Not according to 49 major law firms! Earlier this month, a shareholder of Pershing Square Tontine Holdings, Ltd., filed derivative litigation against the company’s board, its sponsor and other related companies, contending that the company, a SPAC organized by a billionaire hedge-fund investor, is really an investment company that should be registered under the Investment Company Act of 1940 and that its sponsor is really an investment adviser that should be registered under the Investment Advisers Act of 1940. Had they registered, so the argument goes, they would have been subject to substantial regulation regarding the rights of the SPAC’s shareholders and the form and amount of the SPAC managers’ compensation. According to the complaint, under the ICA, “an Investment Company is an entity whose primary business is investing in securities. And investing in securities is basically the only thing that PSTH has ever done.” The complaint sought “a declaratory judgment, damages, and rescission of contracts whose formation and performance violate” the ICA and IAA. What’s especially notable about the litigation—aside from its novel premise—is that the plaintiff’s lawyers include Yale law professor John Morley and Robert Jackson, an NYU law professor and former SEC Commissioner. Now, a group of 49 major law firms—including Cooley—have issued a joint statement pushing back on the plaintiff’s claims, asserting that there is no legal or factual basis for the allegation that SPACs are investment companies.
Yesterday, the SEC announced settled charges against Healthcare Services Group, Inc., a provider of housekeeping and other services to healthcare facilities, its CFO and its controller, for alleged failures to properly accrue and disclose litigation loss contingencies—accounting and disclosure violations that “enabled the company to report inflated quarterly [EPS] that met research analysts’ consensus estimates for multiple quarters.” This action is the result of SEC Enforcement’s “EPS Initiative, which uses risk-based data analytics to uncover potential accounting and disclosure violations caused by, among other things, earnings management practices.” Gurbir Grewal, the new Director of Enforcement, warned that the SEC will continue to leverage its “in-house data analytic capabilities to identify improper accounting and disclosure practices that mask volatility in financial performance, and continue to hold public companies and their executives accountable for their violations.” The company paid $6 million to settle the action. The SEC Order makes the matter of accruing for loss contingencies sound simple and straightforward, implying that the company’s behavior involved “big bath” accounting and other earnings management practices, and that may well be the case in this instance. However, in many cases, deciding whether, when and what to disclose or accrue for a loss contingency is not so clear cut and can often be a challenging exercise.
It should hardly come as a surprise to anyone that the new Nasdaq board diversity rule (see this PubCo post) would be challenged in the courts. The rule was approved by the SEC on Friday, August 6. On Monday, August 9, the Alliance for Fair Board Recruitment filed a slim petition under Section 25(a) of the Exchange Act in 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. The petition itself is not particularly revealing, but it’s notable that the petitioner is also the most recent plaintiff challenging California’s two board diversity laws.
On Tuesday, the SEC announced that it had filed a complaint in the U.S. District Court charging a former employee of Medivation Inc., an oncology-focused biopharma, with insider trading in advance of Medivation’s announcement that it would be acquired by a big pharma company. But it’s not what you might think. The employee didn’t trade in shares of Medivation or shares of the acquiror, nor did he tip anyone about the transaction. No, according to the SEC, he used the information about his employer’s acquisition to purchase call options on a separate biopharma company, Incyte Corporation, which the SEC claims was comparable to Medivation. According to the SEC, the employee made that purchase based on an assumption that the acquisition of Medivation at a healthy premium would probably boost the share price of Incyte. Incyte’s stock price increased after the sale of Medivation was announced. The SEC charged that the employee breached his “duty to refrain from using Medivation’s proprietary information for his own personal gain” and traded ahead of the announcement, in violation of Rule 10b-5. Will the SEC succeed or is the factual basis of the charge just too attenuated?
It’s déjà vu all over again! On Monday, the SEC announced settled charges against Pearson plc, an NYSE-listed, educational publishing and services company based in London, for failure to disclose a cybersecurity breach. You might recall that just a few months ago, the SEC announced settled charges against another company for failure to timely disclose a cybersecurity vulnerability that led to a leak of data, with disclosure ultimately spurred by imminent media reports. Is there a trend here? In this instance, it wasn’t just a vulnerability—there was an actual known breach and exfiltration of private data. Nevertheless, Pearson decided not to disclose it and framed its cybersecurity risk factor disclosure as purely hypothetical. The SEC viewed that disclosure as misleading and imposed a civil penalty on Pearson of $1 million. The case serves as yet another reminder of the dangers of risk disclosures presented as hypothetical when those risks have actually come to fruition—a presentation that has now repeatedly drawn scrutiny in the context of cybersecurity disclosure.
The SEC’s whistleblower program provides for awards in amounts between 10% and 30% of the monetary sanctions collected in an SEC action based on the whistleblower’s original information. The program, which has been in place for more than ten years, is widely acknowledged to have been a resounding success. In September 2020, the SEC adopted a number of amendments to the whistleblower rules, some of which were quite controversial. In early August, SEC Chair Gary Gensler issued a statement indicating that he had directed the SEC staff to revisit the whistleblower rules, in particular, two of the amendments that had been adopted in 2020. (See this PubCo post.) Gensler observed that concerns have been raised, including by whistleblowers as well as by Commissioners Allison Herren Lee and Caroline Crenshaw, that those amendments “could discourage whistleblowers from coming forward.” Now, the SEC has issued a policy statement advising how the SEC will proceed in the interim while changes to those rules are under consideration. Commissioners Hester Peirce and Elad Roisman were none too pleased with the SEC’s action here, questioning whether it might be part of a troubling pattern of unwinding actions taken by the last Administration. They made their views known in this statement.
Most everyone knows that trading on the basis of material non-public inside information is likely to get you in trouble with the law, but charitable giving on the basis of MNPI—maybe not so much. As reported in this article in the WSJ, a new study from a group of business and law school professors looked at “insider giving,” or, as the study authors describe it, “opportunism posing as, or at least muddled with, ordinary philanthropy.” In essence, according to the WSJ, with insider giving, the donor “tim[es] the donation of a stock to a charity around inside information about the stock. That way, you take a tax deduction before bad news sends the share price tumbling or after good news sends the price higher—and the gift delivers a bigger deduction than you would have gotten otherwise.” The donation is not only tax deductible, it’s also exempt from capital gains tax that would be due on the appreciation in value upon the sale. One of the authors characterized these donations to the WSJ as “suggest[ing] more than chance….The fact that large shareholders can determine or choose—with pinpoint accuracy—the average maximum price over a two-year period when they give gifts is surprising.’” The study authors argue that the practice is “far more widespread than previously believed,” and relied on by insiders, including large investors. Insider giving, they conclude, “is a potent substitute for insider trading.” It’s worth remembering that it was a study reported in the WSJ about stock option backdating that kicked off the option backdating scandal of the mid-2000s (see, e.g., this news brief, this news brief and this news brief). Could “insider giving” be the new option backdating scandal?
According to Law 360 reporting on a webcast panel last week, Acting Director of Enforcement Melissa Hodgman, warned that, in addition to “increased scrutiny” of “funds touting green investments,” we may well see more ESG disclosure-related enforcement actions in general. In March, then-Acting SEC Chair Allison Herren Lee announced the creation of a new climate and ESG task force in the Division of Enforcement. The moderator of the panel, a former co-Director of Enforcement, observed that “usually you don’t stand up a task force unless you’re pretty sure that task force is going to produce something.” So what should we expect?
There’s a new case challenging both of California’s board diversity laws. The case, , Alliance for Fair Board Recruitment v. Weber, which was filed in a California federal district court against the California Secretary of State, Dr. Shirley Weber, seeks declaratory relief that California’s board diversity statutes (SB 826 and AB 979) violate the Equal Protection Clause of the 14th Amendment and the internal affairs doctrine, and seeks to enjoin Weber from enforcing those statutes. The plaintiff, the Alliance for Fair Board Recruitment, is described as “a Texas non-profit membership association,” with members that include “persons who are seeking employment as corporate directors as well as shareholders of publicly traded companies headquartered in California and therefore subject to SB 826 and AB 979.” Will this case be the one to jettison these two statutes?