Snap Inc., which debuted on the New York Stock Exchange (NYSE) on March 2nd, was the largest tech IPO since Alibaba went public in 2014.  Initially priced at $17 per share, the share price jumped to more than $24 by the end of the first trading day, raising $3.4 billion and beating market expectations.

Beyond the magnitude of the offering and its implications for the broader deal pipeline, Snap’s IPO has raised interesting governance issues around its non-voting shares, which the SEC’s Investor Advisory Committee (IAC)[1] tackled on March 9th at its quarterly meeting.  The IAC’s discussion centered on Snap’s three-tiered capital structure: Class C shares with 10 votes per share for founders Evan Spiegel and Bobby Murphy, Class B shares with one vote per share for pre-IPO VC investors and other insiders, and Class A shares with no voting rights for public investors. Companies like Facebook and Google have employed similar structures in the past; in fact, a recent study by Institutional Shareholder Services (ISS) noted that dual- and multi-class capital configurations are common, especially in the technology sector.[2]  However, the notion of affording no voting rights whatsoever to public investors is unprecedented.

SNAP RAISES CONCERNS FROM INVESTOR GROUPS AROUND GOVERNANCE CONTROLS

Some have expressed concern that the issuance of no-vote shares weakens corporate governance controls. The same ISS study referenced above found that “controlled companies” – those with multi-class or unequal voting rights like Snap – tend to underperform relative to their non-controlled peers in several key areas of assessment including shareholder returns, revenue growth, and return on equity.  The most critical investors’ rights advocates argue that Snap’s no-vote share class will be disastrous for the company’s shareholders who will be left without a say while Snap is given the go-ahead to operate as a public company without being subject to traditional public company voting and disclosure requirements.[3]

Others who were not on the IAC’s meeting agenda are less fatalistic in their assessment of Snap’s potential impact on shareholder rights. Looking at industry trends, some of the most successful public technology companies have concentrated voting power among the company’s founders, and shareholders appear to have benefitted (or at least not to have been disadvantaged) as a result.[4]  Facebook and Alphabet are prime examples.  Others maintain that Snap is an anomaly – as a tech “unicorn” (one of a select group of private ventures valued at more than $1 billion), Snap is able by virtue of its rarefied status to issue no-vote shares whereas smaller-cap or less prestigious companies likely could not.  As long as Snap continues to prosper, so will its Class A holders, even without a direct say in the company’s decision making.

SNAP’S DISCLOSURE OBLIGATIONS TO CLASS A HOLDERS

Beyond the general governance concerns, Snap’s IPO has also generated discussion around the company’s disclosure obligations. Are Snap’s no-vote shares entitled to the same degree of disclosure as voting shares?  Technically no, though Snap has indicated in its SEC filings that it intends to afford Class A holders the same degree of transparency as those with voting rights.[5]  According to Snap’s prospectus, the company plans to invite the Class A holders to attend the annual meeting and to submit questions to the management team.  Snap simultaneously acknowledges that its Class A shares are its only class of stock registered under Section 12 of the Exchange Act, and therefore Snap is not required to file a proxy statement unless a vote of Class A holders is required by applicable law.  The company promises, “[W]e will provide holders of our Class A common stock … any information that we provide generally to the holders of our Class B common stock and Class C common stock, including proxy statements, information statements, annual reports, and other information and reports.”[6]

Snap caveats that promise in several important ways. First, if the company doesn’t deliver proxy statements or information statements to Class B holders, then it will not do so to Class A holders – that goes without saying.  Second, Snap will be still obligated to comply with the ongoing periodic and current disclosure requirements of the Exchange Act, including Form 8-K, which may be filed up to four business days after a material event and which, by its nature, is less detailed and more open ended in terms of content requirements than a proxy statement.  This means that Snap’s disclosures on executive compensation and related matters may include less information than would otherwise be required by a proxy statement.  Lastly, because Snap is not bound by the proxy filing requirements, any filing the company does make may not contain all the information that would otherwise be required of a public company with voting shares.  Class A holders will essentially be reliant on the company’s annual, quarterly and current reports, without the ability to refer to proxy statements for information on, for example, its compliance with proxy access rules.  As a side note, Snap will not be required to comply with the Dodd-Frank Act’s “say-on-pay” and “say-on-frequency” rules, by virtue of its status – for now – as an emerging growth company under the JOBS Act.[7]

OBLIGATIONS OF NYSE AND OTHER NATIONAL EXCHANGES

Testifying before the IAC, Ken Bertsch of the Council of Institutional Investors (CII) questioned what Snap’s IPO means for institutional asset owners, which hold the majority of publicly traded securities in the U.S.[8]  He criticized the NYSE for being “asleep at the wheel” by allowing Snap to list a non-voting class of securities on the exchange, which he argued were more akin to preferred stock or derivatives.  Aside from Snap’s ability to trade on the NYSE, Bertsch asserted that the company should not be permitted to participate in public company stock indices.  Under his theory, an investment in an index fund pegged to the S&P or any other index carries with it certain expectations regarding the underlying disclosures of listed companies, and Snap’s no-vote shares run afoul of those expectations by adding a layer of complexity that will not be adequately reflected in the price.

Given the SEC’s regulatory power over national securities exchanges like the NYSE, a number of related questions emerge: How does allowing Snap to list on NYSE impact exchanges outside the U.S. where listing requirements are generally less onerous? Should the SEC be concerned about a potential race-to-the-bottom amongst non-U.S. exchanges?[9]  How should the SEC balance investor protection directives against the desire to entice private companies to go public?

None of these questions were answered on March 9th.  At most, the testimony amounted to a call by investor groups to revisit the rules surroundings multi-class common structures listed on U.S.-domestic exchanges in light of Snap and the potential for other companies to replicate its offering structure.  Those who are skeptical of CII’s argument with respect to index funds will note that Snap is still subject to ‘34 Act reporting requirements, which generally puts it on par with other companies listed in the index (proxy rules excepted).  Certainly, fewer or limited disclosures are of concern to any investor who wants to ensure the share price accurately reflects the totality of information available.  Those concerns may be better directed at deregulatory efforts generally, rather than at Snap, which continues – at least as of this writing – to trade above its initial IPO price.

CONCLUSION

It’s unclear whether the Commission will address the topic of no-vote shares again in the near term, especially given its change in leadership and priorities. All parties would benefit to wait and see how Snap performs over time and whether the company endeavors in good faith to provide its Class A holders with a degree of transparency that resembles that of more traditional shareholders.

[1] The IAC is a mandate under Dodd-Frank, set up to advise the SEC on various regulations affecting investors. Here’s a link to the agenda, as posted on the IAC’s website: https://www.sec.gov/spotlight/investor-advisory-committee-2012/iac030917-agenda.htm.

[2] See Rob Kalb and Rob Yates, Snap Inc. Reportedly to IPO with Unprecedented Non-Voting Shares for Public, Harvard L. Sch. Forum on Corp. Governance and Financial Regulation (Feb. 7, 2017), https://corpgov.law.harvard.edu/2017/02/07/snap-inc-reportedly-to-ipo-with-unprecedented-non-voting-shares-for-public/ (looking at post-IPO companies holding their first annual meetings, finding several instances of 10-to-1 voting structures between insiders and outsiders).

[3] See generally Testimony of Ken Bertsch before the IAC (Mar. 9, 2017), available at https://www.sec.gov/spotlight/investor-advisory-committee-2012/bertsch-remarks-iac-030917.pdf.

[4] See, e.g., Kurt Wagner, One way Shapchat’s IPO will be unique: The shares won’t come with voting rights, Recode (Feb. 21, 2017), http://www.recode.net/2017/2/21/14670314/snap-ipo-stock-voting-structure.

[5] See, e.g., Preliminary Prospectus, filed with the SEC: https://www.sec.gov/Archives/edgar/data/1564408/000119312517056992/d270216ds1a.htm.

[6] Id. at 5.

[7] See Eleanor Bloxham, Snap Shouldn’t Have Been Allowed to Go Public Without Voting Rights, Fortune (Mar. 3, 2017), http://fortune.com/2017/03/03/snap-ipo-non-voting-stock/.

[8] See supra note 3.

[9] See generally SEC Should Bar No-Vote Share Structures, Committee Told, Law360 (Mar. 10, 2017), https://www.law360.com/capitalmarkets/articles/900042?utm_source=rss&utm_medium=rss&utm_campaign=section.

SEC Acting Chairman Michael S. Piwowar issued a public statement on February 6, 2017 requesting input on any unexpected challenges that companies have experienced as they prepare for compliance with the CEO pay ratio rule, which will become required disclosure in public company 2018 proxy statements. Piwowar also directed SEC staff to “reconsider the implementation of the rule” based on comments submitted.

This public statement and request for comments is a first step in considering changes to the rule, as part of the Republican Party’s effort to modify or roll back certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd Frank). Any SEC modifications to the CEO pay ratio rule would take time to implement and may be challenged. The easiest route to prevent its implementation would be for Congress to repeal this provision of Dodd Frank.

Every year at around this time, the Mintz Levin securities lawyers are busy collaborating with our December fiscal year-end clients to prepare for the annual year-end reporting season, involving a flurry of 10-Ks, proxy statements, governance review and upkeep, and related matters. Pam Greene and I have worked together for several years now (more than we would care to admit!) on what we fondly refer to as the “year-end kickoff memo,” which you can find here. Each year, we focus on a combination of new developments, reminders of things to keep in mind, and anticipated “hot topics” from the perspective of regulators, shareholders and companies themselves. We are pleased this year to have some terrific contributions to the memo from our partner Bret Leone-Quick, who focuses on securities litigation and related governance issues. We welcome your questions on the memo and look forward to working with all of you on this important annual process.

In her year and a half as Assistant Attorney General in charge of the Criminal Division, Leslie R. Caldwell has repeatedly emphasized the importance of a company having a compliance program fine-tuned to its specific risks to prevent fraud and corruption and to best position the company in the event that misconduct nonetheless occurs.

On November 2, 2015, AAG Caldwell spoke extensively on this topic at the SIFMA conference in New York.  She stated that when DOJ prosecutors are considering whether to charge a corporation criminally, they “look closely at whether compliance programs are simply ‘paper programs’ or whether the institution and its culture actually support compliance.  [They] look at pre-existing programs, as well as remedial measures a company took after discovering misconduct – including efforts to implement or improve a compliance program.”

On November 3, the Criminal Division added a resource for evaluating compliance programs with the hiring of Hui Chen as Compliance Counsel for the Fraud Section.  AAG Caldwell addressed this addition in her remarks at the SIFMA conference, noting that DOJ wanted “the benefit of the expertise of someone with significant high-level compliance experience across a variety of industries.”  (Ms. Chen reportedly was head of anti-bribery and corruption at Standard Chartered and an Assistant General Counsel at Pfizer focusing on compliance before that).  In the context of making charging decisions, Compliance Counsel “will help [DOJ] assess a company’s program, as well as test the validity of its claims about its program, such as whether the program truly is thoughtfully designed and sufficiently resourced to address the company’s compliance risks, or essentially window dressing.”  Additionally, Compliance Counsel “will help guide Fraud Section prosecutors when they are seeking remedial compliance measures as part of a resolution with a company.”  The idea is to require an effective program without being unduly burdensome.

AAG Caldwell specifically addressed speculation in the legal community that the hiring of compliance counsel was a precursor to a compliance defense.  She said it is not and that review of a company’s compliance program will remain one of the several factors considered when DOJ considers whether to charge a company.

On October 22, 2015, the U.S. Department of Justice Principal Deputy Assistant Attorney General Benjamin C. Mizer, who oversees DOJ’s Civil Division, spoke at the 16th Pharmaceutical Compliance Congress and Best Practices Forum in Washington, D.C.  In addressing “current law enforcement efforts that may bear on what the future holds,” Mizer led off with the recent memo by Deputy Attorney General Sally Yates on individual accountability. Mizer’s remarks complement those by the Assistant Attorney General in charge of the Criminal Division, Leslie R. Caldwell, last month.  For our previous discussions on the memo and Caldwell’s prior remarks click here and here.

Mizer emphasized a few points from the Yates memo, beginning with the one that has been most discussed: in order to qualify for cooperation credit, a corporation must identify all individuals involved in the wrongdoing and provide all relevant evidence implicating those individuals to the government.  As Mizer bluntly stated, “this means no partial credit for cooperation that doesn’t include information about individuals.”  He also stressed that the requirement applies to not only criminal but civil investigations, including False Claims Act investigations.  Mizer called particular attention to the fact that “in order to qualify for the reduced multiples provision under the False Claims Act, the organization must voluntarily identify any culpable individuals and provide all material facts about those individuals.”

Mizer made two other points following on the Yates memo:  both DOJ’s Criminal and Civil Divisions will focus on individuals from the outset of their investigations and DOJ criminal and civil attorneys “have been directed to cooperate to the fullest extent permitted by law at all stages of an investigation.”  The latter is a point that Caldwell made early in her tenure overseeing the Criminal Division at the Taxpayers Against Fraud Education Fund Conference.  It was at that September 2014 conference that Caldwell announced a new procedure whereby qui tam complaints would be shared by the Civil Division with the Criminal Division as soon as the cases were filed and that attorneys in the Frauds Section of the Criminal Division would immediately review them to determine whether a parallel criminal case should be brought.

The public debate about the Yates memo has centered on whether it really says anything new.  In apparent recognition of this debate, Mizer said the memo was issued “to reinforce the department’s commitment” to pursuing not just corporations but the individuals who caused the misconduct to occur and that it shows the “renewed commitment” to pursuing not just corporations but the culpable individuals. Mizer may be foreshadowing that results of this Criminal/Civil Division cooperation are on the horizon.

On September 22, 2015, the U.S. Department of Justice’s  Assistant Attorney General in charge of the Criminal Division, Leslie R. Caldwell, spoke at the Global Investigations Review Conference in New York, addressing the recent memo by Deputy Attorney Sally Yates on individual accountability.  Her comments provided a straightforward approach to how the Yates memo could play out in practice.

As recently reported in our Health Law & Policy Matters blog, a central tenet of the Yates memo is that in order to qualify for cooperation credit, a corporation must identify all individuals involved in the wrongdoing and provide all relevant evidence implicating those individuals to the government.  AAG Caldwell explained “This means that companies seeking cooperation credit must affirmatively work to identify and discover relevant information about culpable individuals through independent, thorough investigations.  Companies cannot just disclose facts relating to general corporate misconduct and withhold facts about the responsible individuals.  And internal investigations cannot end with a conclusion  of corporate liability, while stopping short of identifying those who committed the criminal conduct.“

Expanding upon DAG Yates’ remarks last week at NYU Law School, AAG Caldwell stated “We recognize, however, that a company cannot provide what it does not have.  And we understand that some investigations – despite their thoroughness – will not bear fruit.  Where a company truly is unable to identify the culpable individuals following an appropriately tailored and thorough investigation, but provides the government with the relevant facts and otherwise assists us in obtaining evidence, the company will be eligible for cooperation credit.  We will make efforts to credit, not penalize, diligent investigations.  On the flip side, we will carefully scrutinize and test a company’s claims that it could not identify or uncover evidence regarding the culpable individuals, particularly if we are able to do so ourselves.”  AAG Caldwell also explicitly recognized that DOJ can sometimes obtain evidence that a corporation cannot.

To the extent that practitioners read the Yates memo as erecting an impossible hurdle to cooperation credit, AGG Caldwell’s remarks indicate that each case will be evaluated on its facts.  AAG Caldwell made at least one other point worth noting:  the Yates memo does not change existing DOJ policy regarding the attorney client privilege and work product protection.  Prosecutors will not be seeking corporate waiver of these protections.

On August 5, by a vote of 3-to-2 with the SEC Commissioners voting along party lines, the SEC approved the final rule to implement the requirements of Section 953(b) of the Dodd-Frank Act, which instructed the SEC to amend existing rules under Item 402 of Regulation S-K to require public companies to disclose the ratio of their CEO’s annual total compensation to that of the median annual total compensation of all company employees. All public companies will be subject to this new disclosure requirement, with the exception of emerging growth companies, smaller reporting companies and foreign private issuers.

The rule requires companies to disclose:

(a) The median of the annual total compensation of all company employees, excluding the CEO;

(b) The annual total compensation of the company’s CEO; and

(c) The ratio of (a) to (b).

Companies will be required to provide disclosure of this ratio commencing with their first fiscal year beginning on or after January 1, 2017, which information will be disclosed in the Executive Compensation section of a company’s Form 10-K (or proxy statement). Thus, disclosure will begin in the 2018 proxy season. In addition to the ratio itself, disclosure describing the methodology used to identify the median employee, determine total compensation and any material assumptions, adjustments (including allowable cost-of-living adjustments) or estimates used to identify the median employee or to determine annual total compensation will also be required. As described in the proposed rule, when identifying the median employee, the final rule requires companies to include all employees, including full-time, part-time, temporary, seasonal, and foreign employees employed by the company or any of its subsidiaries and to annualize the compensation of permanent employees who were not employed for the entire year, such as new hires. Companies may not, however, annualize the compensation of part-time, temporary, or seasonal employees. Consultants and other advisors who are not employees and individuals who are employed by unaffiliated third parties are not to be included in the calculation.

Continue Reading SEC Finalizes the CEO Pay Ratio Rule – Additional Executive Compensation Disclosure for Public Companies Beginning in 2017

Last week, I attended a conference organized by the illustrious Broc Romanek of TheCorporateCounsel.net, whose blog and website provide untold amounts of useful, practical and timely guidance to securities practitioners. The conference provided an opportunity for 100 women from the securities and corporate governance worlds to network with and learn from each other. One of the highlights for me was hearing from the indomitable Peggy Foran, Chief Governance Officer of Prudential Financial, Inc. and by any measure one of the foremost luminaries in the world of corporate governance.

Continue Reading Women’s 100 Securities Conference – Thanks to Broc Romanek

A recent decision by Judge F. Dennis Saylor of the U.S. District Court for the District of Massachusetts, Butler v. Moore, C.A. No. 10-10207-FDS U.S. Dist. LEXIS 39416 (D. Mass. Mar. 26, 2015), offers an example of how fiduciary duties can continue to govern the conduct of participants in a closely held corporation or LLC under Massachusetts law, even where parties claim that those duties have been abrogated by contractual agreement.  The decision offers a cautionary tale reminding shareholders and members in closely held companies of the fiduciary duties they owe to one another and to the company under Massachusetts law, and of the resulting requirement that they should be scrupulously fair and forthright, and carefully observe corporate formalities, in their dealings with one another.

Butler v. Moore will take an important place in the long line of Massachusetts decisions dealing with fiduciary duties in closely held entities. It offers a comprehensive overview of fiduciary duty law and carefully applies this law to a complex set of facts. In its breadth, depth, and human interest, it is comparable to previous landmark decisions in the field such as Demoulas v. Demoulas Super Markets, Inc., 424 Mass. 501, 677 N.E.2d 159 (1997). Judge Saylor’s opinion is particularly noteworthy for:

(1) its detailed findings chronicling how the individual defendants progressively siphoned assets and opportunities from Eastern Towers through “an extensive pattern of deceit, concealment, and manipulation”;

(2) its evaluation of the relationship between Eastern Towers, Inc. and Eastern Towers, LLC, holding that the two companies should be treated as a single entity in light of the failure to observe corporate formalities and their confused intermingling of operations and assets; and

(3) its close analysis of the intersection between the principals’ fiduciary duties and the Eastern Towers, LLC operating agreement, concluding that the operating agreement did not insulate the defendants from liability.

The decision presents a clear warning to entrepreneurs and leaders of start-up businesses that, where a company is closely held, negotiations with other shareholders or members concerning corporate governance and related party transactions must be carried out with transparency, full disclosure, and good faith, consonant with the fiduciary duties incumbent upon them as shareholders, members, and/or directors of closely held companies under Massachusetts law.

Continue Reading Massachusetts Federal Court Holds That LLC Operating Agreement Does Not Shield Defendants from Liability for Breaching Their Fiduciary Duties to Closely Held Corporations

Section 162(m) of the Internal Revenue Code precludes the deduction by public companies for compensation paid to certain covered employees in excess of $1,000,000 in any taxable year. This limitation on deduction does not apply to performance-based compensation. Such performance-based compensation is deductible so long as the following requirements are met:

  • the compensation is paid solely on account of the attainment of one or more pre-established, objective performance goals,
  • the performance goals must be established by a compensation committee comprised solely two or more outside directors,
  • the material terms of performance goals under which the compensation is to be paid must be disclosed to and approved by the shareholders, and
  • prior to payment of the performance-based compensation, the compensation committee must certify in writing that the performance goals have been attained.

Under the existing regulations, compensation attributable to stock options or stock appreciation rights are deemed to satisfy the performance-goal so long as, among other requirements, the plan under which the option or right is granted states the maximum number of shares with respect to which the option or right may be granted to any employee during any specified period and that cap is preapproved by the public company shareholders.

On March 31, the IRS issued final regulations clarifying the satisfaction of the performance-goal and shareholder approval requirement with respect to stock options and stock appreciation rights. Specifically, the IRS clarified that the performance-goal requirement is satisfied if the plan states the maximum number of shares with respect to which options or rights may be granted during a specified period to any individual employee. Further, the IRS clarified that the plan will satisfy this per employee limitation even if the plan provides the aggregate maximum number of shares with respect to which any equity-based award may be granted to any individual employee, such as restricted stock units and restricted stock. The IRS noted that this is not meant to be a substantive change in the regulations but only a clarification regarding satisfaction of the per employee limitation requirement.

The final regulations clarifying the per employee limitation requirement apply to compensation attributable to stock options or stock appreciation rights granted on or after June 24, 2011.

The final regulations also clarified the applicability of the transition rules for compensation payable pursuant to a restricted stock unit by companies that become publicly held after the grant. Generally, when a company becomes publicly held, the compensation deduction limitation under Section 162(m) does not apply to any compensation paid pursuant to a plan existing during the period prior to the company becoming public, and the company may rely on this transition relief provision until the earliest of:

  • the expiration of the plan,
  • a material modification of the plan,
  • the issuance of all employer stock that has been allocated under the plan, and
  • the first meeting of the shareholders at which directors are to be elected that occurs after the close of the third calendar year following the calendar year in which the IPO occurs or, in the case of a company that did not have an IPO, the first calendar year following the calendar year in which the company becomes publicly held.

This transition relief applies to any compensation received pursuant to the exercise of a stock option or stock appreciation right, or vesting of restricted stock (even though the compensation from time based restricted stock grants would not generally be exempt as a performance-based grant after the transition period), granted under a plan that would be eligible for the transition relief so long as the grant is before any of the above events. Under the final regulations, the IRS clarified that restricted stock units are eligible for the transition relief only if the compensation attributable to the restricted stock unit is paid (i.e. the shares underlying the award are delivered) before the first to occur of the above events, not merely granted.

The final regulations regarding the transition relief provisions apply to remuneration resulting from a stock option, stock appreciation right, restricted stock or restricted stock unit that is granted on or after April 1, 2015.

While the IRS does not deem these regulations to be significant, they do provide needed clarification to compensation committees and practitioners tasked with ensuring that compensation payable under equity and bonus plans is deductible by the companies. Moreover, private companies that become public are now on notice that the transition relief is limited for restricted stock units that vest after the transition period has terminated.