Two Marathons

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I just walked up the hill to my house in Newton, Massachusetts, after watching the Boston Marathon participants run, walk, wheel and stagger past the foot of my street at mile 16.  It was a strange sight to see so many people, unmasked and breathing heavily on each other and on the large crowds on the roadside, although of course all of this is in the open air.

There were the usual heart-breakers: impaired  kids being wheeled in carts in front of panting parents, vets without legs propelling their low carriages with cranking arms, the occasional runner with metal spring-like devices instead of lower legs.   There were the usual inspirations: first the wheel chairs, then the elites, then the real heroes, the thousands of real people panting up the road from Wellesley to the crest of our shallow hill, a couple asking me “is this Heartbreak Hill?” and thus lacking any sense of what awaits them a few miles up the road; and, all those people with gray hair, lined faces, limps and leg wraps, pain on their faces, lurches in their strides, leaning towards Boston and not to be denied.

This is my 15th or 16th time I have stood on this corner and watched the parade of pride and pain.  I swear to you this was different, the crowd more supportive of everyone, the sidelines in need of giving support to other people and gaining emotional  strength from seeing those people absorbing their gift of  support (and if you suggest it was just different for me, well who is to say you are wrong about that?).  All of us high on the Boston moment (go Patriots; go Sox) of this 125th running of the world’s oldest marathon, there were two races being run past the foot of Beacon Street today: the road race, and the race of people racing to outrun the isolating memory of the past year and a half.

Today, we all have trudged up the same hills, together.

 

The Future of US Business

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The future for US companies will be marked by increasing consumer demands, temporary disruption of supply chains, difficulty in hiring and retaining employees, a retreat from inflation, acceleration in the use of technology, and a growing focus by companies in providing customers with a better experience to drive profit and prevent injury to brand identification.

These conclusions were expressed at a virtual September 22 program mounted by the National Association of Corporate Directors.  While typically I do not spend time posting the pedigree of panelists, in this case the source of these conclusions is important, so: the panel included CEOs of Panera Bread (a food services holding company), Eastern Bank and Perkin Elmer (a major consumer-facing company, a rapidly expanding bank and a health care company doing business in 180 countries); Cathy Minehan, former CEO of the Boston Fed, presided.

There is a labor shortage which is long-term based on demographics.  Today there are 11,000,000 US job openings and yet 8,000,000 unemployed (likely result of trauma and government stimulus). Companies will need to offer to employees more than money, but rather a clarity as to the value of the company mission and a discernible career path,

In the near term, consumer demand will be frustrated by supply chain impact on available products.  Consumer-facing companies will need to embrace ESG, DEI and other issues bearing upon brand reputation; many factors will force consolidations in various business verticals.  Further, customer needs must be met at a higher level in terms of healthy products, speed and ease of delivery, identification of company core values with those of the consumer (“consumers are a group of one”; “I want it for ME.”)

COVID has accelerated trends in AI, on-line commerce, need for efficiencies which are driving mergers as necessary to meet channel challenges and the expense of technology expense.  (No one mentioned the increasing US government pressure on merger activity, for which see my recent post on that issue).

There are challenges with return to offices; some industries require people on site, some require only a fraction of people on site; professional offices are likely not to have full attendance. This latter question raises issues of how employers respond: those people who are not at home incur greater expenses, hassles in commuting, greater health risks, issues with child and elder care.  How do employers compensate for this greater pressure on these workers, which pressure goes beyond number of hours “on the job”?

Finally, two panelists expressed confidence that the “new normal” would arrive some time in 2022; in a mildly contrary vein, the CEO of Perkin Elmer (the health care company perhaps best positioned to have this insight) said that you can never tell about things like that….

M&A Trends by Private Equity

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GF Data Resources issues a quarterly report on deal terms for Private Equity acquisitions which is a gold-mine of market information.  Trends noted in the Q-2 2021 report:

PE firms are using warranty and representation insurance almost 60% of the time, a recovery from a dip in 2020.

Strong target firms that can obtain robust insurance command a valuation premium, which is not surprising based on company strength and insurance reducing acquirer risk.

Consistent with the impact of the foregoing, in the fist half of 2021 the size of payment holdbacks (payments held in escrow to satisfy claims of erroneous representations) has fallen to the lowest level in several years in most categories of transactions (measured by size of transactions) and the period of time during which funds are held back similarly has declined; targets with insurance of course enjoy smaller and briefer hold-backs.

Finally, indemnification caps (the limitation on the percentage of deal price to which target companies expose themselves by way of liability for misstatements or errors in representations) remains consistent with 2020 for smaller deals but has increased for deals in the larger categories, a development that seems inconsistent with the the trend for insurance (although perhaps this increase is consistent with the very existence of insurance and reflects confidence on the part of insurers and target companies).

IPO Lock-ups

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When a company goes public with an Initial Public Offering, it has long been the practice that underwriters require major (sometimes all) prior shareholders to agree not to trade their shares into the public marketplace for 180 days.  This “lock-up” period permits the underwriters and market-makers to stabilize the price of the stock, and to protect the offering price against a sell-off of a large number of shares.

But, things are changing.  Starting in late 2020, many high-profile IPO companies have reduced the lock-up period.  This suggests a change in thinking about the IPO markets, or alternately hubris on the part of high-flyers that their companies are so strong that the sale of a chunk of shares will not work to deflate market price.

Companies that have reduced the 180-day lock-up include: Robinhood Markets, AppLoving Corp., SentinelOne, DoorDash, Airbnb and most recently, filings by Dutch Brothers, Inc. and ForgeRock Inc.

Developments in the securities markets can be credited with some of the impetus, as alternate methods of reaching public markets do not typically involve lock-ups: “direct listings” by companies placing shares on an exchange without underwriters, and using the SPAC acquisition model.

ForgeRock, which just went public, tied release of prior shares for public sale to the market pricing of its shares at  25% or more above the IPO price, a hedge against the IPO price getting walloped.  How common reduced lock-ups will become, and whether the ForgeRock approach will become common, cannot be predicted; IPO marketplaces can turn on a dime and smaller companies or companies coming out when IPOs are not “hot” could lead to a retrenchment.

Mergers Subject to Greater Scrutiny under Biden

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On July 9, the President by executive order directed government agencies to bolster competition through stricter analysis under the anti-trust laws.  On the 15th of September, the FTC, by 3-2 party vote, rescinded vertical merger guidelines adopted under the Trump administration (although such action left no formal guidance on the books).  That same day, the DOJ announced it was reviewing both its vertical and horizontal guidelines.

The rescinded Trump era guidance permitted vertical mergers if they created efficiencies or had some procompetitive effects; such provisions were declared unacceptable.

Separately on the same day, the FTc by 3-2 vote issued a policy statement holding health apps to the FTC rules requiring such apps to comply with the sweeping rules requiring consumer notification in the event of health data breaches.

\It is not a surprise that a Democratic administration would land on the side of greater governmental regulation of business; nor do I suggest such a result is necessarily a negative.  However, as to vertical integration mergers I do note that such deals might be a partial solution to the supply chain issues which hamper the supply side of our economy during and coming out of COVID.

SEC SPAC Attack Intensifies

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SEC Rules are expected this Spring to affect SPAC offerings; last week the SEC’s Investor Advisory Committee provided the Commission with a list of recommendations for consideration.

These recommendations focus primarily on enhanced disclosures: use of financial projections (generally omitted in regular IPOs); disclosure of profits for promoters regardless of share performance by SPAC founders; receipt of sizable equity in the target by founders regardless of how the target performs; plain English explanations of founder comp; disclosure of risks in finding a good targets; how the SPAC determines public readiness of a target, including accounting factors.

Commentary in the lawyer publishing service Law360 quotes one SEC Advisory Committee member as follows: “many target companies seem to prefer the more certain pricing and timing that comes with a blank-check [SPAC] merger compared with a traditional IPO;” and no doubt the robust compensation of promoters (and the generation of related professional service fees) support the prevalence of SPACs and the hundreds which today are funded and in the marketplace seeking acquisition targets, so it is not at all likely that SPACs will be mortally wounded by new regulation; and query if enhanced disclosure will matter much to the retail investor if the market generally remains “hot.”

Insider Trading Update: SEC Rules Coming

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The SEC is expected this fall to issue Rules restricting the use of so-called Rule 10b5-1 “Plans,” which are used as trading safe harbors by executives and directors of public companies to permit trading even while they may possess material inside information.

Briefly, a Plan provides a program for permitted trades, buy or sell, based on pre-determined metrics: date, number of shares, price or other triggering events.  The theory is that the Plan runs automatically and thus the trader is not by definition using inside information.

The SEC effort is being informed by the SEC’s Investor Advisory Committee, which Committee has just made recommendations to the Commission.  These include a cooling off period of four months before trading can begin under a Plan, and a ban on multiple Plans for one person.

It is not clear whether the SEC will attack the ability to de facto alter a Plan by aborting its operation in certain defined circumstances; such alteration can render a Plan subject to inside information manipulation.  Plans are on the SEC’s own list of rulemaking priorities, driven by the 3-2 Democratic majority.

DEI in Corporate America–Perspectives

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Corporate America treats DEI as a problem to be fixed, and often relies on DEI training as part of the process.  This approach was roundly criticised last week by a panel of corporate experts convened by the New England Chapter of the National Association of Corporate Directors, which posited that DEI rather should be framed as a “search for excellence.”

Directors should ask themselves: “what result do we want” rather than “how do we fix” what DEI addresses. How can a corporation create equity “at scale?”  Equity is not a zero sum game, where the winners’ existence must imply that there are losers also.  These recommended concepts must be invented in the marketplace as they have not been taught in business schools.

What does “diversity” mean?  Companies should not try to define it, as these lists inevitably center on one or more cohorts: race, sex, economics, color, country of origin, gender, etc.  Diversity should be approached holistically: it means human beings and how do we advance all of them as a group?

DEI is a cultural effort, not a response to “events.”  Reputational risk to enterprises is of great and of  growing importance.  Institutional investors are driving home this point. There is a delta between promises and progress today– why?  Should not DEI be placed into the purview of a “Risk Committee” along with all other potential pitfalls?

SPAC Attack

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SPACs are under attack in litigation file in New York Federal Court, claiming these entities should be closely regulated as investment companies under the ’40 Act.  SPACs typically invest their funds in market securities during they year or more they seek a company to acquire.

Not surprisingly, about sixty law firms (many of great size, all with SPAC business) have fought back, asserting that these investments are incidental and transitory and that the ’40 Act was not designed for the SPAC model (no doubt true as eighty years ago there were no SPACs).   SPACs seem to be relying on an implicit “grace period” which is nowhere specified in law or regulation.

If a SPAC is an investment company then the “promote” kept by the founders (typically 20% of the deal) would be illegal as to amount and form under the law; indeed, one plaintiff in current litigation so alleges.

It seems unlikely that these suits will prevail, particularly as the SEC has failed to object to SPACs conceptually for many years, and since there are today hundreds of funded SPACs on the hunt for an acquisition.

Parenthetically, the Singapore Stock Exchange just last week adopted rules that will permit SPACs to be traded, subject to mandatory quality standards which echo better US practice.

SEC Hits Brokers and Advisers on Cyber

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The SEC supervises brokers and investment advisers and people in those professions know that periodic compliance visits can get very granular.  We all also know that the SEC is deeply interested in protecting the investing public.

Latest SEC move: at end of August, the Commission levied hundreds of thousands of dollars of fines against brokerages and advisory firms based on failure to maintain cyber security over customer data. Client emails were hacked though on the cloud.  The Commission also has complained against at least one firm where there was no hack but a failure to maintain robust data security.

Although rules covering cyber for brokers and advisers are old and general, they do require written policies (SEC) and periodic review (Advisers Act).  Clearly the SEC has broad general supervisory powers, so it is clear that they do not think there is a need for more rule-making as part of its enforcement tool kit.