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

In a Presidential Memorandum, President Trump directed the Secretary of the Treasury, as a member of the Financial Stability Oversight Council, not to cast a nonemergency vote to subject nonbank financial companies to enhanced regulation or to designate any financial market utilities as systematically important for a period of 180 days.  The Presidential Memorandum also directs the Secretary of Treasury to undertake a thorough review of the related FSOC determination and designation processes under the Dodd-Frank Act and to report to the President.

In a separate Presidential Memorandum, President Trump directed the Secretary of Treasury not to exercise powers under the Dodd-Frank Act to place a financial company in receivership and initiate liquidation because it is in default or in danger of default and its failure and resolution would have serious adverse effects on financial stability in the United States, among other considerations for a period of 180 days. The Presidential Memorandum also directs the Secretary of Treasury to review and report to the President on the so-called orderly liquidation authority, including whether a new chapter in the U.S. Bankruptcy Code, in which the claims against a failed financial company would be resolved pursuant to the procedures of bankruptcy law rather than the provisions of the Dodd-Frank Act, would be a superior method of resolution for financial companies.

In what seems to be a bow to the Trump Administration, FINRA has issued Regulatory Notice 17-14 which broadly seeks comments on FINRA rules that impact capital formation. Specific rules FINRA is seeking comment on include:

  • Capital Acquisition Broker Rules
  • Funding Portal Rules
  • Rule 2241 (Research Analysts and Research Reports)
  • Rule 2242 (Debt Research Analysts and Debt Research Reports)
  • Rule 2310 (Direct Participation Programs)
  • Rule 5110 (Corporate Financing Rule – Underwriting Terms and Arrangements)
  • Rule 5121 (Public Offerings of Securities With Conflicts of Interest)
  • Rule 5122 (Private Placement of Securities Issued by Members)
  • Rule 5123 (Private Placements of Securities)
  • Rule 5130 (Restrictions on the Purchase and Sale of Initial Public Equity Offerings)
  • Rule 5131 (New Issue Allocations and Distributions)
  • Rule 5141 (Sale of Securities in a Fixed Price Offering)
  • Rule 5150 (Fairness Opinions)
  • Rule 5160 (Disclosure of Price and Concessions in Selling Agreements)
  • Rule 5190 (Notification Requirements for Offering Participants)
  • Rule 5250 (Payments for Market Making)
  • Rule 6432 (Compliance with the Information Requirements of SEA Rule 15c2-11)
  • Trading Activity Fee (TAF)

Separately, in Regulatory Notice 17-15, FINRA is seeking comment on Rule 5110, known as the Corporate Financing Rule. Rule 5110 prohibits unfair underwriting arrangements in connection with the public offering of securities. The rule requires a FINRA member that participates in a public offering to file information with FINRA about the underwriting terms and arrangements. FINRA’s Corporate Financing Department reviews this information prior to the commencement of the offering to determine whether the underwriting compensation and other terms and arrangements meet the requirements of the applicable FINRA rules.

Some of the aspects of the proposed rule include:

  • FINRA is proposing to allow members more time to make the required filings with FINRA (from one business day after filing with the SEC or state equivalent to three business days).
  • The SEC’s Regulation S-K requires fees and expenses identified by FINRA as underwriting compensation to be disclosed in the prospectus. FINRA is proposing to modify the underwriting compensation disclosure requirements. Although the proposal would continue to require that a description of each item of underwriting compensation be disclosed, it would no longer require the disclosure to include the dollar amount ascribed to each individual item of compensation. FINRA is proposing to permit a firm to disclose the maximum aggregate amount of all underwriting compensation, except the discount or commission that must be disclosed on the cover page of the prospectus.
  • FINRA is proposing to clarify what is considered underwriting compensation for purposes of Rule 5110.
  • Subject to some exceptions, Rule 5110 requires a 180-day lock-up restriction on securities that are considered underwriting compensation. Because a prospectus may become effective long before the commencement of sales, FINRA proposes that the lock-up period begin on the date of commencement of sales (rather than the date of effectiveness of the prospectus).
  • Rule 5110 currently prescribes specific calculations for valuing convertible and nonconvertible securities received as underwriting compensation. However, applying these calculations can be time and resource intensive for both firms and FINRA. Rather than the specific calculations currently in the rule, FINRA is proposing in the Supplementary Material to instead allow valuing options, warrants and other convertible securities received as underwriting compensation based on a securities valuation method that is commercially available and appropriate for the type of securities to be valued (e.g., the Black-Scholes model for options).
  • FINRA is proposing to clarify the list of prohibited terms and arrangements in connection with a public offering of securities and eliminate from the list the prohibition of a nonaccountable expense reimbursement in excess of 3 percent of the offering proceeds.

The House Financial Services Committee has released a discussion draft of a revised Financial Choice Act. The Committee will hold a hearing on the Act on April 26, 2017.

Section 845 of the Act would prohibit the SEC from requiring the use of a universal proxy. It states “The Commission may not require that a solicitation of a proxy, consent, or authorization to vote a security of an issuer in an election of members of the board of directors of the issuer be made using a single ballot or card that lists both individuals nominated by (or on behalf of) the issuer and individuals nominated by (or on behalf of) other proponents.”

Section 844 of the Act would drastically alter the shareholder proposal rules. The Act would require the SEC to eliminate the option to satisfy the holding requirement by holding a certain dollar amount, require the shareholder proponent to hold one percent of the issuer’s voting securities and increase the holding period from one year to three years.  It would also increase thresholds for resubmission of proposals.

Interestingly, the Act would prohibit the common practice of having a proxy submit a proposal on behalf of a shareholder. One would hope, if passed, coaching from the sidelines by those frequently granted proxies today would be interpreted as the unauthorized practice of law.

You can find an extract of the two provisions discussed above here. The full 593 pages of the discussion draft can be found here. It’s worth a look.

The FTC explained it was undertaking the following regulatory reform steps in a press release:

  • New groups within the Bureau of Competition and the Bureau of Consumer Protection are working to streamline demands for information in investigations to eliminate unnecessary costs to companies and individuals who receive them.
  • Both enforcement Bureaus are reviewing their dockets and closing older investigations, where appropriate.
  • The entire agency continues to work to identify unnecessary regulations that are no longer in the public interest.
  • The Bureau of Consumer Protection is actively reviewing closed data security investigations to extract key lessons for improved guidance and transparency.
  • The Bureaus of Consumer Protection and Economics are working together to integrate economic expertise even earlier in FTC investigations to better inform agency decisions about the consumer welfare effects of enforcement actions.
  • Acting Chairman Ohlhausen has established a new capability within her office to collect and review ideas on process streamlining and operational efficiency opportunities from across the agency.

In Re Paramount Gold And Silver Corp. Stockholders Litigation examines the interaction of Corwin, Unocal and deal protection measures.  At issue was a Merger Agreement which provided for Coeur Mining, Inc. to acquire all of the outstanding shares of Paramount Gold and Silver Corporation’s common stock after Paramount spun off its Nevada assets into SpinCo. Upon completion of the Merger, Paramount would become a wholly owned subsidiary of Coeur. Paramount stockholders would receive 0.2016 of a share of Coeur common stock in exchange for each share of Paramount common stock. They also would receive a pro rata share of a 95.1% interest in SpinCo. Coeur would provide SpinCo with $10 million in cash and hold the remaining 4.9% interest in SpinCo.

On the same day Paramount and Coeur entered into the Merger Agreement, Paramount and certain of its subsidiaries entered into a Royalty Agreement concerning a project located in Mexico, referred to as the San Miguel Project, with a wholly-owned subsidiary of Coeur. Under the Royalty Agreement, Coeur Mexicana would receive a perpetual royalty “privileged and preferential in payment” of 0.7% of the net smelter returns from the sale or other disposition of productions produced from the San Miguel properties in exchange for a payment of $5.25 million.

Over 54% of Paramount’s outstanding common stock voted to approve the Merger Agreement. The Court noted in Corwin v. KKR Financial Holdings LLC, the Delaware Supreme Court explained “when a transaction 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 plaintiffs contended Corwin did not apply because the combined effect of the termination fee in the Merger Agreement and of certain provisions in the Royalty Agreement constituted a “preclusive and per se unreasonable” deal protection device “rendering the vote coerced.”

The Court observed that deal protection devices ordinarily should be reviewed under the Unocal enhanced judicial scrutiny standard.  The defendants claimed that the Unocal standard did not apply because the Merger was approved by a fully informed and uncoerced vote of a majority of Paramount’s disinterested stockholders. Plaintiffs claimed that this position could not be squared with the Delaware Supreme Court’s earlier decision in In re Santa Fe Pacific Corporation Shareholder Litigation. Santa Fe held, in the context of a post-closing challenge, that a fully informed stockholder vote approving a merger did not preclude review of certain deal protection devices under Unocal. The Court stated the Supreme Court in Corwin did not discuss or expressly overrule this aspect of Santa Fe. The Court decided it did not need to reconcile Corwin and Santa Fe because it was apparent the provisions challenged by Plaintiff did not constitute an unreasonable deal protection device.

The plaintiffs conceded that the $5 million termination fee in the Merger Agreement—representing 3.42% of the estimated value of the Merger excluding SpinCo, and about 2.72% of the estimated value of the overall transaction including SpinCo—was not unreasonable by itself. The ultimate question was whether the termination fee, when coupled with provisions of the Royalty Agreement, were unreasonable.  The Court examined the Royalty Agreement and determined that was not the case, as the Royalty Agreement was not a deal protection mechanism.

Important to the Court’s reasoning was a superior bidder did not have any obligation to buy out Coeur’s royalty interest in the San Miguel Project in order to propose or consummate a transaction with Paramount. A potential bidder could simply acquire Paramount subject to the Royalty Agreement.

Plaintiffs argued that Coeur could use the Royalty Agreement to block Paramount from entering into an alternative transaction because a competing offer would require the consent of Coeur under a change of control provision. The Court rejected this reasoning, because the Royalty Agreement only referred to a change of control of Paramount’s subsidiaries, and not Paramount itself.  The Court similarly rejected that a topping bid would violate an anti-assignment provision in the Royalty Agreement, because the properties referred to in the Royalty Agreement were again owned by Paramount’s subsidiaries, and not Paramount itself.

The Court concluded that the Royalty Agreement was not a deal protection device because Coeur did not have a “block right” under the Royalty Agreement to veto an alternative transaction to the Merger. Because the plaintiffs conceded that the $5 million termination fee in the Merger Agreement alone was not an unreasonable deal protection device, plaintiffs’ assertion that defendants adopted unreasonable deal protection devices in connection with the Merger failed to state a claim for relief.

The Court then rejected several alleged disclosure violations, noted that the business judgment rule applied under Corwin, and that the Complaint must be dismissed for failure to state a claim.

The SEC announced enforcement actions against 27 individuals and entities behind various alleged stock promotion schemes that left investors with the impression they were reading independent, unbiased analyses on investing websites while writers were being secretly compensated for touting company stocks.

The SEC filed fraud charges against three public companies and seven stock promotion or communications firms as well as two company CEOs, six individuals at the firms, and nine writers. Of those charged, 17 have agreed to settlements that include disgorgement or penalties ranging from approximately $2,200 to nearly $3 million based on frequency and severity of their actions.  The SEC’s litigation continues against 10 others.

SEC investigations uncovered scenarios in which public companies hired promoters or communications firms to generate publicity for their stocks, and the firms subsequently hired writers to publish articles that did not publicly disclose the payments from the companies. The writers allegedly posted bullish articles about the companies on the internet under the guise of impartiality when in reality they were nothing more than paid advertisements.  More than 250 articles specifically included false statements that the writers had not been compensated by the companies they were writing about, the SEC alleges.

According to the SEC’s orders as well as a pair of complaints filed in federal district court, deceptive measures were often used to hide the true sources of the articles from investors. For example, one writer wrote under his own name as well as at least nine pseudonyms, including a persona he invented who claimed to be “an analyst and fund manager with almost 20 years of investment experience.”  One of the stock promotion firms went so far as to have some writers it hired sign non-disclosure agreements specifically preventing them from disclosing compensation they received.

Effective immediately, the SEC staff has relaxed conflict minerals reporting requirements by public companies. The change was triggered by the entry of a final judgment in the conflict minerals case.

SEC Guidance

The SEC staff took the action because of uncertainties surrounding the constitutionality of Item 1.01(c) of Form SD. Under the new guidance, Item 1.01(c) reporting is no longer required.  Item 1.01(c) of Form SD requires a public company to conduct detailed and costly due diligence on its supply chain if a less costly reasonable country of origin inquiry determines “if the registrant knows that any of its necessary conflict minerals originated in the Democratic Republic of the Congo or an adjoining country and are not from recycled or scrap sources, or has reason to believe that its necessary conflict minerals may have originated in the Democratic Republic of the Congo or an adjoining country and has reason to believe that they may not be from recycled or scrap sources.”

Specifically, the SEC staff stated:

“[T]he Division of Corporation Finance has determined that it will not recommend enforcement action to the Commission if companies, including those that are subject to paragraph (c) of Item 1.01 of Form SD, only file disclosure under the provisions of paragraphs (a) and (b) of Item 1.01 of Form SD. This statement is subject to any further action that may be taken by the Commission, expresses the Division’s position on enforcement action only, and does not express any legal conclusion on the rule.

Acting SEC Acting Chairman Michael S. Piwowar explained the rational for the staff position:

The primary function of the extensive and costly requirements for due diligence on the source and chain of custody of conflict minerals set forth in paragraph (c) of Item 1.01 of Form SD is to enable companies to make the disclosure found to be unconstitutional.

In light of the foregoing regulatory uncertainties, until these issues are resolved, it is difficult to conceive of a circumstance that would counsel in favor of enforcing Item 1.01(c) of Form SD.

Required Conflicts Minerals Reporting Going Forward

As noted, public companies subject to the conflict minerals must continue to conduct a reasonable country of origin inquiry and file a Form SD. In most circumstances, Item 1.01(a) of Form SD requires public companies to conduct in good faith a reasonable country of origin inquiry regarding those conflict minerals that is reasonably designed to determine whether any of the conflict minerals originated in the Democratic Republic of the Congo or an adjoining country, or are from recycled or scrap sources.

In addition, Item 1.01(b) of Form SD continues to require public companies to report the following:

Based on its reasonable country of origin inquiry, if the registrant determines that its necessary conflict minerals did not originate in the Democratic Republic of the Congo or an adjoining country or did come from recycled or scrap sources, or if it has no reason to believe that its necessary conflict minerals may have originated in the Democratic Republic of the Congo or an adjoining country, or if based on its reasonable country of origin inquiry the registrant reasonably believes that its necessary conflict minerals did come from recycled or scrap sources, the registrant must, in the body of its specialized disclosure report under a separate heading entitled “Conflict Minerals Disclosure,” disclose its determination and briefly describe the reasonable country of origin inquiry it undertook in making its determination and the results of the inquiry it performed. Also, the registrant must disclose this information on its publicly available Internet website and, under a separate heading in its specialized disclosure report entitled “Conflict Minerals Disclosure,” provide a link to that website.

Next Steps

Public companies required to conduct due diligence under Item 1.01(c) should determine whether it is beneficial to complete the due diligence and report in accordance with past practice or to cease due diligence. When making this determination, public companies should consider requirements of their customers to maintain a socially responsible supply chain and the benefit of maintaining relations with other stakeholders in this area.

Any company that completes questionnaires or other due diligence at the request of its suppliers should check with the relevant supplier before ceasing efforts. Questionnaires are generally part of the “reasonable country of origin inquiry” which will continue under the SEC’s new guidance. In addition, as noted above, some public companies are likely to continue the due diligence required by Item 1.01(c) and will look to their suppliers to support this effort.

[Update.  This case was overruled on appeal.  See our analysis here.]

The Delaware Court of Chancery examined equity grants to directors in In Re Investors Bancorp, Inc. Stockholder Litigation.  The equity incentive plan, or EIP, at issue included the following limitations on grants:

  • A maximum of 4,411,613 shares, in the aggregate (25% of the shares available for stock option awards), may be issued or delivered to any one employee pursuant to the exercise of stock options;
  • A maximum of 3,308,710 shares, in the aggregate (25% of the shares available for restricted stock awards and restricted stock units), may be issued or delivered to any one employee as a restricted stock or restricted stock unit grant; and
  • The maximum number of shares that may be issued or delivered to all non-employee directors, in the aggregate, pursuant to the exercise of stock options or grants of restricted stock or restricted stock units shall be 30% of all option or restricted stock shares available for awards, “all of which may be granted in any calendar year.”

The EIP was put to a stockholder vote at a subsequent annual meeting. Of the shares voted at the meeting, 96.25% voted to approve the EIP (representing 79.1% of the total shares outstanding).

A series of Board and Compensation Committee meetings were held following stockholder approval. As a result of the meetings, grants were approved for all of the employee directors and non-employee directors within the limits established by the EIP.

Litigation ensued following public disclosure of the grants. The litigation alleged that the directors had breached their fiduciary duties by awarding themselves grossly excessive executive compensation.

The Court noted that since the Board approved the grant of equity awards to themselves, entire fairness was the default standard of review. However, the Defendants raised the affirmative defense of stockholder ratification. If the Defendants defense was evident from the well-pled allegations of the Complaint, then the Court must review the awards under the business judgment rule standard, which defaults to a waste standard.

The Plaintiffs claimed that the awards at issue here were not ratified because the specific parameters of the EIP were such that no award of equity compensation under the EIP could have been approved by stockholders in advance. In other words, according to the Plaintiffs, the awards at issue here were not ratifiable because the Board failed to seek stockholder approval for the specific awards made under the plan.

The opinion notes the Court of Chancery recently performed an exhaustive review of the law of stockholder ratification with regard to director equity compensation in Citrix.  The Citrix court noted that there is a distinction between stockholder approval of a plan that features broad parameters and “generic” limits applicable to all plan beneficiaries on the one hand and, on the other hand, a plan that sets “specific limits on the compensation of the particular class of beneficiaries in question.”  Approval of broader plans will not extend to subsequent grants of awards made pursuant to that plan; approval of plans with “specific limits,” however, will be deemed as ratification of awards that are consistent with those limits.

In Citrix, the court concluded “that the defendants have not established that Citrix stockholders ratified the RSU Awards because, in obtaining omnibus approval of a Plan covering multiple and varied classes of beneficiaries, the Company did not seek or obtain stockholder approval of any action bearing specifically on the magnitude of compensation to be paid to its non-employee directors.”

According to the Court, once a plan sets forth a specific limit on the total amount of options that may be granted under the plan to all directors, whether individually or collectively, it has specified the “director-specific ceilings” that Citrix found to be essential when determining whether stockholders also approved in advance the specific awards that were subsequently made under the plan.

The plan at issue here provided for “specific limits on the compensation of” the non-employee and executive members of the Board such that the stockholders’ approval of the EIP reflected their ratification of all of the specific awards later approved by the Board.  The EIP expressly stated that “[t]he maximum number of shares of Stock that may be covered by Awards granted to all non-Employee Directors, in the aggregate, is thirty percent (30%) of the shares authorized under the Plan all of which may be granted during any calendar year.”  The EIP also stated that “[t]he maximum number of shares of Stock that may be subject to stock options to any one Participant who is an employee covered by Code Section 162(m) during any calendar year . . . shall be 4,411,613 shares” and that “[t]he maximum number of shares of Stock that may be subject to Restricted Stock Awards or Restricted Stock Units which are granted to any one Participant who is an employee covered by Code Section 162(m) during any calendar year . . . shall be 3,308,710 shares, all of which may be granted during any calendar year.”

The Court noted the foregoing limits were unlike the “generic” limit for all beneficiaries under the equity compensation plan in Citrix.  Therefore, the Directors decision must be reviewed for waste under the business judgment rule, and the Plaintiffs did not plead waste.

The United States District Court for the District of Columbia has entered a final judgment in the conflict minerals case. The final judgment is identical to the proposed judgment which we described here.

It’s important to remember that public companies subject to the conflict minerals rules must continue to make conflict minerals filings consistent with the SEC’s guidance.

In Re Saba Software, Inc. Stockholder Litigation considered whether a stockholder vote satisfied the Corwin test for a full informed, uncoerced vote to determine if the shift to the business judgement rule was warranted.  The Delaware Court of Chancery determined it did not.

The opening paragraphs of the opinion sets forth the relevant facts:

“The Plaintiff’s Second Amended Verified Class Action Complaint (the “Complaint”), and its description of the unfortunate series of events leading up to the Merger, calls out to Samuel Barber’s Adagio for Strings to set the mood for the final scene. According to the Securities and Exchange Commission (“SEC”), Saba, through two of its former executives, engaged in a fraudulent scheme from 2008 through 2012 to overstate its pre-tax earnings by $70 million. Thereafter, Saba repeatedly promised regulators, its stockholders and the market that it would get its financial house in order. Each promise included assurances to stockholders that Saba would restate its financial statements by a certain date. And each time Saba inexplicably failed to deliver the restatement by the promised deadline. When it failed to meet a deadline for filing its restatement set by the SEC, the SEC revoked the registration of Saba’s common stock. Not surprisingly, the stock price suffered. In the midst of this chaos, the Company announced that “it was exploring strategic alternatives, including a sale of the Company.”

When Saba’s board of directors ultimately sought stockholder approval of the Merger, after a months-long sales process, the choice presented to stockholders was either to accept the $9 per share Merger consideration, well below its average trading price over the past two years, or continue to hold their now-deregistered, illiquid stock. Not surprisingly, the majority of Saba’s stockholders voted to approve the Merger.”

While the Court dispensed with many allegations that disclosures were insufficient, the Court found that adequate disclosures were not made regarding the ability of the Company to ever complete the restatement. According to the Court, the Plaintiff earned a pleading-stage inference that the stockholders would need all material information regarding the likelihood that the Company could ever complete the restatement in order meaningfully to assess the credibility of the management projections. The Company had repeatedly failed to meet deadlines to restate its financials. The management projections assumed the Company would complete the restatement at some point in the future. Without the means to test that assumption by drilling down on the circumstances surrounding the Company’s past and latest failure to deliver its restated financials, stockholders had no basis to conclude whether or not the projections made sense.

Additionally, according to the Court, in order to cast a fully informed vote, a reasonable stockholder would have needed to understand what alternatives to the merger existed. Plaintiff alleged that the investment banker advised a board committee that the purchaser’s proposal was a “discount to current market prices” of Saba stock and, importantly, that a transaction with purchaser “would ‘eliminate further upside for investors from standalone value creation.’” The investment banker cautioned that further pursuit of the proposed transaction “could trigger ‘[l]ikely shareholder litigation … due to price below market.’”   The Court said it is reasonably conceivable that Plaintiff will be able to demonstrate a substantial likelihood that a reasonable Saba stockholder would have found this information to be important when deciding how to vote on the merger.

The Court also considered whether the stockholder vote was coerced. Delaware courts will find wrongful coercion where stockholders are induced to vote “in favor of the proposed transaction for some reason other than the economic merits of that transaction.”  The Court said in voting on the merger, Saba stockholders were given a choice between keeping their recently-deregistered, illiquid stock or accepting the merger price of $9 per share, consideration that was depressed by the Company’s nearly contemporaneous failure once again to complete the restatement of its financials.  Examining the facts, the Court pointed out the forced timing of the merger and the proxy’s failure to disclose why the restatement had not been completed and what financing alternatives might be available to Saba if it remained a standalone company left the Saba stockholders staring into a black box as they attempted to ascertain Saba’s future prospects as a standalone company. This left them with no practical alternative but to vote in favor of the Merger.

Since Corwin did not apply, the Court found that the merger is subject to enhanced scrutiny and that the individual defendants bear the initial burden of demonstrating that they were fully informed and acted reasonably in the sales process to secure the best available price.

As the decision was based on a motion to dismiss, the Court assumes the well-pleaded facts in the complaint are true. Ultimately the litigation could come out differently.