Corporate Governance in the WSJ

Take a look at the last page of the WSJ section A today: a list of six principles of corporate governance as recommended by  twelve corporate heavy hitters: Buffett, Immelt, Dimon, Larry Fink of Black Rock, etc.  Although I confess to not being quite sure why this group would buy a full page to extol good governance, their suggestions are not very controversial and all are commonly endorsed by governance attorneys, board advisers and indeed by the National Association of Corporate Directors:

Independent boards should meet regularly including without CEOs present; diverse boards are better; boards need a strong leader independent of management; there is no mandatory requirement to provide earnings guidance; alternate financial reporting should not obscure GAAP reporting; shareholders need “constructive engagement” with management and perhaps the board to permit them to vote properly (of course, access is articulated in terms of institutional investors).

In all events, it is hard to quarrel with the list, which really is a very basic list of some fundamental good governance practices.  It is a corporate analog to the suggestion that “everything I needed to know I learned in kindergarten.”  More later?  We shall see.

Mass Noncomp Law–status report

The below interim report is from my Boston labor law partner Bronwyn Roberts:

The Massachusetts noncompete and trade secret bill passed the House today 150-0.  To become law, the bill still needs to pass the Senate and be signed by Governor Baker.  (So not ripe for a client alert – in my opinion).

Here are some highlights (lowlights as the case may be):

Noncompete entered into at the commencement of employment must be provided the earlier of a formal offer of employment or 10 business days before commencement of employment.

Noncompetes must expressly state that the employee has a right to consult with counsel prior to signing.

There is a 1 year limit to noncompetes unless there is a breach of fiduciary duty or employee theft in which case the duration cannot exceed 2 years.

Noncompetes must be supported by “Garden leave” or “other mutually agreed consideration” specified in the agreement.  “Garden leave” is payment during the restricted period of at least 50% of the employee’s annualized base salary within the 2 years preceding termination.  There is no definition of “other mutually agreed consideration.”

Noncompetes are unenforceable as to nonexempt workers under the FLSA, student interns, employees terminated without cause (not defined) or laid off, employees under age 18.

Partnering in Healthcare, Healthcare IT investments

There are 36 Blue Cross/Blue Shield groups in the country, some covering multiple States, but the Massachusetts group has decided to go it alone. As part of this independent effort, Blue Cross/Blue Shield has established a wholly-owned subsidiary, Zaffre Investments, that invests in healthcare funds and also makes direct equity investments. Additionally, Zaffre also incubates a few companies at Zaffre’s own facilities.

Who should look to Zaffre for potential funding? Zaffre has a long term view of things: it asks, can this technology assist in the efficient delivery of healthcare over time? This sometimes creates some “interesting discussions” when Zaffre makes an investment along with professional investors (venture capital or private equity) with a shorter time frame to exit, according to Vice President for Investments Steve Fox, speaking at the June 24 Boston meeting of Sky Ventures (a platform for the presentation of emerging life sciences and healthcare companies).

Generally, Zaffre does not invest in device companies, nor in drugs and pharmaceuticals. They are looking for service and IT companies that support a service model focused on outcomes. They have an interest in consumer-driven health including health wellness, telemed, caregiving; and, in big data analytics.

Beyond that, Zaffre is all over the place, but to good effect. They will invest anywhere between $50,000 and (as part of a syndicate) $20,000,000. They do not seek control. They are stage-agnostic; they will do seed, early rounds, growth rounds, mature companies. They will lead or follow. Their geography is the United States. They do seek a board seat. They promise networking opportunities “through the front door” by direct access.

According to Fox, Massachusetts Blue Cross/Blue Shield, as a one-State non-profit, needed to diversify its revenue stream. Hence, a broad platform for investment.

Mass Noncomp Law Coming??

The Mass General Court (legislature) seems primed this session (about to expire) to pass and send to Baker a comprehensive law regulating non-comp agreements in Massachusetts.  Many details are still open, and Baker has not signaled whether he would sign.

Key issue: “garden leave” provision requiring company to pay 50% of salary to enforce most non-comps.  Also not clear: can you have a non-comp enforced against an employee you fire without cause?

Stay tuned.

Trends in SEC Enforcement


The Securities and Exchange Commission is utilizing enhanced tools to tighten its regulatory oversight, focusing fraud and corruption in particular, according to an expert panel presenting to the June 14th Boston breakfast meeting of the National Association of Corporate Directors of New England.

According to the current head of the SEC’s Boston office and to the former co-director of the SEC’s national Division of Enforcement, three particular tools are receiving substantial focus.

First, an explosion in the availability of data permits robust quantitative analysis of a company. Aggregating and analyzing this data may provide indicators of fraud. For example, by analyzing data concerning inventory, sales and income, data might provide predictability with respect to risk of income misstatement.

Second, the whistle-blower program provides persons who notify the SEC of wrong-doing with a reward of not less than 10% and up to 30% of any governmental recovery. There was discussion as to the efficacy of this program, however; many whistle-blowers prove to be disgruntled employees, or raise insubstantial matters, or are unsophisticated and lack understanding. It was proposed that an intelligent whistle-blower with good motives would almost certainly have come forward in any event. However, because of the likelihood of SEC focus (any whistle-blower advising the company is likely to also advise the SEC), whistle-blowing is forcing companies to take greater interest in employees disclosures.

Third, the SEC-Department of Justice recently announced a program to treat companies committing Foreign Corrupt Practices Act violations less harshly if the companies self-report. In no event will disgorgement of improperly obtained economic benefit be avoided, but DOJ penalties may be abated. It was noted, however, that one of the alleged “rewards” for self-reporting, the grant by the SEC of a “non-prosecution” agreement, is really illusory; in such cases, the SEC will issue a press release containing the same kind of damaging information as would have been publicized in a “prosecuted” case (which results in a consent decree outlining the same negative facts).

The SEC also is paying attention to the growing prominence of utilization of non-GAAP economic measures in reporting earnings; these alternate financial statements, typically keyed to the elimination of non-recurring expenses, are not subject to rigorous accounting standards and fall under deep SEC scrutiny if they are given “prominence” in disclosure or in the marketplace.

Finally, the SEC is focusing on municipal debt. Many municipal issuers are unsophisticated in finance and disclosure, are subject to manipulation by advisors, and present the risk of political corruption. Munis are an opaque market where valuations are arbitrary; bonds are purchased for long-term hold and tax-advantaged income (thus not subject to active trading which would ultimately mark-to-market).

Boards and “Bad” CEOs

Check out the recent article in the Harvard Business Review about what happens when your CEO lies about personal matters, has a sexual affair, makes questionable use of corporate funds, commits “objectionable” personal behavior, or offends customers or public groups.

The article predictably concludes that boards need to investigate and be proactive; no surprise there.  What seems anomalous is that eleven of the 38 studies incidents resulted in positive stock price action (although average stock prices fell slightly in the short term), yet 45% of companies later suffered adverse  reactions such as accounting restatements, lawsuits, shareholder action or bankruptcy.  And 58% of CEOs eventually lost their jobs over their actions.  And only actions involving financial activities resulted in uniform dismissal.

It is hard to parse all this data.  It may be that we do not know the whole story in many of these cases, or that the sample size is too small to be of much help beyond generating the obvious: boards should act.

And as for those companies where the stock ticked upwards?  Perhaps there is some truth in the adage that it doesn’t matter what you say about someone, just so long as you spell their name correctly.

Buying Companies in the PRC


There has been a lot of publicity about investments being funded out of China (in 2015, they totaled $118 billion dollars). But of equal interest is the opportunity for making acquisitions within China. Foreign investment into China in 2015 totaled $126.3 billion dollars. Not shabby.

First, let’s talk about the Chinese economy. Obviously the GDP growth rate has fallen, but even last year (2015) it was a more-than-robust 6.9%. The ongoing planning goal for the near term is estimated to be 6%, and bear in mind that this rate is now being applied to a more robust base (it is easy to have double digit GDP growth if your base is small).

There are numerous regulatory steps in order to make an inbound acquisition. You need anti-trust clearance, government approval for any foreign investment (it is wide open for biotech and completely shut for investments in internet media). There is a national security review not unlike that in the United States. As the RMB is not readily exchangeable, you need foreign exchange approval. Payment for the deal is tightly regulated (typically all deal consideration must be paid in full within three months; with special permission, you can stretch that to a year provided half is paid within six months).

There is sometimes a squabble as to the controlling language of the agreement (is it English or is it Chinese). But more importantly, there is discussion concerning governing law and venue of dispute resolution. In an acquisition, Chinese law must control. But for dispute resolution, you can negotiate for the utilization of Chinese courts, or arbitration in China, or arbitration in several identified international venues (Hong Kong, Singapore, Stockholm or London). According to my recent meeting with one of the three largest law firms in China (the firm has a startling 1,200 lawyer staff), commercial disputes generally are given fair hearing in Chinese courts (at least in the larger cities where local bias is less likely, and commercial sophistication higher).

Doing a deal in China is like doing a deal anywhere: you to pay attention to tax planning, tax rate (the corporate rate in the PRC is 25% and there is no “state” tax), and there is the usual dispute as to whether an acquisition is for equity or for assets.

These kinds of issues are important and require attention but, given the volume of money going into China, ultimately they will not constitute an absolute block (unless you are seeking an acquisition in a sensitive or totally prohibited space).

The Lawyer in the Dell

Today’s business news may seem technical but it is very important from a corporate standpoint: the Delaware Chancery Court stuck its nose into Michael Dell’s management buyout of Dell stock and   stuck buyers with millions of extra liability above and beyond the apparently market-set tender price.

AND– the court explicitly and purposely wholly ignored the market price in reaching its determination.

Shareholders claimed that the management buy-out was not at “fair value” and sued for more money under the Delaware appraisal statute: as in (I believe) all States, the corporate law permits disgruntled shareholders to seek court determination as to whether the price paid in a shareholder buy-out is fair to the selling shareholders, who as a practical matter will not have an option to stay in the company under most structures.  Until now, the trend for courts as been to say “well, shareholders in the market took the deal and the deal was thus priced fairly by market forces.”

Two take-aways: at least in management buy-outs where management by definition will always have better information than the shareholders no matter how robust the written disclosures may be, shareholders now have renewed hope which will lead to more litigation; and, in private buy-outs with small numbers of shareholders (to which the statutes apply and as to which a claim that the “market” fixed the price fairly doesn’t really ring true) it is a time for buyers to beware of litigation, as litigants have little to lose and lawyers often will take such cases on favorable economic terms in hopes of a big score.

New Federal Trade Secret Law

To date, trade secret protection has fallen under State law. On May 11th, the President signed a bill establishing a parallel scheme of Federal trade secret enforcement, granting new tools for the protection of company proprietary information.

Why should the addition of a Federal basis for protecting trade secrets be of significance to a company?

First, Federal courts are often faster and more efficient than state courts, and provide the benefit of nationwide subpoena power. Second, there is, in extraordinary circumstances, an ability to go into court and temporarily physically seize the property being utilized by someone infringing your trade secret.

In the employment arena, in order to make sure that an employee who is a whistleblower does not inadvertently incur liability when blowing the whistle, the new law states that such a disclosure is immune from civil and criminal liabilities under both the new Federal and all old State trade secret laws. Along with this immunity is a provision which permits an employer to collect legal fees or exemplary (punitive) damages from an employee, provided the employee agreement (or company policy) setting the ground-rules for trade secret protection specifically gives notice of such immunity (presumably to encourage whistle-blowing in the first place). Consequently, employers may well want to revise their standard trade secret documentation in order to obtain these additional liability protections (although of course the immunity notice can be viewed as a two-edged sword).

With respect to industrial espionage, the maximum penalty for criminal violation has been increased from $5,000,000 to the greater of $5,000,000 or three times the value of the stolen trade secrets, and the RICO law has been expanded to include foreign economic espionage and the criminal theft of trade secrets.

All agreements, whether with employees or with third parties with whom trade secrets will be shared (for example in negotiating an acquisition, effecting a joint venture, etc.), could benefit from revision in light of the new law to make clear its coverage, and in the case of employees to enhance employer rights. Particularly with respect to business transactions, in today’s mobile economy having recourse to Federal courts with nationwide subpoena power also can be a substantial enforcement tool.

Proposed Mass Legislation: Employee Noncomps

For several years, as noted in prior posts, Massachusetts has been toying with enactment of a law limiting permissible non-competition agreements for employees (other than those relating to the sale of a business). Yesterday the Mass House reported out of committee a bill far more complex and textured than prior efforts. While there can be no clue, let alone assurance, of what the Legislature will finally enact, if anything, nor what the Governor (historically silent on the matter) might sign, the draft legislation is fascinating and unlike any law of which I am aware in any other State. Highlights (lowlights) follow:

Who is covered? Employees (and independent contractors of certain types).

Who cannot be restricted? Low-paid employees (non-exempt), students on internship, anyone terminated without cause or laid off, anyone under 18.

How long can you restrict someone? Normally one year tops; if someone breaches his fiduciary duty or steals property/secrets whether physically or electronically, two years tops.

How broad a net can you cover? Aside from being necessary (not just convenient) to protect trade secrets or employer goodwill, an employer-imposed noncomp can only restrict to a geography in which the employee worked or had influence (not the area in which the company did business), and must relate to the tasks performed by the employee (not the overall business of the company).

Do you have to pay someone during the restricted period? Yes! Unless the employee breached a duty or stole secrets or property, you must pay at least 50% of highest annualized base salary paid during last two years. This is called “garden leave.” A major departure from prior practice in Massachusetts and the other States, this rule already has attracted negative comment from the Boston Chamber of Commerce.

Massachusetts courts have a history of redrawing noncomps to a standard which the judge considers reasonable to protect employers. Still possible? Nope, strictly prohibited.

What about a company with most of its operations out of state but with someone working in Massachusetts, or someone who is a Mass resident? The proposed law would apply, the company cannot elect the law of another State which is less favorable to the employee.

When would this come into effect? July 1, 2016, but only for agreements after that date and for misappropriations of information and property by employees after that date.

Employers often spring noncomps on employees when they first report for work or after they are hired, and such agreements were historically reviewed by the courts on an individual basis. Is there now a mandatory waiting period before a noncomp can attach to an employee? Yes, ten days with a right to say “no” which means there will be a mandatory lag time at the front end. If you are already working, you have ten days to say no (and I’ll bet you won’t be able to be fired if you say no). Employment noncomps must be in writing, signed by both sides, must expressly say that the employee is entitled to have a lawyer if sought after employment started and must be supported by “fair and reasonable consideration independent from the continuation of employment.”

Bottom line: if this proposed legislation becomes law, Massachusetts will move very far towards the California rule which is that, except in cases of a business sale, noncomps are not enforceable.