The Law and Other Anomalies

This morning, Mary Jo White (Chair of the SEC) addressed a meeting of the SEC Advisory Committee on Small and Emerging Companies and checklisted certain areas of SEC activity.  In reference to the issue of whether “finders and other intermediaries” in small business capital raises should be regulated, which the Staff “continues to review,”  there was NO mention of the deregulation of finders and intermediaries in the M&A area.

This notwithstanding over a decade of heated debate, proposed legislation, and Bar Association recommendations to deregulate M&A finders and brokers, or subject them to a so-called “Broker Dealer Lite” regimen.

Maybe White assumed the M&A issue was subsumed in her list.  Maybe she did not think the M&A issue is particular to small and emerging companies (which btw is incorrect).  Maybe….

In the immortal words of somebody: “go figure.”

How do boards of directors function in larger, privately-held companies? The answer is: pretty much like boards of directors in publicly-held companies, according to a panel of directors convened February 9^th in Boston by the National Association of Corporate Directors-New England Chapter.

Panelist came from a broad variety of companies: Mike Jeans sits on the board of the large Rhode Island insurer AMICA; Ralph Crowley is on the board (and is CEO) of Polar Beverages in Worcester; Ken Dreyer sits on the board of 225 year old King Arthur Flour in Vermont, a company owned by all its employees through an employee stock ownership plan (ESOP) and also organized as a “benefits corporation” with charter obligations to assist the community; Debra Jackson, President of Cambridge College, chairs the governance committee of 198 year old Eastern Bank.

Some commonalities: each company has a robust board of directors a majority of which are “from the outside;” each has a disciplined methodology for adding new directors, and each in a different way attempts to fill particular needs (rather than just hiring “cronies”); each emphasizes formal board procedures including robust “board books” in advance of meetings and reasonably formalized structure for the conduct of meetings; each has a relatively sophisticated system of committees in support of the board.

Notwithstanding somewhat differing fiduciary obligations (King Arthur Flour has strong fiduciary duties to its ESOP as well as to the community, Eastern Bank dedicates 10% of earnings to its foundation, AMICA is responsible as a mutual company to its policyholders, Polar Beverages is still a family owned enterprise), everyone identified their primary obligation in the first instance as flowing to “the company.” If a company is strong, then the rest of the mission can follow.

Other interesting takeaways:

Private boards, as public boards, see a primary function in fixing strategy (management presents strategy and “management comes to the board to have their answers questioned”); for full board meetings, no one goes on the telephone, some companies simply do not allow it (occasionally practice at the committee level may vary); boards are built not only to provide independent input and not only to provide diversity of race, geography, age and the like, but also with a strategic view toward retirements and ongoing need for continuity.

One over-riding theme: public company best practices have substantially infiltrated the operations of all these companies, including with respect to director independence, committee structure, often a designation of a lead director to provide guidance to the board and liaison to management, and in one instance the guidance of counsel to conform governance to listing standards of the New York Stock Exchange.

Clearly, larger private companies are being managed to a high level of professionalism, and directors in these companies attribute robust economic results to that practice.

Moving into the proxy season, what are the hottest board topics this year? Disclosure of corporate political contributions, the impact of enhanced SEC disclosure requirements on executive compensation, heightened audit committee responsibility, and board responsiveness to socially motivated activist shareholders, according to an expert panel convened January 12^th  by the National Association of Corporate Directors-New England Chapter.

Additional discussion included speculation as to the impact on board governance of the growing number of foreign shareholders (about 15% of all United States equities are now held overseas), and foreign countries have different ideas, including about proxy access [it is normal and why is there resistance?], boardroom diversity [many foreign countries have statutes fixing quotas for female board members], and a greater focus on macro societal issues [impact of overseas reincorporation, breaking up big banks, political contributions].

The panel was critical of proposed SEC regulations attempting to prescribe disclosure of the relationship between corporate performance and executive compensation. The SEC proposals rest on total shareholder return as the metric against which performance pay should be evaluated, and TSR is not appropriate for all companies.

Audit committees will be under increasing pressure to supervise auditors to ensure “audit quality.” This involves making sure that the team of accountants has the requisite time, experience and industry knowledge. There will be increased pressure also on the quality of critical accounting estimates such as fair value, pension liability, loss contingencies and asset impairment. Further down the road, in 2019, revised treatment of long-term leasehold obligations will have substantial impact on balance sheet presentation.

Socially active shareholders last year created pressure on disclosure of corporate political spending, environmental and climate change matters, deforestation, renewable energy, board gender diversity, and perhaps most importantly opening proxy access (minority shareholders having access to the corporate proxy mechanisms for soliciting board vote proxies). These pressures will continue.

Long-term trend? A changing view of the role of the corporation in society, driven by data (for example, data demonstrates higher profitability for gender diverse boards), and demographics, as women and millennial investors seem more interested in corporate social responsibility than traditional investors.

Last week the SEC issued a staff report seeking reaction to proposed amendments to the definition of an “accredited investor.”

Regulation D is the most relied-upon exemption from SEC (and typically State) registration requirements for the sale of securities, and Reg D relies primarily upon one definition: that of “accredited investor.”  For individuals that means you and spouse have a net worth of $1M or earn $200K (combined $300K)/year.

Possible amendments: limit investments per issuer to a percentage of income or net worth (borrowed concept from new crowd funding rule?); adjusting thresholds for inflation, once or ongoing by indexing; expanding the spousal pooling to cover all marriage/civil union arrangements; grandfathering existing investors who today qualify; setting an additional standard for experienced investors or certain professionals.

The financial standards now in effect date to the Reg’s adoption (although a few years back an amendment excluded primary residence equity as part of the net worth calculation), so marking the financial triggers to market makes some sense; we have not been subject to great inflation of late, but it has been many years and with the Fed now advancing interest rates some greater inflation is reasonable to anticipate.  Capping investment per issuer is more problematical; is it prudence (albeit externally enforced), or meddling in personal decisions (someone is rich enough to invest in speculation but the government will tell you just how much).

Most intriguing is establishing an alternate approach: you may not be rich, but you are pretty smart based on experience or professional credentials so, go for it!  This is a faint echo of the law prior to Reg D, when the registration exemption under Section 4(2) of the ’33 Act was defined under common law and where courts would sometimes consider both how rich and how smart an investor was in order to avoid declaring an offering as needing registration.  Problem in those days was: we never knew how rich OR how smart you had to be, and whether being sophisticated trumped near-poverty.

Dealing with the FDA today is getting slightly easier, but it is nothing to write home about. Agency plans will attempt to improve the regulatory experience; success remains to be demonstrated. Presentations by a research firm and by the Regional FDA office explored the situation at the December 9 MassMEDIC symposium referenced in the last two blog posts here.

For the first half of 2015, FDA approvals have increased markedly as compared to 2014, although the time to PMA approval remained roughly constant which suggests not so much increased speed as existence of backlog. De novo device approvals for the first six months did somewhat better; ten were granted with an average processing time of 12 months. Cardiology approvals seemed to be faster tracked for both PMAs and HDEs (humanitarian device exemption requests). 510(k) approvals for 2014 and 2015, geographically, both showed California as having the highest number, followed by Massachusetts; in 2015 so far, Florida was third, Minnesota fourth.

A rough survey of the activity of the New England FDA District (covering all six states) revealed robust investigative activity, with nine warnings issued for medical devices. Imports are growing “expotentially” with the three primary importers being (in order) Germany, Switzerland and Ireland.

Tentative FDA plans for 2016: increased training for each District office to meet growing device sophistication, and a reorganized focus on assigning reviews based on specialized substantive knowledge as opposed to assigning work merely based on geography.. This latter target is disquieting only in the sense that, presumably, the best people seemingly have not been deployed up to now where their expertise might have been best applied.