Wednesday, September 30, 2020

Speakers at the 2020 Garrett and Corporate Counsel Virtual Institute addressed key employment law issues

By Mark S. Nelson, J.D.

This year’s Northwestern Pritzker School of Law spring programs on corporate and securities law, delayed due to the COVID-19 pandemic, featured online panel discussions held over a three-day period in late September during which diversity and inclusion and companies’ pay practices during the COVID-19 pandemic were omnipresent topics. The panel discussions occurred at the 2020 Garrett and Corporate Counsel Virtual Institute, a combination of the 40th Annual Ray Garrett Jr. Corporate & Securities Law Institute and the 59th Annual Corporate Counsel Institute, both hosted by Northwestern Pritzker School of Law. The discussion below is organized topically such that commentary on each topic has been drawn from multiple panels, thus demonstrating how a few important topics permeated discussions on subject matter as varied as racial inequality, employment law, COVID-19, data analysis, and executive compensation.

Diversity and inclusion. Shannon P. Bartlett (she/her), associate dean, Inclusion & Engagement, Northwestern Pritzker School of Law, speaking on a panel titled "Moving from Diversity Talk to Action: How Law Firms and Legal Departments Can Address Systemic Racism," observed generally that studies have shown how random problem solvers often outperform a group of pre-selected problem solvers. She suggested that studies of this type are strong indicators that diversity is important in improving workplace performance.

Bartlett also addressed the question of how persons with diverse backgrounds come to the attention of companies’ human resources departments. According to Bartlett, referral networks can overshadow the more traditional pipeline of job candidates, although sometimes the pipeline itself is the problem.

Bartlett noted the recent apology issued by Wells Fargo CEO Charlie Scharf, who had suggested that the reason the company had not hired more persons of color was that the talent pool from which the bank draws did not contain enough qualified persons. Said Scharf: "I apologize for making an insensitive comment reflecting my own unconscious bias. There are many talented diverse individuals working at Wells Fargo and throughout the financial services industry and I never meant to imply otherwise. I’ve worked in the financial services industry for many years, and it’s clear to me that, across the industry, we have not done enough to improve diversity, especially at senior leadership levels. And there is no question Wells Fargo has to make meaningful progress to increase diverse representation. As I said in June, I have committed that this time must be different." Scharf’s comments also had drawn criticism from Democratic leaders in Congress, where legislation seeking to improve public companies’ diversity has been passed by the House (see, e.g., H.R. 5084 and S. 360).

Bartlett commented that in situations in which a company’s jobs pipeline seems not to be achieving diversity goals, it is important to understand why that pipeline is missing qualified applicants.

Another panel titled "Updates in Employment Law" addressed both diversity and inclusion and COVID-19-related compensation issues (the latter topic is discussed below). Ami N. Wynne of Morgan, Lewis & Bockius LLP noted that many companies spoke out about their commitment to combating racial injustice after the police-involved killing of George Floyd although, just as with the #metoo movement, some companies still were caught flat-footed by complaints posted on social media by employees, customers, and suppliers. Wynne said companies should view diversity and inclusion as an issue with both qualitative and quantitative aspects. For example, on the qualitative side, companies should know their current culture and what culture they want to achieve. Companies also need to mull how effective annual culture surveys are, especially when employees may view these surveys negatively.

With respect to quantitative issues, Wynne said that if a company discloses workforce demographics, it should know what that data will show and what it means. She added that authenticity is important. Wynne further noted that companies might, to get a better grasp on their demographics, do some internal analyses of their demographics aided by the attorney-client privilege. When companies do publish demographic data, they can try to put the data in context by stating aspiration goals, offering a company narrative, or comparing their demographics to competitors’ demographics.

Wynne also noted the federal government’s recent order to agencies to not do certain types of racial trainings. Specifically, President Trump announced an executive order rejecting what it termed "ideology [] rooted in the pernicious and false belief that America is an irredeemably racist and sexist country; that some people, simply on account of their race or sex, are oppressors; and that racial and sexual identities are more important than our common status as human beings and Americans." The executive order applies to the U.S. military, federal agencies, and federal contractors.

Wynne, however, said such trainings are a pillar in the private sector regarding diversity and inclusion. She said in the post-George Floyd era it was likely that companies would "double down" and expand their trainings from discrimination and implicit bias to add cultural conversations that include critical race theories.

Marissa Ingley, chief counsel, Labor & Employment Law, Archer Daniels Midland, offered three tips for starting a company’s diversity and inclusion program: (1) determine what needs and areas of weakness should be addressed and ensure the program is "authentic;" (2) be patient because diversity and inclusion is often a "work-in-progress" and requires the temperament to run a "marathon" instead of a "sprint;" and (3) focus on compliance training. She said that ADM emphasizes unconscious bias, having someone take the contrarian view, and keeping their program fresh.

Lastly, another panel titled "What Lawyers Need to Understand About Data" examined many general data analysis issues but also briefly looked at human resources data used to study whether a company discriminates in employment. First, Shaila Ruparel, Associate General Counsel, II-VI Inc., observed that while data has some intrinsic value, its true value derives from how it is used. Andrew Cripe, shareholder and chair of the Employment Advice and Investigations group at Polsinelli PC, agreed that data is "only as good what it was built for" and went on to suggest a human resources example. According to Cripe, human resources data is generally set up only to process payroll and benefits, but beyond these purposes it is often a "dumpster fire." For example, human resources data could be used to study whether a company has gender pay equity issues but, unless data has been "leveled," it can be difficult to discern which employees perform similar work.

COVID-19 and workplace health. The COVID-19 pandemic appeared during several employment law panels. Companies already face issues of how to monitor employees for illness to reduce the transmission of COVID-19 in the workplace while maintaining a safe environment for those employees who must be in the workplace rather than working from home. Still other companies plan for the day when those who are working from home begin to resume in-person work.

Dr. Janna Kerins, medical director, Environmental Health, Chicago Department of Public Health, explained the basics of epidemiology on a panel titled "Post-COVID-19: Front-end Planning for a Crisis – What Do We Know Now?" Dr. Kerins defined "outbreak" as a sudden increase in disease above what is normally expected in some population. An outbreak could involve just two or more confirmed or probable cases within 14 days, the incubation period for the virus that causes COVID-19.

Dr. Kerins said outbreak notification typically involves case investigation, an employer report, or a complaint, although these steps vary by state and locality. Public health authorities and companies should focus on modifiable risk factors that can be changed to reduce risk of disease transmission. She also said contract tracing is important in the workplace and could emphasize: (1) when employees’ symptoms started; (2) whether employees had close contacts with infected persons such as through work, car pools, or work-adjacent activities; and (3) when an employee last was at work or when an employee was last tested for infection.

Speaking on that same panel, Kathryn Montgomery Moran, principal, at Jackson Lewis P.C., observed that COVID-19 requires companies to focus on business continuity and that for the first time in a long time businesses had seen "extremely rapid" legal change. She also noted that COVID-19-related legislation contains many employment provisions that have deadlines. For example, she explained that the Families First Coronavirus Response Act (FFCRA) (see Section 3101, et. seq.) added a new Family and Medical Leave Act category that was due to sunset on December 31, 2020, unless additional legislation extends the provision. It is also important to check the Coronavirus Aid, Relief, and Economic Security (CARES) Act for adjustments to FFCRA provisions.

Once again, the "What Lawyers Need to Understand About Data" panel noted several important things to know about data companies may be collecting on employees’ COVID-19 status. For example, companies typically will take an employee’s temperature and ask them questions about their current health before allowing them to enter an office building. Polsinelli PC’s Cripe observed that some companies had retained this data, even though it was intended for a one-off "go, no go" type of use. As a result, those companies collected "medical information" for purposes of OSHA regulations that must be maintained according to OSHA standards. Cripe suggested that companies in the COVID-19 context not collect such data, especially on employees, that they do not actually need.

Cripe would return to the topic of COVID-19 toward the end of the data panel discussion. Here, Cripe reminded listeners that an employer cannot tell other employees of an employee’s health status because of privacy concerns. Cripe explained that clients may then ask how are they supposed to stop COVID-19 in the workplace if they cannot identify sick employees? He said carefully designed contact tracing can help to minimize privacy issues but that a better approach may be to avoid uncertainties in the first place by embracing remote working or having employees keep track of their contacts in advance of any illness.

Executive compensation and COVID-19. The "Updates in Employment Law" panel, in addition to discussing diversity and inclusion, addressed issues that can affect how executives and other employees are paid during the COVID-19 pandemic. Michelle L.C. Carpenter, Latham & Watkins LLP, for example, said that early 2020 or multi-year bonus pools may no longer work in light of the pandemic. Instead, she suggested that some companies may set up discretionary bonus programs, modify performance goals (something she said was more popular earlier in 2020), or shift performance measures from metrics focused on financials to ones focused on operational goals.

Carpenter also noted several additional topics for companies to consider. For one, the Tax Cuts and Jobs Act of 2017 amended Internal Revenue Code Section 162(m) but grandfathered certain compensation arrangements; as a result, a company should consult its tax advisers about whether changed plan terms could remove the company’s plan from the grandfather provision. Second, shareholder-approved equity plans should be checked for terms regarding the following: (1) share limits; (2) limits on awards to an individual employee within a calendar year; and (3) vesting schedules. More generally, if a company seeks to modify financial goals related to compensation plans, it should consult its accounting advisers to avoid any possible accounting charges.

Securities law disclosures. Although not mentioned in the several relevant panel discussions, the SEC recently issued Compliance and Disclosure Interpretations (C&DIs) regarding executive compensation disclosures and COVID-19. New C&DI Question 219.05 addresses issues regarding executive compensation disclosures under Items 402(a) and (c) of Regulation S-K. Item 402(c)(2)(ix)(A) requires disclosure of perquisites and other personal benefits, the aggregate amount of which is $10,000 or more. The C&DI further address executives who are named executive officers under Item 402(a)(3)(iii) and (iv), that is, subject to some qualifications, the three highest paid executives (other than the PEO and PFO) plus up to two more individuals who would have been subject disclosure but who were not serving as executive officers.

The C&DI begins by reaffirming that SEC Release No. 33-8732A applies to the determination of benefits and perquisites. As result, an item is not a benefit or perquisite if it is integrally and directly related to job performance, an evaluation that depends on the particular facts and circumstances. However, an item is a benefit or perquisite if it confers a benefit that has a personal aspect, unless the item is generally available on a non-discriminatory basis to all employees. With respect to COVID-19, the C&DI explained in detail how these principles might apply:

"In some cases, an item considered a perquisite or personal benefit when provided in the past may not be considered as such when provided as a result of COVID-19. For example, enhanced technology needed to make the NEO’s home his or her primary workplace upon imposition of local stay-at-home orders would generally not be a perquisite or personal benefit because of the integral and direct relationship to the performance of the executive’s duties. On the other hand, items such as new health-related or personal transportation benefits provided to address new risks arising because of COVID-19, if they are not integrally and directly related to the performance of the executive’s duties, may be perquisites or personal benefits even if the company would not have provided the benefit but for the COVID-19 pandemic, unless they are generally available to all employees."

Waiver of salary. Early in the pandemic, many companies imposed salary cuts or allowed executives and other employees to waive their salaries. However, Carpenter said salary waivers can raise a number of issues. For example, she said waivers should focus on executives rather than rank-and-file employees. She also noted that employment contracts must be reviewed for provisions that establish a fixed base salary, target bonuses, and the right to terminate for good reason.

Carpenter further noted that severance paid to departing employees should be based on the employee’s original salary before a waiver instead of their salary resulting from a waiver. The severance issue would be especially important for lower-level managers who choose to waive their salaries (likely to a lesser extent than higher up executives) to show their solidarity with the employee base.

With respect to waving bonuses, Carpenter said companies should plan ahead because if a bonus is waived after it has been approved and earned, the IRS could take the view that the bonus was constructively received by the employee and, thus, it would be taxable. Moreover, Carpenter said a company must be aware of applicable minimum wage laws; she suggested that companies obey minimum wage laws and, if desired, allow waiver of any salary above that amount.

Payroll tax deferral. The employment panel also discussed the Trump Administration’s recent announcement via presidential memorandum that some employees will be able to defer payment of payroll taxes and the Treasury Department’s announcement of related IRS guidance (See Notice 2020-65). On a related matter, the Treasury Department also has stated that the payroll tax deferment program should not impact the social security trust funds due to the temporary nature of the deferral program and the need for payroll taxes to be repaid.

The payroll tax deferral applies to wages paid during any bi-weekly (or equivalent) pay period of less than $4,000 during the period September 1, 2020 to December 31, 2020. The IRS guidance states that repayment of payroll taxes must occur between January 1, 2021 and April 30, 2021; otherwise, on May 1, 2021, a taxpayer will be subject to interest, penalties, and other additions to tax.

According to Carpenter, the deferral applies to the employee portion, not the employer portion, of the tax. She said employers must decide to make the deferral available to employees as well as whether the deferral is mandatory or elective. Carpenter noted that if an employer makes the deferral mandatory, it would be hard to repay amounts in early 2021 and that it would be especially difficult to get repayment from an employee who has left the company. ADM’s Ingley said many employers are likely not to participate in the payroll tax deferral program because of its administrative burdens, especially regarding the need for companies to get employees to repay deferred amounts. Ingley added that whatever decision a company makes about participation in the deferral program, it should clearly communicate that decision to its employees.

COVID-19 lawsuit trends. Jeffrey Webb of Paul Hastings LLP, moderator of the "Updates in Employment Law" panel, warned of a possible increase in COVID-19-related employment lawsuits. He said the number one litigated claim is for retaliation against employees who raise COVID-19 workplace safety concerns. Other types of claims include: (1) those for job loss where the employee belonged to a protected category; (2) WARN Act cases regarding layoffs and furloughs; (3) cases when an employee was fired because they were believed to have COVID-19 or when an employee refused to go to their workplace because of COID-19 worries; and (4) cases that involve mask wearing, especially when it would be important for an employee to be able to read lips.

Lastly, Polsinelli’s Cripe, speaking separately on the "What Lawyers Need to Understand About Data" panel, noted that cases alleging that an employee spread COVID-19 outside the workplace potentially could expose companies to significant tort liability. Following the conclusion of the 2020 Garrett and Corporate Counsel Virtual Institute, Reuters published an article spotlighting some of the first "take home" COVID-19 lawsuits in which it is alleged that employees brought COVID-19 home to family members who then also became sick. Sources cited in the Reuters article suggested that 7 percent to 9 percent of total U.S. deaths from COVID-19 (which recently surpassed 200,000) may be from take-home infections and that take home lawsuits would likely rely on theories that could avoid recovery limits imposed on employees by workers compensation laws.

Tuesday, September 29, 2020

Judge Barrett of the Seventh Circuit tapped to fill Supreme Court vacancy

By Rodney F. Tonkovic, J.D.

President Trump has nominated Seventh Circuit Judge Amy Coney Barrett to fill the Supreme Court seat left vacant by the death of Justice Ruth Bader Ginsburg. As the Court returns from mourning Justice Ginsburg and prepares for the October 2020 term, confirmation hearings for the potential ninth Justice are scheduled to begin soon. While the larger implications of Judge Barrett's possible ascent to the Supreme Court will be covered in other publications, this post will examine her potential impact on securities law.

Confirmation battle. Judge Barrett was nominated to the Seventh Circuit by President Trump in May 2017. During the confirmation hearing on September 6, 2017, Democratic leaders opposed Judge Barrett’s nomination on the grounds that she had little appellate courtroom experience, over concerns about her views on stare decicis, and over her religious views. Republican leaders defended Judge Barrett’s nomination and alleged that Democrats were trying to apply a religious test to her nomination that is forbidden by Article VI of the U.S. Constitution. The Senate confirmed Judge Barrett by a vote of 55-43, and she received her commission on November 2, 2017.

Sen. Lindsey Graham (R-SC), chair of the Senate Judiciary Committee, has indicated that Judge Barrett's confirmation hearings will begin on October 12, 2020. In an expedited process, October 13th and 14th will be devoted to questioning, and the mark-up process will start on October 15th, Graham said. As this appointment is expected to tip the ideological balance of the Court toward the conservative side, the hearings will surely be contentious. As of this writing, battle lines are still being drawn, although it is likely the arguments for and against will resemble the positions taken during Judge Barrett's 2017 hearings.

Another wrinkle is the nomination's proximity to the presidential election. Senate Majority Leader Mitch McConnell (R-Ky) issued a statement in which he sought to distinguish his refusal to give President Barack Obama's last Supreme nominee Senate floor vote during an election year and his pledge that Justice Ginsburg’s replacement will get such a vote. After the nomination, McConnell applauded the selection of Judge Barrett and confirmed that a vote will occur in the coming weeks. Democrat leaders, such as House Majority Leader Steny Hoyer (D-Md), have noted that Justice Ginsburg had expressed the view that she should not be replaced until the winner of the 2020 presidential election has been sworn in. Other Democrats, including presidential candidate Joe Biden, have similarly criticized the timing of the nomination. Some have taken the position that they view the nomination as illegitimate and will not meet with Judge Barrett, and procedural tools may be employed that could delay the hearings.

Barrett's jurisprudence. In the upcoming term, the Court is expected to address several important securities law cases. For example, the Court will again face the question of the boundaries of disgorgement in Jalbert v. SEC, which questions whether disgorgement awards violate separation-of-powers principles; this case has been distributed for conference on September 29, 2020, and an analogous case involving the FTC has yet to be addressed. Other petitions awaiting disposition concern the Basic presumption, jurisdiction over ALJ challenges, and insider trading.

Having been a judge only a short while, Judge Barrett has authored no published opinions on federal securities matters. She has sat on the panel for some precedential matters, as well as a number of nonprecedential orders, but these offer no real insight into her views on the securities laws.

Because there are no substantive decisions on securities law by Judge Barrett, her views are difficult to discern at this point. She has, however, written and spoken more generally concerning her views on the rule of the judiciary, and these views could factor into her treatment of Supreme Court precedent. Most recently, during her speech accepting the nomination, Judge Barrett remarked on her clerkship with Justice Scalia, noting his "incalculable influence" on her life. "His judicial philosophy is mine, too: A judge must apply the law as written," she said. Judges are not policymakers, she continued, and must set aside any such views that they might hold.

As a professor, Judge Barrett wrote several law review articles setting out forth her views of stare decisis and other jurisprudential topics. In a 2017 article, for example, she examined the tension between originalism and stare decisis in the context of Justice Scalia's concession that stare decisis was a "pragmatic exception" to his originalist philosophy. The late Justice, she writes, distinguished between decisional theory and results; in other words, leaving the result of a precedent in place versus applying the logic of the precedent to a new context. In addition, Judge Barrett observed, in this article and in an earlier piece, that there are features of the judicial system that keep most challenges to precedent off the Court's docket. And, stability is fostered by an implicit assumption that precedent is correct, unless its validity is explicitly put on the table.

The above is presented with the obvious caveat that it is impossible to predict the exact approach to be taken by Judge Barrett should she be confirmed and if she opines on securities-related matters. Even Judge Barrett's mentor, she acknowledged in the 2017 article, described himself as a "faint-hearted originalist" willing to make pragmatic exceptions.

Professorship and clerk experience. Judge Barrett was nominated to fill a vacant seat on the U.S. Court of Appeals for the Seventh Circuit and was confirmed by the Senate on October 31, 2017. Before rising to the bench, Judge Barrett taught at her alma mater, Notre Dame Law School, starting in 2002. She has continued to teach while sitting as a judge in the areas of federal courts, constitutional law, and statutory interpretation. Judge Barrett also has held several visiting professorships.

Prior to her career in academia, Judge Barrett was an associate at Miller, Cassidy, Larroca & Lewin. Before entering private practice, she clerked for Supreme Court Justice Antonin Scalia (1998-1999) and for the Hon. Laurence H. Silberman of the U.S. Court of Appeals for the D.C. Circuit (1997-1998). Judge Barrett also served on the federal Advisory Committee on Appellate Rules for nearly six years. The 48-year old jurist is a resident of South Bend, Indiana.

Monday, September 28, 2020

CorpFin Director Hinman elaborates on shareholder proposal changes at virtual conference

By Mark S. Nelson, J.D.

Keith Higgins, chair of Ropes & Gray LLP's securities and governance practice and former Director of the SEC’s Division of Corporation Finance (CorpFin), moderated a discussion with William Hinman, current CorpFin director, on a variety of topics. The discussion occurred at the 2020 Garrett and Corporate Counsel Virtual Institute, a combination of the 40th Annual Ray Garrett Jr. Corporate & Securities Law Institute and the 59th Annual Corporate Counsel Institute, both hosted by Northwestern Pritzker School of Law.

Shareholder proposals. Hinman’s remarks on the SEC’s new regulation for shareholder proposal submissions and resubmissions are among his first since the Commission adopted those requirements at an open meeting yesterday. In general, the Commission created tiered submission thresholds based on the amount of stock owned by a shareholder and the time the stock has been held. The Commission also increased the resubmission thresholds. The rules changes are effective 60 days after publication in the Federal Register and will apply to annual or special meetings to be held on or after January 1, 2022.

Higgins asked Hinman to comment on the purpose of the amendments to the shareholder process. According to Hinman, the Commission sought to refresh the shareholder submission rules because they had not been addressed for several decades. Previously, a shareholder need only own $2,000 (or one percent) of a company’s stock for one year. Under the new rules, a shareholder must continuously hold $2,000 for three years, $15,000 for two years, or $25,000 for one year.

However, Hinman emphasized that a set of transition rules will allow a shareholder who is already eligible to submit a proposal to do so for a period of time. Specifically, the adopting release provides that a shareholder that meets the immediately prior submission threshold of $2,000 for at least one year as of the effective date of the amendments and continuously holds such securities from the effective date of the amendments to the date on which she submits a proposal remains eligible to submit a shareholder proposal to a company without having to meet the amended submission requirements for an annual or special meeting to be held before January 1, 2023.

With respect to the resubmission thresholds, the Commission increased them from 3-, 6-, and 10 percent to 5-, 15-, and 25 percent. Hinman said the purpose of this amendment was to modernize the regulatory requirement to ensure that a resubmitted shareholder proposal has a reasonable chance of obtaining higher support or approval. Hinman also suggested that social media had perhaps made it easier to get votes, but the Commission wanted to achieve a balance regarding the costs and administrative issues associated with the companies’ efforts to deal with shareholder proposals.

By way of further background, the now-defunct, Republican-led Financial CHOICE Act would have reset the resubmission thresholds at 6-, 15-, and 30 percent. Reform of the SEC’s shareholder proposal process described in Exchange Act Rule 14a-8 had also prompted the Treasury Department to express concerns about the $2,000 holding amount and resubmission thresholds but without offering a specific recommendation. The Treasury’s Capital Markets report had recommended only that the Exchange Act Rule 14a-8 thresholds be "substantially revised." The Treasury report also had recommended that shareholder eligibility requirements be tied to something other than "solely" a fixed dollar holding or percentage of a company’s outstanding stock (e.g., the "shareholder’s dollar holding in company stock as a percentage of his or her net liquid assets").

Higgins, upon re-entering private practice after his stint as CorpFin director, had blogged about freshening the resubmission thresholds, which he said were "low." Higgins suggested that proper thresholds could be reset near to those proposed in the CHOICE Act, which mirrored the SEC’s proposal from 1997 (See also, Commissioner Wallman’s concurrence to the SEC proposal, noting that the proposed resubmission thresholds "…will rise to the very high level of 30% in the third year—without any practical benefits being provided in return to a large percentage of the proponents").

Higgins also asked Hinman about a few other less well known aspects of the amended shareholder proposal regulation. For example, Hinman said the new rules put a premium on shareholder engagement with a company. The amended regulation requires that a shareholder provide a written statement that she is able to meet with the company in person or via teleconference sometime between 10 and 30 days after submitting a proposal.

Hinman said the Commission had been worried that, in the past, shareholders sometimes did not make themselves available to engage with companies. Hinman noted that 80 percent of proposals recently had been submitted by a small group of shareholders with whom it was a challenge for companies to engage. Hinman also observed that companies sometimes change their policies after shareholder engagement.

Moreover, unlike the prior rules, the amended rules prohibit shareholders from aggregating holdings to meet the submission thresholds. Hinman explained that the Commission wanted to make sure that "a" shareholder has a meaningful interest and that aggregation would undercut the need for a shareholder to have such a meaningful interest in a company.

Lastly, although not mentioned at the conference, the Commission struck the momentum provision from the final version of the shareholder proposal regulation. That provision had been proposed as a method to weed out proposals that received less than a majority of votes and whose support had declined by 10 percent.

Insider trading. Hinman also spoke about good corporate hygiene and insider trading as part of a larger discussion on a variety of topics that was initiated by Higgins. Specifically, Hinman pointed to SEC Chairman Jay Clayton’s letter responding to a request by Rep. Brad Sherman (D-Cal). The SEC has, in the context of COVID-19 relief, warned against executives and others possessing material nonpublic information (MNPI) about trading company stock in a volatile market environment and such trades have ensnared members of Congress and Kodak executives in recent insider trading investigations.

Clayton stated in the letter that "My view is that, during this time of stress and acute uncertainty, our public companies as a general matter have discharged their responsibilities in the related areas of public disclosure and corporate controls well. That said, these are areas where market confidence, integrity and fairness require a universal commitment to compliance and regulatory vigilance." Clayton’s letter also addressed the specific topics of company policies for executives and directors on insider trading, Rule 10b5-1 trading plans, and the issuance and pricing of stock options.

Hinman observed that the SEC had talked to the market about good corporate hygiene in the context of COVID-19 and cybersecurity. He also acknowledged that Congress had taken note of the topic by introducing legislation focused on Form 8-K black-out periods for company executives. Hinman reiterated that executives and directors should carefully consider trades, even if they lack personal knowledge of MNPI. Hinman further explained that good corporate hygiene on insider trading can dovetail with good corporate citizenship. Higgins suggested that attorneys send the Clayton letter to their clients.

Virtual annual meetings. The onset of the COVID-19 pandemic accelerated the pace at which many companies sought to hold virtual annual meetings. Hinman observed that roughly 1,500 companies held virtual annual meetings in 2020, which was significantly more than the 300 companies in prior years. Hinman said participation in virtual meetings ranged from about 1,000 to 5,000 shareholders.

According to Hinman, however, one source of "friction" was that some companies restricted the Zoom microphone to company representatives that read shareholder proposals instead of allowing proponents to speak directly. Hinman reminded listeners that the SEC does not directly regulate the microphone at annual meetings because that is a topic for state corporate laws. But the SEC had encouraged companies to make virtual meetings as close as possible to in-person meetings.

Friday, September 25, 2020

Lee calls on SEC to require diversity disclosure, address disparity of opportunity

By Anne Sherry, J.D.

In remarks at a Council of Institutional Investors conference, SEC Commissioner Allison Herren Lee emphasized the need for greater diversity within companies and even the financial regulators. Lee reiterated her call for the SEC to mandate diversity disclosure, saying that "what gets measured gets managed." She also called on the Commission to do more not just to increase diversity within its own ranks, but also to ensure that its rules address disparities such as wealth gaps and unconscious bias that can hinder minority and women entrepreneurs.

Lee first tackled the arguments that policymakers should not mandate social progress in the boardroom and that calls for corporate diversity are about equality for equality’s sake. "How can one possibly justify—in economic terms—the systematic exclusion of a major portion of our talent base from the corporate pool?" she asked. The commissioner cited several studies showing that diverse companies are more profitable and better innovators and said she has spoken to analysts at quant firms who include diversity metrics in their algorithms because diversity increases alpha. Nevertheless, and despite the SEC’s rules mandating disclosure of how diversity factors into board nominations and guidance encouraging disclosure of characteristics of board candidates, women of color hold less than 5 percent of Fortune 500 board seats, and less than 1 percent of Fortune 500 CEOs are Black.

To improve diversity, Lee suggested that the SEC revisit the amendments to Regulation S-K to require disclosure of workforce diversity. The SEC adopted the amendments in August over Lee’s dissent, which criticized the release’s silence about diversity and climate risk. In her speech at the CII conference, Lee said that the SEC has recognized both that disclosure can influence corporate conduct and that impact is consistent with the philosophy of the disclosure provisions of the securities laws. The "what gets measured gets managed" phenomenon means that requiring a company to disclose certain topics can influence their treatment of those topics. Furthermore, transparency creates external pressure because investors and others can then make comparisons between companies.

Lee also pointed to a lack of diversity at the top levels of financial regulators as well as within the financial services industry. On the latter point, she said a 2017 GAO report found only a marginal increase in minority representation, and no increase for women, at the management level of financial services firms between 2007 and 2015. The commissioner said that a wealth gap between minority and non-minority communities can prevent minority entrepreneurs from using their own capital in their businesses or as collateral, and disparities in lending practices can hinder minority and women founders from obtaining loans.

The SEC could address some of these challenges by having its Division of Economic and Risk Analysis analyze how the SEC’s rules will affect underrepresented communities, Lee said. She observed that the economic analyses in rules, particularly rules relating to capital-raising, often claim that minority- and women-owned businesses will benefit simply because the rule is loosening restrictions that apply equally to all businesses. A better approach would analyze whether and, if so, how a proposed rule addresses the challenges faced by minority- and women-owned businesses.

Lee also said that the SEC has "a tremendous resource" in the Office of Minority and Women Inclusion and should consider better integrating that office’s work into the agency’s policymaking. OMWI implemented a voluntary diversity self-assessment for regulated entities, but the response rate has been only 4 percent. The SEC could ask for comment on how to encourage voluntary reporting or on whether it should add these disclosures to those already required for regulated entities. The agency could also give OMWI an expanded role in the rulemaking process, offering the office an opportunity to review and comment on drafts with a particular eye on how the rulemaking may affect existing disparities or affect diversity concerns.

Finally, Lee suggested the Commission work with other agencies, such as the Consumer Financial Protection Bureau and the Small Business Administration, to address discrimination and support minority- and women-owned small businesses. The agency could also work with the banking regulators to address a House FSC staff report finding that women- and minority-owned firms are underrepresented as asset managers and that large banks generally do not prioritize investing with diverse firms.

Thursday, September 24, 2020

Divided Commission approves controversial amendments to shareholder proposal process

By John Filar Atwood

In a 3 to 2 vote, the SEC adopted amendments to Rule 14a-8, which governs the shareholder proposal process, to put in place stricter eligibility requirements for shareholder proponents and higher thresholds to resubmit proposals that do not receive widespread shareholder support. The agency issued the proposals for public comment in November 2019 and received thousands of letters in response, many of which opposed the planned changes.

Chairman Jay Clayton lauded the amendments, saying that they represent a much-needed modernization of the shareholder proposal process, and will better align the interests of proponents and their fellow shareholders. Commissioner Elad Roisman, who spearheaded the Commission’s efforts on the issue, said that the amendments will curb the potential misuse of the process by a few proponents at the expense of the rest of a company’s shareholders.

Commissioners Allison Herren Lee and Caroline Crenshaw voiced strong opposition, with Lee calling the move the capstone in a series of actions taken by the Commission that will dial back shareholder oversight of companies. Lee expressed particular concern that the amendments will reduce the focus on environmental, social, and governance (ESG) issues just when they have become critical to a company’s value, and that the changes will largely shut out smaller investors from the process.

New eligibility requirements. The final amendments change Rule 14a-8(b) by replacing the current ownership threshold, which requires holding at least $2,000 or 1 percent of a company’s securities for at least one year, with three alternative thresholds. A shareholder will now be required to demonstrate continuous ownership of at least:
  • $2,000 of the company’s securities for at least three years;
  • $15,000 of the company’s securities for at least two years; or
  • $25,000 of the company’s securities for at least one year.
The amendments eliminate the ability of shareholders to aggregate their holdings for purposes of satisfying the amended ownership thresholds.

The amendments require that a shareholder that elects to use a representative for the purpose of submitting a shareholder proposal provide clear documentation that the representative is authorized to act on the shareholder’s behalf. In addition, a proponent must now state that he or she is able to meet with the company, either in person or via teleconference, no less than 10 calendar days, nor more than 30 calendar days, after submission of the shareholder proposal.

Resubmission requirements. The SEC amended Rule 14a-8(i)(12) to revise the levels of shareholder support a proposal must receive to be eligible for resubmission at the same company’s future shareholder meetings. Existing levels are 3 percent, 6 percent and 10 percent for matters previously voted on once, twice or three or more times in the last five years. The new requirements are 5 percent, 15 percent, and 25 percent, respectively. Consequently, a proposal will need to achieve support by at least 5 percent of the voting shareholders in its first submission in order to be eligible for resubmission in the following three years. Proposals submitted two and three times in the prior five years would need to achieve 15 percent and 25 percent support, respectively, in order to be eligible for resubmission in the following three years.

One-proposal rule. The Commission also amended Rule 14a-8(c) to apply the one-proposal rule to "each person" rather than "each shareholder" who submits a proposal. As a result, a proponent may not submit one proposal in his or her own name and simultaneously serve as a representative to submit a different proposal on another shareholder’s behalf for consideration at the same meeting. Similarly, a representative cannot submit more than one proposal to be considered at the same meeting, even if the representative were to submit each proposal on behalf of different shareholders.

In support of the new eligibility requirements, Clayton emphasized that any investor who can submit a proposal today by having held at least $2,000 worth of company securities for one year will continue to be able to submit a proposal without increasing the dollar amount of their holdings. They simply will be required to continue to hold those securities, he added.

Clayton and Roisman also pointed out that currently a very small number of proponents impose the expense associated with including a proposal on other shareholders. Clayton cited the adopting release which states that of the 65 million direct and indirect investors in companies subject to the proxy rules in 2018, only 170 shareholder-proponents submitted proposals that appeared in proxy statements. Roisman took that statistic a step further, noting that between 2003 and 2014, only five people accounted for the vast majority of all the proposals submitted by individual shareholders.

In Roisman’s view, the adopted amendments strike a balance by ensuring that a shareholder who submits a proposal to a public company has interests that are more likely to be aligned with the other shareholders who bear the expense. He also believes that the new resubmission thresholds address the existing situation where even if 90 to 97 percent of a company’s shareholders vote against a proposal, a person can still resubmit the same proposal every year.

Opposition. In voting against the amendments, Lee noted that the Commission received thousands of letters from all corners of the industry in opposition to the proposals. Those who opposed the changes vastly outnumbered those who supported them, she said.

One of her primary concerns with the amendments is that she believes they undermine ESG initiatives, which comprise most of the subject matter of recent proposals, at a time when support for such proposals is rising. There has been a marked increase in support for ESG proposals in recent years, she noted, and the amendments will restrain those efforts just as they are gaining real traction with companies. A similar claim was leveled by the Council of Institutional Investors and other investor advocacy groups this summer following a Roisman speech in which he said shareholders should use private ordering for environmental and social issues, not shareholder proposals

Crenshaw agreed, noting that many corporate governance advancements, and annual and majority votes for director elections have come from investor-led proposals.She is concerned that the amendments mean that proposals related to the COVID-19 pandemic and climate risk, both of which are material to company’s performance, will no longer make the ballot. The rule amendments may chill the debate over these important issues, she added, and will effectively curtail shareholders’ rights to express their views.

Clayton countered these arguments by claiming that the revised requirements are agnostic as to the subject matter of any particular shareholder proposal. The rule will not be a way for the SEC to regulate or make judgments with respect to the merits of any particular shareholder proposal topic, he added.

Disenfranchising small shareholders. Lee’s other major concern, also shared by CII, is that the adopted amendments severely restrict smaller shareholders from accessing the process, and prohibit them from banding together to protect their interests. The rules hike the one-year eligibility threshold 12.5 times the current required investment amount, she argued, forcing smaller shareholders to either invest a substantial portion of their portfolio into a single company, or hold an investment for two additional years. Wealthier investors face no such restrictions, she noted.

Lee views the amendments as a sharp departure from the goal of the shareholder proposal process to provide an avenue of communication for smaller shareholders. The amendments not only make such communication harder, she said, but go a step further by dismissing this disenfranchisement as irrelevant since it did not merit analysis in the final release.

Crenshaw concluded by pointing out that the Commission has recently focused on increasing the participation of everyday Americans in the markets. One of the bases for expanding the "accredited investor" definition was the idea that the ability to participate in private capital markets should not be limited to those with high income and wealth, she noted. In her view the Rule 14a-8 amendments send the message that the ideas of retail investors are not worth hearing.

Wednesday, September 23, 2020

Exec compensation and SPACS highlighted in new C&DIs

By Mark S. Nelson, J.D.

The SEC’s Division of Corporation Finance has issued two new, unrelated Compliance and Disclosure Interpretations (C&DIs) covering executive compensation related to the COVID-19 pandemic and the Form S-3 eligibility requirements in the context of shells and special purpose acquisition companies (SPACs). The executive compensation C&DI suggests when accommodations made to executives due to the pandemic must be disclosed as benefits or perquisites under Regulation S-K. The C&DI addressing shell/SPAC combinations with private operating companies provides timely guidance in an era when such combinations have significantly grown in number and now often have celebrity-like backers, such as Executive Network Partnering Corporation, which is backed by former House Speaker Paul Ryan. While any such entities initially register under other SEC forms, some of them will later seek to make streamlined offerings under Form S-3.

Executive compensation and COVID-19. New C&DI Question 219.05 addresses issues regarding executive compensation disclosures under Items 402(a) and (c) of Regulation S-K. Item 402(c)(2)(ix)(A) requires disclosure of perquisites and other personal benefits, the aggregate amount of which is $10,000 or more. The C&DI further address executives who are named executive officers under Item 402(a)(3)(iii) and (iv), that is, subject to some qualifications, the three highest paid executives (other than the PEO and PFO) plus up to two more individuals who would have been subject disclosure but who were not serving as executive officers.

The C&DI begins by reaffirming that SEC Release No. 33-8732A applies to the determination of benefits and perquisites. As result, an item is not a benefit or perquisite if it is integrally and directly related to job performance, an evaluation that depends on the particular facts and circumstances. However, an item is a benefit or perquisite if it confers a benefit that has a personal aspect, unless the item is generally available on a non-discriminatory basis to all employees. With respect to COVID-19, the C&DI explains in detail how these principles might apply:

"In some cases, an item considered a perquisite or personal benefit when provided in the past may not be considered as such when provided as a result of COVID-19. For example, enhanced technology needed to make the NEO’s home his or her primary workplace upon imposition of local stay-at-home orders would generally not be a perquisite or personal benefit because of the integral and direct relationship to the performance of the executive’s duties. On the other hand, items such as new health-related or personal transportation benefits provided to address new risks arising because of COVID-19, if they are not integrally and directly related to the performance of the executive’s duties, may be perquisites or personal benefits even if the company would not have provided the benefit but for the COVID-19 pandemic, unless they are generally available to all employees."

Shells and SPACs. Form S-3 is used for a variety of offerings, such as shelf offerings, by companies that meet the registrant eligibility requirements set forth in General Instructions I.A.1 through I.A.7. of the form. As a result, a company may use Form S-3 if: (1) it is organized and has its principal business operations in the U.S. or U.S. territories; (2) its securities are registered under Exchange Act Sections 12(b) or 12(g) or it files reports under Exchange Act Section 15(d); (3) it is subject to and meets Exchange Act reporting requirements for 12 calendar months before filing the registration statement; (4) has not failed to pay dividends or sinking funds and it has not defaulted on its debts or material leases; and (5) it has made all required electronic filings and has submitted all interactive data files to the Commission. Special provisions apply to successor registrants and foreign issuers.

New Securities Act C&DI Question 115.18 asks whether the combined entity resulting from the merger of a private operating company into a reporting shell (e.g., a SPAC) can rely on the shell’s pre-combination reporting history to establish eligibility to use Form S-3. Form S-3, General Instruction I.A.6 provides that certain of the eligibility requirements can be met if the combination was accomplished primarily to change the predecessor’s state of incorporation or to form a holding company such that the successor’s assets and liabilities at the time of the succession were substantially the same as the predecessor’s. Alternatively, General Instruction I.A.6 provides that eligibility can be established if all predecessors met the requirements of Form S-3 at the time of the succession and the registrant has met those requirements since the succession.

According to the SEC staff, the hypothetical merger would not likely meet the eligibility requirements for Form S-3. First, a new entity would need 12 calendar months of Exchange Act reports to satisfy General Instruction I.A.3. Second, a successor registrant would not meet General Instruction I.A.6.(a) because the merger is not primarily to change the predecessor’s state of incorporation or create a holding company; likewise, the predecessor(s) would not satisfy General Instruction I.A.6.(b)’s requirement that all predecessors meet the requirements of Form S-3 at the time of the succession because, not being a new entity or successor registrant, the combined entity would have fewer than 12 calendar months of post-combination reporting history.

The C&DI further explained the rationale behind Form S-3’s registrant requirements and the consequences of not satisfying those requirements: "Form S-3 is premised on the widespread dissemination to the marketplace of an issuer’s Exchange Act reports over at least a 12-month period. Accordingly, in situations where the combined entity lacks a 12-month history of Exchange Act reporting, the staff is unlikely to be able to accelerate effectiveness."

Tuesday, September 22, 2020

Remembering Justice Ginsburg’s impact on securities law

By Mark S. Nelson, J.D.

Justice Ruth Bader Ginsburg already had had an iconic career in the law before she was nominated by President Bill Clinton in 1993 to be only the second woman to serve as a justice on the U.S. Supreme Court. Many years later, a once-obscure Internet post would famously turn Justice Ginsburg into the "Notorious RBG," a moniker derived from the name of a rap musician with a similar name, and from then on she would become known to a much wider audience for her taxing exercise routine, her love of opera, her odd-couple friendship with the late Justice Antonin Scalia, Kate McKinnon's comic portrayal of her on NBC’s late-night show "Saturday Night Live," and her perseverance through multiple serious illnesses, including pancreatic cancer, from which she died of complications on Friday September 18, 2020 at age 87 according to a Supreme Court press release. Those stories will be told many times over by other publications. Today, Securities Regulation Daily takes a look back at several of Justice Ginsburg’s lesser known, but also significant, opinions that impact securities law.

Response to passing of Justice Ginsburg. All five SEC commissioners paused to remark on Justice Ginsburg’s role in the evolution of securities law. "Justice Ginsburg's powerful intellect and determination shaped decisions that had meaningful impacts for all Americans, including our nation's investors. She inspired many, and her trailblazing career will serve as a model of public service and dedication to our country for generations to come," said a public statement.

Supreme Court Chief Justice John Roberts also recalled Justice Ginsburg’s career: "Our Nation has lost a jurist of historic stature. We at the Supreme Court have lost a cherished colleague. Today we mourn, but with confidence that future generations will remember Ruth Bader Ginsburg as we knew her -- a tireless and resolute champion of justice." The Supreme Court also has announced that Justice Ginsburg will lie in repose at the Supreme Court on September 23 and 24 atop the steps under the front portico for outdoor public viewing. House Speaker Nancy Pelosi (D-Cal) has also announced that Justice Ginsburg will lie in state in the U.S. Capitol on September 25.

President Donald Trump called Justice Ginsburg a "titan of the law" and remarked that she was "[r]enowned for her brilliant mind and her powerful dissents." Vice President Michael Pence stated: "As an advocate and an Associate Justice of the Supreme Court, she was a champion for women whose tireless determination reshaped our national life."

It has been widely reported that President Trump intends to nominate a woman to replace Justice Ginsburg as early as Friday or Saturday (September 25 or 26). Media have focused attention on two potential nominees, Amy Coney Barrett, currently a judge on the U.S. Court of Appeals for the Seventh Circuit, and Barbara Lagoa, a judge on the U.S. Court of Appeals for the Eleventh Circuit.

Previously, President Trump has issued lists of potential Supreme Court nominees, including Judge Lagoa, that also include several names familiar to securities practitioners. For example, a recent list adds former Solicitor General Noel Francisco, who oversaw the government’s changed position in a brief that conceded that SEC administrative law judges are officers of the U.S. and not mere employees for Appointments Clause purposes. That same list includes Paul Clement, another former Solicitor General and currently a partner at Kirkland & Ellis LLP, who has argued numerous securities cases before the Court and who recently was appointed amicus curiae to argue in favor of the judgment below in a case regarding the Consumer Financial Protection Bureau’s single-director structure.

With respect to what comes next, both Democrat and Republican leaders have spoken. House Majority Leader Steny Hoyer (D-Md) noted in his statement on Justice Ginsburg that she had expressed the view that she should not be replaced until the winner of the 2020 presidential election has been sworn in. Senate Majority Leader Mitch McConnell (R-Ky) issued a statement in which he sought to distinguish his refusal to give President Barack Obama’s last Supreme Court nominee, Judge Merrick Garland, a Senate floor vote during an election year and his pledge that Justice Ginsburg’s replacement will get such a vote.

Class actions. The first stop on a review of Justice Ginsburg’s Supreme Court opinions focuses on a case in which her brief concurrence may have spoken more loudly than the majority’s opinion and, depending on her replacement, may have consequences for another related opinion in which Justice Ginsburg wrote for a court majority. In the 2014 case of Halliburton II, the Supreme Court re-affirmed the Basic v. Levinson presumption of reliance without modifying or overruling it. Basic concluded that the price of a stock traded in an efficient market will incorporate all public information about the stock and, thus, a class action plaintiff may be presumed to rely on that information by purchasing the stock rather than having to establish their direct reliance by, for example, reading the offering materials.

However, the Halliburton II Court also concluded that, in order to align the Basic presumption with FRCP 23, defendants in securities class actions should be given the opportunity at the class certification stage to rebut the presumption by showing there was a lack of price impact. The Court also grappled with the implicit issue of how much of the merits of a case should be before a court at the class certification stage and concluded that affording defendants an additional procedural device would not bring too much of the merits into play too early.

One year before Halliburton II, the Supreme Court held in Amgen, an opinion written by Justice Ginsburg, that there was no need to prove the merits of a securities class action at the class certification stage. In Halliburton II, an opinion written by Chief Justice Roberts, Justice Ginsburg wrote a one paragraph concurrence in which she explained that she agreed with the Court based on the "understanding" that a defendant must show the absence of price impact and that a plaintiff’s "tenable claims" would be capable of proceeding.

There remain several justices on the Court who believe that judicially created causes of action, such as the private securities class action, should be curtailed or even eliminated. For example, Justices Thomas, Scalia, and Alito in Halliburton II would have overruled Basic.

The majority in Halliburton II strongly emphasized stare decisis as the reason for upholding Basic. In recent Supreme Court terms, there have been several cases that suggest that some justices may view stare decisis as a more malleable concept (see, e.g., Knick v. Township of Scott, Pennsylvania ; Gamble v. U.S.; Franchise Tax Board of California v. Hyatt ; Janus v. American Federation of State County And Municipal Employees Council 31 ), although some cases suggest that stare decisis remains a strong, albeit sometimes messy, concept for the Roberts court (see, e.g., June Medical Services L.L.C. v. Russo and Ramos v. Louisiana ; Trump v. Hawaii (Japanese internment camp case Korematsu "overruled in the court of history")).

As a result, it seems unlikely that Basic would be in serious trouble of being overruled in the near term, but it is at least plausible that a conservative replacement for Justice Ginsburg could help shift the Court’s thinking in favor of expanding upon Halliburton II’s rebuttal procedure afforded to securities class action defendants by chipping away at Amgen and allowing more of the merits of a securities class action to be addressed at the class certification stage. In fact, a pending petition for certiorari from the Second Circuit in a case involving Goldman Sachs could provide such a vehicle.

Insider trading and other criminal cases. In 1997, Justice Ginsburg wrote for the majority in U.S. v. O’Hagan. The Court first held that a person who trades in securities for personal profit, using confidential information misappropriated in breach of a fiduciary duty to the source of the information, can be guilty of violating Exchange Act Section 10(b) and Rule 10b-5. Second, the Court held that the Commission did not exceed its rulemaking authority by adopting Exchange Act Rule 14e-3(a) to bar trading on undisclosed information in tender offers, even in the absence of a duty to disclose.

It is the first question in O’Hagan that has likely drawn the most commentary. O’Hagan’s conception of a person being liable for insider trading based on her breach of a fiduciary duty owed to the source of the information brought about the era of insider trading premised on misappropriation theory. This advancement of the law of insider trading provided a new theory of liability in addition to the long-standing classical theory of insider trading, which is premised on a person trading in the securities of her own company by breaching a duty of trust and confidence to the company and its shareholders.

Insider trading has taken on increased importance in recent years as the Supreme Court has reaffirmed key principles announced in Dirks (see, e.g., Salman ) and Congress has introduced several bills seeking to statutorily define insider trading. Recent events linked to the ongoing COVID-19 pandemic regarding stock trading by members of Congress and by Kodak executives have kept the problem of insider trading alive.

However, a new twist on insider trading may take headlines going forward. For example, an amendment to the Sarbanes-Oxley Act created a type of insider trading liability under Title 18 of the U.S. Code that does not appear to depend on proof of a personal benefit, as does the judge-made insider trading theory in Title 15-based violations.

Prosecutors have thus far sparingly used this new theory of insider trading but a recent petition for certiorari asks the justices to mull the Second Circuit’s interpretation of the Title 18 version of insider trading. The Second Circuit majority affirmed convictions under Title 18 and, after considering the differing goals of Title 15 and 18, concluded: "Given that Section 1348 was intended to provide prosecutors with a different – and broader – enforcement mechanism to address securities fraud than what had been previously provided in the Title 15 fraud provisions, we decline to graft the Dirks personal-benefit test onto the elements of Title 18 securities fraud."

In the 2010 opinion in Skilling v. U.S., Justice Ginsburg wrote for fractured majorities on two questions: (1) Did pre-trial publicity deprive the defendant of a fair trial? and (2) Whether 18 U.S.C. §1346’s prohibition on honest services fraud reached alleged wrongdoing beyond bribery and kickback schemes. Defendant Jeffrey Skilling was a long-time executive at Enron Corporation who had eventually become the company’s CEO, but he abruptly resigned after holding the CEO position for just six months. Enron then fell precipitously into bankruptcy and charges swirled of securities fraud, insider trading, and of executives enriching themselves at the expense of the company and its shareholders.

Justice Ginsburg led five justices in concluding that Skilling had received a fair trial despite pre-trial publicity. According to the Court, Skilling did not establish a presumption of juror prejudice or actual prejudice. With respect to the honest services fraud question, Justice Ginsburg led six justices in concluding that 18 U.S.C. §1346 did not reach conduct beyond bribery and kickback schemes. The Court traced the origins of honest services fraud to court interpretations of the 1872 mail fraud statute which the Supreme Court would later curb as too far reaching in 1987 only to be legislatively reversed by the modern Congressional statute embodied in 18 U.S.C. §1346. Justice Ginsburg then construed (rather than invalidate) the "the intangible right of honest services" language contained in 18 U.S.C. §1346 to mean that phrase’s historical reach to bribery and kickback schemes; that is: "fraudulent schemes to deprive another of honest services through bribes or kickbacks supplied by a third party who had not been deceived." This more limited view of honest services fraud, the Court concluded, avoided the constitutional vagueness concerns raised by Skilling. As a result, Skilling’s honest services fraud conviction was vacated and remanded.

Lastly, Justice Ginsburg announced the judgment of the Court and issued an opinion for a plurality of the justices in what might be called the Yates "fish case." John Yates was a commercial fisherman in the Gulf of Mexico who was prosecuted for tossing allegedly undersized red grouper overboard after an encounter with wildlife conservation officials. Specifically, Yates was convicted of violating 18 U.S.C. §1519, an evidence spoliation provision added to the federal criminal laws by the Sarbanes-Oxley Act, which itself had as one of its main goals the restoration of public confidence in U.S. companies following the Enron scandal.

Under 18 U.S.C. §1519, a person can be penalized if they knowingly destroy a "tangible object" with the intent of obstructing a federal agency investigation. The question was whether a fish is a "tangible object." Justice Ginsburg answered that a fish, although it can be destroyed, is not the type of "tangible object" contemplated by the statute. Rather, she explained that a "tangible object" is an object that has ties to the purpose of the SOX provision, meaning that it is "used to record or preserve information." This interpretation, Justice Ginsburg further explained, would "match[]" SOX’s focus on "corporate and accounting deception and cover-ups." Justice Alito, emphasizing the "filekeeping" nature of "tangible object" ("How does one make a false entry in a fish?"), provided the necessary fifth vote via his concurrence to reverse and remand Yate’s conviction.

However, one of the enduring mysteries about Yates is why Justice Scalia, who often invoked the rule of lenity in criminal cases (Justice Ginsburg had invoked lenity as one argument in support of her opinion in Yates) joined Justice Kagan’s dissent emphasizing the literal meaning of "tangible object." Justice Kagan took the view that the words surrounding "tangible object" in the statute indicated Congressional intent for the statute to apply widely to all kinds of objects. According to Justice Kagan, the plurality were on a "fishing expedition" of their own; Justice Kagan instead concluded that "[a] fish is, of course, a discrete thing that possesses physical form [citation omitted]. So the ordinary meaning of the term ‘tangible object’ in §1519, as no one here disputes, covers fish (including too-small red grouper)." To make her point, Justice Kagan even cited the Dr. Seuss book "One Fish Two Fish Red Fish Blue Fish." With respect to lenity, Justice Kagan criticized the plurality’s emphasis on the "breadth" of the statute and supposed lack of notice to Yeats as justifying lenity; for Justice Kagan, however, "breadth" and "ambiguity," the traditional touchstone for lenity, are not the same.

Whistleblowers. Although the late Justice Scalia was better known as a textualist, Justice Ginsberg could sometimes focus closely on the letter of the law, a tendency possibly rooted in her role as the Court’s resident civil procedure expert. A prime example was her opinion for the Court in Somers, in which the Court held that the clear meaning of the Dodd-Frank Act’s SEC whistleblower provision required a person to report directly to the SEC in order to invoke the anti-retaliatory protections afforded by the Dodd-Frank Act.

The case arose when a prospective whistleblower sought to invoke the Dodd-Frank Act’s anti-retaliatory provisions, but without first reporting to the SEC; the whistleblower also had not followed the SOX procedures and was ineligible to pursue protections available under SOX. The Sarbanes-Oxley Act and the Dodd-Frank Act contain similar whistleblower provisions, although the Dodd-Frank Act provision potentially allows for larger whistleblower recoveries with similar anti-retaliatory protections but, unlike the SOX provision, has fewer administrative procedure requirements and defines "whistleblower" as a person who reports to the SEC.

Justice Ginsburg reasoned that the Dodd-Frank Act’s goal was to get whistleblowers to report to the SEC, while the SOX provision sought more broadly to break down the code of silence at many companies such that whistleblowers could report to the SEC or other government agencies, to Congress, or internally to company authorities. In adhering to the clear meaning of the statute in Somers, the Court similarly rejected the SEC’s contrary interpretation of the Dodd-Frank Act provision. Justice Ginsburg had opened the analysis section of the Court’s Somers opinion thus: "’When a statute includes an explicit definition, we must follow that definition,’ even if it varies from a term’s ordinary meaning. This principle resolves the question before us" (citation omitted).

In an earlier case, Lawson, Justice Ginsburg wrote for the Court that the SOX whistleblower provision not only protected public company employees but also protected employees of privately held contractors and subcontractors who perform work for the public company.

Scienter. The element of scienter is often key to many securities fraud cases. As a general matter, scienter is the securities law equivalent of intent and often depends on evidence of a defendant’s knowledge of or reckless disregard of the truth. In Tellabs, Justice Ginsburg addressed the scope of the Private Securities Litigation Reform Act of 1995’s requirement that a private securities fraud plaintiff "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind" (emphasis added).

The Court in Tellabs sought to resolve a circuit split and, in doing so, rejected the Seventh Circuit’s test, which focused on whether a reasonable person could infer the defendant’s liability-producing state of mind from the complaint. The Court instead re-cast the analysis of a "strong inference" of scienter as a "comparative evaluation" that instead states that the "inference of scienter must be more than merely plausible or reasonable—it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent."

Significantly, Justice Ginsburg’s close friend on the Court, Justice Scalia, wrote a scathing concurrence in the judgement in Tellabs, in which he (predictably) rejected Justice Ginsburg’s analysis of legislative history, such that he would not join the Court’s opinion even if he agreed with the Court’s test of "strong." Justice Scalia opened his concurrence with an alternative test: "I fail to see how an inference that is merely ‘at least as compelling as any opposing inference,’ can conceivably be called what the statute here at issue requires: a ‘strong inference.’ If a jade falcon were stolen from a room to which only A and B had access, could it possibly be said there was a ‘strong inference’ that B was the thief? I think not, and I therefore think that the Court's test must fail. In my view, the test should be whether the inference of scienter (if any) is more plausible than the inference of innocence."

Justice Ginsburg in dissent. Justice Ginsburg had at least some tendency to join other justice’s dissents in securities cases rather than writing her own. One example would be Lucia, in which she partially joined Justice Breyer’s concurring and dissenting opinion and in which she joined Justice Sotomayor dissent from the majority’s conclusion that SEC administrative law judges are officers of the U.S. for purpose of the Appointments Clause. A variant of the issue addressed in Lucia could reach the Court via a petition for certiorari asking if federal district courts have jurisdiction to hear constitutional challenges to the tenure protections of SEC ALJs.

However, Justice Ginsburg recently did write a dissent in the ANZ Securities case showcasing her previously-mentioned background in civil procedure. There, the Supreme Court held in a 5-4 opinion that American Pipe’s equitable tolling rule is unavailable to save an individual suit filed outside the three-year repose period contained in Securities Act Section 13. As the Court would explain in a case a year later, American Pipe held, subject to multiple clarifications by the Court, that the timely filing of a class action tolls the applicable statute of limitations for all persons encompassed by the class complaint.

In ANZ Securities, the majority reasoned that American Pipe’s reliance on federal courts’ equitable powers must yield to the statutory mandate contained in Securities Act Section 13. The case involved a timely filed class complaint from which an institutional plaintiff, who was a member of the class but not a named plaintiff, sought to opt out in the belief that it could obtain a greater recovery by filing its own claim than as a member of the class.

Justice Ginsburg argued in dissent that the filing of the class complaint had provided notice of claims and the identities of claimants within the repose period and that the plaintiff who opted out should have been allowed to pursue its claim. Said Justice Ginsburg of the import of the majority’s opinion: "The harshest consequences will fall on those class members, often least sophisticated, who fail to file a protective claim within the repose period. Absent a protective claim filed within that period, those members stand to forfeit their constitutionally shielded right to opt out of the class and thereby control the prosecution of their own claims for damages."

Justice Ginsburg also warned that securities fraud defendants will now "slow walk discovery" and that the increased number of protective filings and related expenses could make securities litigation even more costly. Justice Ginsburg also was concerned that district courts and class counsel should apprise class members about the need to make protective filings in advance of the expiration of the repose period.

A year after ANZ Securities, however, Justice Ginsburg would write for the Court in China Agritech that American Pipe tolling is inapplicable to the filing of a class action beyond the limitations period. In China Agritech, two prior timely class actions had been filed, denied class certification, and then settled. In the first class action the district court found the defendant company’s stock did not trade in an efficient market, so the Basic reliance presumption did not apply. Class counsel in the first suit had notified class members of their rights; "You must act yourself to protect your rights. You may protect your rights by joining in the current Action as a plaintiff or by filing your own action against China Agritech." In the second class action, the district court denied certification on grounds of typicality and adequacy.

In China Agritech, the Court concluded that a plaintiff who delays filing a class action until after expiration of the limitations period cannot "piggyback" on prior, timely-filed class actions. Said Justice Ginsburg for the Court: "The ‘efficiency and economy of litigation’ that support tolling of individual claims [citing American Pipe] do not support maintenance of untimely successive class actions; any additional class filings should be made early on, soon after the commencement of the first action seeking class certification."

Monday, September 21, 2020

In a bipartisan showing, CFTC unanimously approves four final regulations and one proposed rule supplement

By Brad Rosen, J.D.

CFTC Chairman Heath Tarbert led off a virtual open meeting that lasted over five hours, without interruption, observing that "data is the lifeblood of our markets". Those comments were a prelude to an agenda-packed meeting where the Commission unanimously approved three final rules to revise CFTC regulations for swap data reporting, dissemination, and public reporting requirements calculated to improve the quality, accuracy, and completeness of the data reported to the agency. The Commission also unanimously approved a final rule which permits derivatives clearing organizations (DCOs) organized outside of the U.S. to be registered with the CFTC. Finally, the Commission unanimously approved a supplemental notice of proposed rulemaking regarding amendments to the CFTC’s regulations that govern bankruptcy proceedings for commodity brokers.

Amendments to real-time public reporting requirements (Part 43). This final rule revises CFTC regulations for real-time public reporting and dissemination requirements for swap data repositories (SDRs), DCOs. swap execution facilities (SEFs), designated contract markets (DCMs), swap dealers (SDs), major swap participants (MSPs), and swap counterparties that are neither SDs nor MSPs.

Amendments to swap data recordkeeping and reporting requirements (Part 45). This final rule revises CFTC regulations that establish swap data recordkeeping and reporting requirements for SDRs, DCOs, SEFs, DCMs, SDs, MSPs, and swap counterparties that are neither SDs nor MSPs. This rule will give the CFTC access to uncleared margin data for the first time thereby significantly improving the agency’s ability to monitor for systemic risk.

Amendments to regulations relating to certain swap data repository and data reporting requirements (43, 45, and 49 verification). This final rule seeks to improve the accuracy of data reported to, and maintained by SDRs, and provides enhanced and streamlined oversight of SDRs and data reporting generally. Among other changes, the amendments modify existing requirements for SDRs to establish policies and procedures to confirm the accuracy of swap data for both counterparties to a swap. Additionally, the amendments update existing requirements related to corrections for data errors and certain provisions related to SDR governance.

The commissioners weigh in on the swap data reporting final rules. Beyond voting to approve swap data rules, each commissioner had something further to say about them as follows:
  • Chairman Tarbert observed that the data rules "would for the first time require the reporting of margin and collateral data for uncleared swaps significantly strengthen[ing] the CFTC’s ability to monitor for systemic risk" in those markets."
  • Commission Brian Quintenz noted "Today’s rule makes sensible adjustments to how reporting counterparties submit swap data to SDRs and how SDRs fulfill their responsibilities as Commission registrants." He added, "These adjustments are based on the almost decade-long experience of the CFTC staff in supervising SDRs and reviewing swap data, as well as the public’s informed comments to the proposal."
  • In voicing his support for the new framework, Commissioner Rostin Behnam recalled the 2008 financial crisis stating, "Lack of transparency in the over-the-counter swaps market contributed to the financial crisis because both regulators and market participants lacked the visibility necessary to identify and assess swaps market exposures, counterparty relationships, and counterparty credit risk."
  • While approving the general framework, Commissioner Stump took issue with manner by which the final rules addressed the issue of block size thresholds noting, "Despite many years of experience with SEFs and SDRs then, the Commission is today choosing to continue down the previously determined path of raising block sizes instead of leveraging data."
  • Commissioner Dan Berkovitz enthusiastically endorsed the final rules declaring, "The amended rules provide major improvements to the Commission’s swap data reporting requirements." He added, "They will increase the transparency of the swap markets, enhance the usability of the data, streamline the data collection process, and better align the Commission’s reporting requirements with international standards."
Registration with alternative compliance for non-U.S. DCOs. This final rule permits DCOs organized outside of the U.S. to be registered with the CFTC, yet comply with the core principles applicable to DCOs set forth in the Commodity Exchange Act through compliance with their home country regulatory regimes, although subject to certain conditions and limitations. Chairman Tarbert, Commissioners Quintenz, Behnam, Stump and Berkovitz each had further comments about the final alternative compliance rule.

Part 190 Bankruptcy Regulations. This supplemental notice of proposed rulemaking amends Commission regulations that govern bankruptcy proceedings for commodity brokers. In response to comments for rule amendments proposed in April, the Commission now proposes a revision in connection with efforts to foster a resolution proceeding under Title II of the Dodd-Frank Act for a systemically important derivatives clearing organization (SIDCO). This proposed rule has a 30-day comment period after its publication in the Federal Register. Commissioner Berkovitz also had further comment regarding the supplemental notice.

Friday, September 18, 2020

SEC advisory subcommittee outlines spectrum of potential approaches to ESG disclosure

By Amanda Maine, J.D.

At a recent meeting of the SEC’s Asset Management Advisory Committee, the ESG subcommittee presented an overview of its work regarding potential Commission action on ESG (environmental, social and governance) issues. While not an official subcommittee recommendation, the overview sets the stage for its recommendations at the next AMAC meeting in December. The subcommittee outlined five "workstreams" related to ESG: performance management, issuer disclosure, truth in labeling, "values versus value," and proxy voting, of which the first three will provide the basis of the subcommittee’s December recommendations.

Performance measurement. Aye Soe of S&P Dow Jones Indices provided a summary of the subcommittee’s thoughts on how ESG strategies contribute to performance. According to Doe, the subcommittee examined research on the performance of ESG funds during the COVID-19 selloff compared to the broad market index. When controlled for different variables such as industry, liquidity, accounting measures, and intangible assets, the research indicated that while ESG was not significantly associated with market returns during the first quarter of 2020, "COVID crisis" returns were positively associated with intangible assets such as research and development (R&D) and information technology (IT).

Soe also discussed how companies with high ESG scores compare to those with high scores on the individual environmental, social, and governance factors. According to a study by MSCI, the whole is greater than the sum of the parts when it comes to ESG, Soe said. Companies with high ESG scores outperformed those with high individual scores. Specifically, those with high governance scores outperformed those with high social scores, which outperformed those with high environmental scores, the MSCI study found.

The subcommittee noted that existing performance disclosure requirements can be used as a baseline, Soe advised. For example, on Form N1-A, ESG measures can be disclosed on the risk/return summary under the Investment Objectives & Goals and the Investments, Risks, and Performance categories. In particular, risks of investing in a fund can be disclosed on the narrative risk disclosure and the risk/return bar chart and table.

Soe described the pros and cons of potential recommendations that the subcommittee explored regarding performance measurement, from doing nothing to strong intervention. While doing nothing would not impose added costs on managers and allow innovation to continue, it would remain difficult for investors to assess performance without a relevant benchmark.

The subcommittee also described two models of "moderate intervention." Both approaches would incorporate best practice guidelines or mandate the use of ESG performance objectives or secondary style-adjusted benchmarks. While these approaches would provide for greater transparency regarding "values versus value" performance objectives, the subcommittee notes that unless mandated, compliance would be voluntary and could increase burdens on ESG funds and suffer from a lack of standardization.

The "strong intervention" approach would mandate performance attribution of individual E, S, and G as well as ESG factors. This approach would result in greater comparability and more information on ESG factor performance. However, currently the methodology, data, and system infrastructure to measure ESG factor performance does not exist and this approach would result in an increased burden that is placed only on ESG funds and may reduce the incentive to develop new strategies, the subcommittee found. Soe remarked that the market is probably not ready for this level of intervention.

Issuer disclosure. The subcommittee also examined opportunities to improve the quality of ESG disclosure by issuers. Presenting the subcommittee’s findings on this workstream, Jeff Ptak of Morningstar Research Services outlined considerations that should be taken into account by the SEC on any guidance or regulations for how issuers disclose and present ESG information. Implicit in the subcommittee’s work is the concept of materiality, Ptak said. Since ESG issues are material, investors should be able to obtain this information from issuers and that information should be comprehensive, meaningful, and comparable. Each of these "dimensions" have different aspects to examine, the subcommittee outlined.

A comprehensive ESG issuer disclosure regime would require disclosure and metrics of all material ESG issues. However, fewer than 30 percent of public companies disclose ESG risks, and the number is even lower for private companies. Regarding the meaningfulness of disclosure, any new standards should acknowledge the dynamic nature of materiality while keeping in mind that voluminous metrics can make analysis challenging. In addition, some ESG disclosure may be "cherry-picking" by issuers, making it look more like a "marketing glossy" than a true disclosure, Ptak advised.

For ESG issuer disclosures to be comparable, they should balance standardization (which promotes comparison across industries) with specificity (to enhance comparability within industries). The existence of multiple standard setters, including the Global Reporting Initiative, the Sustainability Accounting Standards Board, and the Financial Stability Board’s Task Force on Climate-related Financial Disclosures, can detract from the comparability aspect.

Like its presentation on performance measurement, the subcommittee offered a spectrum of potential recommendations on issuer ESG disclosure, from "do nothing" to "strong intervention." And like performance measurement, the choice of doing nothing would present a low burden on issuers and facilitate market-driven responses. However, it would also impede the development of a common disclosure framework, resulting in continued inefficiency.

The "moderate intervention" approach would encourage and then mandate disclosure according to principles developed by third-party standard setters, tiered by materiality and issuer size. While this approach favors a common disclosure standard that is not overly prescriptive and encourages tailoring and customization, a "gradual patchwork" approach would not promote standardization and comparability. In contrast, a "strong intervention" approach codifying a comprehensive set of disclosure rules through regulation, irrespective of materiality and issuer size, would enshrine a comprehensive standard for the disclosure of ESG matters. However, this approach would also put a heavy burden on issuers, and a rules-based (as opposed to a principles-based) approach could detract from the meaningfulness of the disclosures, the subcommittee reported.

Truth in labeling. The subcommittee’s paper also discussed the role of ESG rating systems and benchmarks. While the initial objective of this workstream was to provide recommendations on third-party ESG ratings systems and benchmarks, the subcommittee expanded it to address "truth in labeling" and concerns regarding the potential for "greenwashing" in ESG funds. The "do nothing" approach may lead to misrepresentations by funds that brand themselves as ESG funds. The "moderate intervention" approach would provide best practice guidelines for ESG fund disclosure. The subcommittee said that this approach could use the Investment Company Institute’s classification taxonomy. Benefits would include relatively low costs for managers and better comparability. However, as the subcommittee points out, the voluntary nature may still result in funds that misrepresent their ESG portfolios or engage in selective disclosure.

The "strong intervention" approach would require funds claiming to be ESG funds to have a higher ESG score than their benchmark from an organization analogous to an NRSRO for ESG. While this approach would improve consistency and reliability, it could also drive costs for managers higher. In addition, if there are too few "ESG NRSROs," development could be limited, while too many could cause comparability to suffer. The subcommittee also notes that current rating approaches for ESG differ markedly.

Values versus value and proxies. The subcommittee’s review also considered workstreams regarding "values versus value" and proxies, although these workstreams will not be included in the subcommittee’s eventual recommendation. The subcommittee considered how ESG should be treated under Rule 35d-1 of the Investment Company Act, also known as the "Names Rule." The Names Rule prohibits materially deceptive or misleading fund names and requires that 80 percent of assets by value to be consistent with certain attributes included in fund’s name. ESG is currently considered a "strategy" and is thus not subject to the 80 percent requirement. Rich Hall of the University of Texas/Texas A&M Investment Management Company said that at some point, ESG may become fundamental, rather than a strategy, but there is still work to be done in this area.

While the subcommittee did contemplate what requirements should govern ESG funds’ proxy voting practices, Jane Carten of Saturna Capital said that the SEC’s new proxy voting rules and related guidance, which were approved in July, effectively improved the process by requiring additional conditions to the availability of exemptions from filing requirements used by proxy advisory firms, requiring the disclosure of conflicts of interest between proxy advisors and affiliates, clarifying that proxy voting advice generally constitutes a solicitation, and clarifying that failure to disclose certain information may be subject to the antifraud provision of the proxy rules. As such, the subcommittee will not move forward on a recommendation regarding ESG proxy voting at the next meeting.