June 2012

Following the recent financial crisis and government bailouts of major U.S. financial institutions, the federal government has gradually facilitated a power shift from companies and their officers and boards of directors to their shareholders. A prime example of this is the recently enacted “say-on-pay voting” requirements. Through provisions of the Dodd-Frank Act which was passed in July 2011, Congress directed the SEC to adopt rules requiring public companies to give their shareholders a vote, on an advisory basis, on the approval of executive compensation (“say-on-pay”). The implemented rules also require public companies to hold an advisory vote on the frequency (“say-on-when”) with which the say-on-pay vote would occur. Taking into account the results of the say-on-when vote, companies determined whether to hold say-on-pay votes on an annual, biennial, or triennial basis, with most electing to hold annual say-on-pay votes. Despite these shareholder votes being advisory, and as we explained in a previous blog, these votes may actually be more impactful than originally anticipated due to the effect of poor or failed say-on-pay votes on the recommendations from proxy advisory firms, such as ISS. For example, a “poor” (i.e., less than 70% shareholder approval) or “failed” say-on-pay vote result (i.e., less than 50% shareholder approval) could lower one or more of a company’s ISS “GRId” scores (or other proprietary proxy advisory firm corporate governance rating scores) which would negatively impact the recommendations published by the proxy advisory firms with respect to the election of directors and other corporate governance matters being put to a vote of the shareholders at the annual meeting. By way of example, if a public company receives less than 70% shareholder approval for executive compensation, the company must show that it took steps to address its perceived executive pay shortcomings, otherwise ISS will recommend a “withhold” vote for the directors up for re-election at the next annual meeting.

Going one-step further, however, the United Kingdom announced on June 20, 2012 that it will be implementing a binding say-on-pay vote requirement for public companies. According to the Department for Business Innovation and Skills, the U.K. government will “introduce a new binding vote on companies’ pay policies in order to empower shareholders and Continue Reading Binding say-on-pay: Is it coming to a public company near you?

The “Risk Factors” section of any disclosure document is vital to the protection of the issuer. Generations of securities lawyers and accountants have worked into the night to develop lists of risks that would make any sane potential investor run away screaming. Most of us have seen innumerable examples of conventional risk factors like competition, legal and regulatory changes, impact of the loss of key personnel and others. Many of these risk factors are virtually identical regardless of the issuer’s industry space, and it’s doubtful that many readers of disclosure materials pay much attention to these risk factors.

The new breed of public technology companies, however, present some novel and interesting risks. The disclosure of these risks still strives to protect the issuer and give the potential purchaser the relevant information necessary to make an informed investment decision, but they focus on areas that are quite different from the disclosures used by more conventional companies. These technology company disclosure documents still contain many conventional risk factors, but it’s interesting to see the new areas that are considered material risks for these companies.

Here are several of the key items that been used as material risk factors in recent technology company disclosure documents filed by prominent technology companies:

Data Security.  This is a very hot issue for most technology companies these days, especially in the social media space. Facebook is a great example, as it has data from close to 900 million users. LinkedIn has similar dynamics and issues on a smaller scale. A data breach for any of these companies would have huge legal ramifications, as state, Federal and international regulatory authorities and private plaintiffs would quickly react. LinkedIn recently experienced these negative ramifications first hand as it was sued for $5 million in connection with its recent data breach.  The potential damage to a company’s brand and credibility could also be significant.  Click here for language from the Facebook prospectus and the LinkedIn prospectus as good examples. The SEC also offered some guidance on this topic in “CF Disclosure Guidance Topic No. 2 – Cybersecurity”. Continue Reading That sounds risky: New generation of risk factors for technology companies

Issuers who would not otherwise meet the NASDAQ independence rules may now breathe (a small) sigh of relief. On May 30, the SEC published notice of NASDAQ’s proposed change to Listing Rule 5605.

Generally, Rule 5605 requires issuers to maintain an “independent” audit, compensation, and nominating committees. There is an exception to the independence rules that allows one nonindependent director to serve on one of these key committees under “exceptional and limited circumstances” for up to two years.

Generally, this exception is rarely used — in the two-year period ended December 31, 2011, only 37 issuers used the exception – and is usually used only by the smallest of the listed issuers.

Under the current exception, if a director would not be considered independent because either the Board determined that the director had a relationship that interfered with the director’s independent judgment or if the director failed one of NASDAQ’s objective tests such as being employed by the company or one of its affiliates or accepting certain payments from the company in excess of $120,000 in a year, then the director could serve in an “exceptional and limited circumstance” provided that the company did not employ a family member of that director.

Under the proposed new rules, the director would be permitted to serve provided that the employed family member was not an executive officer.

While the exception does not impact a tremendous amount of companies, it does have a disproportionate benefit to smaller issuers, particularly companies with large shareholders who may be deemed affiliates of the issuer. The expected impact will be small, but I welcome any relief for smaller issuers especially given the tremendous burden placed on smaller issuers over the past 10 years.

With the passing of the Jumpstart Our Business Startups (JOBS) Act, the thresholds for whether a company must be public changed dramatically. This is particularly true for smaller banks and bank holding companies. 

The prior rule required registration with the SEC if the institution reached 500 or more holders of a single class of stock and had $10 million in assets. After the JOBS Act, the ownership number increased to 2,000 shareholders. Further, banks and bank holding companies may now deregister with fewer than 1,200 shareholders, a number previously set at 300. 

So the race is on for many smaller banks and bank holding companies to go private and save the high costs associated with being a public company.

At first glance, it may appear obvious that going private is the best thing to do. However, this is not necessarily the case. 

  • Many investors prefer having regular and comprehensive disclosures about their investments. This is required for public companies, but not for private ones. 
  • Also, investors like liquidity in their stocks. However, stocks in private companies are harder to trade, if they can be traded at all. 
  • Merger prospects can also be reduced by going private because it is harder to use private company stock as currency in a deal. 

For these reasons, the decision to go private should be considered carefully on a case-by-case basis.