Supreme Court Tips the law on Tipping: Insider Trading liability standard set

You will read  that the United States Supreme Court unanimously re-established the “old rule” for liability for insider trading: if person A tips person B with material inside information, both parties will be liable for insider trading under the securities laws. This should not be analytically startlingly and, indeed, the Supreme Court had no trouble with it; how often do you see an unanimous decision? But the importance of this decision is that it overturns a cryptic 2014 case decided by the Federal Second Circuit (New York), which held that the government had to prove that the tipper and the tippee “needed to know that insiders . . . were improperly leaking confidential information in exchange for some personal benefit.” Justice Alito made analysis far simpler, removing the test of trying to measure the presence of personal benefit to the tipper: “[Tipper] would have breached his duty had he personally traded on the information here himself and then given the proceeds as a gift to[Tippee]. It is obvious that [Tipper] would personally benefit in that situation. But [Tipper] effectively achieved the same result by disclosing the information to [Tippee], and allowing him to trade on it.” The practical effect of this decision is significant, particularly as it comes from the Supreme Court so it is not likely to be messed with by a trial judge who is charging a jury. Practically speaking, if somebody has a relationship with another person which is sufficiently close as to induce the passing of inside information, both parties are going to have liability.

VCs: Present Practices and the Election

At the Boston breakfast meeting this week of the Association for Corporate Growth, venture capital fund managers discussed how they do business, and the impact of the presidential election. The answer: there will be changes in the business environment, but it is necessary to continue to evaluate investments based on fundamentals, as usual.

Dana Callow of Millennia Partners and Deepak Sindwani of WaveCrest Growth Partners agreed on fundamentals in selecting companies: you need to take a macro view, look for markets which are growing, have a reasonably long time line, and do not get distracted by inevitable changes in the world as you move forward in building great companies. If you build great companies, the money will follow.

The speakers were primarily focused above the seed/A-round of investing. Deepak’s fund is for “growth capital” for firms with revenues and EBITDA. Callow, whose fund focuses on healthcare, will invest with companies with zero to five million dollars of EBITDA, tending toward the lower end of the range, but clearly above the seed/A-round level.

The impact of the election?

For Deepak, whose investments are primarily in the B to B software space, his companies are most affected by “high end” immigration, corporate tax and trade. He speculated that the first two issues would be resolved favorably but trade was a “wild card.” He did not think that companies of less than $50 million dollars of sales would be substantially affected by the election in any event.

Dana similarly seemed unconcerned by the election, noting that the Affordable Care Act was destined for substantial re-write even in a Democratic administration, and that simplification of the approval process in the FDA would be a benefit.

Other significant takeaways include the following:

The investment focus has to be in a robust and growing vertical; Dana for example wants a space to be highly competitive, and looks for “forty or fifty companies” or else he thinks it is likely the wrong vertical.

Best IRR has come from funds with $250 million to $350 million dollars to invest. First time funds tend to be the most successful.

While seed money has mushroomed in the Boston market, A-rounds have become difficult. Growth capital at the low end is also difficult, but easier at the high end. Capital is generally available in the buy-out space.

Family offices are a significant support for raising funds. Family offices tend to be long term investors, and co-investors, and are favored by fund managers.

Finally, there was substantial emphasis on the quality of the CEO. You need to be in a company for the long run. The world will change, and you need a quality CEO to respond; some investment funds have venture partners whom they place on company boards or as advisors to assist in these responses, and they may even share in the fund’s carried interest.

Advice for Compensation Committees of Boards

The NACD panel on executive compensation set forth its perceptions of tasks for the public compensation committee for 2017. Set forth below are some significant take-aways:

The first job of the compensation committee is to figure out how to motivate executives to do the right thing for the company. Don’t get distracted by changing policies of the proxy advisory community (see the November 11th post to this site concerning changes in ISS parameters for measuring executive compensation).

What is the best way for the compensation committee to understand what motivates the CEO and executive team? The committee should stay very close to the CEO and include the CEO in its meetings. A suggestion to make sure that the committee also has its own time to separately consider compensation: an executive session held both before and after each committee meeting.

Executive compensation may be almost “out of control.” The audience was asked, “how many people here are in a company where the compensation committee target is to pay below the industry average?” There is a constant natural pressure, given human nature, to inflate CEO compensation. Coupled with research indicating that virtually every CEO views himself/herself as materially under-compensated, there is a problem which compensation committees may not be able to contain.

Although surveys may be valuable for lower echelon employees, compensation surveys for the C-suite should be looked at with great suspicion. Who did not participate? How accurate is the data? Most compensation committees do try to gauge compensation of chief executives of comparable companies.

There is growing pressure from the proxy regulatory companies on selecting the “correct” peer group for your company, as selecting an “aspirational” peer group will tend to drive up compensation.

See the following post re pay disparity.

Trump’s Impact on SEC reporting of Executive Comp

Those reading newspapers know that Mary Jo White, Chair of the Securities and Exchange Commission, resigned effective in January. What does this foretell for financial reporting of publicly-held companies?

This subject was discussed at the Tuesday morning meeting of the National Association of Corporate Directors/New England, where an expert panel chaired by Ted Buyniski of Radford (comp consultants) explored — or at least attempted to look into — the future.

Simply put: Trump promised to repeal the Dodd-Frank Act; several financial reporting provisions of that Act already are in force by SEC Rule (say-on-pay, say-on-golden parachutes, committee independence, independence of consultants).

Perhaps the most maligned, disclosure of the ratio of a CEO’s pay to the median pay of all company employees, also has been finalized, and is effective for the 2018 proxy season. Also, there are pending proposed rules, covering pay-for-performance disclosure, anti-hedging policy, and clawback from executives.

So what happens next? Will a new Trump-designated SEC chair and Republican majority (three of the five seats goes to the ruling party) put a hold on enforcement of prior disclosure provisions? Will they scotch anything that is pending? Who will be the new chair? (The named leading candidate, commission member Michael Piwowar, is known for his numerous, literate dissents from prior SEC regulatory pronouncements, and his course of action is reasonably predictable.)

As is true with much of the American governance infrastructure, we will have to wait and see. But nary a good word was said by the panel about the pay ratio disclosure requirement (roundly criticized in this space previously), and I wouldn’t bet a plug nickel that ratio disclosure survives for long.

For the broader implications of pay disparity, which the Congress attempted to address by requiring pay ratio disclosure, see a following post.

ISS and Executive Compensation

ISS, proxy advisor to institutions invested in publicly-held companies, has issued changes in its methodology for evaluating executive compensation in connection with recommending shareholder voting under the SECs “Say-On-Pay” advisory procedure. The big take-away is this: ISS is retreating from primary reliance on TSR (total shareholder return) and is considering other factors based upon its own policy survey of both investors and companies.

The test in assessing executive comp has been two-fold: a quantitative test which compares a company to its peers economically, and then a qualitative assessment which presumably accounts for differences between companies (for example, an executive doing a great job on a turnaround may have much weaker statistics than an executive in a more robust company, and thus the turnaround executive may appear to be over-compensated).

Compensation committees (and ultimately full boards) now will have to consider the following additional standards: return on equity, return on assets, return on invested capital, revenue growth, EBITDA and cash flow.

Some interesting factors: in the ISS survey the “least important” metric both for investors and companies was “economic profit,” which is indeed excluded from the list of new financial measures; investors were most heavily in favor of ROIC, and companies most favored earnings per share or EBITDA. When you think about it, these are expectable results; companies are managed by people who often have been economically rewarded, in option plans and otherwise, by robust earnings, while investors want to know their ultimate bottom line: what is their return on their invested capital?

Mass Challenge: Unexpected Geographies and Players

Each year for the past seven years, the MassChallenge program has accepted approximately 128 emerging companies in many industries, which become resident in the MassChallenge incubator (now in South Boston). For each of the last seven years, our firm has been a primary sponsor. Various firm partners, myself included, have mentored many companies. At last night’s award ceremonies, $1,500,000 in monetary awards were distributed to all kinds of businesses from high-tech to beauty aids to a vegan restaurant (hopefully soon to be a chain).

Although based in Boston (now with branches in Newton, London and Israel by the way), MassChallenge attracts an international cadre of emerging companies. The three largest cash award winners included a German company with U.S. operations in Houston, a South Korean company, and a Cambridge start-up that analyzes satellite imagery for commercial purposes.

Innovation is everywhere and some of the world’s largest companies, including those which you might not think would be interested in making investments and supporting emerging companies, were represented at the award ceremony, hosting tables or speaking from the stage. For example, I was seated at the table sponsored by State Farm, the insurance company. I learned that, in several cities, State Farm has representatives of its Innovation Office, and 90 persons are active in seeking  emerging companies for possible investment. The insurance industry is being disrupted, we were told, and it is necessary for any large enterprise to adapt to and become a part of the new economy.

Death of Lawyers?

Not quite yet, no matter how hard you may be in favor of that result, says Harvard Professor David Wilkins in remarks to the Boston Bar Association Annual Meeting at the Westin Copley on October 20th.

Law school applications are down 40% from several years ago and yet only 50% of law graduates achieve jobs requiring a law degree. What is happening, and is this a paradigm shift or just a “correction?” The Professor says the answer is “unclear;” it is “too early to tell — ask me in thirty years.”

Whether or not it is a paradigm shift, it is not the death of lawyers. But there will be some changes. Law firms will fail, some lawyers will be replaced, and things will not be the same. 2007 isn’t coming back any time soon.

What is driving these changes? Globalization, information technology, the merger of things we thought to be separate (global vs. local; public vs. private; law vs. business). The law is a trailing, not a leading, indicator. But all lawyers are noting changes in the profession: a concentration toward big firms, growth of the size of in-house law offices, increased diversity including the rise of women in a profession which was designed “for a male lawyer with a wife who stays at home.” Finally, great competition among law firms for talent and clients.

What remains stable? This is a profession, and it is delivered by and to human beings. There is need for continuity at the core; the professional model maintains quality and principles.

Current systemic failures include inability to train young attorneys to be wise counsellors as well as technicians, and inability to provide services for poorer people subject to the justice system (mainly because legal services have become too expensive).

So readers of this blog won’t be getting rid of lawyers just yet.

I don’t think.

Cyber Security for Boards

 

Big problems just keep getting bigger.

In 2003, hackers succeeded in reaching their targets 74% of the time with a 20% detection rate by those being hacked.

In 2015, detection increased to 25%, but hackers were now successful 95% of the time.

What is the current thinking with respect to the obligations and best practices of a corporate board of directors in the face of this reality? This issues was discussed by an expert panel, headed by the Chief Technology Officer for Cyber Security in the Department of Homeland Security, at an October 18th breakfast meeting of the New England Chapter of the National Association of Corporate Directors. Major takeways:

Consistent with the role of boards as supervisors and not direct implementers, boards should monitor management instituting robust protection measures. Aside from having a plan for remediation and crisis control, the board should be fully involved with monitoring cyber security as part of a company-wide enterprise risk management program.

Boards should obtain outside consultative help and analysis; boards should be trained in cyber security or, at a minimum, one board member should have expertise in the space.

It may not be wise for the CIO, with responsibility for running the networks, to also have primary responsibility for security. Increasingly, companies are designating cyber security officers. It was suggested that this be a report directly to the CEO and not to the CIO.

Boards often use commercial portals for intra-board communication. These portals are safer than the open use of the internet, but they should not be treated as fully secure. Some companies are providing secure, dedicated I-Pads to board members, the only function of such device being to communicate with the board portal.

The internet of things is making life more complex. Since everything is connected, and there are no standards for manufacture or testing of devices, and since manufacturers therefore are “all over the place” (according to Homeland Security), there is a need to standardize all that is interconnected so that it can be policed and defended.

Speaking of Homeland Security, right now they are deeply focused on protecting the election functions of the various States so that the presidential election cannot be compromised.

One question from the floor raised the issue as to whether block-chain technology might be promising in terms of increasing internet security. The answer: block-chain is a promising technology, currently being studied, but it is complex and we are a long way from being able to harden our systems using it.

For boards, there are two things to keep in mind: the first is to be sufficiently acquainted with the technology of cyber security as to be able monitor; the second is to document the board’s robust process, so as to be safe from criticism (and lawsuits) when the seemingly inevitable occurs: you will be hacked.

Continuing New Healthcare Models

 

By now, everyone is generally aware that the model for healthcare delivery in the United States is moving away from “pay-for-service” and will focus in the long run on so-called “value-based care.” Dr. David Feygin of Becton Dickinson (a major international supplier of medical devices and biological research) sees this change as “abrupt” and, perhaps more interestingly, the basis for greatly enhanced revenues.

Addressing an investment forum at the September 16th Boston meeting of Sky Ventures Group, Dr. Feygin generally outlined the hallmarks of value-based care: a focus on the patient and not the provider; payments to providers based upon the general wellness of the population being served rather than the number of procedures being performed.

His definition of “abrupt,” he noted, should be taken within the context of healthcare: he was talking about a seven to ten year window. But the process has already started, and healthcare providers are now reorganizing to meet the challenge; restructuring through mergers or organizational transformation. The mindset that needs to be addressed is the inherent tension between pay-for-service (fill the beds and perform services) against the standard of general wellness (how can we keep patients out of the beds and healthy). He observed that the Medicare model has been redesigned to reward overall positive clinical experience, with an Alternative Payment Program that will provide revenue boosts for favorable clinical performance which avoids providing service, devices or medications.

While change is often said to be good, we all know that it is not always good; however, based upon Dr. Feygin’s projections, the net revenue for healthcare providers can increase fivefold, over pay-for-service, for those healthcare providers who can “figure it out.”

Greater Boston Commercial Space

Everyone know that office and RD space in greater Boston is facing a “tight” market.

There are well over 2,000,000 square feet of office and RD space within the 495 band, according to Tom Hynes (CEO of Colliers International, presenting at the Thursday morning ACG breakfast). Boston itself contains about 30% of that space, and Boston A buildings draw an average of $58/sq. ft.; Cambridge A space, with only a 3% vacancy rate, draws an average of $64/sq. ft.

Real estate is affected by a variety of economic factors external to Boston, including but not limited to the attractiveness of investing in our buildings for foreign government funds and investors from China, Japan, Canada, Norway, Qatar and Australia. But the principal local drivers for the real estate market are our innovation and life science economy, and the growth of Boston-based hospitals. The largest general draw seems to be MIT (not Harvard); MIT was the institution cited by GE in its relocation to Boston.

Current construction plans are generally known, spear-headed by the $1,000,000,000 Wynn Casino but including redevelopment of garages at Winthrop Square, Harbor Towers and Bullfinch Crossing, as well as proposals for One Dalton Street, Back Bay Station and South Station.

One problem is to provide affordable housing; the City itself, having peaked in population at 801,000 in 1950, fell to about 562,000 in 1980 but now has recovered to 667,000. Can housing (and our shaky transportation infrastructure) effectively support this continuing influx? The economics of constructing affordable residential housing in Boston are daunting.

Asked about the difference between the “bid” and “ask” for class A high-rise space in Boston, Hynes thought that there was very little spread and not nearly the kind of spread that obtained in the past. [I do however note that, per a recent meeting with the senior leasing folks at Cushman and Wakefield, selective opportunities for modest front-end free rent and enhanced build-out allowances in certain sectors of the market were still available.]

Finally, Hynes noted the real risk presented by climate change, citing the flooding in other cities where recent storms hit head-on and with back-up generators and other support facilities often housed in basements. Real estate expansion in Boston needs to think long and hard about climate change in our law-lying coastal city.