Yearly Archives: 2020

ESG and the Earnings Call

Posted by Kevin Eckerle (NYU), Brian Tomlinson (CECP), and Tensie Whelan (NYU), on
Wednesday, June 17, 2020
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Kevin Eckerle is Director of Corporate Research and Engagement at the Center for Sustainable Business at the NYU Stern School of Business; Brian Tomlinson is Director of Research, CEO Investor Forum at Chief Executives for Corporate Purpose; and Tensie Whelan is Clinical Professor for Business at the NYU Stern School of Business. This post is based on their recent report.

The information shared through quarterly reporting moves markets. Institutional investors highly value the transparency and outputs of frequent periodic reporting. Investor Relations Officers (IROs) consistently identify the earnings call as the most important venue through which to communicate their story to the capital markets. Within the C-suite, preparing for the earnings call—and its associated package of disclosures—requires a significant commitment of time and resources.

The Earnings Call and the Short-Term

Quarterly reporting has been identified as a potential source or amplifier of short-term market pressures. Management’s focus on hitting quarterly financial targets can cause overweighting by both the C-suite and equity markets of in-year or in-quarter performance benchmarked to a narrow set of financial indicators. This underweights strategic issues with a longer-term time horizon, or those that are harder to quantify in the near-term, and consequently results in insufficient analysis and reporting of these issues in the earnings call.

For example, management teams may cut research and development (R&D) or other discretionary spending in order to meet an earnings target. Chief financial officers (CFOs) report that this occurs; it is an anticipated peer-group behavior among CFOs. This expected behavior is confirmed in the literature as firms that issue and just meet near-term earnings per share (EPS) targets display discontinuous R&D spending, which illustrates the underlying pattern that planned R&D spending (and economic value) is often sacrificed to avoid a short-term earnings miss. Overall, when compared with equivalent privately held peer firms, public companies have a shorter-term focus. Concern regarding the perceived impatience of the equity markets also appears to depress listing activity.

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Unanticipated Costs of Paycheck Protection Program Loans in M&A Transactions

Posted by Jennifer S. Conway and J. Leonard Teti II, Cravath, Swaine & Moore LLP, on
Wednesday, June 17, 2020
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Jennifer S. Conway and J. Leonard Teti II are partners at Cravath, Swaine & Moore LLP. This post is based on their Cravath memorandum.

Two mutually exclusive programs under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) designed to encourage workforce retention during the COVID-19 pandemic—the Paycheck Protection Program and the Employee Retention Credit—clash in the case of an M&A deal involving a buyer that has received one benefit and a target that has received the other. This scenario could result in unanticipated costs in the form of lost tax benefits due to an acquisition, even a very small one.

Background

The Paycheck Protection Program (PPP) is the Small Business Administration’s forgivable loan program designed to provide small businesses with a direct incentive to keep workers on their payrolls over the eight-week period after the loan is originated. The Employee Retention Credit is a payroll tax credit for certain wages paid between March 13 and December 31, 2020, by an employer of any size that has experienced significant disruption to its business due to the pandemic. A company that receives a PPP loan cannot claim the Employee Retention Credit, regardless of when the loan is received and whether it is repaid in full or forgiven (with a limited exception for loans repaid by May 18, 2020). Furthermore, ineligibility extends to all subsidiaries of the PPP loan recipient as well as all other affiliates linked by at least fifty percent (50%) common ownership or control (referred to herein as affiliates).

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SEC Improves Financial Disclosure Relating to Business Acquisitions and Dispositions

Posted by Robert Meyers, Mark Metts, and Martin Wellington, Sidley Austin LLP, on
Tuesday, June 16, 2020
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Robert Meyers, Mark Metts, and Martin Wellington are partners at Sidley Austin LLP. This post is based on a Sidley memorandum by Mr. Meyers, Mr. Metts, Mr. Wellington, George Vlahakos, Jennifer F. Fitchen, and Casey Hicks.

The SEC’s long-expected reforms to Regulation S-X regarding financial disclosure for business acquisitions and dispositions were published as final amendments on May 21, 2020. Most of the final amendments are substantially in line with the SEC’s May 2019 proposing release, on which we commented in our May 2019 Sidley Update. Part of the SEC’s overall initiative to improve and streamline disclosure, the final amendments reflect a comprehensive re-thinking—and we believe substantial improvement—of a business combination disclosure system that has in many ways vexed registrants and their professional advisors for decades. The final amendments will become effective on January 1, 2021, but issuers are permitted to voluntarily comply with the final amendments in advance of the effective date.

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How A Reconceived Compensation Committee Can Help Tackle Inequality

Posted by Leo E. Strine, Jr. (Wachtell, Lipton, Rosen & Katz and Harvard Law School) and Kirby Smith (Wachtell, Lipton, Rosen & Katz), on
Tuesday, June 16, 2020
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Leo E. Strine, Jr., the former Chief Justice of the Delaware Supreme Court, is the Austin Wakeman Scott Lecturer in Law and Senior Fellow at the Harvard Law School Program on Corporate Governance, as well as Of Counsel at Wachtell, Lipton, Rosen & Katz. Kirby Smith is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here) and The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here).

In the three decades after World War II, workers and stockholders shared equitably in the nation’s growing wealth. But, during the last several decades, this fair gainsharing has diminished as the power of the stock market, in the form of institutional investors, has grown, and the comparative voice and leverage of workers has declined. As a result of these and other factors, a much greater share of the gains from increased corporate profitability and productivity has gone to stockholders and top management, on the one hand, and much less to employees, on the other. Contributing to this divide has been a push to tie top management pay to total stockholder return and to create incentives for management to deliver returns to stockholders, even if that requires decreasing the share that the workers primarily responsible for corporate success get. The resulting economic insecurity and inequality have caused demands for serious change in corporate governance to give greater weight to the interests of workers.

This state of affairs has led to calls to reform our corporate governance system’s power dynamic to give workers more voice. And business leaders have acknowledged that an economic system that does not work for everyone is unsustainable, most prominently through the Business Roundtable’s revised statement on corporate purpose making clear that employee well-being and fair compensation are central issues for corporate management.

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Boards Need to Stay Vigilant and Keep Stockholders Informed Towards Closing

Posted by Paul Tiger, Freshfields Bruckhaus Deringer LLP, on
Tuesday, June 16, 2020
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Paul Tiger is partner at Freshfields Bruckhaus Deringer LLP. This post is based on his Freshfields memorandum.

It’s a natural human phenomenon. After a period of intense activity, it’s perfectly understandable to relax, take a step back and catch one’s breath. M&A deals are no different. The push to get a deal signed is often marked by long days and, sometimes, long nights for all involved. Once the deal is signed, it’s natural for the deal teams, for management, for the respective boards of directors, to go home, get a bit of sleep and go into “execution mode.” “Let’s get this closed,” they say.

But in the current environment—marked by significant volatility and radical shifts in the prospects for one or both merger parties or the combined company—that sentiment can lead to the wrong result for stockholders as circumstances change post-signing. Where a stockholder vote is required for a transaction (on either the buy-side or the target side) and has not yet been obtained and therefore the recommendation and disclosures by the board to its stockholders remain in the spotlight, the board needs to remain especially vigilant and active.

The potential has never been higher for new circumstances to arise that potentially alter the assessment of whether a transaction is still in the best interests of the stockholders that will be voting on that transaction. Directors need to remember their continuing duty to stockholders to consider this issue in the run-up to the stockholder vote.

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The Forum Attracts Numerous Citations from Courts, Legislators, Regulators, and National Organizations

Posted by Tami Groswald Ozery (Harvard Law School), on
Monday, June 15, 2020

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Tami Groswald Ozery is a co-Editor of the Forum and a Fellow at the Harvard Law School Program on Corporate Governance.

In the past fifteen years, Forum posts have had considerable influence on the corporate governance field. In an earlier post (see here), I discussed the vast number of citations that Forum posts have attracted from articles by academics and practitioners. This post, in turn focuses on the numerous citations that Forum posts have received from courts, regulators, legislators, and national organizations.

The list of such citations of Forum posts is available here. In particular, Forum posts have been cited by:

  • Court decisions, including by:
    • The Chancery Court of Delaware
    • United States District Courts in Virginia and Texas
  • Congressional bodies including:
    • The House Committee on Financial Services
    • The House Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets
    • The House Subcommittee on Terrorism, Nonproliferation, and Trade
    • The House Subcommittee on Asia and the Pacific
    • The Senate Committee on Banking, Housing, and Urban Affairs
    • The Congressional Research Services
  • Regulatory agencies including:
    • Securities and Exchange Commission
    • Consumer Financial Protection Bureau
  • Public Statements and Speeches by SEC Commissioners and high-ranking officials including by:
  • Major organizations active in the field including:
    • AFL-CIO
    • American Bar Association Business Law Section
    • Council of Institutional Investors
    • Sustainability Accounting Standards Board (SABS)
    • Teachers Insurance and Annuity Association of America (TIAA)

Established in 2006 by Professor Lucian Bebchuk and the Harvard Law School Program on Corporate Governance, the Forum has become the leading online resource and the central outlet for the exchange of ideas and debate in the field of corporate governance. In an article about the Forum that was featured in the Harvard Law Bulletin a few years ago, former Chief Justice Leo Strine observed that “[i]t is amazing to see the [Forum] become required reading among the intelligentsia … of corporate governance.”

The success of the Forum has been made possible by the contribution of numerous authors, as well as by the engagement of the Forum’s ever-growing readership. We are deeply grateful for the support of our contributors and readers.

Renewed Interest by Public Companies in NOL Rights Plans

Posted by Julie Hogan Rodgers, Andrew Bonnes, and Benjamin C. Kelsey, Wilmer Cutler Pickering Hale and Dorr LLP, on
Monday, June 15, 2020
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Julie Hogan Rodgers and Andrew Bonnes are partners and Benjamin C. Kelsey is an associate at Wilmer Cutler Pickering Hale and Dorr LLP. This post is based on a WilmerHale memorandum by Ms. Hogan Rodgers, Mr. Bonnes, Mr. Kelsey, Joseph B. Conahan and Hal J. Leibowitz. Related research from the Program on Corporate Governance includes Toward a Constitutional Review of the Poison Pill by Lucian Bebchuk and Robert J. Jackson, Jr. (discussed on the Forum here).

As we reported in COVID-19: Revisiting Shareholder Rights Plans, the turmoil in U.S. equity markets created by the COVID-19 pandemic has resulted in many companies facing depressed stock prices, leaving them vulnerable to unsolicited acquisition proposals or activist activity, which has led to heightened interest in shareholder rights plans (also known as “poison pills”). Such depressed stock prices may also cause companies with significant net operating loss carryforwards (“NOLs”) to consider implementing an NOL rights plan, which is similar to a traditional shareholder rights plan but has distinct differences. WilmerHale’s Tax Group, along with the Mergers and Acquisitions practice, has prepared a high-level overview of the purpose and advantages of NOL rights plans.

Section 382 Background

The NOLs of a company [1] generally can be used to offset its future taxable income, thereby making the company’s NOLs a potentially valuable asset. However, when a company undergoes an “ownership change,” as defined in Section 382 of the Internal Revenue Code and the Treasury Regulations promulgated thereunder (“Section 382”), Section 382 limits the company’s ability to use its pre-change NOLs to offset its future taxable income in each year following the ownership change. The annual limitation is generally equal to the value of the stock of the company immediately before the ownership change multiplied by a long-term tax-exempt interest rate published by the Internal Revenue Service. Today’s low stock prices, combined with historically low interest rates, would generally result in a very low Section 382 limitation, severely limiting (and potentially devaluing) a company’s NOLs following an ownership change. These factors, combined with the greater portion of public companies experiencing or expecting operating losses in the wake of the COVID-19 pandemic, have led to increased interest in NOL rights plans among our clients.

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Redesigning Corporations: Incentives Matter

Posted by Nicholas Benes, The Board Director Training Institute of Japan, on
Monday, June 15, 2020
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Nicholas Benes is founder and Representative Director of The Board Director Training Institute of Japan, and proposed Japan’s Corporate Governance Code.

The Birth of the Corporation: Public Interest Organizations

The evolution of the modern corporation is the fascinating story of a series of self-serving legal and societal mutations over hundreds of years, which have morphed the original concept and endowed corporations with freedom of activity, rights, and limitations on liability that would shock their original “inventors”.

As we all know, for many years most corporations were established by way of an exceptional “charter” by a sovereign, granted only in specific cases where: (a) large amounts of capital were needed (b) to conduct investments and activities that served public or national interests and had good profit potential, but (c) where the risks were so large that few parties would invest if their risk were not shared with many others and/or limited to the amount of money they invested.

In the 1600s and 1700s, the activities that sovereign nations felt met those requirements were the exploration of foreign lands on the other side of the globe, the creation and administration of colonies there, and conducting lucrative trade on long (and dangerous) sea routes to and from those colonies. Thus, the most well-known early corporations include organizations such as the British East India Company (the original “too-big-to-fail company), The Dutch East India Company, the Hudson’s Bay Company, and companies to construct the Erie Canal.

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Court Holds that Syndicated Bank Loan Is Not a “Security”

Posted by Udi Grofman, Brad S. Karp, and Richard C. Tarlowe, Paul, Weiss, Rifkind, Wharton & Garrison LLP, on
Sunday, June 14, 2020
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Udi Grofman, Brad S. Karp, and Richard C. Tarlowe are partners at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul, Weiss memorandum by Messrs. Grofman, Karp, Tarlowe, Andrew J. Ehrlich, Roberto Finzi, and Gregory F. Laufer.

Federal and state securities laws generally apply only to instruments that qualify as “securities.” The question of whether a particular instrument is a security, therefore, can have significant and far-reaching consequences. Nearly 30 years ago, in Banco Espanol de Credito v. Security Pacific National Bank, the Second Circuit Court of Appeals held that certain loan participations at issue in that case were not securities. [1]

Although the syndicated loan market has grown substantially since then, courts have only rarely had occasion to consider whether a syndicated loan qualifies as a security (and thus falls within the scope of federal and state securities laws). That question was squarely presented in Kirschner v. JPMorgan Chase Bank, N.A. et al, a case pending in the Southern District of New York, and on May 22, 2020, U.S. District Judge Paul Gardephe held that syndicated bank loans were not securities. [2] Judge Gardephe noted in his decision that he had not identified any decisions from other courts concluding that a syndicated bank loan was a security, and he rejected the plaintiffs’ argument that changes in the syndicated loan market compelled a different conclusion.

Kirschner arose out of a $1.775 billion syndicated loan transaction in which several banks served as lenders to Millennium Laboratories LLC (“Millennium”), a private company, and then syndicated the loan to a group of approximately 70 institutional investors. Shortly after the transaction was completed, Millennium lost a significant litigation involving alleged kickbacks and entered into a settlement with the U.S. Department of Justice to resolve alleged violations of the False Claims Act. Millennium thereafter filed for bankruptcy, and the bankruptcy trustee filed a lawsuit against the banks, claiming they had, among other things, violated state securities laws (so-called “blue sky” laws) by making misrepresentations to investors, including falsely assuring investors that Millennium had no exposure to material litigation.

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Changes to Required Disclosures for Acquisitions and Dispositions

Posted by Mark Brod, Will Golden, and Joe Kaufman, Simpson Thacher & Bartlett LLP, on
Saturday, June 13, 2020
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Mark Brod, Will Golden, and Joe Kaufman are partners at Simpson Thacher & Bartlett LLP. This post is based on a Simpson Thacher memorandum by Messrs. Brod, Golden, Kaufman, and Sarah Ali.

On May 21, 2020, the Securities and Exchange Commission adopted changes to the financial disclosure requirements relating to the acquisition and disposition of businesses. [1] As set forth in greater detail below, these changes will greatly assist SEC reporting companies in terms of streamlining and eliminating immaterial information relating to acquisitions and dispositions and will provide additional flexibility in terms of presenting pro forma adjustments relating to such transactions. Of note, the rule amendments:

  • Reduce the maximum number of years of required audited financial statements from acquired businesses from three years to two;
  • Eliminate the requirement that financial statements of certain “major” acquisitions continue to be presented once the acquired company has been reflected in the registrant’s operations for a full fiscal year;
  • Modify the significance tests used to determine whether historical and/or pro forma financial statements for acquisitions and dispositions are required, which will reduce the likelihood of anomalous results; and
  • Adopt new criteria for the presentation of pro forma adjustments, including the ability for registrants under certain circumstances to voluntarily include the impact of synergies and other adjustments that are not permitted under current SEC guidance.

The final rules will be effective on January 1, 2021, but voluntary compliance is permitted in advance of the effective date. As a result, we expect that many registrants will take advantage of the incremental flexibility afforded by these amendments immediately.

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