SEC Acts: Insider Trading, Stock Buy-Backs

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.

Spring-Loaded Stock Options

These are options granted to executives just prior to favorable announcements relating to the company which are likely to jump the market price above the strike price set forth in the options themselves; executives wake up one day soon to find themselves “in the money.”

It is not surprising that, last week, the SEC issued guidance requiring companies to make disclosure to the public of the facts surrounding the wholly anticipated increase in share price and the expected immediate added compensation value to the executive optionee.  Disclosure now should disclose this “additional value” accruing to the executive.

Express disclosure of this sort of course is not viewed favorably by investors, who likely find the practice a bit “fast” albeit not illegal.  (Whether proxy advisory firms find it problematical is another issue; surely these firms do fine-line math on compensation and thus are not unfamiliar with the arrangement.)  Certainly there is enough of a stigma to these options that the current SEC was motivated to seek disclosure in hopes of curtailing the practice, although history tells us that disclosure itself does not necessarily result in deterrence in the current environment.

 

The Human Capital Thing

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….)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tripadvisor: a Path to Success

Last Friday, C Level Community (a networking organization) sponsored a Waltham breakfast and interview with Stephen Kaufer, founder and president/CEO of Tripadvisor.  In the 22 years since its founding, Tripadvisor has grown into an international travel powerhouse, was acquired and later spun out again, and is a major force in US and European travel.  What’s Kaufer’s secret?

Kaufer notes that his company is an internet business and needs to act quickly to respond to the market.  Additionally, Tripadvisor has to maintain the independence and non-hackability of its posted reviews so that it remains an accurate guide to well-advised travel.

Although it feels gimmick-y, Kaufer claims that the enterprise has prospered by adhering to the messages on the three signs in his office:

“Speed wins.”  His market runs fast.  Put stuff up on the web.  If it doesn’t work, just take it down.

“Impact.”  Evaluate ideas not just if they will work but, if so, will they have material impact.

“If it’s worth doing, it’s worth measuring.”  How else do you know what works, particularly when you’re adhering the sign #1?

Interesting take-aways:

They must guard against fake travel reviews, and businesses puffing themselves.  Devices include using sophisticated web fraud investigators, gathering names of sites which overtly advertise that they will sell you good reviews (post them for you) by setting up mock hotels so that when good reviews come in, paid for by Tripadvisor pretending to be such a hotel, the fake reviewer organization can be tracked back and identified.

Second, what is Kaufer’s take on the revival of travel, post-COVID?  Leisure travel already has come back (people have felt locked indoors), travel in the US and Mexico has been robust and the US just relaxed border restrictions. 2021 summer travel was more robust than the same period in 2019.  Business travel will take 4-5 years to recover; conferences and marketing trips will be robust but certain kinds of business will continue to be done by zoom, such as periodic review meetings with customers.

Director Liability for Physical Catastrophe

We all know that over 340 people died on crashed 737s, that Boeing paid the DOJ $2.5 billion dollars for criminal conspiracy due to misrepresentations by employees to the FAA, that the chief pilot was indicted on criminal charges.  Now the Boeing directors have reached a proposed settlement of about $238 million to compensate pension funds which lost investment value in their Boeing holdings. (A court still needs to approve this settlement.)

The directors were accused of gross negligence and, indeed, willful breach of fiduciary duty in ignoring warnings about safety issues in the rush to get to market.  A settlement means directors will not be faced with a trial as to their alleged willful misconduct.

More interesting than the money (if anything can be more interesting than money) is the shopping list of corporate changes to which Boeing is agreeing: instituting missing reporting systems on safety and concerning what is told the FAA, adding a director with aircraft experience so there are more intelligent eyes on the company, establishing an ombudsperson for five years, guaranteeing that at least three directors have engineering or safety experience, splitting the offices of CEO and board chair.

There is no “takeaway” from this settlement relating to willfully ignoring safety concerns –you don’t need courts to inform directors about that — but there is learning here as to the standard of care which directors must bring to supervising companies which face the public and involve physical risks.  The ERM (enterprise risk management) function needs to have robust reporting systems that report to the board; boards cannot say they did not know what they could have known.  The duty to oversee, born in case law but little used for many years, now is front and center as to board governance.

Frontiers of Fraud

When you issue stock per a traditional underwritten prospectus, say an IPO, a purchaser has a right to sue if there is a material omission or misstatement.

Over the last few years, many companies have gone public by offering their shares directly to the public in what is called in the trade a “direct listing,” one advantage of which is that there is no underwriter in the deal insisting that existing stockholders refrain from selling their shares immediately.  SO– if you buy shares in a direct listing and the prospectus lies, you can also sue the company, right?

Wait– in an underwritten offering you know your seller: the company sold all the shares.  But in a direct listing, how to you know whom to sue?  Maybe the company did not sell the shares you bought.  Under SEC law, according to the requirement of “tracing,” you need to prove shares were issued pursuant to a registration statement or traceable to it.

The net result is of course unacceptable to have different outcomes, and by a 2-1 vote the Federal Ninth Circuit, known as an activist appellate jurisdiction, declared that the remedial purpose of the Securities Act of 1933 requires that the company be liable with respect to all shares in a direct listing without proving the identity of the seller.  This is the first such  judicial determination in a direct listing; it likely will be appealed, and is binding only on the Left Coast where the Ninth Circuit reigns.

Someone call a Congressperson quick…..

SEC and its Social Agenda

The SEC has just issued guidance requiring public companies to place on the agenda for shareholder meetings matters of general social importance even if they do not create material business impact on the registrant’s business.  This action is in furtherance of the concept that corporations have social responsibility that extends beyond shareholder investment returns.

While argument can be made, cogently, that in the long run investors get no return when the world collapses through global warming or through social protest, that range of thinking is not the typical purview of the SEC.  The new policy in effect reverses Trump regulation; now, the SEC will force onto the agenda “issues with a broad societal impact, such that they transcend the ordinary business of the company.”

It is not surprising that the two minority (Republican) members of the Commission objected to revision of contrary Trump era regulations, claiming that the SEC is erasing the prior SEC work with a “regulatory flavor-of-the-day” approach. That colorful characterization surely misses the point, since the Trump rules were themselves reflective of the Commission’s then-composition, and as SEC Chair Gensler noted in his related statement in support of the change, many members of the current staff “contributed” to the recent promulgation.

The disclosure trend can also be seen as consistent with the 2019 Business Roundtable Statement to the effect that corporations owe responsibilities to societal cohorts beyond the shareholders; this Statement was endorsed by very many companies including a large percentage of major US corporations.  Could the SEC action be seen as proof that one must be careful what one asks for?

In any event, the risk to management of ignoring for too long the strong wishes of shareholders is going to cause management to at last appear to embrace social values by placing such matters on the shareholder agenda and, thus, they will be forced in some manner to address those matters substantively.  Will major institutional shareholders also be forced by their constituents to push these agenda items on the companies in which they own shares?

 

Tightening Merger Regulation

The Federal watchdog agency of first resort for anti-trust issues is the Federal Trade Commission, and the FTC is becoming a political battleground as the Democratic majority peels back liberalizations from the Trump era.

The most recent skirmish involves the FTC reinstitution of a rule requiring companies which have entered into settlements of merger challenges to again require such companies to apply for approval of  future acquisitions.  Not only did the two Republican members object to substance, but also they objected to the manner of voting; former Commissioner Chopra voted just as she left the FTC to head the Consumer Financial Protection Bureau.  (If the vote were to occur today, there would be 2-2 deadlock as Commissioner-elect Alvaro Bedolya needs to be confirmed.)

There are a few limits on the new rule; it relates for example only to markets wherein a prior merger violation was alleged.  But the rule is categorical as it applies to deals clearly not anti-competitive.

Developments in the FTC/Department of Justice world have been trending towards tighter regulation, and that is consistent with the generally more activist bent of the Democratic administration.  My upcoming article in the November issue of InHouse (my column has run regularly in this newspaper directed to in-house counsel for almost two decades) does a deep dive into substantive developments in both the anti-trust and securities regulation fields as two case studies.  All of us are no doubt aware that in areas such as education, climate control, labor policy, financial regulation and myriad other theaters, the Democratic administration is systematically moving agencies into a more intrusive stance.

What Constitutes Illegal Trading for Non-Insiders?

The law is pretty clear today; persons within a public company cannot trade on material inside information, and their tippees cannot either, in virtually all cases. But what about someone who does not fall in one of those categories, who may appear shall we say “less than clean-handed,” but does not seem to owe any duty to, or have any relationship with, the company or its shareholders, nor the counter-party to the trades, nor the original source of the inside information itself.

A person convicted of deceptive trading as a criminal offense has petitioned the US Supreme Court to consider overturning his conviction; his conviction was confirmed by the Second Circuit Court of Appeals based on theories of conspiracy to commit securities fraud, computer intrusions, and securities fraud. The prosecution alleged appellants owed a duty to the trading public when they earned about $18M on their trades, but those trades were through exchanges and without dealing with the counterparties and the information was originally hacked by persons not known to the defendants.

Although the appeal addresses only the securities fraud convictions (seemingly it is clear that defendants re-hacked), the appeal does raise the issue that, by extension, the court reasoning could support a conviction in virtually every case where someone obtains inside information by virtually any means, however removed that person is from the company, tippees, buyers, sellers, anyone.

Do outsiders owe a floating duty to “the integrity of the marketplace”?  This is not a direction alien to past arguments by the SEC.  Where is the line?  Will the Supreme Court exercise discretion to hear this case?  Was the activity here so bad on its own that it supports a securities law conviction?

Just the Facts…

When is public company management held liable when it issues incorrect financial statements?

Enter the Second Circuit’s Monday decision in the Kandi Technologies Group case, wherein the US District Court in New York threw out an investor suit against Kandi management in a matter wherein Kandi was required to make a material restatement of prior financials.  Indeed, the Court might well have been quoting Sergeant Joe Friday by demanding not conclusions but “just the facts….”

There was no doubt that the original financials were materially wrong.  There was no doubt that the plaintiff shareholders alleged that management “knew, or were deliberately reckless in not knowing, that the adverse facts … had not been disclosed” which created an “opportunity to prevent” the incorrect issuance.  Not good enough; such statements are conclusions and not facts.  The officers owed a duty which is breached if there is some evidence of scienter (a legal term generally understood to infer willfulness or intent in some degree); error does not equal evil intent.  Error can be just that–error.

The resignation of the Kandi CFO at the time of restatement was not probative of scienter, either, absent explanation of how a resignation is proof or prior improper intent.

Note to lawyers reading this post: plaintiffs have a couple of weeks to amend their complaint if they have any facts to add.