Yesterday, yet another complaint was filed in federal district court charging that California’s board diversity statutes, SB 826 and AB 979, are unconstitutional under the equal protection provisions of the 14th Amendment. This complaint was filed by The National Center for Public Policy Research, which, you may recall, has also filed a petition challenging the Nasdaq board diversity rule (see this PubCo post and this PubCo post). The NCPPR describes itself as “a non-profit 501(c)(3) organization that supports free market solutions to social problems and opposes corporate and shareholder social activism that detracts from the goal of maximizing shareholder returns.” The case is National Center for Public Policy Research v. Weber, and the initial scheduling conference for this case isn’t set to occur until March of next year.
Since the onset of the COVID-19 pandemic, the number of whistleblower complaints received by regulators has exploded on both sides of the Atlantic. That’s the subject of this new Cooley Alert, Whistleblower Complaints and Rewards Explode Worldwide, from our White Collar Defense and Investigations group.
On October 19, a federal district court judge held a hearing on a motion for a preliminary injunction in Meland v. Weber, a case challenging SB 826, California’s board gender diversity statute, on the basis that it is unconstitutional under the equal protection provisions of the 14th Amendment. The judge had previously dismissed the case on the basis of lack of standing, but was reversed by the 9th Circuit. What did the hearing reveal? (This post has been updated to reflect additional information regarding the hearing. See “At the hearing” below.)
For years, many companies and business lobbies, such as the National Association of Manufacturers, repeatedly raised concerns about proxy advisory firms’ concentrated power and significant influence over corporate elections and other matters put to shareholder votes, leading to questions about whether these firms should be subject to more regulation and accountability. (See, e.g., this PubCo post, this PubCo post and this PubCo post.) In July 2020, the SEC adopted, by a vote of three to one, new amendments to the proxy rules regarding proxy advisory firms. At the time of adoption of the new rules, then-SEC Chair Jay Clayton observed that the final rules were the product of a 10-year effort—commencing with the SEC’s 2010 Concept Release on the U.S. Proxy System—which led to “robust discussion” from all market participants. Commissioner Allison Herren Lee, who dissented, objected to the rule changes as “unwarranted, unwanted, and unworkable.” When new SEC Chair Gary Gensler was confirmed, he asked the SEC staff to take another look at the rule amendments, and Corp Fin stated that, during the reconsideration period, it would not recommend enforcement action. Now, as reported on thecorporatecounsel.net blog, NAM has just announced that it has filed suit in federal court against the SEC for failure to enforce its final rules on proxy advisory firms.
On October 19, a federal district court judge held a hearing on a motion for a preliminary injunction in Meland v. Weber, a case challenging SB 826, California’s board gender diversity statute, on the basis that it is unconstitutional under the equal protection provisions of the 14th Amendment. The judge had previously dismissed the case on the basis of lack of standing, but was reversed by the 9th Circuit. What did the hearing reveal?
A new petition has been filed challenging the Nasdaq board diversity rule (see this PubCo post). The National Center for Public Policy Research filed the petition on Tuesday with the U.S. Court of Appeals for the Third Circuit, but asked the court to transfer the proceeding to the Fifth Circuit, where an earlier petition filed by the Alliance for Fair Board Recruitment is pending. (See this PubCo post.) The new Nasdaq listing rules, which were approved by the SEC on August 6, adopt a “comply or explain” mandate for board diversity for most listed companies and require companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding the composition of their boards.
When the SEC was considering the NYSE’s proposal to permit direct listings of primary offerings, one of the frequently raised problems related to the potential “vulnerability” of “shareholder legal rights under Section 11 of the Securities Act.” Section 11 provides standing to sue for misstatements in a registration statement to any person acquiring “such security,” typically interpreted to mean a security registered under the specific registration statement. The “vulnerability” was thought to arise as a result of the difficulty plaintiffs may have—in a direct listing where both registered and unregistered shares may be sold at the same time—in “tracing” the shares purchased back to the registration statement in question. In approving adoption of the NYSE rule, the SEC said that it did not “expect any such tracing challenges in this context to be of such magnitude as to render the proposal inconsistent with the Act. We expect judicial precedent on traceability in the direct listing context to continue to evolve,” pointing to Pirani v. Slack Technologies. As the NYSE had observed, only the district court in Slack had addressed the issue, and had concluded that, at the pleading stage, plaintiffs could still pursue their claims even if they could not definitively trace the securities they acquired to the registration statement. However, the NYSE noted, the case was on appeal. (See this PubCo post.) That appeal, Pirani v. Slack Technologies, has just been decided by a three-judge panel of the 9th Circuit. The Court affirmed, with one dissent, the district court’s order, ruling that the plaintiff had standing to sue under Section 11.
In In re The Boeing Company Derivative Litigation, Vice Chancellor Morgan Zurn of the Delaware Court of Chancery opened her opinion this way:
“A 737 MAX airplane manufactured by The Boeing Company…crashed in October 2018, killing everyone onboard; a second one crashed in March 2019, to the same result. Those tragedies have led to numerous investigations and proceedings in multiple regulatory and judicial arenas to find out what went wrong and who is responsible. Those investigations have revealed that the 737 MAX tended to pitch up due to its engine placement; that a new software program designed to adjust the plane downward depended on a single faulty sensor and therefore activated too readily; and that the software program was insufficiently explained to pilots and regulators. In both crashes, the software directed the plane down. The primary victims of the crashes are, of course, the deceased, their families, and their loved ones. While it may seem callous in the face of their losses, corporate law recognizes another set of victims: Boeing as an enterprise, and its stockholders.”
Do the directors bear any responsibility for these losses? The question before the Court in this derivative litigation was whether the plaintiff stockholders—New York and Colorado public pension funds—had adequately alleged, under In re Caremark International Inc. Derivative Litigation and Marchand v. Barnhill, that, as a result of the directors’ “complete failure to establish a reporting system for airplane safety,” or “their turning a blind eye to a red flag representing airplane safety problems,” the board faced a “substantial likelihood of liability for Boeing’s losses.” In a 103-page opinion, the Court concluded that the answer was yes—on both bases. (Other claims regarding the company’s officers and the board’s handling of the CEO’s retirement and compensation were dismissed.) It’s worth noting that this case is one of several Caremark claims in recent years to survive dismissal (see, e.g., this PubCo post). In Marchand, then-Chief Justice Strine remarked that Caremark presents a very high hurdle, observing that “Caremark claims are difficult to plead and ultimately to prove out,” and constitute “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” (See this PubCo post.) In light of this series of decisions, you have to wonder—at least with regard to matters that involve “essential and mission-critical” risk and safety issues—if that’s still the case.
Attorneys who may think they can give short shrift to those pesky legal opinions to transfer agents might think twice after reading this complaint, SEC v. Frederick Bauman, filed on September 8, 2021, in the federal district court in Nevada. As described in the SEC’s litigation release, the SEC charged Bauman “with playing a critical role as an attorney who facilitated the unregistered sale of millions of shares of securities by two groups engaged in securities fraud.” According to the SEC’s complaint, between 2016 and August 2019, Bauman issued at least a dozen legal opinions to transfer agents advising that certain shares of four public companies were unrestricted and freely tradeable and that the holders of the shares were not affiliates of the public company issuers. However, the SEC alleged, the shareholders were actually part of groups that controlled those issuers, which made them affiliates under the securities laws. In “each instance where Bauman’s opinion letters violated Section 5,” the SEC alleged, “he lacked a reasonable basis for representing that the shareholders were not affiliates.” The complaint charged that the sales by these control groups were unregistered and violated Section 5 of the Securities Act and that Bauman violated Sections 5(a) and 5(c) of the Securities Act.
On Friday, the SEC announced settled charges against Kraft Heinz Company, its Chief Operating Officer and Chief Procurement Officer for “engaging in a long-running expense management scheme that resulted in the restatement of several years of financial reporting.” According to the SEC’s Order regarding the company and the COO, as well as the SEC’s complaint against the CPO, the company employed a number of expense management strategies that “misrepresented the true nature of transactions,” including recognizing unearned discounts from suppliers, maintaining false and misleading supplier contracts and engaging in other accounting misconduct, all of which resulted in accounting errors and misstatements. The misconduct, the SEC contended, was designed to allow the company to report sham cost savings consistent with the operational efficiencies it had touted would result from the 2015 merger of Kraft and Heinz, as well as to inflate EBITDA—a critical earnings measure for the market—and to achieve certain performance targets. And, once again, charges of failure to design and implement effective internal controls played a prominent role. After the SEC began its investigation, KHC restated its financials, reversing “$208 million in improperly-recognized cost savings arising out of nearly 300 transactions.” According to Anita B. Bandy, Associate Director of Enforcement, “Kraft and its former executives are charged with engaging in improper expense management practices that spanned many years and involved numerous misleading transactions, millions in bogus cost savings, and a pervasive breakdown in accounting controls. The violations harmed investors who ultimately bore the costs and burdens of a restatement and delayed financial reporting….Kraft and its former executives are being held accountable for placing the pursuit of cost savings above compliance with the law.” KHC agreed to pay a civil penalty of $62 million. Interestingly, this case comes on the heels of an earnings management case brought by the SEC against Healthcare Services Group, Inc. for alleged failures to properly accrue and disclose litigation loss contingencies.