Death of LIBOR

We all (should) know that LIBOR is an interest rate by which major banks borrow from one another; it also has constituted the “reference rate” for the pricing of credit transactions of all sorts in commercial and financial situations: bonds; loans; mortgages; interest swaps, and the like.

After 2021, LIBOR will be discontinued.  Various world economies are working to replace LIBOR with a different, generally accepted reference rate mechanism.

To fully understand the depth of the potential issue for existing financial relationships, it is informative to look at the July 12 staff statement issued by the Securities and Exchange Commission.  There is a detailed discussion of how companies should transition from LIBOR.  The theme of the nine page SEC statement is: you had better start addressing this now, given many “legacy contracts” which specifically reference LIBOR.

There is also this warning: even if a replacement rate has been specified, over the passage of time has that rate ceased to be logically applied to any given contractual arrangement?

For new contracts, it is suggested that companies might choose a different, non-LIBOR rate even today.

Finally, there is warning that information technology systems may not be amenable to a transition from LIBOR or handle the establishment of a different base rate.  This would be a compliance issue for management to address in advance of the switchover date.  And, since this information comes from the SEC, there is an admonition that the risks and concerns for any given public business must not only be addressed internally but also must be shared with the investing public through appropriate disclosure.  The SEC’s Office of the Chief Accountant is particularly focused on these issues as they impact financial reporting.

Market for VC Convertible Debt

Kudos for the law firm Fenwick & West for their publication of a survey of over 100 issuer-side convertible debt VC investments during the fifteen months ended this past March 31.  While there are no startling developments, it seems to me that there is a wide range of negotiation available in structuring these deals.  (NB: the geography of the reported deals is not clear [West vs East coast?] and there is no mention of SAFEs.)

Conversion discounts (to my mind a sine qua non here, why else post the money up front at higher risk, at least for new investors?) are on the rise, typically paired with a valuation cap (another investor touchstone although this issue gets confused with whether the cap number really is the target price for the following round).  Of interest: 11% of deals used a valuation cap without a discount on conversion, which for the investor seems to invite confidence that the cap is very favorable and itself guarantees economic leverage.

In change of control situations before occurrence of an investment into which the note converts to equity, the standard is to receive back your investment with a premium; about half the deals give noteholders an option to take the premium or convert to common.  There is a wide variance in the size of the premium, which one may infer is thus highly negotiated.

The study separates out bridges (further divided between early and late).  The later the bridge, the more likely the discount on conversion will ratchet up; further, the average size of later bridges shrank somewhat, and perhaps those financing later bridges are looking more carefully at the timing plans for the late A or early B rounds.  Further, as bridges get later, valuation caps become less popular (although 41% of late bridges still had one).

Under caps, what is the definition of “fully diluted”?  71% of all deals include the option pool, 10% exclude it and 19% of deals did not specify, suggesting perhaps some confusion at closing.

Lastly, when there is a discount on conversion into the same preferred class as the new investors, the new investors get a liquidation preference for not only their payment but also for the dollars represented by the discount.  One option is to give the converting debt an identical preferred share except for a lesser liquidation preference (could be a different class or, more conveniently, a different series).  I have been seeing this adjustment in a growing number of deals, although the report states that in all types of debt (new money, all bridges) the typical deal is still to grant new investors the extra preference right.

 

 

AI–the Future May Not Be Benign

I had breakfast this morning with an AI guy and we agreed that AI stocks might be a bit ahead of themselves, but they are red hot and, further, that the power of AI will be substantially disruptive in the future and maybe the near-term also.  Those with data plus AI power will know the buttons to push in order to win a wide variety of games, including the games of profit, longevity, security from marginalization, and mating.

Two dark glimpses of the impact of AI in our futures can be had by reference to two current books, one non-fiction and the other a new novel.

Yual Harari, best-selling author of Sapiens, has a new book entitled “21 Lessons for the 21st Century,” in which he argues that AI and big data will drive wealth and power and create a ruling class that will outperform and render redundant — well, the rest of us.  Combined with control over gene editing technology, these humans will end up richer, smarter and longer-lived.  Further, although other changes in technology have ultimately generated new jobs (after some admittedly disastrous personal dislocations), this next revolution in the workplace will be different.  In the past, each industrial revolution created a new pool of required physical labor and presence.  In the future, AI and its machines will have no need for labor or indeed people.  When AI and machines rule the landscape, those in control will have all the money and all the power (and all of the few jobs).

Ian McEwan’s new novel, “Machines Like Me,” explores a future where cyborgs are introduced into human society, possessing vast initial knowledge and powerful machine learning skills.  It would be unkind to reveal the plot of a novel to potential readers, but suffice it to say that the fall-out from this revolution is not wholly benign to us homo sapiens.

Those of us of such seniority as we will not need to compete in the world that is being created may feel left behind, but being left behind in a brighter world may not be the worst choice….

Union Organizers Barred from Employer Premises

This month the National Labor Relations Board rolled back to 1956 the groundrules for non-employee union organizers, by barring them from organizing activities in the public spaces of a business establishment.  Employers now can bar organizers from their public spaces subject to two minor exceptions; you are respectfully referred to my firm’s client alert providing specifics, see

https://www.duanemorris.com/alerts/nlrb_curbs_union_access_public_spaces_employers_property_0619.html

This reversion to prior law should require employers to review their policies concerning use of public space, and the manner of doing so is addressed in the client alert.  But also there is a bit of history playing out here that is not startling but is telling: the decline of the US labor movement and its loss of clout.

Unions have been slipping in power in the industrial marketplace, and indeed generally.  With notable recent exceptions in the service sector (organizing at universities, organizing low-wage workers in fast food), overall union membership is eroding nationally.  It is not surprising that the ability of organizers to enter employer premises has been scaled back in this fashion; note that the right of access was granted organizers during the Republican administration of Eisenhower, indicating the strength of the unions at that time; now, under a new Republican administration, organizer access has been rolled back.

In mid-century, when I was attending law school, I enrolled in a course in collective bargaining because it was taught by the best teacher I had ever had, Derek Bok (who later became the President of Harvard University).  He reviewed the steady rise of labor power, and noted that one measure of its strength was that now union organizers were even permitted to walk into a place of business and extol union membership; implicitly, I believe he found that fact a strain on one’s capacity to comprehend the world, although in those days law schools were certainly likely to be strongly pro-business.

In any event, while it is not unusual to see that law and governmental regulation echo the reality of our society at any given time, and while I always thought that the right to enter private property to foster unionization was at bit bizarre, I harbor a small residual melancholy over the passing of the era of worker strength in an increasingly gig-driven economy.

Rent-a-Director

In times of Board stress, it is possible to rent one or more directors to do your heavy lifting.  Hence, “Special Purpose Directors.”

Typically, if there is a possible conflict of interest to be resolved, or if there is a pending derivative suit against the board brought by a stockholder, or if a forensic investigation is called for, standing directors may be ill-suited, too conflicted, or too time-constrained, to undertake the fiduciary duty of investigating and deciding on proper corporate action. In these instances it is growing more common to retain one or more completely independent directors to undertake the intense task.

(Note that if there is no apparent conflict involving the board or controlling stockholder, as in the case of a possible company sale to an independent third party, boards typically form their own special committee from existing members and are advised by independent outside sources.  But if there is an odor of possible conflict of interest suffered by the whole board or a substantial portion of the board, it is not unusual to recruit outside.)

The test for independence in such circumstances is very strict, beyond the definition of independence typical of SEC or Exchange situations; and, the actual appearance of independence on the part of the new directors, in fulfilling their duty, also will be examined for any taint of bias even after they are elected.

Speaking of elections, a board needs to be sure that it has the power under charter and by-laws to expand the board without a shareholder meeting (pretty critical for public companies), or it may need to ask one or more directors to step down and make room within a board size cap.  And it is wise to provide a mechanism to make sure that a specially named director steps down when the dust settles; holding a resignation subject to board acceptance is one easy method.

Finally, compensation must be addressed.  Serving as a special director is more like a full-time job in intense situations, and generally cash compensation well beyond the typical board stipend is in order; equity can be considered although in some circumstances it may create a hint of self-interest.

 

Random Thoughts in a Random Time

My wife must be wealthier than I thought.  In one day last week, she received mailed notices that she had been pre-approved for loans from five sources, for a total of $520,000.

I received no pre-approvals.  What am I missing?

I now commute to downtown Boston by commuter rail.  First time not driving in many decades.  Boston traffic must be slowing growth here; imagine the growth on top of what is already happening if Boston were a livable city?

Yesterday late afternoon, walking back from a meeting in the new Waterfront district, I came upon an outdoor yoga lesson on a vast lawn.  I counted one instructor and about 180 exercise-ers.  Could not see clearly the end of the long expanse of bodies.

The 8:11 commuter rail train at Wellesley Farms is interesting; if you are a woman there you are over 90% likely to be blonde, unless you are Asian in which case your hair is black.  Since only 5% of older people are naturally blonde, there are a lot of well-cared-for women standing on the Wellesley platform sporting their dye jobs.

Did you know that a greatly disproportionate percentage of women Senators and CEOs are blonde?  Just sayin’.

By the time the 8:11 arrives at a newly minted stop, called Boston Landing for no particular reason, the train is swamped with millennials.  Where do they live?  No housing is visible.  A year ago there wasn’t even a stop.  Who are these people?

Next stop is Landsdowne Street.  It used to be Yawkey before the old guy was defrocked of his street designation.  Many of the millennials depart but even more pile on.  Who ARE these people?

Next stop is Back Bay.  Exit virtually all millennials, filing past my seat and whacking my head with their back-packs.  Who the HELL are these people and what are they doing in the Back Bay?

South Station, downtown last stop.  All exit.  I am the only person with a suit and tie.  I feel self-righteous, judgmental and old.

I am reading my poetry these days in poetry clubs in Cambridge.  Young crowd.  We are admonished to give “trigger warnings” if we are about to recite something that might give someone offense.  I am constrained by this admonition to not read a significant number of poems in my book.  Never realized before how offensive I actually am.

This concept of a “trigger warning” is new to me.  When I was in my 20’s I got offended all the time.  I responded by yelling back or sulking, depending upon the size of the perp.

Like the rabbit said, “that’s all, folks.”  Next post is about the law….

Kennedy, Lennon and Ortiz

We all, I have found, have deaths of people with which we deeply identify although they are neither family nor friend.

In the 60s, a decade notable for  major shootings, it was Jack Kennedy for me.  I sat on the curbstone in Harvard Square and could not stop crying.  I was not alone in both acts.

When John Lennon was shot in 1980, a senior associate working with me was almost functionally destroyed.  When I questioned his reaction, as Lennon was after all “just a singer, although a very successful one,” I increased his hurt by not recognizing the meaning of Lennon in this associate’s life and indeed, he stated, for his entire generation.

My 16 year old son doesn’t read newspapers but the last two mornings I have found him buried in the interior pages of the Boston Globe.  It is all about David Ortiz.  My son played Little League avidly (with great enthusiasm if not great skill), helped me haunt Fenway (a member of whatever the junior club was called at the time, he knew the game and team so well that they had him introduced from the mound once and on a couple of occasions was on camera live on the field reading the line-ups), and actually met Big Papi at a Little League field in Newton (Ortiz’ nephew was on a team playing on an adjacent field and the guy was totally charming and signed everything that could actually take a line of ink).

Turns out that Ortiz is his Kennedy, his Lennon.  He is obsessed about Papi’s health, the perps, the hospitals, the nightclub in the DR.  He listed all the famous people who reportedly expressed sorrow over the shooting.  “Even Rudy Giuliani.  At least he got ONE thing right,” my son intoned, although I am not even sure how he came to possess a  critical view on the Mayor of America; much of the world gets its news these days from sources that do not get thrown onto your front porch.

Diversity on Boards of Directors.

Recently, NBC News online reported that General Motors for the first time had a board of directors which contained more women than men; this after 110 years of corporate existence.

What is the status of board diversity?  Thought you’d never ask.  My article in InHouse, a newspaper for inside corporate general counsel, published just days ago, reports holistically on the status of diversity and inclusion on boards both here and overseas and contains a general discussion of the problems in achieving desired inclusiveness.

See https://newenglandinhouse.com/2019/05/28/diversity-on-corporate-boards-a-tortuous-path/

And let me know what you think.  The goal of true inclusive board representation remains an aspiration even after so many years of attention.  Remarkable!

Be a Big Brother NOW

Big Brothers Big Sisters needs YOU to volunteer.  We are particularly working right now on finding 30 male Big Brothers in the next 30 days to mentor kids in Waltham.  You do not need to live IN Waltham to do this of course.  We are responding to an appeal from the Mayor of Waltham to help out his town’s kids.

Here is a link introducing just one of the kids we are trying to place.  Our shopping list of kids is extensive and we will match Bigs appropriately.  https://www.bbbsmb.org/waiting-little-eduardo/

If you are interested in meeting Eduardo, or some other boy from Waltham or even if you are interested in meeting a boy from a town nearer to you, please just let me know directly: smhonig@duanemorris.com.   

Or just tell that to our office by responding through the BBBS link above.

Your reward is that you will no longer have to pay to receive these blogs. … I have just been told that my blogs are free.  Such a deal!  How about a nice bottle of wine?

 

Boards, Digital Disruption, Ethics and Society

This second post discusses two issues raised from the audience in the Q&A with the excellent NACD panel discussing Board best practices relating to the digital disruption that the new economy inexorably will require for company survival and profitability, goals central to the mission of directors.

This is an age where businesses are being held accountable for the impact they have on society; examples include most recently Facebook, Google, energy companies, opiate manufacturers.  The panel had the task of educating directors on their duties to engage and advance actions of digital disruption; otherwise, their companies will suffer greatly.  In light of this awareness, two questions rose from the floor.

The first question was mine: in this context, should Boards today consider the proposition advanced by Professor Yuval Harari, in his current best-selling book 21 Lessons for the 21st Century, which suggests that the convergence of AI and big data and the digital revolution is anti-democratic and contributes to a growing wealth gap, as those in control of AI and data pull ahead and create a super-wealthy, controlling elite?

The second question, from a member of the Bentley faculty (I believe) working in corporate governance, asked if Boards today should be considering personal privacy and other ethical considerations while undertaking strategic planning.

One director answered the first question, albeit only partially: she would not want to be on a Board where the company did not consider the impact of technology on the jobs of its employees.

One director answered the second question also, to the effect that Boards had a duty to evaluate risk in its strategy (presumably suggesting that violations of privacy or other rights created company risk).

Now let me speculate, and I admit I come at the following from an arguably biased starting point (and indeed was one of the two people raising this type of issue).

First, I found it telling that, although there was much panel interchange on almost every other question, each of these two questions was answered, after a pause by the panel, by one person offering an answer to fill the void.  No one else wanted to touch these issues, it seemed.

Second, after the second question the next speaker started his own question, which was admittedly more in tune with the prior discussions, with a phrase something like “getting back down to earth….”  I got the sense that the speaker was put off by broader speculation about societal and ethical ramifications of the technological revolution which the panel was explaining how to implement effectively; he needed nuts and bolts information to get on with the task.

If I am correct and neither paranoid nor argumentative, this wonderful panel (and it was indeed great) embodies the problem raised.  We move forward with progress, driving business efficiency, better service to customers and consumers, higher productivity and profits– I do not argue with these goals.  But consideration of long-term societal and ethical costs are the business of philosophers and social futurists, and not today’s Boards.

I hope I am wrong, but if companies do not consider these issues now, strategically and to some degree in concert as part of a general awareness, then by the time that technology, AI, big data and the integration of society into the new technological order is complete, that is the time when the insights of the philosophers and social futurists will be, by definition, too late.