Category: Litigation
Will Chevron deference survive? Why you might really care about a case about fishing
On May 1, SCOTUS granted cert in the case of Loper Bright Enterprises v. Raimondo, a case about whether the National Marine Fisheries Service has the authority to require fishing vessels to pay some of the costs for onboard federal observers who are required to monitor regulatory compliance. So why is this relevant to public companies? Because one of the questions presented to SCOTUS was whether the Court should continue the decades-long deference of courts, under Chevron U.S.A., Inc. v. Nat. Res. Def. Council, to the reasonable interpretations of statutes by agencies (such as the SEC). The doctrine of Chevron deference, articulated in that case, mandated that, if there is ambiguity in how to interpret a statute, courts must accept an agency’s interpretation of a law unless it is arbitrary or manifestly contrary to the statute. The decision, expected next term, could narrow, or even completely undo, that deference. Of course, the conservative members of the Court have long signaled their desire to rein in the dreaded “administrative state.” (See, for example, the dissent of Chief Justice John Roberts in City of Arlington v. FCC back in 2013, where he worried that “the danger posed by the growing power of the administrative state cannot be dismissed.”) But, in recent past cases, the Court has resolved issues and avoided addressing Chevron. This case, however, may well present that long-sought opportunity. Depending on the outcome, its impact could be felt far beyond the Marine Fisheries Service at many other agencies, including the SEC.
SCOTUS hears oral argument in Slack direct listing case—did the Court float its likely resolution?
When the SEC was considering the NYSE’s proposal to permit direct listings of primary offerings, one of the frequently raised difficulties related to the potential “vulnerability” of “shareholder legal rights under Section 11 of the Securities Act.” Section 11 provides statutory standing to sue for misstatements in a registration statement to any person acquiring “such security,” historically 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 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.) The case, Pirani v. Slack Technologies, was decided by a divided three-judge panel of the 9th Circuit, with the court affirming, with one dissent, the district court’s order, ruling that the plaintiff had standing to sue under Section 11. But that decision was appealed to SCOTUS, which granted cert. On Monday, SCOTUS heard oral argument. Justice Kagan may be a bellwether: addressing Pirani’s counsel, she advised that “it does seem to me like you have a hard row to hoe here.” But that was about Section 11. Section 12(a)(2)? Well, that’s another matter.
Cooley Alert: DOJ amps up antitrust enforcement against interlocking directorates
The Department of Justice has stepped up its enforcement of antitrust rules against interlocking directorates. Subject to de minimis exceptions, Section 8 of the Clayton Antitrust Act prohibits the same person from serving on the boards of two competitors. But recently, the DOJ has interpreted the statute more broadly, leading to director resignations where different individuals—who were associated with the same private equity or venture capital firm—served on the boards of competing companies. Companies should take care to assess their Section 8 exposure, as discussed in this excellent Alert from the Cooley Antitrust group, Biden Justice Department Continues Focus on Interlocking Directorates. Be sure to check it out!
Sustainability reports—not a liability-free zone
In April of last year, as described in this press release, the SEC filed a complaint against Vale S.A., a publicly traded (NYSE) Brazilian mining company and one of the world’s largest iron ore producers, charging that it made “false and misleading claims about the safety of its dams prior to the January 2019 collapse of its Brumadinho dam. The collapse killed 270 people, caused immeasurable environmental and social harm, and led to a loss of more than $4 billion in Vale’s market capitalization.” The SEC alleged that Vale “fraudulently assured investors that the company adhered to the ‘strictest international practices’ in evaluating dam safety and that 100 percent of its dams were certified to be in stable condition.” Significantly, these statements were contained, not just in Vale’s SEC filings, but also, in large part, in its sustainability reports. In discussing the charges, the press release made reference to the SEC’s Climate and ESG Task Force formed in 2021 in the Division of Enforcement “with a mandate to identify material gaps or misstatements in issuers’ ESG disclosures, like the false and misleading claims made by Vale.” On Tuesday, the SEC announced that Vale had agreed to pay $55.9 million to settle the SEC charges. According to the Associate Director of Enforcement, the SEC’s “action against Vale illustrates the interplay between the company’s sustainability reports and its obligations under the federal securities law….The terms of today’s settlement, if approved by the court, will levy a significant financial penalty against Vale and demonstrate that public companies can and should be held accountable for material misrepresentations in their ESG-related disclosures, just as they would for any other material misrepresentations.”
Workplace sexual harassment has a cost—to the company, to employees, and even to shareholders
Workplace sexual harassment and related misconduct—a toxic boys’-club atmosphere—led to three recent cases against McDonald’s, its management and board. And studies have shown that workplace sexual harassment can have substantial adverse “psychological, health, and job-related consequences” for employees, often resulting in “higher employee turnover, lower employee productivity, increased absenteeism, and increased sick leave costs.” But what is the impact for shareholders? A study in the Journal of Business Ethics, “How Much Does Workplace Sexual Harassment Hurt Firm Value?”, looked at just this question. Earlier studies of the impact of workplace sexual harassment looked at the short-term impact on the market, but this study analyzed the “longer-term effect on firm value starting from the date when harassment risk affects employee morale.” The study found that sexual harassment led to much greater damage—manifested in significant reductions in stock performance and profitability—than previously realized: the stock prices of the group of companies with the highest levels of pervasive harassment underperformed those of an equivalent group with low levels of harassment by about 17%. The study also showed that these “high-SH” companies experienced a decline in operating profitability and an increase in labor costs. One of the paper’s co-authors told Corporate Secretary, “[f]inancial analysts and investors often undervalue intangibles such as the effect of a toxic work environment…But [workplace safety] is indicative of all sorts of other underlying issues, including poor control systems and overall bad governance, which can directly impact employee performance, company performance and stock market value.”
McDonald’s court dismisses Caremark claims against directors
Here we have another in a string of McDonald’s cases—all of them arising out of workplace misconduct at McDonald’s, none even dipping its toe into employment law. First, you’ll remember, there were settled charges brought by the SEC against McDonald’s and its former CEO, Stephen Easterbrook, arising out of disclosure about the termination of Easterbrook on account of workplace misconduct. Then there was the derivative Caremark litigation for breach of fiduciary duty against David Fairhurst, who formerly served as Executive Vice President and Global Chief People Officer of McDonald’s, for consciously ignoring red flags about workplace misconduct and engaging in some pretty extensive workplace misconduct himself. Now, we have a new decision out of Delaware regarding the derivative Caremark litigation against the company’s directors alleging that they ignored red flags about the company’s culture that condoned workplace misconduct. But this case turned out to be different—VC Laster of the Delaware Chancery Court dismissed the complaint against the directors. The Court held that, in this case, the directors did not ignore the numerous red flags: the facts cited in the pleadings did “not support a reasonably conceivable claim against them for breach of the duty of oversight.” Once again, the case reinforces that high bar described by former Chief Justice Leo Strine for Caremark claims: “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.)
SEC charges DXC with misleading non-GAAP disclosures and absence of non-GAAP disclosure controls
The SEC has announced settled charges against DXC Technology Company, a multi-national information technology company, for making misleading disclosures about its non-GAAP financial performance in multiple reporting periods from 2018 until early 2020. According to the Order, DXC materially increased its reported non-GAAP net income “by negligently misclassifying tens of millions of dollars of expenses ” as non-GAAP adjustments related to strategic transactions and integration and improperly excluding them from its reported non-GAAP earnings. In addition to misclassification, DXC allegedly failed to accurately describe the scope of the expenses included in the company’s non-GAAP adjustment, with the result that “its non-GAAP net income and non-GAAP diluted EPS in periodic reports and earnings releases were materially misleading.” What’s more, the SEC alleged, DXC’s disclosure committee “negligently failed to evaluate the company’s non-GAAP disclosures adequately,…and failed to implement an appropriate non-GAAP policy” or adequate disclosure controls and procedures specific to its non-GAAP financial measures. Consequently, DXC “negligently failed to evaluate the company’s non-GAAP disclosures adequately.” DXC agreed to pay a civil penalty of $8 million. According to the SEC’s Associate Director of Enforcement, “[i]ssuers that choose to report non-GAAP financial metrics must accurately describe those metrics in their public disclosures….As the order finds, DXC’s informal procedures and controls were not up to the task, and, as a result, investors were repeatedly misled about its non-GAAP financial performance.”
Ransomware attack—SEC charges misleading disclosures and disclosure control failure—again!
Last week, the SEC announced settled charges against Blackbaud, Inc., a provider of donor data management software to non-profit organizations, for misleading disclosures and disclosure control failures. According to the SEC, in May 2020, employees at the company discovered evidence of a ransomware attack. After an investigation, the company announced the incident and advised affected customers—specifying that sensitive donor data was not involved. But just a couple of weeks later, the SEC alleged, company personnel learned that the attacker had, in fact, accessed sensitive donor data for a number of customers—including bank account and social security numbers. But—you guessed it—it’s disclosure controls again! The personnel with knowledge of the scope of the breach “did not communicate this to Blackbaud’s senior management responsible for disclosures, and the company did not have policies or procedures in place designed to ensure they do so.” As a result, the SEC claimed, the company filed a Form 10-Q that still omitted mention of the exfiltration of sensitive donor data and framed its cybersecurity risk factor disclosure as purely hypothetical. The SEC viewed Blackbaud’s disclosure as misleading and its disclosure controls as inadequate and imposed a civil penalty of $3 million. According to the Chief of SEC Enforcement’s Crypto Assets and Cyber Unit, “Blackbaud failed to disclose the full impact of a ransomware attack despite its personnel learning that its earlier public statements about the attack were erroneous….Public companies have an obligation to provide their investors with accurate and timely material information; Blackbaud failed to do so.”
DOJ and SEC bring charges for insider trading and fraudulent scheme using purported 10b5-1 plans
Government officials, especially those in SEC Enforcement, have been making noise about the potential for insider trading abuse of Rule 10b5-1 plans since at least 2007, when then-SEC Enforcement Chief Linda Thomsen expressed concern that “executives are taking advantage of a legal safe harbor to sell their stock and profit before their companies report bad news….[A]cademic studies suggest that the rule may be a cover for improper activity, Thomsen said. ‘We’re looking at this hard….If executives are in fact trading on inside information and using a plan for cover, they should expect the ‘safe harbor’ to provide no defense.’” (See this Cooley News Brief.) Now, in 2023, DOJ has unsealed an indictment against Terren Peizer, the executive chair of Ontrak, Inc., representing the first time, according to the press release, that DOJ has brought “criminal insider trading charges based exclusively on an executive’s use of 10b5-1 trading plans.” (Note, however, that the SEC did bring a case last year against executives of Cheetah Mobile related to sales under a purported 10b5-1 trading plan entered into while in possession of material nonpublic information. See this PubCo post.) DOJ charged that Peizer entered into a fraudulent scheme using 10b5-1 plans and engaged in insider trading, both of which charges carry stiff criminal penalties. DOJ said that the FBI is continuing to investigate this case. Not to be completely outdone—although it’s hard not to be outdone by the threat of serious jail time—the SEC has also filed a civil complaint against Peizer, charging that he engaged in insider trading in Ontrak shares using 10b5-1 plans as part of a scheme to evade insider trading prohibitions: when Peizer entered into the plans, the SEC alleged, he was aware of material nonpublic information about the company. As you probably know, to be effective in insulating an insider from potential insider trading liability, the 10b5-1 plan must be established when the insider is acting in good faith and not aware of MNPI. Creating the plan once the insider has learned of MNPI, as alleged in this case, would seem to defeat the whole purpose of the rule—to ensure an even playing field for all investors. The SEC alleged that Peizer sold more than $20 million of Ontrak stock, avoiding more than $12.7 million in losses. At the end of last year, Bloomberg reported that the SEC and DOJ were using data analytics “in a sweeping examination of preplanned equity sales by C-suite officials.” (See this PubCo post.) That effort appears to have paid off in this case; DOJ advises that this investigation was “part of a data-driven initiative led by the Fraud Section to identify executive abuses of 10b5-1 trading plans,” suggesting perhaps that this may not be the last prosecution we will see for abuse of 10b5-1 plans.
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