United States: Securities And Governance Update - June 2014

Focus on Disclosure Effectiveness

By Elizabeth A. Diffley

In December 2013, the staff of the SEC's Division of Corporation Finance (Corp Fin) issued its report on the Review of Disclosure Requirements in Regulation S-K (the S-K Study).  As we noted in a, previous publication though the S-K Study indicated an intention to implement "disclosure reform," many aspects of the initiative were uncertain.  In a recent speech before the ABA Business Law Section Spring Meeting (a transcript of which can be found here), however, Corp Fin Director Keith Higgins, reported that the SEC Chair, Mary Jo White, has tasked Corp Fin to develop specific recommendations for updating the disclosure requirements, and he also outlined the path forward for the newly minted "disclosure effectiveness" project.  In doing so, he called on companies to participate in the process by improving their disclosure now.

With the summer season upon us and many companies taking advantage of this time of year to revisit and update certain of their "core" disclosures, it is worth highlighting the examples Higgins cited as ripe for improvement now, even before the SEC has implemented any changes to the disclosure requirements.  In particular, he said public companies should:

  • Reduce Repetition.  Though repetition may sometimes be worthwhile (and consistency is critical), Higgins recommended considering whether disclosure needed to be repeated in multiple sections of one disclosure document.  In an effort to reduce redundancy, more liberal use of cross-referencing may be appropriate.

    Commentary:  Securities law practitioners often take the view that MD&A, the purpose of which is to present to investors information about a company's past performance, financial position and future prospects through the eyes of management, should "stand on its own" while it provides that perspective.  Accordingly, though increased cross-referencing may be appropriate, many will resist excluding disclosure from the MD&A section in favor of referring to disclosure elsewhere.  In addition, when deciding whether to omit disclosure and include a cross-reference, consider whether doing so would lead to potential confusion by eliminating needed context.
  • Focus on the Company's Disclosure.  Higgins recommended that companies scale back the length and extent of disclosure by resisting the urge to include disclosure primarily because other companies disclose it or because a subject is considered a "hot button" topic for SEC staff comment letters, and to instead focus on the relevance of that issue to the company.

    Commentary:  In raising this topic, Higgins specifically highlighted what he characterized as overly lengthy risk factor disclosure.  Given the importance of risk factor disclosure to secure the safe harbor under the Private Securities Litigation Reform Act of 1995 and the litigious world in which we live, we do not recommend drastic reductions to risk factor disclosure absent more formal SEC guidance.  Failure to include references to risks that are identified by peers or competitors may be inviting trouble, even if one size does not fit all. Nevertheless, many companies could benefit by making their risk factor disclosure less generic and more tailored.
  • Eliminate Outdated Information.  Companies should regularly evaluate their disclosures to determine whether they are material and, if not material and not required, eliminate that disclosure.  Higgins underlined that disclosure initially included in reports in response to SEC staff comments is not sacred; materiality and specific disclosure requirements should still guide the disclosure decision. In remarks before the Annual Conference of the Society of Corporate Secretaries and Governance Professionals on June 27, 2014, Higgins reiterated that companies should not be reluctant to change prior disclosure for fear of receiving SEC comments, noting that reviewers are engaged in the disclosure effectiveness project and will be open to a constructive dialogue with companies about their disclosures.

    Commentary:  Higgins' remarks are a valuable reminder to companies to remember that, while updating existing disclosure for recent developments, they should focus not only on adding new information but also on eliminating what no longer belongs.

Though Higgins' recommendations are focused on reducing disclosure, we should not assume that the disclosure effectiveness project will only result in removing disclosure requirements or in suggesting ways to make disclosure documents shorter.  His current recommendations are really intended to reduce redundancy and eliminate immaterial information rather than to reduce the amount of material information disclosed.  A goal of the disclosure effectiveness project is to increase the transparency of information, and Higgins has said that Corp Fin's recommendations may include both removing some disclosure requirements and adding new ones. 

The disclosure effectiveness project also includes a public outreach component. The SEC has launched a spotlight page on sec.gov where it invites market participants to publicly share their views on these topics.

Delaware Law Update: Fee-Shifting Bylaw Provisions and the Use of a Poison Pill in Response to Activist Investor Activities

By Joseph C. Schoell

ATP Tour, Inc. – Fee-Shifting Corporate Bylaws.  The Delaware Supreme Court issued a decision holding that a non-stock corporation could adopt a fee-shifting bylaw provision, in effect implementing a "loser pays" arrangement for intra-corporate litigation.1 Not long after the decision was issued, legislation was introduced in the Delaware General Assembly that would have limited the decision's impact to non-stock entities.  However, that legislation has not been passed and instead the Delaware General Assembly passed a resolution calling for further study of the potential impact of fee-shifting bylaw provisions, and recommending potential legislation to address the balance between discouraging meritless litigation without unduly restricting stockholder attempts to vindicate legitimate interests in court.  While awaiting consideration by the Delaware legislature, corporations and their counsel will assess whether and how fee-shifting bylaws might be implemented with respect to stock corporations.

ATP Tour Inc., a Delaware membership corporation that operates a global men's tennis tour, adopted a bylaw requiring a member who brings suit against ATP or other members to pay the attorneys' fees and litigation costs of defendants unless the suing member obtains a judgment for substantially all of whatever the suing member initially demanded.  After certain members brought suit challenging changes to ATP's tennis tour schedule and lost their suit in federal court, ATP attempted to enforce the fee-shifting provisions of the bylaws, seeking attorneys' fees and other costs from the plaintiffs.

The federal court issued certified questions to the Delaware Supreme Court related to the enforceability of the fee-shifting bylaw.  The Delaware Supreme Court held that a fee-shifting bylaw is permissible as a matter of Delaware law and the bylaw before the court was "facially valid" in that it complied with the Delaware General Corporation Law and was not otherwise prohibited.  The court added that the enforceability of any specific bylaw, including ATP's bylaw, would depend in part on the manner in which the bylaw was adopted and invoked.  Even where it is within a corporation's power to adopt a bylaw, it may be invalid if adopted or applied for an inequitable purpose.  The court did not reach that issue with respect to the specific bylaw before it and left the issue to be decided by the federal district court.

The ATP decision was widely discussed and many commentators considered the issue of whether fee-shifting bylaw provisions might be broadly adopted by stock corporations, including public companies attempting to curtail stockholder litigation.  On June 3, 2014, a bill to limit the application of the ATP decision to non-stock entities was introduced in the Delaware General Assembly.  Senate Bill No. 236 would prohibit a corporation from adopting a charter or bylaw provision that imposed liabilities on stockholders for bringing litigation against the corporation or other corporate constituents.  Supporters of the legislation argue that the ATP decision is overbroad in its application, discouraging even meritorious litigation, and that it cuts against the usual norm of limited liability for corporate stockholders.  Opponents of the legislation argue that the result in ATP is consistent with Delaware law's long-held respect for private ordering, and that stock corporations should have the option of implementing a bylaw to curtail unproductive and costly stockholder litigation, subject to the constraints recognized by the ATP court.  Senate Bill 236 was not passed before the General Assembly's adjournment on June 30, 2014.  Rather, Senate Joint Resolution No. 12, which was introduced and unanimously passed in the Delaware State Senate on June 18, 2014 and passed by the Delaware House of Representatives on June 30, 2014, directs that the Corporation Law Council of the Delaware Bar further study the issue of bylaw provisions and similar restrictions on the conduct and forum for litigation involving corporations or other business entities. That examination may lead to new legislation addressing fee-shifting bylaws in 2015.  In the absence of legislative restrictions on the adoption of fee-shifting bylaws, at least some Delaware corporations will consider and adopt fee-shifting bylaw mechanisms.  Additional court cases will be needed to develop a more detailed analysis of the effectiveness of such a provision as applied in particular circumstances.  

Sotheby's – Adoption of Poison Pill to Address Activist Investors' Stock Acquisition.  In a recent decision, the Delaware Court of Chancery clarified key issues of Delaware law concerning the use of a stockholder rights plan – commonly referred to as a "poison pill" – in circumstances in which activist investors are trading in a company's stock.2

The case involved renowned auction house Sotheby's, a Delaware corporation whose shares are widely traded on the New York Stock Exchange.  In 2013, several "activist" hedge funds, including Third Point LLC, a fund controlled by Daniel Loeb, began purchasing significant amounts of Sotheby's stock on the open market.  By early October 2013, Third Point alone controlled approximately 9.4% of the company's outstanding stock, which made Third Point the company's largest single stockholder, and Loeb issued a letter critical of incumbent management suggesting the company needed a new board and CEO.

 In response to this activist trading activity, the Sotheby's board adopted a rights plan.  A rights plan customarily provides for the issuance of additional stock (actually, rights to purchase stock) when one investor reaches a certain threshold of ownership (or "trigger" for the pill).  Historically, companies have employed rights plans as defensive tactics in the face of a hostile acquisition proposal.  Prior to the Sotheby's decision, the use of a rights plan to restrict "activist" investors' purchasing activities had not been the subject of significant judicial scrutiny.

The Sotheby's rights plan provided for a "two-tier" trigger.  For an investor filing a Form 13D with the Securities and Exchange Commission, the pill would be triggered when the investor reached a 10% threshold.  However, for investors filing a Form 13G (which can only be filed by an investor disclaiming any interest in changing the control of the issuer), the threshold to trigger the pill was 20%.  

In February 2014, Third Point filed a Form 13D disclosing that it owned 9.53% of Sotheby's stock and was nominating three directors to the board at the company's upcoming annual meeting.  Third Point requested that Sotheby's waive the 10% trigger and permit Third Point to purchase up to 20% of the company's shares.  The board denied Third Point's request.  Thereafter, Third Point brought suit in the Court of Chancery seeking a preliminary injunction invalidating the application of the rights plan and delaying Sotheby's annual meeting.

 After expedited discovery and a hearing, the court denied Third Point's request for a preliminary injunction on the ground that the plaintiffs did not show that they would prevail on the merits with respect to their challenge to the rights plan.  The court invoked the long recognized standards of Unocal, which provide that a defensive measure will be upheld where (i) it is in response to a board's good faith assessment of a legally cognizable threat to corporate policy, and (ii) the response is reasonably proportionate to that threat.

The court found that the board's concern with respect to "creeping control" – the possibility that Third Point and other activist investors trading in the company's stock might band together to obtain effective control of the company's management, without paying any control premium to other Sotheby's stockholders – constituted a legally cognizable and reasonable threat for the board to consider.  The court emphasized that Sotheby's board was independent and reviewed the circumstances related to activist investors with competent and qualified legal and financial advisors before adopting the pill.  The court also found that the rights plan was proportionate to the threat presented.  In particular it was not "coercive" or "preclusive." The plan was not coercive in that it did not dictate a particular way that stockholders should vote in the pending proxy contest.  The plan was not preclusive because it would not render Third Point's proxy contest unviable.  In fact, the court noted that the ongoing proxy contest was considered a "toss-up" at the time it rendered its opinion.

The court expressed concern about the pill's "two-tier" nature.  The plan was concededly discriminatory against activist investors (i.e., those that file Form 13D) as compared to "passive" investors (i.e., those that file Form 13G).  The court found that distinction insignificant to the case before it.  With holdings of 9.6% of the company's outstanding stock, Third Point was the largest company stockholder.  There were no "passive" investors who owned more than Third Point and therefore the distinction, in the court's words, was a "complete non-issue."

The court separately considered whether the board's refusal to waive the 10% limit for Third Point violated the Unocal standards.  By March 2014, management of Sotheby's was in the midst of a hotly contested proxy contest with Third Point and Third Point's inability to acquire and vote more shares in that contest might have affected the outcome of the stockholder vote.  Ultimately, the court determined that the board's refusal to waive the 10% trigger was within the range of reasonableness, in that allowing Third Point – already Sotheby's largest stockholder – to go to 20% might provide it with a blocking position (termed "negative control" by the court).

Based upon its limited consideration of the merits, the court declined to issue a preliminary injunction invalidating the rights plan or delaying Sotheby's annual meeting.  Within days of the court's decision, Sotheby's and Third Point announced a settlement in which Loeb and his two nominees were seated on Sotheby's board, and the threshold under the pill was raised to 15% for Third Point.

The Sotheby's case clarifies key issues of Delaware law with respect to the use of a poison pill to constrain activities of activist stockholders.  It confirms that a board can adopt and employ a poison pill with respect to more tenuous threats to control than the direct and imminent threat of a hostile acquisition offer, including as a defensive measure in light of opportunistic activist investor activity in the company's stock.  The Delaware courts will consider the board's actions in adopting or refusing to waive defensive measures.  Boards are well-advised to consult legal and financial advisors with respect to any rights plan, and to ensure that the minutes of the board meetings during which the adoption of the rights plan is considered reflect the reasons for the board's decision, including the perceived threat.  In addition, it is notable that the court did not endorse "two-tier" rights plans, i.e., those that discriminate between activist and passive investors, so it is not clear that such an approach would pass judicial muster in future cases.


1 ATP Tour, Inc. v. Deutscher Tennis Bund, --- A.3d ---, No. 534, 2013, 2014 WL 1847446 (Del. May 8, 2014).

2 Third Point, LLC v. Ruprecht, C.A. No. 9508-VCP, 2014 WL 1922029 (Del. Ch. May 2, 2014).

Recent Guidance: Securities in Tweets

By Elizabeth A. Diffley and Kyla Rivera

The staff of the SEC's Division of Corporation Finance recently published a series of Compliance and Disclosure Interpretations (CDIs) regarding the use of social media, such as Twitter, in business combinations, securities offerings, proxy solicitations and tender offers (the guidance can be found here. (Questions 110.01, 110.02, 164.02, 232.15 and 232.16)). The new guidance permits social media users to satisfy SEC legend requirements — if the communication platform imposes certain limitations on the number of characters or amount of text — by using an active hyperlink to the full legend.  While the new guidance is not a free pass for all social media platforms, it enhances the ability to use character-limited social media platforms such as Twitter (but not Facebook or LinkedIn) in connection with these transactions.

Description of the Guidance

The new guidance recognizes both the growing interest in social media as a means to communicate with security holders and potential investors and the technological limitations imposed by some platforms.  Although not official statements, rules or regulations of the SEC, the CDIs provide useful information and insight into the SEC's views on social media usage in these contexts.

Under the new guidance, using an active hyperlink to the required legend will suffice in certain circumstances.  Use of a hyperlink to satisfy the legend requirement is permitted only where:

  • The electronic communication is distributed through a platform that has limitations on the number of characters or amount of text that may be included in a communication;
  • The inclusion of the legend, together with the other information, would cause the communication to exceed the limit on the number of characters or amount of text; and
  • The communication contains an active hyperlink to the required legend and prominently conveys, through introductory language or otherwise, that important or required information is provided through the hyperlink.
  • The communications covered by the guidance include:
  • Communications made pursuant to Rule 165 under the Securities Act of 1933, as amended (the Securities Act), in connection with a pending business combination in which securities will be offered. 
  • Offering announcements made in reliance on Securities Act Rule 134 and free writing prospectuses in accordance with Securities Act Rule 433 relating to securities offerings.
  • Proxy solicitations before delivery of a proxy statement pursuant to Rule 14a-12 under the Securities Exchange Act of 1934, as amended (the Exchange Act).
  • Pre-commencement tender offer communications under Exchange Act Rules 13e-4, 14d-2 and 14d-9.

Re-tweets in Public Offering Context

The SEC staff also clarified that, in the context of a securities offering, a third-party re-transmission (such as a "re-tweet") of an issuer's social media electronic communication originally made in compliance with Securities Act Rule 134 or 433 would generally not be attributable to the issuer.  The guidance would require that in this context (1) the third party that re-transmits the issuer's communication is neither an offering participant nor acting on behalf of the issuer or an offering participant; and (2) the issuer has no involvement in the third-party's re-transmission beyond having initially prepared and distributed the communication in compliance with Securities Act Rule 134 or 433. In these circumstances, the re-transmission will not be attributable to the issuer, and the issuer would not be required to ensure the re-transmission's compliance with Securities Act Rule 134 or 433.

Implications and Limitations of the Guidance

Because the active hyperlink solution is only available where inclusion of the legend in its entirety, together with the other information, would cause the communication to exceed the platform's character or text limit, it is only useful for microblogging platforms such as Twitter.  Though issuers and investors also make use of other social media platforms having certain character and length limitations, the new guidance does not provide any breathing room to use a hyperlinked legend where a social media platform allows for enough characters to include a full legend.  For example, the guidance does not allow those using popular social media platforms such as LinkedIn and Facebook to max out a post with other content to avoid including the full legend.  While companies are increasingly using Twitter for investor communications, anecdotal evidence suggests that a common use of Twitter feeds in these contexts is by shareholder activists looking to air their grievances.  The new guidance may result in increased Twitter usage in activist campaigns, making it all the more important that companies monitor third-party social media communications about them.  Companies may also wish to consider capitalizing on their increased freedom to use social media to expand their capabilities and comfort level with these communication avenues so they are better prepared to use them in the event of activist shareholder activity.

It is also important to recognize what the new guidance does not do.  The guidance does not address communications made using multiple transmissions.  Each transmission via Twitter feed is limited to 140 characters, so Twitter users often tweet in a series of multiple transmissions.  The guidance does not specify whether it is sufficient to include the hyperlink in the first tweet only or if it also needs to be included in each subsequent tweet.  Particularly in the context of the types of transactions covered by the guidance, absent further guidance from the staff, we recommend including the legend hyperlink in each tweet.  The guidance also does not specify how to "prominently convey" that important information is provided through the legend hyperlink, though hyperlinks identified as "Important Information" would seem to be sufficient.  Given the character limits of Twitter and other microblogging platforms, we expect there will be pressure to reduce the number of characters as much as possible by abbreviating the hyperlink text.  It remains unclear to what extent words can be abbreviated and still convey the importance of the linked information. 

The recently issued CDIs also do not remove restrictions on information that can be included in communications or eliminate the requirements to file these communications with the SEC via EDGAR.  If companies use Twitter for communications related to business combinations, securities offerings, proxy solicitations and tender offers, they will need to have processes in place not only to ensure that the legend hyperlink is properly included in tweets, but also to timely file these communications with the SEC.  Members of the SEC staff have also indicated that the staff intends to monitor communications by the parties involved in business combinations to confirm they are making the required filings.  

Important Take-Aways

The new guidance significantly clarifies the SEC's stance regarding social media usage as a means to communicate with security holders and potential investors in business combinations, securities offerings, proxy solicitations and tender offers.  Below are some practical measures issuers should consider in light of the new guidance:

  • Adhere to a social media policy and deal communications plan. The transaction deal team should include a small group of communications personnel and other authorized social media users who are knowledgeable about the legend requirements.  Implement procedures and processes that, particularly in light of an accelerated deal pace, help ensure that communications via electronic social media include the required legend hyperlinks and are filed via EDGAR before the filing deadline on the same day.
  • Prohibit directors, officers and affiliates from re-tweeting or "liking" company or third-party social media communications. Though the guidance clarifies that third-party re-transmissions may not be attributable to the company, that exception is unlikely to apply to communications made by directors and officers, meaning that their re-transmissions of company or third-party communications must comply with the legend requirements.  Unless a company can ensure inclusion of the required legends and same-day SEC filing of their social media communications, directors and officers should be prohibited from re-tweeting or "liking" company or third-party social media communications. Additionally, because the exception does not apply to "offering participants", affiliates participating in a secondary offering should also be counseled to refrain from "re-tweeting" or "liking" these communications.
  • Monitor and make use of social media communications. The new guidance facilitates use of social media by issuers and activist investors alike.  Companies should monitor third-party social media communications relating to or about them and consider increasing their use of Twitter, microblogging and other social media platforms.  Companies may be better suited to face an activist shareholder social media campaign if they develop a stronger social media presence and expand their capabilities with these platforms.
  • Proceed with caution. The use of social media in these contexts is a developing practice that will continue to evolve as future platforms are introduced and technologies advance.  This recent guidance may not translate easily to new technologies.  If companies find themselves in a situation not addressed by the guidance, as an alternative to proceeding without guidance or to refraining from using the new technology, consider engaging in a dialogue with the SEC staff.
  • Do not lose sight of other SEC rules. The SEC's anti-fraud rules apply to social media communications.  Even at 140 characters, tweets should not omit material information and should include adequate context to avoid being misleading. In addition, the new guidance does not change existing Regulation FD guidance, which provides that social media is only a Regulation FD-compliant recognized channel of distribution if a company has taken adequate steps to inform the market that it intends to disclose information through that channel.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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