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

The SEC previously noted in a Compliance and Disclosure Interpretation that financial measures included in forecasts provided to a financial advisor and used in connection with a business combination transaction are not non-GAAP financial measures if:

  • the financial measures are included in forecasts provided to the financial advisor for the purpose of rendering an opinion that is materially related to the business combination transaction; and
  • the forecasts are being disclosed in order to comply with Item 1015 of Regulation M-A or requirements under state or foreign law, including case law, regarding disclosure of the financial advisor’s analyses or substantive work.

The SEC has now issued two new C&DIs on this topic. In one, the SEC confirms a registrant can rely on the foregoing interpretation if the same forecasts provided to its financial advisor are also provided to its board of directors or board committee.

In the other new C&DI, the SEC notes that disclosure of forecasts provided to bidders in a business combination transaction are not non-GAAP financial measures if the registrant determines the forecasts are material and that disclosure of such forecasts is required to comply with the anti-fraud and other liability provisions of the federal securities laws.

ISS has updated its frequently asked questions on U.S. Proxy Voting Research Procedures & Policies (Excluding Compensation-Related). New and updated questions include:

  • When are ISS’s proxy reports issued?
  • How and when will ISS change a vote recommendation in a proxy alert?
  • How can a company request engagement with the U.S. research analysts?
  • When is the best time to request an engagement?
  • What topics are generally discussed in engagements regarding non-contentious meetings?
  • Is there a blackout period for engagement with research?
  • What exceptions to the attendance policy apply in the case of a newly-appointed director?
  • Proxy access proposals: How will ISS evaluate a Board’s implementation of proxy access in response to a majority-supported shareholder proposal?
  • How will ISS apply the new 2018 policy whose previously-grandfathered poison pills will be expiring shortly?
  • How do companies terminate poison pills prior to the expiration date?
  • Does ISS still consider deadhand or slowhand provisions problematic?
  • What if a company adopts a poison before the company goes public?
  • Removal of Shareholder Discretion on Classified Boards
  • Which types of charter/bylaw adoptions are likely to result in continued adverse voting recommendations?
  • What is the purpose of the Governance Failures Policy?

Over the last two years the financial industry has seen an uptick in litigation and enforcement actions aimed at banks and their non-bank lending partners. These actions have primarily challenged the validity of the bank partnership model that is used by many non-bank lenders to generate consumer and small dollar business loans.

Bank and Non-Bank Lender Partnerships

Although the structure of a bank and their non-bank lending partners can take many forms, the typical relationship involves the non-bank lender identifying loan opportunities for the bank, which then originates the loan and either immediately assigns the loan to their non-bank partner or another third-party. By partnering with banks, non-bank lenders avoid certain regulatory and licensing requirements in states where their bank partners operate.  In return, banks are able to utilize their relationships with their non-bank lending partners to generate leads for additional loans.

In many circumstances, banks are not subject to state usury laws in every state in which they operate. Instead, banks get the benefit of the state usury law in the bank’s “home state.”  For example, if the state where the bank is headquartered has a usury law of 20%, the bank gets the benefit of that usury rate for all loans it makes in any state in which it operates, even if the usury rate in one of those states is less than 20%.  This is known as “federal interest rate exportation.”

Under the traditional bank partnership model, the loans originated in the name of a bank by their non-bank lending partner would be subject to the “home state” usury law. However, recent litigation and regulatory enforcement actions have challenged the validity of those arrangements.  Specifically, those actions challenge whether the loans should be subject to the usury interest rate limitations in the state where the consumer is located and not the bank’s “home state,” because the non-bank lender, not the bank, is the “true lender.”

Colorado’s Uniform Consumer Credit Code Administrator Takes Action

In January 2017, the Colorado’s Uniform Consumer Credit Code (“UCCC”) Administrator, Julie Meade, filed two substantially similar complaints in Colorado state court against Marlette Funding, LLC, and Avant of Colorado, LLC. The complaints alleged violations of the UCCC based on the theory that Marlette and Avant were the “true lender,” not their bank partners, in a series of loans made to Colorado consumers, which loans contained interest rates that exceeded Colorado’s usury laws.

The complaint against Marlette asserts that Marlette utilized its relationship with New Jersey chartered Cross River Bank to subvert Colorado usury laws in making loans to Colorado consumers. The complaint alleges that it acted as the “true lender,” because, among other things, (i) it picked which loan applicants received loans; (ii) it raised the capital used to fund the loans; (iii) it paid all the costs, including marketing and legal costs, incurred by Cross River Bank, associated with originating the loans; (iv) it purchased the loans from Cross River Bank within two days of their origination; (v) Cross River Bank had no liability to Marlette under the loans sold; and (vi) Marlette was required to indemnify Cross River Bank concerning any claim that alleges the lending program violates the law.

Similarly, the complaint against Avant alleges that it, not its Utah based bank partner, WebBank, was the “true lender” in the loan transactions at issue. Supporting that assertion, the complaint alleges that (i) Avant was responsible for all costs and expenses, including costs incurred in evaluating loan applications; (ii) WebBank had no risk of loss if any of the loans defaulted; (iii) Avant was responsible for developing and implementing a Bank Secrecy Act and Truth in Lending Act policy related to the lending program; and (iv) WebBank sold the loans to Avant shortly after they were originated.

Avant removed the case to federal district court in Colorado, which removal was challenged by the UCCC Administrator. On March 1, 2018, the district court adopted the magistrate judge’s recommendation to remand the action to state court.  The federal court held that the UCCC Administrator’s claims were not completely preempted by the Federal Deposit Insurance Act, because the claims were not asserted against a state bank, nor was WebBank even a party to the lawsuit.  Although the district court held that federal preemption did not exist to keep the case in federal court, the district court did state that Avant still may have a preemption defense in state court to the state law claims if it can prove that WebBank was, in fact, the “true lender.”  The case is now pending in Colorado state court.

Massachusetts Consumers File Suit Against Bank and Its Non-Bank Lending Partner

In October 2017, NRO Boston, LLC, and its owner, Alice Indelicato, filed a lawsuit against Celtic Bank and its non-bank partner, Kabbage, Inc., in Massachusetts federal court, alleging violations of Massachusetts’ criminal usury laws. Specifically, the complaint alleges that Kabbage and Celtic Bank’s lending program constituted a criminal enterprise designed to evade the criminal usury laws, by attempting to portray Celtic Bank as the “true lender” when, in fact, the “true lender” was Kabbage.  The complaint further alleges that Kabbage was the “true lender” because it originates, underwrites, funds and assumes all risk of loss for the loans, and the loans are immediately assignable to Kabbage after their origination.  The plaintiffs argue that the loans are void because they allegedly charge interest in excess of what is permitted by Massachusetts’ criminal usury laws.  The defendants challenged the lawsuit arguing that a mandatory arbitration provision required dismissal of the action.  The parties eventually entered into a stipulation whereby the plaintiff was required to file a demand for arbitration by March 25, 2018.

The CashCall and Madden Decisions

The above-described “true lender” lawsuits all explicitly or implicitly rely on the reasoning in CashCall, Inc. v. Morrisey, No. 12-1274, 2014 WL 2404300 (W.Va. May 30, 2014), and Madden v. Midland Funding, LLC, 787 F.3d 246 (2d Cir. 2015), for the argument that the non-bank lending partners are the “true lenders,” and are not entitled to utilize the bank’s federal interest rate exportation authority to circumvent state usury laws.

In CashCall, the court held that non-bank CashCall, not its bank partner First Bank & Trust of Milbank, was the “true lender” for certain loans made to West Virginia consumers.  To reach that conclusion, the court relied on a “predominate economic interest” test that analyzed which party shouldered the most economic risk in the transactions and, therefore, should be deemed the “true lender.”

In Madden, non-bank Midland Funding, LLC, purchased a consumer’s defaulted credit card debt from a national bank located in Delaware.  The New York consumer challenged Midland’s ability to enforce the debt arguing that Midland should not be able to rely on “federal exportation” to circumvent state usury laws since it was not the original lender nor was it a bank.  The Second Circuit Court of Appeals agreed with the consumer and held that preemption of state usury laws under the National Bank Act does not extend to non-bank purchasers of debt. This decision calls into question the “valid-when-made” doctrine, which has historically held that the determination of whether a debt is valid in the hands of a subsequent purchaser is determined based on the circumstances existing when it was made (i.e., according to the original lender’s rights, not the rights of the subsequent purchaser).  In this context, pursuant to that doctrine, the question should be whether the interest rate on the credit card debt was permissible when the credit card debt was created, not whether the current holder, Midland, would be able to charge that interest rate now.

Broad Reaching Implications

The CashCall, Madden, and other related actions threaten the traditional bank partnership model that the financial industry relies on to originate, buy, sell, and transfer loans.  The uncertainty these cases create continues to increase with the expansion of fintech companies that rely heavily, if not exclusively, on their bank partnerships to exist.  Many banks and non-bank lenders have started altering their business models and even pulling out of markets like Colorado for fear of being the next defendant in the UCCC Administrator’s cross-hairs.

Legislative Fix Coming?

There is currently at least one bill pending in the House and Senate that, if passed, would address both the “true lender” issue and the consequences of the Madden decision.

H.R. 4439 (or the “true lender” bill) would amend the Bank Service Company Act, and others, to add language providing that the geographic location of service provider for an insured deposit institution “or the existence of an economic relationship between an insured depository institution and another person shall not affect the determination of the location of such institution under other applicable law.” It would also amend Section 85 of the National Bank Act to add language providing that a loan or other debt made by a national bank and subject to the bank’s rate exportation authority where the national bank “is the party to which the debt is owed according to the terms of the [loan or debt], regardless of any later assignment.”

H.R. 3354 (or the “Madden” bill) would amend the Home Owners’ Loan Act, the Federal Credit Union Act, and the Federal Deposit Insurance Act, which provide rate exportation authority to their respective institutions, to provide that a loan that is made at a valid interest rate remains valid with respect to such rate when the loan is subsequently transferred to a third-party and can be enforced by such third-party even if the rate would not be permitted under state law.

What to Do in the Meantime?

Until a legislative fix occurs, this area of the law will remain unsettled, which will likely lead to additional lawsuits and enforcement actions. As such, banks and non-bank lenders that enter into relationships to facilitate lending programs must be aware of the risks to those programs.  Those risks vary depending on state law remedies available to consumers or regulators upon a finding of a violation of state usury laws or other consumer protection laws.  For instance, in the Kabbage case, relying on remedies under Massachusetts’ criminal usury code, the plaintiffs are seeking an order holding that the underlying loans are void.  In the Avant and Mallette cases, the UCCC Administrator is not requesting that the entire loan be set aside, but is requesting that the court set aside any excess interest rate found to violate Colorado usury law and to award the consumers a civil penalty in the greater amount of the overall finance charge or ten times the amount of the excess charge.

Given the risks, banks and non-bank lenders should evaluate the usury and other relevant consumer protection laws in the states where they offer loans to better understand potential risks in the event of litigation or regulatory action. They should also evaluate their loan programs to ensure that the non-bank participant does not control and fund most of the program and that the bank has risk of loss related to the loans.

Bottom Line: Non-bank lending programs that rely on bank partnerships to enjoy the benefit of the bank’s interest exportation authority is not without risk.  However, the risks can be mitigated through evaluation and modification of lending programs to ensure that the “true lender” is the bank and not the non-bank partner.

An advocacy group, Public Citizen, has requested the SEC to investigate irregularities and inconsistencies in pay ratios reported by public companies. According to the group’s press release:

The letter documents a number of irregularities and inconsistencies in the reported data, highlighting dramatically different reported figures from similar companies in the same industries – companies that have nearly identical business models, numbers of employees and compensation structures. As this is the first time such data has been collected and made available to the public thanks to the SEC’s new pay ratio disclosure rule, Public Citizen is encouraging the division “to exercise appropriate diligence in oversight of this important new disclosure.”

“President Ronald Reagan famously said ‘trust but verify,’ and that’s all we’re asking the SEC to do,” said Bartlett Naylor, financial policy advocate for Public Citizen’s Congress Watch division and author of the letter. “It’s possible that there are reasonable explanations for the discrepancies we found, but it’s also possible that some of the companies fudged their numbers or reported bogus data to mislead the public. The SEC should check the math so we know for sure.”

The group appears to misunderstand the nature of the calculation and disclosure but hopefully it won’t take a great amount of SEC resources to set the record straight. Unfortunately, without much more than arm chair observations, they state that it’s possible some companies “fudged their numbers or reported bogus data to mislead the public.”

 

On March 14, 2018, the Senate passed the Economic Growth, Regulatory Relief and Consumer Protection Act which has been billed as Dodd-Frank reform. Some refer to it as the “Crapo bill”, which is a reference to its sponsor, Republican Michael Crapo from Idaho.

Some characterize the Crapo bill as providing needed regulatory relief for smaller banks while others call it a Wall Street gift.

The future of the bill in the House is uncertain. House Financial Services Committee Chairman Jeb Hensarling (R-TX) is seeking to include a “bucket of bipartisan bills” in the legislation which previously passed the House.  In a TV interview, Representative Hensarling said:

“We have called on the Senate to negotiate. Otherwise, the bill that the Senate passed – which is sitting on the Speaker’s desk – is going to remain on the Speaker’s desk until and unless the Senate negotiates. We are trying to negotiate in good faith. They have to give us some reason –you know, Maxine Waters voted for roughly half the bills we’re trying to negotiate with the Senate….so somebody needs to explain to me why they can’t accept this legislation.”

Some of the provisions Representative Hensarling is seeking to include are discussed in this Forbes article.

The current debate also indicates the Financial Choice Act is doomed, which was sweeping Dodd-Frank reform legislation previously passed by the House on which the Senate never acted.

The Minnesota legislature is on the verge of approving several changes to the Minnesota Business Corporation Act, Chapter 302A of the Minnesota Statutes (the MBCA), in order to modernize the statute and follow the lead of Delaware in several areas. The bill in question passed the Minnesota House of Representatives on March 12th and had its second reading in the Minnesota Senate on March 15th.

Written Actions by Email

A change to Section 302A.011, Subd. 36 makes clear that a written action includes a record “consented to by authenticated electronic communication” by the requisite parties. Under existing law, an authenticated electronic communication includes an electronic communication received by a corporation or an officer of a corporation that “sets forth information from which the corporation can reasonably conclude that the communication was sent by the purported sender.”  Combined, these provisions make clear that a written action could be circulated to board members or shareholders via email and the board members or shareholders could validly consent to the action merely by replying to the email, without going through the hassle of printing and signing a document and sending back a pdf.

Exclusive Forum Bylaws

Minnesota is following the approach reflected in Section 115 of the Delaware General Corporation Law (DGCL) with respect to exclusive forum bylaws, which seek to control the forum in which internal corporate claims may be litigated by shareholders. New Section 302A.191 of the MBCA expressly allows the articles of bylaws of a Minnesota corporation to require that all “internal corporate claims” be brought exclusively in Minnesota courts, and disallows any provision of the articles or bylaws of a Minnesota corporation that would seek to designate a different jurisdiction for the litigation of internal corporate claims.  “Internal corporate claims” are defined to include fiduciary duty claims, all derivative claims, and any claim arising under the MBCA or the corporation’s articles or bylaws.

Pre-Authorization for Share Issuance

New subsection (b) of Section 302A.401 provides board with greater flexibility in approving the issuance of shares. The new language specifically allows a board to pre-authorize the issuance of shares in one or more transactions or at the direction of a person, who need not be a director, so long as certain parameters are described in the authorizing resolution, such as the maximum number of shares that can be issued, the time period during which the shares can be issued, and the minimum consideration that must be received in connection with the issuance of the shares.

Fast Track for Two-Step Mergers

The amendments will also facilitate faster transaction timelines for the two-step merger process used in going-private transactions. At the first step of such transactions, the acquirer launches a tender offer to acquire shares of the public corporation.  Provided that more than 50% of the shares are tendered, the ultimate approval of a subsequent merger with the acquirer is assured.  Nevertheless, under current Minnesota law the corporation would still be required to hold a meeting of the shareholders to vote on the merger and incur all of the cost, expense, and delay associated with producing a proxy statement and holding a meeting.  A new subdivision 4 to Section 302A.613 provides that the second-step merger can be completed without a vote of the shareholders provided that several fairly straight-forward requirements are satisfied.

This significant change ripples through several other sections of the MBCA, as well, such as in Section 302A.473 which now provides the option for a corporation to provide a notice of dissenters’ rights at the initial tender-offer stage in a two-step merger rather than waiting until the subsequent merger to provide the required notice and begin the process of dealing with dissenting shareholders. A first-step tender offer is also excluded from the definition of “takeover offer” in Section 80B.01, Subd. 8, so long as the tender offer was part of a two-step merger plan approved by the board.

Subject to its limits, Rule 701 permits non-reporting companies to grant employees equity without registration under the Securities Act of 1933.  One component of Rule 701 requires certain disclosure materials to be delivered to employees if the aggregate sales price or amount of securities sold during any consecutive 12-month period exceeds $5 million.  Rule 701 provides that for options to purchase securities, the aggregate sales price is determined when an option grant is made (without regard to when the option becomes exercisable).

In a settled enforcement action, the SEC alleged Credit Karma, Inc., which the SEC describes as a “pre-IPO internet-based financial technology company headquartered in San Francisco, California”, blew through the $5 million disclosure limit. Specifically, the SEC alleged “From October 2014 to September 2015, Credit Karma issued approximately $13.8 million in stock options to its employees “ and  “failed to comply with the disclosure requirements of Rule 701, even though senior executives were aware of Rule 701”.

Credit Karma agreed to pay a civil money penalty in the amount of $160,000.  The SEC noted it considered remedial acts promptly undertaken by Credit Karma and cooperation afforded the Commission staff.  Credit Karma did not admit or deny the SEC’s findings.

Cummings v. Eden et al was a case where the Delaware Court of Chancery examined allegations that members of a board of directors breached their fiduciary duties in connection with the approval of an asset acquisition at an unfair price from an entity controlled by an investment group.  The Plaintiff asserted that a majority of the Board were either interested in the transaction or disabled by conflicts arising from various relationships with the founder of an investment group that was also a member of the Board.  Central to the Court’s analysis in analyzing the motion to dismiss was whether to apply the business judgment or entire fairness standard of review.

The Defendants maintained that the Court should review Plaintiff’s claims under the business judgment rule as a result of compliance with Section 144(a)(1) of the Delaware General Corporation Law. Section 144(a)(1) provides as follows:

No contract or transaction between a corporation and 1 or more of its directors or officers, or between a corporation and any other corporation, partnership, association, or other organization in which 1 or more of its directors or officers, are directors or officers, or have a financial interest, shall be void or voidable solely for this reason, or solely because the director or officer is present at or participates in the meeting of the board or committee which authorizes the contract or transaction, or solely because any such director’s or officer’s votes are counted for such purpose, if:

(1) The material facts as to the director’s or officer’s relationship or interest and as to the contract or transaction are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; . . .

In particular, the Defendants argued:

  • approval by a majority of disinterested directors under Section 144(a)(1) triggers review under the business judgment rule;
  • for purposes of applying the safe harbor of Section 144(a)(1), the Court should consider only whether directors are interested in the transaction, and should not be concerned with whether the majority of the board is also independent; and
  • since Plaintiff only challenged three directors on grounds they were interested in the challenged transactions, the majority of the Board met the requirements of Section 144(a)(1) and their decisions must, therefore, be protected as valid business judgments.

While the Court noted that Delaware case law interpreting Section 144(a) was “murky at best”, the Court disagreed with the Defendants’ theory. The interaction between Section 144(a) and the common law business judgment rule must be considered.  Looking to precedent, the Court noted satisfaction of Section 144(a)(1) simply protects against invalidation of the transaction “solely” because it is an interested one and that equitable common law rules requiring the application of the entire fairness standard on grounds other than a director’s interest still apply.

To illustrate the point, the Court quoted Finding Safe Harbor: Clarifying the Limited Application of Section 144 (Del. J. Corp. L. 719, 737– 38 (2008)) which explains:

section 144(a)(1) provides that a covered transaction will not be void or voidable solely as a result of the offending interest if it is approved by an informed majority of the disinterested directors, even though the disinterested directors be less than a quorum. Under the section 144 statutory analysis, so long as there is one informed, disinterested director on the board, and so long as he or she approves the transaction in good faith, the transaction will not be presumptively voidable due to the offending interest. In other words, a nine-member board with a single disinterested director may approve a covered transaction and reap the benefits of the section 144 safe harbor.

Under the common law, however, the factor is somewhat different; approval must be by a disinterested majority of the entire board. That is, a plaintiff may rebut the presumption of the business judgment rule by showing that a majority of the individual directors were interested or beholden. In the common-law analysis, therefore, a transaction approved by the nine-member board discussed above (with the single disinterested director) will be subject to the entire-fairness standard. The standards are phrased similarly for the statutory and common-law analyses, but they are in fact quite different.

Quoting Orman v. Cullman, the Court described the test for overcoming the business judgment presumption at the pleading stage by alleging that the Board acted out of self-interest or with allegiance to interests other than the stockholders’:

As a general matter, the business judgment rule presumption that a board acted loyally can be rebutted by alleging facts which, if accepted as true, establish that the board was either interested in the outcome of the transaction or lacked the independence to consider objectively whether the transaction was in the best interest of its company and all of its shareholders. To establish that a board was interested or lacked independence, a plaintiff must allege facts as to the interest and lack of independence of the individual members of that board. To rebut successfully business judgment presumptions in this manner, thereby leading to the application of the entire fairness standard, a plaintiff must normally plead facts demonstrating that a majority of the director defendants have a financial interest in the transaction or were dominated or controlled by a materially interested director.

In this case, the Court found the Plaintiff plead sufficient facts to overcome the presumption of the business judgment rule at the pleading stage.

In Re Rouse Properties, Inc. Fiduciary Litigation considers what the Delaware Court of Chancery describes as a pattern in the post-Corwin, post-MFW world. The pattern involves post-closing challenges to corporate acquisitions where a less-than-majority blockholder sits on either side of the transaction, but the corporation in which the blockholder owns shares does not recognize her as a controlling stockholder.  Therefore the corporation does not attempt to neutralize her presumptively coercive influence.

The pattern, in its simplest form, according to the Court, consists of two elements:

  • the stockholder plaintiff pleads facts in hopes of supporting a reasonable inference that the minority blockholder is actually a controlling stockholder such that the MFW paradigm is implicated and the Corwin paradigm is not; and
  • failing that, the plaintiff pleads facts in hopes of supporting a reasonable inference that the stockholder vote was uninformed or coerced such that Corwin does not apply.

In this case, Plaintiffs were stockholders of Rouse Properties Inc., which was acquired by Brookfield. Brookfield and its affiliates owned 33.5% of Rouse. Plaintiffs sought to recover damages on behalf of a putative class of Rouse stockholders for alleged breaches of fiduciary duty by Rouse’s directors and Brookfield as a controlling stockholder as a result of the merger.

The Court first examined the claim that Brookfield was a controlling stockholder. The Court noted Corwin cannot protect a board’s determination to recommend a transaction when it is reasonably conceivable that a conflicted controller may have influenced the board and stockholder decisions to approve the transaction. Delaware law recognizes that “controller transactions are inherently coercive,” and that a transaction with a controller “cannot, therefore, be ratified by a vote of the unaffiliated majority.

Under Delaware law, a stockholder is a controller only if she:

  • owns more than 50% of the voting power of a corporation or
  • owns less than 50% of the voting power of the corporation but exercises control over the business affairs of the corporation.

The Court further noted a “minority blockholder” like Brookfield “is not considered to be a controlling stockholder unless it exercises such formidable voting and managerial power that, as a practical matter, it is no differently situated than if it had majority voting control.” The Court stated its “power must be so potent that independent directors cannot freely exercise their judgment, fearing retribution from the controlling minority blockholder.”

The Court did not find that Brookfield was a controlling stockholder after conducting a detailed analysis. Among other reasons, it declined to follow Cysive which was the “most aggressive finding that a minority blockholder was a controlling stockholder.” In Cysive the alleged controller was a combined 40% blockholder and the court was satisfied that the alleged controller could, in his roles as CEO and 40% blockholder, wield “his voting power . . . to elect a new slate [of directors] more to his liking without having to attract much, if any support from public stockholders” in the event he became “dissatisfied with the independent directors.”  Since Brookfield was not a controlling shareholder of Rouse it owed no fiduciary duties to Rouse’s shareholders and the related count in the complaint was dismissed.

The Court next applied Corwin where the Delaware Supreme Court noted the “proposition that when a transaction [is] not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies.”  The Court discussed three types of coercion which could prevent application of the business judgment rule:

  • The notion of “inherent coercion” arises in transactions involving conflicted controlling stockholders. However there was no controller in this case; thus, there is no inherent coercion.
  • “Structural coercion” occurs when the Board structures the vote in a manner that requires stockholders to base their decision on factors extraneous to the economic merits of the transaction at issue. Plaintiffs did not allege or argue that the stockholder vote was structurally defective in this case.
  • “Situational coercion” can arise when the board, by its conduct, creates a situation where “stockholders are being asked to tender shares in ignorance or mistaken belief as to the value of the shares.”

In this case the Plaintiffs’ situational coercion theory was that the Board (and Brookfield) knew that Rouse’s trading price was temporarily depressed when the Brookfield proposal came across the transom. The theory was also based on the notion the Board knew the stock price would be lifted from the trough as soon as Q4 2015 financial results were released to the market. The Court rejected the Plaintiff’s analysis because all of the 2015 financial data was included in the proxy statement.  In addition the stockholders received the Q4 2015 financial results, along with the rest of the public, on February 29, 2016, nearly four months before the June 23, 2016 stockholder vote.

The Plaintiffs’ also failed in their attempt to cast the stockholder vote as uninformed under Corwin because they did not plead “a [material] deficiency in the operative disclosure document.”  The Court noted the materiality of a disclosure was tested by asking whether “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote,” not whether the information at issue “might be helpful.”

The Court did not find any material deficiency in the disclosure documents. Among other things, the Court addressed disclosures regarding a conflict of interest by Rouse’s financial advisor:

It is true that “the [Committee] was obliged to disclose potential conflicts of interest of its financial advisors so that stockholders could decide for themselves what weight to place on a conflict faced by the financial advisor.” The Proxy did just that. It disclosed that Bank of America has provided, currently is providing and may in the future provide “investment banking, commercial banking and other financial services to [Brookfield] for which it has received and may receive compensation.” It further disclosed the aggregate revenues Bank of America received from Brookfield between 2014 and 2016. Finally, it explained that the Committee considered this information before engaging Bank of America but determined that the potential conflicts were not material in the context of the proposed transaction or expected to impair the banker’s ability to perform financial advisory services for the Committee.  With this information in hand, stockholders had more than enough information to evaluate Bank of America’s fitness to serve as the Committee’s financial advisor.

In February 2018 the SEC outlined its views with respect to cybersecurity disclosure requirements under the federal securities laws as they apply to public reporting companies. Set forth below is a checklist of items included in the release that may trigger specific cybersecurity disclosures.

  • Risk Factors: Item 503(c) of Regulation S-K and Item 3.D of Form 20-F require companies to disclose the most significant factors that make investments in the company’s securities speculative or risky. Companies should disclose the risks associated with cybersecurity and cybersecurity incidents if these risks are among such factors, including risks that arise in connection with acquisitions. In meeting their disclosure obligations, companies may need to disclose previous or ongoing cybersecurity incidents or other past events in order to place discussions of these risks in the appropriate context.
  • MD&A of Financial Condition and Results of Operations: Item 303 of Regulation S-K and Item 5 of Form 20-F require a company to discuss its financial condition, changes in financial condition, and results of operations. In this context, the cost of ongoing cybersecurity efforts (including enhancements to existing efforts), the costs and other consequences of cybersecurity incidents (including, but not limited to, immediate costs of the incident, engaging in remediation efforts, and addressing harm to reputation), and the risks of potential cybersecurity incidents, among other matters, could inform a company’s analysis.
  • Description of Business: Item 101 of Regulation S-K and Item 4.B of Form 20-F require companies to discuss their products, services, relationships with customers and suppliers, and competitive conditions. If cybersecurity incidents or risks materially affect a company’s products, services, relationships with customers or suppliers, or competitive conditions, the company must provide appropriate disclosure.
  • Legal Proceedings: Item 103 of Regulation S-K requires companies to disclose information relating to material pending legal proceedings to which they or their subsidiaries are a party. This requirement includes any such proceedings that relate to cybersecurity issues.
  • Financial Statement Disclosures: The Commission expects that a company’s financial reporting and control systems would be designed to provide reasonable assurance that information about the range and magnitude of the financial impacts of a cybersecurity incident would be incorporated into its financial statements on a timely basis as the information becomes available.
  • Board Risk Oversight: Item 407(h) of Regulation S-K and Item 7 of Schedule 14A require a company to disclose the extent of its board of directors’ role in the risk oversight of the company, such as how the board administers its oversight function and the effect this has on the board’s leadership structure. To the extent cybersecurity risks are material to a company’s business, the SEC believes this discussion should include the nature of the board’s role in overseeing the management of that risk including disclosures regarding a company’s cybersecurity risk management program and how the board of directors engages with management on cybersecurity issues.
  • Disclosure Controls and Procedures: Companies should assess whether they have sufficient disclosure controls and procedures in place to ensure that relevant information about cybersecurity risks and incidents is processed and reported to the appropriate personnel, including up the corporate ladder, to enable senior management to make disclosure decisions and certifications and to facilitate policies and procedures designed to prohibit directors, officers, and other corporate insiders from trading on the basis of material nonpublic information about cybersecurity risks and incidents.
  • Certifications. Exchange Act Rules 13a-14 and 15d-14 require a company’s principal executive officer and principal financial officer to make certifications regarding the design and effectiveness of disclosure controls and procedures, and Item 307 of Regulation S-K and Item 15(a) of Exchange Act Form 20-F require companies to disclose conclusions on the effectiveness of disclosure controls and procedures. These certifications and disclosures should take into account the adequacy of controls and procedures for identifying cybersecurity risks and incidents and for assessing and analyzing their impact. In addition, to the extent cybersecurity risks or incidents pose a risk to a company’s ability to record, process, summarize, and report information that is required to be disclosed in filings, management should consider whether there are deficiencies in disclosure controls and procedures that would render them ineffective.

As emphasized in the SEC’s guidance, the materiality of cybersecurity risks or incidents remains the primary guidepost for disclosure. In this context, issuers must assess the nature, extent, and potential magnitude of risks and incidents, particularly as they relate to any compromised information or the business and scope of company operations. The materiality of cybersecurity risks and incidents also depends on the range of harm that such incidents could cause to, for example, a company’s reputation, financial performance, and customer and vendor relationships, as well as the possibility of litigation or regulatory investigations or actions, including regulatory actions by state and federal governmental authorities and non-U.S. authorities.