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

In this publication ISS Special Counsel Pat McGurn discusses his views on lessons learned during economic crises over the past three decades and what that means for governance during and after the COVID-19 pandemic. Mr. McGurn covers his views on considerations for boards and directors, evaluating executive pay, the impact on board-shareholder engagement, and more as the current crisis begins to reshape the corporate governance landscape.

Some of Mr. McGurn’s thoughts include:

  • In contrast to previous crises, most boards appear to be dealing with the pandemic in a highly thoughtful fashion.
  • The pandemic likely strains over boarded directors and when the crisis subsides, hopefully some of these directors may rethink their workloads and cut back.
  • Given that some boards have already formed ad hoc panels to address the pandemic, he expects to see the prevalence of standalone risk panels to grow in the future.
  • While some breathless commentators have cited the “record numbers” of pill adoptions over the past month, boards (and some, but not all, of their outside advisers) have shown a significant degree of restraint.

In an immediately effective rule change approved by the SEC, Nasdaq will permit a longer period of time for companies to regain compliance with Price-based Requirements under continued listing requirements by tolling the compliance periods through and including June 30, 2020.  Nasdaq’s rule proposal refers to Price-based Requirements as those continued listing standards which relate to continued listing bid price and market value of publicly held shares requirements.

The Price-based Requirements applicable to any company depend on a number of factors.  Nasdaq’s summary of continued listing standards (available here) suggests that Nasdaq Global Select and Nasdaq Global issuers must maintain a bid price of $1 per share and a market value of publicly held shares of $5 million to $15 million.

Nasdaq is seeing an increase in the number of companies whose securities are becoming non-compliant with the Price-based Requirements amidst the current market uncertainty and believes that relief is appropriate for the same reasons that the Commission has granted relief to its requirements. The decline in general investor confidence has resulted in depressed pricing for companies that otherwise remain suitable for continued listing. Similarly, Nasdaq believes that it is difficult for companies that are already non-compliant with these requirements to take action to regain compliance. For example, large daily market moves make it difficult for a company to predict what ratio may be required for a reverse stock split that will enable the company to achieve and maintain compliance with the bid price requirement. Similarly, it could be harmful to existing shareholders for a company to sell securities at an artificially low price, solely to regain compliance with the market value of publicly held shares requirement. Moreover, the need to develop and implement actions to address potential or actual non-compliance can draw management and board attention away from the more immediate needs of their employees and customers, as well as the communities where they operate.

Accordingly, under the approved rule Nasdaq will permit companies that are out of compliance with the Price-based Requirements additional time to regain compliance by tolling the compliance periods through and including June 30, 2020. However, throughout the tolling period, Nasdaq will continue to monitor these requirements and companies will continue to be notified about new instances of non-compliance with the Price-based Requirements in accordance with existing Nasdaq rules. Companies that are notified about non-compliance are required by Nasdaq rules to make a public announcement disclosing receipt of the notification by filing a Form 8-K, where required by SEC rules, or by issuing a press release.  Starting on July 1, 2020, companies will receive the balance of any pending compliance period in effect at the start of the tolling period to come back into compliance with the applicable requirement. Similarly, companies that were in the delisting hearings process would return to that process at the same stage they were in when the tolling period began. Companies that are newly identified as non-compliant during the tolling period will have 180 days to regain compliance, beginning on July 1, 2020.

The Unites States District Court for the Northern District of California recently found that 10b-5 litigation regarding Elon Musk’s tweets could move forward after reviewing a motion to dismiss in In Re Tesla Inc. Securities Litigation.

Mr. Musk famously tweeted “Am considering taking Tesla private at $420. Funding secured.” Mr. Musk later responded to comments related to his tweet and also posted new tweets on the subject. Tesla’s Senior Director of Investor Relations received three e-mails inquiring about Mr. Musk’s tweets. One response given was “I can only say that the first Tweet clearly stated that ‘financing is secured.’ Yes, there is a firm offer.”

Tweet is Actionable

The Court rejected the defendants’ argument that the tweet was not false and misleading. Among other things, the Court found even if the entire tweet is deemed an opinion about the future funding, that would not insulate the tweet from scrutiny; a statement of opinion can be deemed misleading if it conveys facts, and this is especially so when the opinion contains highly specific facts—e.g., here, the specific price of $420. Because Mr. Musk, the CEO of Tesla, included the highly-specific price of $420 at which shares would be bought for the going-private transaction, and because his tweet followed with “funding secured,” a reasonable investor would have interpreted it as something more than a speculative amorphous opinion about future possibilities. Instead, it can be read as implying a more concrete state of affairs.

The Court also noted many investors and analysts did not read the tweet as a speculative statement of opinion.  In addition Tesla’s own Senior Director of Investor Relations informed analysts that Mr. Musk’s tweet was correct, that there was a “firm offer” that was “as firm as it gets.”

Tesla’s Liability

Defendants argued that Mr. Musk’s statements were not actionable against Tesla as a matter of law because it did not have ultimate authority over the statement, its content, or how to communicate it.  The Court rejected arguments that Janus precluded the action against Tesla. The Court noted the “issue here is whether liability attaches to a company for statements made by its own CEO. It is beyond dispute that a corporation can be liable for the fraud committed by its officers, so long as the officer commits it within the scope of his or her employment. Janus did not change that.”

The Court rejected Defendants argument that Mr. Musk spoke as a potential bidder and not as the CEO of Tesla.  Tesla had previously filed a Form 8-K discussing channels through which it releases material news which stated  “For additional information, please follow Elon Musk’s and Tesla’s Twitter accounts: twitter.com/elonmusk and twitter.com/TeslaMotors.”

The Court only ruled on Tesla’s motion to dismiss and has not found that any Defendants violated the law.

On April 6th, the Securities and Exchange Commission approved the New York Stock Exchange’s request to provide temporary waivers of the shareholder approval requirements applicable to certain kinds of equity issuances under the NYSE’s Listed Company Manual as part of the Exchange’s ongoing efforts to respond to the challenging fund-raising environment for listed companies during the COVID-19 crisis.

Based in part on the NYSE’s observations during the financial crisis of 2008-09, the waivers are intended to ease restrictions on listed companies who will have “urgent liquidity needs in the coming months due to lost revenues and maturing debt obligations” and “who will need to access additional capital that may not be available in the public equity or credit markets.”

In particular, the NYSE’s accommodations temporarily modify the shareholder approval requirements for transactions under Section 312.03 of the NYSE Listed Company Manual through June 30, 2020, including:

  • Issuances to related parties (including directors, officers or substantial security holders of the company) if the number of shares of common stock to be issued exceeds 1% of the number of shares of common stock (or voting power) before the issuance; and
  • Transactions relating to 20% or more of the company’s outstanding common stock (or voting power) before such issuance.

Issuance to a Related Party

Section 312.03(b) of the NYSE Listed Company Manual requires shareholder approval of any issuance to a director, officer or substantial security holder of the company (each a “Related Party”) or to an affiliate of a Related Party if the number of shares of common stock to be issued, or if the number of shares of common stock into which the securities may be convertible or exercisable, exceeds either 1% of the number of shares of common stock or 1% of the voting power outstanding before the issuance.

Previously, the only exemption to this rule permitted cash sales to substantial security holders and their affiliates that meet the “minimum price” requirements as set forth in Section 312.04.7 of the NYSE Listed Company Manual (i.e., the lower of (i) the official closing price immediately preceding signing of the binding agreement; or (ii) the average official closing price for the five trading days immediately preceding the signing of the binding agreement) where the sale relates to no more than 5% of the company’s outstanding common stock.

The NYSE’s waiver allows companies to sell their securities to Related Parties and other persons subject to Section 312.03(b) without complying with the numerical limitations of that rule (and the exception thereto), as long as the sale is in a cash transaction that meets minimum price requirements and also meets the other requirements specified in the rule.

In making this change, the NYSE observed that existing large investors are often the only willing providers of necessary capital to companies facing financial challenges and expressed its belief that the modification is appropriate to increase companies’ flexibility to access this source of capital for a limited period of time.

The NYSE’s modified rules implement the partial waiver of the application of Section 312.03(b) through and including June 30, 2020, with the waiver specifically limited to transactions that involve the sale of the company’s securities for cash at a price that meets the applicable minimum price requirements. In addition, to rely on the waiver, any such transaction must be reviewed and approved by the company’s audit committee or a comparable committee of independent directors.

The waiver is not applicable to a sale of securities by a listed company to any person in a transaction, or series of transactions, whose proceeds will be used to fund an acquisition of stock or assets of another company where such person has a direct or indirect interest in the company or assets to be acquired or in the consideration to be paid for such acquisition.

As provided by Section 312.03(a), any transaction benefitting from the waiver will still be subject to shareholder approval if required under any other applicable rule, including the equity compensation requirements of Section 303A.08 and the change of control requirements of Section 312.03(d).

The temporary waiver concerning Section 312.03(a) is intended to mirror the application of NASDAQ Marketplace Rule 5635(a) for sales of a listed company’s securities to related parties.

Transactions of 20% or More

Section 312.03(c) of the NYSE Listed Company Manual requires shareholder approval of any transaction relating to 20% or more of the company’s outstanding common stock or 20% of the voting power outstanding before such issuance other than a public offering for cash.

Section 312.03(c) includes an exception for transactions involving a cash sale of the company’s securities that comply with specified “minimum price” requirements and meet the definition of a “bona fide private financing,” as set forth in Section 312.04(g) of the NYSE Listed Company Manual, which refers to a sale in which either:

  • a registered broker-dealer purchases the securities from the issuer with a view to the private sale of such securities to one or more purchasers; or
  • the issuer sells the securities to multiple purchasers, and no one such purchaser acquires, or has the right to acquire upon exercise or conversion of the securities, more than five percent of the shares of the issuer’s common stock or voting power before the sale.”

In view of the current circumstances, the NYSE is waiving, for purposes of the bona fide financing exception to the 20% requirement, the 5% limitation for any sale to an individual investor in a bona fide private financing, to permit companies to undertake a bona fide private financing. This change has the effect of permitting companies to undertake a bona fide private placement financing without complying with the previously applicable shareholder approval requirements regardless of the offering size or the number of participating investors or the amount of securities purchased by any single investor, provided that the transaction is a sale of the company’s securities for cash at a price that meets the minimum price requirement. Pursuant to the waiver, any such transaction must be reviewed and approved by the company’s audit committee or a comparable committee comprised solely of independent directors.

Like the NYSE’s waivers pursuant to Section 312.03(b) discussed above, if a company is raising capital through a transaction, or series of transaction, via the waiver to Section 312.03(c), they cannot use such capital to fund an acquisition. Furthermore, any transaction benefitting from the waiver under Section 312.03(c) will still be subject to shareholder approval if required under any other applicable rule, including the equity compensation requirements of Section 303A.08 and the change of control requirements of Section 312.03(d) of the NYSE Listed Company Manual.

The NYSE’s modification to Section 312.03(c) is intended to be consistent with the application of NASDAQ Marketplace Rule 5635(c) with respect to private placements relating to 20% or more of a company’s common stock or voting power outstanding before such transaction.

Public companies have begun to make disclosures regarding receipt of loan proceeds from the Paycheck Protection Program established by the CARES Act. Two recent examples are set forth below.

Potbelly Corporation Form 8-K:  On April 10, 2020, Potbelly Sandwich Works, LLC (the “Borrower”), an indirect subsidiary of Potbelly Corporation (the “Company”), was granted a loan (the “Loan”) from JPMorgan Chase Bank, N.A. in the aggregate amount of $10,000,000, pursuant to the Paycheck Protection Program (the “PPP”) under Division A, Title I of the CARES Act, which was enacted March 27, 2020.

The Loan, which was in the form of a Note dated April 6, 2020 issued by the Borrower, matures on April 6, 2022 and bears interest at a rate of 0.98% per annum, payable monthly commencing on November 6, 2020. The Note may be prepaid by the Borrower at any time prior to maturity with no prepayment penalties. Funds from the Loan may only be used for payroll costs, costs used to continue group health care benefits, mortgage payments, rent, utilities, and interest on other debt obligations incurred before February 15, 2020. The Company intends to use the entire Loan amount for qualifying expenses. Under the terms of the PPP, certain amounts of the Loan may be forgiven if they are used for qualifying expenses as described in the CARES Act.

Blonder Tongue Laboratories, Inc. Form 10-K: On April 10, 2020, the Company received loan proceeds in the amount of approximately $1,769,000 under the Paycheck Protection Program (“PPP”).  The PPP, established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest are forgivable after eight weeks as long as the borrower uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness will be reduced if the borrower terminates employees or reduces salaries during the eight-week period.

The unforgiven portion of the PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments for the first six months.  The Company intends to use the proceeds for purposes consistent with the PPP. While the Company currently believes that its use of the loan proceeds will meet the conditions for forgiveness of the loan, we cannot assure you that we will not take actions that could cause the Company to be ineligible for forgiveness of the loan, in whole or in part.

The above examples are informational only and we do not suggest they are complete or comply with applicable disclosure obligations.

The SEC staff provided limited relief for those who wish to file Form 144 in paper as a result of the COVID-19 pandemic.  A Form 144 must be filed with the SEC upon the sale of restricted securities when specified in Rule 144.  The relief is temporary and covers those who submit a Form 144 for the period from and including April 10, 2020 to June 30, 2020.

Division of Corporation Finance staff will not recommend enforcement action to the Commission if Forms 144 filed in paper under Rules 101(b)(4) or 101(c)(6) of Regulation S-T are submitted via email in lieu of mailing or delivering the paper form to the SEC if the filer or submitter attaches a complete Form 144 as a PDF attachment to an email sent to PaperForms144@SEC.gov.

If the filer or submitter is unable to provide a manual signature on the Form 144 submitted by email, the staff will not recommend enforcement action to the Commission if the filer or submitter provides a typed form of signature in lieu of the manual signature and:

  • the signatory retains a manually signed signature page or other document authenticating, acknowledging, or otherwise adopting his or her signature that appears in typed form within the electronic submission and provides such document, as promptly as practicable, upon request by Commission staff;
  • such document indicates the date and time when the signature was executed; and
  • the filer or submitter (with the exception of natural persons) establishes and maintains policies and procedures governing this process.

ISS issued guidance on its policy application in light of the global impacts of the COVID-19 pandemic. The guidance addresses how ISS plans to apply ISS’ benchmark proxy voting policies over the coming months as annual shareholder meeting season gets underway.

The guidance provides direction on a number of annual meeting issues including postponements and virtual-only meetings. It also covers ISS’ approach to defensive measures and board considerations, including the adoption of poison pills and  director attendance, respectively, against the backdrop of the pandemic’s impact on capital markets.  It further addresses compensation issues such as changes in metrics and shifts in goals or targets and option repricing. Finally, capital structure and payouts, dividends, share repurchases, and capital raisings are also covered in the guidance.

As additional issues and impacts are created by the pandemic and associated regulatory developments, ISS intends to update its guidance and provide new information as needed throughout the remainder of the 2020 main annual meeting seasons.

SEC Chair Jay Clayton and William Hinman, Director, Division of Corporation Finance, shared their views in a public statement on first quarter earnings communications. Highlights of the wide-ranging statement are discussed below.

According to Messrs. Clayton and Hinman, company disclosures should reflect investor interest in:

  • where the company stands today, operationally and financially,
  • how the company’s COVID-19 response, including its efforts to protect the health and well-being of its workforce and its customers, is progressing, and
  • how its operations and financial condition may change as all our efforts to fight COVID-19 progress.

The two SEC officials noted that providing detailed information regarding future operating conditions and resource needs is challenging, including because our national response strategies to COVID-19 are in their incipient stages (and are likely to change), but it is important on many levels.  Updating and refining these estimates should become less difficult over time.

They discussed benefits that extend beyond the goal of traditional securities law disclosures. Well thought out disclosures addressing the foregoing topics will enhance valuable communication and coordination across our economy—including between the public and private sectors—as together we pursue the fight against COVID-19. This transparency can foster confidence in countless specific instances, for example, between a supplier and a manufacturer as well as between an investor and a company, which in combination will benefit all.

Messrs. Clayton and Hinman encourage companies that respond to their call for forward-looking disclosure to avail themselves of the safe-harbors for such statements and also note that they would not expect good faith attempts to provide appropriately framed forward-looking information to be second guessed by the SEC.

As a result of the COVID-19 pandemic, SEC staff provided guidance on changing the date time and place of an annual meeting, switching to a virtual shareholder meeting and certain matters related to shareholder proposals.  The SEC has now expanded on that guidance, focusing primarily on problems associated with issuers who mail a full set of proxy materials rather than using the notice-only delivery model.

In the guidance, the SEC staff notes that some issuers may be encountering delays in the printing and physical mailing of the “full set” of their proxy materials for their upcoming shareholder meetings due to the impact of COVID-19 on the facilities and staffing of their proxy service providers or transfer agents.  In particular the SEC has apparently been receiving inquiries from some issuers that would like to furnish their proxy materials through the “notice-only” delivery option permitted by Exchange Act Rule 14a-16, but have concerns about their ability to comply with certain provisions of the rule. For example, due to unexpected delays caused by COVID-19, an issuer may not be able to send the notice of the electronic availability of the proxy materials at least 40 calendar days before the meeting, provide intermediaries (such as a broker, dealer, or bank) with the information needed so the intermediaries can send the notice to beneficial owners within the 40 calendar days timeframe required by Exchange Act Rule 14b-1 or 14b-2, or respond to a shareholder’s request for paper copies of proxy materials in a timely manner.

In the guidance the SEC staff encourages issuers affected by printing and mailing delays caused by COVID-19 to use all reasonable efforts to provide timely information to shareholders without putting the health or safety of anyone involved at risk. In some cases, this may mean delaying a meeting in accordance with state law requirements and the procedures provided in the previous guidance, if necessary, in order to provide materials on a timely basis.

However the staff advised that in circumstances where delays are unavoidable due to COVID-19 related difficulties, the staff would not object to an issuer using the “notice-only” delivery option in a manner that, while not meeting all aspects of the notice and timing requirements of Rule 14a-16, will nonetheless provide shareholders with proxy materials sufficiently in advance of the meeting to review these materials and exercise their voting rights under state law in an informed manner and so long as the issuer announces the change in the delivery method by following the steps described in the previous guidance for announcing a change in the meeting date, time, or location. Affected issuers and intermediaries also should continue to use their best efforts to send paper copies of proxy materials and annual reports to requesting shareholders, even if such deliveries would be delayed.

In a public statement, Sagar Teotia, Chief Accountant of the SEC, spoke to a number of implications of COVID-19 and financial reporting. Among other things, Mr. Teotia noted that the SEC staff recognizes that the accounting and financial reporting implications of COVID-19 may require companies to make significant judgments and estimates.  Certain judgments and estimates can be challenging in an environment of uncertainty.  Mr. Teotia noted that the SEC Office of the Chief Accountant, or OCA, has consistently not objected to well-reasoned judgments that entities have made, and OCA will continue to apply this perspective.

Mr. Teotia’s statement highlights some of the many accounting areas that may involve significant judgments and estimates in light of the evolving status of COVID-19 which include:

  • Fair value and impairment considerations;
  • Leases;
  • Debt modifications or restructurings;
  • Hedging;
  • Revenue recognition;
  • Income taxes;
  • Going concern;
  • Subsequent events; and
  • Adoption of new accounting standards (e.g., the new credit losses standard).

Mr. Teotia also offered guidance on the CARES Act which allows a limited number of entities the option to temporarily defer or suspend the application of two provisions of U.S. Generally Accepted Accounting Principles, or GAAP.  OCA has received inquiries from preparers and auditors where the preparer has concluded that election of these narrow and limited options in Sections 4013 and 4014 of the CARES Act would be deemed to be in accordance with GAAP.  Mr. Teotia advised that those entities that are eligible for, and elect to apply, either of Sections 4013 or 4014 of the CARES Act, the staff will not object to the conclusion that this is in accordance with GAAP for the periods for which such elections are available.

Public companies should consider these issues when preparing their upcoming periodic quarterly or annual reports on Form 10-Q or Form 10-K, including financial statement footnote disclosures and Management’s Discussion and Analysis of Financial Position and Results of Operations (MD&A) and potentially Risk Factors.