Government in the Board Room

Posted on by

Recent news items: the SEC bars Elon Musk from board chairmanship for three years and fines each of Musk and Tesla $20M; California passes a law requiring public companies headquartered there to have at least one woman director, and in the future multiple women for larger boards.

It has been a long time since internal board governance became “news” but there is much imprecise thinking (to my mind) swirling around these news items.

First, as to Musk, the day his comments hit the news it was clear to SEC lawyers there was an issue.  He was hung out to dry based on established law, nothing new.  Commentary suggests that the fact that the board was static (mostly the same folks serving since the 2010 IPO) constitutes an argument for board renewal.  But any board, even long-serving in a company owned 22% by its founder, needs to institute control of the flow of news; board management 101.  This is the same problem the current Federal administration enjoys.  But in a public company, the SEC is there to enforce the need for accuracy and evidence.

As to California, the idea that you need one woman is in conflict with my understanding of the evidence, which is that one woman does not make much of a difference, you need multiple women to create an atmosphere where woman are active (and then the statistics show that performance improves).  Then also, it may well be that California is constitutionally not able to regulate management of an entity formed in another state (think Delaware for most public companies).  Corporate governance issues are driven by state of formation of an entity, not where it builds its shiny home office building.

The question of women on boards has triggered a broader discussion, however: the intrusion of government into the board room.  Today’s Boston Business Journal argues against Massachusetts following the California lead, even though only 19.2% of board members of the largest Massachusetts companies (public and private) are women.

It is interesting that there is resistance to government sticking their noses into board rooms, since nose-sticking is fundamental to the way in which US corporations operate.  Major examples: the SEC requires public companies to have independent key committees and in most cases an independent board majority; State statutes and courts impose substantial fiduciary duties on boards, sometimes by complex and arcane analysis of whether boards have properly authorized certain action involving risk of majority abuse of minority interests.  So governmental interference with the board room is pervasive, substantial, and well-established.  (I do not suggest disagreement with these “intrusions” but only note they are robust and firmly established.)

Since academic analysis demonstrates the superiority of gender-mixed board management, why the resistance to legislation in the gender/board discussion?  There is something different, as we have recently learned in the Federal setting, about issues perceived as gender-driven.  I do not dare take a dive into the basis for this difference or the appropriate way to address it as to matters of policy, except to say that the issue in the governance area should not be avoided by legislative bodies on the grounds that it constitutes inappropriate governmental impact on board governance; the train of governments messing with boards left the station, and at high speed, a very long time ago.

Cyber in M&A: Controlling Risk

Posted on by

When you are acquiring a company, what sort of steps should you take to limit cyber risk within your target?  What do the big boys do?

Lawyers always will insert warranties, representations and indemnities in acquisition agreements but, on the ground, what should a business do?  This issue was addressed at the September 27 ACG Boston breakfast, where Kevin Neifert, Raytheon’s CIO, described how Raytheon protects itself in its numerous acquisitions.

Statistically, smaller companies (prone to being acquisition targets) are also prone to cyber-attack; 58% of all cyber breaches last year occurred in the category of “small businesses,” according to the industry-valued Verizon Report.

Raytheon has a rigid M&A policy (not an IT policy).  IT gets involved at an early stage and doesn’t wait for the deal to become firm.  Further, Raytheon specifically admonishes its people not to tell an acquisition target that “we will leave you alone.”  In fact, Raytheon acquisitions will be entirely integrated, from a cyber-standpoint as well as an operational standpoint, according to a rigid 18-month policy requirement.  During the acquisition process, Raytheon will undertake a standard security check according to their own internal checklist.  What happens as soon as a deal closes?  Even before the press release, Raytheon descends on the executives of the target because, apparently, hackers believe that the best way to be able to infiltrate the acquirer is through the busy and unsuspecting executive level of the target.

What does cyber integration mean?  If there is any thought that hacking has occurred, key data will be extracted from the target equipment, and installed on Raytheon equipment and the target equipment will be jettisoned.  It means that all personal computers will be replaced.  It means that in-person training is given to all target employees, because most problems arise through email staff not dealing appropriately with email content.

What about the cloud?  It seems that Raytheon, and apparently other larger companies, are getting more and more comfortable in placing everything on the cloud.  Because of the scale of what appears on the cloud, the most robust and updated protections for data security will be constantly applied, and being in the cloud is just going to be safer than what any given single company is likely to be able to achieve.

Are not mobile devices the biggest risk?  The answer for Raytheon is “no” because by “mobile device management” it is possible to wipe clean the contents of cell phones and iPads.  The computers are the problem, and that is why all target computers are discarded upon acquisition.  (When travelling abroad, Raytheon people are given a clean PC with the data they need for their particular trip encrypted on a thumb drive; nothing is connected back to Raytheon.)

Great question from the floor: what are the two biggest vulnerabilities of smaller companies?  Answer: first, employees must be trained not to click through on any links because you cannot be sure who sent them, even if they appear to be internal; and second, take a look at the gear that is utilized within your company because most of it is likely accessed through the original default user name and password; apparently things like routers are given a user name that is “user name” and a password “password” as default settings and these devices need to be updated immediately.

Trends in Life Science

Posted on by

Everyone knows that greater Boston is “what’s happening” in the science and business of life science and biotech.  On September 20, 2018, the Boston Bar Association brought together lawyers and scientists in an effort to educate lawyers as to trends in the science, and for lawyers to share business practices that the science is driving.

A quick summary of some of the high points follows.

Big data is coming, which should be no surprise, but at Mass General the application of machine learning and clinical genomics are being regularly used to provide targeted therapies to cancer treatment.  No longer do doctors look through a microscope to look at cancerous cells.  Rather, originally informed by biomarkers which can be harvested onsite (for example through blood analysis), the General compares these biomarkers through millions of items of data from other tumors.  Machine learning improves accuracy of analysis.  The genes involved in the tumor are located.  Specifically focused treatment follows.

Further, big data is being utilized to test the effect of combining various drugs with disease models to identify possible palliatives.  The effort that used to take place in the laboratory, over a long period of time at great expense, to test the effect of possible treatments now can be jump-started by conducting experiments, using big data, right within the computer.  One company suggested that its automated biology platform could “conduct” more than 100,000 experiments every week in order to identify likely efficacious treatments.

The conference also addressed the business side of bio and life science.  Highlights included: speculation on how best to protect, through patent or trade secret, new modalities of technology; what do you do with the science that permits the printing, by computer, of DNA (did I hear that one correctly?)?  How do you protect the AI/big data set, which is typically subject to a software patent which may well be difficult to defend in litigation?

Finally, prospects for raising capital for bio were explored at some length.  Major takeaways included:

There is a “raging bull market” to finance promising A rounds.  The slowdown in private capital formation seems to be the C round and the D round.  This may have ramifications for who makes these kinds of investments; with very long lead times to bring a product to market, even if successful, investment funds with a fixed term of life may not be the best choice of investor.  Perhaps strategic investors are better.  Also, funds may have a tendency to invest in companies that have benefited from being incubated in incubators in places like Boston, San Francisco, San Diego, etc., in order to shorten the timeline.

Valuations for A rounds and B rounds are creeping up.  This may be one reason why there are problems at the C round and D round level.  Overpricing the early rounds make subsequent rounds difficult.  In 2017 eighty percent of later rounds were “up rounds” while current experience is that up rounds are only at about the seventy percent level.

In terms of financing through public offerings, there were fifty life science IPOs in the first half of 2018 of which eighteen were in biotech.  Sixteen of these offerings came out of California and thirteen out of Massachusetts; the source of others were scattered.  The pipeline seems full for the second half of 2018.

 

Trending Public CEO Issues

Posted on by

Tariffs.  Business Cycles.  Immigration Policy.  Infrastructure.  Cost of Health Care.  These are the issues that were on the minds of senior CEOs convened for a Boston breakfast meeting on September 20, 2018 by the National Association of Corporate Directors-New England Chapter.

Most interesting was the broad philosophical view of CEO participants to the open question:  what are you worried about?  Thoughtful, policy-oriented responses over broad areas were voiced by Jeff Leiden (CEO of Vertex), Roger Crandall (CEO of MassMutual) and Sheila Marcelo (CEO of Care.com, a public company dedicated to providing home care).

No one liked tariffs.  The concern was that over the long run they would increase the cost of goods sold to the U.S. consumer and, in the near term, cost jobs.  Further, interference with complex supply chains, worked out over long periods of time, would materially disrupt efficiency of American businesses.  Not a good word could be found in favor of the current tariff regime undertaken by the administration.

Next, on the tenth anniversary of the Lehman collapse, did these business leaders foresee the continued bull market?  That depends on how you read their tea leaves.  There are lots of risks out there (some of them are set forth in other sections of this post).  The world is cyclical and the cycle must cut in at some time.  We have been at strong growth for a very long time.  The economy may be strong but history tells us that readjustments will come.  Isn’t it anomalous that interest rates are not higher?  What about the risk of the strengthening U.S. dollar; other countries have borrowed huge sums denominated in dollars, and as their currencies deteriorate they are going to have failures in repayment.  In the words of one: “the party has gone on too long.”  Further, a widening gulf, between those people benefiting from the innovation economy and those people suffering a widening wealth gulf because they do not participate, is increasing in the United States, leading us to look much like Europe (which was described as “flat” in terms of entrepreneurship and invention).  Not good signs for the future.

Immigration:  We need it to provide low-end support for critical industries such as home care.  We need it because we need more people as our population ages.  We need it because we are shipping back to our competitor countries the innovators we are assiduously training.  By the way, we are also wasting the lives of an overly numerous cadre of incarcerated people, who according to our system are rendered substantially unemployable and un-promotable.

It is not news to learn that the lack of support for infrastructure was roundly decried.  Broadband 5G will develop very slowly outside of urban centers.  Roads and bridges are a mess.  Traffic is terrible.  Education is the key to many things in the future, and it is being short-shrifted.  “Our social policy is not congruent with our economy.”

Finally, cost of healthcare.  Healthcare really is not that expensive in absolute terms given the lives that are being saved and the quality of life being generated.  But in absolute dollars, it is increasing substantially and adds to societal burdens.  The focus of proposed government intervention is wrongminded.  The governmental attack mostly is on the cost of pharmaceuticals.  Pharmaceuticals only constitute 10% to 12% of our healthcare costs, and with a profit margin of 2.3%, which is below the inflation rate, if you were to cause drugs to be distributed within the society at bare cost, with no profit whatsoever (which would squelch innovation), you would only reduce healthcare costs minimally.  The areas that should be attacked: the systemic misuse of emergency room services by people without adequate access to far less expensive healthcare through distributed healthcare vendors now available in much of the economy; addressing long-term care costs for Alzheimer patients (the Vertex CEO seemed to allege that by the year 2050, the long-term care costs of Alzheimer patients will not only bankrupt the healthcare system but also will exceed the gross domestic product of the entire country); support for innovation which will allow the diagnosis of medical conditions from remote locations, including online from the home.

Overall, a unifying theme was the awareness of these CEOs that the future of their companies is entwined with the health of the economic, political and social fabric within which they function.

Weep for the Lawyers

Posted on by

Herewith, the sad ending to the demise of a once-great lawfirm that cratered about five years ago, sticking creditors with large unpaid debt.  Dewey & Lebouef, the result of a merger of two large firms with one tracing its roots back to Governor Tom Dewey (famously defeated by Truman in ’48), expanded quickly and borrowed $150,000,000 by issuing its debt under a private bond placement and pursuant to a private placement memorandum which inaccurately described the firm’s finances.

Although typically the SEC chases fraud committed by shady sellers of securities to unsuspecting citizens, or committed in connection with the public markets, Federal (and State) law prohibits material misstatement and omissions in connection with any sale of securities, whether or not public or private and regardless of other exemptions from regulation.

Today the SEC resolved litigation brought in 2014 against the CFO, Controller and lawyer/firm chairman for securities fraud.  While the settlement announced today enjoined all three from future violations, the actual monetary settlements were startlingly small, given the magnitude of the allegations and the fact that many Dewey partners had to pay back many thousands of dollars to the bankruptcy trustee to help pay off creditors.  Monetary assessments of $43,178.82, $8,635.78 and (for the chairman) $130,000 ended all SEC claims against the three.  The chairman also is prohibited from sitting as a director or officer of any publicly held company.

The Dewey matter stands as a cautionary tale for law firms and professional firms generally to be careful about leverage, to be careful about growth, and to be careful about the reach of the securities laws.  Indeed a melancholy end-note to a once-great international law firm, and perhaps one more small nail in the coffin of public opinion of lawyers generally.

Future of Private Placements

Posted on by

Last week SEC Chair Jay Clayton announced that the SEC has begun a study to completely revise the matrix of laws and rules that permit the sale of securities without filing a Federal prospectus.  Characterizing the current system as a patchwork and noting that it grew incrementally as the government increasingly liberalized or clarified the groundrules for private placements, Clayton promised a “concept release” that would reformat and rationalize the placement rules to make them more easily understood by business.

Followers of the SEC know that a concept release can take a long time to produce as it wends its way through the SEC, and then it is open to comment and public input which may lead to proposed legislation or regulation which, in turn, must move through the Congress or through the drafting and public comment process for new SEC regulations.  So don’t expect immediate clarifications.  But surely our current system could use rationalization.

A couple of recommendations from this quarter: why not preempt State regulation so we have a single Federal system?  Why not address the issue of deregulating people who act as agents in raising funds in private placements, rather than requiring that they hold a BD ticket (or violate the letter of the law, as is common in present practice)?  Why not either simplify or scrap crowdfunding, which is seldom used to date, is complex and labor-intensive, makes risky equity plays available to people who cannot afford it, and attracts dumb money to highly speculative ventures?  Why not establish a simple, lightly regulated trading market for shares of very large private companies which now function with very many shareholders but are privately held (think Uber for example)?

In the old days, before we had Regulation D and Rule 144, the common law established a level of practice that may not have been clearly articulated to the business community but nonetheless was simple to utilize.  Why not a regulatory scheme that includes a substantially unregulated private capital market for qualified investors, with no need for reporting anything to anyone and with an exemption from State interference (which always was, and remains, a major problem)?

The real issue is fraud and lying.  The real issue therefore is very difficult to regulate.  We know it is illegal to defraud and lie.  Now all we need is a system that prevents it.  I bet Clayton doesn’t try to tackle that one….   We rely primarily on back-end enforcement and if anyone out there has a better plan, please let us (and Clayton) know.

Bible, Bob Dylan and Massachusetts Supreme Judicial Court

Posted on by

The wicked flee when no man pursueth: but the righteous are bold as a lion. — Proverbs 28:1

In the 2016 Massachusetts SJC decision of Commonwealth v Warren, the Court declared that running away from the police, without additional indications of wrongdoing, was not an admission of guilt.  In that case, a man’s conviction for a weapons violation was overturned because when initially stopped by a uniformed police officer, the defendant simply ran away.  While running together with other clues might constitute a righteous stop, the defendant had done nothing but soundlessly taken off across a nearby park.

Putting aside that most of us would not act that way either because of respect for the police function or fear of getting shot in the leg, it is interesting to note that the law is clear that, upon being approached by the police, you can remain totally silent and just walk away.  It is up to the policeman to then apprehend you, but the police must have “reasonable suspicion.”  If you have a color TV with wires hanging out tucked under your arm, you are going to be intercepted but, if you are just out for a stroll, any stop of your progress, by itself, is improper and any evidence found on your person (gun, stolen property) will not reverse the impropriety of the police action.

While the holding did not turn on the race of the defendant, the Court went out of its way to note that, in the case of black males in Boston who are stopped, questioned and arrested in greater proportion than non-minorities, the fact that such a person of color might just choose to exercise his Constitutional right to run away is quite understandable.

This case reminds me of a lyric from my favorite Bob Dylan song, Brownsville Girl:

I was crossing the street when shots rang out, I didn’t know whether to duck or to run, so I ran….

Note: credit for a great analysis of this case by Peter T. Elikann in the current issue of Massachusetts Law Review, and for the quote from Proverbs, a source I confess that I seldom reference.

Millennials and Boomers

Posted on by

Will the twains ever meet in the board-room?  Sort of.

Recent statistics cited by the Korn Ferry placement firm looked at boards of the S&P companies.  Only twenty directors were in their thirties while a whopping 2,488 were in their 60s. In fact, there were 49 times as many directors in their 70s and 80s as there were millennial directors.

Several points:  First, smaller companies, particularly those not public, likely have different demographics, by reason of inclusion of family members and younger key operations people sitting on the board.  Second, of course time will cure this disparity by flipping it on its ear.  Third, many emerging companies are founded by millennials, who may blend in some grey hairs but do sit on their own boards.

What interests me is that one theory of board building (one of the best ones) is to add directors who cover gaps in crucial board skills.  Without suggesting that us older folks do not learn new tricks, I have seen seeming growing interest in boards adding younger members adept at cyber issues (uses and risks), blockchain, marijuana, mobile apps, changing consumer tastes — the new economy.  I would have suspected greater millennial representation on S&P boards.  Of course, companies large enough to make the S&P also are large enough to acquire requisite skills from staff hired below the board level, but that approach denies the board the direct guidance of millennial thinking in setting company strategy (the key board function, which would not be supported robustly by non-board staff).

On a different aspect, Korn Ferry statistics about the world-wide occurrence of millennials and boomers casts some focus on the oft-stated US plaint that we are inundated with too many boomers:  while the US ranks third (behind China and India) with the absolute number of boomers, we are not even in the top five worldwide (UN 2015 stats) by percentage; each of Japan, Bulgaria, Malta, Finland and Hungary top that list with 25-26%.

Are we awash in millennials, then?  Seems not, perhaps reflective in part of our birth rate in the US.  We do not make the top five list in either absolute number of millennials (of course we are blown away by China and India, but are also behind Indonesia, Brazil and Pakistan), nor with the highest percentage in the general population (stunningly at first blush, the top five are all Arab / Arab Gulf countries).

Then we get to Generation Z….

I’ve Been Thinking

Posted on by

 

Why does most of my spam received on my blog come to me in Russian or Chinese?

If sharks can bite a man standing on a sand bar, as happened  in Truro on Cape Cod, why did they keep the beaches open?

If the Beachcomber Bar in Wellfleet loses its parking lot under 5” of rain, what happens when the next hurricane arrives?

Why are coffee beans more expensive per pound than prime steak?

How can a plurality of any group of Americans believe that the government should have the power to close news outlets for “bad behavior” and 23% believe that the administration should close down CNN, the Washington Post and the New York Times?  [Report by Daily Beast of Republican opinion poll]

With Brexit, Poland, Greece and Italy creating major problems, and Merkel under pressure, is the EU in danger of simply imploding in the near term?  [Non-hint: the other day a senior German lawyer from a large firm answered this question by telling me he did not know.]

With major sources documenting world-wide increase in burning forests as being caused by climate change, why do we permit construction deep in vulnerable forests? [recent issues: NY Times, Economist, Harpers]

And provide emergency financial assistance when they repeatedly burn?

If scientists now believe that ordinary matter makes up only 5% of the universe and perhaps another 25% is made up of recently discovered dark matter, what is the form of mass/energy making up the other 70% of everything?  Darker Matter?

If tariffs on Chinese goods are thought to be so effective, and if economic growth is fading in China and the government is managing a major credit crisis in the peer loan space, and if mega-cities have been overbuilt and some remain only sparsely populated, why is the Chinese economy projected to grow by 6.9% per year?

If you can multiply a number by zero, why do mathematicians tell us we cannot divide a number by 0?

And why is not 0 divided by 0 = 0?  Or, = 1?

Why does my wine merchant keep sending me write-up of wines that taste like fresh-cured leather or the forest floor?  I haven’t eaten either of those things in several years….

Why do I feel like the Red Sox (who won a ballgame last night in the bottom of the ninth inning only because the totally inept Miami team committed a throwing error) may echo the 1951 Brooklyn Dodgers, who blew their 13 1/2 game lead and went on to surrender their place in the World Series to the Giants on Bobby Thompson’s playoff game home run?

 

 

Broker-Dealer Auditing Failures

Posted on by

The PCAOB is the board supervising accounting services to public entities.  Its 2017 report on the quality of audits of 75 BDs is troubling.

I must add that it is not clear that any of the errors noted caused any material misstatements, and that much criticism about over-regulation continues to be leveled at the regulatory framework applied to US public companies.  However and with that overlay of caution, note:

8% of auditors even failed the initial test of their independence.  Some had performed non-audit work for the BD which they now were to audit; interestingly, one auditor was disqualified because its engagement letter indemnified the auditor from liability if management knowingly misrepresented (a seemingly logical protection but the idea is that the auditor is supposed to be able to uncover that misrepresentation).

66% of audits failed properly to report revenue.  64% did not fully assess risk of misstatement due to fraud.  32% failed fully to report related party transactions.  59% failed properly to review the quality of their performance of the audit engagement.

Facially, one might conclude that BD audits are just plain unreliable, an unsettling thought about the industry that controls the care and investment of much of my, and I suspect your, personal wealth.  The PCAOB report does not necessarily mean that material error occurred, a helpful observation.  The report does suggest that material error has some palpable chance of occurring, a less sanguine thought.  The true import of this report (it is highlighted today in the leading securities lawyer blogsite “Jim Hamilton’s World of Securities Regulation”) is just obscure.

But food for thought: auditors who audit both reporting companies and broker dealers performed better than auditors who only worked on BDs.  Seems a broader world view may be better than a deep dive into only the BD universe.