Today, the Co-Directors of the SEC Division of Enforcement, Stephanie Avakian and Steven Peikin, issued a brief cautionary statement regarding market integrity in the era of the COVID-19 pandemic. The statement acknowledged the unprecedented impact of COVID-19 on the securities markets and emphasized the importance of “maintaining market integrity and following corporate controls and procedures.”
The SEC has just settled an action against Diageo PLC, a producer of liquor, wine and beer, for failure to disclose known trends and uncertainties. Diageo’s omission resulted in materially misleading disclosures regarding its financial results and material inflation of key performance indicators—organic net sales growth and organic operating profit growth. It’s worth noting that the SEC has not been reluctant to take enforcement action against companies that have misled investors by inflating KPIs, such as subscriber counts, revenue-per-subscriber, number of vehicles sold monthly, net new customers added, backlog and now organic net sales growth and organic operating profit growth. These types of metrics—typically outside of the financial statements—are metrics on which investors and analysts often rely to assess performance, and companies have been held to account if their presentations are materially inaccurate or misleading or the related controls are inadequate.
As reported on Columbia Law School’s Blog on Corporations and the Capital Markets, the Bharara Task Force on Insider Trading, chaired by former U.S. Attorney for the SDNY, Preet Bharara, and comprising former U.S. Attorneys and staff, academics and judges, has now issued its report and recommendations. The objective of the Task Force was to address the problem that insider trading law “has suffered—and continues to suffer—from uncertainty and ambiguity to a degree not seen in other areas of law, with elements of the offense defined by—and at times, evolving with—court opinions applying particular fact patterns.” Why is that? Because insider trading law is not defined by statute and has instead “developed through a series of fact-specific court decisions applying the general anti-fraud provisions of our securities laws across a broadening set of conduct.” The result has been a lack of clarity that “has left market participants without sufficient guidance” on how to avoid, or defend against, insider trading, made it more difficult for prosecutors to establish their cases and given the public “reason to question the fairness and integrity of our securities markets.”
You might recall that, at the end of October, proxy advisory firm ISS filed suit against the SEC and its Chair, Jay Clayton (or Walter Clayton III, as he is called in the complaint) in connection with the interpretation and guidance directed at proxy advisory firms issued by the SEC in August. (See this PubCo post.) That interpretation and guidance addressed the application of the proxy rules to proxy advisory firms, confirming that proxy advisory firms’ vote recommendations are, in the view of the SEC, “solicitations” under the proxy rules, subject to the anti-fraud provisions of Rule 14a-9, and providing some suggestions for disclosures that would help avoid liability. (See this PubCo post.) Then, in November, the SEC proposed amendments to the proxy rules to add new disclosure and engagement requirements for proxy advisory firms, codifying and elaborating on some of the earlier interpretation and guidance. (See this PubCo post.) As reported in Bloomberg, the SEC has now filed an Unopposed Motion to Hold Case in Abeyance, which would stay the litigation until the earlier of January 1, 2021 or the promulgation of final rules in the SEC’s proxy advisor rulemaking. In the Motion, the SEC confirmed that, during the stay, it would not enforce the interpretation and guidance. ISS did not oppose the stay, and the Court has granted that motion. As a result, this proxy season, companies should not expect proxy advisory firms to feel compelled to comply with the SEC interpretation and guidance, including advice to proxy advisors to provide certain disclosures to avoid Rule 14a-9 concerns.
Yesterday, the Delaware Supreme Court heard the appeal in Sciabacucchi v. Salzberg (pronounced Shabacookie!) in which the Chancery Court held invalid exclusive federal forum provisions for ’33 Act litigation in the charters of three Delaware companies. Few of the justices revealed their inclinations, so it’s difficult to predict the outcome. We’ll have to wait for the Court’s final decision.
Today, ISS filed suit against the SEC and its Chair, Jay Clayton (or Walter Clayton III, as he is called in the complaint) in connection with the interpretation and guidance directed at proxy advisory firms issued by the SEC in August. (See this PubCo post.) That interpretation and guidance (referred to as the “Proxy Adviser Release” in the complaint) confirmed that proxy advisory firms’ vote recommendations are, in the view of the SEC, “solicitations” under the proxy rules and subject to the anti-fraud provisions of Rule 14a-9. In its complaint, ISS contends that the Proxy Adviser Release is unlawful and its application should be enjoined for a number of reasons, including that the SEC’s determination that providing proxy advice is a “solicitation” is contrary to law, that the SEC failed to comply with the Administrative Procedures Act and that the views expressed in the Release were arbitrary and capricious.
Interestingly, the litigation comes right before the SEC is scheduled to consider and vote (on November 5) on a proposal to amend certain exemptions from the proxy solicitation rules to provide for disclosure, primarily by proxy advisory firms such as ISS and Glass Lewis, of material conflicts of interest and to set forth procedures to facilitate issuer and shareholder engagement and otherwise improve information provided. There are various rumors circulating about the details of the proposal, including this Reuters article stating that the proposal would require proxy advisory firms to “give companies two chances to review proxy materials before they are sent to shareholders.” (Note that also on the agenda is a proposal to “modernize” the shareholder proposal rules by changing the submission and resubmission requirements.) Whether the firms’ advice is a “solicitation” takes on particular significance given that the SEC’s anticipated proposal appears to be predicated on the firms’ reliance on the exemptions from the proxy solicitation rules.
At the end of September, the SEC announced that it had filed a complaint in federal court charging pharma Mylan N.V. with failing to timely disclose in its financial statements the “reasonably possible” material losses arising out of a DOJ civil investigation. The DOJ had investigated whether, by misclassifying its biggest product, the EpiPen, as a “generic,” Mylan had overcharged Medicaid by hundreds of millions of dollars. According to the complaint, although the investigation continued for two years, Mylan also failed to accrue for the “probable and reasonably estimable” material losses, as required under GAAP, until the announcement of a $465 million settlement with DOJ. In addition, some of Mylan’s other allegedly misleading disclosure flowed from its omission to discuss the claims. The SEC alleged that Mylan’s risk factor was misleading because it framed the government’s misclassification claim as a hypothetical possibility, when, in fact, the claim had already been made. As a consequence of these failures, the SEC alleged, Mylan’s SEC filings were false and misleading in violation of the Securities Act and Exchange Act. Mylan agreed to pay $30 million to settle the SEC’s charges. While the SEC complaint makes the matter sound straightforward, in practice, deciding whether, when and what to disclose or accrue for a loss contingency can often be a challenging exercise.