Dubious en banc Fifth Circuit hears oral argument on Nasdaq board diversity rules
In August 2021, the SEC approved a Nasdaq proposal for new listing rules regarding board diversity and disclosure, accompanied by a proposal to provide free access to a board recruiting service. The new listing rules adopted a “comply or explain” mandate for board diversity for most listed companies and required companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding the composition of their boards. (See this PubCo post.) It didn’t take long for a court challenge to these rules to materialize: the Alliance for Fair Board Recruitment and, later, the National Center for Public Policy Research petitioned the Fifth Circuit Court of Appeals—the Alliance has its principal place of business in Texas—for review of the SEC’s final order approving the Nasdaq rule. (See this PubCo post and this PubCo post) In October 2023, a three-judge panel of the Fifth Circuit denied those petitions, in effect upholding Nasdaq’s board diversity listing rules. Given that, by repute, the Fifth Circuit is the circuit of choice for advocates of conservative causes, the decision to deny the petition may have taken some by surprise—unless, that is, they were aware, as discussed in the WSJ and Reuters, that the three judges on this panel happened to all be appointed by Democrats. Petitioners then filed a petition requesting a rehearing en banc by the Fifth Circuit, where Republican presidents have appointed 12 of the 16 active judges. (See this PubCo post.) Not that politics has anything to do with it, of course. That petition for rehearing en banc was granted, vacating the opinion of the lower court. Yesterday, oral argument was heard. Let’s just say that, while some points were made in support of the rule, the discussion seemed to be dominated by rule skeptics. But the feud between Drake and Kendrick Lamar did figure in the discussion. Some highlights below.
Cooley Alert: EU Adopts Mandatory Rules on Corporate Sustainability Due Diligence
In late April, the European Parliament voted to adopt the Corporate Sustainability Due Diligence Directive, which will apply to EU companies and to non-EU companies with activities in the EU that meet specified thresholds. A discussed in this new Cooley Alert, EU Adopts Mandatory Rules on Corporate Sustainability Due Diligence That Will Apply to Many US Companies, from Cooley’s International ESG and Sustainability Advisory team, the CSDDD could turn out to be a “heavy lift” for many in-scope companies: the new law will mandate, for the first time, comprehensive “human rights and environmental due diligence obligations, with significant financial penalties and civil liability for companies that do not fully comply,” as well as new requirements for companies “to adopt and put into effect a climate transition plan” and “to report on their due diligence processes.” As the Alert observes, these requirements “reframe existing international soft laws”—UN Guiding Principles and OECD guidelines—as “mandatory obligations.”
Is ESG a “must have” only in boom-times?
Not so long ago, zeal for corporate action on ESG was skyrocketing. Now? Not so much. What happened? Many have attributed the decline in appetite for ESG to the politicization of ESG and particularly to ESG backlash. This paper from the Rock Center for Corporate governance at Stanford has another idea. Has “ESG enthusiasm” reached its expiration date or, as the paper posits, is it like an alligator Birkin bag, just a luxury—something to pursue only when you’re “feeling flush”? In economics, the authors explain, demand for most items declines as prices increase. Not so with luxury goods, where “a high price tag stimulates demand in part because of the social benefits the purchaser receives by signaling to others their ability to afford it.” Demand for luxury goods often rises and falls with the economy; when times are prosperous, demand for luxury goods increases and when money is tight, demand falls. In that light, a “case can be made,” the authors contend, “that ESG is a luxury good.”
NYSE proposes trading halt in the event of reverse stock split
In 2023, as a corollary to revised listing standards related to notification and disclosure of reverse stock splits, Nasdaq adopted a rule change providing for a new regulatory halt procedure specific to the pre-market trading and opening of a Nasdaq-listed security undergoing a reverse stock split. Pointing to an increased volume of reverse splits, Nasdaq believed that the proposed amendment would help to better detect errors that might result from “market participants’ processing of the reverse stock split, including incorrect adjustment or entry of orders” before trading in the stock begins. (See this PubCo post.) Although, according to the NYSE, it has not experienced the same increased volume of reverse stock splits, it has now proposed to follow suit by amending Rule 123D (Halts in Trading) to “set forth specific requirements for halting and resuming trading in a security that is subject to a reverse stock split.” The proposed rule change has become effective under Rule 19b-4(f)(6).
Are boards overseeing AI?
Is there a hotter topic in the business world than AI? AI offers major opportunities for progress and productivity gains, but substantial risks as well. According to FactSet, 179 companies in the S&P 500 used the term “AI” during their earnings call for the fourth quarter of 2023, well above the 5-year average of 73. Among these companies, “the average number of times ‘AI’ was mentioned on their earnings calls was 13, while the median number of times ‘AI’ was mentioned on their earnings calls was 5. The term ‘AI’ was mentioned more than 50 times on the earnings calls of nine S&P 500 companies.” Similarly, Bloomberg reports that “[a]t least 203, or 41%, of the S&P 500 companies mentioned AI in their most recent 10-K report, Bloomberg Law’s review found. That’s up from 35% in 2022 and 28% in 2021. A majority of the disclosures focused on the risks of the technology, while others focused on its benefit to their business.” One of the many challenges that AI presents is on the corporate governance front, in particular board oversight, a topic addressed in this recent paper from ISS, AI Governance Appears on Corporate Radar. For the paper, ISS examined discussions of board oversight and director AI skills in proxy statements filed by S&P 500 companies from September 2022 through September 2023 to “assess how boards may evolve to manage and oversee this new area of potential risks and opportunities.”
Auditor problems are not just auditor problems
On Friday, SEC Enforcement charged audit firm BF Borgers CPA PC and its owner, Benjamin F. Borgers, with “massive fraud” involving “deliberate and systemic failures” to comply with PCAOB standards in auditing and reviewing financial statements incorporated into more than 1,500 SEC filings from January 2021 through June 2023. The charges also included “falsely representing to their clients that the firm’s work would comply with PCAOB standards; fabricating audit documentation to make it appear that the firm’s work did comply with PCAOB standards; and falsely stating in audit reports included in more than 500 public company SEC filings that the firm’s audits complied with PCAOB standards.” In settlement, the audit firm agreed to pay a $12 million civil penalty, and Benjamin Borgers agreed to pay a $2 million civil penalty, along with censures, cease-and-desists and permanent suspensions from appearing and practicing before the SEC as accountants. According to SEC Enforcement Director Gurbir S. Grewal,
“Ben Borgers and his audit firm, BF Borgers, were responsible for one of the largest wholesale failures by gatekeepers in our financial markets….As a result of their fraudulent conduct, they not only put investors and markets at risk by causing public companies to incorporate noncompliant audits and reviews into more than 1,500 filings with the Commission, but also undermined trust and confidence in our markets. Because investors rely on the audited financial statements of public companies when making their investment decisions, the accountants and accounting firms that audit those statements play a critical role in our financial markets. Borgers and his firm completely abandoned that role, but thanks to the painstaking work of the SEC staff, Borgers and his sham audit mill have been permanently shut down.”
This case has received an unusual amount of press—for an audit firm that many have never even heard of before—because Borgers was the auditor for the social media company of a certain former president. (See, e.g., the NYT, CNBC, CBS News) But, as we’ve often seen in other contexts, such as auditor independence (see, e.g., this PubCo post), this case also illustrates the importance for companies to keep in mind that these types of violations may have serious consequences not only for the audit firm, but also for the audit clients. In fact, in this case, the staff of Corp Fin and the Office of Chief Accountant issued this Staff Statement on Issuer Disclosure and Reporting Obligations in Light of Rule 102(e) Order against BF Borgers CPA PC.
Cooley Alert: Proposed Regulations on Stock Buyback Excise Tax
In April, the Treasury Department and the IRS published proposed regs on the 1% excise tax on stock buybacks imposed under the Inflation Reduction Act. As discussed in this comprehensive Cooley Alert, IRS Publishes Proposed Regulations on Stock Buyback Excise Tax, from our Comp & Benefits and Tax groups, the proposed regs take an expansive approach, applying the excise tax to transactions not typically considered stock buybacks, including redemptions and transactions that are economically similar to redemptions, such as exchanges of target stock in acquisitive reorganizations and other economically similar transactions. The Alert cautions that “companies may have excise tax liability or tax return filing obligations in myriad circumstances.”
Is the proxy advisory industry a net benefit or cost to shareholders?
In Seven Questions About Proxy Advisors, from the Rock Center for Corporate Governance at Stanford, the authors, David Larcker and Brian Tayan, examine the proxy advisory firm industry—all two of them. Well, actually, as the paper observes, there are a large number of small players, but Institutional Shareholder Services and Glass Lewis “control[] almost the entire market.” It’s well-known that recommendations from ISS and GL are considered important—sometimes even a major aspect of the battle—especially in contests for corporate control and director elections. But, the authors point out, the extent of their influence on “voting outcomes and corporate choices is not established, nor is the role they play in the market. Are proxy advisory firms information intermediaries (that digest and distill proxy data), issue spotters (that highlight matters deserving closer scrutiny), or standard setters (that influence corporate choices through their guidelines and models)? Because of the uncertainty around these questions, disagreement exists whether their influence is beneficial, benign, or harmful. Defenders of proxy advisors tout them as advocates for shareholder democracy, while detractors fashion them as unaccountable standard setters.” The paper examines “seven important questions about the role, influence and effectiveness of proxy advisory firms.” The authors explore why there is so much controversy about the purpose, role and contribution of proxy advisory firms, asking whether “the proxy advisory industry—as currently structured—[is] a net benefit or cost to shareholders?”
Cooley Alert: FTC bans noncompetes
The Federal Trade Commission has just voted, three to two, to prohibit post-employment noncompete agreements, with some limited exceptions. The ban will take effect 120 days after the final rule is published in the Federal Register. Why the ban? As discussed in this terrific new Cooley Alert, FTC Passes Sweeping Noncompete Ban, from our Labor and Employment group, the FTC noted that it views non-competes as “unfair method[s] of competition” that “restrict the freedom of American workers, suppress wages, and stifle new business and innovation.” The Alert indicates that the rule has an expansive application: in its definition of noncompetes, the rules sweeps in “certain provisions that are commonly thought to constitute alternatives to noncompetes.” In addition, the rule “broadly applies to noncompete agreements affecting virtually all workers—including employees, independent contractors, externs, interns, volunteers, apprentices or sole proprietors.” Under the rule, employers are required to “issue notices informing affected employees about the cessation of noncompete agreements.”
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