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The Securities Edge

Securities Blog for Middle-Market Companies

Does governance matter?

Posted in Bob's Upticks, Corporate Governance

I’m a governance nerd. I really believe that corporate governance is important, that it makes a difference, and that there is such a thing as good governance – though I don’t believe that one size fits all.

So it troubles me that in governance, as in life, virtue is usually not its own reward. In fact, no one seems to care about governance unless and until performance deteriorates.

I was reminded of this the other day when reading a story about an investigation by New York Attorney General Schneiderman of governance practices at Cooper Union, a venerated educational institution in New York. It seems that Cooper Union, whose mission is to provide free education, started charging tuition last year because of poor financial condition. (As an aside, Cooper Union’s major asset is the Chrysler Building in New York City – yes, THAT Chrysler Building, which to me and many others is the most beautiful skyscraper ever built.) The story says that the investigation “has signaled that the laissez-faire approach to nonprofit governance is over.” In other words, as long as performance was OK, no one cared about governance. Or so it seems.

Another story made the same point a couple of months ago, albeit in different circumstances, when an institutional shareholder announced that it had submitted a proposal to separate the positions of CEO and board chair at a major company. In the article, the proponent seemed to be saying that the proposal hadn’t been necessary before because the company had been performing well. Now I’m no advocate of CEO/board chair separation, but if you believe that having an independent, non-executive board chair is critical (which the proponent clearly believed), why should it make a difference that the company had been performing well?

And just the other day, an executive told me that while his company doesn’t have Grade A governance, it doesn’t hear anything on the subject from investors because it’s had year after year of improved performance.

So the question is out there: does governance matter? What do you think?

Being careful what you wish for

Posted in Bob's Upticks, Insider trading, SEC Enforcement

Last December, I wrote an UpTick (“There ought to be a law”) about a decision in the Second Circuit Court of Appeals that appears to be wreaking havoc with insider trading prosecutions past and present. The Second Circuit has now rejected a Justice Department request to reconsider the decision, and so we now face a period of uncertainty regarding whether and to what extent insider trading can be prosecuted.

Since the terms “inside information” and “insider trading” have never been defined, one suggestion is that Congress should enact legislation that would define one or both terms. That’s a good idea in principle, but the proposals that have been bandied about thus far provide little confidence that legislation would clarify the situation. For example, one bill would prohibit trading on information that “is not publicly available” but not “information that the person has independently developed from publicly available sources”. I’m not sure this helps; after all, Ray Dirks (the subject of an SEC vendetta that, in my opinion, led to the current confusion on what is and is not insider trading) independently developed the information in question, but the SEC prosecuted him anyway.

Another bill would (1) define inside information as nonpublic information obtained illegally from the issuer “with an expectation of confidentiality” or “in violation of a fiduciary duty” and (2) remove the requirement that a tipper receive a personal benefit for leaking the information. I like the second part, but I’m not sure that the first part works; for example, if I hear the information from someone who heard it from someone who heard it from the issuer, does that remove the taint?

There are also suggestions that Congress may consider a broader approach – i.e., making it illegal to trade when in possession of confidential information regardless of how it’s obtained. This reminds me of a hypothetical posed years ago by Stanley Sporkin, then the very feisty Director of the SEC’s Enforcement Division: you’re flying in a plane and look out of your window to see XYZ Corporation’s biggest plant going up in flames. As interpreted by Mr. Sporkin, if you got off the plane and called your broker with a sell order, you would be engaging in illegal insider trading. Of course, these days you could place the order online well before the plane lands. Is that really how we’d like it to turn out?

It seems to me that before Congress even thinks about acting (not that Congress can act on very much if anything these days), we need to think about what goal we’re trying to achieve. If the objective is to create a level playing field for all investors, that’s one thing, and would probably require a much broader approach. If the goal is less ambitious — i.e., to curtail trading based on knowing leaks and thefts of inside information — that’s another. In any case, wishing for legislation on this topic reminds me of the old saw about being careful what you wish for.

Your thoughts?

Political contributions disclosure: My Exchange Act report is bigger than yours

Posted in Bob's Upticks

As some of us contemplate which disclosure rules we’d like to do away with, others are thinking about new rules that would require more disclosure. One possible area of rulemaking relates to disclosure of political contributions. Regardless of one’s views of the merits of such disclosure, significant and vocal groups of shareholders advocate it, and for that reason alone it’s not something that companies (or regulators) can blithely ignore.

What I don’t understand is why those who are pressing for such disclosure seem to believe not only that it is imperative, but also that it must be included in Exchange Act reports, such as 10-Ks or 10-Qs. To the extent (albeit limited) that any securities lawyers are OK with political contributions disclosure in the first place, the insistence upon including it in a 10-K or 10-Q is a major turn-off, because doing so would lengthen those already voluminous reports and, more importantly, would subject a company to Exchange Act liability.

I’ve spoken to one of the principal advocates of such disclosure – who, by the by, is a smart and decent man – about this insistence. I asked why, for example, he’d oppose posting the information on a company’s website, or including it in a supplemental report (both of which are the current norms for such disclosure) outside the framework of the Exchange Act. He countered by saying, first, that only an SEC rule would require all public companies to provide the information and that only an SEC rule would set universal disclosure standards. I disagree; it seems to me that both of those goals could be achieved through industry standard-setting or exchange listing standards. But even if he’s right and the SEC were to impose requirements, that doesn’t mean that the disclosure should have to be in an Exchange Act report. No offense to my smart and decent friend, but I’m still waiting for an answer.

As we approach disclosure “reform” with hopes that the web will offer us some respite from ever-longer SEC filings through more “layered” disclosure, much of it posted on the web, and not all of which needs to be printed or “filed” or even “furnished,” it seems anomalous if not downright ill-advised to insist upon this particular push to make our filings look more and more like doorstops. The good news is that thus far the SEC has shown little or no interest in rulemaking in this area, but time will tell.

Your thoughts?

Ineffective disclosure

Posted in Bob's Upticks, Disclosure Guidance

It’s not for nothing that I’m a securities lawyer.  I sincerely believe in the need for and efficacy of full and fair disclosure, both professionally and personally.  That’s one of the many reasons why I have been advocating disclosure reform – or, as we now call it, “effective disclosure” – to assure that important matters are disclosed, and that unimportant matters need not be.

So it’s not surprising that I’m upset about something that happened recently.  I attended a program at which a representative of a major institutional investor said that his firm just doesn’t have time to read the proxy statements of the companies in which the firm has invested.  I’ve heard this song before in various guises – for example, one major institution told me a few years ago that the most they’d ever spend reading a 100-page proxy statement was 15-20 minutes – but for some reason the statement I heard recently really bothered me.

Why do securities lawyers spend most of their waking hours, and many of the hours when they should be sleeping, trying to provide investors with the information they need to make important decisions?  (And, for the cynics out there, I’ve never heard a securities lawyer say anything like “How can we hide this?”)  Why do companies spend untold amounts of money paying their lawyers to do that?  More important, why is it acceptable for major investors to say that they don’t read their investees’ disclosures?  Does it ever occur to them that they may be in violation of their legal and ethical obligations to their clients by blowing off the obligation to read those disclosures and voting on significant matters without reading those disclosures?

Which brings me back to “effective disclosure.”  I’m passionate about the topic, and I’ve put my time (which is, after all, money) where my mouth is.  But I’d be crazy not to think about whether it’s really worth the time and effort it will take to overhaul our approach to disclosure if, at the end of the proverbial day, few if any people will benefit from it or even care about it.

Years ago I commented on an SEC rule proposal by saying, among other things, that it would result in more disclosure that no one would read.  I was told by the then-Director of the SEC Division of Corporation Finance that rulemaking isn’t based on whether anyone reads the disclosures in question.  At the time, I thought he was probably right, but now I’m not so sure.

Your thoughts?

Marketplace lending: A hot new industry looking for crowdfunding

Posted in Capital Raising

Marketplace lending surely had its day in the sun in 2014.  Peer-to-peer lending, which now goes by the term marketplace lending, took a big step forward last year.  We saw the IPO of Lending Club rocket in its first day of trading on December 11, 2014 by first pricing above the range at $15 per share and then touching a high mark of 67% that day. Lending Club has been the leader in this field and its IPO highlighted the importance and the emergence of this new lending alternative. Despite this surge, however, not everyone attended the party in 2014. Noticeably, the SEC still has not finalized its crowdfunding rules, which are an important next step for the marketplace lending industry.

So what exactly is marketplace lending? Put simply, it is an Internet based lending market that is created by connecting borrowers with lenders or investors.  There are various companies with different approaches to the concept.  In Lending Club’s case, potential borrowers fill out online loan applications.  The company (and its bank behind the scenes) then uses online data and technology to evaluate the credit risks, set interest rates and make loans.  On the other side of the equation, Investors are offered notes for investment that correspond to portions of the loans and can earn monthly returns on their notes that are backed by borrower payments.  As a result, marketplace lending effectively offers secondary market trading for loans.

On the positive side, marketplace lending can be good for borrowers because the lower cost structure of an online platform can be passed along to borrowers in the form of lower interest rates.  The use of the Internet and online credit resources can also speed up the credit approval process so that borrowers can get funds faster.  In addition, some borrowers may get access to loans that they could not get from traditional banks.  In other words, the marketplace could help individuals with lower credit scores or negative credit histories find loans.  Thus, despite its critics, marketplace lending can help serve a niche that has historically been underserved by the banking industry.

Marketplace lending, however, at least when it comes to Lending Club and those like it, still has a bank at its core. So some borrowers will still not be able to get loans through this marketplace model.  Also, the investors are buying registered securities with interests in the loans made in the marketplace.  Lending Club turned to registering their notes with the SEC when Continue Reading

In sickness and in health

Posted in Bob's Upticks, Disclosure Guidance

Jamie Dimon, CEO of JPMorgan Chase, is reputed to be a decisive person with a strong personality.  Of course, that shouldn’t be news to anyone who follows business or who knows what it takes to be CEO of a major company.  So it’s interesting that he recently said that he struggled with whether JPM should disclose that he was battling cancer.  (For the record, he seems to have won the battle.)

I’m not the only securities lawyer who’s had similar struggles when the CEO of a client has become seriously ill.  It’s a very challenging issue for several reasons.  First, there isn’t any rule – or even any literature (at least to my knowledge) – that tells us whether and what to disclose in this situation.  So when a client says, “show me the rule that says we have to disclose this,” there’s nothing to show.  Second, and more important, the issue pits the need to disclose against information that is quintessentially personal.  It’s also not just an issue between the executive and the company; often, the executive’s family and, possibly, his/her medical team and others are equally involved.  And even when there’s agreement to disclose, it’s very difficult to know what to say about the prognosis, if and when the executive can return to work, and so on.

I think JPM’s decision to disclose was the right one.  Among other things, JPM and Mr. Dimon are inextricably linked with each other; he is the public face of the company, and it’s hard to imagine mentioning one without the other.  In fact, it’s arguably this linkage that led to the defeat of shareholder proposals seeking to deprive Mr. Dimon of his title as Chairman of the Board; no one wanted to see if he would carry out his threat to leave the company if the proposals passed.  Second, his illness was grave and could have killed him.  In other words, it seems pretty clear that the information was market-moving – a factor that must be considered in making the disclosure decision.  (That said, contrast this with Apple’s treatment of Steve Jobs’s illness.)  Also, according to Mr. Dimon, he lost 35 pounds in his battle, making it painfully obvious that something was up.  So why hesitate to disclose something that everyone could see?

Another way of evaluating the matter is to consider whether there are any meritorious reasons not to disclose.  When I had to grapple with a similar decision, the facts were different; among other things, the CEO wasn’t the company’s alter ego, and it was questionable whether the stock would tank if we disclosed.  On the other hand, the company had just gotten past a nasty scandal and a period of intense upheaval in which two senior people had left and the company’s credibility had been shattered.  In these circumstances I couldn’t see a significant reason not to disclose.  I took some heat from the CEO’s family, but I had no doubt that I made the right decision.

Your thoughts?

Update to the JOBS Act? Probably not…

Posted in Disclosure Guidance
Long Delay for JOBS Act Changes

Photo by Omar Parada

On January 14th, the House passed H.R. 37 “Promoting Job Creation and Reducing Small Business Burdens Act.”  Although passed with some support from the Democrats (29 votes, which in these days of hyper-partisanship is practically a bipartisan bill), the White House issued a veto threat on January 12th because the bill also delays part of the Volker Rule effectiveness until July 21, 2019.  Thus, in its current form, it looks dead on arrival, but there are some interesting ideas that I support and will hopefully make it in a revised bill later in the term:

  • Delays the requirement for savings and loan holding companies to register under the Securities Exchange Act of 1934 to the same extent as bank holding companies (assets of $10 million and class of equity securities held of record by 2,000 or more persons).  Also allows deregistration for savings and loan holding companies when they have fewer than 1200 shareholders of record.  This seems fair and was likely an unintended distinction made when the JOBS Act passed.  Unfortunately, this innocuous bill was grouped with the Volker delay. 
  • Provides for an exemption from the Securities Exchange Act of 1934 for certain business brokers.  The bill provides for some restrictions such as Continue Reading

Shock and awe at the SEC (and turning it into chicken salad)

Posted in Bob's Upticks, No-action letters, Proxy access, Shareholder proposals

Something shocking happened at the SEC yesterday.  SEC Chair Mary Jo White directed the SEC Staff to review its long-standing position on when a shareholder proposal conflicts with a company proposal and may be excluded from the proxy statement.  As a result, the SEC’s Division of Corporation Finance withdrew a no-action letter that had given Whole Foods the green light to exclude a shareholder proposal on proxy access by including its own (less shareholder-friendly) proposal on the subject.  Corp Fin also said that it would not be issuing any additional no-action letters under the rule in question. It’s worth noting that these actions were taken at a sensitive time, as calendar-year companies approach peak proxy season and a major investor campaign is under way to impose proxy access upon companies that have been resisting it.

The SEC’s shareholder proposal rules are very complex, and I won’t go into details here.  However, as a general matter, the rules lay out the process by which eligible shareholders can submit proposals for inclusion in a company’s proxy statement.  Relevant here is that (1) the rules provide certain conditions under which a company can exclude a proposal and (2) companies can avail themselves of a “no-action” process to get the SEC’s permission to exclude a proposal if the conditions are satisfied.  It’s worth noting that the no-action process isn’t dispositive; the proponent or the company can take the matter to court, and there are usually a couple of cases each year in which that happens.

Continue Reading

The challenges in ‘refreshing’ board committees

Posted in Corporate Governance
Committee Rotation

Photo by Justin Kern

Director “refreshment” has become a very hot topic in the governance community.  Investors increasingly are calling for replacing longer-serving board members with newer directors, possibly in order to achieve greater board diversity, possibly to get some fresh blood (or fresh thinking) on the board, or possibly to achieve other goals.  There is also increased talk about the use (and appropriateness) of age limits, term limits and other processes to assure regular board turnover.  For example, Institutional Shareholder Services has suggested that a director serving more than nine years may no longer qualify as independent.  As part of this discussion, questions have also been raised about the need for “committee refreshment” – rotating directors off and on committees to keep them fresh and receptive to new ideas.

Governance practitioners have been grappling with the issue of board and committee refreshment for many years, even though the objective may not have been called “refreshment” until recently.  For example, corporate secretaries and others have scratched their heads as to how to enforce age limits, how to decide when those limits should be waived or raised, how to grapple with the political and personal issues that can arise when the age limit is waived for one director but not for another, and whether term limits would be preferable to age limits.  Recent discussions have also generated pushback from companies and their directors that age and/or long tenure may generate greater, rather than less, independence; after all, a director with 15 or more years of service who has overseen two or more CEOs may feel far less dependent upon the current CEO than a director who has joined the board only recently.

These and other concerns are challenging enough at the board level, but they can be far more challenging at the committee level.  In an era when much of the substantive, detailed work of the board is handled by committees, and committee service increasingly calls for subject matter expertise, refreshing a committee is not as simple as putting Mr. or Ms. X on the committee when Mr. or Ms. Y retires.  The qualifications and abilities – and, in some cases, expertise – of the replacement need to be considered before he or she can be used to fill the vacancy or simply “rotated on” a new committee.

Continue Reading

Bad laws make hard cases

Posted in Bob's Upticks, Corporate Governance, Financial Institutions

There have been a number of press reports in recent days about attempts by the new Republican majority to repeal all or part of Dodd-Frank.  Depending upon whom you choose to believe (assuming you choose to believe anyone in the current political environment), the Republicans want to eviscerate it, and the Democrats refuse to change one word, or possibly even a punctuation mark.

The real problem with Dodd-Frank is that it’s a mixed bag – a mess, of course, but a mixed bag nonetheless.  My take on it is that there are some provisions that are reasonable and make sense; others go way too far; and still others don’t go far enough.  For example, the infamous (and, IMHO, ridiculous) provision requiring public companies to disclose the ratio of the CEO’s pay to that of the mean of all employees’ compensation.  On the other side, one wonders if the statute really did anything to regulate the financial services industry or if it did nothing more than exponentially increase the costs of compliance while leaving open the possibility that recent history (i.e., an economic collapse) could happen all over again for the same reasons.

What this suggests is that to make Dodd-Frank a good statute – assuming that’s possible – would require delicate surgery that would take time, careful thought and bipartisanship.  It may go without saying, but I’ll say it anyway – that isn’t going to happen in the current environment.  Grandstanding and blustery populist oratory seem to be the order of the day, and careful drafting isn’t even on the agenda.  (Of course, that was the case when the statute was being drafted – one of the scariest things I ever saw on a monitor was a live webcast of Barney Frank’s subcommittee hearing, when multi-page riders were waltzed in to the hearing room and voted upon before anyone could read them – much less debate them.)

I’m not sure where that leaves us, but wherever that is, it’s not a good place to be.

There it is.  I’d like to know what you think.