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

The SEC has adopted amendments that it believes will modernize filing fee disclosure and payment methods. The revised rules amend most fee-bearing forms, schedules, statements, and related rules to require each filing fee table and accompanying disclosure to include all required information for fee calculation in a structured format. The amendments also add options for fee payment via Automated Clearing House (“ACH”) and debit and credit cards, and eliminate options for fee payment via paper checks and money orders.

The current methods by which filers and the SEC staff process and validate EDGAR filing fee information within the filing are highly manual and labor-intensive.  Filing fee related information is generally not machine-readable and the underlying components used for the calculation are not always required to be reported.

Currently, the SEC staff conducts a manual review of the filing fee information for every fee-bearing filing that is filed with the SEC. When there are discrepancies between filing fee information appearing in the header and in the filing fee table on the cover page of the filing, the staff must resolve the discrepancy and often has to contact the filer to do so. The SEC expects the new amendments will make the filing fee payment validation process faster and more efficient by enabling the staff to use automated tools to help validate payment information with respect to complicated situations.

The revised rules generally require the filing fee-related information in a separate filing fee exhibit rather than on the cover page of a filing.  Filers’ presentation of filing fee-related information in one location in a structured format will help filers and Commission staff quickly identify and correct errors, as the SEC’s EDGAR system will automatically check the structured filing fee-related information for internal consistency.

The amendments generally will be effective on Jan. 31, 2022. The amendments that will add or eliminate payment options will be effective on May 31, 2022. Pursuant to the transition provision, large accelerated filers will become subject to the structuring requirements for filings they submit on or after 30 months after the Jan. 31, 2022 effective date. Accelerated filers, certain investment companies that file registration statements on Forms N-2 and N-14, and all other filers will become subject to the structuring requirements for filings they submit on or after 42 months after the Jan. 31, 2022 effective date. Compliance with the amended disclosure requirements other than the structuring requirements will be mandatory on the Jan. 31, 2022 effective date.

The amendments permit all filers to file their filing fee-related information structured in Inline XBRL prior to the compliance date for each category of filers. The SEC will make available a separate filing agent test system for this purpose. Filers will be able to file under the amendments once the EDGAR system has been modified to accept filing fee related information in Inline XBRL for all fee-bearing documents subject to the amendments, which is anticipated to be approximately six months before the earliest compliance date.

Section 312.07 of the NYSE Listed Company Manual provides that, where shareholder approval is a prerequisite to the listing of any additional or new securities of a listed company, or where any matter requires shareholder approval, the minimum vote which will constitute shareholder approval for such purposes is defined as approval by a majority of votes cast on a proposal in a proxy bearing on the particular matter. Section 312.07 is currently applicable to shareholder approval of stock issuances under Sections 303A.08 (equity compensation) and 312.03 of the Manual.

The text of Section 312.07 does not specifically address the treatment of abstentions. However, the NYSE has historically advised companies that abstentions should be treated as votes cast for purposes of Section 312.07. Under that approach, a proposal is deemed approved under Section 312.07 only if the votes in favor of the proposal exceed the aggregate of the votes cast against the proposal plus abstentions. This approach has caused confusion among listed companies. The corporate laws of many states, including Delaware, allow companies to include in their governing documents that votes cast for purposes of a shareholder vote includes yes and no votes (but not abstentions), such that consistent with those state laws, many public companies have bylaws indicating that abstentions are not treated as votes cast.

The NYSE has filed a rule proposal with the SEC to amend Section 312.07 to provide that a company must calculate the votes cast with respect to a proposal that is subject to Section 312.07 in accordance with its own governing documents and any applicable state law. The NYSE believes that this treatment of abstentions will avoid any complications engendered among issuers and shareholders when different voting standards are applied under the NYSE rule, a company’s governing documents, and/or applicable state laws.

In the rule proposal the NYSE notes that Nasdaq has a rule requiring that proposals receive a majority of “the votes cast,” but is silent on the question as to whether abstentions should be treated as votes cast. Nasdaq has published an FAQ on its website that clearly states: “Nasdaq does not define the term “votes cast”. As such, a company must calculate the ‘votes cast” in accordance with its governing documents and any applicable state law.”

Our preliminary list of important planning considerations for the 2022 proxy season is set forth below.

Directors’ and Officers’ Questionnaires; Committee Charters

We have identified only a few possible changes to date for D&O questionnaires and committee charters for the 2022 proxy season.

The NYSE amended the first paragraph of Section 314.00 (which was subsequently revised) of the listed company manual by stating that, for purposes of Section 314.00, the term “related party transaction” refers to transactions required to be disclosed pursuant to Item 404 of Regulation S-K under the Exchange Act, and, in the case of foreign private issuers, the term “related party transaction” refers to transactions required to be disclosed pursuant to Form 20-F, Item 7.B.

NYSE listed issuers who have detailed questions in their D&O questionnaires which reflect the current version of Item 404 of Regulation S-K should not need to update their D&O questionnaires.  It may be worthwhile for NYSE listed issuers to double check their audit committee charters to make sure the charters reflect other changes made by the rule amendments.

As noted in previous years, the Tax Cuts and Jobs Act eliminated the exception to IRC §162(m) for performance-based compensation, subject to a transition or “grandfather” rule. While likely few compensation arrangements are still grandfathered, this should be confirmed before eliminating questions in directors’ and officers’ questionnaires related to §162(m) for compensation committee members or references to §162(m) in compensation committee charters.

Nasdaq issuers may wish to begin modifying their D&O questionnaires to prepare for disclosures for the Board Diversity Matrix which is discussed below.

Nasdaq Diversity Rules

While the Nasdaq Board Diversity rules are not effective for the upcoming proxy season, the rules requiring disclosure of the Board Diversity Matrix become effective during 2022.  Nasdaq has published FAQS regarding the Board Diversity Rules, which contain information regarding publication of the Board Diversity Matrix:

“Companies must disclose the initial matrix in 2022.

      • If a company files its 2022 proxy BEFORE August 8, 2022 and DOES NOT include the Matrix, then the company has until August 8, 2022 to provide the Matrix.
      • If a company files its 2022 proxy ON or AFTER August 8, 2022, then it must either include the Matrix in its proxy or post the Matrix on its website within one business day of filing its proxy.
      • If a company does not intend to file a 2022 proxy, then the company has until August 8, 2022 to provide the Matrix on its website.

Companies that elect to provide the Matrix on its website must also complete a short form through the Listing Center that includes the URL link to the disclosure.”

Physical or Virtual Annual Meeting

Public companies will again need to determine whether to hold a physical or virtual annual meeting in the upcoming year.

Determine Your Status as an Issuer

Issuers should verify whether they are a large accelerated filer, accelerated filer, smaller reporting company (“SRC”) or emerging growth company (“EGC”).

Changes to Form 10-K: Holding Foreign Companies Accountable Act

The SEC has adopted interim final amendments to Form 10-K, Form 20-F, Form 40-F, and Form N-CSR to implement the disclosure and submission requirements of the Holding Foreign Companies Accountable Act, or the HFCA Act.  The HFCA Act became law on December 18, 2020. Among other things the HFCA Act requires the SEC to identify each “covered issuer” that has retained a registered public accounting firm to issue an audit report where that registered public accounting firm has a branch or office that:

  • Is located in a foreign jurisdiction; and
  • The PCAOB has determined that it is unable to inspect or investigate completely because of a position taken by an authority in the foreign jurisdiction.

We do not expect the HFCAA to affect the issuers we work with.  We do note however that the SEC interim amendments requires companies subject to the interim rules to make certain disclosures in new Item 9C to Form 10-K captioned “Disclosure Regarding Foreign Jurisdictions that Prevent Inspections.”  As such issuers should include the Item and caption in their Form 10-K and indicate the item is not applicable where appropriate.

Say-on-Pay Frequency Vote

Rule 14a-21(b) requires a say-on-pay frequency vote every six years. Issuers should review their own particular facts and circumstances to determine if they are required to hold a say-on-pay frequency vote.  We note that issuers that formerly qualified as EGCs should also remain mindful of say-on-pay requirements as issuers that no longer qualify as EGCs lose their exemption from the requirements under Exchange Act Sections 14A(a) and (b).  Such former EGCs are required to begin providing say-on-pay votes within one year of losing EGC status (or no later than three years after selling securities under an effective registration statement if an issuer was an EGC for less than two years).  Typically, such companies will also hold say-on-pay frequency votes when they hold their first say-on-pay vote as a non-EGC.

If you include a frequency vote, consider the related Form 8-K filing obligations.


The SEC adopted wide ranging final rules affecting MD&A and other matters in a release captioned “Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information.”  Registrants are required to comply with the rule beginning with the first fiscal year ending on or after August 9, 2021.

Climate Change

In 2010 the SEC issued an interpretive release on registrant’s disclosures related to climate change. Public pronouncements indicate the SEC s in the process of formulating updated rules.  In all likelihood any new rule would not be effective for the upcoming proxy season.

Registrant disclosures under the existing interpretation have been under review by the SEC.  Compliance with the interpretation has also attracted the attention of the Division of Enforcement.  As such, public companies may want to ensure compliance with the 2010 interpretation where applicable.

You can find our analysis here.

SEC Adopts Final Rules Regarding Proxy Advisors

In September 2019, the Commission issued an interpretation and guidance addressing the application of the proxy rules to proxy voting advice businesses. In July2020, the Commission adopted amendments to Rules 14a-1(l), 14a-2(b), and 14a-9 concerning proxy voting advice.

Gary Gensler, Chair of the SEC directed the staff to consider whether to recommend further regulatory action regarding proxy voting advice. In particular, the staff was directed to consider whether to recommend that the Commission revisit its July 2020 codification of the definition of solicitation as encompassing proxy voting advice, the 2019 Interpretation and Guidance regarding that definition, and the conditions on exemptions from the information and filing requirements in the 2020 Rule Amendments, among other matters.

In light of Chair Gensler’s direction, the Division of Corporation Finance determined that it will not recommend enforcement action to the Commission based on the 2019 Interpretation and Guidance or the 2020 Rule Amendments during the period in which the Commission is considering further regulatory action in this area.

As a result, these rules and interpretations are not expected to play a role in the upcoming proxy season.

Modernization of Property Disclosures for Mining Registrants

The SEC adopted amendments to modernize the property disclosure requirements for mining registrants, and related guidance, previously set forth in Item 102 of Regulation S-K and in Industry Guide 7. The amendments are intended to provide investors with a more comprehensive understanding of a registrant’s mining properties, which should help them make more informed investment decisions. The SEC’s revised mining property disclosure requirements now appear in Subpart 1300 of Regulation S-K.

Registrants engaged in mining operations must comply with the final rule amendments for the first fiscal year beginning on or after January 1, 2021. Industry Guide 7 will remain effective until all registrants are required to comply with the final rules, at which time Industry Guide 7 will be rescinded.

ISS Proxy Voting Policies

ISS is in the process of formulating changes to its voting recommendation policies.  Earlier it released its benchmark policy survey which generally is the first public step in the process.  We recommend that issuers monitor ISS’s new and updated policies, including ISS’s official proxy voting guidelines, which are typically issued in December for the upcoming proxy season.

Inline XBRL

All other filers (basically anyone other than an accelerated filer that has not already been phased in) are required to use Inline XBRL with their first Form 10-Q filing for the fiscal period ending on or after June 15, 2021.  Further information can be found here.

Shareholder Proposals

The Commission adopted rules altering the shareholder proposals submission framework under Rule 14a-8 of the Exchange Act for the first time in over twenty years.

The share ownership thresholds for eligibility to submit an initial shareholder proposal were revised to employ a sliding scale based on the amounts of securities owned.

The Commission’s revised rules also modified the resubmission thresholds under Rule 14a-8 to increase the required support necessary to resubmit a proposal.

The new thresholds became effective January 4, 2021 and will apply to any proposal submitted for an annual or special meeting to be held on or after January 1, 2022.  The amendments also include a transition rule permitting shareholders to submit proposals in reliance on the prior initial submission threshold for meetings held prior to January 1, 2023.

Our expanded analysis of the changes is available here.

Resource Extraction Issuers

In December 2020, the SEC adopted final rules that will require resource extraction issuers that are required to file reports under Section 13 or 15(d) of the Securities Exchange Act of 1934 to disclose payments made to the U.S. federal government or foreign governments for the commercial development of oil, natural gas, or minerals.  The rules implement Section 13(q) of the Exchange Act, which was added by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).

The SEC adopted a two-year transition period so that a resource extraction issuer will be required to comply with Rule 13q-1 and Form SD for fiscal years ending no earlier than two years after the effective date of the final rules.   The final rules were effective March 16, 2021.  Accordingly, the compliance date for an issuer with a December 31 fiscal yearend would be Monday, September 30, 2024 (i.e., 270 days after its fiscal year end of December 31, 2023).

Other Regulatory Initiatives

Proposed rules have also been issued on the following topics in prior years, but final rules have not been adopted:

In 2010 the SEC issued an interpretive release on registrant’s disclosures related to climate change. Public pronouncements indicate the SEC s in the process of formulating updated rules.  In all likelihood any new rule would not be effective for the upcoming proxy season.

The SEC has issued sample comments related to compliance with the interpretive release which should be reviewed when determining compliance with the interpretive release

The 2010 interpretation begins by citing existing SEC rules which can trigger climate change disclosures in the following areas:

  • Description of business
  • Legal proceedings
  • Risk factors
  • Management’s discussion and analysis

The 2010 interpretation then goes on to discuss some of the ways climate change may trigger disclosure required by the current commission rules.

Impact of Legislation and Regulation. Significant developments in federal and state legislation and regulation regarding climate change may trigger disclosure.   Existing federal, state and local provisions which relate to greenhouse gas emissions may require disclosure of any material estimated capital expenditures for environmental control facilities.

Risk factor disclosure may be required regarding existing or pending legislation or regulation that relates to climate change. Registrants should consider specific risks they face as a result of climate change legislation or regulation.

The current MD&A rules, which have been revised since the 2010 interpretation, require disclosure of known trends or uncertainties that have had or that are reasonably likely to have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations and any known material trends, favorable or unfavorable, in the registrant’s capital resources.

According to the 2010 interpretation, examples of possible consequences of pending legislation and regulation related to climate change include:

  • Costs to purchase, or profits from sales of, allowances or credits under a “cap and trade” system;
  • Costs required to improve facilities and equipment to reduce emissions in order to comply with regulatory limits or to mitigate the financial consequences of a “cap and trade” regime; and
  • Changes to profit or loss arising from increased or decreased demand for goods and services produced by the registrant arising directly from legislation or regulation, and indirectly from changes in costs of goods sold.

International Accords. Registrants also should consider, and disclose when material, the impact on their business of treaties or international accords relating to climate change. The potential sources of disclosure obligations related to international accords are the same as those discussed above for U.S. climate change regulation. Registrants whose businesses are reasonably likely to be affected by such agreements should monitor the progress of any potential agreements and consider the possible impact in satisfying their disclosure obligations based on the MD&A and materiality principle.

Indirect Consequences of Regulation or Business Trends.

Legal, technological, political and scientific developments regarding climate change may create new opportunities or risks for registrants. These developments may create demand for new products or services, or decrease demand for existing products or services. For example, possible indirect consequences or opportunities may include:

  • Decreased demand for goods that produce significant greenhouse gas emissions;
  • Increased demand for goods that result in lower emissions than competing products;
  • Increased competition to develop innovative new products;
  • Increased demand for generation and transmission of energy from alternative energy sources;
  • Decreased demand for services related to carbon based energy sources, such as drilling services or equipment maintenance services; and
  • Adverse impact on the registrant’s reputation.

According to the 2010 interpretation, these business trends or risks may be required to be disclosed as risk factors, in MD&A or the business description.

Physical Impacts of Climate Change.  Significant physical effects of climate change, such as effects on the severity of weather (for example, floods or hurricanes), sea levels, the arability of farmland, and water availability and quality, have the potential to affect a registrant’s operations and results.

Possible consequences of severe weather could include:

  • For registrants with operations concentrated on coastlines, property damage and disruptions to operations, including manufacturing operations or the transport of manufactured products;
  • Indirect financial and operational impacts from disruptions to the operations of major customers or suppliers from severe weather, such as hurricanes or floods;
  • Increased insurance claims and liabilities for insurance and reinsurance companies;
  • Decreased agricultural production capacity in areas affected by drought or other weather-related changes; and
  • Increased insurance premiums and deductibles, or a decrease in the availability of coverage, for registrants with plants or operations in areas subject to severe weather.

According to the 2010 interpretation, registrants whose businesses may be vulnerable to severe weather or climate related events should consider disclosing material risks of, or consequences from, such events in their publicly filed disclosure documents.

Most are familiar with the facts of the crashes of Boeing’s 737 MAX.  Later Boeing stockholders brought a claim that Boeing’s directors failed them in overseeing mission-critical airplane safety to protect enterprise and stockholder value.  The Delaware Court of Chancery issued an opinion that these Caremark claims survived a motion to dismiss.

The Court noted that at the pleading stage, a plaintiff must allege particularized facts that satisfy one of the necessary conditions for director oversight liability articulated in Caremark, either that:

  • the directors utterly failed to implement any reporting or information system or controls; or
  • having implemented such a system or controls, the directors consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.

The Court explained Caremark does not constitute a freestanding fiduciary duty that could independently give rise to liability.  A showing of bad faith is a necessary condition to director oversight liability.  In re Walt Disney Co. Derivative Litigation established that the intentional dereliction of duty or conscious disregard for one’s responsibilities, that is more culpable than simple inattention or failure to be informed of all facts material to the decision, reflects that directors have acted in bad faith and cannot avail themselves of defenses grounded in a presumption of good faith. Accordingly, in order to plead a derivative claim under Caremark, a plaintiff must plead particularized facts that allow a reasonable inference the directors acted with scienter which in turn requires proof that a director acted inconsistently with her fiduciary duties, but also that the director knew she was so acting.

Throughout the opinion the court looked to the precedent in MarchandMarchand addressed the regulatory compliance risk of food safety and the failure to manage it at the board level, which allegedly allowed the company to distribute mass quantities of ice cream tainted by listeria. Food safety was the “most central safety and legal compliance issue facing the company.” In the face of risk pertaining to that issue, Marchand noted the board’s oversight function “must be more rigorously exercised.” That, according to the opinion, “entails a sensitivity to compliance issues intrinsically critical to the company.”

Marchand held the board had not made a “good faith effort to put in place a reasonable system of monitoring and reporting” when it left compliance with food safety mandates to management’s discretion, rather than implementing and then overseeing a more structured compliance system. The Court considered the absence of various board-level structures “before the listeria outbreak engulfed the company.” The Court concluded that the complaint fairly alleged several dispositive deficiencies, such as the absence of a board committee that addressed food safety and the absence of a regular process or protocols that required management to keep the board apprised of food safety compliance practices, risks, or reports existed.

The Court concluded that Plaintiffs had carried their pleading burden that the Boeing directors had utterly failed to implement any reporting or information system or controls. According to the Court, like food safety in Marchand, airplane safety “was essential and mission critical” to Boeing’s business, and externally regulated. To support its conclusion, the Court looked to several facts such as:

  • The Boeing Board had no committee charged with direct responsibility to monitor airplane safety.
  • The Board did not monitor, discuss, or address airplane safety on a regular basis.
  • The Board had no regular process or protocols requiring management to apprise the Board of airplane safety; instead, the Board only received ad hoc management reports that conveyed only favorable or strategic information.
  • Management saw red, or at least yellow, flags, but that information never reached the Board.

In addition to the inferences drawn above, the Court found the pleading-stage record supported an explicit finding of scienter.  Here the Court looked to internal emails amongst Board members stating things like “we should devote the entire board meeting (other than required committee meetings and reports) to a review of quality within Boeing,” The Court also noted that the Board knowingly fell short was also evident in the Board’s public crowing about taking specific actions to monitor safety that it had not actually performed.

Yatra Online, Inc., v. Ebix, Inc. concerned an abandoned merger that Plaintiff, Yatra Online Inc. (“Yatra”), asserts was sabotaged post-signing by Defendants, Ebix, Inc. and EbixCash Travels, Inc. after Ebix determined the deal was no longer attractive.

Delays were encountered as an S-4 was awaiting SEC clearance and Ebix sought to renegotiate certain matters.  Fed up with Ebix’s behavior during the extended renegotiations, and after the final outside closing date lapsed, Yatra terminated the Merger Agreement and filed a lawsuit against Ebix.  The complaint included an action for breach of the Merger Agreement amongst other things.

The relevant provision of the merger agreement read as follows:

“In the event of any termination of this Agreement as provided in Section 8.1, the obligations of the parties shall terminate and there shall be no liability on the part of any party with respect thereto, except for the confidentiality provisions of Section 6.4 (Access to Information) and the provisions of Section 3.26 (No Other Representations and Warranties; Disclaimers), Section 4.17 (No Expenses), this Section 8.2, Section 8.3 (Termination Fees) and Article IX (General Provisions), each of which shall survive the termination of this Agreement and remain in full force and effect; provided, however, that, subject to Section 8.3(a)(iii), nothing contained herein shall relieve any party from liability for damages arising out of any fraud occurring prior to such termination, in which case the aggrieved party shall be entitled to all rights and remedies available at law or equity. The parties acknowledge and agree that nothing in this Section 8.2 shall be deemed to affect their right to specific performance under Section 9.9 prior to the valid termination of this Agreement. In addition, the parties agree that the terms of the Confidentiality Agreement shall survive any termination of this Agreement pursuant to Section 8.1 in accordance with its terms.”

Ebix argued that Yatra’s decision to terminate the Merger Agreement barred its claims for breach of contract.  Yatra responded that the phrase “with respect thereto” can reasonably be read to modify “any termination of this Agreement” (as opposed to “obligations”). Under this construction, the provision cannot be understood to eliminate damages owed for prior breaches of “obligations,” but only damages caused by the act of terminating the Merger Agreement.

The Court found Yatra’s reading of the provision stretched the words beyond their tolerance. The comma following “Section 8.1” breaks the sentence, reading naturally to indicate the Merger Agreement’s drafters intended the phrase “with respect thereto” to modify “the obligations of the parties” as opposed to “any termination of this agreement.”

Yatra’s position—that the provision only extinguished liability arising from “any termination of this Agreement”—was inconsistent with the language immediately following “with respect thereto,” which “except[s]” certain obligations under the Merger Agreement, as specifically enumerated, from the effects of the contractual limitation of liability. That clause would be superfluous if the effect of the provision was to limit liability only arising from the act of terminating the Merger Agreement.

Moreover, contrary to Yatra’s contention that termination leaves claims for breach of contract based on prior acts unaffected, the Court noted Section 8.2 expressly carved out only liability for “fraud occurring prior to such termination,” implying that liability for all other claims (including contract based claims) for acts “occurring prior” to termination did not survive post-termination.

The Court also considered the precedent set by AB Stable VIII LLC v. Maps Hotels & Resorts One LLC. The court in AB Stable expressly observed that “[u]nder the common law, termination results in an agreement becoming void, but that fact alone does not eliminate liability for a prior breach.” The court went on to explain that when parties include a provision stating that “there shall be no liability on the part of either party” upon termination, they “alter[] the common law rule” and “broadly waive[] contractual liability and all contractual remedies.”

The Court rejected Yatra’s argument that the result was absurd.  By Yatra’s own admission, its obligations under the Merger Agreement “ceased, because Ebix materially breached the Merger Agreement.” Thus, the Merger Agreement provided a choice to a party faced with a breach by the counterparty: either (a) sue for damages (or specific performance) or (b) terminate the Merger Agreement and extinguish liability for all claims arising from the contract (except those specifically carved-out, including claims for fraud). According to the Court, the latter option would be preferable where the terminating party believed it had some liability exposure of its own and would prefer to terminate the Merger Agreement to eliminate that risk. This is a perfectly logical way for parties contractually to manage risk, and the Court should not to redline the parties’ bargained-for limitations of liability because one party now regrets the deal it struck.

Stockholders of Zimmer Biomet Holdings, Inc., brought a derivative law suit.  Zimmer is a company that manufactures and markets various products in the highly regulated medical device industry. The plaintiffs’ claims stemmed from a September 12, 2016 “for cause” inspection of Zimmer’s North Campus site in Warsaw, Indiana by the U.S. Food & Drug Administration. The compliance problems identified during that inspection resulted in Zimmer issuing a blanket hold on shipments of products processed at the North Campus facility. Zimmer subsequently reported disappointing financial results for the third quarter of 2016, reduced its fourth quarter guidance, and saw its stock price fall 14%.

As with many derivative actions, a threshold issue was whether the plaintiffs’ failure to make a pre-suit demand on the Zimmer board was excused. Of the eleven-member board in place when this lawsuit was filed, the plaintiffs acknowledge that eight directors were independent. However, plaintiffs argued that making a demand would nonetheless have been futile because a majority of those directors face a substantial likelihood of liability.

However, the plaintiffs did not allege particularized facts to support that argument that directors faced a substantial likelihood of liability. Zimmer had an exculpation provision in its charter, meaning that the plaintiffs were required to plead facts suggesting a fair inference that the directors breached their duty of loyalty.

According to the Court, the only challenged disclosure that came close to directly implicating any of the Board members is the third quarter earnings release that was reviewed and approved by the Audit Committee.

On October 24, 2016, the Audit Committee—along with Zimmer’s officers, its counsel, and its external auditor—met to review the Company’s draft earnings release for the third quarter of 2016 and were given an “update on the ongoing FDA inspection” of the North Campus. After discussion, the Audit Committee members “expressed no objections” to the contents of the draft release.

Citing well accepted law, the Court noted that whenever directors communicate publicly or directly with shareholders about the corporation’s affairs, with or without a request for shareholder action, directors have a fiduciary duty to shareholders to exercise due care, good faith and loyalty.”  The duty of disclosure “is not an independent duty, but derives from the duties of care and loyalty.” The contours of that duty and what it requires of fiduciaries are context specific. Where (like here) the disclosures at issue did not concern a request for stockholder action, Malone v. Brincat requires that a plaintiff demonstrate scienter—i.e., that the directors “deliberately misinform[ed] shareholders about the business of the corporation, either directly or by a public statement.” Because Zimmer’s certificate of incorporation included an exculpatory provision under Section 102(b)(7), the plaintiffs “must plead particularized factual allegations that ‘support the inference that the disclosure violation was made in bad faith, knowingly or intentionally’” to establish demand futility.

According to the Court, Delaware courts may infer scienter for Malone claims where certain types of specific factual allegations are made. A plaintiff must plead with particularly that directors “had knowledge that any disclosures or omissions were false or misleading or . . . acted in bad faith in not adequately informing themselves.” A plaintiff also must allege “sufficient board involvement in the preparation of the disclosures” to “connect the board to the challenged statements.”

The third quarter earnings release covered the period ending September 30, 2016—just one day after the first ship hold went into effect. It was uncertain how much, if at all, the ship hold affected Zimmer’s third quarter results (or what the Audit Committee knew about potential effects). But based on the Complaint, there was reason to infer that the Audit Committee members knew that the FDA inspection of the North Campus would have an effect on Zimmer’s revenue guidance when they approved the earnings release. As the Complaint points out, the Audit Committee was given an update “on the ongoing FDA inspection of [North] Campus” during its October 24, 2016 meeting. “At the conclusion of [that] discussion, the Committee members expressed no objections to the contents of the draft earnings release.”

The plaintiffs argued that the earning release was an attempt to “hide and obscure” information from the public because the release “contained no disclosure of the FDA inspection or manufacturing shutdown.” In other words, plaintiffs argued the Audit Committee did not ensure that Zimmer adequately disclosed a potential reason for its reduced guidance. According to the Court, that assertion might call into question the Audit Committee members’ “‘erroneous judgment’ concerning the proper scope and content of the disclosure.” But that would, at best, support an exculpated claim for breach of the directors’ duty of care according to the Court. An inference cannot be drawn, from the limited allegations in the Complaint, that the Audit Committee approved an earnings release reducing revenue guidance while intentionally omitting material information about a possible underlying cause. The plaintiffs did not ascribe any bad faith actions or motives to the Audit Committee members that would demonstrate otherwise.

The SEC announced a settled enforcement action against Healthcare Services Group, Inc., John C. Shea, CPA, and Derya D. Warner regarding failure to make accruals for outstanding litigation.

According to the SEC’s order:

  • Under ASC 450-20-25-2, a loss contingency shall be accrued if (a) it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and (b) the amount of loss can be reasonably estimated. A loss or liability is considered probable if it is likely to occur. ASC 450-20-20.
  • By Q1 2014, HCSG had determined to seek an out-of-court settlement of the three pending class-action lawsuits in California state court (collectively, the “Irizarry” cases) after a joint mediation of those cases with plaintiffs. Under the proposed settlement, HCSG agreed to pay between $2.5 million and $3 million to plaintiffs, with the final amount to be determined based on the amount of claims submitted by class members. These and other settlement terms were set forth in a proposed settlement agreement that was submitted to the court for preliminary approval in Q1 2014. Shea, HCGS’ CFO, had participated in the mediation along with lawyers on behalf of HCSG. At all times, Shea was aware of the proposed settlement amount and the submission of the settlement agreement to the court for preliminary approval.
  • HCSG, however, did not accrue for the loss contingency related to the settlement of the Irizarry cases even though the loss was both probable and reasonably estimable no later than Q1 2014. Based on the information available at the time, Shea was aware that, like the other California employment class actions that HCSG had settled in 2013, HCSG intended to settle the Irizarry cases instead of continuing to litigate them. Shea also knew that HCSG would likely incur a liability between $2.5 million and $3 million under the out-of-court settlement, depending on the amount of claims submitted by class members. Shea determined that no amount for this loss contingency was probable or reasonably estimable because the Irizarry settlement claims process was not complete, and the settlement had not received final court approval at the time. Shea also did not maintain any documentation of any purported analysis under ASC 450 of a litigation loss contingency.
  • HCSG also did not disclose the nature of this loss contingency or an estimate of the amount of loss in its Q1 2014 Form 10-Q. The Form 10-Q stated HCSG was “subject to various claims and legal actions[,]” including “payroll and employee-related matters[.]” It also stated HCSG “provide[s] accruals if the exposures [to claims and legal actions] are probable and estimable,” and “[i]f an adverse outcome of such claims and legal actions is reasonably possible, we assess materiality and provide such financial disclosure, as appropriate.” Notwithstanding these statements, which were repeated in other Forms 10-Q and 10-K from 2014 to 2015, HCSG did not disclose the nature or an estimate of the loss contingency for the settlement of the Irizarry cases under ASC 450.
  • No accrual was made in Q2 2014 even though the Court had granted preliminary approval of the settlement.
  • HCSG accrued $2.5 million for the settlement of the Irizarry cases in Q3 2014. This amount was based, in part, on the number of claims submitted under the settlement agreement – an amount which the SEC stated was probable and reasonably estimable no later than Q1 2014.
  • The SEC made similar allegations with respect to an out-of-court settlement of a collective action brought against it in 2013 captioned, Kelly v. Healthcare Services Group, Inc.

Among other things, HCSG agreed to pay a $6,000,000 civil monetary penalty to the SEC to resolve the matter.

The defendants (respondents) did not admit or deny the facts set forth in the SEC order.

The NYSE recently amended its related party transaction rules to align with Regulation S-K Item 404.  The one key difference from Regulation S-K was that the NYSE did not apply the $120,000 transaction threshold which qualifies Regulation S-K.  Therefore, theoretically, a $1 transaction could trip the NYSE rule, although that was unlikely because it would be doubtful a related party would have a material interest in a $1 transaction as required by Regulation S-K.

Having seen the error it its ways, the NYSE has now modified it related party rules to include the $120,000 transaction threshold.

The rule change is effective upon filing, subject to SEC review.

In its rule filing the NYSE noted that in the period since the adoption of the previous amendment, it became clear to the Exchange that the amended rule’s exclusion of the applicable transaction value and materiality thresholds was inconsistent with the historical practice of many listed companies, and had unintended consequences. The Exchange learned that many listed companies  had a longstanding understanding that they were required to subject related party transactions to the review process required by the NYSE’s rules only if such transactions exceeded any applicable transaction value or materiality thresholds in the applicable SEC rules and therefore were required to be disclosed. This approach is embodied in the written related party transaction policies of many listed companies and is typically a part of the annual questionnaire completed by directors and officers in connection with the company’s annual meeting. By not permitting the use of transaction value and materiality thresholds, the previous amendment had the unintended effect of disrupting the normal course transactions of listed companies. Because of the previous amendment, many companies have been required to adopt for the first time two separate standards for related party transactions — one for disclosure and another for review and approval of transactions. This has created a significant compliance burden for issuers with respect to small transactions that are considered immaterial for purposes of other regulatory requirements. Furthermore, the Exchange believes that the review and approval of large numbers of immaterial transactions is not an effective use of the time of independent directors who have many other time-consuming oversight obligations with respect to matters that are higher risk and more material to the company.

Suzanne Flannery v. Genomic Health, Inc. et al is a case about the acquisition of Genomic Health, Inc. (“Genomic” or the “Company”) by Exact Sciences Corp. (“Exact”) pursuant to a Merger Agreement.

Count I of the inevitable complaint asserted the Baker Brothers Entities, which were purportedly the controlling stockholders of Genomic, along with Exact and Genomic, violated Section 203 of the Delaware General Corporation Law because the Baker Brothers Entities separately agreed to sell their greater than 15% stake in Genomic to Exact prior to the Merger.  More specifically, Plaintiff contended that Defendants violated Section 203 because Exact entered into a business combination with Genomic two days after Exact became an interested stockholder.

Plaintiff claimed Exact became an interested stockholder of Genomic on July 26, two days prior to the Board signing the Merger Agreement, when the Baker Brothers Entities allegedly agreed to vote their shares in favor of the transaction.

Defendants disagreed and argued Plaintiff’s Section 203 claim failed for among other things, the following reasons:

  • Exact never became an “Interested Stockholder” because the Baker Brothers Entities did not agree with Exact to vote in favor of the Merger until after the Board approved the Merger (when the Voting Agreement was actually executed), and
  • the Board implicitly approved the Voting Agreement prior to July 26, the date Plaintiff claims the two sides came to an agreement.

Plaintiff pointed to the Proxy, which stated that on July 26 “representatives of Akin Gump contacted representatives of Skadden to inform them that the Baker Brothers Entities were no longer willing to agree to transfer restrictions on their shares between signing and closing, but would still agree to vote in favor of the transaction.” This, according to Plaintiff, evidenced an “agreement, arrangement or understanding for the purpose of acquiring . . . such stock,” in violation of Section 203.

According to the Court, the Proxy’s language did not evidence either a formal or informal meeting of the minds between the Baker Brothers Entities and Exact on prior to approval of the Merger on July 26. In fact, the Proxy disclosed that the Baker Brothers Entities had plainly rejected Exact’s proposed voting agreement and that they would only agree to a voting agreement with different terms.

The fact that that the Baker Brothers eventually expressed their intent to support the Merger did not change the analysis. Without an agreement, Exact cannot conceivably be classified as an Interested Stockholder and thus cannot have violated Section 203. This was further bolstered by the existence of the later-executed Voting Agreement, entered into immediately after the Board approved and executed the Merger Agreement. That agreement evidenced nothing more than the commonplace scenario where a large stockholder agreed to vote its shares in favor of a transaction approved and authorized by the board of the target company.

As to implicit approval, the Court noted the only reasonable inference was that the Board well understood Exact would require voting agreements in connection with the Merger.  By continuing to negotiate with Exact on those terms, the Board demonstrated its agreement to the unremarkable proposition that Exact would seek to secure the commitment of Genomic’s largest stockholder to the Merger prior to the stockholder vote. That agreement to the transaction which resulted in Exact becoming an Interested Stockholder,” prior to the parties themselves agreeing, excepted the transaction from Section 203’s proscriptions.

Ultimately, the Court found Plaintiff’s attempt to pigeonhole Defendants’ conduct into a violation of Section 203 was inconsistent with the statute’s designated purpose. According to the Court, Section 203 was intended “to strike a balance between the benefits of an unfettered market for corporate shares and the well-documented and judicially recognized need to limit abusive takeover tactics.”

The Court stated Plaintiff’s view of Section 203 would authorize the court to prevent a merger even when a target’s board was aware of, and did not object to, a buyer’s attempt to secure the endorsement of a significant stockholder in favor of a deal that the board itself was attempting to secure for all of the target’s stockholders. Even if Plaintiff was correct that the Board had not formally approved of either the Merger or Voting Agreement prior to July 26, and that there was a meeting of the minds between the Baker Brothers Entities and Exact with respect to voting on July 26, it was undeniable that the Merger was formally approved by the Board on July 28 (with full knowledge of the Voting Agreement negotiations) and endorsed by the Board much earlier than that.  Nothing about this dynamic suggested Exact was engaged in “abusive takeover tactics.” The Court noted that it should be hesitant to strain the statute’s language to cover situations that do not threaten the interests the statute was designed to protect. Therefore, Plaintiff’s Section 203 was dismissed.