How to Improve Your Board of Directors

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Add a social dimension to the interaction of board members; in your annual survey of board members, ask them to comment on the performance not only of themselves but also of other board members.  Reduce the size of your board to 7-9 members.  These were among the suggestions offered by an expert panel in today’s program presented by the New England Chapter of National Association of Corporate Directors.

Each of these take-aways is not obviously manifest.

Will not commenting on your fellow members create animosity? The goal is to make a better director and if done carefully a board can educate itself.  It was noted that a majority of  S&P 500 companies in fact gather this information at present.

If you target a small board, what do you do with your current larger board; and, do you have a problem staffing committees.  As to the first point, while term limits may not be the answer (why remove an older director who is contributing), that device might tend to add younger directors who are more tech-savvy and closer in age and viewpoint to customers.

As to social contact, this helps build the culture of the board and, while difficult  to achieve when meetings are remote, I have come to the view that doing business in person is highly desirable and long overdue; COVID is never going away entirely, and the lack of interpersonal contact in so many settings has a palpable social and economic toll in the long run.  Surely at the board level, so vital to the proper guidance of an enterprise, personal contact seems essential.

Another salient point has to do with the definition of a properly diligent board member: it is necessary to get better educated as part of the job, and not just show up at meetings.  The world is changing both in the tech sense and the social sense, and directors should be expected to read widely, utilize other methods of gaining information (example: pod casts, industry conferences), and learn all that there is to know about the company, including but not limited to visiting facilities and fully reading the board materials.

Although it is commonly thought that service on up to five boards can be acceptable, it was suggested that if a director is to be able to direct for what a company will look like five years in the future, rather than ten years in the past, the heightened educational curve should cause good directors to serve on fewer boards so they can do a better job in a fast-changing world.

 

FTC Strikes Again– Unfair Competition

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A couple of weeks ago I posted about a new Federal Trade Commission initiative to toughen the anti-trust laws by proposing to ban all non-comps, even those previously executed.  Now the FTC proposes to begin enforcing the now-obscure Robinson Patman Act.  This Act, in 2007 considered for repeal, prohibits (in theory) unfair price advantages given by manufacturers or suppliers to larger customers.

Not all favorable  prices charged to larger customers were illegal under this Act; only those that tended to lessen competition; a vague judgmental standard if ever there was one.

I have been practicing law long enough to recall with clarity spending a lot of time counselling sellers about how they could not favor the big purchaser with lower pricing, or better payment or delivery terms, or better marketing and promotional support just because that purchaser was buying a zillion dollars of goods.  Were those actions “unfair”?  Often we would counsel that, if the larger purchaser “earned” better treatment, then better treatment from the seller was justified.  Did the purchaser warehouse and support the product?  Did the purchaser take over tasks generally performed by the seller, thus relieving the seller of cost so that a discount or benefit could be afforded to the purchaser in return?

By the way, this was a hard message to sell to the sellers; there was so much efficiency and profit in large orders, and it was so hard for the smaller purchaser to bring suit to enforce the Act, and so hard for the FTC to get interested enough to bring governmental action, that many a client listened to what I had to say, paid my fee and went ahead and continued favoring the big purchasers.

So today, an activist FTC is itself going to undertake the protection of the little guy, claiming that sheer quantity discounts are “unfair” price discrimination.  No doubt the government will start with the largest, most blatant cases, and perhaps those to which the consuming public will be most sensitive (the FTC has been looking hard at the soft drink industry).

It will be interesting to see, if the FTC is successful in preventing sheer quantify discounts, if in fact the retail price of some goods will increase (while small business profits will increase?).  Stay tuned as the FTC takes us down the rabbit hole…

Can the FTC Void All Employee Non-Comps?

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The FTC on January 5 issued a stunning proposed rule that wipes out all employment noncomps for all employees and consultants, including those that comply with State laws and those that are currently in existence.

The theory is that non-comps are unfair competition.  Can the FTC do this?  Some observers think not but if the FTC in fact adopts its proposal, we will find out in court.

There are exceptions but precious few: franchisee noncomps are excluded, of course NDAs for trade secrets and technology are excluded, and employee non-solicitation agreements would survive.  And if you have a noncomp in connection with sale of a business in which you own at least 25%, your non-comp will be enforced (theory there: you are an owner selling good will and if you compete you impair that good will).  The cancellation of non-comps would apply to all workers, including senior executives in the C-suite.

This proposed rule will grab lots of headlines in the near term.  It is just not clear that the FTC has rule-making authority here, and further the business lobbies (and Republicans) will no doubt howl and with reason; this feels more like social policy engineering and less like regulating business competition.  Stay tuned.

SEC Heightens 10b5-1 Trading Programs

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Officers and directors of public companies run a risk, in trading their company shares, that they will be liable to injured buyers or sellers of their shares if, shortly after the trade, the stock price moves and makes clear that the trading officer or director received an unusual economic advantage.  Since it is always possible that a trader will at a given moment know something more than the general public, how can officers and directors safely trade their company shares without risking accusations of insider information?

About two decades ago the SEC adopted Rule 10b5-1 which, in concept, allowed officers and directors to set up a plan by which at certain future dates their broker would buy or sell shares, or would buy or sell if certain price points were hit; the Rule required a written Plan that worked automatically at such later time so that there was little chance that the transaction reflected inside information; after all, the transaction was set a long time before (and was set up at a moment when the trader stated that they did not then have any insider information unknown to the general public).

Certain practices became common over time which “gamed” the system, the result no doubt of failure to define the permitted behavior properly and thus allowing corporate lawyers to, shall we say, stay within the letter if not the spirit of the law.  For the last year the SEC has been considering closing loopholes and the SEC last month issued final Rules doing just that, effective early 2023.

As with much SEC regulation, it is both technical and precise; as always, these posts are general and are not legal advice and should not be relied upon; if you are an officer or director, you have your own lawyer and you should consult there.  Generally speaking, aside from heightened disclosure about these plans, the major substantive changes are set forth below. I note that for once, all five SEC Commissioners, regardless of party, voted in favor.

  • Once a plan is set up, no trading can occur earlier than between 90 and 120 days (details control), making doubly sure no non-public information is being used by the trader
  • trading executives and directors must assert they are setting up the plan in good faith and not to circumvent regulation (this will assist regulators in penalizing those who later abuse the system)
  • Control use of multiple plans which can be maneuvered to in fact effect trades under the plan based on inside information (for example, under plans a proposed transaction can be cancelled and then a trade that is benefited by then-current information can be “automatically” effected under a different over-lapping plan)
  • limitations on single-trade plans.

All this becomes effective shortly. Officers and directors are well advised to consult promptly with their own counsel.

 

SEC Proposals May Impact Retail Stock Trades

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Last month the SEC proposed a change in the manner in which your retail stock broker places a trade order for you, the first such amendment in two decades.  The changes are technical in nature, are subject to revision after a comment period running at least to next March 31, and half of them were not agreeable to the two-member Republican minority of SEC Commissioners, even though they have been posited as lowing execution costs for the retail investor.

To simplify a bit, today your order to your broker is typically sent to a small number of wholesalers; many wholesalers pay a fee to your broker in exchange for getting assigned the task of executing the order (think Robinhood, paid last year $235M in consideration of receiving the broker’s order flow).

The Democratic members saw ultimate savings for retail investors; Republican members thought this was too much tinkering with how stocks are sold, noting that the system is not fully tested n high-volume situations and imposes a new requirement on brokers to explain all this to their customers.

(I avoid here describing the benefit of having the order flow to the wholesalers, or why Democratic SEC  Chairman Gensler stated that “Zero commission doesn’t mean zero cost,” describing the payments to the brokers in exchange for order  flow as “economic rent” which brokers pass on to their retail accounts.)

All Commissioners did vote in favor of proposals to make execution disclosure more complete about how orders are executed, and by lowering the increments allowed for stock trading.

 

HAPPY HOLIDAYS AND A GREAT NEW YEAR

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I will post new developments (I am researching now) that you should know concerning the SEC and the securities markets between now and year-end.  In the meanwhile, as we move into the Holiday Season, let me wish all my readers the very best of everything for this Season and for 2023 (and, indeed, well after that also!)

Proxy Advisory Firm Increases Scrutiny

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Glass Lewis, one of the two major firms which provide advisory service to investors relative to voting for or against director candidates, has announced some substantial (if not surprising) revisions to its review standards designed to foster ESG-related elections to boards.  For 2023, among other changes (and in some cases depending on size of the registrant public company):

  • tightened review of gender and other diversity on boards
  • mandatory disclosure of corporate racial/ethnic demographics
  • limits on outside board involvements (query reflecting criticism of Musk being diverted to Twitter?)
  • specific requirement of articulation of board supervision of cyber risk, environmental and climate-related matters
  • focus on officer exculpation, tying long-term incentives more close to performance, nature and duration of poison pills and issuance of shares with unequal voting rights, and with supermajority voting and classified boards.

The foregoing list is not complete, nor does it reflect the granular treatments to be applied within various categories.  As proxy advisory firms influence stock value and thus impact corporate governance, public companies had best look carefully this year at Glass Lewis (and also ISS) pronouncements; there are changes that affect not just disclosure but also substance.

Critics of ESG and similar standards, a growing number questioning their appropriateness as standards for investment return, are not making progress with their critique in this arena.

 

Anti-trust News?

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A week or so ago I almost posted about a criminal anti-trust complaint brought by the Department of Justice, the first in decades.  I chose not to, thinking the event an outlier that must have involved incredibly horrendous facts; after all, anti-trust laws have not been vigorous enforced in recent memory.  However, see below.

On November 10, the Federal Trade Commission issued a revised policy statement that purported to make the bringing of anti-trust actions by the government far more likely.  Citing the FTC Act which bars “unfair method of competition,” broader if less precise than the prohibitions of the anti-trust laws (Sherman and  Clayton Acts), the policy purports to criminalize a wide range of ill-defined actions: conduct that is coercive, collusive, deceptive, involves use of economic power, action “otherwise restrictive or exclusionary,” or which “tends to negatively affect competitive conditions” or limit consumer choice.

For lawyers and clients seeking bright line guidance, these vague standards are troublesome.  No doubt the policy of the current liberal administration (the sole Republican FTC Commissioner was almost apoplectic in dissent), it is hard find a discernable line drawn here.  Every time a company has a better product which derives out a competitive product or company, competitive conditions and consumer choices are by definition impaired.

Vague standards give government agencies great power to shape business actions simply by reason of the fear of violation, a practice long the hallmark of the SEC during Democratic administrations.  For more detail please see my law firm’s November 18 website Alert at www.duanemorris.com.

The Dell-ema

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Six years ago Dell Technologies financed its multi-billion dollar acquisition of EMC Technologies by issuing a special class of “V” shares.  Two years later Dell, under the leadership of Michael Dell, recapped the V class and distributed to holders $14 billion in cash and about 150 million shares of Class C Common.  Company and its founder and certain directors were sued by shareholders  claiming that on the exchange the investors were short-changed to the tune of about $6 billion.

This high-stakes court battle has just been settled, subject to approval by the Delaware Chancery court, for $1 Billion dollars payable by defendants Dell and four directors who were allegedly coerced and/or were self-interested.  Or perhaps not.  Seems the deal is dependent on the entire tab being paid by either the company itself under indemnity agreements (isn’t that circular– shareholders were harmed and now shareholders are to pay their own damages to themselves) OR by the insurers of the company (presumably under D&O coverage).

Finally and also interesting, this is the second case I am posting about this week wherein founding and wealthy company CEOs are being implicated by allegation in mounting coercive tactics against sitting directors to achieve personal benefit.  Assume you want to undertake a transaction involving your company that has benefit to yourself–how do you “vet” that deal?  How do you avoid implicit coercion where independent directors are also of course selected by you?  Independent committee review may be necessary but not dispositive.  Investment banking opinions you pay the bankers to give?  Is it practical to get a vote of shareholders (discounting interest shares)?  How can you be sure that your disclosure in soliciting the vote will not be challenged as biased?

The impact of the class action plaintiffs’ bar is pretty scary these days.  What’s a corporate mogul to do?

Musk Redux

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I seldom post two days in a row, let alone on the same subject, but I am intrigued by Elon Musk’s  10-year comp agreement at Tesla that can net him as much as $56 Billion dollars (see yesterday’s post).

In court yesterday we learned that the pay package was approved by an independent committee of the board.  Having an independent comp committee is pretty standard and in fact actually mandatory, although yesterday I had suggested also the hiring of recognized consultants who could relate the comp to peers; perhaps this was not done as Elon, self-admittedly, has no peers nor does his company fall into a peer group….

From a lawyering standpoint, which I admit is less titillating but more useful a focus, we should consider that independent director action typically enjoys immunity from analysis under the business judgment rule, which keeps courts out of the practice of second-guessing directors in the use of their business discretion.  However, such protection is not afforded to interested directors nor, as in this case, to allegedly coerced directors. Plaintiffs here suggest that Musk had such power that independence was compromised.

Another of the tid-bids as reported by Law360, a service sending prompt news items to attorneys: there is suggestion that Musk may be violating his acrimoniously reached settlement agreement with the SEC which among other matters required Musk to have his tweets first reviewed by company counsel (can one imagine how that requirement must rankle Musk to this day).

I promise to attempt to not post on this trial tomorrow; though I may not be able to resist.