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

Often in M&A transactions one stumbles across conversions to and from LLCs that do not strictly adhere with statutory formalities or terms of related limited liability company agreements.  The Delaware Court of Chancery considered the validity of a conversion of a Delaware LLC to a Puerto Rico LLC in In re Coinmint, LLC which was effected without technical compliance with the Delaware LLC Act and the related Operating Agreement.

As background, the Court found Prieur Leary controlled 18.5% of Coinmint through Mintvest Capital Ltd.   Ashton Soniat controlled the balance of Coinmint through Coinmint Living Trust, or CLT.

On or about January 19, 2018, the Company filed a Certificate of Conversion with the Delaware Secretary of State and the Secretary of State. On January 25, Coinmint domesticated in Puerto Rico. As of that date, Coinmint became and was thereafter operated as a Puerto Rican entity. Mintvest contested the Conversion, claiming that Leary was unaware of the Conversion until September 2019 and that the Conversion was invalid because Leary never authorized it on Mintvest’s behalf.

The Court advised that actions that do not comport with an operating agreement’s terms may be void or voidable. Void acts are those the entity itself has no implicit or explicit authority to undertake or those acts that are fundamentally contrary to public policy. Stated differently, they are acts that the entity lacks the power or capacity to effectuate. Voidable acts are within the power or capacity of an entity, but were not properly authorized or effectuated by the representatives of the entity. The Court also advised that drafters of operating agreements are also free to use their flexibility in contracting to agree that failure to follow certain procedures means an otherwise voidable action is void.

Summarizing, the Court stated where:

  • the Delaware Limited Liability Company Act enables the entity or its representatives to take certain action as distilled in the operating agreement;
  • the operating agreement implements that grant of authority and prescribes certain approvals for effectuating it; and
  • the operating agreement does not expressly deem the action void for failure to obtain those approvals,

that action will be “voidable, not void,” as the entity and its representatives could have carried out the action had “the proper approvals had been obtained.” Such voidable breaches of LLC agreements are subject to equitable defenses, including waiver, estoppel, and laches.

Coinmint’s Operating Agreement did not specify the manner of authorizing a conversion.  Therefore the Court reviewed the Delaware Limited Liability Company Act. Section 18-216 of the Act governs conversion of a Delaware limited liability company. Section 18-216(b) supplies a default rule that is subject to contractual variation, not a mandatory rule.  It provides that if the limited liability company agreement does not specify the manner of authorizing a conversion of the limited liability company and does not prohibit a conversion of the limited liability company, the conversion shall be authorized in the same manner as is specified in the limited liability company agreement for authorizing a merger or consolidation that involves the limited liability company as a constituent party to the merger or consolidation.

The Operating Agreement’s relevant terms required two steps to effect a merger:

  • majority Member consent under Section 4.6,
  • followed by formal Board approval via meeting or written consent, under Sections 4.3(f) and 4.4.

It was undisputed that the Managers did not approve the Conversion at a board meeting or secure written consents. But in view of CLT’s majority stake and the interplay of Sections 4.3(f), 4.4, and 4.6, that failure rendered the Conversion voidable under the Operating Agreement, rather than void.

Section 4.6 of the Operating Agreement conditioned the Board’s power to effectuate a conversion on the consent of a “Majority of Members” who “in the aggregate, own more than fifty percent (50%) of the Sharing Ratios owned by all of the Members.”  That provision provided:

Notwithstanding anything to the contrary contained in this Agreement, without the consent of Majority of Members, neither the Board nor any Manager or Officer shall have the power or authority . . . . [t]o effect a merger or plan of exchange of the Company . . . .

Failure to obtain that majority consent would strip the Board and any Manager of its power to effectuate a merger, or, in this case, the Conversion. If a conversion were completed without the consent of the Majority of Members, then it would be void ab initio, not voidable.

But in other parts of the opinion the Court found Mintvest was diluted to 18.2%, and CLT held 81.8%. CLT alone “own[ed] more than fifty percent (50%) of the Sharing Ratios owned by all of the Members.” So CLT alone could give consent of the “Majority of Members” and did so. As a result, the Board retained the power to authorize the Conversion.

With majority Member consent, conversion must then follow Section 4.4 of the Operating Agreement, which provides that “all actions of the Board provided for here in shall be taken either at a meeting and evidenced by written minutes thereof . . . or by written consent without a meeting.”

If a conversion is challenged because the Board did not formally authorize it under Sections 4.3(f) and 4.4, that failure is voidable and subject to equitable defenses. CLT and Mintvest’s failure to comply with Section 4.3 and 4.4’s formalities on Coinmint’s behalf is ratifiable because the Company could lawfully accomplish it “if it d[id] so in the appropriate manner.”

The Court held Mintvest’s challenge to the Conversion as improperly authorized under Sections 4.3(f) and 4.4 was barred by the equitable defenses.  The record showed Leary was intimately involved in pursuing redomestication in Puerto Rico and invoked that decision in several Company initiatives.  Nothing in the record indicated that Leary objected to the Conversion as it was taking place or after.  The record reflected that Leary participated in the Conversion and did not object to it on Mintvest’s behalf until filing the action in the Delaware Court of Chancery. Because Leary  confirmed the Conversion on multiple occasions he therefore waived the Operating Agreement’s Board vote and consent requirements.

ISS has opened its annual benchmark policy survey.  The survey usually foreshadows upcoming changes to its policies.

Areas addressed in this year’s survey include:

  • Should non-financial Environmental, Social, and/or Governance-related metrics be incorporated into executive compensation programs?
  • Opinions regarding third-party racial equity audits.
  • Detrimental and/or problematic practices for virtual only shareholder meetings.
  • Should ISS’ pay-for-performance screen include a longer-term perspective (for example, a three-year assessment) of CEO pay quantum beyond the one-year horizon currently utilized in the ISS pay-for-performance quantitative screen?
  • Views on mid-cycle changes to long-term incentive programs for companies incurring long-term negative impacts.
  • For companies with poor governance structures that were previously grandfathered, should ISS revisit these problematic provisions and consider issuing adverse voting recommendations in the future where they still exist?
  • If a company has sought shareholder approval to eliminate supermajority vote requirements, but the management proposal failed to receive the requisite level of shareholder support needed for approval, should ISS continue to make recurring adverse director vote recommendations for maintaining the supermajority vote requirements?
  • Does it make sense for investors to generally vote in favor of SPAC transactions, irrespective of the merits of the target company combination or any governance concerns?

In tandem, ISS is launching a separate Climate Survey for feedback relevant to both ISS’ benchmark and specialty climate policy evolvement, in order to determine views on minimum criteria for boards in overseeing climate-related risks, plus market sentiment on shareholders having the right to regularly vote on a company’s climate transition plans.

Both surveys are slated to close on August 20, 2021.

The SEC has approved the Nasdaq board diversity rules.

Diverse Board Representation

In general, each Nasdaq listed company must have, or explain why it does not have, at least two members of its board of directors who are Diverse, including (i) at least one Diverse director who self-identifies as Female; and (ii) at least one Diverse director who self-identifies as an Underrepresented Minority or LGBTQ+.

Diverse is defined to mean an individual who self-identifies in one or more of the following categories: Female, Underrepresented Minority, or LGBTQ+.

Female is defined to mean an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth.

Underrepresented minority is defined to mean an individual who self-identifies as one or more of the following: Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, or Two or More Races or Ethnicities.

LGBTQ+ means an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender, or as a member of the queer community.

Amongst other things, the rules provide accommodations for:

  • A smaller reporting company must have, or explain why it does not have, at least two members of its board of directors who are Diverse, including at least one Diverse director who self identifies as Female. The second Diverse director may include an individual who self-identifies as one or more of the following: Female, LGBTQ+, or an Underrepresented Minority.
  • Each company with a board of directors of five or fewer members must have, or explain why it does not have, at least one member of its board of directors who is Diverse. If a Company has five members on its board of directors before becoming subject to the new rules, it shall not become subject to the requirement to have at least two members of its board of directors who are Diverse if it adds one director to satisfy this this rule for five or fewer board members, thereby becoming a six-member board. However, a company would become subject to the new rules if it subsequently expands its board.
  • Certain modifications are made for foreign private issuers.
  • The following types of companies are exempt: acquisition companies; asset-backed issuers and other passive issuers; cooperatives; management investment companies; and issuers of nonvoting preferred securities, debt securities and derivative securities.

If a company satisfies the requirements of the rule by explaining why it does not meet the applicable diversity objectives of the rule, the company must: (i) specify the requirements of the rule that are applicable; and (ii) explain the reasons why it does not have two Diverse directors (or one Diverse director where permitted). Such disclosure must be provided: (i) in advance of the company’s next annual meeting of shareholders in any proxy statement or any information statement (or if none, Form 10-K etc.) or on the Company’s website. If the Company provides such disclosure on its website, then the Company must also notify Nasdaq regarding the disclosure.  Nasdaq will not evaluate the substance or merits of the response.

Each Company listed on The Nasdaq Global Select Market, The Nasdaq Global Market, and The Nasdaq Capital Market (including a Company with a permitted smaller board) must have, or explain why it does not have, at least one Diverse director by the later of:

  • two calendar years after August 6, 2021 (the “First Effective Date”); or
  • the date the Company files its proxy statement or its information statement (or, if the Company does not file a proxy, in its Form 10-K etc) for the Company’s annual shareholders meeting during the calendar year of the First Effective Date.

Each Company listed on The Nasdaq Global Select Market or The Nasdaq Global Market must have, or explain why it does not have, at least two Diverse directors by the later of:

  • four calendar years after August 6, 2021 (the “Second NGS/NGM Effective Date”); or
  • the date the Company files its proxy statement or its information statement (or, if the Company does not file a proxy, in its Form 10-K or 20-F) for the Company’s annual shareholders meeting during the calendar year of the Second NGS/NGM Effective Date.

Each Company listed on The Nasdaq Capital Market must have, or explain why it does not have, at least two Diverse directors by the later of:

  • five calendar years after August 6, 2021 (the “Second NCM Effective Date”) or
  • the date the Company files its proxy statement or its information statement (or, if the Company does not file a proxy, in its Form 10-K etc.) for the Company’s annual shareholders meeting during the calendar year of the Second NCM Effective Date.

Board Diversity Disclosure

In addition, each Nasdaq listed company must annually disclose, to the extent permitted by applicable law, information on each director’s voluntary self-identified characteristics in a prescribed format referred to as the Board Diversity Matrix. Following the first year of disclosure, all companies must disclose the current year and immediately prior year diversity statistics using the Board Diversity Matrix.

In the proposed Board Diversity Matrix, a company would be required to provide the total number of directors on its board, and the company (other than a Foreign Issuer) would be required to provide the following:

  • the number of directors based on gender identity (female, male, or non-binary) and the number of directors who did not disclose gender;
  • the number of directors based on race and ethnicity (African American or Black, Alaskan Native or Native American, Asian, Hispanic or Latinx, Native Hawaiian or Pacific Islander, White, or Two or More Races or Ethnicities), disaggregated by gender identity (or did not disclose gender);
  • the number of directors who self-identify as LGBTQ+; and
  • the number of directors who did not disclose a demographic background under the second and third bullet points above.

The Board Diversity Matrix must be provided in any proxy statement or any information statement (or if none, Form 10-K etc.) or on the Company’s website.  Companies exempt from the board diversity rules do not need to comply with these disclosures.

This disclosure rule is operative one year after August 6, 2021 (the “Effective Date”). A Company must be in compliance with this rule by the later of:

  • one calendar year from the Effective Date;
  • the date the Company files its proxy statement or its information statement for its annual meeting of shareholders (or, if the Company does not file a proxy or information statement, the date it files its Form 10-K or 20-F) during the calendar year of the Effective Date.

In Houseman et al v. Sagerman et al the Plaintiffs challenged the enforceability of the indemnification provisions in a merger agreement amongst other things.  The Merger Agreement provided for an indemnification escrow. A subset of the Shareholders collectively owning over 72% of target’s shares (the “Owners”) were parties to and signed the Merger Agreement.  The Owners agreed to provide certain indemnification for amounts in excess of the escrow or after the escrow was depleted. However, Plaintiffs did not execute the Merger Agreement.

Plaintiffs argued that indemnification from the escrow was illegal and unenforceable. They cited to Cigna Health & Life Insurance Company v. Audax Health Solutions as support for the proposition that, as stockholders who did not consent to the merger, they cannot be bound by the indemnification obligations. In Cigna, the Court concluded that the indemnification obligation imposed by the merger agreement was void and unenforceable because it violated 8 Del. C. § 251. The post-closing adjustments permitted by the merger agreement as indemnification were not limited in amount or in duration. Accordingly, the stockholders would never have been able to know the exact value of the merger consideration and the merger agreement failed to set forth “the cash, property, rights or securities of any other corporation or entity which the holders of such shares are to receive” as required by § 251(b)(5). Thus, Cigna did not reach the more general question whether post-closing price adjustments can bind non-consenting stockholders.

In this case the Merger Agreement explicitly limited the Plaintiffs’ indemnification obligation to the escrow, and, with the exception of certain fundamental representations and warranties guaranteed solely by the Owners, the obligations did not survive indefinitely. The terms of the indemnification rights were both made explicit and limited in duration. Therefore, the Court concluded Cigna was inapplicable.

The next question before the Court was whether the Shareholder Representative could act on behalf of all of the shareholders or only the Owners that signed the Merger Agreement. The Court found that even though the Shareholders’ Representative was appointed by the Owners, and not all shareholders, that did not limit the ability of the Shareholder Representative to act on behalf of the other shareholders. The Merger Agreement provided that “[t]he Owners hereby appoint Thomas D. Whittington (the “Shareholders’ Representative”) as their attorney-in-fact with full power . . . to perform any and all acts necessary or appropriate in connection with the Agreement.” The Merger Agreement further provided that the actions of the Shareholders’ Representative “shall be binding upon all of the Owners and Shareholders.”

In the view of the Court, the actions of a stockholders’ representative are generally binding on all stockholders. Looking to prior precedent, the Court noted that all Section 251 of the DGCL required was for the representative to be designated as the individual who would follow the procedures and make or participate in the determinations called for by the Merger Agreement. In this case the Merger Agreement designated the Shareholders’ Representative to carry out the actions contemplated by that Agreement. Therefore, the Shareholders, whether signatories or not, were bound by the actions and determinations of the Shareholders’ Representative to the extent they are in accordance with the Merger Agreement’s terms.

Finally, the Plaintiffs argued that Delaware law prohibited the contractual modification of a shareholders’ representative’s fiduciary duties and, therefore, that the Merger Agreement’s grant of “sole and absolute discretion” to the Shareholder Representative was impermissible.

According to the Court, a shareholders’ representative, as attorney-in-fact for the selling shareholders, generally assumes the obligations of a fiduciary. However, the duties of an attorney-in-fact, like those of some other types of fiduciaries, may be modified by contract.  The shareholders’ representative is generally not a corporate fiduciary. Rather, a shareholders’ representative is an agent of the shareholders whose powers and responsibilities are circumscribed by contract.

The Court reasoned that the Merger Agreement explicitly rejected the Shareholders’ Representative’s common law duties, by providing that “[t]he Shareholders’ Representative shall not have any duties or responsibilities except those expressly set forth in this Agreement.” The Shareholders’ Representative’s duties were, broadly, “to perform any and all acts necessary or appropriate in connection with this Agreement,” including “doing any and all things and taking any and all action that the Shareholders’ Representative, in such Person’s sole and absolute discretion, may consider necessary, proper or convenient in connection with or to carry out the activities . . . contemplated by this Agreement.”

The standard in the Merger Agreement, according to the Court, was equivalent to a duty of subjective good faith. The discretion of the Shareholder’s Representative was cabined by the determination that a contemplated action is “necessary, proper or convenient” in connection with carrying out the Merger Agreement on behalf of the Shareholders. If the Shareholder Representative acted without such a determination, the Shareholder Representative would have breached a duty.

The United States District Court for the District of Minnesota decided a case where Plaintiff was a limited partner in an entity where the partnership interests were the subject of a Purchase Agreement entered into by the Defendants that controlled the limited partnership.  Plaintiff alleged that Defendants breached the Partnership Agreement by failing to honor Plaintiff’s Tag-Along Rights and also breached an implied duty of good faith and fair dealing by structuring the Purchase Agreement “in a wrongful effort to circumvent” its Tag-Along Rights.  Plaintiff sought a declaratory judgment, injunctive relief, and monetary damages “believed to total at least $300,000,000.00.”  Relevant portions of the cases were reviewed by the Court on a motion to dismiss. The limited partnership agreement was governed by Minnesota law.

The acquisition agreement was structured  to allow the Buyer to acquire partnership interests in a series of “Tranches,” and the Buyer was required to exercise them, if at all, in a specific order. The First Tranche consisted of a 20% ownership share in limited-partnership interests, to be purchased from one of the Defendant Sellers at a June 30 closing.  In the Second Tranche, the Buyer would acquire all general-partnership interests as well as a nearly-32% ownership share in limited-partnership interests. Those limited-partnership interests would include all the interests of all the non-Defendant Limited Partners, including the interest of Plaintiff. Finally, in the Third Tranche, the Buyer would acquire the remaining 20% in limited-partnership interests from Defendants.

The Buyer was also not required to exercise all of the Call Options—or any of them. If the Buyer failed to exercise any Call Option prior to the specified expiration date for the respective Tranche, all subsequent Call Options would immediately terminate and thereafter be null and void.

The Plaintiff believed that the Purchase Agreement, as a whole, set out a “series of related transactions” that constituted a Control Sale under the Partnership Agreement, thereby triggering its Tag Along Rights for the first June 30 closing.  Defendants responded that a Control Sale would only occur if the Buyer exercised the Call Option for the Second Tranche, since that is the only Tranche that would involve the acquisition of a majority of the general-partnership interests. And because the exercise of the Second Tranche Call Option would obligate defendants to exercise drag rights, Plaintiff’s  Tag-Along Rights would never come into play.

The Partnership Agreement provided that a Control Sale was a “sale, exchange, or other disposition . . . , in a single transaction or series of related transactions, . . . of Partnership Interests which includes a majority of all the General Partnership Interests[.]”  However, the Buyer would not purchase—and Defendants would not relinquish—any general-partnership interests at the June 30 closing. But Defendants were required to grant the Buyer an option to acquire all of the general-partnership interests at a later date. That raised the question whether the grant of an option to acquire partnership interests is a “sale, exchange, or other disposition” of those interests. Neither Party has cited Minnesota authority addressing this precise question.

The Court noted the ordinary meaning of all three words—”sale,” “exchange,” and “disposition”—presupposed a transfer or conveyance of something. Plaintiff disagreed and argued that “disposition” means something broader than “sale” and “exchange.” The Court resolved the issue by noting that when a catchall term like “other disposition” follows a series of specific words, the “[g]eneral words are construed to be restricted in their meaning by [the] preceding particular words.”  Accordingly, under the Partnership Agreement, a Control Sale only occurs when there is an actual transfer of “Partnership Interests which includes a majority of all the General Partnership Interests.” And a “Partnership Interest” consists of “the entire ownership interest of a Partner in the Partnership at any particular time[.]”

With that understanding, the Court held the June 30 grant of an option to acquire general-partnership interests did not fit the bill and the Tag-Along rights were not triggered. When Defendants extend the Buyer an option on June 30 to acquire general-partnership interests, there will be no agreement for the transfer of those interests. No transfer—and thus no Control Sale—would occur unless and until the Buyer exercised the Second Tranche Option and a closing occured sixty to ninety days after that.

Plaintiff also argued Defendants violated their duty to act in good faith under the Partnership Agreement by structuring the Purchase Agreement to hinder Plaintiff’s ability to exercise its Tag-Along Rights.  The Court stated under Minnesota law, every contract includes an implied covenant of good faith and fair dealing requiring that one party not ‘unjustifiably hinder’ the other party’s performance of the contract.  The duty governs the parties’ performance and prohibits a party from failing to perform for the purpose of thwarting the other party’s rights under the contract

The Court stated Plaintiff did not plausibly alleged the type of bad-faith conduct that would violate the covenant of good faith and fair dealing. Nothing in the Partnership Agreement prohibited what Defendants had done. No provision stopped them from using options to structure a potential transaction or from selling some of their limited-partnership interests before entering into a Control Sale to sell their general-partnership interests.

Key to the Court’s analysis was none of the quintessential examples of bad-faith conduct were alleged by Plaintiff. Defendants had not wrongfully repudiated the Partnership Agreement, improperly extracted a waiver of rights from Plaintiff, or “fail[ed] to perform” any of their own obligations “for the purpose of thwarting” Plaintiff’s rights.  At most, Defendants had structured the deal such that a Control Sale would occur later than it may otherwise have occurred.

Finally, the Partnership Agreement did not seem to give Plaintiff the per se right to sell immediately at the outset of a Control Sale. The implication of Plaintif’s allegations was that the call-option arrangement was a sham and that the Buyer has already functionally agreed to purchase the entire Partnership in a series of related transactions. But if that were true, the Partnership Agreement would not seem to require that Plaintiff be allowed to sell all of its partnership interests before the general partner sold any of its own.

In a recently settled SEC enforcement action, the defendant asked employees to sign an acknowledgement, upon hire and on an annual basis, that they had received, read, and would adhere to the defendant’s employee manual. The employee manual contained a “Communications with Regulators” section that stated, in relevant part:

Employees are also strictly prohibited from initiating contact with any Regulator without prior approval from the Legal or Compliance Department. This prohibition applies to any subject matter that might be discussed with a Regulator, including an individual’s registration status with FINRA. Any employee that violates this policy may be subject to disciplinary action by the Firm.

Among other things the defendant’s annual compliance training materials in those years contained a slide with a section titled “Communication with Regulators” and a sub-bullet point that stated:

Employees are prohibited from initiating contact with any regulator without prior approval from Legal or Compliance, including conversation[s] regarding an individual’s registration status with FINRA.

The SEC stated it was not aware of any specific instances in which an employee of defendant was prevented from communicating with Commission staff about potential securities laws violations or that defendant took action to enforce the employee manual’s restriction or otherwise prevent such communications.

The SEC found the defendant willfully violated Rule 21F-17 of the Exchange Act, which prohibits any person from taking any action to impede an individual from communicating directly with the SEC about possible securities law violations.

Upon being contacted by the SEC the defendant made the following changes to its employee manual amongst others:

“nothing in [the GS Manual] prohibits or restricts any person in any way from reporting possible violations of law or regulation to any governmental agency or entity, or otherwise prevent anyone from participating, assisting, or testifying in any proceeding or investigation by any such agency or entity or from making other disclosures that are protected and/or permitted under law or regulation.”

The SEC assessed defendant a civil monetary penalty in the amount of $208,912.

The defendant did not admit or deny the findings in the SEC order.

The Supreme Court issued its decision in Goldman Sachs Group, Inc., et al. v. Arkansas Teacher Retirement System, et al. The case analyzes what the Defendants considered were generic statements that did not have a price impact.  The case is important because it addresses when a securities fraud case can be certified as a class action. Once class certification is granted, the settlement value of a case increases.

Plaintiffs alleged that Goldman maintained an artificially inflated stock price by making generic statements about its ability to manage conflicts—for example, “We have extensive procedures and controls that are designed to identify and address conflicts of interest.”  Plaintiffs claimed that Goldman’s generic statements were false or misleading in light of several undisclosed conflicts of interest, and that once the truth about Goldman’s conflicts came out, Goldman’s stock price dropped and shareholders suffered losses.

Here, the Plaintiffs sought to certify a class of Goldman shareholders by invoking the presumption endorsed by the Supreme Court in Basic Inc. v. Levinson.  The Basic presumption is premised on the theory that investors rely on the market price of a company’s security, which in an efficient market incorporates all of the company’s public misrepresentations.

To invoke the Basic presumption, a plaintiff must prove:

  • that the alleged misrepresentation was publicly known;
  • that it was material;
  • that the stock traded in an efficient market; and
  • that the plaintiff traded the stock between the time the misrepresentation was made and when the truth was revealed.

The Basic presumption allows class-action plaintiffs to prove reliance through evidence common to the class. That in turn makes it easier for plaintiffs to establish the predominance requirement of Federal Rule of Civil Procedure 23, which requires that “questions of law or fact common to class members predominate” over individualized issues.

As a result, class-action plaintiffs must prove the Basic prerequisites before class certification—with one exception. In Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, the Supreme Court held that materiality should be left to the merits stage because it does not bear on Rule 23’s predominance requirement.

Satisfying those prerequisites, however, does not guarantee class certification. Defendants may rebut the Basic presumption at class certification by showing that an alleged misrepresentation did not actually affect the market price of the stock. If a misrepresentation had no price impact, then Basic’s fundamental premise “completely collapses, rendering class certification inappropriate.”

On appeal Goldman argued the Second Circuit erred twice:

  • first, by holding that the generic nature of its alleged misrepresentations is irrelevant to the price impact inquiry at the class certification stage; and
  • second, by assigning Goldman the burden of persuasion to prove a lack of price impact.

The Supreme Court noted as to the first question—whether the generic nature of a misrepresentation is relevant to price impact—the parties’ dispute had largely evaporated. Plaintiffs conceded that the generic nature of an alleged misrepresentation often will be important evidence of price impact because, as a rule of thumb, a more-general statement will affect a security’s price less than a more-specific statement on the same question.

The Supreme Court concurred in the parties’ view. The Supreme Court stated in assessing price impact at class certification, courts “should be open to all probative evidence on that question—qualitative as well as quantitative—aided by a good dose of common sense.”

The Supreme Court noted the generic nature of a misrepresentation often will be important evidence of a lack of price impact, particularly in cases proceeding under the inflation-maintenance theory. Under that theory, price impact is the amount of price inflation maintained by an alleged misrepresentation—in other words, the amount that the stock’s price would have fallen “without the false statement.” Plaintiffs typically try to prove the amount of inflation indirectly: They point to a negative disclosure about a company and an associated drop in its stock price; allege that the disclosure corrected an earlier misrepresentation; and then claim that the price drop is equal to the amount of inflation maintained by the earlier misrepresentation.

But that final inference, according to the Supreme Court—that the back-end price drop equals front-end inflation—starts to break down when there is a mismatch between the contents of the misrepresentation and the corrective disclosure. That may occur when the earlier misrepresentation is generic (e.g., “we have faith in our business model”) and the later corrective disclosure is specific (e.g., “our fourth quarter earnings did not meet expectations”). Under those circumstances, it is less likely that the specific disclosure actually corrected the generic misrepresentation, which means that there is less reason to infer front-end price inflation—that is, price impact—from the back-end price drop.

However, the parties did disagree about whether the Second Circuit properly considered the generic nature of Goldman’s alleged misrepresentations. The Supreme Court remanded the case because the Second Circuit’s opinions left the Supreme Court with sufficient doubt on this score.  The Supreme Court directed the Second Circuit to take into account all record evidence relevant to price impact, regardless whether that evidence overlaps with materiality or any other merits issue.

On the second question before the Supreme Court Goldman argued that the Second Circuit erred by requiring Goldman, rather than Plaintiffs, to bear the burden of persuasion on price impact at class certification.  The Supreme Court rejected Goldman’s argument that the Federal Rules of Evidence placed the burden on Plaintiffs, noting that the burden of persuasion under Basic was a settled question.

By a razor thin vote of 215 to 214, the House of Representatives passed the ESG Disclosure Simplification Act of 2021.

The Act would require public companies to disclose in any proxy or consent solicitation material for an annual meeting of the shareholders:

  • a clear description of the views of the issuer about the link between ESG metrics and the long-term business strategy of the issuer; and
  • a description of any process the issuer uses to determine the impact of ESG metrics on the long-term business strategy of the issuer.

The bill mandates the SEC:

  • to require each public company to disclose environmental, social, and governance metrics in any filing of the issuer described in such part that requires audited financial statements; and
  • to define ESG metrics.

According to the legislation, it is the sense of Congress that ESG metrics are de facto material for the purposes of disclosures under the Securities Exchange Act of 1934 and the Securities Act of 1933.

The legislation also requires the SEC to establish a permanent advisory committee to be called the “Sustainable Finance Advisory Committee.”  Among other things, the Committee would be required to:

  • submit a report to the Commission not later than 18 months after the date of the first meeting of the Committee that:
    • identifies the challenges and opportunities for investors associated with sustainable finance; and
    • recommends policy changes to facilitate the flow of capital towards sustainable investments, in particular environmentally sustainable investments;
  • when solicited, advise the Commission on sustainable finance; and
  • communicate with individuals and entities with an interest in sustainable finance.

The bill defines “sustainable finance” as the provision of finance with respect to investments taking into account environmental, social, and governance considerations.

The Interfaith Center on Corporate Responsibility, James McRitchie and As You Sow have sued the SEC to invalidate the most recent amendments to Rule 14a-8 which permits small shareholders to submit proposals to public companies for inclusion in proxy statements.

According to the complaint, the SEC’s purported justifications for the amendments were flawed at every turn. The plaintiffs allege the SEC recognized that it had a legal obligation to provide an economic analysis of the costs and benefits of the proposed rule, but it made no serious attempt to do so.

The complaint was filed in the United States District Court for the District of Columbia.

The SEC announced a settled enforcement action concerning First American Financial Corporation’s violations of disclosure controls and procedures.  The violations related to disclosures made in connection with a cybersecurity vulnerability involving the company’s “EaglePro” application for sharing document images related to title and escrow transactions. According to the SEC, First American failed to maintain disclosure controls and procedures designed to ensure that all available relevant information concerning the vulnerability was analyzed for disclosure in the company’s reports with the Commission.

The SEC’s order states:

On the morning of May 24, 2019, a cybersecurity journalist notified First American that its application had a vulnerability exposing over 800 million title and escrow document images dating back to 2003, including images containing sensitive personal data such as social security numbers and financial information.

In response, First American issued a statement for inclusion in the cybersecurity journalist’s report published on the evening of May 24, 2019, and furnished a Form 8-K to the Commission on May 28, 2019.

First American’s senior executives responsible for the press statement and Form 8-K were not apprised of certain information concerning the company’s information security personnel’s prior knowledge of a vulnerability associated with First American’s EaglePro system before making those statements—information that would have been relevant to management’s assessment of the company’s disclosure response to the vulnerability and the magnitude of the resulting risk.

In particular, First American’s senior executives were not informed that the company’s information security personnel had identified a vulnerability several months earlier in a January 2019 manual penetration test of the EaglePro application, or that the company had failed to remediate the vulnerability in accordance with its policies.

As a result the SEC alleged First American did not maintain disclosure controls and procedures designed to ensure that senior management had all relevant information about the January 2019 report prior to issuing the company’s disclosures about the vulnerability.

First American did not admit or deny the SEC findings in the SEC’s order settling the proceeding.