The Mass General Court (legislature) seems primed this session (about to expire) to pass and send to Baker a comprehensive law regulating non-comp agreements in Massachusetts. Many details are still open, and Baker has not signaled whether he would sign.
Key issue: “garden leave” provision requiring company to pay 50% of salary to enforce most non-comps. Also not clear: can you have a non-comp enforced against an employee you fire without cause?
Stay tuned.
The Securities and Exchange Commission is utilizing enhanced tools to tighten its regulatory oversight, focusing fraud and corruption in particular, according to an expert panel presenting to the June 14th Boston breakfast meeting of the National Association of Corporate Directors of New England.
According to the current head of the SEC’s Boston office and to the former co-director of the SEC’s national Division of Enforcement, three particular tools are receiving substantial focus.
First, an explosion in the availability of data permits robust quantitative analysis of a company. Aggregating and analyzing this data may provide indicators of fraud. For example, by analyzing data concerning inventory, sales and income, data might provide predictability with respect to risk of income misstatement.
Second, the whistle-blower program provides persons who notify the SEC of wrong-doing with a reward of not less than 10% and up to 30% of any governmental recovery. There was discussion as to the efficacy of this program, however; many whistle-blowers prove to be disgruntled employees, or raise insubstantial matters, or are unsophisticated and lack understanding. It was proposed that an intelligent whistle-blower with good motives would almost certainly have come forward in any event. However, because of the likelihood of SEC focus (any whistle-blower advising the company is likely to also advise the SEC), whistle-blowing is forcing companies to take greater interest in employees disclosures.
Third, the SEC-Department of Justice recently announced a program to treat companies committing Foreign Corrupt Practices Act violations less harshly if the companies self-report. In no event will disgorgement of improperly obtained economic benefit be avoided, but DOJ penalties may be abated. It was noted, however, that one of the alleged “rewards” for self-reporting, the grant by the SEC of a “non-prosecution” agreement, is really illusory; in such cases, the SEC will issue a press release containing the same kind of damaging information as would have been publicized in a “prosecuted” case (which results in a consent decree outlining the same negative facts).
The SEC also is paying attention to the growing prominence of utilization of non-GAAP economic measures in reporting earnings; these alternate financial statements, typically keyed to the elimination of non-recurring expenses, are not subject to rigorous accounting standards and fall under deep SEC scrutiny if they are given “prominence” in disclosure or in the marketplace.
Finally, the SEC is focusing on municipal debt. Many municipal issuers are unsophisticated in finance and disclosure, are subject to manipulation by advisors, and present the risk of political corruption. Munis are an opaque market where valuations are arbitrary; bonds are purchased for long-term hold and tax-advantaged income (thus not subject to active trading which would ultimately mark-to-market).
Check out the recent article in the Harvard Business Review about what happens when your CEO lies about personal matters, has a sexual affair, makes questionable use of corporate funds, commits “objectionable” personal behavior, or offends customers or public groups.
The article predictably concludes that boards need to investigate and be proactive; no surprise there. What seems anomalous is that eleven of the 38 studies incidents resulted in positive stock price action (although average stock prices fell slightly in the short term), yet 45% of companies later suffered adverse reactions such as accounting restatements, lawsuits, shareholder action or bankruptcy. And 58% of CEOs eventually lost their jobs over their actions. And only actions involving financial activities resulted in uniform dismissal.
It is hard to parse all this data. It may be that we do not know the whole story in many of these cases, or that the sample size is too small to be of much help beyond generating the obvious: boards should act.
And as for those companies where the stock ticked upwards? Perhaps there is some truth in the adage that it doesn’t matter what you say about someone, just so long as you spell their name correctly.
There has been a lot of publicity about investments being funded out of China (in 2015, they totaled $118 billion dollars). But of equal interest is the opportunity for making acquisitions within China. Foreign investment into China in 2015 totaled $126.3 billion dollars. Not shabby.
First, let’s talk about the Chinese economy. Obviously the GDP growth rate has fallen, but even last year (2015) it was a more-than-robust 6.9%. The ongoing planning goal for the near term is estimated to be 6%, and bear in mind that this rate is now being applied to a more robust base (it is easy to have double digit GDP growth if your base is small).
There are numerous regulatory steps in order to make an inbound acquisition. You need anti-trust clearance, government approval for any foreign investment (it is wide open for biotech and completely shut for investments in internet media). There is a national security review not unlike that in the United States. As the RMB is not readily exchangeable, you need foreign exchange approval. Payment for the deal is tightly regulated (typically all deal consideration must be paid in full within three months; with special permission, you can stretch that to a year provided half is paid within six months).
There is sometimes a squabble as to the controlling language of the agreement (is it English or is it Chinese). But more importantly, there is discussion concerning governing law and venue of dispute resolution. In an acquisition, Chinese law must control. But for dispute resolution, you can negotiate for the utilization of Chinese courts, or arbitration in China, or arbitration in several identified international venues (Hong Kong, Singapore, Stockholm or London). According to my recent meeting with one of the three largest law firms in China (the firm has a startling 1,200 lawyer staff), commercial disputes generally are given fair hearing in Chinese courts (at least in the larger cities where local bias is less likely, and commercial sophistication higher).
Doing a deal in China is like doing a deal anywhere: you to pay attention to tax planning, tax rate (the corporate rate in the PRC is 25% and there is no “state” tax), and there is the usual dispute as to whether an acquisition is for equity or for assets.
These kinds of issues are important and require attention but, given the volume of money going into China, ultimately they will not constitute an absolute block (unless you are seeking an acquisition in a sensitive or totally prohibited space).
Today’s business news may seem technical but it is very important from a corporate standpoint: the Delaware Chancery Court stuck its nose into Michael Dell’s management buyout of Dell stock and stuck buyers with millions of extra liability above and beyond the apparently market-set tender price.
AND– the court explicitly and purposely wholly ignored the market price in reaching its determination.
Shareholders claimed that the management buy-out was not at “fair value” and sued for more money under the Delaware appraisal statute: as in (I believe) all States, the corporate law permits disgruntled shareholders to seek court determination as to whether the price paid in a shareholder buy-out is fair to the selling shareholders, who as a practical matter will not have an option to stay in the company under most structures. Until now, the trend for courts as been to say “well, shareholders in the market took the deal and the deal was thus priced fairly by market forces.”
Two take-aways: at least in management buy-outs where management by definition will always have better information than the shareholders no matter how robust the written disclosures may be, shareholders now have renewed hope which will lead to more litigation; and, in private buy-outs with small numbers of shareholders (to which the statutes apply and as to which a claim that the “market” fixed the price fairly doesn’t really ring true) it is a time for buyers to beware of litigation, as litigants have little to lose and lawyers often will take such cases on favorable economic terms in hopes of a big score.
To date, trade secret protection has fallen under State law. On May 11th, the President signed a bill establishing a parallel scheme of Federal trade secret enforcement, granting new tools for the protection of company proprietary information.
Why should the addition of a Federal basis for protecting trade secrets be of significance to a company?
First, Federal courts are often faster and more efficient than state courts, and provide the benefit of nationwide subpoena power. Second, there is, in extraordinary circumstances, an ability to go into court and temporarily physically seize the property being utilized by someone infringing your trade secret.
In the employment arena, in order to make sure that an employee who is a whistleblower does not inadvertently incur liability when blowing the whistle, the new law states that such a disclosure is immune from civil and criminal liabilities under both the new Federal and all old State trade secret laws. Along with this immunity is a provision which permits an employer to collect legal fees or exemplary (punitive) damages from an employee, provided the employee agreement (or company policy) setting the ground-rules for trade secret protection specifically gives notice of such immunity (presumably to encourage whistle-blowing in the first place). Consequently, employers may well want to revise their standard trade secret documentation in order to obtain these additional liability protections (although of course the immunity notice can be viewed as a two-edged sword).
With respect to industrial espionage, the maximum penalty for criminal violation has been increased from $5,000,000 to the greater of $5,000,000 or three times the value of the stolen trade secrets, and the RICO law has been expanded to include foreign economic espionage and the criminal theft of trade secrets.
All agreements, whether with employees or with third parties with whom trade secrets will be shared (for example in negotiating an acquisition, effecting a joint venture, etc.), could benefit from revision in light of the new law to make clear its coverage, and in the case of employees to enhance employer rights. Particularly with respect to business transactions, in today’s mobile economy having recourse to Federal courts with nationwide subpoena power also can be a substantial enforcement tool.
For several years, as noted in prior posts, Massachusetts has been toying with enactment of a law limiting permissible non-competition agreements for employees (other than those relating to the sale of a business). Yesterday the Mass House reported out of committee a bill far more complex and textured than prior efforts. While there can be no clue, let alone assurance, of what the Legislature will finally enact, if anything, nor what the Governor (historically silent on the matter) might sign, the draft legislation is fascinating and unlike any law of which I am aware in any other State. Highlights (lowlights) follow:
Who is covered? Employees (and independent contractors of certain types).
Who cannot be restricted? Low-paid employees (non-exempt), students on internship, anyone terminated without cause or laid off, anyone under 18.
How long can you restrict someone? Normally one year tops; if someone breaches his fiduciary duty or steals property/secrets whether physically or electronically, two years tops.
How broad a net can you cover? Aside from being necessary (not just convenient) to protect trade secrets or employer goodwill, an employer-imposed noncomp can only restrict to a geography in which the employee worked or had influence (not the area in which the company did business), and must relate to the tasks performed by the employee (not the overall business of the company).
Do you have to pay someone during the restricted period? Yes! Unless the employee breached a duty or stole secrets or property, you must pay at least 50% of highest annualized base salary paid during last two years. This is called “garden leave.” A major departure from prior practice in Massachusetts and the other States, this rule already has attracted negative comment from the Boston Chamber of Commerce.
Massachusetts courts have a history of redrawing noncomps to a standard which the judge considers reasonable to protect employers. Still possible? Nope, strictly prohibited.
What about a company with most of its operations out of state but with someone working in Massachusetts, or someone who is a Mass resident? The proposed law would apply, the company cannot elect the law of another State which is less favorable to the employee.
When would this come into effect? July 1, 2016, but only for agreements after that date and for misappropriations of information and property by employees after that date.
Employers often spring noncomps on employees when they first report for work or after they are hired, and such agreements were historically reviewed by the courts on an individual basis. Is there now a mandatory waiting period before a noncomp can attach to an employee? Yes, ten days with a right to say “no” which means there will be a mandatory lag time at the front end. If you are already working, you have ten days to say no (and I’ll bet you won’t be able to be fired if you say no). Employment noncomps must be in writing, signed by both sides, must expressly say that the employee is entitled to have a lawyer if sought after employment started and must be supported by “fair and reasonable consideration independent from the continuation of employment.”
Bottom line: if this proposed legislation becomes law, Massachusetts will move very far towards the California rule which is that, except in cases of a business sale, noncomps are not enforceable.
The accredited investor definition is the well-known standard to permit persons of reasonable liquidity to invest in unregistered offerings of companies seeking capital; it facilitates the so-called Regulation D offerings which raise about as much investment capital as to all public offerings combined (2014 data). The SEC this May 18 will conduct a meeting of its Advisory Committee on Small and Emerging Businesses to consider revisions to this vital definition. Here are some of the SEC staff recommendations for consideration:
There likely will be revisions to the economic parameters. The present individual requirements (family net worth excluding principal residence of $1 Million, individual earnings of $200,000 or family earnings of $300,000) should remain, although those minimums now may invoke caps on investment amounts; higher economics may be established to qualify for avoidance of investment caps.
If an older-definition accredited person has invested in a given company, that investor will be “grandfathered” as fully accredited as to that particular company.
The present sole definition of accredited status, which is economic, should be expanded for some sophisticated investors, including experienced investors based on various definitions, certain professionals and those who pass an “investor examination.”
Of course it is not clear which if any proposal will be adopted, but the SEC this year seems committed to a systematic review of the accredited investor definition.
When you open this post on Monday the 16th of May, you are doing so on the first day of truly general crowdfunding ability under Federal Law. Until now, crowdfunding either did not allow the issuance of securities, or was limited to securities transactions that were otherwise exempt under Federal law (for example, offerings under State laws for deals within that State).
As of Monday, pursuant to the SEC’s “Regulation Crowdfunding, ” companies can offer securities anywhere, without Federal registration, to the ordinary citizen. Almost….
Like all SEC regulations, this is complex but generally you should know: there are limits on the kinds of companies which can use this mechanism; there are limits on how much a company can raise in this manner in any year ($1 Million); there are limits to the amount anyone or any entity is allowed to invest in any one company or in any one year; all transactions must be done through a broker dealer or SEC-approved portal; there are certain mandatory informational filings to be made by an offering company, and at least one year of follow-up filings.
There is more; but it is true that as of Monday someone with zero experience or knowledge in investing can invest thousands of dollars, anywhere in the US, in a company which may be shaky, may have no track record, and may be, well, a lousy bet. Although it is assumed in the capital markets that companies of real commercial promise will avoid raising this “dumb money,” and the sophisticated finance and angel communities view this as a non-event, for struggling entrepreneurs with few options we are going to see this “democratization” of investment opportunity utilized in ways we cannot imagine — and with results we likely are unable at this point to foresee. Whether this new device energizes innovation and employment, as Congress intended, or just lends itself to unfortunate fraud, remains to be seen.
It is company management which typically proposes, and almost always executes, an M&A transaction. What is the board of directors doing while all this is going on?
A panel at the May 10th Breakfast Meeting of the National Association of Corporate Directors-New England explored major M&A pitfalls. The most important: a proposal of an acquisition transaction which is not in line with the strategic direction of the company. Sometimes CEOs and management teams get excited about an acquisition which is off on a tangent. It is the role of the board to be forceful in questioning any such transactions; is it truly strategic, is it large enough to divert the company, what is the rationale and why should we be doing it?
Sometimes a subcommittee of a board is named in order to pursue a transaction. It is important that the subcommittee keep the board generally informed; no one likes surprises. If, in a large company, smaller acquisitions have been delegated to management, without board input, nonetheless management should be attentive to keeping the board posted so that board members are not embarrassed by a lack of knowledge as to what is going on in the company.
Sometimes stock ownership in a company can impact thinking about acquisitions. In a company with a private equity investor, there is time pressure for exit at a certain point; other shareholders may have an interest in maximizing value over a longer period of time. Sometimes there thus is pressure to achieve an acquisition because the market may be rewarding acquisitions, attracting PEs to overpay in order to maximize early exit value. These issues need to be sorted out by the board.
The board should be attentive to cultural fit. What is the motivation, and style of leadership, of the target and its executive team? Is it overly aggressive, so as to cause the board to ask management to double-check financials and projections? Will there be, in fact, an appropriate fit of cultures?
Directors have the task of making sure that a company fully evaluates an M&A transaction; perhaps the company should walk away. After all, for any major acquisition, it is the board which ultimately must pass upon it. It is the board’s responsibility to grant or withhold approval based on strategic or economic considerations.
