Changes in Rating of Banks

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Banks are evaluated by a Federal Council staffed by several other agencies, including the Federal Reserve Bank.  The existing bank rating criteria, in effect in current form for thirty years, considered capital, asset quality, management quality, earnings, liquidity and exposure to market risk.

Proposed new guidance, being suggested by the Federal Council, moves away from this general analysis and focuses not on what may seem abstractly undesirable, but rather  focuses on what in fact creates material financial risks to safety and soundness.  Inter alia, the new framework removes consideration of management depth and succession per se as extraneous and not necessarily bearing on current risk.

Further, the current ratings consider reviews of information technology, consumer compliance and compliance with the Community Reinvestment Act in evaluating management; these evaluations under new guidance will be irrelevant unless they can be related to an actual current material risk to bank soundness.

I now note a theme in the above regulatory approach that may be an undercurrent in the regulatory approach of the current Federal Administration.  My immediately prior post noted that the SEC proposal revising regulation of public company climate disclosure, to eliminate reporting of what might be considered socially undesirable factors if these factors did not in fact create a current risk or weakness in the public company involved, took the same approach as these bank rating criteria: do not need to report things that may seem facially “bad” top some people, but only report what has current material detriment to the entity involved in the instant report.

This trend reflects, I suggest, an effort to remove general social critiques reflecting an intrusive liberal disclosure philosophy from government-mandated disclosure or consideration.  Regulation should not reflect policies which call for disclosure by, or intrusion into the affairs of, private business unless current material problems exist.  While this approach may offend liberal sensibilities, there is some logic to such a close definition of the proper role of government under libertarian principles.

SEC Regulation of Greenhouse Gasses

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In 2024 the SEC adopted a rule requiring robust reporting of emissions of greenhouse gasses by public companies.  The current SEC, under this administration, does not enforce this extant requirement; the rule itself has engendered various lawsuits claiming that the required disclosures are too costly and complex and that, in any event, the SEC is over its head in trying to address this technical area.

It should be noted that general disclosure rules require disclosure in prospectuses and periodic filings of all matters that are material to the business and profitability of a public company.  The 2024 regulations did not rely on such elements of materiality, however.  The driver was  that climate damage is per se important to understand, and thus disclosure required information about emissions of gasses in the chain of production even if no environmental damage was apparent or palpable.

Last week the SEC has announced that it is seeking repeal of the 2024 disclosure requirements, noting that the rule fell outside the SEC’s “core mandate.” This is an administrative process and so will take time, with mandatory two month public comment period; but the impact of this SEC effort is not today of great importance in that, again, the old rule is not being enforced and reporting is spotty by public companies.

Further and an aside simply reflecting the nature of current politics, one Republican SEC Commissioner gratuitously opined that the old rule reflected efforts of special interests to weaponize the securities law for “their own climate-related goals.”

There is in fact initial facial logic to the elimination of a rule that is not being enforced.  And the proposed action, to its credit, does not eliminate the disclosure requirement where current impact is being felt.  It address, in effect, the elimination of reporting for matters that may harm the environment but not the company.  However, the issue is a bit more subtle.

First, investors may be of the belief that current corporate practice does not create a current  material impact on the value of company shares, but might well believe that over time there will be economic impact which might affect investment judgment and timing.  Second, and I see this with investment policies of non-profit entities and some socially conscious individuals, there are some investors who just do not want to invest in companies with a pollution profile.  Are not these constituents entitled to disclosure as part of the SEC mandate?

Outcome is pretty clear: the rule will be killed by the Republican-controlled SEC.  Perhaps private watchdog entities will try to fill this gap; or, erhaps in the future the ebb and flow of political power will reverse what is about to happen.

Mailing Tax Checks

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I find many clients are not aware that at some point in the foreseeable future the IRS will require that Federal tax payments be sent on-line.  We today await guidance on this mandate, although it is fair to anticipate a period of time in which taxpayers can become acclimated.

It  also is today possible to pay on line, and doing so avoids issues of lost checks and saves the now-increased postage for certified, return receipt submissions. However, and not to appear to be elitist about this, I am not sure how this new rule will play with folks who are at the lower end of the economy.  It may be that electronic financial transactions are not part of their normal tool kit.  If I am selling my fellow citizens short, I beg forgiveness…..

Among matters presently noted by the IRS: you can pay without charge from your bank account but if you use a credit or debit card, or pay out of your digital wallet, there is a processing fee (excepting payroll tax remittances); and, for those paying off a tax debt under a payment agreement, the forms appear to permit scheduling a stream of payments at one time.

For those having returns prepared by accountants, of course the mechanics will be made simpler with help at hand.  For all others, the game will change in the foreseeable future as society moves its very existence on line…..  Perhaps AI will facilitate the mechanics here?

AI and other Legal Developments: Part One

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Every Monday I peruse the legal press to see what’s new, interesting, important. Sometimes it is  M&A or capital markets.  But this Monday’s mailbox was full of interesting stuff.

Posts are supposed to be short revelations, not long rambles– SO let me take these one at a time and let me start with AI. (Posts in the next day or two will reach taxation, cannabis, SEC climate disclosure and government ratings of banking institutions.)

The State of Florida has today instituted litigation against Open AI and Sam Atman, in Florida State court.  The claim is that Chat GPT is harmful to users and that the company ignored safety warnings.  Accusations, according to  the State Attorney General, include violation of product liability laws, negligence, deceptive and unfair trade practices.  The State seeks civil recovery and a ban on collecting data from children under 13 without parental consent.

This follows a pending criminal investigation by the State exploring the use of Chat GPT in the Florida Sate University mass shooting.  And, the daily press often contains reports of claims of risk from AI generally, proposed litigation to prevent misuse in spoofing posts (some relating to sexually explicit usage), theft of literary and artistic and musical works, etc.

Whether the current administration has the intent to step into an AI regulatory role, given the sweep of litigation and general fearfulness of AI, not to mention the recent Papal announcement concerning who “owns” AI, remains to be seen.  It is no secret that, generally speaking, the present US government is not inclined to regulate industries in most regards so– stay tuned.

Sardonic aside: I just used Chat GPT to inquire about the status of the widely rumored proposed public offering of Altman’s company, wondering what the prospectus might say about the risks involved, and the liabilities arising, from the dissemination of an AI platform such as Chat.  FYI: it is still a rumor, no formal public action towards going public having been taken.  If and when it does happen, the disclosures in the prospectus will make remarkable reading.

Lawyer Fees and AI– Big Money Games

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Those readers of my posts no doubt have views about the fees we lawyers charge.  Many folks think we are overpaid; we of course bemoan our poverty.  Now, another law firm is working to make sure they do not fall into the poverty pit–they are seeking a mere $187.5 Million dollar fee.  And of course,  as with all business matters involving huge numbers, we are not surprised that AI is involved.

On April 30, I posted about the infringement suit brought by authors against Anthropic because Anthropic read tons of books to educate its AI.  The court there ruled that if Anthropic did not purchase a book then its scanning was not fair use and it had to pay for that scan; the judgment was for over $3000 per book.  The total was $1.5B in cash.

This case was a “class action” wherein counsel is paid only upon court approval. Anthropic applied for a fee of $187.5M no doubt based on a clearly robust result; it surely was not based on a multiple of hourly rates.  As I have seldom received a fee of that size (I would have to check my back records but I think I would have remembered [and retired]), I was curious as to the reasoning of the law firm.

There are general metrics often applied to class action results but here counsel asserted that the result was “fantastic” and that the settlement arrangement (which also included prospective injunctions) was in fact a “creation of class counsel.”  Counsel also  argued that the case required a huge amount of work and preparation of a list of injured authors of an aggregate of 482,000 books.  (Confession: if you asked me how many books existed in the world, I am not sure I would have reached such a total.)

Seems  authors who will be receiving their $3000 or more almost all are sanguine; the number of objections are reported as  “miniscule” according to counsel.

I will report the results when known.  I also note for the record that I am  not suggesting that counsel did anything other than a great job; the courts will determine the fee and it is what it is–whatever the court approves is by definition the proper fee and well earned.  My only question is whether I will myself get a check in the mail.  Having published 11 books, I am hopeful.  But for some reason I have not received any notice of my inclusion in the class.  I damned sure am going to inquire…..

More SEC Deregulation Efforts

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Right after my last post about proposed SEC changes to reduce financial reporting, today’s press notes an SEC proposal sent to the White House which would reverse  a 54-year old rule  barring defendants against SEC civil actions, who choose to settle, from being allowed to deny culpability.  Today, the defendant in a settlement can only announce that the matter has settled, leaving on the public record a description of the complaint and the payment made by the target to make it go away.

Not surprisingly, interested parties and groups subject to SEC enforcement actions have been bringing suits to effect this change in SEC policy, trying also to bring the matter to the Supreme Court (think Elon Musk and Mark Cuban).

Investor advocates of course object to this change in practice, claiming that the now-permitted denial by a defendant short-changes the investing public by withholding  valuable information (eg that a guilty party may have just bought his way out the charge by writing a check).

Fairness does suggest that there are circumstances when innocent parties receive complaints from zealous regulators which are ill-founded; resisting such complaints is not easy, typically requires hiring attorneys, and  is quite expensive; particularly, smaller companies or less affluent individuals may not have much of a choice but to plead it out and pay a fine, leaving an implicit black mark on the public record.

Those of us who over the years have fought esoteric claims against the SEC, dealing with junior regulators right out of law school, understand the position  that defendants ought to be able to say, in effect, “we give up but think we did [whatever] correctly.”  And given the current Administration’s deregulation bias, it is not surprising to see the current SEC proposing this policy change, albeit of a 54 year practice.

SEC Easing Reporting Regime?

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The SEC is proposing to alter the quarterly reporting requirement for registered companies; presently all must file a form 10-Q showing inter alia company quarterly financials.  The current proposal is to require financials only twice a year.  This revision is consistent with President Trump’s long-stated agenda and purports to encourage more public offerings.

In my personal view this step towards providing less information to the public makes little sense.  First, experience in the capital markets for decades has taught me that investors want more information, not less, and investors respond almost immediately to each iota of information that may be predictive of future performance (witness the daily trading triggered by the current state of affairs in the Middle East).  And the dynamics leading to a public offering, to my experience, do not turn on whether the reporting regime calls for quarterly versus semi-annual financials; and, the pressure for information will remain regardless of SEC reporting requirements.  The current regime for SEC reporting, even after any adoption of this new proposal, remains intrusive and substantial and while in some instances the promise of public scrutiny bears on the decision to undertake public registration, that decision turns on broader issues and not on this detail.

In some sense the unwinding of the granular administrative state, if that is your goal, is advanced by small as well as large steps; nonetheless this proposed tweak strikes this observer as trivial and unwise.

AI Litigation: What Are the Limits on Scanning to Educate AI?

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Anthropic is in court again, sued by the music publication industry for copyright infringement by reason of the scanning of extant music to educate Claude as part of the development of generative AI.

The question: is such use “fair use” and thus permitted under applicable case law. Anthropic offers the argument that GAI will be a transformative advance and that it is anomalous to utilize the copyright laws, designed to foster human progress and creativity, to prevent such actions. Outcome is unclear to me, as for example earlier litigation held that authors could not prevent Anthropic from scanning works that Anthropic purchased but could recover monetarily for “pirated” books; that case cost Anthropic a $1.5 billion settlement (which in the old days was a lot of money).

The professed injury to the plaintiff music publishers is purely economic, but allegedly considerable and something the copyright laws are designed to prevent: the market will be flooded by works that will divert income from human creators of the works which have been copied.

Another example of science presenting equities that need to be weighed in light of laws enacted when the cases now presented could not even be imaged.

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How to Build Board of Emerging Company

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If you are involved with an emerging company, how is your board of directors structured?  Chances are you are not doing it right, says the National Association of Corporate Directors.  You are respectfully directed to my blog site, just click on www.stephenhoniglawblog.com   

Note that I do post regularly on a variety of business issues at this site; you are invited to visit regularly to see what is new.  Lots of material has been and will be posted about the world’s hottest topic, AI; posts are searchable by category on the site.

Boards of Directors– New Challenges

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What should a board of directors focus upon in today’s world?  Likely not a hard question but you need to think about it.  The below thoughts arose in last night’s program presented by the New England Chapter of National Association of Corporate Directors (disclosure: I am former board member, now on advisory board).

Two major “headings” emerged: strategy and AI.

Strategy: with the world in flux for many reasons today (I hereby spare you the obvious list), strategy needs to be monitored closely and constantly.  Remembering that the CEO is the head of strategy and must be involved, guided and reminded to lead, what should directors be doing beyond working closely with the CEO?

Since so many current issues are in play which affect every business, maintaining a wide diversity of backgrounds among board members is desirable.  Selecting directors for the way in which they think about and tackle issues is more important than deep expertise in a given field.  In some instances directors today are themselves very short of time (dealing with issues in their own enterprises, serving on several boards each of which needs more attention); care need be given in selecting directors with requisite ability to spend the time needed and in formatting board meetings and retreats to be efficiently focused on key issues.

In all cases, financial literacy is a requisite for the board, and it is better if it is broadly spread.  Domain expertise is important but feeds into — what  —  financial performance!

When several issue may need substantial board attention at the same time, it may make sense to set up task forces consisting of one or two directors together with non-director support to analyze and report back to the whole board (efficiently breaking up tasks,  and for public companies avoiding the need to report “missed” formal board meetings).

AI: THE hot topic. Particularly relates today to production of company deliverables (hard goods or not) but, since AI will impact all company operations, the addition of an AI director often is not the solution (eg if you add such a person, do not turn all issues wholly over to them).That is because present staff understands the business more than a newcomer can.  And AI will not be the elephant in the room just for production of deliverables, as may appear to be its most typical utilization today; AI will totally transform every aspect of your company.

AI should not be assigned, at least for final decisions, to a committee.  It is a key strategic issue at every level and must be passed upon after discussion with the whole board and with CEO involvement.  It is useful for board members individually to achieve exposure and education to AI of course, but group analysis at each operational level of the enterprise is needed.  And AI at this instant is in fact not moving as fast as you may think, not necessarily calling for a need for an AI consultant — it depends (things will get faster later).

AI today can be a great tool in finding what is happening in the marketplace: both with your customers (present and intended) and with your competitors; make sure you are using AI to probe current events.

In light of the current job market plus the general fear that AI replaces low-level jobs, boards need to make sure the work force is being managed properly.  It is not necessarily true (it, well, “depends”) that entry level jobs should not be filled at this point.  And entry level people on hand at the birth if AI may prove valuable as the job mix moves upwards to utilize AI.  There also is a social component to maintaining your best workforce, which may vary given your business staffing model (some enterprises may thrive with major remote staffing while others perceive that at least some components of the staff should be in person a certain part of the time and AI can seem to be contrary to that latter perception).  And, at end of this part of the program it was suggested that perhaps the best employees in the future may not need a college degree….  (My add-on: college degrees may be used today as a test of intelligence and diligence [and finding workers you relate to culturally?] but the skills that directors ought to value may be somewhat different?)

Finally, this next comment was made by a panelist with great street cred so I invite you to consider: “statistical reasoning by AI is superb statistically, but it is only statistical reasoning and not ‘reasoning.’ ”  Numbers alone are only numbers and must not wholly drive judgment.