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

In public remarks SEC Gary Gensler hinted at the following changes to Rule 10b5-1:

  • When insiders or companies adopt 10b5-1 plans, there’s currently no cooling off period required before they make their first trade. Chair Gensler worries that some bad actors could perceive this as a loophole to participate in insider trading. Proposals to mandate four- to six-month cooling-off periods have received public, bipartisan support from former SEC Chair Jay Clayton and current Commissioners Caroline Crenshaw and Allison Herren Lee. Chair Gensler believes this approach deserves further consideration.
  • There currently are no limitations on when 10b5-1 plans can be canceled. As a result, insiders can cancel a plan when they do have material nonpublic information. This seems upside-down to Chair Gensler who believes this may undermine investor confidence. In Chair Gensler’s view, canceling a plan may be as economically significant as carrying out an actual transaction. That’s because material nonpublic information might influence an insider’s decision to cancel an order to sell. Thus, Chair Gensler has asked staff to consider limitations on when and how plans can be canceled.
  • There are no mandatory disclosure requirements regarding Rule 10b5‑1 plans. Chair Gensler believes more disclosure regarding the adoption, modification, and terms of Rule 10b5‑1 plans by individuals and companies could enhance confidence in our markets.
  • There are no limits on the number of 10b5-1 plans that insiders can adopt. With the ability to enter into multiple plans, and potentially to cancel them, Chair Gensler believes insiders might mistakenly think they have a “free option” to pick amongst favorable plans as they please. Chair Gensler has asked staff to consider whether there should be a limit on the number of 10b5-1 plans.

In Shareholder Representative Services LLC v Albertsons Companies, Inc., the aggrieved former shareholders of DineInFresh, Inc., d/b/a Plated, sought recovery of earnout consideration from Plated’s acquirer, Defendant, Albertsons Companies, Inc.  Plated had failed to reach any of the earnout milestones set forth in the Merger Agreement and Albertsons, therefore, refused to make any earnout payments.

In the Merger Agreement, Albertsons had bargained for the right to operate Plated post-closing in its discretion.  However, the foregoing right was limited by Albertson’s express commitment not to operate Plated in a manner intended to avoid the obligation to pay the earnout.

Plaintiff’s story was throughout the course of negotiating the merger, Albertsons made numerous representations regarding plans for the operation of Plated’s business post-closing.  According to Plaintiff, Albertsons asserted that Albertsons would continue to focus and grow Plated’s proven e-commerce business, rather than pivoting Plated’s operations to suit Albertsons’ traditional grocery retail business.

Plaintiff alleged that the revenue targets triggering the earnout were based on Plated’s past performance and forecasts, and, if Plated continued on its then current trajectory, Plated had a reasonable expectation that the revenue targets would be readily achieved.

According to Plaintiff, Albertsons’ internal documents reveal that it knew Plated’s success depended on investment in the e-commerce business; it acknowledged that if it provided support to Plated’s e-commerce business, the business would achieve +125% growth in 2018, well above the earnout levels.

Nevertheless, according to Plaintiff, immediately upon closing, Albertsons directed that Plated drastically reallocate its resources to get a retail product into 1,000 stores in the span of one week, to the detriment of the e-commerce business. Albertsons, according to Plaintiff, knew this endeavor was commercially unreasonable.  It created a reasonable inference that Albertson’s knew its push for in-store sales at the expense of subscriptions and the e-commerce business would cause Plated to fail to reach the earnout targets.

According to the Court, the reasonable inference allowed by Plaintiff’s allegations is not that Albertsons sabotaged a company it just paid $175 million for.   Rather it created an inference that Albertsons intended to avoid short-term earnout targets in favor of long term gains. Even if Albertsons took these actions only in part with the purpose of causing Plated to miss the earnout milestones, this was enough at the pleading stage to support Plaintiff’s breach of contract claim.

Albertsons argued that Plaintiff’s allegations cannot sustain a breach of contract claim when the conduct giving rise to the claim was expressly permitted under that same contract. In doing so the Court said Albertsons seized upon its contractual allowance to operate Plated within its discretion.  However, Albertsons had ignored the contractual prohibition against operational decisions intended to avoid or reduce the earnout.

The Court held that because Plaintiff’s well-pled allegations made it at least reasonably conceivable that Albertsons acted with the intent to avoid or reduce the earnout, it cannot be said, as a matter of law, that Albertsons’ conduct was expressly permitted.

In Re GGP, Inc. Stockholder Litigation arose out of a case where Brookfield Property Partners, L.P. and its affiliates acquired GGP.  The merger agreement provided upon approval of a majority of the GGP stock unaffiliated with Brookfield, GGP would declare a pre-closing dividend amounting to about 98.5% of the deal consideration, and $0.312 per share in cash would be paid at closing, representing the balance of the deal consideration, capped at $200 million.

Plaintiffs, stockholders of GGP, urged the Delaware Court of Chancery to conclude that the transaction’s two step structure—the payment of the pre-closing dividend followed by a post-closing payout—violated positive law. Specifically, plaintiffs argued that 8 Del. C. § 262 required Defendants to offer GGP stockholders appraisal for their shares at a pre-transaction value. By paying the pre-closing dividend separately, plaintiffs asserted defendants removed almost all value underlying the GGP shares available for appraisal.

According to the Court, neither party could identify case law addressing how a pre-closing dividend would (or should) be treated in an appraisal proceeding, but the Court believed the answer lies in the statute itself at Section 262(h).  That section directs the Court to value GGP “shares” as if GGP were a going concern “exclusive of any element of value arising from the accomplishment or expectation of the merger,” and then empowers the court to “take into account all relevant factors.” The Court stated that language is designed to endow Delaware courts with flexibility, enabling the presiding judge to view the transaction as a whole in the course of determining GGP’s fair value at the time of the merger. The Court concluded the pre-closing dividend would, in its view, qualify as a “relevant factor” in the court’s assessment of the fair value of a GGP stockholder’s shares.

As a result, the Court believed a GGP stockholder seeking appraisal could argue, and the Court could determine under Section 262, that the pre-closing dividend plus the closing consideration undervalued the dissenting stockholder’s shares. The fundamental issue raised for resolution in the appraisal proceeding would remain unchanged: did the stockholder receive fair value for its proportionate share of the corporation upon closing? After deciding the relevant substantive issue, the Court went on to reject plaintiff’s contention that appraisal rights were not properly disclosed to GGP stockholders.

Manichaean Capital, LLC et al v. Exela Technologies, Inc., et al begins with the Delaware Court of Chancery recounting the results of an appraisal action with respect to the acquisition of SourceHOV Holdings, Inc.  The former shareholders of Source HOV who properly exercised their appraisal rights received a significant award. SourceHOV appealed and the plaintiffs prevailed again. Following the entry of final judgment, the court entered a charging order against SourceHOV’s interests in its subsidiaries to facilitate the payment of the judgment.  However, the judgment was not satisfied.

As a result, certain of the appraisal award recipients sought to hold the acquirer, Exela, and its affiliated entities accountable for the appraisal judgment.  One of the theories plaintiffs argued was given the abuse of corporate form by Exela and its subsidiaries, principally through fraudulent maneuvers, the Court should pierce the SourceHOV corporate veil upwards to reach Exela and downwards to reach SourceHOV’s solvent subsidiaries so that plaintiffs can enforce their charging order against those entities.

According to the Court the plaintiffs had adequately pled that Exela, lacking in corporate formality, engaged in a transaction for the purpose of preventing funds that would otherwise flow from SourceHOV’s subsidiaries directly to SourceHOV to flow instead directly to Exela, thereby leaving the judgment debtor unable to satisfy the plaintiffs’ appraisal judgment. Because the charging order required any money flowing through SourceHOV Holdings first to be paid to the judgment creditors, including the plaintiffs, Exela’s participation in a scheme to deprive SourceHOV of those funds had conceivably rendered the charging order worthless. Those facts supported the plaintiffs’ requested relief in the form of traditional veil-piercing (i.e., piercing SourceHOV Holdings’ corporate veil to reach upwards to Exela).

The Court also found it was reasonably conceivable that SourceHOV’s subsidiaries knowingly participated in the wrongful scheme, such that the plaintiffs’ requested relief in the form of reverse veil-piercing (i.e., piercing SourceHOV’s corporate veil to reach downwards to its wholly owned subsidiaries) is likewise appropriate. However, the Court noted that the legality of reverse veil-piercing appeared to be a matter of first impression in Delaware.

Since it was a matter of first impression, the Court examined other judicial precedents regarding reverse veil piercing.  Courts declining to allow reverse veil-piercing have relied primarily on a desire to protect innocent parties. Reverse veil-piercing has the potential to bypass normal judgement collection procedures by permitting the judgment creditor of a parent to jump in front of the subsidiary’s creditors.  The Court found that these risks were not sufficient to reject reverse veil piercing.  Rather, the recognition of the risks creates an opportunity to manage them, and to do so in a manner that serves the interests of equity per the Court.

Reviewing the other precedents, the Court noted there were common sense ways to manage the risk of harm to innocent parties in reverse veil piercing. The Court then outlined an analytical framework for reviewing reverse veil piercing claims.  The starting place is to evaluate the traditional factors Delaware courts consider when reviewing a traditional veil-piercing claim—the so-called “alter ego” factors that include insolvency, undercapitalization, commingling of corporate and personal funds, the absence of corporate formalities, and whether the subsidiary is simply a facade for the owner.

The court should then ask whether the owner is utilizing the corporate form to perpetuate fraud or an injustice. This inquiry should focus on additional factors, including:

  • the degree to which allowing a reverse pierce would impair the legitimate expectations of any adversely affected shareholders who are not responsible for the conduct of the insider (here the insiders are SourceHOV’s subsidiaries) that gave rise to the reverse pierce claim, and the degree to which allowing a reverse pierce would establish a precedent troubling to shareholders generally;
  • the degree to which the corporate entity whose disregard is sought (here, disregard is sought for SourceHOV) has exercised dominion and control over the insider who is subject to the claim (here the insider are SourceHOV’s subsidiaries) by the party seeking a reverse pierce;
  • the degree to which the injury alleged by the person seeking a reverse pierce is related to the corporate entity’s dominion and control of the insider, or to that person’s reasonable reliance upon a lack of separate entity status between the insider and the corporate entity;
  • the degree to which the public convenience, as articulated by the Delaware General Corporation Law and Delaware’s common law, would be served by allowing a reverse pierce;
  • the extent and severity of the wrongful conduct, if any, engaged in by the corporate entity whose disregard is sought by the insider;
  • the possibility that the person seeking the reverse pierce is himself guilty of wrongful conduct sufficient to bar him from obtaining equitable relief;
  • the extent to which the reverse pierce will harm innocent third-party creditors of the entity the plaintiff seeks to reach; and
  • the extent to which other claims or remedies are practically available to the creditor at law or in equity to recover the debt.

After carefully reviewing the complaint, the Court was satisfied this was one of those “exceptional circumstances” where a plaintiff has well pled a basis for reverse veil piercing.  This was a motion to dismiss under Court of Chancery Rule 12(b)(6).  Under Court of Chancery Rule 12(b)(6) all well-pled factual allegations are accepted as true amongst other things. Thus the Court did not determine the truth or falsity of plaintiff’s allegations.

The House Financial Services Committee has approved the Climate Risk Disclosure Act of 2021. The bill now heads to the House floor.

The Climate Risk Disclosure Act directs the SEC, in consultation with climate experts at other federal agencies, to issue rules within two years that require every public company to disclose:

  • Its direct and indirect greenhouse gas emissions;
  • The total amount of fossil-fuel related assets that it owns or manages;
  • How its valuation would be affected if climate change continues at its current pace or if policymakers successfully restrict greenhouse gas emissions to meet the 1.5 degrees Celsius goal; and
  • Its risk management strategies related to the physical risks and transition risks posed by the climate crisis.

The bill directs the SEC to tailor these disclosure requirements to different industries and to impose additional disclosure requirements on companies engaged in the commercial development of fossil fuels.

If the SEC does nor issue the required rules during the two-year period, public companies will be in compliance if they provide disclosure in their annual report that satisfy the recommendations of the Task Force on Climate-related Financial Disclosures of the Financial Stability Board as reported in June, 2017, or any successor report, and as supplemented or adjusted by such rules, guidance, or other comments from the SEC.

The Public Company Accounting Oversight Board has proposed a new rule provide a framework for its determinations under the Holding Foreign Companies Accountable Act, or the HFCAA.

The HFCAA calls for the Board to determine whether it is unable to inspect or investigate completely registered firms located in a foreign jurisdiction because of a position taken by an authority in that jurisdiction. The HFCAA, among other things, also mandates that after the Board makes such a determination, the Commission shall require covered issuers that retain firms subject to the Board’s determination to make certain disclosures in their annual reports and, eventually, if certain conditions persist, shall prohibit trading in those issuers’ securities.

The proposed rule would establish:

  • the manner of the Board’s determinations;
  • the factors the Board will evaluate and the documents and information the Board will consider when assessing whether a determination is warranted;
  • the form, public availability, effective date, and duration of such determinations; and
  • the process by which the Board can modify or vacate those determinations.

In connection with an M&A transaction, in In Re Pattern Energy Group Inc. Stockholders Litigation the Delaware Court of Chancery determined that that the plaintiff had stated a claim against the director defendants for breach of the duty of loyalty.  The Court then considered the director defendants’ argument that any such breach was cleansed by a stockholder vote and that therefore dismissal was appropriate under Corwin. Corwin gives rise to the irrebuttable presumption of the business judgment rule when a transaction “is approved by a fully informed, uncoerced vote of the disinterested stockholders.”

Plaintiff contended that Corwin does not apply because the vote was uninformed and because a significant block of votes by a preferred holder, CBRE, was not disinterested. According to plaintiff CBRE was neither disinterested nor uncoerced.  Plaintiff argued the vote was not uncoerced as CBRE was contractually obligated to vote its preferred shares in accordance with CBRE Board’s recommendation regardless of its own economic interest.  In addition, plaintiff claimed CBRE was not disinterested because its “preferred shares rolled over into the combined company with an increased dividend rate.”

The Court agreed with the plaintiff. When CBRE acquired its preferred stock it agreed that in the event of any proposed merger it would vote its preferred shares in a manner consistent with the recommendation of the Board. The Court found that because of CBRE’s contractual obligation to vote in favor of the merger, which CBRE agreed to without being informed of the merger’s terms, the director defendants could not invoke Corwin’s protections. Accordingly, CBRE’s vote in favor of the Merger was not informed, and therefore the votes should not be counted to determine of Corwin cleansing applied.

Defendants also failed to demonstrate that CBRE’s vote was voluntary. The business judgment rule standard of review applies only if disinterested and informed stockholders have had the voluntary choice to accept or reject a transaction. According to the Court, the term ‘ratification’ applies only to a voluntary stockholder vote. The essence of Corwin is a court declines to second-guess the board when the stockholders, as a second set of decision makers, have approved the economic merits of a transaction for themselves. To be a meaningful ratifying vote, the stockholder must be voting on the transaction of her own accord and on the transaction’s merits. A stockholder voting in favor of a specific transaction because it had previously contracted to vote in favor of any transaction in exchange for consideration is not offering the second review that supports application of the business judgment rule.

The Court also found CBRE was interested with respect to the Merger and CBRE’s vote could not be counted to determine of Corwin cleansing applied.  CBRE bargained for the right to rollover its preferred stock at a premium into the post-closing company and keep its shares after a merger. In addition, after a change in control, the annual dividend rate on CBRE’s preferred stock would increase by as much as seventy-five basis points, and the holders would receive an accelerated payment on certain otherwise contingent dividends. As a result, CBRE’s merger benefits were not shared with the Company’s public common stockholders, who were to be cashed out. Accordingly, CBRE was interested by virtue of the preferred stock purchase agreement, as it stood to receive benefits from the merger that were not shared with the cashed-out majority.

In Re Pattern Energy Group Inc. Stockholders Litigation involved an M&A transaction where the sales process of Pattern Energy Group Inc. was run by an undisputedly disinterested and independent special committee that recognized and nominally managed conflicts, proceeded with advice from an unconflicted banker and counsel, and conducted a lengthy process attracting numerous suitors that the special committee pressed for value.  The foregoing positive attributes were offset by selecting a bidder that did not offer the highest price at the behest of perhaps conflicted parties supported by conflicted management.

While the decision on a motion to dismiss covers significant ground on many matters, the Court also found the directors engaged in bad faith when delegating preparation of the proxy statement to management. The Board adopted a resolution giving certain officer defendants the power to “prepare and execute” the merger proxy “containing such information deemed necessary, appropriate or advisable” by only the officer defendants, and then to file the proxy with the SEC without the Board’s review.

The plaintiff contended that the delegation to prepare the proxy constituted an unexculpated acted of bad faith. Specifically, the plaintiff claimed the director defendants acted in bad faith by abdicating their strict and unyielding duty of disclosure, and relatedly, by knowingly fail to correct a proxy statement that they knew was materially incomplete and misleading.

The Court cited precedent which noted that while the board may delegate powers to the officers of the company as in the board’s good faith, informed judgment are appropriate, that power is not without limit.  The precedent provided the board may not either formally or effectively abdicate its statutory power and its fiduciary duty to manage or direct the management of the business and affairs of this corporation. As a result, the Court found it is well established that while a board may delegate powers subject to possible review, it may not abdicate them. Under Delaware law, the board must retain the ultimate freedom to direct the strategy and affairs of the Company for the delegation decision to be upheld.

In the next step of the analysis, the Court noted abdication of directorial duty evidences disloyalty.  In this case the Court noted the plaintiff alleged that the director defendants delegated to conflicted management total and complete authority to prepare and file the proxy and that the director defendants did not review the proxy before it was filed.

The director defendants did not provide any information to rebut the plaintiff’s allegations.  The plaintiff’s allegations were consistent with the delegating Board resolution. For example, there were no meeting minutes demonstrating that the director defendants oversaw the proxy’s preparation or that they reviewed the proxy before the officer defendants filed it with the SEC.

The Court had to accept the plaintiff’s allegations as true for the purpose of the motion to dismiss.   Therefore, the Court found plaintiff had alleged facts making it reasonably conceivable that the director defendants delegated full authority to prepare and disseminate the Proxy to the allegedly conflicted officer defendants, and did so in bad faith.  According to the Court, bad faith is reflected in the choice of agent and the complete scope of delegation.

Expanding on the bad faith analysis, the Court noted the Board delegated drafting the proxy to the officer defendants, known conflicted individuals who had been ostensibly walled off from the sale process but still assisted in tilting the playing field toward buyer. Second, the Court found the scope of the delegation went too far. The Board’s resolution granted the officer Defendants full power and discretion to prepare the Proxy with information they thought it needed to contain, and then to file the Proxy with the SEC without the Board’s review. The Board authorized interested parties to unilaterally describe the process to the stockholders with finality, thereby infecting the stockholder vote as well.

According to the Court, the plaintiff also adequately alleged that the director defendants failed to correct a proxy they knew to be false and misleading. The Complaint’s allegations indicated that the director defendants knew the truth so if the director defendants had reviewed the proxy, even if only after it was issued, they would have known it was false or misleading. Because the Company issued further disclosures before the stockholder vote in a supplemental proxy, the director defendants conceivably had the opportunity to correct any alleged misstatements but failed to do so.

The Securities and Exchange Commission charged eight companies for failing to disclose in SEC Form 12b-25 filings, commonly known as Form NT, that their request for seeking a delayed quarterly or annual reporting filing was caused by an anticipated restatement or correction of prior financial reporting. The companies agreed to pay penalties of $25,000 to $50,000 each.

According to the SEC, Rule 12b-25 provides that if an issuer fails to file a Form 10-K or 10-Q within the time period prescribed for such report, the issuer, no later than one business day after the due date for such report, shall file a Form 12b-25 with the Commission, disclosing the issuer’s inability to file the report timely and the reasons therefore in reasonable detail. Form 12b-25 requires the issuer to affirm, among other things, that the subject periodic report will be filed within fifteen calendar days, for a Form 10-K, or within five calendar days, for a Form 10-Q, of the report’s prescribed due date, and requires that the report actually be filed within such period. Form 12b-25 also requires the issuer to confirm whether or not it anticipates that any significant change in results of operations from the corresponding period for the prior fiscal year will be reflected by the earnings statements to be included in the subject periodic report. If such change is anticipated, the issuer must attach a narrative and quantitative explanation of the anticipated change and, if appropriate, state the reasons why a reasonable estimate of the results cannot be made.

The SEC orders find that each of the companies announced restatements or corrections to financial reporting within 4-14 days of their Form NT filings despite failing to provide details disclosing that anticipated restatements or corrections were among the principal reasons for their late filings. The orders also find that the companies failed to disclose on Form NT, as required, that management anticipated a significant change in quarterly income or revenue.

According to the SEC, they will “continue to use data analytics to uncover difficult to detect disclosure violations.”  Data analytics are sometimes referred to as robo-cop routines.  It’s probably not that hard to match up Form 12b-25’s with Form 8-K’s announcing restatements filed in short proximity of one another.

The House of Representatives has passed the “The Promoting Transparent Standards for Corporate Insiders Act” (H.R. 1528) by a vote of 355-69.  The bill directs the Securities and Exchange Commission to study and report on possible revisions to regulations regarding 10b5-1 trading plans. 10b5-1 plans allow employees of publicly traded companies and others to sell their shares without violating insider trading prohibitions. The bill requires the SEC to revise its regulations consistent with the results of the study.