The Law and Other Anomalies

SPACs have been criticized extensively for favoring the promoters and their cronies while the merged operating company does not reward the investors.  Most SPACs are formed and will continue to be formed in Delaware.  The Chancery Court early this month agreed to allow a shareholder suit to proceed against the founders of a SPAC in a manner suggesting how Delaware courts will view claims leveled at SPAC directors (see In re: MultiPlan Corp Stockholders Litigation, #2021-0300).

There are technical elements to this case which defy terse analysis,  but basically the claim is that the promoters did not give full disclosure of details to the SPAC investors, who then did not ask for their investment to be refunded (as they were at the time legally entitled to request), but stayed invested and became thus shareholders of target company that the SPAC acquired; in this fashion the acquired company became publicly held.  Stockholders claim that they were not given all the facts when they decided to stay with the merged company, and sued the directors (and the promoter who got a .$300M promote on the merger) for the money they lost when the new company shares fell in value by reason of facts known to the directors at time of deal.

Disclosure in SPAC acquisitions historically has not been complete as to the insider deals, and promoters have sometimes named the same people over and over as directors, who made profit without risk and voted in favor of the acquisition.  Perhaps the thrust of this case is that the level of SPAC disclosure of deal terms will be stepped up in order to protect promoters and directors; the mere receipt of profit is not itself wrongful if it is disclosed in fullness, so as to permit investors to say “no” and get their money back pre-merger if they so elect.

A separate issue is the SEC regulatory view: if SPAC acquisition disclosure were made as robust as is required in a regular IPO as to insider benefits, presumably application of such a standard would insulate profiting directors and promoters from liability even if those SPAC investors ultimately lose money by staying in the deal.

Forgive me, finally, if you know this but I just love the nomenclature here: the transaction by which a SPAC acquires a target and makes the target a publicly held entity is called a “de-SPAC.”  I guess the plaintiffs in the above case would choose different wording.

I have written here, and in my recent article (Fall 2021 issue in Massachusetts InHouse) about the activist agenda of the Democratic-controlled SEC under Chair Gary Gensler.  Yesterday, Gensler furthered that agenda by announcing that the SEC will address transparency in fees paid to sponsors of PE and hedge funds.

The SEC cannot attack substance, in the sense that the amount of fees taken by the sponsor-operators of these funds is a matter of freedom of contract.  But every dollar going to these folks is indeed a dollar less going to the investors.  The SEC is of the view that funds are not making sufficiently clear what the sponsors are in fact taking off the table– a matter of disclosure.

The stated SEC drivers are to increase competition which will lower fees, and thus assist the investor cadre, which is appealingly described  as consisting of pension funds, school endowments, retiring people and those paying for college.  I  suppose that wealthy, non-retired, childless trading professionals also will be allowed to benefit from whatever investor benefits will be derived from this effort…..  🙂

Nor do I suggest that the bottom line goals of the SEC are misguided and, in this context, it is a bit difficult to understand Republican member resistance, which is actually framed in what seems a thin disguise of complaining that comment periods on new regulations are being expedited to shrink public comment periods from customary 60 days to 45 days or less; readers of public comments on pending SEC regulations, accessible to the public at SEC.gov., know that people with a real interest are prompt to post support or objections.  Surely lawyers for fund sponsors and managers are not going to miss an earlier comment deadline.

The activist SEC agenda has generated for comment two new rules designed to provide greater information to the marketplace; not surprisingly, providing information= more rules about what must be disclosed and even more forms to be filed.  As if public disclosure is not already overwhelming….

Insider trading by executives with early access to material facts was to be controlled by permitting trading safe harbor rules under Rule 10b5-1.  These plans were designed to make trades respond to mechanical triggers such as price or timing, divorced from exercise of investor discretion which could be unfairly informed by knowing what the market did not yet know.  In operation it became clear that the safe harbor was subject to clever gaming, including some now the subject of a proposed new rule (and some not…).

Specifically the rule, open for public comment would impact plans by: requiring a time delay between plan adoption and market trading; banning multiple trading overlapping plans; limiting single-trade plans to once each 12 months; requiring trading officers and directors to certify they in fact did not have any material nonpublic information at time of adoption  (in some instances, not such a great regulatory idea depending on the content of the plan itself).

Companies would be required to disclose: policies relating to insider trading as relates to option grants; any options granted within 14 days of release of non-pubic material information; changes in market price of securities for each of the day before and the day after release of information.

Stock buy-backs also are subject to a proposed new rule open for public comment.  Generally speaking, companies would be required to make prompt disclosures of repurchases, include buy-back reporting in periodic reports, and state reasons for the repurchase  (which presumably would NOT list  as a purpose “facilitating executive sale of company shares”).

For persons interested in learning more or commenting on the proposals, the SEC website can link you to the granular releases describing the rules (for example, the release for Rule 10b5-1[(33-11013] weights in at 163 pages) and the comment pages to record your view–no special qualifications or status are required to post your commentaries.

It used to be “employee management,” and then “HR;” now with the Great Resignation, the shrinking of the labor force, the reshaping of “work” via pandemic, and the inflation of wages, it is re-named “human capital” and it has become a major business problem, disclosure issue and board of directors focus.

And the subject of a two-hour deep dive by a panel convened this morning by the New England Chapter of the National Association of Corporate Directors, at which BU Professor Charles Tharp coordinated a panel discussion with Independent Director Cynthia Egan, Eastern Bank President Quincy Miller, and Melisa Means of Pearl Meyer’s Boston consultancy.  Below, some important director take-aways:

There is little doubt but that the SEC will propose enhanced disclosure requirements; given the schedule for rule-making, it is likely that change will  become effective in 2023 after debate of drafts in 2022.  Emphasis will be on disclosing demographics, costs (salary and wages being a huge burner of corporate capital), DEI, succession and enterprise risk.

Disclosure also likely will track board work on strategy, now widely ongoing in many companies.  Will disclosure of strategy serve to inform competitors to detriment of the discloser?  The panel thought not, as strategy depends on skill of execution and depth of adherence to that strategy within the culture and ethos of a company; indeed, general disclosure of approaches ought to assist all companies.

Structurally many companies are remaking their organizational approach to human capital, given both the business imperative and the reputational risk of failing to address the growing corporate awareness of the perceived obligations of business to cohorts other than shareholders, e.g. customers and society.  Board Committees are being renamed from “HR” to capture the concept of human capital.  The predicate for success is whether an enterprise philosophically embraces this shift by empowering relevant committees in terms of resources, recognition when fixing corporate strategy, and evaluating entity risk.

How will companies deal with driving equity in the new workplace?  Classic approach is to key executive compensation to success, often effective but much depends on corporate culture and on finding a metric to which management compensation responds.  Some companies use management of human capital as part of a holistic checklist in evaluating and compensating management; larger companies often specifically key part of compensation (particularly bonuses) to demonstration of meeting identified targets.  Of these companies, 10%  weight (of executive comp)  typically has been given, although it was suggested that something like 20% is required to really attract management focus.  On the other hand, since this metric often only affects bonus and not base, it was noted that even at 20% the impact on total executive comp may not be huge.  Further, making progress in pay, sex and racial equity is a slow process, and such metrics should be placed in the longer-term corporate plan (as is done for example by Pru and Starbucks).

How do you measure success, to trigger rewards to management?  One measure is simple headcount of employee population, but that is not alone sufficient. With respect to employee compensation, there are two statistics: the “raw” number (women earn 74 cents to each dollar earned by men) or the “adjusted” number (looking at each department, as they have differing natural pay scales and turnover rates affecting seniority).  Eastern Bank also measures success by measuring employee engagement: charitable engagement, community engagement, turnover, number of calls to the ethics hotline.

Another heads-up for boards: add to the report on risk management an analysis of risk presented by human capital management: defections, inability to hire, shortage of staff, payroll cost increases to be competitive.

Finally there was discussion of dealing with remote workers, who are anticipated to be a constant even when the pandemic is wholly quashed. Seemingly the push for human contact is less powerful than had been assumed, and can be addressed by modest in-office attendance. Can there be equal promotion when people do not come to the office? And, it was noted that remote workers tend to over-work and suffer mental stress.  (I note that there are contrary view in terms of which employee cohort needs the most attention– those who commute have more expense, commuting time and stress, greater child-care an elder-care burdens….)