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Selected Recent Developments for Public Companies
Aug 16, 2024Summary
Public companies should take note of several recent developments, including:
- Reversal of the Pegasystems trade secrets lawsuit that nevertheless preserves guidance to take care when describing litigation as “without merit”.
- Recent Delaware law changes that provide flexibility for stockholder agreements establishing corporate governance requirements but also some uncertainty.
- Increased SEC focus on disclosures related to artificial intelligence.
- Trends in risk factor disclosures related to recent U.S. Supreme Court administrative law decisions.
Continue to tread carefully if describing lawsuits as “without merit”
As discussed in our August 7, 2023 post, Pegasystems Inc. and its CEO lost motions to dismiss securities fraud claims based on:
- Statements in 10-Qs and 10-Ks that a competitor’s trade secrets lawsuit was “without merit.”
- Assurances in the code of conduct that the company would not use “illegal or questionable means to acquire a competitor’s trade secrets or other confidential information.”
The claims were filed shortly after a $2 billion trade secrets verdict awarded to one of the company’s competitors arising out of a corporate espionage campaign.
After our post:
- In April, Pegasystems settled the securities fraud claims for $35 million.
- Last month, the Virginia Court of Appeals reversed the $2 billion judgment and ordered a new trial, based on evidentiary and jury instruction errors.
However, the lessons provided by the case remain relevant:
- Review disclosure controls and procedures relating to litigation.
- Be sure mechanisms are in place for input from relevant officers and employees.
- Be cautious about using boilerplate language characterizing litigation as “without merit”.
- Consider alternatives such as “the company plans to assert vigorous defenses” or, if reasonably supported, “the company believes that it has substantial defenses”.
- Review codes of conduct and evaluate in light of corporate practices and stock exchange requirements.
Recent Delaware law changes to permit governance restrictions in stockholder agreements provide both flexibility and uncertainty
Effective August 1, 2024, Delaware amended its corporate statute to permit companies, among other things, to contract with stockholders to restrict or prohibit actions or require consent or approval of matters that might otherwise be viewed as contrary to director fiduciary duties, including director nomination rights, board composition and size requirements, and governance consent rights. These types of provisions commonly appear in venture-backed investor rights agreements, proxy contest settlements and private equity arrangements for IPO companies.
The changes were designed to address a Delaware Chancery Court decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company in February that invalidated various corporate governance covenants contained in a stockholder agreement, while acknowledging such provisions would be permissible in the certificate of incorporation. The final language reflects amendments confirming that no provision of a contract shall be enforceable against the company to the extent contrary to the certificate of incorporation or state law if included in the certificate of incorporation.
Other changes include:
- Providing greater flexibility to contract for specific pre-closing remedies in M&A and address post-closing matters, such as indemnities, earn-outs and working capital adjustments.
- Allowing board action to approve a merger agreement in either final or substantially final form, as well as to ratify an agreement before the certificate of merger is filed. Although disclosure schedules are not deemed part of such an agreement, the amendments do not relieve the board of its duty of care to consider material elements.
The amendments gave rise to controversy, including:
- Objections by CII to allowing stockholder agreements to impose governance restrictions as contrary to the interests of long-term investors: July 10, 2024 CII letter to Delaware.
- Criticism by prominent law professor to allowing boards boards to contract away powers without shareholder input: Letter in Opposition to the Proposed Amendment to the DGCL.
As illustrated by a law professor’s speculation as to the potential inadvertent revival of dead-hand pills, the full impact of the amendments may not be known until after future lawsuits are resolved. In particular, the amendments do not alter the fiduciary duties of directors.
SEC increasing focus on disclosures related to artificial intelligence
As discussed in our May 24, 2023 post, issues related to artificial intelligence continue to proliferate. Recent developments include recent SEC enforcement actions for “AI washing,” as discussed in our June 20, 2024 post.
In late June, the Director of the SEC’s Division of Corporation Finance published remarks addressing artificial intelligence as a disclosure priority, stating:
“As companies incorporate the use of artificial intelligence into their business operations, they are exposed to additional operational and regulatory risks. A number of existing rules or regulations may require disclosure about how a company uses artificial intelligence and the risks related to its use, including disclosure in the description of business section, risk factors, MD&A, the financial statements, and the board’s role in risk oversight. In 2024, the Division staff will consider how companies are describing these opportunities and risks, including, to the extent material, whether or not the company:
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clearly defines what it means by artificial intelligence and how the technology could improve the company’s results of operations, financial condition, and future prospects;
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provides tailored, rather than boilerplate, disclosures, commensurate with its materiality to the company, about material risks and the impact the technology is reasonably likely to have on its business and financial results;
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focuses on the company’s current or proposed use of artificial intelligence technology rather than generic buzz not relating to its business; and
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has a reasonable basis for its claims when discussing artificial intelligence prospects.”
As discussed in our June 20, 2024 post:
“As use of artificial intelligence in businesses continues to expand, the temptation to highlight its applications can also grow. Companies should exercise care to ensure that any discussion of AI is supported with internal documentation and balanced in presentation, with appropriate consideration of risks and limitations.”
Consider relevance of risks resulting from U.S. Supreme Court administrative law decisions
As discussed in our July 9, 2024 post, several recent U.S. Supreme Court decisions create uncertainties for federal agency regulations and interpretations. This month, a number of companies included risk factors in their quarterly filings addressing those decisions and potential risks they create. A majority came from the life sciences or healthcare industries. See the examples included in Exhibit A below.
Companies that operate in regulated industries, as well as those that rely on established regulatory environments, should evaluate potential risks of future challenges to agency rules or interpretations – particularly by competitors that operate at a regulatory disadvantage.