Monthly Archives: June 2020

Renewed Interest by Public Companies in NOL Rights Plans

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.


Redesigning Corporations: Incentives Matter

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.


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

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.


Changes to Required Disclosures for Acquisitions and Dispositions

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.


SEC Staff Shows New Openness to Closed-End Fund Defenses

Clifford J. Alexander, Jennifer R. Gonzalez, and George Zornada are partners at K&L Gates LLP. This post is based on a K&L Gates memorandum by Mr. Alexander, Ms. Gonzalez, Mr. Zornada, Steven B. Levine, Shane C. Shannon, and Jacob M. Derr. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).

In a potentially significant reversal of a prior Securities and Exchange Commission (SEC) staff position that could enhance the ability of closed-end funds to defend against activist shareholders, the Division of Investment Management of the SEC on May 27, 2020, withdrew a 2010 no-action letter that criticized the use by closed-end funds of certain defensive measures permitted under state corporate law. The 2010 letter, issued to Boulder Total Return Fund (Boulder Letter), [1] had long been an impediment to a closed-end fund opting in to state statutes that permit companies to restrict the ability of certain shareholders to vote control shares. The Boulder Letter stated that the SEC staff believed such a statute would be “inconsistent with the fundamental requirements of Section 18(i) of the Investment Company Act that every share of stock issued by [a fund] be voting stock and have equal voting rights with every other outstanding voting stock.”

The statement withdrawing the Boulder Letter (Statement) [2] adopts the position that the SEC staff “would not recommend enforcement action to the Commission against a closed-end fund under [S]ection 18(i) of the [Investment Company] Act for opting in to and triggering a control share statute if the decision to do so by the board of the fund was taken with reasonable care on a basis consistent with other applicable duties and laws and the duty to the fund and its shareholders generally.” The Statement also requests input as to whether the SEC staff should recommend that the SEC take additional action to provide clarity regarding the applicability of the 1940 Act to a closed-end fund’s decision to opt in to a control share statute. The withdrawal of the Boulder Letter and the latitude apparently offered by the Statement removes an SEC staff interpretation that arguably has had a chilling effect on closed-end funds’ and their boards’ willingness to opt in to, or rely on, control share statutes. States have adopted the control share statutes under corporate statutes primarily to protect public companies incorporated in their jurisdictions. Investment companies established in states without applicable control share statues may have adopted similar provisions in their organizational documents. The SEC staff position in the Boulder Letter also has had a potential chilling effect on their boards’ willingness to rely on these provisions.


A Successful Season for SASB-Based Shareholder Resolutions

Paul Rissman is Co-Founder of Rights CoLab, and Andrew Behar is CEO of As You Sow.

Timed to the 2020 Annual General Meeting (AGM) season, shareholder advocacy non-profit As You Sow filed seven shareholder resolutions, on behalf of individual proponents, that specifically requested material disclosure compliant with environmental and social corporate reporting standards published by the Sustainability Accounting Standards Board (SASB). SASB standards are explicitly designed to reflect financially material aspects of corporate behavior as it pertains to sustainability topics. Large investment advisors have committed to SASB, even to the extent that BlackRock and State Street Global Advisors, the world’s largest and third-largest asset managers, announced in January that they would use SASB disclosure to frame their proxy voting policies. Resolutions calling for SASB disclosure should be expected to enjoy widespread support from both investors and corporate managements. Indeed, the results produced by these resolutions have suggested that this is the case.

The seven resolutions addressed climate-related water usage risks in the semiconductor and food processing industries, and human capital risks such as diversity and fair labor practices in the specialty retailers and distributors industry. One was withdrawn on a technicality. Of the other six, two received commitments to implement and were withdrawn, one was fully implemented after a shareholder vote of 11%, and the remaining three earned overwhelming shareholder support, of 61%, 66%, and 79% approval. This post comprises an analysis of these resolutions and speculates on the general potential for SASB-based resolutions to act as game-changers for corporate accountability.


Weekly Roundup: June 5–June 11, 2020

More from:

This roundup contains a collection of the posts published on the Forum during the week of June 5–June 11, 2020.

Value Creation in Private Equity

Shareholder Proposals Shaking Up Shareholder Say

Mitigating Accounting Fraud Risk During the Pandemic: Regulators’ Concerns and Prospective Solutions

Top 10 Key Trends at 2020 Proxy Mid-Season

Climate Change Litigation Takes an Ominous Turn

Delisting Chinese Firms: A Cure Likely Worse than the Disease

COVID-19: A Review of Recent Securities Fraud Enforcement Actions

Loss Causation in Securities Fraud Cases Brought After a Crisis

An Early Look at the 2020 Proxy Season

COVID-19 and Club Deals: An Alternative to Debt Financing for Acquirors

Stock Ownership Guideline Administration

Stock Ownership Guideline Administration

John R. Sinkular and Don Kokoskie are partners at Pay Governance LLC. This post is based on their Pay Governance memoradum. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

  • Stock ownership guidelines are a common element of today’s pay programs for executives and directors which reinforce one of the key objectives of equity awards: building and maintaining stock ownership over an individual’s career.
  • Compliance with those guidelines can be problematic in times when there is considerable volatility in financial results and stock prices as most companies are currently experiencing.
  • Companies may want to examine the structure and administrative practices associated with their guidelines to ensure they align with the spirit and intent behind them.
  • Some companies already have guideline provisions that mitigate stock price volatility (e.g., using an average stock price to assess ownership compliance) and recognize the highest long-term incentive weighting is typically on performance shares (e.g., not fixed time for compliance).
  • Ownership guideline designs and administrative provisions can and should vary by company, recognizing there is no universal approach mandated by the Securities and Exchange Commission or the stock exchanges.

The financial impact of the current pandemic has affected most aspects of the compensation programs for executives and nonemployee members of the Board of Directors. Stock ownership requirements covering those individuals are no exception and will be reviewed by companies as they assess compliance with those guidelines.


COVID-19 and Club Deals: An Alternative to Debt Financing for Acquirors

George E. Rudy is counsel, Philip O. Brandes is partner, and Joshua J. La Vigne is an associate at Mayer Brown LLP. This post is based on a Mayer Brown memorandum by Mr. Rudy, Mr. Brandes, Mr. LaVigne, and William R. Kucera.

As the COVID-19 pandemic continues to cause turmoil in the global economy and financial markets, debt financing sources are tightening their grip on available liquidity while reassessing existing facilities and lending practices in light of these new market conditions. Many companies have drawn down existing revolvers as a source of liquidity to ride out the downturn. These factors have limited the availability of acquisition financings and resulted in more lender-friendly terms for any newly issued debt, including increased borrowing costs and stricter financial covenants. In light of the current economic circumstances, acquirors who wish to pursue new opportunities could consider a club deal as an alternative to debt financing and a way in which they may pursue larger targets, stretch their available dry powder, and spread their risk across a wider number of investments.

Club Deals

A club deal, also known as a consortium, is when two or more private equity firms, family offices or other investors jointly purchase a business. There are a number of reasons why an acquiror may consider a club deal in today’s market. First and foremost is access to additional capital, especially when access to debt may be limited and/or only available on very lender-friendly terms. Teaming up with one or more parties allows joint acquirors to pursue larger transactions than they otherwise may not have had the capital to pursue. In addition, sellers typically prefer an all-equity transaction because it generally can be executed quicker and offers greater deal certainty than a debt-financed deal (though this deal certainty may be offset somewhat by concerns a seller may have with a deal with joint bidders, as described below). Addressing another important concern in today’s market, club deals allow the joint acquirors to spread their risk over a number of investments rather than committing a large amount of capital to one target. Finally, certain partners can bring unique industry experience and synergy opportunities to the consortium that it may not otherwise have, making it a more appealing buyer, allowing it to pay more for the asset and enhancing the chances of success of the target following the acquisition.


Investment Advisers’ Fiduciary Duties: The Use of Artificial Intelligence

Amy Caiazza and Rob Rosenblum are partners and Danielle Sartain is an associate at Wilson Sonsini Goodrich & Rosati. This post is based on their WSGR memorandum.

Artificial intelligence (AI) is an increasingly important technology within the investment management industry. AI has been used in a variety of ways—including as the newest strategy for attempts to “beat the market” by outperforming passive index funds that are benchmarked against the S&P 500, despite the long-standing finding that index funds consistently win that contest.

Investment advisers who use AI should consider the unique issues the technology raises in light of an adviser’s fiduciary duty to its clients. In this client alert, we provide an overview of how AI is being used by investment advisers, the fiduciary duties applicable to investment advisers, and particular issues advisers should consider in designing AI-based programs, to ensure they are acting in the best interests of their clients.

How Artificial Intelligence Is Being Adopted by Investment Advisers

AI is currently used by investment advisers in a variety of innovative ways:


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