to limit global warming to an increase of 2º C.
On April 11, 2014, Keith F. Higgins, Director of the U.S. Securities and Exchange Commission’s (SEC) Division of Corporation Finance, gave a speech before the ABA Business Law Section discussing the new Disclosure Project that is being led by the Division of Corporation Finance. In an effort to improve disclosure in SEC filings, the project will involve reviewing specific sections of Regulation S-K and Regulation S-X. The goal, according to Director Higgins, is to determine if the disclosure requirements can be updated (1) to reduce the costs and burdens on companies while continuing to provide material information and (2) to eliminate duplicative disclosures. At the same time, the SEC is trying to determine if there is information not currently required to be disclosed that should be.
Ways to Improve Disclosure Effectiveness
At one point, Director Higgins observed that in addition to SEC updates to Regulations S-K and S-X, companies and their representatives can help improve what Director Higgins referred to as “the focus and navigability” of disclosure documents. Specifically, he recommended that companies improve their SEC filings by (1) reducing repetition, (2) focusing their disclosure and (3) eliminating outdated information.
On April 8, 2014, President Obama signed an executive order to “promote economy and efficiency in Federal Government Procurement[.]” The Executive Order, “Non-Retaliation for Disclosure of Compensation Information[,]”amends Executive Order 11246 covering Equal Employment Opportunity, to include a paragraph prohibiting retaliation against employees of federal contractors who disclose, discuss, or inquire about compensation. The new paragraph prohibiting retaliation will not apply to “an employee who has access to the compensation information of other employees or applicants as part of such employee’s essential job functions . . . unless such disclosure is in response to a formal complaint or charge, in furtherance of an investigation, proceeding, hearing, or action, including an investigation conducted by the employer, or is consistent with the contractor’s legal duty to furnish information.”
Antitrust-Related Recent Developments: Terrell McSweeny Confirmed as FTC Commissioner, Congress Holds Hearings and FTC/DOJ Policy Statement on Sharing of Cybersecurity Information
On April 9, 2014, the U.S. Senate confirmed Terrell McSweeny to serve as FTC Commissioner. Commissioner McSweeny will join Commissioners Edith Ramirez and Julie Brill as the third Democratic member of the five-member Federal Trade Commission (Commission). Commissioners Maureen Ohlhausen and Joshua Wright are the two Republicans. The appointment reduces the possibility of the Commission abstaining from acting as a result of a 2-2 split during its decision-making process.
Commissioner McSweeny has spent most of her career in public service. Her recent appointments include serving as Chief Counsel for Competition Policy and Intergovernmental Relations at the Department of Justice’s Antitrust Division, as a domestic policy adviser to Vice President Joe Biden and as a deputy assistant to President Barack Obama. Commissioner McSweeny has developed a reputation as an insightful and pragmatic problem-solver during her career in public service.
Carlos M. Bermudez is a corporate partner in Akin Gump’s Los Angeles office, focusing on M&A transactions and corporate governance issues. Recently, he has blogged about several important court decisions in California and Delaware affecting the M&A practice.
What is your main practice area?
Mergers and acquisitions, corporate governance, general company representation and securities. Specifically, I represent a broad spectrum of clients, including public and private companies and private equity funds, in acquisitions, mergers, joint ventures, financings and cross-border transactions.
The California Court of Appeals recently issued a decision that an express waiver of the right to challenge a liquidated damages clause that constituted an unreasonable penalty is unenforceable.
In Purcell v. Schweitzer (4th Cir. March 17, 2014), a lender brought a lawsuit after the borrower defaulted on an $85,000 promissory note. The parties entered into a settlement agreement pursuant to which the borrower agreed to pay the lender $38,000 plus 8.5 percent interest, in installments over 24 months, and agreed that any late payment would entitle the lender to have a judgment entered against the borrower for the original liability of $85,000. The stipulation for entry of judgment attached to the settlement agreement described the $85,000 liability as “neither a penalty nor a forfeiture” and stated that the borrower waived any right to an appeal or to contest the judgment.
2013 was a flat year for M&A activity worldwide. Although deals with U.S. targets were up 11.3%, the quiet market meant that a small handful of deals received an outsized share of attention, especially ones that involved activist shareholders.
In one notable case (discussed further here), Greenlight Capital pushed Apple to issue preferred shares as a way to return cash to investors. After pursuing legal action, Greenlight Capital withdrew its shareholder suit after Apple announced it would issue $17 billion in debt securities as part of a plan to return $100 billion to shareholders by 2015.
On April 3, 2014, President Obama signed into law the Support for the Sovereignty, Integrity, Democracy, and Economic Stability of Ukraine Act of 2014 (Public Law No. 113-95). The law includes new authority, not specifically identified in previous executive orders, for the President to impose sanctions on individuals who have committed gross human rights abuses in Ukraine associated with anti-government protests that began in November 2013. The law also provides the President authority to impose sanctions on individuals and entities deemed to have engaged in significant corruption in either Ukraine or Russia. Previously, with regard to corruption, Executive Order 13660 only provided the President authority to impose sanctions on persons involved with the “misappropriation of state assets of Ukraine or of an economically significant entity in Ukraine.”
Many companies have watched with anticipation for the final language of the bill. After several weeks of hearings and negotiations in March, the House and Senate initially passed separate legislation. However, they were able to reconcile their separate versions after the Senate passed an amendment removing controversial language regarding the International Monetary Fund (“IMF”). On April 1, 2014, the House agreed to the amended version passed by the Senate, which the President then signed into law. Below we provide a synopsis of the major provisions of the enacted law.
Companies are increasingly taking advantage of the benefits of using “cloud” based services. Those benefits include:
- lower costs
- rapid scalability
- minimum or no upfront capital investment
- pricing on a consumption basis
- shifting the risk of obsolescence or upgrading technology to the cloud provider.
There is a saying that a man who serves as his own lawyer has a fool for a client. The same may be true for a fund that rushes to act as its own shareholder representative without thinking through the consequences.
Chances are you don’t cut your own hair, mow your own lawn or do your own taxes. So why, after selling your portfolio company, would you—a principal of a PE fund—agree to serve as a principal shareholder representative in post-closing litigation matters? The knee-jerk response is typically, “because I want to keep control.” But that control could come at a serious cost and there may be ways to maintain a reasonable level of control without exposing your fund to the unnecessary risks and expenses associated with being a named defendant in post-closing litigation.
Tomorrow, on April 1, 2014, some potentially important new provisions in the Delaware General Corporation Law (the DGCL) will go into effect.
New Section 204 of the DGCL provides corporations with the ability to ratify certain corporate actions that would otherwise have been void or voidable because of their failure to comply with statutory law or the corporation’s organizational documents. Prior to Section 204 becoming effective, Delaware case law had held that such actions could not be subsequently ratified. Beginning April 1, provided they comply with the procedures set forth in Section 204, corporations may ratify such actions.
The Obama administration announced this week that companies with pending license requests to export certain controlled dual-use goods or technology, defense articles or defense services to Russia will face an indefinite hold on receiving approval from the U.S. government. The policy is expected to have a significant impact on Russia and may affect the U.S. trade balance with Russia.
On March 27, 2014, the U.S. Department of State’s Directorate of Defense Trade Controls (DDTC) released an industry notice indicating that it “placed a hold on the issuance of licenses that would authorize the export of defense articles and defense services to Russia. State will continue this practice until further notice.” On March 25, 2014, the U.S. Department of Commerce’s Bureau of Industry and Security (BIS) announced on its website that “[s]ince March 1, 2014, BIS has placed a hold on the issuance of licenses that would authorize the export or reexport of items to Russia. BIS will continue this practice until further notice.”
Last year, Judge Sullivan in the U.S. District Court for the Southern District of New York issued a preliminary injunction in Greenlight Capital, L.P. v. Apple, Inc. enjoining the “bundling” of multiple proposals by Apple in its definitive proxy statement.1 In addition to eliminating the board’s power to unilaterally issue preferred stock, the proposal sought to conform certain majority voting provisions to California state law, establish a par value for Apple’s common stock and address other ministerial changes.
According to the court, the grouping of these multiple proposals into a single proposal likely violated Rule 14a-4(a)(3) of the Securities Exchange Act of 1934, as amended, the so-called “unbundling rule.” This rule requires the form of proxy to “identify clearly and impartially each separate matter intended to be acted upon, whether or not related to or conditioned on the approval of other matters . . . .” In other words, the rule requires proposed matters to be separated so that shareholders can communicate their views to the board of directors on each matter by voting separately on each one. Although the court in Greenlight ultimately found that it was probable that the proposal impermissibly bundled “separate matters,” it acknowledged that the question of what actually constitutes a “separate matter” has received little attention from the courts. Furthermore, the only Securities and Exchange Commission (SEC) guidance on which the court was able to rely was from the 1992 SEC adopting release that established the unbundling rule and a treatise that secondarily cites “unmemorialized” SEC guidance.
On Wednesday, March 26, 2014, the Senate Committee on Commerce, Science and Transportation held a hearing entitled “Protecting Personal Consumer Information from Cyber Attacks and Data Breaches” and heard testimony from representatives of Target, as well as the University of Maryland (UM), regarding the recent data breaches within their organizations. Testimony was also taken from Edith Ramirez, Chairwoman of the Federal Trade Commission (FTC), who has called on Congress to enhance the Commission’s authority to enforce data security measures. Other witnesses included: Ellen Richey, Chief Enterprise Risk Officer for Visa; David Wagner, President, Entrust, Inc.; and Peter J. Beshar, Executive Vice President and General Counsel, Marsh & McLennan. Prior to the hearing, the Committee released a staff report titled “A ‘Kill Chain’ Analysis of the 2013 Target Data Breach.”
While several Congressional committees held hearings concerning breaches at Target and other retailers back in February 2014, the March 15 breach at UM (the second at the University in as many months) has continued to keep the issue of data security at the forefront of congressional interest.
In February 2014, the American Criminal Law Review published in its 51st edition Asadi v. GE Energy (USA) L.L.C.: A Case Study of the Limits of Dodd-Frank Anti-Retaliation Protections and the Impact on Corporate Compliance Objectives, by Akin Gump’s Nicole H. Sprinzen.
Exploring the intersection of the presumption against extraterritorial application in the context of statutory construction and the protections against retaliation offered by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank), the article highlights the limits on the protections to individuals who blow the whistle on U.S. Foreign Corrupt Practices Act (FCPA) violations. Section 922 of Dodd-Frank offers protection against employment retaliation to statutorily defined whistleblowers who report violations of laws, rules or regulations regulated by the U.S. Securities and Exchange Commission (SEC) to the SEC or, in some cases, their employer, or assists in any SEC investigation.
The ongoing conflict between Russia and Ukraine has led to recent changes in sanctions laws that have significance for U.S., European Union (EU) and Russian companies as well as companies that do business within these geographies or with certain nationals from these countries.
In response to the recent Russian military action in Ukraine, the United States, EU and other countries, including Canada, have implemented list-based sanctions targeting persons deemed to be responsible for creating instability in Ukraine. Some Russian officials have indicated that Russia will respond to sanctions imposed by other countries by establishing similar retaliatory sanctions. Thus far, Russia has imposed limited target sanctions on certain U.S. government officials.
For majority stockholders in Delaware companies, the complications and added expenses often caused by minority stockholders may result in a decision to buy out that minority, simplify the company’s capital structure and potentially inject additional capital into the company to fund future growth.
At this point, you might view this as just another deal—analogous in many ways to the original purchase of your majority position. In fact, you may think completing the transaction is as simple as rounding up a few of the largest stockholders and negotiating terms with them. However, for majority stockholders whose majority interest equates to a controlling position, buying out the minority is complicated by the fact of majority control and the resulting fiduciary duties a controlling stockholder may owe to the minority. Controlling stockholders who are not cognizant of these issues could end up in court despite the seemingly ordinary nature of these transactions.
On February 6, 2014, the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) published notice that it was listing 11 named parties as “Foreign Sanctions Evaders,” pursuant to Executive Order 13608 (May 1, 2012) (the FSE List). The FSE List targets individuals and entities that OFAC determines have violated, attempted to violate, conspired to violate or caused violations of U.S. sanctions against Syria or Iran. U.S. persons and companies are prohibited from engaging in transactions with parties included on the FSE List unless the transaction qualifies for an exemption from OFAC sanctions. In addition, the prohibition may in effect extend to foreign subsidiaries and controlled affiliates to the extent there is U.S. parent entity involvement in their transactions.
This development underscores the need for entities to add the FSE List to the collection of other restricted-party lists that must be covered and reviewed in diligence activities and other compliance screening. The FSE List is not currently incorporated into the Consolidated Screening List made available by the U.S. government at www.export.gov. Consequently, entities must take care to ensure that their screening practices, whether conducted manually or in reliance on commercial screening software services, cover this list.
Last week in Kahn v. M&F Worldwide Corp. (Del. March 14, 2014), the Delaware Supreme Court upheld the decision of the Court of Chancery in the In re MFW Shareholders Litigation (Del. Ch. May 29, 2013) case and also upheld the grant of summary judgment to the defendants.
In that decision, as we discussed here, the Court of Chancery held that the business judgment standard of review will apply to going private mergers with a controlling stockholder and its subsidiary if and only if the merger is conditioned on two specific stockholder protective measures. Typically, transactions that involve a controlling stockholder are subject to the entire fairness level of review, which shifts the burden to the controlling stockholder to show that the transaction is fair to the minority shareholders.
Garrett DeVries is a corporate partner in Akin Gump’s Dallas office, focusing on securities and M&A transactions. Recently he has blogged about the SEC’s update on share-based compensation and enhanced confidential voting shareholder proposals in proxy statements.
During last week’s oral argument in Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317 (“Halliburton II”), the Supreme Court justices sent a strong signal that they would not overrule Basic, but may seek to strengthen defendants’ ability to contest class certification. The two questions presented are (1) whether the fraud-on-the-market presumption established in Basic Inc. v. Levinson, 485 U.S. 224 (1988), should be overruled, and (2) whether the defendants may rebut the fraud-on-the-market presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of their stock.
Going into the argument, defendants knew they likely had three justices on their side: Justices Scalia, Thomas and Alito. In a prior decision in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, No. 11-1085 (2013), Justice Thomas remarked, “Basic is a judicially invented doctrine based on an economic theory adopted to ease the burden on plaintiffs bringing claims under an implied cause of action.” Justice Alito further noted in his Amgen concurrence, “[M]ore recent evidence suggests that the presumption may rest on a faulty economic premise. In light of this development, reconsideration of the Basic presumption may be appropriate.” Justice Scalia’s dissent in Amgen specially noted the “regrettable consequences” of Basic. Although Justice Thomas remained silent, Justice Alito focused on how rare it is for defendants to be successful in rebutting the fraud-on-the-market presumption (Transcript at 8). Justice Scalia emphasized how few securities class actions continue to trial once certified (Tr. at 23). Shortly into oral argument, it became clear that the position seeking to overrule Basic would be unlikely to garner a majority vote.
Richard J. Rabin, Alice Hsu, Francine E. Friedman and Renuka S. Drummond discuss the challenges broker-dealers and other financial advisory firms encounter in their efforts to monitor the business-related activities of their associated persons on social media, as required by the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission under the Investment Advisers Act of 1940, as amended (the Advisers Act).
Existing regulatory regimes that have an impact on social media often conflict, placing firms in the untenable position of having to risk violating one set of laws in order to comply with another. On the one hand, FINRA and the Advisers Act require firms to take steps to prevent financial advisers from using social media in a way that could present an undue risk to investors. On the other hand, the National Labor Relations Board and various state laws place significant limits on firms' ability to monitor or restrict their employees’ social media usage. This article addresses steps companies can and should consider in light of the conflicting regulatory regimes.
To read more, please click here.
U.S. Supreme Court Round-Up: Sun Capital Cert Denied, Omnicare Cert Granted and Whistle-Blower Protection Extended
As first discussed here and here, in July 2013 the First Circuit Court of Appeals held in Sun Capital Partners III, LP, et al. v. New England Teamsters & Trucking Industry Pension Fund that a Sun Capital Partners private equity fund (Sun Capital) constituted a “trade or business” under the controlled group rules of the Employee Retirement Income Security Act of 1974, as amended (ERISA) for multiemployer plan withdrawal liability purposes. Accordingly, a private equity fund (or affiliated funds) can be held liable for pension obligations of a bankrupt portfolio company.
Sun Capital asked the Supreme Court to review the case, but on March 3, 2014, the Supreme Court denied certiorari. The case will be remanded to the district court for additional factual development regarding the “common control” prong of the “control group” test, which is based on economic ownership instead of voting control. Although the “common control” analysis is complex, generally two entities will be considered to be under common control if one entity owns 80 percent or more of the other entity or when five or fewer persons directly or indirectly own 80 percent or more of two or more entities and have effective control over each entity.
Plaintiff’s Attorney’s Fees in Shareholder Suits Subject to Heightened Scrutiny (In re Theragenics Case)
It’s virtually inevitable: Within hours (or less) of a press release announcing a merger or acquisition involving a public company, a group of shareholders will file a class action lawsuit against the public company target’s directors and officers. The suit will customarily allege, among other things, that the target company’s board of directors breached their fiduciary duties by failing to get a fair price for their company and that the process used to approve the deal was deficient. Shortly thereafter, the target public company typically settles with the plaintiffs for relief that almost always includes increased disclosures to the public company’s shareholders in revised filings with the Securities and Exchange Commission (SEC). Such settlements rarely include any monetary relief for the shareholders, but almost always will include provisions for reimbursement of the plaintiffs’ attorney’s fees and expenses.
In February 2014, the Securities and Exchange Commission’s (SEC) Division of Corporation Finance updated Section 9520 of its Financial Reporting Manual. Section 9520 is part of Topic 9, which provides guidance for Management’s Discussion and Analysis of Financial Condition and Results of Operation, or MD&A. In particular, Section 9520 relates to the disclosure of critical accounting estimates for share-based compensation in the prospectus for a company’s initial public offering (IPO).
As discussed in Section 9520, estimating the fair value of underlying shares of a pre-IPO company can be highly complex and subjective because the shares are not yet publicly traded. Therefore, such estimates are often considered critical, prompting enhanced discussion and analysis.
Fueled by the controversy during the 2013 proxy season over access to interim vote tallies, “enhanced confidential voting” proposals have been submitted to over a dozen high profile companies for the 2014 proxy season, including Verizon Communications, Inc., Amazon.com, Inc. and United Continental Holdings, Inc. A majority of these shareholder proposals have been submitted by shareholder activist, John Chevedden, and are based on a shareholder proposal that was submitted to CenturyLink, Inc. last year. That proposal received 42% approval from shareholders, despite an apparent recommendation against the proposal from proxy advisor Glass, Lewis & Co., according to Reuters. A similar proposal recently also received 40% approval at the annual shareholders meeting of Whole Foods Market, Inc. on February 24, 2014.
The “enhanced confidential voting” proposal would restrict management’s access to a running tally of votes and prohibit their use of such information for the solicitation of votes, except for the purpose of achieving a quorum or “other proper purposes.” Votes on the election of directors and contested proxy solicitations are excluded from the restriction.
When choosing an entity, limited liability companies (LLCs) are an attractive option because they insulate their members from personal liability, allow governance flexibility and provide a single layer of income tax. For these reasons, their use has increased significantly.
Properly using LLCs requires an understanding of the default provisions of the applicable laws of the organizing jurisdiction. Below are some key provisions from the Delaware Limited Liability Company Act to consider when drafting an LLC operating agreement.
1. An LLC must have an operating agreement. It can be written or oral. The statute of frauds does not apply to operating agreements.
2. Only having one member does not make an LLC’s operating agreement unenforceable.
Private equity funds investing in a company should be aware of the possible labor issues that may arise and carefully consider their role in the company.
In a Law360 article, Akin Gump counsel Lauren Leyden, among others, discusses the following issues that private equity funds should be mindful of:
1. Latent wage-and-hour liabilities
2. Human resources after an asset sale
3. Control and liability
4. WARN Act liability
5. Union bargaining obligations
To read the full article on the potential pitfalls, see here.
In the Dodd-Frank Act of 2010, Congress required the Securities and Exchange Commission (SEC) to adopt a rule requiring transparency and disclosure regarding the use of “conflict minerals” sourced from the Democratic Republic of the Congo (DRC). Shortly after the rule’s August 2012 adoption, the SEC found itself defending the rule in court against the National Association of Manufacturers, the Chamber of Commerce, and Business Roundtable (“Plaintiffs”) who argued that the Final Rule is arbitrary and capricious and unconstitutional. The District Court in the District of Columbia ruled in favor of the SEC in July 2013 and the Plaintiffs appealed. A panel of three judges, consisting of Circuit Judge Sri Srinivasan, Senior Circuit Judge David Sentelle and Senior Circuit Judge A. Raymond Randolph, heard oral argument in the D.C. Circuit Court of Appeals in early January 2014.
The SEC answered pointed questions about whether the rule exceeded the scope of the underlying statute and its rule-making authority and about whether the rule’s requirements unduly burden industry. The discourse delineated three main issues: first, the SEC’s choice not to include a de minimis exception to the rule; second, the statutory language substitution of the broader reporting requirement — “may have originated in the conflict region” rather than “did originate,” the latter of which was the language in the underlying Dodd-Frank statute; and third, whether the reporting obligations run afoul of the First Amendment by compelling private speech. Based on the exchange between the panel and counsel during argument, the panel seemed to find the Plaintiffs’ de minimis argument unpersuasive but seemed more compelled by the Plaintiff’s First Amendment challenges.
The fraud-on-the-market presumption of reliance will not go down without a fight in Halliburton v. Erica P. John Fund (No. 13-317), a Supreme Court case that may reshape securities litigation for years to come. At issue, according to Respondents, is (1) whether a “statutory interpretation precedent that Congress has left unchanged for more than a quarter century” should be overruled or modified and (2) whether evidence of price impact may be considered at class certification to rebut the presumption. The Respondents have lined up their cavalry, with eleven amici in their support. The plaintiffs’ bar has risen to the occasion, with heavy hitters Milberg LLP, Bernstein Litowitz Berger & Grossmann LLP, Berger & Montague PC, Labaton Sucharow LLP, Kessler Topaz Meltzer & Check LLP, Pomerantz LLP, and others all authoring briefs in support of Respondents.
Three central arguments are raised by the Respondents and their supporting amici. First, Respondents appeal to the common sense rationale of Basic. Millions of shares change hands daily in modern securities markets, and “the market is interposed between seller and buyer and ideally transmits information to the investor in the processed form of a market price.” They reason that “material statements typically affect the price of a stock through the conduct of analysts who report on significant public statements and market professionals and others who trade on that information,” which price is then relied upon by the ordinary investor.
Uncertainty continues as Broadridge flip-flops over its policy on the disclosure of interim proxy tallies in a proxy contest. In early February 2014, Broadridge announced a new policy that a company and shareholder proponents would only receive results of votes cast in favor of their respective proposals. A few days later, Broadridge reversed course and announced that it would not implement that policy but that “[b]oth sides of a proxy contest will continue to receive interim voting updates for their own and each other’s ballot.”
The policy updates follow last year’s controversy over Broadridge’s disclosure of interim proxy tallies during a contested shareholder proposal at JPMorgan. Historically, Broadridge had disclosed interim vote tallies to the company and to proponents of shareholder proposals who used Broadridge to distribute proxy soliciting materials. The interim vote tallies were reportedly leaked to the public and, days before the annual shareholder’s meeting, Broadridge declined to share interim vote tallies with the shareholder proponents, citing its contractual obligation to broker clients who had expressed concern over the practice. The policy was later reviewed by the Broadridge Steering Committee, which noted in a July 2013 newsletter that Broadridge was taking a neutral stance on the policy but was contractually obligated to cease its practice in response to concerns received from brokers about the early release of their voting data.
Dan Fisher is a corporate partner in Akin Gump’s Washington D.C. office whose focus is on mergers and acquisitions (M&A). Recently, he has blogged about Delaware cases affecting the M&A practice and the financial provisions reviewed in a deal term study. You can read his posts here and here.
What is your main practice area?
I practice at the nexus of M&A, private equity and restructuring. I represent large public companies in traditional M&A transactions, private equity firms and their portfolio companies in transactions and their day-to-day legal needs, and creditors of all sorts (with special experience representing convertible noteholders) in the financial distress and restructuring context.
Last week, in American Capital Acquisition Partners, LLC v. LPL Holdings, Inc. (February 3, 2014), the Delaware Court of Chancery, in connection with a disputed earnout provision, allowed a claim for breach of the implied covenant of good faith and fair dealing to survive a motion to dismiss. In taking this relatively rare step, the court showed a willingness to fill a ‘gap’ in contractual drafting with an obligation to act in good faith, and deal fairly, with respect to a matter the parties did not focus on in negotiations. Specifically, the claims that survived were based on allegations that clients, personnel and opportunities of the acquired company were actively diverted post-closing to another subsidiary of the buyer, thereby impeding the acquired company’s ability to meet the performance guidelines that would have entitled the sellers (plaintiffs) to certain contingent payments (both under the Stock Purchase Agreement (SPA) and their employment agreements).
On the other hand, the court dismissed the claims alleging breach of those implied covenants by the buyer in failing to make technological adaptations to help increase profitability because the plaintiffs anticipated, but failed to bargain for, such an obligation in the SPA.
Update Regarding Chevron Forum Selection Litigation: Chevron Requests Delaware Supreme Court Certification
As discussed here and here, on June 25, 2013, the Delaware Court of Chancery upheld the facial validity of forum selection bylaws unilaterally adopted by the boards of directors of Chevron Corporation and FedEx Corporation. In October 2013, the plaintiffs voluntarily dismissed their appeal of that decision, thereby avoiding the possibility of the Delaware Supreme Court’s (likely) affirmation of the Honorable Chancellor Leo Strine’s decision.
Now, in a similar case in California, plaintiffs are again challenging the Chevron forum selection clause. In response, on January 31, 2014, Chevron requested that the Honorable Jon Tigar, U.S. District Court for the Northern District of California, certify the question regarding the validity of its forum selection bylaws to the Delaware Supreme Court. The hearing for the certification case is scheduled for March 13, 2014.
The Securities and Exchange Commission’s Division of Corporation Finance posted a few additional interpretations (at 260.33 and 260.34) late January relating to the continuation of offerings commenced prior to September 23, 2013, under the new general solicitation regime.
First, the staff confirmed that the transitioning of an offering that would have satisfied the previous version of a private offering to an offering that includes general solicitation would not require the issuer to go back and “verify” the accredited investor status of persons who invested prior to the transition.
Next, the staff confirmed such a continuing offering may be transitioned to the new general solicitation regime even if the offering included non-accredited investors admitted prior to the transition.
On January 13, ISS released FAQs expressing its views on a board’s adoption of director compensation bylaws. To counteract the increasing practice implemented by hedge funds and other dissident shareholders of paying their director nominees compensation arrangements tied to their election to a board or performance-based metrics, some companies are implementing director nomination and qualification bylaws. These bylaws would disqualify any director nominee who receives compensation from a third party. The ISS has now formalized its position on such director disqualification bylaws.
ISS generally opposes the adoption of a director compensation bylaw that would disqualify a director nominee who receives third-party compensation without putting such a bylaw to a shareholder vote. It takes the position that such adoption without shareholder approval could be considered “a material failure of governance because the ability to elect directors is a fundamental shareholder right…[and] [b]ylaws that preclude shareholders from voting on otherwise-qualified candidates unnecessarily infringe on this core franchise right.” Consistent with its policy on “Governance Failures,” ISS could, therefore, recommend a vote against or withhold from director nominees for any such material failures.
On February 5, the House Energy & Commerce Subcommittee on Commerce, Manufacturing and Trade held a hearing titled “Protecting Consumer Information: Can Data Breaches Be Prevented?” The hearing follows two consecutive Senate hearings this week on the same topic and featured testimony from representatives from the Federal Trade Commission (FTC), U.S. Secret Service, Department of Homeland Security (DHS), Target, Neiman Marcus and data security firms, as well as Illinois Attorney General Lisa Madigan.
The first panel of witnesses, consisting of FTC Chairwoman Edith Ramirez, U.S. Secret Service Deputy Special Agent in Charge William Noonan, Attorney General Madigan, and DHS National Cyber and Communications Integration Center Director Lawrence Zelvin, focused on whether Congress should grant regulators and law enforcement additional authority to establish and enforce data security and notification standards. Chairwoman Ramirez reiterated her agency’s call for a national data security standard and breach notification requirement. Attorney General Madigan also called for a national standard, but held the stance that any federal standard should not preempt existing state standards, so long as a state’s standard was equal to or stronger than the national standard. Attorney General Madigan also testified that, in the course of her research and investigation, she has found that “the notion that companies are doing all they can [to secure personal customer data] is false.” She repeatedly pointed to these discoveries to make the case for a national standard. The Attorney General also recommended the creation of a data breach investigative body modeled on the National Transportation Safety Board that would be tasked with investigating the failures of companies to reasonably secure their customers’ data. The DHS and Secret Service witnesses gave detailed testimony about their investigative actions in the wake of the recent data breaches at several retailers.
On Monday, February 3, and Tuesday, February 4, the Senate Banking and Senate Judiciary Committees (respectively) held hearings on the topic of data security and breach notification. Witnesses at both hearings included representatives from the Federal Trade Commission (FTC), the U.S. Secret Service, Target, Neiman Marcus and security firms such as Symantec.
On Monday, the Senate Banking Committee’s Subcommittee on National Security and International Trade and Finance held a hearing entitled “Safeguarding Consumers’ Financial Data.” The hearing focused on the criminal hacking of consumers’ financial data, including payment card information. Witnesses from the FTC and U.S. Secret Service outlined the existing investigative tools and enforcement authority to deal with these types of crimes. Jessica Rich, Director of the FTC Bureau of Consumer Protection, told the Committee that the FTC supports the creation of a federal standard for data security and breach notification, along with civil penalties for non-compliance. Much of the discussion focused on the transition of the payment card industry to a “chip and PIN” security standard, which would place microchips in payment cards and require personal identification numbers for processing retail transactions. Further, there were many questions regarding the extradition and prosecution of criminal actors who commit cyber crimes from locations outside the United States. U.S. Secret Service Deputy Special Agent in Charge William Noonan told the committee that extradition depends on the laws of the country where the hacker is physically located, and that some European countries have better records of extraditing persons suspected of committing crimes than others.
Recently, the 2013 Private Target Mergers & Acquisitions Deal Points Study was finalized by the M&A Market Trends Subcommittee of the Mergers & Acquisitions Committee of the American Bar Association. This bi-annual study, which was first published in 2007, analyzes a variety of deal points commonly negotiated in publicly reported M&A transactions involving a public buyer and a privately held target company. The 2013 study reviews 136 transactions that closed during 2012, with deal values ranging from $17.2 million to $4.7 billion. While the 2013 study reveals a number of interesting insights, this summary focuses on the financial deal points that most directly affect a deal’s bottom line. These findings should provide a useful reference as parties negotiate the appropriate financial terms of their transaction.
Post-Closing Purchase Price Adjustments
The study indicates that 85% of the deals included a post-closing purchase price adjustment, slightly higher than in prior years. While working capital was still the most common adjustment (in 91% of the relevant deals), adjustments for debt, cash and other items increased compared to the previous study. More of the relevant deals excluded current tax assets and current tax liabilities from the definition of “working capital” than in prior years (39% in 2012 versus 20% in 2010). Of the relevant deals, 88% included a payment at closing based on the target’s estimate, and in 74% of such deals the buyer did not have an approval right regarding the payment amount, in each case reflecting an increase over prior years. Most deals (69%) still did not have a separate purchase price adjustment escrow, and in a majority (57%) the true-up was paid from the indemnity escrow, up from 44% in the previous study. Finally, in more deals than in prior years (91% versus 84%), the purchase price adjustment amount did not need to exceed a certain threshold to be paid.
Mainstream media have recently noticed efforts by business interests to address potential risks to their business from a changing environment. As business entities assess potential risks, the drumbeat for disclosure of such assessments in public announcements grows louder. In addition, as discussed below, reporting companies should consider their disclosure obligations in this context in their risk factor disclosure and “forward looking statements” language.
Earlier this month, a former Securities and Exchange Commission member and a former deputy chief accountant, along with a London-based investor activist, called for the Financial Accounting Standards Board (FASB) to require companies with “significant fossil fuel reserves” to disclose information regarding assets that would be rendered “unburnable” by more stringent regulation (and become “stranded assets”).The authors suggest that such disclosure will permit investors to “pass judgment on the future viability of fossil fuel reserves.”
Class Certification Denied? Courts Denied Class Certification in Fewer Than 24 Securities Actions since 2002; Halliburton Petitioners Seek to Change that Trend
There is no shortage of arguments from the defense bar in Halliburton v. Erica P. John Fund (No. 13-317), a Supreme Court case that may be the most significant securities decision to come out of the Court in decades. At issue is whether the Court should overrule the fraud-on-the-market presumption of reliance or, alternatively, whether defendants should be allowed to rebut the presumption by introducing evidence that the alleged misrepresentation did not distort the market price of the stock. The decision will have far-reaching impact on securities class actions: since 2002, although nearly 2,000 cases have been filed, courts have denied class certification on substantive grounds in fewer than 24 cases.
In the last few weeks, the Halliburton Petitioners’ merits brief was followed by 11 amicus curiae briefs, each arguing that the fraud-on-the-market presumption of reliance should be overturned for a myriad of reasons.
In identifying issues facing corporate boards this year, the Financial Times identified board composition and director tenure as major topic. Our discussion on board composition, which was one of the Top 10 Topics for Directors in 2014 identified in our client alert, was mentioned in a column written by Anthony Goodman of Tapestry Networks. Please click here to read more.
Based on a number of cases decided by the Delaware courts in 2013, we have summarized practice tips regarding careful drafting of contractual provisions and complying with technical and statutory requirements:
- Disclaimers of Reliance and Accuracy Clauses Likely Do Not Bar Fraud Claims
- Modification of Default Fiduciary Duties in Limited Liability Companies (LLCs) Versus the Covenant of Good Faith and Fair Dealing
- Attorney-Client Privilege Passes to the Surviving Corporation in a Merger
- No Assignment of Agreements in Reverse Triangular Mergers
- Survival Clauses Can Shorten Statute of Limitations
- Need for Provisions Regarding Status of Former Partners and Valuation of Capital Account
- Earn-Out and Indemnification Provisions Need to be Clear and Specific
- Strict Requirements for Valid Stock Issuance
- Technical Requirements for Valid Stockholder Consents
Click here to read more.
During 2013, in addition to the important changes to the Delaware General Corporation Law (“DGCL”) and the Limited Liability Company Act, described here, the Delaware courts issued a number of decisions that have a direct impact on the M&A practice. Below are our Top 5 case law picks for M&A practitioners:
- A new look at the standard of review in going-private mergers (the Business Judgment Rule)
- Deal process considerations for target company boards
- Validity and enforcement of forum selection clauses
- Financial manipulation and/or missed sales forecasts may lead to a material adverse effect
- Directors must protect the interests of common stockholders (vs. preferred stockholders)
To read more, please click here.
Alice Hsu is a corporate partner in Akin Gump’s New York office, focusing on securities and general corporate matters. Recently, she has blogged about developments involving social media, for example here and here.
Q: What is your main practice area?
A: I advise and represent issuers, underwriters and selling stockholders in public offerings and private placements of equity and debt securities. Specifically, most of my day-to-day advice involves helping clients with issues related to federal securities regulation, corporate governance, disclosure and reporting and other general corporate matters.
Q: How has your practice evolved over the years?
A: Over the last decade, the federal securities laws have evolved a few times, including the Securities Offering Reform in 2005, the Dodd-Frank Act in 2010 and the JOBS Act in 2012. It has been interesting and stimulating to operate in this environment and keep pace with the changes and the various developments affecting our clients in order to provide them the best counsel.
In the wake of recent data breaches at major retailers Target and Neiman Marcus, Senate Judiciary Chairman Patrick Leahy (D-VT) has renewed his efforts to enact stronger data security requirements for companies that collect consumers’ personal data. Sen. Leahy has introduced the Personal Data Privacy and Security Act (S. 1897), detailed in a previous post, which would create a national data breach notification standard. Several other lawmakers have introduced similar legislation or made calls for stronger regulatory enforcement of data security rules. Now, Sen. Leahy has announced that his Committee will hold a hearing on the recent data breaches on February 4, 2014. According to a statement from Committee staff, the hearing will focus on “privacy in the digital age,” including how to prevent data breaches and combat cybercrime. The House Energy & Commerce Committee has also announced it will hold a hearing in early February.
With proxy season just around the corner, I would be remiss if I did not (once again) remind Nominating and Governance Committees that it is time, and it is not too late, for you mix it up a little . . . or a lot. Think fruit salad: a big, colorful, healthy fruit salad. That’s what Apple’s board of directors has recently vowed to do. In its 2014 proxy statement, Apple has announced that its “[Nominating and Corporate Governance Committee] is committed to actively seeking out highly qualified women and individuals from minority groups to include in the pool from which board nominees are chosen.” Yeah! One good Apple may unspoil the bunch. . . .
But wait a minute. Before we give Apple a standing ovation for its board of directors’ forward-thinking efforts to pursue corporate governance with the same vim and vigor with which the company pursues the development of technology and its product lines, let’s be clear: Apple had uninvited cooks in its kitchen pushing Apple to spice things up a little. Two investor groups, the Sustainability Group and Trillium Asset Management, met with Apple representatives several times this past fall, stating their displeasure and disappointment that Apple had only one woman on its eight-member board. The shareholders threatened to bring the issue to a vote at a February 28 shareholder meeting. Ultimately, they backed off after Apple added language in November to its Nominating and Corporate Governance Committee charter, promising to consider women and minorities.
As calendar-year public companies approach annual reporting season, issuers should consider whether or not their current risk factor disclosures, as well as their “forward looking statements” language, are adequate in light of recent high-profile cybersecurity incidents. While there are currently no comprehensive federal laws explicitly mandating disclosure in connection with data security breaches (a fact that several legislators are working to change), the emerging and existing business risks have not gone unnoticed by the Securities and Exchange Commission (SEC). In 2011 the SEC advised companies to approach cybersecurity as they would any other part of the business: if cybersecurity is a significant factor that makes an investment in the company speculative or risky, then issuers should address it in their risk factor disclosures. Similarly, if a past incident or current risk of cybersecurity is likely to have a material effect on operations or financial statements, then such incident or risk should be included in their Management’s Discussion and Analysis of Financial Condition and Results of Operations.
In light of recent, well-publicized, data security breaches at major retailers and social media company Snapchat, legislators are renewing the call for new federal laws that would strengthen data security and notification requirements.
On December 19, 2013, Target issued a press release disclosing that approximately 40 million credit and debit card account numbers had been hacked from its system, a number that has since risen to potentially as many as 110 million accounts. The breach is currently being investigated by the U.S. Secret Service Electronic Crimes Task Force. Further, state attorneys general across the country said they will examine whether Target provided enough protection for its customers. On New Year’s Eve, an anonymous group or person hacked into Snapchat’s servers and publicly released the usernames and phone numbers of more than 4.6 million Snapchat users. Additionally, on January 11, 2014, retailer Neiman Marcus confirmed that hackers had breached its servers and accessed customer payment information.
The core elements of a prima facie case of contract-related fraud are generally consistent from state to state. But within the basic elements of this cause of action are distinctions between states that become particularly salient in the context of sophisticated business transactions. Choice of law provisions among contracting parties may therefore play an important role in contractual fraud claims. As New York and Delaware are often designated in contractual choice of law provisions, the differences between these states are particularly relevant. In this regard, case law demonstrates that it is likely more difficult to establish a prima facie case of contract-related fraud in New York than in Delaware.
The staff of the SEC's Division of Corporation Finance recently published additional "Compliance and Disclosure Interpretations" [here], starting at 260.28, relating to the bad actor disqualification in Rule 506 under the Securities Act of 1933. The new C&DIs principally relate to the interpretation of "beneficial ownership" and include the following:
- The disqualifying effect of a 20 percent beneficial owner's bad act only applies to the potential sale of securities after the bad actor has acquired 20 percent [CDI 260.28]
- Beneficial ownership is determined pursuant to Rule 13d-3 under the Securities Exchange Act of 1934 (i.e. persons who have or share voting or investment power over the securities or have the right to acquire such power within 60 days) and, therefore, it is necessary to look through entities to their controlling persons in determining beneficial ownership. [CDI 260.29 and 30]
- Just because a group that beneficially owns more than 20 percent of the issuer's securities has a member that is a "bad actor" does not necessarily mean that the issuer is disqualified. More than mere group membership by a bad actor is required to apply the bad actor disqualification. The bad actor must have control over the securities owned by the group, such as voting or dispositive control over the entire group's block of securities, in order for the bad actor's group membership to cause bad actor disqualification. A group may also be disqualified if the group itself is subject to orders, convictions, bars, suspensions or expulsions covered by the rule. [CDI 260.31]
- A court or regulatory authority may not exempt the disclosure of a bad act that occurred before September 23, 2013, pursuant to Rule 506(e) under the Securities Act of 1933. The court or relevant regulatory authority may, however, determine that an order that was issued prior to September 23, 2013 would not have triggered disqualification if it were issued after such date because the violation was not a "final order based on a violation of any law or regulation that prohibits fraudulent, manipulative or deceptive conduct." [CDI 260.32]
The boards of all public companies should consider adopting a forum selection bylaw, if they have not already put one in place. The purpose of such a provision is to designate an exclusive venue for stockholder derivative suits and certain other stockholder suits, thereby reducing the high cost of duplicative, multi-forum suits challenging corporate actions. Delaware corporations typically designate the Delaware Court of Chancery, which confers the added benefit of ensuring that the matters in dispute will be heard relatively swiftly by a knowledgeable and highly regarded judiciary. In June 2013, the Delaware Court of Chancery rendered an important decision1 holding that such bylaw provisions are within the power of the board of directors to adopt under Delaware law and are enforceable under Delaware law to the same extent as contractual forum selection provisions.2 Prior to the Chancery Court’s decision, the validity of such bylaw provisions had not been addressed by a Delaware court and at least one other court had questioned their validity.3 In the wake of the Chancery Court’s decision, over 100 companies have adopted exclusive forum bylaws.
Bill Ackman’s public disclosure earlier this year of confidential JC Penney board deliberations not only outraged his fellow directors but also stunned the corporate community. His actions, however, were not without precedent. In 2006, a Hewlett-Packard director leaked confidential corporate information to the press and the company came under attack for methods used to ferret out the source of the boardroom leaks. As hedge funds and other shareholder activists increasingly succeed in gaining seats on corporate boards, boardroom confidentiality is an issue that no board of directors can afford to ignore.
Unfortunately, case law regarding a director’s obligation to maintain the confidentiality of corporate information is limited. Under Delaware law, a director’s fiduciary duty of loyalty requires directors not to misuse or disclose confidential corporate information to others to further their own private interests rather than those of the corporation.1 While a director may believe that conveying confidential corporate information to the press is in the best interests of the corporation, a court will decide with 20-20 hindsight whether the disclosure was consistent with the director’s fiduciary duties. In the JC Penney incident, the board reportedly was considering pursuing legal action against Ackman, whose disclosures the company’s chairman characterized as “disruptive and counterproductive.”2 According to at least one report, Ackman sought, in connection with his ultimate resignation from the board, a release from any potential liability.3
Shareholder activism is on the rise. Through the first three quarters of 2013, activist investors submitted 91 initial Schedule 13D filings, well on pace to eclipse the 109 filings made in all of 2012.1 In addition, proxy fight announcements are at their highest level since 2009.2
So far in 2013, 60 percent of activists’ campaigns have focused on boosting earnings at companies or shaking up their boards.3 And companies with a lot of cash on their balance sheets better beware. With companies sitting on more than $1.8 trillion in cash, 41 activist campaigns this year have demanded that companies return cash to shareholders through either dividends or stock buybacks.4
Activists are increasingly drawing larger companies into their crosshairs. In 2013, activists have gone after such large-cap companies as Apple, Dell and Hess Corporation. According to FactSet SharkWatch, as of October 2013, 50 value maximization and board seat campaigns had been announced against companies with a market value exceeding $1 billion, the most in any comparable period since they started tracking this information in 2005.5 And this trend is likely to continue. Not only are new activist funds emerging, but their assets under management are rising and an increasing number of mutual funds and institutional investors are siding with activists, thereby allowing activists to go after these larger companies with some success.6 In addition, many larger companies have become more vulnerable to an activist attack after having acceded to shareholder demands to destagger boards, eliminate poison pills and give shareholders the right to vote by written consent and call special meetings.
Registrants and investors are increasingly placing greater focus on proxy statement presentation. As a result, over the last few years, proxy statements have evolved into more effective disclosure and marketing tools as registrants have adopted a number of best practices, including providing a proxy statement summary and CD&A executive summary.
RR Donnelley recently released the results of its survey of institutional investor use and review of proxy statements. The results of the survey indicate that registrants are on the right track, but should continue to make improvements in the content and presentation of their proxy statements. A summary of the survey results is available here.
In addition to heightened focus on director tenure, companies are facing increasing pressure to diversify their boards. The SEC requires companies to disclose whether and how the board or nominating committee considers diversity in identifying candidates. Last year, after public outcry over its all-male board, Facebook added a woman director shortly after its IPO. Twitter is facing similar criticism this year.1 During the 2013 proxy season, shareholders submitted 27 proposals to companies seeking to ensure that women and minorities are considered for board positions, up from only eight such proposals in 2012.2 The vast majority of these proposals were withdrawn after proponents and companies reached a resolution. The three proposals that went to a vote averaged 35.8 percent shareholder support, with one proposal winning majority approval.3 The dramatic increase in the number of diversity proposals submitted in 2013 was largely to the efforts of the Thirty Percent Coalition,4 an organization composed of national women’s organizations, institutional investors, senior business executives, some major accounting firms, statewide elected officials and others, whose goal is 30 percent female representation on U.S. public company boards by the end of 2015.5 In early 2013, the organization also sent letters to 127 companies that did not have any women on their boards, urging them to embrace gender diversity.6
The Wall Street Journal recently highlighted director tenure in an article titled “The 40-Year Club: America’s Longest Serving Directors.”1 While the article noted that fewer than 30 public company directors have at least 40 years’ tenure,2 the article also made clear that many public company boards are having difficulty refreshing their ranks. According to the latest Spencer Stuart Board Index, the boards of S&P 500 companies elected 339 new independent board members this past proxy season, down 11 percent from five years ago and 14 percent from 10 years ago.3 Last year they elected just 291 new directors, the smallest number in more than a decade.4 At the same time, the average age of directors continues to climb. The average S&P 500 director is now 62.9 years old, compared to 60.3 ten years ago.5 In addition, mandatory retirement ages keep rising. Of the 72 percent of S&P 500 boards that have a mandatory retirement policy, 88 percent now set their retirement age at 72 or older (compared to just 46 percent a decade ago) and almost a quarter set the retirement age at 75 or older (compared to just 3 percent ten years ago).6 At 20 percent of S&P 500 companies, the average board tenure is 11 years or more.7
Low director turnover is drawing the attention of activist investors and governance advocates who question whether aging boards are keeping pace with the rapid technological advances and other new challenges companies face. Critics also charge that the limited availability of new board seats hampers opportunities for achieving greater racial and gender diversity on boards and compromises board oversight since long-serving directors are more likely to align with management.8 The Council of Institutional Investors, whose members consist of pension funds with more than $3 trillion of assets under management, recently revised its best-practices corporate governance policies to include tenure as a factor boards should consider when determining whether a director is independent.9 In addition, while ISS decided not to revise its 2014 proxy voting guidelines to add tenure to the factors it considers when assessing director independence, 74 percent of institutional investors responding to ISS’ request this past summer for comment on its guidelines viewed long tenure as problematic.10 In sharp contrast, 84 percent of responding issuers said that long tenure was not problematic.11
Whether to separate the CEO and chairman positions is one of the most hotly debated issues in corporate governance. During the 2013 proxy season, calls for an independent board chair were the second most frequent proposal submitted to companies.1 Even though JPMorgan Chase managed to win highly publicized battles in each of the last two years against activists seeking to separate the top posts currently held by Jamie Dimon, board leadership structure will likely continue to be a top priority for activists in 2014.
Proponents of separating the CEO and chair positions typically argue that splitting the roles strengthens the independence of the board, thereby improving the board’s oversight function. Proponents also contend that separation can free the CEO to focus on running the company. Opponents generally counter that a separate chair can undermine the CEO’s authority and result in inefficiency.
Despite the continuing legal challenges and political hardball, as well as the delays and technical glitches, it appears that the Patient Protection and Affordable Care Act, more commonly known as Obamacare, is here to stay. As such, companies need to be prepared for certain key provisions of the statute that are scheduled to take effect in 2014 and beyond. Because these provisions will have a major impact on most companies, boards of directors need to be planning how their companies will comply with these regulations and the effect such compliance will have on their company’s cost structure and strategy going forward.
Set forth below is a brief summary of certain key provisions of health care reform that are looming, followed by actions for boards to consider.
State Insurance Exchanges. By January 1, 2014, each state must either (i) implement its own state-run health insurance exchange, (ii) let the federal government run the health insurance exchange for them or (iii) partner with another state or the federal government to implement a health insurance exchange. These health insurance exchanges, among other things, will facilitate the purchase of and make available “qualified health plans” to qualified individuals and employers. Employees of companies with fewer than 50 full-time employees will generally be eligible to purchase insurance within the state insurance exchange (or federally facilitated exchange) and possibly receive a federal subsidy without any penalty to the company. But, as discussed below, larger companies with employees who purchase insurance through these exchanges will be required to pay a penalty. Enrollment under these health insurance exchanges, which began on October 1, 2013, has been anything but smooth, with technical glitches and delays frustrating the masses who have tried to enroll. Because of these issues, the deadline for the uninsured to sign up for health care coverage and avoid paying a penalty has been extended until March 31, 2014.
Constantly changing and overlapping legislative and regulatory requirements are weighing down corporations and usurping more and more board time. It is a telling sign when, according to a recent survey, directors ranked over-regulation second only to the government’s response to the fiscal debt and the debt burden as the greatest external threat to their company’s growth prospects.1
Directors may well have reason for concern. Since 1993, 81,883 new federal rules have been issued,2 and the red tape keeps growing. A recent report of planned regulatory actions lists 2,305 rules in the pipeline, 131 of which are classified as “economically significant” and many of which derive from the Dodd-Frank Act and Obamacare.3 For global companies the regulatory challenge is even more complex. They must expand their focus beyond the country in which they are headquartered, and understand, manage and comply with myriad rules and regulations in multiple jurisdictions.
Executive compensation is a topic that just won’t go away, particularly with pay disparity and pay for performance regulations still looming. We highlight below some of the matters directors should be considering as they craft executive compensation for 2014:
- Say-on-Pay Vote. Say-on-pay proposals, now in their third year, have led to what seems to be routine approval of C-suite compensation for the vast majority of companies, with shareholders at 97 percent of U.S. companies approving executive pay packages and 72 percent of such companies achieving more than 90 percent approval.1 But boards are not letting down their guard. According to a recent survey, 70 percent of directors say their boards took some form of action in response to their company’s most recent say-on-pay vote, with the most common being enhancing proxy statement disclosures, increasing the use of compensation consultants and making compensation more performance based.2 But this does not mean that executive compensation is decreasing. Only three percent of directors surveyed say their company reduced executive compensation during 2013.3
- Proxy Advisory Firm Recommendations. Proxy advisory firms can be a key driver to the outcome of a say-on-pay vote. Companies need to analyze their shareholder base to determine the level of influence proxy advisors have on their investors. And if a proxy advisory firm gives a negative recommendation, companies need to consider whether they want to refute the recommendation through supplemental proxy filings and shareholder outreach. Filing supplemental materials gives companies an avenue to address inaccuracies in the proxy advisory firm recommendation and to further strengthen their case. However, because supplemental filings cost money and draw unwanted attention, many companies opt for direct engagement with major shareholders, as discussed below.
Regulation A currently permits issuers to conduct a limited-scale public offering and subjects issuers that use it to a lighter compliance burden as compared with larger public offerings. However, because of the costs of preparing an offering circular to be filed with the Securities and Exchange Commission (SEC) and the requirement to achieve clearance by the various state securities regulators, especially when compared with the limited amount that may be raised ($5 million), Regulation A has been infrequently used. For example, only one offering was conducted in 2011 under Regulation A. Section 401 of the Jumpstart Our Business Startups (JOBS) Act required the SEC to adopt rules under a new, larger, limited public offering section of the Securities Act of 1933 (the Securities Act) commonly referred to as “Regulation A+.” The Regulation A+ section of the Securities Act increases the offering cap to $50 million and permits sales to be exempted from the review of state securities regulators, but would require (at least) annual filings of audited financial statements.
On December 18, 2013, the SEC proposed rules that would rewrite existing Regulation A to include Regulation A+ requirements to increase the usefulness of its rules relating to smaller public offerings. This new Regulation A would be split into two tiers. Tier 1 would be similar in scope to current Regulation A and would permit sales up to $5 million in any 12 month period ($1.5 million of which may be resales by selling stockholders). Tier 2 would permit sales up to $50 million in any 12 month period ($15 million of which may be resales by selling stockholders). Offerings under $5 million could be conducted under either tier. As with current Regulation A, the sale of securities under either tier, as revised, would involve certain disclosure requirements as specified below, but offerings under Tier 2 would involve additional compliance requirements. Securities sold under Regulation A would not be “restricted securities” and, therefore, would not be subject to holding periods before resale.
Some marriages last forever. Some may only last for hours, weeks or a short few years. Some divorces are quick and quiet. Some are high profile. Think: Brad and Jen, Tiger and Elin, Ashton and Demi. Names, faces and assets differ, but just about every divorce involves drama.
Drama sells magazines. But what the heck does it have to do corporate governance? You might be surprised. Check out the post on the Harvard Law School Forum on Corporate Governance and Financial Regulation entitled “The Impact of CEO Divorce on Shareholders” in which authors David Larker and Allan McCall of the Stanford University Department of Accounting and Brian Tayan of the Stanford Graduate Business School examine the impact that a CEO’s divorce can have on a corporation. They argue that the tumultuous personal life of a CEO—the very person tasked with setting strategy and leading a corporation to better profits and shareholder returns—should be of investor concern because:
- a CEO’s divorce settlement may affect a CEO’s control or influence (e.g., CEO is forced to sell personal shares held in the company);
- a CEO’s divorce may affect a CEO’s productivity, concentration and energy levels;
- a CEO’s divorce, and resulting changes in wealth, may influence a CEO’s risk appetite and decision making.
On December 10, 2013, five federal agencies released the final rules implementing Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Volcker Rule). The Volcker Rule will be effective on April 1, 2014, and will require the banking entities subject to it to fully conform their activities by July 21, 2015.
Similar to previously proposed versions, the final version of the Volcker Rule will continue to restrict insured depository institutions and companies affiliated with insured depository institutions (the banking entities) by (1) prohibiting short-term proprietary trading of certain securities, derivatives, commodity futures and options on these instruments, for their own account, and (2) limiting their investments in or sponsorships of hedge funds or private equity funds, certain foreign funds and certain commodity pools.
As per the statute, the rules will, however, permit banking entities to invest in or sponsor such a fund in connection with organizing and offering a fund and to retain up to 3% of the total investment in a fund that it organizes for its fiduciary customers. In addition, the final rules exempt certain activities, including market making, underwriting, hedging, trading in government obligations and insurance company activities, and clarify that certain activities are not prohibited, including acting as agent, broker or custodian.
Cybersecurity has become one of the hottest topics in the boardroom as companies wrestle with ever increasing threats to their information systems and intellectual property. A recent study by the Ponemon Institute found that in the past year the number of successful cyber attacks on companies surveyed jumped 42 percent compared to the prior year.1 According to the Department of Homeland Security, the number of cyber threats to critical U.S. infrastructure by mid-2013 had already exceeded the total number of incidents in 2012.2
This dramatic rise in cyber attacks and data breaches has placed cybersecurity on the radar screen of virtually all companies. In addition to potential lawsuits, damage to reputation and loss of customers, companies are facing increasing regulatory scrutiny about the adequacy of their data security measures. The FTC has brought more than 40 actions against companies for data breach, claiming that failures to prevent unauthorized access to consumers’ personal information constitute unfair or deceptive acts. In almost all instances, companies have settled by entering into consent decrees requiring them to implement better information security programs and obtain annual independent audits for 20 years. In one closely watched case, however, Wyndham Hotels is challenging the FTC’s authority to impose cybersecurity standards.
The SEC has also made cybersecurity risk a top disclosure priority. In 2011, the SEC issued guidance regarding company disclosure obligations about material cybersecurity risks and cyber incidents. Since then, the SEC has sent comment letters to at least 50 companies regarding the adequacy of their disclosures. In May, SEC Chairman Mary Jo White instructed her staff to evaluate its current guidance and consider whether more stringent requirements are needed.
On November 25, the U.S. Supreme Court set oral argument for March 5, 2014, in Halliburton v. Erica P. John Fund (No. 13-317), a case that could significantly impact the costs of securities litigation in the United States. The case raises one central question: should plaintiffs be entitled to the fraud-on-the-market presumption of reliance, which allows plaintiffs to form a class of investors without first proving that those investors relied on the supposedly false or misleading information from the company?
The Court’s answer to this question could change the face of securities litigation in the United States. For years, securities class actions have been the textbook example of easy-to-certify classes. Under Rule 23(b)(3), proposed class plaintiffs must prove up the common class action elements: commonality, numerosity, adequacy, typicality and predominance. Many proposed classes are never certified because of the predominance element—individual issues predominate over the common issues. In the case of securities class actions, the question revolves around whether investors actually relied on the alleged fraud and what it would take to prove that they did so.
Since SIGA Technologies Inc. v. PharmAthene Inc. (Del. 2013), the duty to negotiate in good faith is well recognized in Delaware, but it is not as clear when exactly that duty arises. On December 2, 2013, in Osco Motors Company, LLC v. Marine Acquisition Corp., the Delaware district court explained how the duty is created and distinguished Delaware law from New York law. The court distinguished between the express, contractual duty of good faith, created through the parties’ agreement (such as in a letter of intent, as long as such provision is binding), and the implied covenant of good faith and fair dealing, created by statute and implied in parties’ agreements (which must be separately claimed).
In addition, the court disagreed with the defendants’ claim that they did not violate the confidentiality agreement because they used the confidential information, but did not disclose the information. The court confirmed the standard from Martin Marietta Materials, Inc. v. Vulcan Materials Co., that “confidentiality agreements are intended and structured to prohibit both the use and disclosure of confidential, nonpublic information, unless the parties agree otherwise.”
Directors recently ranked strategic planning as the number one topic to which they want to devote more time in 2014.1 It’s easy to understand why: gridlock in Washington is wreaking havoc on business planning. Throughout much of the fall, the American economy was held hostage as political brinkmanship in Washington partially shut down the federal government and brought the country to the edge of defaulting on its debt. Ultimately, Congress managed only to kick the can down the road by voting to reopen the government at current spending levels until January 15, 2014 and to raise the debt ceiling until February 7, 2014. During the interim, congressional leaders will try to hammer out a new budget before mandatory spending cuts agreed to in 2011 kick in. Fearing that “governing by crisis” is becoming the new norm, the business community remains skeptical that any meaningful long-term solution to the nation’s fiscal woes will be reached before the country has to suffer through this fire drill again.
Adding to the uncertainty is growing concern over the Federal Reserve’s massive bond buying program. Critics charge that the unprecedented stimulus program may be creating asset bubbles, and the financial markets have reacted strongly to any news about the Fed’s future plans for the program. Hints this past summer that the Fed was eyeing a pull-back roiled markets around the world and dealt a serious blow to many emerging market economies.
Last week, Akin Gump issued our Top 10 Topics for Directors in 2014. Number 7 on that list: “Ensure appropriate board composition in light of increasing focus on tenure and diversity.” Guess what was Number 7 on our Top 10 Topics for Directors in 2013? You got it: “Ensure appropriate board composition in light of changing marketplace dynamics and increasing calls for diversity.”
Some things bear repeating: exercise, eat right, get enough sleep. Do things that are good for you. Corporations: put women on your boards! If you have been zoned out, on your iPod all year or otherwise still have not been convinced of the value of doing so, take a look at Sheryl Axelrod’s “Disregard Diversity at Your Financial Peril: Diversity as a Competitive Financial Advantage,” published in MCCA’s (the Minority Corporate Counsel Association’s) national magazine, Diversity & the Bar.
The staff of the Securities and Exchange Commission’s Division of Corporation Finance published “Compliance and Disclosure Interpretations” (CDIs) on Wednesday, December 4, 2013. They provide important clarification regarding the scope of the “bad actor” disqualification in Rule 506(d) under the Securities Act of 1933 for certain convictions, cease and desist orders, suspensions and bars (“disqualifying events”) that occur on or after September 23, 2013 and the disclosure obligation in Rule 506(e) for disqualifying events that occurred prior to September 23, 2013. The interpretations are available here starting at 260.14. Our previous post summarizing earlier CDIs is available here.
Rule 506 provides that disqualifying events committed by a list of specified “covered persons” affiliated with the issuer or the offering would result in disqualification from using Rule 506 or require disclosure to investors prior to their purchasing securities. However, Rule 506 also provides a defense for issuers that did not know and, in the exercise of reasonable care, could not have known of that disqualifying event. Prior to the issuance of these CDIs, private funds and other issuers offering and selling securities in reliance on Rule 506 were forced to broadly interpret the covered persons with whom an issuer would have to inquire regarding any disqualifying events and the consequences of a disqualifying event.
The most significant of the new CDIs states that the definition of “affiliated issuer” for purposes of the bad actor disqualification is an affiliate of the issuer that is “issuing securities in the same offering, including offerings subject to integration. . .” with the offering for which Rule 506 is being used (see CDI 260.16). Consequently, fund issuers will no longer need to ask controlled portfolio companies whether they have any disqualifying events.
In recent weeks, U.S Department of Justice investigations into currency traders have drawn renewed attention to the permanence of even seemingly fleeting communications. In that investigation, the DOJ is looking at, among other things, Bloomberg chat room transcripts of members of the so-called “Cartel,” a group of currency traders. As a result of such investigations, the days may be numbered for widespread use of Bloomberg chatrooms: the Wall Street Journal reported recently that several large banks are already considering restricting chatroom access. But while regulators and companies have their attention turned to chatrooms, new methods of communication continue to emerge, presenting new challenges for corporate compliance.
Take Snapchat, for instance. For the uninitiated, Snapchat is a smartphone app that allows people to send each other “disappearing” pictures. The sender can choose how long the recipient will be able to view the picture—anywhere from one to ten seconds—before it disappears from the recipient’s phone. Users can also send single-view videos up to 10 seconds long that erase as the recipient plays them. And while Snapchat has its legal uses from the mundane to the prurient, the possibility of its misuse in the securities context is worth attention.
U.S. public companies face a host of challenges as they enter 2014. Here is our list of hot topics for the boardroom in the coming year:
1. Oversee strategic planning amid continuing fiscal uncertainty and game-changing advances in information technology
2. Address cybersecurity
3. Set appropriate executive compensation as shareholders increasingly focus on pay for performance and activists target pay disparity
4. Address the growing demands of compliance oversight
5. Assess the impact of health care reform on the company’s benefit plans and cost structure
6. Determine whether the CEO and board chair positions should be separated
7. Ensure appropriate board composition in light of increasing focus on director tenure and diversity
8. Cultivate shareholder relations and strengthen defenses as activist hedge funds target more companies
9. Address boardroom confidentiality
10. Consider whether to adopt a forum selection bylaw
Click here to read the full alert as a PDF.
Warning shoppers—or, rather, sellers: a company’s failure to meet sales forecasts may amount to a material adverse effect.
In Osram Sylvania Inc. v. Townsend Ventures, LLC, Osram Sylvania Inc. (OSI), a stockholder of Encelium Holdings, Inc., agreed to purchase the other issued and outstanding capital stock of Encelium not already held by OSI pursuant to a stock purchase agreement, which was executed on the last day of the third quarter of 2011. The $47 million purchase price was based on Encelium’s forecasted sales for the 2011 third quarter, estimated at $4 million, as well as representations relating to Encelium’s financial condition, operating results, income, revenue and expenses.
On November 21, 2013, Institutional Shareholder Services Inc. issued updates to its benchmark proxy voting policies for the U.S. The updated policies will be effective for shareholder meetings on or after February 1, 2014. The updates include changes to ISS policy on board responsiveness to majority-supported shareholder proposals and its policy on pay-for-performance quantitative screen.
With respect to its policy on board responsiveness to majority-supported shareholder proposals, ISS will in the future review the responsiveness of a board to any shareholder proposal supported by a majority of votes cast (rather than the previous policy of reviewing a board’s responsiveness to either (i) a proposal supported by a majority of votes cast in the last year and one of the two prior years or (ii) a proposal supported by a majority of outstanding shares). In addition, when recommending voting on director nominees, ISS adopted a case-by-case approach when considering a board’s responsiveness to shareholder proposals, including a list of factors to consider in assessing implementation of majority vote proposals. Finally, ISS clarified that the board’s rationale as provided in the proxy statement for the level of implementation of a shareholder proposal is one of the factors in such a case-by-case analysis.
In addition, ISS modified its methodology for calculating the relative degree of alignment pay-for-performance screen for a CEO’s pay rank within a peer group. The current calculation uses the difference between a company’s TSR rank and the CEO’s total pay rank within a peer group, as measured over one-year and three-year periods (weighted 40%/60%). The revised calculation will measure this difference simply over a three-year period, which will, among other things, eliminate the effects of over-weighting the most recent year’s pay.
To view the ISS 2014 updates, click here.
Financial advisors should remain keenly aware that, in recent years, plaintiffs and courts have been more carefully scrutinizing fairness opinions rendered in the context of public M&A transactions. Post-Great Recession, the trend in fairness opinions has been toward more robust disclosure on projections and deal economics, in part due to decisions of the Delaware Courts and urging by the Securities and Exchange Commission. The plaintiff’s bar has thus taken to attacking aspects of the fairness opinion that are more tangential. Accordingly, the Delaware Courts are demonstrating an increased sensitivity to the risk of their fact-specific decisions being exploited for claims sounding in principles of general liability. Some of the biggest pressure points that remain the target of shareholder claims include: (i) conflicts of interest, (ii) the analysis used by the financial advisor and (iii) management’s projections.
The Netspend case from earlier this year demonstrated the scrutiny imposed upon a fairness opinion when it is being relied upon as the sole ‘market check’ in the transaction i.e., in a single-bidder process for sale of a company when neither the stockholders nor the court have any market-based indication for the adequacy of the price). The Netspend Board forewent a pre-agreement market check; acquiesced to strong deal protections, including, most notably, ‘don’t ask, don’t waive’ provisions against private equity bidders; and relied upon a weak fairness opinion. The financial advisor who rendered the opinion relied upon the stock price as a basis for valuation, when, in fact, the stock price was highly volatile, resulting in the Court’s finding that the fairness opinion was a” particularly poor simulacrum of a market check’. Vice Chancellor Glasscock criticized the investment bank for using dissimilar comparables, most of which were old and predated the financial crisis. The Court also criticized the investment bank for using projections that exceeded the customary practices of management — highlighting the importance for a financial advisor to ensure that the valuation methods used, and the projections made, are those normally utilized by the company.
As discussed here and here, the Securities and Exchange Commission (SEC) adopted changes to Regulation D and Rule 144A, addressing general solicitation, new filing requirements and “bad actor” disqualification events (among others) applicable to Rule 506 offerings. These changes went into effect on September 23, 2013, and on November 13, 2013, the SEC published additional Compliance and Disclosure Interpretations (C&DIs) relating to Rule 144A and Rule 506(c).
The new C&DIs include the following guidance:
- The continuation of an offering that originally commenced under Rule 506 prior to September 23, 2013, under the new general solicitation regime would require an amendment to Form D to check the 506(c) box. [260.05]
- If a purchaser in a Rule 506(c) offering were not accredited, the issuer would not lose the exemption if the other requirements of a Rule 506(c) offering were followed, such as taking reasonable steps to verify the accredited investor status. [260.06]
- On the other hand, even if all purchasers are accredited investors, an issuer is not eligible to use Rule 506(c) if reasonable steps to verify have not been taken. [260.07]
- Statements reviewed for purposes of verification must be dated within three months of the sale of the security in order to satisfy the non-exclusive verification method specified in Rule 506(c). [260.08]
- An attorney or accountant verifying accredited investor status may be licensed in a foreign jurisdiction and satisfy the non-exclusive verification method specified in the rule. [260.09]
- The verification method for existing investors from a prior sale of securities would not be satisfied if the investor had previously invested in an affiliated issuer, such as a fund with a common sponsor. The previous investment must have been in the issuer in which the investor proposes to invest. [260.10]
- An issuer that commences an offering intending to rely on Rule 506(c) may transition to 506(b) so long as the conditions of Rule 506(b) have been “satisfied with respect to all sales of securities that have occurred in the offering.” An amendment to the Form D would be required. [260.11] The opposite also applies, but note that the language of the interpretation looks to all securities sold in the offering and not just those after transitioning from paragraph (b) to (c) or from (c) to (b) of Rule 506.
- An offering that commences under Rule 506(c) and in which general solicitation has actually occurred may not transition to a pure Section 4(a)(2) offering. [260.13]
We understand that guidance on who is an affiliated issuer for purposes of the Rule 506(d) bad actor disqualification will be published at a later date.
In Great Hill Equity Partners v. SIG Growth Equity Fund (November 15, 2013 - Strine), the Delaware Court of Chancery held that attorney-client privilege passes to the surviving corporation in a merger. The case was brought by the buyer of Plimus, Inc., and claimed that the seller had fraudulently induced the buyer to acquire Plimus. The buyer sought a determination regarding the pre-merger attorney-client communications about the transaction it found on Plimus’ computer systems.
Section 259 of the DGCL provides that “all property, rights, privileges, powers and franchises, and all and every other interest shall be thereafter as effectually the property of the surviving or resulting corporation.” The court decided that, in the absence of a contractual provision excluding pre-merger attorney-client communications from the transferred assets, all privileges, including the attorney-client privilege over any pre-merger communications (even regarding the merger negotiations), passed to the surviving corporation in the merger.
As a practical matter, parties should include specific contractual provisions if there is an intent to exclude the transfer of any attorney-client communications.
On August 1, 2013, the Delaware legislature added a potentially important new subchapter to the General Corporation Law, allowing corporations to elect to be formed as, or convert to, a public benefit corporation (PBC) (Subchapter XV of Chapter 1, Title 8 of the Delaware Code). What are the requirements for becoming a PBC? And why would a corporation choose to become one?
Background (for Non-Delaware PBCs)
Traditionally, directors of corporations have had a fiduciary duty to maximize stockholder value in making decisions. However, PBCs, or social purpose corporations as they are known in some jurisdictions, permit a corporation’s directors to also take into account the social purposes of their actions. PBCs are typically required to pursue a general public benefit and make available to the public an annual report measuring their performance in meeting their social goals.
Delaware Supreme Court applies ‘reasonable conceivability’ standard and addresses earn-out and indemnification provisions
Last month, in Winshall v. Viacom International, the Delaware Supreme Court applied the “reasonable conceivability” standard to a motion to dismiss and addressed the earn-out and indemnification provisions in a merger agreement.
The opinion highlights the importance of using clear and specific language to clarify the intent of the parties.
The case was brought by selling stockholders based on the earn-out provisions in the 2006 merger agreement entered into between Viacom International and Harmonix Music Systems, in which Viacom acquired Harmonix. In addition to a $175 million cash payment at closing, the merger agreement provided a contingent right to the selling stockholders to receive certain earn-out payments during 2007 and 2008 based on financial performance, but it did not explicitly require Harmonix to conduct its business so as to maximize the earn-out payments. The merger agreement also contained an indemnification provision requiring the selling stockholders to indemnify and hold harmless Viacom and Harmonix and their affiliates from and against any losses arising out of or by reason of the breach of any representation or warranty of the company in the merger agreement.
Last week, New York Times OpEd columnist Nicholas Kristof joined the chorus of writers and academics calling for public companies to add women to their boards of directors in a piece called “Twitter, Women and Power.” Mr. Kristof criticized Twitter, which is scheduled to launch a blockbuster IPO in November, for seating its board with seven white men. He writes: “. . . the main reason to add women — not just on Twitter’s board, but in politics, business and the news media — isn’t just equity. This shouldn’t be seen as a favor to women but as a step that would be good for all of us . . . In business, there’s abundant evidence that inclusion of women in senior positions is linked to better results.”
Mr. Kristof cites a number of research reports that provide an overwhelmingly strong case for women’s inclusion on corporate boards. These studies find that companies with women on their boards yield higher operating profit, higher return on invested capital and “generally results in increased value for shareholders.” The findings are compelling, indeed, but not new. (See prior post: The Case for Women on Boards: Taking the Long View.)
Court Upholds Claim Against Private Equity Firm for Federal Labor Law Violation Stemming from Closure of Portfolio Company
A decision last month by the district court for the Northern District of Indiana is the latest in a string of recent judicial decisions to confirm that a plaintiff has successfully stated a plausible claim for relief under the WARN Act on the “single employer” theory.
The case, Young v. Fortis Plastics LLC1 was filed by a worker laid off by a manufacturing facility in Forth Smith, Arkansas, alleging violations of the WARN Act upon closure of the facility. The WARN Act seeks to protect workers who suffer job losses due to mass layoffs by requiring that certain employers provide sixty days’ notice to workers before engaging in a mass layoff or plant closure and by enabling aggrieved employees to sue the employer for back pay and benefits upon failure to receive such notice. The federal statute defines “employer” as “any business enterprise” that employs the requisite number of employees. Because the statute does not define the term “business enterprise,” the Indiana district court upheld the application of a multi-factor test based on regulations of the Department of Labor (DOL). The court stated that, due to the nature of mass layoffs and plant closure at issue in the case, a direct employer will often not have the financial means to pay obligations under the WARN Act. As a result, the court deemed it reasonable to require Fortis’ private equity parent to assume those obligations where it could be shown that the private equity firm was partially responsible for the decisions leading to the WARN Act liability.
Applying the DOL five-pronged test to the case, the court found that the plaintiff successfully alleged two of the five prongs, common ownership and de facto control, but not the remaining three: common directors and/or officers; unity of personnel policies emanating from a common source; and dependency of operations. Citing precedent from the Southern District of New York, the court explained that each of the DOL factors is not a necessary element that must be satisfied in order for a plaintiff to succeed under the “single employer” theory, but, rather, that the factors are components of a balancing test that the court will weigh to determine whether the two entities are so interrelated as to constitute a “single employer.”
The Metropolitan Corporate Counsel's November 2013 issue features an in-depth interview with Akin Gump corporate practice co-chair Frank Reddick on compliance. In “Corporate Counsel’s Guide to Compliance,” Reddick discusses, among other topics:
- Reduction of exposure to compliance failures: “The best protection starts with a clear articulation of the risk profile of the company. Managers should have a clear and consistent understanding of the firm’s risk philosophy – the amount of risk a company is willing to accept in pursuit of its business goals.”
- Theories of director liability: “…the potential for directors’ liability runs the gamut from potential liability for failure to put controls in place in the first instance, failure to improve controls once deficiencies are bought to the board’s attention, and failure to investigate once red flags arise or complaints are made.”
Yesterday, the SEC proposed rules to permit companies to offer and sell securities through crowdfunding, as required by the Jumpstart Our Business Startups Act of 2012. Crowdfunding, which has become popular in recent years with the growth in social media, typically involves raising funds for a common cause or venture through small contributions from many individuals. The JOBS Act amended the Securities Act of 1933 by adding a new Section 4(a)(6) that, subject to SEC rulemaking, exempts certain crowdfunding offerings from the registration requirements of the Securities Act. Under the proposed rules, several conditions must be satisfied to qualify for the exemption, including:
- Cap on amount raised. The aggregate amount sold to all investors by the issuer, including any amount sold in reliance on the exemption during the 12-month period preceding the date of the transaction, cannot exceed $1 million.
- Cap on individual investments. The aggregate amount that can be sold to any investor pursuant to the crowdfunding exemption during the 12-month period cannot exceed the greater of:
- $2,000 or five percent of the investor’s annual income or net worth, whichever is greater, if both the annual income and net worth of the investor are less than $100,000; or
- 10 percent of the investor’s annual income or net worth, whichever is greater, not to exceed an amount sold of $100,000, if either the investor’s annual income or the investor’s net worth is $100,000 or more.
- Required use of broker or funding portal. The transaction must be conducted through an SEC-registered intermediary—either a broker-dealer or a new type of entity called a funding portal that complies with the requirements described in the proposed rules.
- Disclosure document. The issuer must file with the SEC on EDGAR and provide to investors and the broker or funding portal certain information, including information about the issuer’s officers, directors and 20 percent shareholders, the issuer’s business and anticipated business plan, the use of proceeds from the offering, the terms of the offering, certain related party transactions, the issuer’s capital structure and financial condition, and details regarding the offering process. The issuer must also provide financial statements of the company that, depending on the size of the offering, would have to be accompanied by the issuer’s tax returns or reviewed or audited by an independent public accountant or auditor.
- Annual reporting. The issuer must file with the SEC on EDGAR and provide to investors an annual report of its results of operations and financial statements within 120 days after the end of the most recent fiscal year. The issuer would be required to file an annual report until (i) the issuer becomes a reporting company under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, (ii) all the securities are purchased or repurchased by the issuer or another party, or (iii) the issuer liquidates or dissolves.
- Eligible issuers. The crowdfunding exemption would not be available to certain companies, including non-U.S. companies, SEC-reporting companies, investment companies, private funds, companies that are disqualified under the bad actor rules, companies that fail to comply with the annual reporting requirements in the proposed rules and companies that have no specific business plan or have a business plan to engage in a merger or acquisition with an unidentified company.
In September 2013, the Delaware Court of Chancery ruled in Costantini, et al. v. Swiss Farm Stores Acquisition LLC that a provision in an LLC agreement that reflects the indemnification language of the Delaware General Corporation Law (DGCL) is interpreted the same way to allow indemnification to a prevailing manager.
Earlier, the court had dismissed the case by Swiss Farm Stores Acquisition LLC (Swiss Farm) against Messrs. Costantini and Kahn for breach of fiduciary duty, because the applicable statute of limitations had run; the dismissal was appealed and affirmed by the Delaware Supreme Court. As a result, Messrs. Costantini and Kahn in this case sought indemnification for their fees and costs incurred in the fiduciary duty litigation.
Sections 145(a) and (b) of the DGCL generally permit Delaware corporations to indemnify their officers, directors, employees and agents in third-party or derivative actions, as long as such person acted in good faith. Section 145(c) generally requires Delaware corporations to indemnify any corporate director or officer who is made a party to a proceeding by reason of his or her service to the corporation and has achieved success on the merits or otherwise.
As discussed here, on June 25, 2013, the Delaware Court of Chancery upheld the facial validity of forum selection bylaws unilaterally adopted by the boards of directors of Chevron Corporation and FedEx Corporation. Last week, the plaintiffs in that case voluntarily dismissed their appeal of that decision, thereby avoiding the possibility of the Delaware Supreme Court’s (likely) affirmation of Chancellor Strine’s opinion.
Social media platforms, including Facebook, Twitter, YouTube and LinkedIn, allow companies to communicate with their investors, customers and the general public, and provide a 24/7 outlet for corporate disclosure. As social media platforms have become more commonplace, companies, and particularly public companies, should consider adopting a social media policy or regularly reviewing their current policy.
If used improperly by a company or its representatives, social media can create significant issues. By having a social media policy, companies can put protections in place, which may help shield a company from certain liability in the event of misuse by its management and employees. To help prevent unauthorized disclosure, a social media policy should restrict the sharing of confidential, classified, material non-public information about the company and its customers, and private information about individuals.
On October 9, 2013, the SEC launched a new website, www.sec.gov/marketstructure, through which it will provide investors and the public with trading data, research and analysis of market activity. This site includes market structure research, interactive data visualization tools to explore a variety of advanced market metrics and dozens of datasets that investors can download to perform their own analyses.
Just last week the SEC issued its largest whistleblower payment to date, awarding an unidentified whistleblower more than $14 million for providing information to the SEC that led to an enforcement action and the recovery of a substantial amount of investor funds within six months of the SEC’s receipt of the tip. This award was only the third under the SEC’s whistleblower program, with the others being relatively small awards of approximately $50,000 and $125,000. Given the life-changing size of this award, the SEC is hopeful that it will encourage more individuals with information to come forward.
It is not unusual to collect signature pages in connection with corporate transactions prior to the transaction and then release them at the time of the transaction. However, Delaware law provides that when a person executes a written consent before actually joining the Board (even if that consent is executed for convenience purposes only to be delivered after he joins the Board) the consent is invalid.
Under Delaware law any action required or permitted to be taken at any meeting of the board of directors may be taken without a meeting if all members of the board consent in writing. In AGR Halifax Fund, Inc. v. Fiscina the Delaware Chancery Court stated that only the lawful board of directors is empowered to take action and that individuals who have not yet been elected to a corporation’s board of directors cannot act as directors. The court concluded that actions taken by individuals who are not members of the board of directors are a nullity. This is true even if these individuals are subsequently appointed as members of the board of directors. Therefore, there seems to be a distinction between directors signing pages in advance of a corporate action and individuals who are not directors signing pages in advance of an action.
This issue often arises in M&A transactions where the target board is replaced in connection with the transaction and written consents of the new board may be collected before the transaction for convenience purposes. A practical solution is for the new directors to expressly deliver their signatures to be held in escrow until their appointment to the new board is official and for the new directors to approve the action by email sent after their appointment to the new board is official in accordance with Section 141(f) of the Delaware General Corporation Law.
Activists. You’ve heard of them. A lot. And, as a board member of a public company you should be wondering to yourself: will they ring our bell? And if they ring, do we answer? And if we answer, what do we say?
Simple questions for sure. But the answers may well vary among the members of your own board and management. Past experiences, conviction of your strategy, risk tolerance and a basic appetite or lack thereof to receive “constructive” criticism are all subjective measures that need to be taken into account before anyone is on the porch.
More likely than not, many of you have never been approached by an activist before - neither individually nor, more importantly, as a part of the company for which you are now a fiduciary. Opening the door to a stranger can be scary. Like riding a horse for the first time. Even scarier when you consider that Loeb, Peltz, Icahn, Ackman and others who emulate them have been to the rodeo once or a hundred times before.
On September 27, 2013, in Washington, D.C., Tax Analysts hosted a panel discussion, including Akin Gump’s partner Patrick Fenn, on the tax implications of the recent Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund case.
The panel discussed the First Circuit Court of Appeals case, which involved pension plan termination liabilities, and the court’s decision that a Sun Capital fund was in an active trade or business for ERISA purposes. This unusual decision could have significant tax and other consequences for private equity funds if they are held to be in an active trade or business.
The staff of the SEC recently issued a comment letter requiring a registrant to evaluate whether a transaction involving the National Iranian Oil Company (NIOC) should have been disclosed in the registrant’s annual report on Form 20-F. A vessel owned by the registrant and chartered to a third party had loaded crude oil in Iran to be shipped by NIOC to a buyer in China. The staff issued a comment letter requiring the registrant to evaluate whether disclosure of the transaction was required under Section 13(r) of the Securities Exchange Act of 1934 (as amended by the Iran Threat Reduction and Syria Human Rights Act of 2012, § 219, 112 P. L. 158), and if so, to amend its annual report.
Section 13(r) requires reporting issuers to disclose in an annual or quarterly report specified information if the issuer or its affiliate, among other things, knowingly conducts a transaction with a person that meets the definition of the “Government of Iran” as specified in the Iran Transactions Regulations (specifically, § 31 C.F.R. § 560.304), without the specific authorization of a department or agency of the U.S. government. The staff stated that NIOC is an entity identified in the cited provision.
On September 30, 2013, the SEC opened a page on its website to allow the public to comment on a study entitled “Asset Management and Financial Stability” by November 1, 2013.
The study was published by the Office of Financial Research of the Treasury Department at the request of the Financial Stability Oversight Council, and describes how activities in the asset management industry might 'create, amplify, or transmit stress' through the financial system and thereby pose risks to the financial stability of the country.
According to the report, the U.S. asset management industry oversees the allocation of approximately $53 trillion in financial assets. The activities performed by the asset management firms and the funds they manage range from managing assets on behalf of clients as their agents, to activities similar to those provided by commercial banks and other financial institutions, such as providing liquidity. These diverse activities across the financial system raise questions regarding their possible effects on our financial stability. In addition, the report mentions the limitations on the data currently available to analyze the asset management industry and certain of its activities, and the resulting limited visibility into market practices.
A copy of the report can be found here.
As reported in the media, SEC spokesman John Nester said yesterday that the agency has “carryover funds” that are sufficient to allow it to remain open for “a few weeks” despite the government shutdown. The SEC is fully open today and that will continue until further notice. Although there is no guarantee that the agency will remain fully open for “a few weeks,” at least the agency is up and running in the near term and we have an idea of what the agency seems to think is possible in the event of an extended government shutdown.
On September 27, 2013, the Securities and Exchange Commission (SEC) posted the following announcement on its website: SEC Operating Status: The SEC will remain open and operational in the event the federal government undergoes a lapse in appropriations on October 1. Any changes to the SEC’s operational status after October 1 will be announced on this website. The SEC’s current operational plan in the event of an SEC shutdown is available here.
Thus, the SEC will be open on Tuesday, October 1, even if the government experiences a lapse in appropriations. It appears that all of the SEC’s functions, including the review of filings, will continue until further notice. The statement on the SEC’s website does not indicate how long the SEC expects to remain open in the event of a government shutdown.
If the SEC later determines to shut down, it will still perform limited functions according to its Plan of Operations During an SEC Shutdown, which is available through its website.
The changes adopted by the Securities and Exchange Commission (“SEC”) to Regulation D and Rule 144A on July 10, 2013, addressing general solicitation, new filing requirements and “bad actor” disqualification events (among others) applicable to Rule 506 offerings, went into effect on September 23, 2013.
Specifically, an issuer, including a private fund, is now permitted to engage in general solicitation and advertising in a private offering under new Rule 506(c), provided that the securities are sold to only accredited investors and that the issuer takes reasonable steps to verify that all purchasers are accredited investors. The SEC amended Form D to add a separate box that an issuer must check if it is relying on new Rule 506(c). The SEC also amended Rule 144A under the Securities Act to permit a person reselling securities under Rule 144A to engage in general solicitation and advertising, provided that the securities are sold to only qualified institutional buyers.
On September 18, 2013, the SEC commissioners voted 3-2 to propose a new rule that would amend existing executive compensation disclosure rules by requiring public companies to disclose the ratio of a CEO’s annual total compensation and the median total annual compensation of all other employees of the company (including part-time, seasonal, temporary and foreign employees). The proposed rule, which is intended to fulfill a requirement of the Dodd–Frank Act, provides companies with some flexibility in determining the median compensation for employees by permitting the use of estimation and statistical sampling in order to ease the compliance burden. However, the proposal has already sparked controversy, with detractors questioning its utility and bemoaning anticipated compliance burdens and proponents touting the rule as providing meaningful information to shareholders. The comment period on the proposal ends 60 days after the publication of the rule in the Federal Register. Whatever the ultimate outcome, the new rule will not apply until after the 2014 proxy season. The rule also will not apply to smaller reporting companies, emerging growth companies or foreign private issuers.
The SEC Fact Sheet summarizing the proposal can be found here.
Ben Heineman, currently a Senior Fellow at Belfer Center for Science and International Affairs and formerly General Counsel at General Electric, is a brilliant man, a respected academic and a thought leader on corporate governance matters and the changing role of the corporate general counsel. But he missed the mark in his recent post entitled “No, GCs Should Not Be on the Board,” which you can access here.
Mr. Heinemen rightly opines that GCs should not be both client and lawyer, which by definition is a conflict of interest no matter whom you ask. But the question and answer as to whether a GC should or should not aspire to sit on a board is by definition too narrow. The question needs to turn on the board on which the GC wishes to sit. It is undeniable that GCs of sophisticated, well managed and well governed companies have experience and expertise that would prove beneficial in almost all board scenarios, including assessment and analysis of risk management, regulatory and tax compliance, strategic planning, compensation matters and governance issues, just to name a few hot topics for all boards and the GCs who counsel them. Who better to have as a member of your board than a person who has delved into, and analyzed, these issues for a living? Lawyers, as the saying goes, think differently. Leaving the jokes aside, lawyers with critical thinking skills that have been practiced and mastered over a career can only lead to broader discussions and better informed decision-making as boards provide direction and advice. I nominate Ben for Chairman.
Over the past year there has been extensive discussion and debate over “default fiduciary duties” in Delaware limited liability companies (LLCs). Much of this debate has been fueled by the differences in opinion between Vice Chancellor Laster and Chancellor Strine, on one hand, and the Delaware Supreme Court, on the other hand.
This debate was effectively put to bed a month ago once a very simple amendment to the Delaware Limited Liability Company Act was approved by the Delaware state legislature. No more debate, right?
Actually, this is where the hard part begins for legal practitioners and investors. There was always the ability to contract away fully fiduciary duties or retain them in the Delaware LLC context. For some reason, many in the legal community and those seeking to use LLCs for business enterprises viewed waiving fiduciary duties as a binary exercise. To waive or not to waive? This is not the question.
“Women care too much about what people think of them” — Sheryl Sandberg, at PwC Talks, Leaning In, together?
Do women really care TOO much? Or do men not care enough? Regardless, there is a general consensus that women are more cognizant of how others perceive them. After all, by the time most girls are 10 years old, they’ve been advised to protect their reputations. Tarnish that reputation in your teen years, and it can follow you your whole life.
Cultured and innate tendencies for women to think about cause and effect — and to weigh the pros and cons of their actions BEFORE they take them — is a compelling reason (among many) why companies should, and indeed need to, find more women to serve on their boards.
In July 2013 the Commission finally approved amendments to its rules to allow general solicitations in Rule 506 and 144A offerings, as contemplated by the JOBS Act. The effective date of the amendments is September 23, 2013. The vote was 4-1 with Commissioner Aguilar dissenting on grounds that the amendments as formulated compromised investor protection. The Commission adopted the rule amendments substantially as proposed, except that, as requested by many commenters, it added a non-exclusive list of methods that issuers may use to satisfy the requirement of the amended rules that the issuer take reasonable steps to verify that purchasers are accredited investors. Simultaneously, the Commission adopted previously proposed rules (called for by the Dodd-Frank Act) disqualifying securities offerings involving “bad actors” from relying on Rule 506 of Regulation D. In addition, the SEC concurrently proposed rules it says are designed to augment investor protection in Regulation D offerings and enhance the Commission’s ability to evaluate development of market practices in Rule 506 offerings. The effective date of the “bad actor” provisions is September 23, 2013. The comment period on the proposals to augment investor protection expires September 23, 2013.
Appeals Court Finds Private Equity Fund Constitutes a “Trade or Business” for Multiemployer Plan Withdrawal Liability Purposes
On July 24, 2013, the First Circuit Court of Appeals held that a Sun Capital Partners (“Sun Capital”) private equity fund constituted a “trade or business” for multiemployer plan withdrawal liability purposes. This court ruling is particularly important for funds (alone or together with affiliates) that could satisfy “common control” for a portfolio company with underfunded pension liabilities. Although the “common control” analysis is complex, generally two entities will be under common control if one entity owns 80 percent or more of the other entity or when five or fewer persons directly or indirectly own 80 percent or more of two or more entities and have effective control over each entity.
The issue arose in connection with a claim by New England Teamsters and Trucking Industry Pension Fund, which argued that investment funds managed by Sun Capital were responsible for pension liabilities for one of its bankrupt portfolio companies. Private equity funds have previously asserted that no liability accrued to their funds because private equity funds were not involved in a “trade or business” — one component of “control group” liability under ERISA. ERISA imposes joint and several liability for certain pension plan liabilities for each member of the controlled group. A controlled group is generally two or more trades or businesses that are under common control.
In the recent In re Trados Incorporated Shareholders Litigation case, there was a reiteration of a principle by Vice Chancellor Laster that bears repeating. In several pages of his 114-page opinion, Vice Chancellor Laster reminds us as practitioners and investors that no special duty is owed by a board of directors of a Delaware corporation to the holders of preferred stock. Rather, the board of directors owes a duty to the residual claimants of a corporation (i.e., common stockholders).
As is often the case, preferred stockholders are provided with a number of preferential rights, including liquidation preferences, special voting rights, rights to board seats and registration rights. However, as Vice Chancellor Laster notes, these rights are contractually established and do not necessitate a fiduciary duty level of protection. Accordingly, these rights will be interpreted in a manner consistent with customary contractual interpretation. Vice Chancellor Laster notes further, “a board does not owe fiduciary duties to preferred stockholders when considering whether or not to take corporate action that might trigger or circumvent the preferred stockholders’ contractual rights.” In re Trados Incorporated. Preferred stockholders are owed fiduciary duties only when they do not involve their special contractual rights and rely on a right shared equally with the common stock.
Recently, the Delaware legislature and governor enacted into law new Section 251(h) of the Delaware General Corporation Law (DGCL), which could provide significant benefits to acquirers looking to make acquisitions of Delaware public companies in a cost-efficient and timely manner. Section 251(h) will eliminate the need in many “two-step” acquisitions to obtain stockholder approval of a back-end merger following a successful first-step tender offer, where the back-end merger was not otherwise able to be effected as a “short-form” merger under the DGCL.
A “two-step” acquisition begins with a first-step tender or exchange offer, subject to a minimum condition that the acquirer obtain more than 50 percent of the outstanding voting stock of the target, followed by a back-end merger that squeezes out the remaining target stockholders if 90 percent of the target’s outstanding shares are tendered in the first-step tender offer. “Top-up” options are stock options designed to help buyers using a “two-step” structure reach the 90 percent ownership threshold needed to effect a short-form merger, and thereby avoid the timing issue otherwise associated with a back-end merger following a first-step tender offer that falls short of achieving 90 percent ownership. Without a “top-up” option, if the buyer holds less than 90 percent of the target company’s shares after the first-step tender offer, the target company must hold a stockholders’ meeting with the accompanying time and expense associated with preparing and filing proxy materials to approve the back-end merger, even though stockholder approval is a certainty (as a result of the buyer having acquired a majority of the voting shares through the tender offer). However, the “top-up” option is not always a practical fix, especially where the target does not have sufficient authorized shares to enable the “top-up” option to be exercised.
The effectiveness of a member of a board of directors should not be measured, directly or indirectly, on the basis of the number of boards on which one sits. Who among us does not recognize that having too much time on one’s hands is just that? For most of us, the busier we are, the better we are.
And yet, shareholder advisory services, the SEC, and the NYSE and NASDAQ listing rules all deem or imply that there is a set number of assignments that a director may take before the law of diminishing returns kicks in. Do these regulators also require seven to eight hours of sleep, three healthy meals and two snacks a day and at least 30 minutes of exercise four times a week? No.
Paternalistic rules that limit the number of board seats per person do not make boards better. I have witnessed professional directors who sit on 10 or more boards at a time and are fully prepared and knowledgeable regarding the company, the industry and overall macro trends, and still provide clear, concise and additive oversight. I have also seen one-board participants who strive to stay awake or are otherwise distracted.
Efficiency and time management should be embraced, not discouraged. Perhaps a board member’s aptitude is better measured by the outside world via a personality test… or even his or her horoscope. The numbers of boards is not a relevant or useful tool.