Stock Buy-Backs: New SEC Regulations

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Today, the SEC announced new Rules requiring wide disclosure relating to corporate redemption of shares.  Buy-backs are huge (in 2021, they totaled $950 Billion), and have been occasionally questioned in the liberal press as events that wrongly reward investors, while the purchase price paid for redeemed shares might have been better used to enhance the company.

Disclosure now is required from redeeming corporations about the obvious (what was redeemed at what price), the suspicious (what did insiders, officers and directors do with their shares around the time of redemption) and perhaps most interesting, the corporate objective for the buyback, and how the redemption decision was reached.

It will be interesting to see how companies explain why returning money to investors was smarter than investing in company growth. Investor return is, after all, the object of investment….

ESG Wars

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The battle over whether ESG belongs in investment decision-making, and whether failure to adhere to ESG principles can lead to litigation against companies, has  created some very curious legal situations.  The two below are wholly unrelated, but also illustrative of what it looks like in the weeds of ESG sensibilities.

Last month, Congress actually agreed on something: they sent to the president a bill that would not permit the US Department of Labor to allow regulated funds to take ESG into investment considerations.  The presumable argument is that ESG may have a downward pressure on profits, hurting worker beneficiaries.  President Biden used his first veto to strike down the law, leaving ESG as a permitted investment consideration in regulated plans.

Two days ago, Wells Fargo moved to dismiss a class action lawsuit brought on behalf of  current Wells Fargo shareholders.  Bear with me here.

*In 2020 WF adopted a policy requiring that diverse candidates constitute at least half the interviewees for high-paying jobs; the definition of diversity was broad and included women also.

*It is alleged that some WF employees conducted interviews after some slots were filled so as to reach the 50% level of interviewees.

*The suit complains that WF propped up the price of its own stock by such practices, and failed to report that WF was not complying with its own DE policy; during this time of allegedly propped-up stock prices, WF repurchased its own shares.

*When it became clear that the WF policy was allegedly not being followed, the share price fell.  SO—the claim is that if WF had not lied about complying with its own policy, the price of the stock would have dropped earlier and then the price of redeeming the stock at inflated valuation cost the company an extra $4.1 billion dollars.  A breach of fiduciary duty by management is alleged.

Putting aside what appears to be a clever basis for the claim and putting aside whether alleged facts are true, this case demonstrates another subtle way  in which ESG can  become relevant in the securities markets– all without regard to the question of whether ESG outside of investment practices is or is not a social benefit.

Who Can Sue if a Registration Statement is Misleading?

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For a long time, it has been settled law that if you bought shares on a public offering and if the prospectus was materially deficient, and if then the price of the shares you purchased fell, then you the investor had a claim for damages under applicable Federal securities laws.  It also seemed clear that this claim was for the benefit of purchases of shares covered by that erroneous filing.

It also was thought that, if someone purchased shares not issued pursuant to the incorrect prospectus, then the purchaser could not make a claim for losses arising from that prospectus since the purchased shares were not “covered” by the disclosures therein.

The US Supreme Court is soon to hear arguments over whether a purchaser of shares of the same class as those covered in the prospectus but not included in the registered securities, and who bought such shares at a higher price because of that erroneous prospectus, can claim damages by reason of buying shares NOT covered by that public offering.  In this case, the shares had not been previously registered and were thus by definition issued under the prospectus.  To decide in favor of the plaintiff would upset Federal law in the seven Federal circuits which have decided such a case and also per a prior SCOTUS decision.

If the Supreme Court decides that unregistered shares are transferred subject to the accuracy of public disclosures in a prospectus, then the potential plaintiff class is greatly expanded, as is the risk of the issuing company; the company then would be in effect making representations of facts to all of its shareholders.  The impact of such a determination on disclosure by registrants, risk metrics considered by underwriters, and the cost of insurance is not known but is potentially material.

Ivy League Athletes Sue Colleges for Price Fixing?

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I am not making this up.

It was reported two days ago that two Ivy League student athletes, a male and a female it seems, have sued all eight Ivy League schools, asserting a class action on behalf of more than 10,000 of their cohorts, claiming  –  wait for it — wait for it —claiming an agreement among those schools (via action of the Ivy League Council of Presidents)  to not grant Ivy Division 1 athletes an athletic scholarship or other incentives to attend, the injury to two distinct classes being that the cost of education increases and that compensation received by the athletes decreases.

Both named claimants, btw, seemingly did receive need-based financial help from their school (Brown, which is in Rhode Island while the litigation was filed in Connecticut where only Yale resides, for no doubt tactical reasons unknown to this writer).

To be fair, the Sherman Act (enacted I recall in 1890 when college students who might have raised this argument at that time would likely have been caned and then expelled) does prohibit price competition in relevant markets; and it is alleged that there are two markets here: smart kids who want to play Division 1 sports and athletic services provided by those students who are admitted.

To date there has been just one response from the Ivy League, which I find interesting but really not on point: it suggests that athletic scholarships might be taxable income to the students.

Given the intense scrutiny of university discrimination by our current US Supreme Court, it is interesting to speculate what they might do with this claim if it gets that far. Stay tuned (or not if you have bigger fish to fry, but I am going to follow this as it is just so darned interesting).

The Crisis in VC Financing

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Everyone seems to know that VC financing in the current environment has dried up to a material extent.  The statistics demonstrating this fact, as set forth in the current issue of Economist magazine, are startling in confirmation, with the greatest impact on the largest deals; seems that seed capital is less impaired, and indeed robust in AI, albeit on tougher terms.

Yesterday’s Webinar presented by the Boston Bar Association, featuring VC lawyers in US and the West Coast (often somewhat disparate markets), explored the numerous practical ramifications of the current environment on actual deal terms for those companies lucky enough to get an actual proposal to invest.  Too numerous to list all, nonetheless below are some of the highlights (or for the company, lowlights).

Pre-money valuations are down of course, that comes with the territory by definition.  Larger equity deals may feature milestone release of funds based on progress of the company, redemption rights for investors, payment of cumulative dividends and even grant of security interests in assets for convertible notes (making them more like real notes), super-preferred returns for preferred classes (eg rather than having a distribution preference equal to cost, the preference before the common participates might be two times cost).

Deals also may provide for full-ratchet repricing of conversion rates to common rather than the typical (and statistically fairer) repricing over the total outstanding shares (the latter actually adjusts properly for the financial harm suffered by the earlier higher-priced preferred).

With convertible notes, aside from now looking like real notes, investors are insisting on receiving warrant coverage in greater amounts, particularly if milestones are not hit.

Investors in all deals are bargaining for greater corporate control: class votes on a broader list of corporate actions, more negative covenants, more board power.

When investors in prior rounds participate in a subsequent round which is a down round (eg the pre- money valuation is less), investors are sometimes insisting on recapping the entire company and repricing their prior investments to the lower valuation.  As a practical matter, also, prior investors are less likely today to waive the anti-dilution protections they obtained in their prior investment (which was often done because the company really needed new money or prior investments were imperiled).

Recapitalizations driven by investors, particularly those who already held an investment, raise fiduciary issues for directors, particularly nominees of the prior VCs and management holding common; recaps help new money investors and the price to be paid is paid by prior classes of stock.  (These fiduciary issues are not herein addressed.)  As to substantive deal terms, recaps often include addition of pay-to-play provisions, forced conversion of prior preferred to common, rights offerings, resetting preferred valuation of prior preferred.

Not addressed in the program was the prior practice in early rounds of requiring management holding large amounts of common to enter into forfeiture agreements whereby outstanding common shares are forfeited back to the company if the employee leaves or is terminated–  a somewhat draconian provision, but with persuasive investor logic behind it; and, incredulity expressed by founders in early rounds, particularly by founders who have not only sweat equity but also cash in the deal.  Empowered investors these days will be more likely to be  aggressive as to this practice.

One can speculate that seed and early stage companies may turn to more self-financing and to non-dilutive funding and joint venture models, in the face of the aggregate dilutive pressure these realities suggest.  Or– just wait it out, though the trough in VC financing in the early 2000s lasted, if I recall correctly, several years.

NLRP Restricts Contents of Certain Severance Agreements

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The National Labor Relations Board ten days ago declared it an unfair labor practice, when offering a severance agreement to an employee, to include in that offer either a broad confidentiality provision or a broad non-disparagement agreement, which terms have been standard in such documents.

While the legal basis for this ruling is rooted in a provision of the National Labor Relations Act which ensures free communication among employees, and thus this ruling does not affect exempt employees (management and certain other senior-level workers), this radical departure from long-standing practice is further indication of the general approach of appointees of the current administration: to protect workers at all levels against pressure from employers.

(Reference is made to our post of late January which reported that the Federal Trade Commission declared general non-comps and non-hiring provisions upon hiring to be illegal (though employment lawyers do see some ability to craft limited restrictions based on specific facts, so that ruling is a story in progress).

In  moving away from Trump-era regulation, the NLRB is seeking to permit former employees to assist coworkers with workplace issues, terms of employment and disputes.  The ruling further makes clear that the mere offering of a noncompliant severance agreement is unlawful, even if rejected by the employee.

If I may be allowed an observation about lawyering: the changes in Federal administration these days sometimes create wide policy swings on the regulatory level (not just labor; look at anti-trust, SEC, etc.)  which whipsaw businesses and drive management to seek counsel from attorneys to readjust standard practices.  No doubt these swings in policy reflect the increased differences in policy held by the political parties, and the stridency with which adherence to those policies is sought both within and outside the government structures.  Current politics may well be described as the “Perpetual Full Employment of Lawyers Program.”

Chatbox as a Destroyer of Worlds?

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Bing’s Chatbox has been much in the news and much reviled on several levels; the New York Times a few days ago did quite a number on its allegedly dangerous functionality.  To me, there was an eerie similarity to the first part of the story line in the movie Terminator I.

May I have the temerity to suggest that you follow this link to another of my blog sites to read an extended and irreverent commentary on the potentially imminent Chatbox War?  http://www.SMHonigAuthor.com

Enjoy!

How to Improve Your Board of Directors

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Add a social dimension to the interaction of board members; in your annual survey of board members, ask them to comment on the performance not only of themselves but also of other board members.  Reduce the size of your board to 7-9 members.  These were among the suggestions offered by an expert panel in today’s program presented by the New England Chapter of National Association of Corporate Directors.

Each of these take-aways is not obviously manifest.

Will not commenting on your fellow members create animosity? The goal is to make a better director and if done carefully a board can educate itself.  It was noted that a majority of  S&P 500 companies in fact gather this information at present.

If you target a small board, what do you do with your current larger board; and, do you have a problem staffing committees.  As to the first point, while term limits may not be the answer (why remove an older director who is contributing), that device might tend to add younger directors who are more tech-savvy and closer in age and viewpoint to customers.

As to social contact, this helps build the culture of the board and, while difficult  to achieve when meetings are remote, I have come to the view that doing business in person is highly desirable and long overdue; COVID is never going away entirely, and the lack of interpersonal contact in so many settings has a palpable social and economic toll in the long run.  Surely at the board level, so vital to the proper guidance of an enterprise, personal contact seems essential.

Another salient point has to do with the definition of a properly diligent board member: it is necessary to get better educated as part of the job, and not just show up at meetings.  The world is changing both in the tech sense and the social sense, and directors should be expected to read widely, utilize other methods of gaining information (example: pod casts, industry conferences), and learn all that there is to know about the company, including but not limited to visiting facilities and fully reading the board materials.

Although it is commonly thought that service on up to five boards can be acceptable, it was suggested that if a director is to be able to direct for what a company will look like five years in the future, rather than ten years in the past, the heightened educational curve should cause good directors to serve on fewer boards so they can do a better job in a fast-changing world.

 

FTC Strikes Again– Unfair Competition

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A couple of weeks ago I posted about a new Federal Trade Commission initiative to toughen the anti-trust laws by proposing to ban all non-comps, even those previously executed.  Now the FTC proposes to begin enforcing the now-obscure Robinson Patman Act.  This Act, in 2007 considered for repeal, prohibits (in theory) unfair price advantages given by manufacturers or suppliers to larger customers.

Not all favorable  prices charged to larger customers were illegal under this Act; only those that tended to lessen competition; a vague judgmental standard if ever there was one.

I have been practicing law long enough to recall with clarity spending a lot of time counselling sellers about how they could not favor the big purchaser with lower pricing, or better payment or delivery terms, or better marketing and promotional support just because that purchaser was buying a zillion dollars of goods.  Were those actions “unfair”?  Often we would counsel that, if the larger purchaser “earned” better treatment, then better treatment from the seller was justified.  Did the purchaser warehouse and support the product?  Did the purchaser take over tasks generally performed by the seller, thus relieving the seller of cost so that a discount or benefit could be afforded to the purchaser in return?

By the way, this was a hard message to sell to the sellers; there was so much efficiency and profit in large orders, and it was so hard for the smaller purchaser to bring suit to enforce the Act, and so hard for the FTC to get interested enough to bring governmental action, that many a client listened to what I had to say, paid my fee and went ahead and continued favoring the big purchasers.

So today, an activist FTC is itself going to undertake the protection of the little guy, claiming that sheer quantity discounts are “unfair” price discrimination.  No doubt the government will start with the largest, most blatant cases, and perhaps those to which the consuming public will be most sensitive (the FTC has been looking hard at the soft drink industry).

It will be interesting to see, if the FTC is successful in preventing sheer quantify discounts, if in fact the retail price of some goods will increase (while small business profits will increase?).  Stay tuned as the FTC takes us down the rabbit hole…

Can the FTC Void All Employee Non-Comps?

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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.