The FTC on January 5 issued a stunning proposed rule that wipes out all employment noncomps for all employees and consultants, including those that comply with State laws and those that are currently in existence.
The theory is that non-comps are unfair competition. Can the FTC do this? Some observers think not but if the FTC in fact adopts its proposal, we will find out in court.
There are exceptions but precious few: franchisee noncomps are excluded, of course NDAs for trade secrets and technology are excluded, and employee non-solicitation agreements would survive. And if you have a noncomp in connection with sale of a business in which you own at least 25%, your non-comp will be enforced (theory there: you are an owner selling good will and if you compete you impair that good will). The cancellation of non-comps would apply to all workers, including senior executives in the C-suite.
This proposed rule will grab lots of headlines in the near term. It is just not clear that the FTC has rule-making authority here, and further the business lobbies (and Republicans) will no doubt howl and with reason; this feels more like social policy engineering and less like regulating business competition. Stay tuned.
Officers and directors of public companies run a risk, in trading their company shares, that they will be liable to injured buyers or sellers of their shares if, shortly after the trade, the stock price moves and makes clear that the trading officer or director received an unusual economic advantage. Since it is always possible that a trader will at a given moment know something more than the general public, how can officers and directors safely trade their company shares without risking accusations of insider information?
About two decades ago the SEC adopted Rule 10b5-1 which, in concept, allowed officers and directors to set up a plan by which at certain future dates their broker would buy or sell shares, or would buy or sell if certain price points were hit; the Rule required a written Plan that worked automatically at such later time so that there was little chance that the transaction reflected inside information; after all, the transaction was set a long time before (and was set up at a moment when the trader stated that they did not then have any insider information unknown to the general public).
Certain practices became common over time which “gamed” the system, the result no doubt of failure to define the permitted behavior properly and thus allowing corporate lawyers to, shall we say, stay within the letter if not the spirit of the law. For the last year the SEC has been considering closing loopholes and the SEC last month issued final Rules doing just that, effective early 2023.
As with much SEC regulation, it is both technical and precise; as always, these posts are general and are not legal advice and should not be relied upon; if you are an officer or director, you have your own lawyer and you should consult there. Generally speaking, aside from heightened disclosure about these plans, the major substantive changes are set forth below. I note that for once, all five SEC Commissioners, regardless of party, voted in favor.
- Once a plan is set up, no trading can occur earlier than between 90 and 120 days (details control), making doubly sure no non-public information is being used by the trader
- trading executives and directors must assert they are setting up the plan in good faith and not to circumvent regulation (this will assist regulators in penalizing those who later abuse the system)
- Control use of multiple plans which can be maneuvered to in fact effect trades under the plan based on inside information (for example, under plans a proposed transaction can be cancelled and then a trade that is benefited by then-current information can be “automatically” effected under a different over-lapping plan)
- limitations on single-trade plans.
All this becomes effective shortly. Officers and directors are well advised to consult promptly with their own counsel.
Last month the SEC proposed a change in the manner in which your retail stock broker places a trade order for you, the first such amendment in two decades. The changes are technical in nature, are subject to revision after a comment period running at least to next March 31, and half of them were not agreeable to the two-member Republican minority of SEC Commissioners, even though they have been posited as lowing execution costs for the retail investor.
To simplify a bit, today your order to your broker is typically sent to a small number of wholesalers; many wholesalers pay a fee to your broker in exchange for getting assigned the task of executing the order (think Robinhood, paid last year $235M in consideration of receiving the broker’s order flow).
The Democratic members saw ultimate savings for retail investors; Republican members thought this was too much tinkering with how stocks are sold, noting that the system is not fully tested n high-volume situations and imposes a new requirement on brokers to explain all this to their customers.
(I avoid here describing the benefit of having the order flow to the wholesalers, or why Democratic SEC Chairman Gensler stated that “Zero commission doesn’t mean zero cost,” describing the payments to the brokers in exchange for order flow as “economic rent” which brokers pass on to their retail accounts.)
All Commissioners did vote in favor of proposals to make execution disclosure more complete about how orders are executed, and by lowering the increments allowed for stock trading.
I will post new developments (I am researching now) that you should know concerning the SEC and the securities markets between now and year-end. In the meanwhile, as we move into the Holiday Season, let me wish all my readers the very best of everything for this Season and for 2023 (and, indeed, well after that also!)
Glass Lewis, one of the two major firms which provide advisory service to investors relative to voting for or against director candidates, has announced some substantial (if not surprising) revisions to its review standards designed to foster ESG-related elections to boards. For 2023, among other changes (and in some cases depending on size of the registrant public company):
- tightened review of gender and other diversity on boards
- mandatory disclosure of corporate racial/ethnic demographics
- limits on outside board involvements (query reflecting criticism of Musk being diverted to Twitter?)
- specific requirement of articulation of board supervision of cyber risk, environmental and climate-related matters
- focus on officer exculpation, tying long-term incentives more close to performance, nature and duration of poison pills and issuance of shares with unequal voting rights, and with supermajority voting and classified boards.
The foregoing list is not complete, nor does it reflect the granular treatments to be applied within various categories. As proxy advisory firms influence stock value and thus impact corporate governance, public companies had best look carefully this year at Glass Lewis (and also ISS) pronouncements; there are changes that affect not just disclosure but also substance.
Critics of ESG and similar standards, a growing number questioning their appropriateness as standards for investment return, are not making progress with their critique in this arena.
A week or so ago I almost posted about a criminal anti-trust complaint brought by the Department of Justice, the first in decades. I chose not to, thinking the event an outlier that must have involved incredibly horrendous facts; after all, anti-trust laws have not been vigorous enforced in recent memory. However, see below.
On November 10, the Federal Trade Commission issued a revised policy statement that purported to make the bringing of anti-trust actions by the government far more likely. Citing the FTC Act which bars “unfair method of competition,” broader if less precise than the prohibitions of the anti-trust laws (Sherman and Clayton Acts), the policy purports to criminalize a wide range of ill-defined actions: conduct that is coercive, collusive, deceptive, involves use of economic power, action “otherwise restrictive or exclusionary,” or which “tends to negatively affect competitive conditions” or limit consumer choice.
For lawyers and clients seeking bright line guidance, these vague standards are troublesome. No doubt the policy of the current liberal administration (the sole Republican FTC Commissioner was almost apoplectic in dissent), it is hard find a discernable line drawn here. Every time a company has a better product which derives out a competitive product or company, competitive conditions and consumer choices are by definition impaired.
Vague standards give government agencies great power to shape business actions simply by reason of the fear of violation, a practice long the hallmark of the SEC during Democratic administrations. For more detail please see my law firm’s November 18 website Alert at www.duanemorris.com.
Six years ago Dell Technologies financed its multi-billion dollar acquisition of EMC Technologies by issuing a special class of “V” shares. Two years later Dell, under the leadership of Michael Dell, recapped the V class and distributed to holders $14 billion in cash and about 150 million shares of Class C Common. Company and its founder and certain directors were sued by shareholders claiming that on the exchange the investors were short-changed to the tune of about $6 billion.
This high-stakes court battle has just been settled, subject to approval by the Delaware Chancery court, for $1 Billion dollars payable by defendants Dell and four directors who were allegedly coerced and/or were self-interested. Or perhaps not. Seems the deal is dependent on the entire tab being paid by either the company itself under indemnity agreements (isn’t that circular– shareholders were harmed and now shareholders are to pay their own damages to themselves) OR by the insurers of the company (presumably under D&O coverage).
Finally and also interesting, this is the second case I am posting about this week wherein founding and wealthy company CEOs are being implicated by allegation in mounting coercive tactics against sitting directors to achieve personal benefit. Assume you want to undertake a transaction involving your company that has benefit to yourself–how do you “vet” that deal? How do you avoid implicit coercion where independent directors are also of course selected by you? Independent committee review may be necessary but not dispositive. Investment banking opinions you pay the bankers to give? Is it practical to get a vote of shareholders (discounting interest shares)? How can you be sure that your disclosure in soliciting the vote will not be challenged as biased?
The impact of the class action plaintiffs’ bar is pretty scary these days. What’s a corporate mogul to do?
I seldom post two days in a row, let alone on the same subject, but I am intrigued by Elon Musk’s 10-year comp agreement at Tesla that can net him as much as $56 Billion dollars (see yesterday’s post).
In court yesterday we learned that the pay package was approved by an independent committee of the board. Having an independent comp committee is pretty standard and in fact actually mandatory, although yesterday I had suggested also the hiring of recognized consultants who could relate the comp to peers; perhaps this was not done as Elon, self-admittedly, has no peers nor does his company fall into a peer group….
From a lawyering standpoint, which I admit is less titillating but more useful a focus, we should consider that independent director action typically enjoys immunity from analysis under the business judgment rule, which keeps courts out of the practice of second-guessing directors in the use of their business discretion. However, such protection is not afforded to interested directors nor, as in this case, to allegedly coerced directors. Plaintiffs here suggest that Musk had such power that independence was compromised.
Another of the tid-bids as reported by Law360, a service sending prompt news items to attorneys: there is suggestion that Musk may be violating his acrimoniously reached settlement agreement with the SEC which among other matters required Musk to have his tweets first reviewed by company counsel (can one imagine how that requirement must rankle Musk to this day).
I promise to attempt to not post on this trial tomorrow; though I may not be able to resist.
Yesterday a trial in Delaware Chancery Court commenced, raising a shareholder complaint accusing directors (and in-house counsel) of breaching their duty by voting compensation to a company CEO that could equal $56 Billion over ten years.
Kudos to those readers who said to themselves, “Sounds like Elon Musk.” That would be a rational conclusion based on Musk’s contribution to his companies, their success and value, and the sheer weight of the numbers, and I hasten to add that I express no implied negative judgment here. The point of this post is: did this board violate its duty or bow to the weight of the CEO’s 22% ownership stake and, as a matter of corporate practice, what can be learned from this case?
Yes, it’s Elon and the car company (not the space company, not Twitter…). The deal was cut in 2018. Today, as I post, is the second day of a likely week-long trial, and if anyone can claim to be worth up to $5.6B a year it’s likely Musk. The deal is based on performance standards such as meeting operational milestones AND increasing market cap by $50Billion. And the number includes the value of the Tesla shares which are one form of compensation (raising the equity stake of the CEO to 28% which dilutes other shareholders but, it’s not company cash). I note that if the market cap increases by $50 Billion, shareholders are in fact diluted but the “pie” being divided will have increased enormously.
Nor can I tell from the reportage whether the board utilized independent outside comp consultants who expressed expert views as to the deal. Boards today are very well advised to get guidance in support of their judgment whenever any issue rises to the “B” level.
Yesterday the SEC issued a massive release which, effective next July 1, substantially tightened reporting on how mutual funds and ETFs must disclose how they vote on proxy issues. Normally one might think this development is of interest only to lawyers who write fund disclosures for the SEC, but people who are investors ought to pay attention to these new rules as they affect understanding of how corporate votes occur at companies in which their money is ultimately invested.
New disclosure formatting rules will make it easier to understand exactly what votes were taken, but of most interest to investors is likely to be the focus on “say-on-pay” (a vote endorsing or not endorsing compensation for the top five executives). In the fund’s/EFT’s annual report, there now must be disclosure on how the proxies were voted, which can give a sense of the degree to which a given fund has tight focus on the relationship between company performance and company pay.
A second requirement appears technical but is important: since funds often “lend” shares to third parties, they cannot vote those shares unless they are “recalled.” If very many shares of a given company are not recalled, the fund has in effect surrendered its vote (and you the investors’ vote) on whether the executive cadre is being over-compensated.
Increased SEC regulation over many fronts, not just here, is driven by the activist Commission majority named by the President. As with very many SEC actions of late, the vote in favor of tighter regulation has been on a 3-2 basis, with the Democratic majority outvoting the Republican minority and heightening regulation. While it is dangerous for this blog to wander into politics, we must wonder if there are not ANY regulatory issues wherein the merits of a proposed action can be resolved not on lines that reflect political parties. Surely there should be some regulatory promulgations that end up with a 4-1 or 5-0 vote, yes?