Corporate AlertJuly 2015
In recent news...
The Arizona Cardinals hired Jen Welter to coach inside linebackers through their upcoming training camp and preseason. Ms. Welter is believed to be the first woman to hold a coaching position of any kind in the NFL. Ms. Welter's hiring is the second such barrier to be broken in the NFL. In April of this year, the NFL announced that Sarah Thomas would be the first woman to be a full-time NFL official. Herrick's Sports Law Group applauds the hiring of Ms. Welter and Ms. Thomas.
SEC Proposes "Clawback" Rules Related to Executive Incentive-Based Compensation
On July 1, 2015, the SEC proposed a change that would require companies to develop a policy enabling the company, in certain situations, to "claw back" incentive-based compensation received by its executive officers. The SEC's stated goal is to increase accountability and the quality of financial reporting. Specifically, the proposed new Rule 10D-1 under the Securities Exchange Act would require national securities exchanges and associations to establish listing standards that would require listed companies to develop and implement policies that provide for the recovery of incentive-based compensation in the event the company is required to prepare an accounting restatement to correct a material error. Upon such accounting restatement, the policy implemented pursuant to the new rule would require both current and former executive officers to pay back the erroneously-awarded incentive-based compensation. The amount of recovery would be the difference between the amount of the incentive-based compensation that the executive officer actually received and the amount that would have been received had that amount been determined based on the accounting restatement. Recovery of compensation in such circumstances is on a "no fault" basis, thereby enabling the recovery of compensation received by executive officers even where they were not responsible for the erroneous financial statements. Further, the proposed rule would require companies to disclose these new policies, as well as the actions taken under them.
As proposed, the new rules would apply to all listed companies with limited exceptions for certain registered investment companies that do not provide incentive-based compensation. Also, the reach of the "clawback" provisions is not unlimited. It applies only to certain forms of executive compensation, namely incentive-based compensation that is granted, earned or vested based wholly or in part on the attainment of any financial reporting measure. This includes compensation that is tied to accounting-related metrics, stock price or shareholder return. Further, recovery of compensation is limited to the amounts received by the executive officer in the three fiscal years preceding the date that the company is required to prepare an accounting restatement. Among the types of compensation outside the reach of the "clawback" provisions are ordinary salary, discretionary bonuses and time-based equity or bonus awards.
Failure by listed companies to comply with the provisions of the proposed new Rule 10D-1 could result in the SEC delisting the company.
The proposed rule is subject to a comment period of 60 days following publication in the Federal Register. Thereafter, from the date of publication in the Federal Register, the exchanges would be required to file their proposed rules within ninety days with such rules thereafter becoming effective within one year.
Clarification of the "Ordinary Business Exclusion" in Shareholder Proxy Proposals
The U.S. Court of Appeals for the Third Circuit addressed a proxy proposal, submitted for inclusion in Wal-Mart's 2014 proxy materials seeking to increase Wal-Mart's oversight of its firearm sales.
Rule 14a-8 of the Securities Exchange Act of 1934, as amended, establishes procedures for shareholders seeking to include a proposal in a company's proxy materials. However, the rules also provide several grounds for a company to exclude a shareholder proposal, including if the proposal "deals with a matter relating to the company's ordinary business operations." In a 1997 release, the SEC provided an exception for the "ordinary business exclusion," if such a proposal presents a significant social policy issue for consideration.
Under the proxy proposal before the Court, Wal-Mart would be required to implement policies and standards to determine, among other things, whether Wal-Mart should sell a product that: "(1) especially endangers public safety and well-being; (2) has the substantial potential to impair the reputation of the Company; and/or (3) would reasonably be considered by many as being offensive to the family and community values integral to the Company's promotion of its brand."
The Court, overturning a Delaware district court's decision, held that Wal-Mart could exclude the proxy proposal, since the proposal related to ordinary business operations even though the proposal raised a significant social policy issue.
The Court clarified that in order to fall under the "significant social policy exception," the social policy issues must "transcend a company's ordinary business." The court notes that "if a significant policy issue disengages from the core of a retailer's business… it is more likely to transcend its daily business dealings." The Court concluded that "because the proposal related to a policy issue that targets the retailer-consumer interaction, it doesn't raise an issue that transcends in this instance Wal-Mart's ordinary business operations, as product selection is the foundation of retail management."
The Court noted an increase in proposals attempting to raise social policy issues and suggested that the SEC revise its regulations and issue new interpretative guidance on proxy contests.
Trinity Wall St. v. Wal-Mart Stores, Inc., No.14-4764 (3d Cir. July 6, 2015)
KKR Action Highlights New Regulatory Focus on Private Equity Fees
On June 29, 2015, the Securities and Exchange Commission charged Kohlberg Kravis Roberts & Co. L.P. ("KKR") with misallocating more than $17 million in broken deal expenses and failing to disclose that certain co-investment vehicles were not allocated any share of such expenses. Without admitting or denying the SEC's findings, KKR agreed to settle the proceedings for nearly $30 million, which includes a $10 million penalty.
According to the SEC, KKR, "specializes in buyout and other transactions" and advises and manages its main private equity funds along with co-investment vehicles and other accounts that invest with these funds in such buyout transactions. The fund at issue was the KKR 2006 Fund L.P. (the "2006 Fund"), which was, from 2006 to 2011 (the "Relevant Period"), KKR's largest private equity fund with $17.6 billion in committed capital. The 2006 Fund invested over $16.5 billion during the Relevant Period. During such time, KKR incurred $338 million in expenses, including diligence expenses, research costs and other deal-sourcing expenses, related to unsuccessful buyout opportunities (such expenses, "broken deal expenses"). Pursuant to the 2006 Fund's limited partnership agreement, KKR was permitted to allocate to, or be reimbursed by, the 2006 Fund for all broken deal expenses that were "incurred by or on behalf of" the 2006 Fund in "developing, negotiating and structuring prospective or potential [i]nvestments that are not ultimately made." Although KKR allocated broken deal expenses to its main private equity funds, except for a partial allocation to certain co-investors in 2011, KKR did not allocate broken deal expenses to the co-investment vehicles that invested alongside the 2006 Fund during the Relevant Period "even though those vehicles participated in and benefited from KKR's general sourcing of transactions." Notably, these vehicles included dedicated co-investment vehicles for its executives and certain consultants.
The SEC alleged that KKR's failure to allocate a portion of the broken deal expenses to the co-investment vehicles, and failure to "expressly disclose" in the limited partnership agreements or related offering materials that KKR did not allocate or attribute any broken deal expenses to the co-investment vehicles constituted a violation of Section 206(2) of the Investment Advisers Act of 1940, as amended, which prohibits an investment adviser from engaging in "any transaction, practice or course of business which operates as a fraud or deceit upon any client or prospective client." Furthermore, the SEC alleged that KKR failed to adopt and implement written policies and procedures "reasonably designed to prevent violations of the Advisers Act and the rules thereunder."
The KKR action reflects the relatively recent and increased focus by the SEC on private equity fees and expenses, including enforcement actions taken by the SEC in respect of improper expense allocation. In September and October 2014, Lincolnshire Management, Inc. and Clean Energy Capital, LLC, respectively, settled enforcement actions with the SEC related to the misallocation of fees and expenses. Furthermore, the Office of Compliance Inspections and Examinations of the SEC listed the allocation of fees and expenses among advisers to private equity funds as a 2015 examination priority.
Delaware Supreme Court Affirms Judgment Effectively Postponing Annual Meeting Due to Lack of Specific Date on Notice
The Delaware Supreme Court recently affirmed a Court of Chancery's grant of a mandatory injunction preventing Hill International, Inc. ("Hill") from conducting business at its annual meeting (other than convening the meeting for the sole purpose of adjourning it for a minimum time period). The basis for the injunction arose after Hill notified plaintiff-stockholder Opportunity Partners L.P. ("Opportunity") that its notice of proposed business and director nominations for the upcoming annual meeting was untimely under Hill's advance notice bylaw, and that Opportunity's proposed business and director nominations would not be presented at the 2015 annual meeting.
The Supreme Court based its analysis on contract interpretation principles applied to the applicable provisions of the bylaws. Hill's advance notice bylaw is seemingly based on Section 222 of the Delaware General Corporation Law instead of the more common provision requiring delivery of advance notices by a number of days prior to the one-year anniversary of the prior annual meeting or the mailing of the previous year's proxy statement. Hill's advance notice provision instead provides, in effect, that notice must be: (a) delivered not less than 60 days prior to the annual meeting or (b) if prior public disclosure of the date of the annual meeting is given less than 70 days from the annual meeting, then the stockholders' notice must be received no later than 10 days after such public disclosure.
The Court of Chancery explained that Hill did not trigger the advance notice bylaws requirement of at least 60 days' advance notice because the date in the initial public disclosure was not a specific date (i.e. "on or about June 10, 2015"). Opportunity's advance notice was timely within the 10 days after the date when the specific date of the annual meeting was disclosed, since the specific date was announced less than 70 days from the meeting. In affirming, the Delaware Supreme Court stated that "the plain meaning of 'the date' [in the advance notice bylaws] means a specific day – not a range of possible days." The Delaware Supreme Court affirmed the judgment of mandatory injunctive relief by the Court of Chancery since Opportunity would have suffered irreparable harm absent injunctive relief.
Hill International, Inc. v. Opportunity Partners L.P., No. 305, 2015 (Del. July 2, 2015)
Cybersecurity Tools and Guidance Released by FFIEC and FTC
On June 30, the Federal Financial Institutions Examination Council ("FFIEC") released a Cybersecurity Assessment Tool (the "Tool") to aid financial institutions in evaluating their inherent cyber security risk profile and determining their level of cyber security preparedness. The Tool was developed in response to last year's pilot assessment of cybersecurity preparedness at more than 500 institutions. It is designed for financial institutions of all sizes and is intended to provide them with a self-assessment tool that can be used periodically on an enterprise-wide basis and as significant operational and technological changes occur. The Tool is consistent with the FFIEC Information Technology Examination Handbook and the National Institute of Standards and Technology (NIST) Cybersecurity Framework, and standard industry practices. Although the FFIEC says use of the Tool is voluntary, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency have said that it will be discussed or used during examinations of financial institutions.
The Tool is divided into two parts.
In part I, the Tool assesses the institution's inherent risk profile by self-assessing against five categories:
- Technologies and Connection Types
- Delivery Channels
- Online/Mobile Products and Technology Services
- Organizational Characteristics
- External Threats
Each category is ranked on its risk level, whether it poses Least, Minimal, Moderate, Significant, or Most Inherent Risk to the institution.
After identifying the institution's risk profile, part II is to evaluate the institution's cybersecurity maturity level, or in other words, its preparedness to combat cyber-attacks or failures. The maturity assessment includes five domains:
- Cyber Risk Management and Oversight
- Threat Intelligence and Collaboration
- Cybersecurity Controls
- External Dependency Management
- Cyber Incident Management and Resilience
Each domain contains several assessment factors, and each factor within a domain is evaluated for whether the institution is at a Baseline, Evolving, Intermediate, Advanced, or Innovative Maturity stage in terms of preparedness to deal with a particular assessment factor. To assist in determining which maturity stage applies, each stage is accompanied by a set of declarative statements, organized by assessment factor, that describe how the behaviors, practices, and processes of an institution can consistently produce the desired outcomes. An institution's management determines which declarative statements best describe the current practices of the institution. All declarative statements in each maturity stage, and all previous stages, must be met in order to achieve that factor's maturity stage.
On the same day the FFIEC released the Tool, the Federal Trade Commission (the "FTC") released a new guide titled, Start with Security: A Guide for Businesses (the "Guide"), intended to assist businesses on improving their data security practices. The Guide is based on 10 "lessons learned" from many of the FTC's data-security settlements. The FTC also announced the first two events of its new "Start with Security" business education initiative to provide guidance on data security best practices. The first event is targeted at start-ups and developers and will be held on September 9, 2015 at the University of California Hastings College of Law. The event will focus on topics such as security by design, common security vulnerabilities, and strategies for secure development. The second event will be held on November 5, 2015 at the University of Texas in Austin.
Delaware Increases Flexibility Related to Consideration for Stock
Delaware has amended its General Corporation Law ("DGCL") to provide greater flexibility to Delaware stock corporations with respect to the consideration received in exchange for stock. Specifically, Section 152 of the DGCL has been amended to permit the board of directors to authorize by resolution the issuance of stock in one or more transactions and at such time or times as determined by a person or body other than the board of directors or committee thereof. Currently, Section 152 requires that this be determined by the board of directors or a committee thereof. Under the revised Section 152, the resolution must fix the maximum number of shares that may be issued pursuant to such resolution, a time period during which such shares may be issued and a minimum amount of consideration for which such shares may be issued. In addition, the amendment to Section 152 permits the consideration for shares to be determined by a formula that utilizes extrinsic facts ascertainable outside of the formula itself. It is important to note, however, that shares having par value may not be issued for consideration less in value than the established par value of the shares, pursuant to Section 153 of the DGCL.
In practice, this amendment permits the board to authorize stock to be issued pursuant to "at the market" programs without requiring the board or committee to authorize separately each individual stock issuance.
The revised statute is effective as of August 1, 2015.
For more information on the issues in this alert, or corporate matters generally, please contact:
Daniel A. Etna at +1 212 592 1557 or [email protected]
Copyright © 2015 Herrick, Feinstein LLP. Corporate Alert is published by Herrick, Feinstein LLP for information purposes only.
Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm