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

Among other things, SEC Staff Legal Bulleting No. 14I provides guidance on excluding images from shareholder proposals. SLB14I provides the Division of Corporation Finance’s view that, consistent with recent no-action letter precedent, the use of images or graphs in shareholder proposals is appropriate. However, SLB14I simultaneously invites issuers to seek exclusion of graphs and/or images under Rule 14a-8(i)(3) where they:

  • make the proposal materially false or misleading;
  • render the proposal inherently vague or indefinite;
  • directly or indirectly impugn character or make charges of improper, illegal, or immoral conduct, without factual foundation; or
  • are irrelevant to a consideration of the subject matter of the proposal.

SLB14I also notes that exclusion would also be appropriate under Rule 14a-8(d) if the total number of words in a proposal, including words in the graphics, exceeds 500.

Ford Motor Company seeks to exclude (assuming the SEC staff does not grant no action relief stating the proposal may be excluded on other grounds) a blurry image of a man that Ford states is presented without context.  According to Ford the image is irrelevant to the subject matter of the proposal.

Likewise, General Electric Company seeks to exclude images it describes as nonsensical in a proposal related to cumulative voting. The images include a line of text that appears to address two stock transactions by “Immelt” (the Company’s former chief executive officer), one in which each dollar invested returns approximately $7.65 and a second in which each dollar invested returns approximately $2.14.  GE states there is no clear connection to how alleged historical securities transactions could be available to shareowners through adoption of cumulative voting. The images should therefore be excluded because they are irrelevant, among other reasons.  GE also argues exclusion of the entire proposal and supporting statements is appropriate when detailed and extensive editing would be necessary in order to bring the proposal and supporting statements into compliance with the proxy rules.

ISS has published updates of the following documents:

As has been ISS’ practice in recent years, new and materially updated FAQs are highlighted in yellow.

The Delaware Supreme Court has reversed the Court of Chancery’s appraisal decision in Dell, Inc. v. Magnestar Global Event Driven Master Fund Ltd. et al.  The Chancery Court had found that fair value was 28% above the deal price.

In the 82 page decision, the Delaware Supreme Court noted that the trial court lacked a valid basis for finding a “valuation gap” between Dell’s market and fundamental value. The Court noted the record showed just the opposite: analysts scrutinized Dell’s long-range outlook when evaluating the Company and setting price targets, and the market was capable of accounting for Dell’s recent mergers and acquisitions and their prospects in its valuation of the Company.

The Court also rejected the Chancery’s Court finding that the lack of strategic bidders was a credible reason for disregarding the deal price. The Court noted that DFC Global Corp. v Muirfield Value Partners, L.P. et al stood for the proposition that the notion of a “private equity carve out” stood on especially shaky footing where other objective indicia suggested the deal price was a fair price.  The Court stated it was clear that Dell’s sale process bore many of the same objective indicia of reliability that it found persuasive enough to diminish the resonance of any private equity carve out or similar such theory in DFC.  Nothing in the record suggested that increased competition would have produced a better result.

Finally the Court noted that features of management buy-outs which can undermine the probative value of the deal price were not present in the Dell sales process. The Court discussed the “winner’s curse” theory which is based on the premise that in outbidding incumbent management to “win” a deal, a buyer likely overpays for the company because management would presumably have paid more if the company were really worth it.  Essentially, a “winner’s curse” theory undermines the utility of a contractual go-shop period.  According to the Court, the likelihood of a winner’s curse can be mitigated through a due diligence process where buyers have access to all necessary information.  Here, Dell allowed a sophisticated go-shop bidder to undertake “extensive due diligence,” diminishing the “information asymmetry” that might otherwise facilitate a winner’s curse.

In a recent decision by the Delaware Supreme Court in In re Investors Bancorp Stockholders Litigation, the court found that director equity grants based on director discretion are subject to an entire fairness standard of review irrespective of whether stockholders have previously approved the equity incentive plan.

According to the court, “when stockholders have approved an equity incentive plan that gives the directors discretion to grant themselves awards within general parameters, and a stockholder properly alleges that the directors inequitably exercised that discretion, then the ratification defense is unavailable to dismiss the suit, and the directors will be required to prove the fairness of the awards to the corporation.”

Accordingly, the Delaware Supreme Court reversed the Court of Chancery’s decision which found that the stockholder ratification defense applied because the plan provided for “meaningful, specific limits on awards to all director beneficiaries.” The Court of Chancery had reasoned that the stockholders’ approval of the plan reflected their ratification of all of the specific awards later approved by the board. Hence, the Court of Chancery found that the director grants should be subject to the business judgment standard of review.

From the Delaware Supreme Court (citations omitted):

[D]irector action is “twice-tested,” first for legal authorization, and second by equity. When stockholders approve the general parameters of an equity compensation plan and allow directors to exercise their “broad legal authority” under the plan, they do so “precisely because they know that that authority must be exercised consistently with equitable principles of fiduciary duty.” The stockholders have granted the directors the legal authority to make awards. But, the directors’ exercise of that authority must be done consistent with their fiduciary duties. Given that the actual awards are self-interested decisions not approved by the stockholders, if the directors acted inequitably when making the awards, their “inequitable action does not become permissible simply because it is legally possible” under the general authority granted by the stockholders.

The Delaware Supreme Court’s decision implies that directors will be entitled to a ratification defense and the business judgment standard of review in only the following situations:

  • When the directors submit their specific compensation decisions for approval by fully informed, uncoerced, and disinterested stockholders
  • When stockholders approve self-executing plans, meaning plans that make awards over time based on fixed criteria, with the specific amounts and terms approved by the stockholders

It is worth noting that the equity plan under which the director grants were made provided directors a considerable amount of latitude in making awards. The directors could allocate to non-employee directors, in a single year or over multiple years, up to 30 percent of all of the options and restricted stock available under the plan.

We surmise that the decision will result in increased litigation regarding equity grants and perhaps other compensation provided to directors. While practice and the understanding of the decision will evolve over time, public companies, even those whose shareholders have approved compensation plans with well-considered, specific limits for directors, should nevertheless make sure that equity grants to directors are based on a developed record and supported by the facts to demonstrate fairness.

 

The NYSE has filed a proposed rule with the SEC to amend the NYSE Listed Company Manual to modify requirements with respect to delivery of proxy materials to the NYSE.  Currently Section 204.00(B) of the Manual requires listed companies to provide six hard copies of proxy materials not later than the date on which the material is physically or electronically delivered to shareholders. Section 402.01 of the Manual currently requires listed companies to provide three definitive copies of the proxy material (together with proxy card) not later than the date on which such material is sent, or given, to any security holders.

The NYSE proposes to delete from Section 204.00(B) a provision stating that listed companies are required to file hard copies of certain SEC reports and other material (such as proxies) with the NYSE. In addition, the Exchange proposes to modify Section 204.00(B) to require companies to send hard copy proxy materials to the Exchange only:

  • in the circumstances specified by revised Section 402.01 as discussed below, and
  • one hard copy of any filing that is not required to be filed through EDGAR, such as pursuant to a hardship exemption granted by the SEC.

The NYSE also proposes to amend Section 402.01 to provide that listed companies will not be required to provide proxy materials to the NYSE in physical form, provided the proxy materials are included in an SEC filing available on the SEC’s EDGAR filing system. Any listed company whose proxy materials are available on EDGAR but not filed pursuant to Schedule 14A under the Act will be required to provide the NYSE information sufficient to identify such filing by designated means not later than the date on which such material is sent, or given, to any security holders. In addition, any listed company whose proxy materials are not included in their entirety (together with proxy card) in an SEC filing available on EDGAR will continue to be required to provide three physical copies of any proxy material not available on EDGAR to the NYSE not later than the date on which such material is sent, or given, to any security holders.

 

The SEC charged a biopharmaceutical company with committing a series of accounting controls and disclosure violations, including the failure to properly report as compensation millions of dollars in perks provided to its then-CEO and then-CFO.

According to the SEC, Tennessee-based Provectus lacked sufficient controls surrounding the reporting and disclosure of travel and entertainment expenses submitted by its executives. The order alleges that Provectus’ former CEO, Dr. H. Craig Dees, obtained millions of dollars from the company using limited, fabricated, or non-existent expense documentation, and that these unauthorized perks and benefits were not disclosed to investors.  Provectus’ former CFO, Peter R. Culpepper, also allegedly obtained $199,194 in unauthorized and undisclosed perks and benefits.

The SEC separately charged Dees in federal district court in Knoxville, Tennessee, alleging that, while Dees was Provectus’ CEO, he treated the company “as his personal piggy bank.” According to the complaint, Dees submitted hundreds of falsified records to Provectus to obtain $3.2 million in cash advances and reimbursements for business travel he never took.  Instead, he concealed the perks and used cash advances to pay for personal expenses such as cosmetic surgery for female friends, restaurant tips, and personal travel.  No court has found Dees committed wrongdoing as of this date.

In a separate SEC order, Culpepper agreed to pay $152,376 in disgorgement and interest, a civil penalty, and to be suspended from appearing and practicing before the SEC as an accountant, which includes not participating in the financial reporting or audits of public companies. The SEC’s order permits Culpepper to apply for reinstatement after three years.

The SEC’s settlement with Provectus did not include any penalty. This took into account the proactive remediation and cooperation by the company’s new leadership.  Steps the company took included:

  • the Audit Committee retaining independent outside counsel and a forensic accounting firm to conduct an investigation;
  • the company replacing its Chief Financial Officer and Interim Chief Executive Officer;
  • instituting legal action or other steps to collect repayments from its Chief Executive Officer and Chief Financial Officer;
  • hiring a Chief Operations Consultant and a Controller, both new positions;
  • replacing the firms that provided or assisted with bookkeeping and internal audit and controls testing; and
  • implementing new internal control procedures and policies concerning travel and expense reimbursement.

Further, following its investigation of Dees’ travel expenses, a Special Committee of Provectus’ Board, utilized independent counsel and a forensic accounting firm, and reviewed executive expenses in general, and then devoted several months to investigate Culpepper’s travel expenses. Provectus voluntarily shared the results and details of the Audit Committee’s and Special Committee’s investigations, which the SEC said reduced the time and resources necessary for the Commission staff to conclude the investigation.

In a somewhat similar enforcement action, the SEC required the issuer to pay a civil money penalty in the amount of $750,000.

Provectus and Culpepper did not admit or deny the SEC’s findings in the SEC orders.

 

Munchee Inc., a California-based company selling digital tokens to investors to raise capital for its blockchain-based food review service halted its initial coin offering (ICO) after being contacted by the SEC. Munchee Inc. agreed to an order in which the SEC found that its conduct constituted unregistered securities offers and sales.  The announcement of the settlement was followed by a statement of SEC Chair Jay Clayton, where he gave his views on certain aspects of ICOs.

Munchee Inc. Order

According to the order:

  • Munchee offered and sold MUN tokens in a general solicitation that included potential investors in the United States. Investors paid Ether or Bitcoin to purchase their MUN tokens. Such investment is the type of contribution of value that can create an investment contract.
  • MUN token purchasers had a reasonable expectation of profits from their investment in the Munchee enterprise. The proceeds of the MUN token offering were intended to be used by Munchee to build an “ecosystem” that would create demand for MUN tokens and make MUN tokens more valuable. Munchee was to revise a Munchee App so that people could buy and sell services using MUN tokens and was to recruit “partners” such as restaurants willing to sell meals for MUN tokens. The investors reasonably expected they would profit from any rise in the value of MUN tokens created by the revised Munchee App and by Munchee’s ability to create an “ecosystem” – for example, the system described in the offering where restaurants would want to use MUN tokens to buy advertising from Munchee or to pay rewards to app users, and where app users would want to use MUN tokens to pay for restaurant meals and would want to write reviews to obtain MUN tokens. In addition, Munchee highlighted that it would ensure a secondary trading market for MUN tokens would be available shortly after the completion of the offering and prior to the creation of the ecosystem. Like many other instruments, the MUN token did not promise investors any dividend or other periodic payment. Rather, as indicated by Munchee and as would have reasonably been understood by investors, investors could expect to profit from the appreciation of value of MUN tokens resulting from Munchee’s efforts.
  • Investors’ profits were to be derived from the significant entrepreneurial and managerial efforts of others – specifically Munchee and its agents – who were to revise the Munchee App, create the “ecosystem” that would increase the value of MUN (through both an increased demand for MUN tokens by users and Munchee’s specific efforts to cause appreciation in value, such as by burning MUN tokens), and support secondary markets. Investors had little choice but to rely on Munchee and its expertise. At the time of the offering and sale of MUN tokens, no other person could make changes to the Munchee App or was working to create an “ecosystem” to create demand for MUN tokens.
  • Investors’ expectations were primed by Munchee’s marketing of the MUN token offering. To market the MUN token offering, Munchee and its agents created the Munchee Website and a MUN White Paper and then posted on message boards, social media and other outlets. They described how Munchee would revise the Munchee App and how the new “ecosystem” would create demand for MUN tokens. They likened MUN to prior ICOs and digital assets that had created profits for investors, and they specifically marketed to people interested in those assets – and those profits – rather than to people who, for example, might have wanted MUN tokens to buy advertising or increase their “tier” as a reviewer on the Munchee App. Because of the conduct and marketing materials of Munchee and its agents, investors would have had a reasonable belief that Munchee and its agents could be relied on to provide the significant entrepreneurial and managerial efforts required to make MUN tokens a success.
  • Even if MUN tokens had a practical use at the time of the offering, it would not preclude the token from being a security. Determining whether a transaction involves a security does not turn on labelling – such as characterizing an ICO as involving a “utility token” – but instead requires an assessment of “the economic realities underlying a transaction.”
  • Munchee offered and sold securities to the general public, including potential investors in the United States, and actually sold securities to about 40 investors. No registration statements were filed or in effect for the MUN token offers and sales and no exemptions from registration were available.
  • On November 1, 2017, Munchee stopped selling MUN tokens hours after being contacted by SEC staff. Munchee had not delivered any tokens to purchasers, and the company promptly returned to purchasers the proceeds that it had received.
  • Munchee and the investors entered into a contract of sale for MUN in which investors were irrevocably bound. Munchee unilaterally terminated the contracts of sale, returning the money to investors. Any offer by Munchee to buy the investors’ securities would have required registration of the transaction or an exemption from registration.
  • Munchee did not admit or deny the findings in the SEC order.

Statement of SEC Chair Jay Clayton

In his statement, SEC Chair Clayton offered warnings to Main Street investors contemplating participating in ICOs. Much of the statement was directed at professionals involved in ICOs.  According to Chair Clayton (emphasis in original):

  • Certain market professionals have attempted to highlight utility characteristics of their proposed initial coin offerings in an effort to claim that their proposed tokens or coins are not securities. Many of these assertions appear to elevate form over substance. Merely calling a token a “utility” token or structuring it to provide some utility does not prevent the token from being a security. Tokens and offerings that incorporate features and marketing efforts that emphasize the potential for profits based on the entrepreneurial or managerial efforts of others continue to contain the hallmarks of a security under U.S. law. On this and other points where the application of expertise and judgment is expected, I believe that gatekeepers and others, including securities lawyers, accountants and consultants, need to focus on their responsibilities. I urge you to be guided by the principal motivation for our registration, offering process and disclosure requirements: investor protection and, in particular, the protection of our Main Street investors.
  • I also caution market participants against promoting or touting the offer and sale of coins without first determining whether the securities laws apply to those actions. Selling securities generally requires a license, and experience shows that excessive touting in thinly traded and volatile markets can be an indicator of “scalping,” “pump and dump” and other manipulations and frauds. Similarly, I also caution those who operate systems and platforms that effect or facilitate transactions in these products that they may be operating unregistered exchanges or broker-dealers that are in violation of the Securities Exchange Act of 1934.
  • By and large, the structures of initial coin offerings that I have seen promoted involve the offer and sale of securities and directly implicate the securities registration requirements and other investor protection provisions of our federal securities laws. Generally speaking, these laws provide that investors deserve to know what they are investing in and the relevant risks involved.
  • I have asked the SEC’s Division of Enforcement to continue to police this area vigorously and recommend enforcement actions against those that conduct initial coin offerings in violation of the federal securities laws.

 

On December 7, 2017, the U.S. House of Representatives passed the “Small Business Mergers, Acquisitions, Sales and Brokerage Simplification Act of 2017 (H.R. 477).” The bipartisan bill passed the House by a vote of 426-0.

The bill seeks to exempt certain brokers who facilitate the merger or acquisition of small businesses, also known as M&A brokers, from SEC registration under the broker registration provisions in Section 15(b) of the Securities Exchange Act of 1934. M&A brokers have already enjoyed de facto exempt status from registration under Section 15(b) pursuant to a SEC No Action letter from 2014, but the new Act goes one step further in seeking to provide a codified exemption.

The bill contains a plethora of exceptions and restrictions on the conduct of M&A brokers in order to satisfy the exemption, including disqualification provisions for “bad actors.” The Act defines “M&A Broker” as:

  • any broker engaged in the business of effecting securities transactions solely in connection with the transfer of ownership of an eligible privately held company, through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the eligible privately held company, if the broker reasonably believes that—
    • upon consummation of the transaction, any person acquiring securities or assets of the eligible privately held company, acting alone or in concert, will control and, directly or indirectly, will be active in the management of the eligible privately held company or the business conducted with the assets of the eligible privately held company; and
    • if any person is offered securities in exchange for securities or assets of the eligible privately held company, such person will, prior to becoming legally bound to consummate the transaction, receive or have reasonable access to the most recent fiscal year-end financial statements of the issuer of the securities as customarily prepared by the management of the issuer in the normal course of operations and, if the financial statements of the issuer are audited, reviewed, or compiled, any related statement by the independent accountant, a balance sheet dated not more than 120 days before the date of the offer, and information pertaining to the management, business, results of operations for the period covered by the foregoing financial statements, and material loss contingencies of the issuer.

The bill defines an “eligible private company” as one (i) without a class of securities registered pursuant to Section 12 of the Exchange Act and (ii) has gross revenues under $250 million or EBITDA of less than $25 million in the year preceding that in which the M&A broker’s services are first used. The bill would also:

  • Require an M&A broker that represents both the seller and buyer to provide them with written disclosures and obtain consent to that conflict of interest;
  • Prohibit M&A brokers from using the exemption to raise capital, rather than transfer ownership of small businesses; and
  • Prohibit shell companies from using the exemption.

Read the full text of the bill here.

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ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 100 largest firms in the U.S., Stinson Leonard Street has offices in 13 cities, including Minneapolis, Mankato and St. Cloud, MN; Kansas City, St. Louis and Jefferson City, MO; Phoenix, AZ.; Denver, CO; Washington, D.C.; Decatur, IL; Wichita, KS; Omaha, NE; and Bismarck, ND.

Drew Kuettel is a member of the firm’s corporate finance group.

 

The SEC has approved the NYSE’s proposal to amend Section 202.06 of the Listed Company Manual to prohibit listed companies from issuing material news after the official closing time for the NYSE’s trading session until the earlier of:

  • publication of such company’s official closing price on the Exchange, or
  • five minutes after the NYSE’s official closing time.

However, the approved rule includes an exception for publicly disclosing material information following a non-intentional disclosure in order to comply with Regulation FD.

The rule specifies the official closing time is typically 4:00 P.M. Eastern Time, except for certain days on which the official closing time occurs early at 1:00 P.M. Eastern Time.

The change was made to reduce the likelihood of investor confusion that could result if material news is issued prior to the completion of the NYSE’s closing auction but while trading is continuing on other markets.

 

The SEC has approved the PCAOB’s standard regarding the communication of critical audit matters for public companies, referred to as CAMs, which will provide information in the audit report about matters arising from the audit that required especially challenging, subjective, or complex auditor judgment, and how the auditor responded to those matters. CAMs will be required to be included in audit reports for large accelerated files for fiscal years ending on or after June 30, 2019. CAMs will be required to be included in audit reports for most other issuers for fiscal years ending on or after December 15, 2020. Auditors may elect to comply with the new standard before the effective date.

Debate has ensued on what public companies can or should do to prepare for the new PCAOB standard and whether CAMs will be common place, how many CAMs a company can expect and like topics.

In addition to preparing the audit committee regarding potential CAMs, public companies should consider the effect of potential CAMs on M&A activity. For companies looking to be acquired, potential CAMs will likely become a subject of due diligence inquiries prior to the effective date.  CAMs may also be a topic for companies subject to activist investor campaigns.  Likewise, public companies looking to issue stock in acquisition transactions may receive due diligence inquiries about their potential CAMs as well.