Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The SEC has approved, effective immediately, new Section 312.03T of the NYSE Listed Company Manual.  Section 312.03T provides a limited, temporary exception from the shareholder approval requirements in Section 312.03(c), accompanied, in certain narrow circumstances, by a limited exception from Sections 312.03(a) and (b) and Section 303A.08. The exception in Section 312.03T is available until and including June 30, 2020.

Among other things, and subject to certain exceptions, Section 312.03(c) of the Manual requires shareholder approval for certain issuances of over 20% of outstanding shares or voting power.  Section 312.03(a) references the requirement for shareholder approval of equity compensation plans set forth in 303A.08 of the Manual.  Section 312.03(b) requires shareholder approval for issuance of equity securities to certain related parties.

Under Section 312.03T, the NYSE’s newest exception would be limited to circumstances where the delay in securing shareholder approval would:

  • have a material adverse impact on the company’s ability to maintain operations under its pre-COVID-19 business plan;
  • result in workforce reductions;
  • adversely impact the company’s ability to undertake new initiatives in response to COVID-19; or
  • seriously jeopardize the financial viability of the enterprise.

In addition to demonstrating that the transaction meets one of the foregoing requirements, the company would have to demonstrate to the NYSE that the need for the transaction is due to circumstances related to COVID-19, that the proceeds would not be used to fund any acquisition transaction, and that the company undertook a process designed to ensure that the proposed transaction represents the best terms available to the company. The NYSE also requires that the company’s audit committee or a comparable committee comprised solely of independent, disinterested directors expressly approve reliance on the exception. The NYSE also requires the approving committee to determine that the transaction is in the best interest of shareholders.

The NYSE must approve all transactions by countersigned application in advance of any issuance of securities in reliance on Section 312.03T. To obtain approval the company must submit a supplemental listing application.  The NYSE advises companies to commence discussions with the NYSE and provide the required documentation as far in advance of the proposed transaction as is possible.

The NYSE requires a company relying on the exception to make a public announcement by filing a Form 8-K, where required by SEC rules, or by issuing a press release disclosing as promptly as possible, but no later than two business days before the issuance of the securities and certain other details.

The carve out from the related party and equity compensation shareholder approval rights is limited to the following circumstances:

  • The affiliated purchaser’s participation in the transaction was specifically required by unaffiliated investors.
  • To protect against self-dealing, Section 312.03T limits such participation to a de-minimis level. Each affiliated purchaser’s participation must be less than 5% of the transaction and all affiliated purchasers’ participation collectively must be less than 10% of the transaction.
  • Any affiliated purchaser investing in the transaction must not have participated in negotiating the economic terms of the transaction.

The NYSE previously waived certain of the shareholder approval requirements under Section 312.03 through June 30, 2020. Specifically, the NYSE waived:

  • A provision limiting a related party or other purchaser affiliated with a related party to purchasing securities representing no more than 5% of the company’s then-outstanding shares or 5% of the company’s voting power before the issuance in a transaction meeting minimum price requirements; and
  • Certain requirements for meeting the bona fide financing exception to Section 312.03(c) where minimum price requirements are met, including waiving requirements that there must be multiple purchasers in the transaction and that no purchaser may acquire securities representing more than 5% of the company’s then-outstanding shares or 5% of its voting power before the issuance.

Many believe that economic disruptions caused by the COVID-19 pandemic will lead to increased bankruptcies.  If that is true, a portion of those bankruptcies would include public companies.  Set forth below are some key SEC reporting considerations for public companies that file for bankruptcy.

Initial 8-K Reporting Obligations

A public issuer must file a Form 8-K disclosing it has filed for bankruptcy.  The required disclosures are high-level.  The report is due within four business days of filing the petition. The SEC encourages companies to file as soon as possible after the bankruptcy, so that all investors and creditors have sufficient information about the issuer’s financial condition.

Form 8-Ks reporting bankruptcies typically include the reporting of other required events as well.  Other required items commonly included are reporting of entry into debtor-in-possession financing arrangements and automatic acceleration of indebtedness caused by filing the bankruptcy petition.

Stock Exchange Listing Requirements

The listing rules of the NYSE and Nasdaq do not provide for automatic delisting of companies that file for bankruptcy.  The approaches of the two exchanges are somewhat different however.

Rule 802.01D of the NYSE Listed Company Manual provides that if an issuer files or announces an intent to file for reorganization relief under the bankruptcy laws (or an equivalent foreign law), the NYSE may exercise its discretion to continue the listing and trading of the securities of the issuer. However, if an issuer is below certain continued listing standards (or subsequently falls below such standards) files or announces an intent to file for relief under any provisions of any bankruptcy laws, it is subject to immediate suspension and delisting.

Nasdaq Rule 5110 provides that Nasdaq may use its discretionary authority under the Rule 5100 Series to suspend or terminate the listing of an issuer that has filed for protection under any provision of the federal bankruptcy laws or comparable foreign laws, or has announced that liquidation has been authorized by its board of directors and that it is committed to proceed, even though the issuer’s securities otherwise meet all enumerated criteria for continued listing on Nasdaq. In the event that Nasdaq decides to continue the listing of such an issuer during a bankruptcy reorganization, the issuer is required to satisfy all requirements for initial listing, including the payment of initial listing fees, upon emerging from bankruptcy proceedings.

A Form 8-K must be filed if an issuer receives notice that it fails to meet a listing standard or the issuer has advised the exchange that it is in noncompliance with the listing standards.  Additional Form 8-Ks may be required during the delisting process.

Ongoing Exchange Act Reporting Obligations

A bankruptcy filing does not terminate a public issuer’s obligation to continue to file reports required by the securities laws, including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.

In 1997, the SEC staff issued Staff Legal Bulletin No. 2, or SLB No. 2, which was meant to address requests to modify the Securities Exchange Act of 1934 periodic reporting of issuers that are either reorganizing or liquidating under the provisions of the United States Bankruptcy Code.

SLB No. 2 provides that the issuer in bankruptcy may request a “no-action” position from the staff of the SEC’s Division of Corporation Finance, or the Division, that limits reporting obligations under the Exchange Act.  In providing a no-action position, the Division determines whether modified reporting is consistent with the protection of investors.

To obtain the relief described in SLB No. 2, the issuer should clearly demonstrate its inability to continue reporting, its efforts to inform its security holders and the market of its financial condition and activities, and the absence of a market in its securities.  The issuer should submit its request promptly after it has entered bankruptcy, not when it is preparing to emerge from bankruptcy.  The Division will consider a request as submitted “promptly” if it is filed before the date the issuer’s first periodic report is due following the issuer’s filing for bankruptcy.  The Division will also consider a request to be submitted “promptly” if the issuer is current in its Exchange Act reporting after filing its Bankruptcy Code petition and through the date of its request.

SLB No. 2 asserts that generally, the Division will accept, instead of Form 10-K and Form 10-Q filings, the monthly reports the issuer must file with the Bankruptcy Court.  The issuer must file each monthly report with the SEC on a Form 8-K within 15 calendar days after the monthly report is due to the Bankruptcy Court.

Notwithstanding the broad promise of relief set forth in SLB No. 2, the Division has only sparingly granted relief under its provisions.  From 1997 through 2005, only 11 of 21 requests were granted. It is likely some applications were withdrawn when the SEC signaled they would not be granted so the foregoing statistics may not paint the full picture.  It’s also possible that the Division may have verbally indicated that modified reporting relief is appropriate outside of the formal no-action letter process.  Amongst these requests, the Division’s responses suggest that the nature and extent of trading in the issuer’s securities is the most critical factor.  In particular, substantial trading volume and continued listing on a national exchange appear to be incompatible with relief under SLB No. 2 in the Division’s view.

Subsequent to 2005, the SEC granted applications under SLB No. 2 only in connection with the high profile GM bankruptcy following the 2008 financial crisis.  Importantly, the relief applied only to residual operations of “old GM” following a Section 363 sale to the “new GM” that operates today and not to the time the reorganization was pending.

Confirmation of Plan of Reorganization and Section 363 Sales

An order confirming a plan of reorganization triggers a required Form 8-K filing.  The plan of reorganization must be filed as an exhibit as well.

An issuer’s Section 363 sale of assets can also trigger required Form 8-K filings.  For example, the related asset purchase agreement may be a material contract that triggers a filing when it is entered into and the closing of a sale of assets may also trigger a required Form 8-K filing if the thresholds set forth in Item 2.01 of Form 8-K are met.  In some circumstances pro forma financial information reflecting the disposition of assets may also be required.

Stockholder Action

Failure to file required reports may make it difficult or impossible to hold stockholders’ meetings.  For instance, to solicit proxies for an annual meeting where directors will be elected, stockholders must be provided with an annual report on Form 10-K (or equivalent information) and certain other specific information, such as compensation and management information.

Termination of Exchange Act Reporting Obligations

Issuers will want to terminate their Exchange Act reporting obligations following a reorganization or liquidation in connection with a bankruptcy proceeding where permitted by relevant law.  This is essentially a three layer analysis where all of the relevant prongs must be satisfied:

  • Delisting from the exchange and deregistration under Section 12(b) of the Exchange Act (the balance of this commentary will assume the issuer has previously been delisted),
  • Deregistering under Section 12(g) of the Exchange Act – Section 12(g) imposes reporting based on the number of shareholders and assets, and
  • Suspension of obligations under Section 15(d) of the Exchange Act – Section 15(d) imposes reporting obligations based on filing and maintaining Securities Act registration statements.

The following table sets forth the general requirements to deregister a class of securities under Sections 12(g) of the Exchange Act and to suspend reporting obligations under Section 15(d) of the Exchange Act.

Requirement 12(g) Deregistration (Rule 12g-4) 15(d) Suspension (Rule 12h-3)
Record holders Held of record by fewer than 300 persons (higher threshold for certain banking entities) Same
Record holders – alternative test Fewer than 500 persons, where the total assets of the issuer have not exceeded $10 million on the last day of each of the issuer’s three most recent fiscal years Same
Current reporting obligations Not applicable Issuer has filed all reports required by Section 13(a) (i.e., 10-Ks and 10-Qs etc.) for the shorter of its most recent three fiscal years and the portion of the current year preceding the date of filing a Form 15
Requirements related to recently filed registration statements Not applicable

Suspension is not available for any class of securities for a fiscal year in which a registration statement relating to that class becomes effective under the Securities Act of 1933, or is required to be updated pursuant to section 10(a)(3) of the Securities Act, and, in the case of alternative test for record holders, the two succeeding fiscal years

The foregoing does not apply to the duty to file reports which arises solely from a registration statement filed by an issuer with no significant assets

Staff Legal Bulleting No. 18 provides some relief with respect to this requirement
Filing requirements to terminate obligations Form 15 must be filed Form 15 must be filed

 

Delinquent Filers

Public companies that do not file required reports or take the steps to properly terminate their reporting obligations following bankruptcy will likely eventually attract the attention of the SEC Delinquent Filings Program.  The SEC’s Divisions of Enforcement and Corporation Finance jointly established the Delinquent Filings Program in 2004 to encourage reporting companies that are delinquent in filing their periodic reports to submit their periodic reports or rectify deficient periodic reports. The SEC’s Delinquent Filings Group in its Division of Enforcement conducts investigations into possible violations of the federal securities laws’ periodic reporting obligations, and prosecutes administrative proceedings against these companies when appropriate. The Division of Corporation Finance identifies reporting companies that are delinquent filers and usually provides them with notice of their failure to submit periodic reports. If a reporting issuer identified as a delinquent filer fails to submit its periodic reports, the SEC may revoke the registration of the reporting issuer.

Section 12(k) of the Exchange Act gives the SEC the authority to suspend trading in a security for up to 10 trading days if the SEC believes that a suspension is required to protect investors and the public interest. A trading suspension by the SEC halts the trading in a security on all trading platforms (e.g., national securities exchanges, over-the-counter market, or alternative trading systems). In addition, Section 12(j) gives the SEC the authority to revoke, or suspend for up to twelve months, the issuer’s securities registration if, after an administrative hearing, the SEC finds that the issuer violated the Exchange Act by failing to file its periodic reports.

Private equity firm Oak Hill Capital Partners owned ODN Holding Corporation, a holding company for Oversee.net. Oak Hill owned a majority of the Company’s common stock and all of its Series A Preferred Stock (the “Preferred Stock”). Oak Hill’s holdings gave it control over the Company at both the stockholder and board levels.

In 2011, after a potential M&A deal fell apart, Oak Hill focused on its right to compel the Company to redeem its Preferred Stock at its liquidation preference of $150 million (the “Redemption Right”).  The Redemption Right was not effective until February 2013. Oak Hill used the intervening period to bolster available cash so the redemption right could be lawfully exercised.  In mid-2011, Oak Hill terminated the Company’s CEO and instructed management to cut expenses to improve profitability. When the Company sold two of its four business units in January 2012, it did not reinvest the proceeds.

With the exercise of the Redemption Right on the horizon, the Company’s Board formed a special committee to negotiate with Oak Hill. In February 2013, Oak Hill told the committee that it was critically important for Oak Hill to receive $45 million by March 2013. The committee agreed to that amount.

After the redemption, the Company continued to accumulate cash. The major source of the Company’s net income was its Domain Monetization business. Although profitable, that business was in steady decline. In April 2014, the Company sold the Domain Monetization business for $40 million. A second special committee approved the fairness of the price. A third special committee agreed to use all $40 million to redeem shares of Preferred Stock from Oak Hill.

The sale of the Domain Monetization business left the Company with only its Vertical Markets business. Over the following three years, the Company sold off that business in pieces. The Company persisted as a shell through the ensuing litigation with approximately $10 million in cash and a single, developmental-stage, travel-oriented website.

Frederick Hsu co-founded the Company and was the second largest holder of its common stock after Oak Hill. According to the Delaware Court of Chancery’s decision in The Frederick Hsu Living Trust v. Oak Hill Capital Partners III, L.P. et al, Hsu maintained that Oak Hill and its representatives on the Board breached their fiduciary duties by causing the Company to accumulate cash in anticipation of a redemption, rather than investing it in the Company’s business to promote long-term growth. He asserted that senior officers of the Company and other members of the Board breached their fiduciary duties by going along with Oak Hill’s cash-accumulation strategy.

At trial Hsu proved that the cash-accumulation strategy conferred a unique benefit on Oak Hill by creating a pool of funds that the Company would be required to use to redeem Oak Hill’s shares of Preferred Stock as soon as the Redemption Right ripened. Because the strategy conferred a unique benefit on the Company’s controlling stockholder, the defendants had the burden at trial of proving that the pursuit of the cash-accumulation strategy was entirely fair.

As is well known, the concept of fairness has two basic aspects: fair dealing and fair price.  The fair process dimension of the entire fairness inquiry examines the procedural fairness of the decision, transaction, or result being challenged. It considers the manner in which the challenged decision, transaction, or result came about. The Court found the defendants fell short on this dimension of the analysis. The reasons appear to be that Oak Hill directed managements’ actions and the lack of Board approval of the cash accumulation strategy.  Noting that Hsu only challenged the cash accumulation strategy, and not the decision to redeem shares or the prices at which assets were sold, the Court found the lack of process was not fatal.  The reason was that although the two aspects –fair dealing and fair price —  may be examined separately, they are not separate elements of a two-part test. The test for fairness is not a bifurcated one as between fair dealing and price. All aspects of the issue must be examined as a whole since the question is one of entire fairness.

The fair price dimension of the entire fairness inquiry examines the substantive fairness of the decision, transaction, or result being challenged. In the traditional formulation, it relates to the economic and financial considerations of the transaction under challenge, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock.

The defendants proved at trial that the cash-accumulation strategy was entirely fair. The defendants proved by a preponderance of the evidence that the Company declined not because of the cash-accumulation strategy, but rather because of industry headwinds and relentless competition, most notably from Google, Inc.

The defendants also proved by a preponderance of the evidence that if the Company had reinvested its net income, it could not have generated a return sufficient to create value for the holders of common stock. The record also showed that although Oak Hill had an interest in achieving a return of capital, Oak Hill’s overall ownership position in the Company, including its ownership of a majority of the common stock, gave Oak Hill an incentive to create value for the common.  Here, Oversee’s common stock would have ended up worthless with or without the cash-accumulation strategy.

The SEC has approved Nasdaq’s proposal to temporarily modify certain of its rules in an effort to streamline listed companies’ access to capital.  The rule proposal is immediately effective.

New Listing Rule 5636T provides a limited temporary exception to the shareholder approval requirements:

  • for transactions other than a public offering in Listing Rule 5635(d); and
  • in certain narrow circumstances, a limited attendant exception to shareholder approval rules for equity compensation plans in Listing Rule 5635(c).

The temporary exception also provides that a company that relies on the exception is not subject to the 15 day prior notification requirement described in Rule 5250(e)(2).

The exception is not  available for the shareholder approval requirements related to equity compensation in Listing Rule 5635(c) except for the limited circumstances described below, certain acquisitions of the stock or assets of another company described in Listing Rule 5635(a) and a change of control in Listing Rule 5635(b).

The temporary exception is available until and including June 30, 2020.

Transactions Other than a Public Offering

The proposed exception to the shareholder approval requirements for transactions other than a public offering in Listing Rule 5635(d) is limited to circumstances where the delay in securing shareholder approval would:

  • have a material adverse impact on the company’s ability to maintain operations under its pre-COVID-19 business plan;
  • result in workforce reductions;
  • adversely impact the company’s ability to undertake new initiatives in response to COVID-19; or
  • seriously jeopardize the financial viability of the enterprise.

In addition to demonstrating that the transaction meets one of the foregoing requirements, the company would also have to demonstrate to Nasdaq that the need for the transaction is due to circumstances related to COVID-19 and that the company undertook a process designed to ensure that the proposed transaction represents the best terms available to the company. Nasdaq also requires that the company’s audit committee or a comparable body of the board of directors comprised solely of independent, disinterested directors expressly approve reliance on this exception and determine that the transaction is in the best interest of shareholders.

Under what Nasdaq refers to as the Safe Harbor Provision, no prior approval of the exception by Nasdaq would be required if:

  • the maximum issuance of common stock (or securities convertible into common stock) issuable in the transaction is less than 25% of the total shares outstanding and less than 25% of the voting power outstanding before the transaction; and
  • the maximum discount to the Minimum Price, as defined in the Nasdaq rules, at which shares could be issued is 15%.

For transactions that do not fall within the Safe Harbor Provision, the Nasdaq Listing Qualifications Department must approve the company’s reliance on the exception before the company can issue any securities in the transaction. This approval will be based on a review of whether the company has established that it complies with the applicable requirements of the temporary exception.

The temporary rule also requires the company make a public announcement by filing a Form 8-K, where required by SEC rules, or by issuing a press release disclosing, among other things, the terms of the transaction and that shareholder approval would ordinarily be required under Nasdaq rules but for the fact that the Company is relying on an exception to the shareholder approval rules.

Equity Compensation

Nasdaq has long interpreted Listing Rule 5635(c) to require shareholder approval for certain sales to officers, directors, employees, or consultants when such issuances could be considered a form of “equity compensation.” Nasdaq has heard from market participants that investors often require a company’s senior management to put their personal capital at risk and participate in a capital raising transaction alongside the unaffiliated investors. Nasdaq believes that as a result of uncertainty related to the ongoing spread of the COVID-19 virus, listed companies seeking to raise capital may face such requests. Accordingly, Nasdaq proposes that the temporary exception allow such investments under limited circumstances.

The temporary rule provides for an exception from shareholder approval under Listing Rule 5635(c) for an affiliate’s participation in a transaction described above under “Transactions Other than a Public Offering” provided the affiliate’s participation in the transaction was specifically required by unaffiliated investors. In addition, to further protect against self-dealing, the temporary rule would limit such participation to a de-minimis level – each affiliate’s participation must be less than 5% of the transaction and all affiliates’ participation collectively must be less than 10% of the transaction. Finally, any affiliate investing in the transaction must not have participated in negotiating the economic terms of the transaction.

Advance Notification

The temporary exception also provides that a company that relies on the exception is not subject to the 15 day prior notification requirement described in Rule 5250(e)(2) but must still provide notification required by that rule to Nasdaq, along with a supplement, certifying in writing that the company complied with all requirements of the temporary exception.  Such submissions must be made, as promptly as possible, but no later than the time of the public announcement required by the temporary exception and in no event, later than June 30, 2020. In such certification, Nasdaq expects the company to describe with specificity how it complied with the temporary exception.

For transactions described in the temporary exception that require approval of the Nasdaq Listing Qualifications Department before the company can issue any securities in reliance on the temporary exception, Nasdaq expects companies to submit the required notification, and a supplement certifying compliance with the requirements of the temporary exception, with enough time to allow Nasdaq to complete its review of the submissions.

The SEC has published a series of FAQs relating to how its COVID-19 Order affects certain matters with respect to the use and filing of Form S-3.  The COVID-19 Order provides that, subject to certain conditions, publicly traded companies have an additional 45 days to file certain disclosure reports.

According to the SEC:

  • A registrant may continue to conduct shelf takedowns using an already-effective registration statement while relying on the COVID-19 Order for a periodic report, including a Form 10-K. However, the registrant must determine that the prospectus used complies with Section 10(a) of the Securities Act of 1933.  Section 10(a)(3) requires that when a prospectus is used more than nine months after the effective date of the registration statement, the information contained therein shall be as of a date not more than sixteen months prior to such use, so far as such information is known to the user of such prospectus or can be furnished by such user without unreasonable effort or expense.
  • When a registrant properly relies on the COVID-19 Order, the due date for filing the Form 10-K is extended and the registrant must reassess its eligibility to use Form S-3 when it files the Form 10-K. At the time of filing the Form 10-K, the registrant must meet all of the requirements of Form S-3 to continue to use a previously filed Form S-3, including that the registrant has filed all the material required to be filed pursuant to Section 13, 14 or 15(d) for a period of at least twelve calendar months immediately preceding the Section 10(a)(3) update. The Form 10-K will be considered timely if all the conditions of the COVID-19 Order are met with respect to the filing.
  • A registrant relying on the COVID-19 Order to delay a required filing is eligible to file a new Form S-3 registration statement between the original due date of a filing and the extended due date. However, registrants relying on the COVID-19 Order should note that the staff will be unlikely to accelerate the effective date of a Form S-3 until such time as any information required to be included in the Form S-3 is filed.

The full text of the FAQs should be reviewed by those planning to rely upon them.

 

In early 2016, the camera manufacturer, GoPro, Inc. planned to roll out two new products to the market, a drone that would house state of the art GoPro cameras and the latest iteration of its signature wearable camera. GoPro provided revenue guidance for 2016 based on projected sales of both products. The forecasts were positive. The product launch for the drone was expected to occur in the first half of 2016, and the new camera was to be ready for market well in advance of the 2016 holiday shopping season.

Unfortunately, the road to market, especially for the drone, was bumpier than expected. GoPro announced that the product launch for the drone would be delayed as it worked out several kinks in the product. Yet its revenue guidance remained unchanged. Once the products were unveiled in the fall of 2016, the Company faced production ramp-up issues, inventory shortages, higher than expected product returns and ultimately a product recall of the drone. GoPro’s board of directors eventually caused the Company’s revenue guidance to be adjusted to account for these problems. When the dust settled, GoPro generated $1.185 billion in revenue during 2016—short of the Company’s updated revenue guidance of $1.25–$1.3 billion. The Company’s stock price suffered a 12% decline in response to the revenue miss.

In the wake of GoPro’s 2016 difficulties, Company stockholders filed class action complaints in federal court alleging that certain GoPro fiduciaries violated federal securities laws because, as of October 2015, they knew the Company could not meet its annual revenue guidance yet failed timely to disclose this reality to stockholders. Based on similar factual allegations, two groups of Plaintiffs filed complaints which were consolidated into In Re GoPro, Inc. Stockholder Derivative Litigation  in the Delaware Court of Chancery, the action discussed in this note, alleging certain GoPro officers and directors breached their fiduciary duties.

As is often the case, the central issue was whether the case should be dismissed because the Plaintiffs failed to make a pre-litigation demand on the board.  The Court noted whenever directors communicate publicly or directly with shareholders about a corporation’s affairs, with or without a request for shareholder action, directors have a fiduciary duty to shareholders to exercise due care, good faith and  loyalty.” If the board of directors intentionally misleads stockholders about the business of the corporation it serves, then its members will be held liable for breach of fiduciary duty. With this in mind, the Court said it follows that directors who knowingly make materially misleading statements to stockholders “may be considered to be interested for the purposes of demand.”

Only one member of the relevant board (i.e., members of the Board when the complaint was filed)  was alleged to have personally made a false or misleading public statement. Plaintiffs attempted to implicate a majority of the relevant board by alleging five of its members contributed to and approved GoPro’s revenue guidance while knowing it was  impossible for the Company to achieve the projected results. In other words, Plaintiffs attempted to allege a majority of the relevant board acted with scienter.

When pressed at oral argument for “some particularized facts that would show the board was actually affirmatively saying to management, ‘yes, keep telling the market that we’re going to meet our revenue guidance, notwithstanding these production issues that we’re having,’” Plaintiffs’ counsel pointed to only one document: the “Bull and Bear Case” slide the board reviewed on October 6, 2016.

According to the Court, the “Bull and Bear Case” slide did not reasonably supports the inference Plaintiffs asked the Court to draw. First, the “Bull and Bear Case” slide appeared to be backwards-looking—not a forward-looking encouragement to continue misstating facts. Second, the Court stated  all the slide showed was that the board was considering the impact of product releases and macroeconomic trends on GoPro’s stock price—i.e., that the director defendants “monitored” the Company’s “business risk” as they were obliged to do under Delaware law.

The Plaintiffs did not plead a Caremark claim, which is sometimes referred to as breach of the duty of oversight, and is invoked when a board fails to act.  The result is Plaintiffs had to plead the board affirmatively took action that was actionable board misconduct.  The Court found that board acquiescence with respect to the earnings guidance cannot support an inference of affirmative board level misconduct. Even if the board were told by its management that the Company was not going to meet its revenue projections, and then the board did nothing as management publicly stood by its market guidance, that factual predicate might support a “classic” Caremark claim for failure to respond to “red flags.” However, it did not support a claim against the board for affirmative action for causing the Company to make false disclosures.

Kandi Technologies Group, Inc. is a publicly traded Delaware corporation based in China. The Company struggled persistently with its financial reporting and internal controls, encountering particular difficulties with related-party transactions. The complaint filed in Hughes v. Hu describes problems dating back to 2010. In March 2014, the Company publicly announced the existence of material weaknesses in its financial reporting and oversight system, including a lack of oversight by the Audit Committee and a lack of internal controls for related-party transactions. The Company pledged to remediate these problems. Instead, in March 2017, the Company disclosed that its preceding three years of financial statements needed to be restated.  In connection with the restatement the Company also disclosed it lacked sufficient expertise related to GAAP, SEC disclosure requirements, effective controls and other matters.

The plaintiff commenced litigation on the Company’s behalf to recover damages from, among others, the three directors who comprised the Audit Committee during the Company’s period of persistent problems.  The plaintiff brought a Caremark claim and contended that the director defendants consciously failed to establish a board-level system of oversight for the Company’s financial statements and related-party transactions, choosing instead to rely blindly on management while devoting patently inadequate time to the necessary tasks. The plaintiff also contended that the director defendants’ failures led to the March 2017 restatement, which caused the Company harm.

The defendants moved to dismiss the complaint pursuant to Rule 23.1, contending that the plaintiff failed to make a demand on the board or plead that demand would have been futile.  The Court noted a plaintiff can state a Caremark claim by alleging that “the company had an audit committee that met only sporadically and devoted patently inadequate time to its work, or that the audit committee had clear notice of serious accounting irregularities and simply chose to ignore them or, even worse, to encourage their continuation.

The Court found the allegations in this case support inferences that the board members did not make a good faith effort to do their jobs. The Audit Committee only met when spurred by the requirements of the federal securities laws. Their abbreviated meetings suggest that they devoted patently inadequate time to their work. Their pattern of behavior indicates that they followed management blindly, even after management had demonstrated an inability to report accurately about related-party transactions.

For instance, documents that the Company produced indicated that the Audit Committee never met for longer than one hour and typically only once per year. Each time they purported to cover multiple agenda items that included a review of the Company’s financial performance in addition to reviewing its related-party transactions. On at least two occasions, they missed important issues that they then had to address through action by written consent. According to the Court, the plaintiff was entitled to the inference that the board was not fulfilling its oversight duties.

Given the persistent and prolonged problems at the Company, the Court found the defendants faced a substantial likelihood of liability under Caremark for breaching their duty of loyalty by failing to act in good faith to maintain a board-level system for monitoring the Company’s financial reporting. The Court also found defendants who face a substantial likelihood of liability constituted a majority of the relevant board members. Accordingly, the Board lacked a disinterested and independent majority that could have considered a demand, rendering demand futile and dismissal under Rule 23.1 was denied.

It is important to note that the Court has not found any of the defendants are liable for the actions alleged in the complaint.

Minnesota Governor Tim Walz has signed Emergency Executive Order 20-43 addressing the annual meeting requirements of Minnesota public companies as a result of the COVID-19 pandemic.  According to the Executive Order:

  • If, as a result of the public health threat caused by the COVID-19 pandemic, a board of directors wishes to change a meeting currently noticed for a physical location to a meeting conducted solely by remote communication, it may notify shareholders of the change at least ten days before the meeting by both identifying the change in a document publicly filed by the corporation with the SEC pursuant to sections 13, 14, or 15(d) of the Securities Exchange Act of 1934, as amended, and by issuing a press release that identifies the change. The press release must promptly be posted on the corporation’s website after release. In addition, notification must simultaneously be provided to shareholders by email, if those email addresses are known to the corporation.
  • If it is impracticable for a corporation to convene a currently noticed meeting of shareholders at the physical location for which it has been noticed due to the public health threat caused by the COVID-19 pandemic, such corporation may adjourn such meeting to another date or time, to be held by remote communication, by providing notice of the date and time and the means of remote communication in a document filed by the corporation with the SEC pursuant to sections 13, 14, or 15(d) of the Securities Exchange Act of 1934, as amended, and by issuing a press release, which must promptly be posted on the corporation’s website after release. In addition, notification must simultaneously be provided to shareholders by email, if those email addresses are known to the corporation.

In 2015, the stockholders of nominal defendant, Investors Bancorp, Inc. (“Investors Bancorp” or the “Company”), voted to approve an equity incentive plan (“EIP”) adopted by the Company’s board of directors (the “Board”). After the stockholders approved the EIP, the Board awarded itself substantial restricted stock awards (“RSAs”) and stock options under its terms (the “2015 Awards”). Kevin Cummings, a Board member and Company CEO, and Domenick Cama, also a Board member and Company President and COO, were the EIP’s two largest beneficiaries.

Plaintiff, Robert Elburn, previously brought a derivative action in 2016 alleging the Board breached its fiduciary duties by approving the 2015 Awards. Defendants moved to dismiss that complaint and the Delaware Court of Chancery granted the motion. The Delaware Supreme Court reversed and remanded for further proceedings. Shortly before trial, the parties reached a settlement (the “Settlement”). Under the Settlement, the EIP awards to Cummings and Cama were rescinded and the awards to the non-executive members of the Board were substantially reduced.

In April 2019, two months before the Settlement was presented to the Court for approval, Investors Bancorp filed its Proxy Statement (the “Proxy”) for the Company’s 2019 Annual Stockholders Meeting (the “Annual Meeting”) during which, among other business, the stockholders were to vote on the reelection of four current members of the Board. The Proxy informed the stockholders that the Board intended to consider the issuance of new awards to Cummings and Cama under the previously approved EIP (the “Replacement Awards”).

True to its disclosure, a month later, the Company’s Compensation Committee recommended, and the Board approved, Replacement Awards for Cummings and Cama that were similar in scope to the awards that were rescinded in the Settlement.

The Court of Chancery approved the Settlement in June 2019, and the Replacement Awards were granted on July 22, 2019. Plaintiff Robert Eldburn filed his complaint in the present action two months later.

In a motion for summary judgment in the current case, Plaintiff argued there was no genuine dispute of material fact that Defendants withheld information from the stockholders in advance of the 2019 Annual Meeting that would have been material to them when deciding whether to reelect the directors to the Board.   The Plaintiff sought an order declaring the election results void and ordering a new stockholder vote on director elections.

Among other things, Plaintiff alleged Defendants had an obligation to supplement the Proxy immediately before the stockholder vote to apprise stockholders that the Replacement Awards under Board consideration had been approved.

According to the Court, Defendants could not meaningfully dispute that the Proxy was rendered stale when the Board actually approved the Replacement Awards. By the time of the vote, shareholders knew only that the Board had “commenced” a  process for the review and assessment of replacement equity grants to Messrs. Cummings and Cama, and that a compensation consultant and outside legal counsel had been retained. In reality, when the shareholders cast their vote at the Annual Meeting on May 21, 2019, the Compensation Committee had completed its “process,” had recommended issuance of the Replacement Awards and the full Board had voted to approve the awards. According to the Court, stating an outcome as a possibility, that in fact is not a possibility, is misleading.

The Court then noted the next step of the analysis was whether the omission was material. Defendants argued the omitted facts could not be material as “[a] reasonable stockholder could expect that by the time of the Annual Meeting, over a month after the Proxy was filed, the decision-making process would likely have progressed, potentially to the point of actually determining the awards.”

The Court was unable to grant the Plaintiff’s motion for summary judgment as it could not conclude there was no genuine dispute of material facts. While the Board had completed its “process” and approved the Replacement Awards before the Annual Meeting, the Replacement Awards were still conditioned on the Court’s approval of the Settlement, and therefore not final as of the time of the stockholder vote. Moreover, the stockholders had already approved the equity incentive plan, or EIP,  from which the Replacement Awards were to be drawn. The approval suggested, at least, that the stockholders understood and approved of the EIP, the manner in which awards under  the EIP would be made and the purpose of such awards. Thus, while the stockholder approval of the EIP did not leave the Board unaccountable for the awards it chose to make under that plan, as the Delaware Supreme Court made clear, the fact of the stockholder approval made the materiality inquiry more challenging than Plaintiff’s summary judgment argument allows.  The Court noted that instances where new director elections were ordered involved far more serious malfeasance than the disclosure violations Plaintiff has alleged here.

 

Judith Araujo, Jack Bowling, Susan Warshaw Ebner, Steve Quinlivan, Patrick Respeliers and Gerald Weidner also contributed to this post.

A number of public companies applied for and received potentially forgivable loans under the Paycheck Protection Program (PPP). To be eligible for a PPP loan a borrower does not need to demonstrate that it is unable to obtain credit through other sources, but the borrower does need to provide its certification that a PPP loan is “necessary to support the ongoing operations” of the borrower in light of the current economic uncertainty.

There has been some media scrutiny of large public companies that obtained PPP loans, most notably a $10 million PPP loan to Shake Shack (Shake Shack very publicly announced it would return the $10 million loan).  During an April 21, 2020 press briefing, U.S. Treasury Secretary Steven Mnuchin specifically addressed the issue, stating that PPP loans were not intended for large public companies and promising that the Small Business Administration (SBA) would soon release clear guidance on this point.

As of this morning (April 23, 2020), the SBA appears to have released that guidance (although it may fall short of the promised clarity). The SBA updated its running list of FAQs on the PPP to add question and answer 31, which is excerpted in its entirety below.

“31. Question: Do businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan?

Answer: In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification. Lenders may rely on a borrower’s certification regarding the necessity of the loan request. Any borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020 will be deemed by SBA to have made the required certification in good faith.”

As has become typical of the PPP, every attempt at clarification also raises new uncertainties.  What is the threshold for “substantial market value”?  Does a public company that would currently be unable to raise equity capital on favorable terms really have “access to capital markets” in a meaningful way?  Should any debt financing be considered “significantly detrimental” to a business as compared to equity capital in light of the additional cash load it places on the borrower?  If a borrower has undrawn but committed capital under its current financing facilities, can it still make the good faith certification required by the PPP application?

These are only some of the questions that borrowers will struggle to answer in light of this new guidance. However, in light of the very specific certifications and representations required of the applicant in its loan application, and the CARES Act’s establishment of a Special Inspector General for Pandemic Recovery (SIGPR) to carry out audits in order to ferret out waste, fraud and abuse in this process, answering these questions should be done with an appropriate level of care.

Businesses that are now uncertain as to their eligibility under the new SBA guidance should consider whether they should withdraw their PPP loan application, and those that have received a PPP loan already may want to consider repaying their loan by May 7, 2020 to take advantage of the good faith certification safe-harbor under the new guidance.