Yearly Archives: 2020

PE Seller May Have Liability for Portfolio Company Concealing Steep Earnings Decline Post-Signing

Posted by Gail Weinstein, Robert C. Schwenkel, and Andrea Gede-Lange, on
Tuesday, September 1, 2020
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Gail Weinstein is senior counsel, and Robert C. Schwenkel and Andrea Gede-Lange are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on their Fried Frank memorandum and is part of the Delaware law series; links to other posts in the series are available here.

Agspring v. NGP (July 30, 2020) involved the sale of a portfolio company, Agspring LLC, by one PE fund (the “Seller”) to another (the “Buyer”). At the pleading stage of litigation, the Delaware Court of Chancery found it reasonably conceivable that: (i) the Agspring officers deliberately concealed from the Buyer a steep decline in earnings that occurred before and after the signing and closing; and (ii) as a result of the decline, certain of the representations and warranties in the sale agreement and a related financing agreement were false when made. The court concluded that not only the Agspring officers but also the Seller may have known or been in a position to know that the representations were false when made; and that therefore they faced potential liability for fraud.

Key Points. The decision serves as a reminder that:

  • A PE-seller may have liability for its portfolio company’s fraudulent representations. When a PE fund sells a portfolio company, the fund can be liable for fraudulent representations made in the sale (or a related) agreement–even if the fund is not a party to the agreement.
  • A decline in earnings may implicate the accuracy of representations. A steep decline in earnings can support a reasonable inference that certain representations in a sale agreement (or related agreements) may have been false when made. In this case, at the pleading stage, the court found it reasonably conceivable that Agspring’s officers and the Seller were in a position to know that the steep decline in its earnings that began just before the sale agreement was signed may have (i) constituted a Material Adverse Effect and (ii) put the company on a course that would lead to a default under a Material Contract that occurred three years later.

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Venture Capitalists and COVID-19

Posted by Will Gornall (University of British Columbia), on
Tuesday, September 1, 2020
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Will Gornall is Assistant Professor of Finance at the Sauder School of Business at the University of British Columbia. This post is based on a recent paper by Professor Gornall; Paul A. Gompers, Eugene Holman Professor of Business Administration at Harvard Business School; Steven N. Kaplan, Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business; and Ilya A. Strebulaev, the David S. Lobel Professor of Private Equity at the Stanford Graduate School of Business.

Related research from the Program on Corporate Governance includes Carrots & Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups, by Jesse Fried and Brian Broughman (discussed on the Forum here); Do Founders Control Start-Up Firms that Go Public? by (discussed on the Forum here); and Do VCs Use Inside Rounds to Dilute Founders? Some Evidence from Silicon Valley by Jesse Fried and Brian Broughman (discussed on the Forum here).

In this paper, we survey over 1,000 institutional and corporate venture capitalists (VCs) at over 900 VC firms to learn how their decisions and investments have been affected by the COVID-19 pandemic. Understanding how COVID-19 impacted venture capital is important because many of the most innovative young companies depend on a steady inflow of VC money. The sudden arrival of the COVID-19 pandemic has dramatically affected many facets of the global economy, and many commentators worry this shock will choke off venture capital flow. VCs have variously described COVID-19 as the “Black Swan of 2020” and claimed the “global VC market has completely locked up.” If such dire predictions are true, that would have important consequences for the innovation ecosystem.

We measure the impact of COVID-19 using a survey of venture capitalists. Our results are based off answers by VCs who make up a significant fraction of the industry, including over 900 institutional VCs at over 800 VC firms and over 100 corporate VCs representing over 100 corporations. We compare their survey answers to those provided by a large sample of VCs in early 2016 and analyzed in Gompers, Gornall, Kaplan, and Strebulaev (2020), which allows us to see how COVID-19 has changed VC attitudes.

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2020 Mid-Year Securities Litigation Update

Posted by Jefferson E. Bell, Brian M. Lutz, and Robert F. Serio, Gibson, Dunn & Crutcher LLP, on
Tuesday, September 1, 2020
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Jefferson E. Bell, Brian M. Lutz, and Robert F. Serio are partners at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn memorandum by Mr. Bell, Mr. Lutz, Mr. Serio, Monica Loseman, Mark Perry, and Mark H. Mixon, Jr.

The first half of 2020 brought the spread of COVID-19 and unprecedented changes in daily life and the economy. We discuss how, nevertheless, there has still been a variety of securities-related lawsuits, including securities class actions, insider trading lawsuits, and government enforcement actions. We also discuss developments in the securities laws that have occurred against this backdrop.

This post highlights what you most need to know in securities litigation developments and trends for the first half of 2020:

  • In Liu v. SEC, the U.S. Supreme Court affirmed the SEC’s ability to obtain disgorgement as an equitable remedy in civil actions, but left open several questions about the permissible scope of the remedy. In addition, a petition for a writ of certiorari was filed in National Retirement Fund v. Metz Culinary Management, Inc., a case posing the question of how to calculate withdrawal liability based on interest rate assumptions for union pension plans.
  • We discuss the Delaware Supreme Court’s decision in Salzberg v. Sciabacucchi, which confirmed the facial validity of federal-forum provisions, as well as the Court of Chancery’s treatment of Caremark claims and director independence with respect to a putatively controlling stockholder.
  • We continue to analyze how lower courts are applying the U.S. Supreme Court’s decision in Lorenzo, with a focus on recent district court opinions interpreting Lorenzo’s scope.
  • We survey securities-related lawsuits arising in connection with or related to the coronavirus pandemic, including securities class actions, insider trading lawsuits, and government enforcement actions filed by both the SEC and the Department of Justice.
  • We discuss recent decisions illustrating the difficulty plaintiffs face in attempting to overcome Omnicare’s formidable barrier to adequately pleading securities fraud.
  • We examine the Second Circuit’s noteworthy decision in Goldman Sachs II regarding how defendants may rebut the presumption of reliance under Halliburton II.
  • Finally, we examine the intersection of the federal securities laws and ERISA, discussing the U.S. Supreme Court’s recent Sulyma decision, which clarified the statute of limitations for fiduciary breach claims, and the lower court decisions addressing significant issues in the wake of the Court’s January decision in Jander.

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Delaware Public Benefit Corporations—Recent Developments

Posted by Michael R. Littenberg, Emily J. Oldshue, and Brittany N. Pifer, Ropes & Gray LLP, on
Monday, August 31, 2020
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Michael R. Littenberg and Emily J. Oldshue are partners and Brittany N. Pifer is an associate at Ropes & Gray LLP. This post is based on a Ropes & Gray memorandum by Mr. Littenberg, Ms. Oldshue, Ms. Pifer, Anne-Marie L. Beliveau, and Nellie V. Binder. Related research from the Program on Corporate Governance includes For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); and Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).

Over the last few years, corporate purpose has been under a spotlight. This scrutiny, which has intensified in 2020 and shows no signs of abating, is coming from institutional investors that are integrating the consideration of environmental, social and governance factors into investment and voting decisions, as well as other stakeholders, in particular consumers, employees and regulators.

Public benefit corporation statutes provide an alternative for-profit corporate form that expressly takes corporate responsibility into account. The Delaware General Corporation Law was amended in 2013 to add a public benefit corporation alternative. However, until the most recent DGCL amendments in July, a PBC was in a large number of cases an impractical or unavailable alternative. In this Alert, we discuss recent changes to the DGCL that in some cases may make PBCs a more attractive alternative, as well as related market trends.

The Delaware Public Benefit Corporation Provisions

Public benefit corporation legislation was enacted in Delaware in 2013. As defined under the statute, a “public benefit corporation” is a for-profit corporation that is intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner. The public benefit to be promoted by the corporation must be specified in its certificate of incorporation. Under the DGCL, a “public benefit” is a positive effect (or reduction of negative effects) on one or more categories of persons, entities, communities or interests (other than stockholders in that capacity), including but not limited to effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature.

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The Performance of Hedge Fund Performance Fees

Posted by Itzhak Ben-David (Ohio State University), Justin Birru (Ohio State University), Andrea Rossi (University of Arizona), on
Monday, August 31, 2020
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Itzhak Ben-David is the Neil Klatskin Chair in Finance and Real-Estate at The Ohio State University Fisher College of Business; Justin Birru is Associate Professor at The Ohio State University Fisher College of Business; and Andrea Rossi is Assistant Professor of Finance at the University of Arizona Eller College of Management. This post is based on their recent paper.

One of the tenets of modern economics is that agency conflicts can be mitigated by implementing compensation contracts that align the agents interests with those of the principal. Over the past three decades, compensation contracts in the hedge fund industry have sought to achieve this goal by charging a variable performance fee to complement a fixed annual management fee of 1-2%. Performance fees, often called incentive fees, are typically around 20% of profits over a quarter or year and often are accompanied by provisions meant to ensure that incentive fees are only paid on profits exceeding a predetermined benchmark, which often includes the previous highest portfolio valuation. On its surface, the structure of hedge fund incentive fees appears to closely align the incentives of hedge fund managers and hedge fund investors. But how do these incentive fees fare in practice?

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FedNow: The Federal Reserve’s Planned Instant Payments Service

Posted by Margaret Tahyar, Jai Massari and Andrew Samuel, Davis Polk & Wardwell LLP, on
Monday, August 31, 2020
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Margaret Tahyar and Jai Massari are partners, and Andrew Samuel is an associate at Davis Polk & Wardwell LLP. This post is based on a Davis Polk memorandum by Ms. Tahyar, Ms. Massari, Mr. Samuel, Luigi De Ghenghi, Randall Guynn, and Daniel Newman

The FedNow Service

The Board of Governors of the Federal Reserve System (the Fed) announced details of its planned FedNow Service on August 6, 2020 in a release describing its core functionality and future implementation.

  • If launched as described in the release, FedNow will be a real-time gross settlement (RTGS) payment system with integrated clearing It will offer 24x7x365 payment processing for every bank in the United States (instant payments).

The initial launch target date is 2023 or 2024. This release may mark the start of the next phase of implementation work by the Fed and eligible participants.

  • The initial launch will provide baseline functionality and help banks manage the transition to a 24x7x365 service. It will include a liquidity management tool (FedNow LMT) so that FedNow participants can transfer funds between accounts at the Reserve Banks to meet the liquidity needs associated with instant payments.

The Fed stated that it will take a phased approach to implementation, including pilot programs, providing additional features and functionality over time.

The FedNow Service will facilitate end-to-end instant payment services for consumers and businesses, increase competition, and ensure equitable access to banks of all sizes nationwide.

The Federal Reserve is uniquely positioned to build an instant payment infrastructure, given our long history of operating payment systems to promote a safe, efficient, and broadly accessible payment infrastructure.”
—Governor Lael Brainard, The Future of RetailPayments in the United States (August 6, 2020)

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SEC Revises Regulation S-K

Posted by Andrew R. Brownstein, Sabastian V. Niles, and Jenna E. Levine, Wachtell, Lipton, Rosen & Katz, on
Sunday, August 30, 2020
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Andrew R. Brownstein, Sabastian V. Niles, and Jenna E. Levine are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Brownstein, Mr. Niles, Ms. Levine, and Albertus G. A. Horsting.

The SEC has adopted a set of amendments to the periodic disclosure requirements relating to a registrant’s business, legal proceedings and risk factors, which will go into effect 30 days after publication in the Federal Register. The amendments will affect a wide variety of SEC filings, including upcoming annual and quarterly reports and registration statements (including for spin-offs and IPOs). The stated purpose of the amendments, which are the most recent step in the SEC’s disclosure modernization exercise, is to make SEC disclosure documents more relevant to investors while reducing the burden on issuers. The changes eliminate certain prescriptive requirements in favor of a more flexible “principles-based, registrant-specific” approach, designed to elicit more tailored disclosures. The amendments also permit increased use of summaries, cross-references and hyperlinks in order to reduce repetition, among other changes seeking to discourage overly lengthy disclosure that can make it more difficult to identify important information.

While some have criticized the amendments as not going far enough or as being insufficiently prescriptive, the potential impacts may be significant.

Companies will need to update their disclosure controls, practices and procedures, transition to principles-based materiality assessments that call for more judgments and consultation, plan for and draft more tailored (non-boilerplate) business, human capital, compliance and risk factor discussions germane to their industry and business models and newly consider whether certain voluntary disclosures made in other documents (e.g., proxy statements, sustainability/CSR/ESG reports and human capital management reports) ought now be included, in whole or in part, in annual and quarterly reports where material.

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SEC Preparing Proposals to Implement Recommendations Regarding Emerging Market Listings

Posted by Cydney Posner, Cooley LLP, on
Sunday, August 30, 2020
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Cydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley memorandum by Ms. Posner.

For over a decade, the PCAOB has been unable to fulfill its SOX mandate to inspect audit firms in “Non-Cooperating Jurisdictions,” or “NCJs,” including China. To address this issue, in May, the Senate passed the Holding Foreign Companies Accountable Act, which would amend SOX to impose certain requirements on public companies that are audited by a registered public accounting firm that the PCAOB is unable to inspect, and a version was subsequently passed by the House as an amendment to a defense funding bill. Around the same time, Nasdaq also proposed rule changes aimed at addressing similar issues in restricted markets, including new initial and continued listing standards. (See this PubCo post.) Now, the President’s Working Group on Financial Markets, which includes Treasury Secretary Steven T. Mnuchin, Fed Chair Jerome H. Powell, SEC Chair Jay Clayton and CFTC Chair Heath P. Tarbert, has issued a Report on Protecting United States Investors from Significant Risks from Chinese Companies. The Report makes five recommendations “designed to address risks to investors in U.S. financial markets posed by the Chinese government’s failure to allow audit firms that are registered with the Public Company Accounting Oversight Board (PCAOB) to comply with U.S. securities laws and investor protection requirements.” In this Statement, the SEC Chair Jay Clayton, Chief Accountant Sagar Teotia and the Directors of various SEC Divisions responded to the Report, indicating that Clayton had already “directed the SEC staff to prepare proposals in response to the report’s recommendations for consideration by the Commission and to provide assistance and guidance to investors and other market participants as may be necessary or appropriate. The SEC staff also stands ready to assist Congress with technical assistance in connection with any potential legislation regarding these matters.”

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ESG + Incentives 2020 Report

Posted by John Borneman, Tatyana Day, and Olivia Voorhis, Semler Brossy, on
Saturday, August 29, 2020
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John Borneman is Managing Director, Tatyana Day is Senior Consultant, and Olivia Voorhis is a Consultant at Semler Brossy. This post is based on a Semler Brossy report by Mr. Borneman, Ms. Day, Ms. Voorhis, and Kevin Masini. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); and Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Shareholders have increasingly highlighted the importance of measures of social and environmental sustainability as a key component of ESG. The COVID-19 crisis and growing focus on racial inequities will only accelerate the demand for companies to expand their definition of social responsibility to include the broader societal impact of the corporation.

In recent years, debates over the role of the corporation in society have become more prominent, with corporations increasingly seen as responsible towards a broad group of stakeholders. Though some critics have argued that these debates don’t portend a fundamental departure from how businesses currently operate, there does seem to be a true shift in shareholder demands. Pushing for responsibility to a wider range of stakeholders is an attempt to encapsulate and operationalize these demands, with a growing emphasis on the long-term social and environmental sustainability of the corporate model.

As part of, and in response to, these demands are growing calls for increased transparency and standardization of companies tracking and disclosing ESG progress. The “Big Four” accounting firms, for example, are partnering with the World Economic Forum International Business Council to set standards for disclosure on ESG issues, with the intention of identifying common, verifiable ESG metrics for all companies to report on. Third-party ESG rating systems are gaining prominence as sustainability-linked loans and ESG investing  gather momentum. The SEC’s Investor Advisory Committee has also recommended the SEC require standardized ESG disclosures. Environmental and social sustainability metrics are key pillars of many of these disclosure initiatives.

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Leadership in Turbulent Times: Better Foresight, Better Choices

Posted by Andrew Blau and Lauren Lubetsky, Deloitte, on
Saturday, August 29, 2020
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Andrew Blau is Managing Director and Lauren is a Senior Strategy Consultant at Deloitte. This post is based on their Deloitte Center for Board Effectiveness memorandum.

A global pandemic shuts down normal life around the world. Market volatility creates price swings not seen in nearly a century. Millions of people turn out to protest racism and social injustice and call for meaningful and lasting change. [1] To many, the world feels more turbulent and uncertain than it ever has. Many are left to wonder: How might business and society be remade as a result?

Although it is impossible to know precisely what the world will look like in the coming years, companies can ill afford to do nothing until the future becomes clear. As renowned management scholar Peter Drucker once said, “[t]he greatest danger in times of turbulence is not the turbulence itself, but to act with yesterday’s logic.” [2]

Boards can play a key role in guarding against that danger, and it is critical that they collaborate with management to make use of time-tested tools to help them improve resilience in a rapidly changing landscape. Scenario planning—a technique specifically created to navigate uncertain futures— is one such tool that boards and leaders can rely on to help their organizations do more than simply react to and recover from the recent turbulence. Effective scenario planning can help organizations adapt to a future no one can predict and position themselves to thrive in the long run.

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