April One-Minute Reads

SEC brings enforcement actions for AI washing

In March 2024, the Securities and Exchange Commission (SEC) settled enforcement actions for a total of $400,000 in penalties against two investment advisers for making false and misleading statements about their use of artificial intelligence. The SEC found that the two investment advisers claimed they were using an AI model, and that they were the “first regulated AI financial advisor,” when they were not. In a statement, Gurbir Grewal, director of the SEC’s Division of Enforcement, said, “As more and more investors consider using AI tools in making their investment decisions or deciding to invest in companies claiming to harness its transformational power, we are committed to protecting them against those engaged in ‘AI washing.’” Grewal also extended his comments to issuers, warning that “public issuers making claims about their AI adoption must also remain vigilant about similar misstatements that may be material to individuals’ investing decisions.”

State Street releases 2024 proxy voting and engagement policy

On March 25, 2024, State Street released its 2024 proxy voting and engagement policy, effective for voting decisions as of March 26, 2024. The only material change in the policy made by State Street was to its overboarding policy. Under the revisions, State Street has updated its policy on limits for the number of outside boards on which a public company director may serve. This is in exchange for a company-centric approach that requires a company to adopt a director time commitment policy – inclusive of an annual review process for evaluating director time commitments and numerical limits to the number of outside boards a director can serve on. For companies that do not adopt a director time commitment policy, State Street will impose strict numerical limits on named executive officers, nonexecutive board chairs, lead independent directors and nonexecutive directors. See a complete summary of the updated policy.

Amendments proposed to Delaware General Corporation Law

The Council of the Corporation Law Section of the Delaware Bar Association has proposed amendments to the Delaware General Corporation Law that address the effects of recent Delaware cases. The proposed amendments would:

1. Explicitly permit a corporation to enter into contracts with current or prospective stockholders that contain the consent rights over certain corporate actions.
2. Allow for parties in a merger to contract for penalties or other consequences for a breach of the merger agreement or other failure to consummate the merger, and allow for the appointment of a stockholder representative to enforce any post-closing rights on behalf of stockholders.
3. Provide boards with the ability to approve agreements in either final or substantially final form, allow boards to timely ratify agreements, and exclude certain schedules to an agreement, including disclosure schedules, from being deemed part of the agreement unless expressly stated in the agreement.

The amendments still need to be approved by the executive committee of the Delaware Bar Association, as well as the Delaware General Assembly, before becoming effective. For additional reading, see this April 2 PubCo post.

California’s climate rules face challenges

In January 2024, the US and California Chambers of Commerce, along with other parties, filed a complaint against the California Air Resources Board (CARB) and the California attorney general challenging California’s new climate reporting laws – the Climate Corporate Data Accountability Act and the Climate-Related Financial Risk Act. The complaint seeks declaratory and injunctive relief to prevent California from enforcing the laws under the theory that they violate the First Amendment, are precluded under the supremacy clause by existing federal legislation and are invalid under the dormant commerce clause of the US Constitution. CARB filed a motion to dismiss the complaint for lack of subject matter jurisdiction and failure to state a claim. For details on CARB’s motion to dismiss, see this April 1 PubCo post. For a summary of the California climate laws at issue in the lawsuit, refer to this September 19, 2023, Cooley client alert.

Disclosure reminders noted for March 31 year-end companies

For companies with a fiscal year that ended on or after March 31, 2024 – excluding smaller reporting companies – the Rule 10b5-1 and insider trading disclosure requirements adopted in December 2022 will be required in their upcoming annual reports and proxy statements. Specifically, new Item 402(x) requires issuers to disclose their option grant policies and practices in relation to the disclosure of material nonpublic information, as well as providing tabular disclosure showing grants made in the four business days before, or one business day after, the release of material nonpublic information in periodic or current reports. This includes the percentage change in the market price of the underlying securities from the trading day before and after the release of such information. In addition, issuers will be required to disclose in their Form 10-Ks, 20-Fs, or proxy and information statements whether – and, if not, why not – they have adopted insider trading policies and procedures and, file a copy of their insider trading policies and procedures as an exhibit to Forms 10-K or 20-F, respectively. Disclosure, other than the exhibit filing, must be tagged using iXBRL.

Jury confirms shadow trading theory

On April 8, 2024, the jury in the Panuwat case against the SEC returned with a verdict, finding Matthew Panuwat liable for insider trading on the theory of shadow trading. In this case, the SEC claimed that Panuwat, an employee at Medivation, inappropriately used insider information related to Medivation’s upcoming merger with Pfizer to trade in the securities of an unrelated public company, Incyte Corporation, in violation of the Exchange Act. The SEC’s claim rested on the theory that because Medivation and Incyte were comparable companies in the same industry, the news of Medivation’s merger would boost the stock price of Incyte. Thus, using Medivation’s material nonpublic information to trade in Incyte’s securities ahead of the public announcement was still a violation of Rule 10b-5. The jury returned a verdict in two hours and sided with the SEC. For further analysis of the case, see this April 8 PubCo post.

Delaware Supreme Court applies MFW framework to other conflicted transactions

The Delaware Supreme Court recently issued a decision in In Re Match Group, Inc. Derivative Litigation, finding that in a transaction where a controlling stockholder stands on both sides of a transaction with a controlled corporation and receives a nonratable benefit, then entire fairness (and not business judgment) is the presumptive standard of review. A controlling stockholder may shift the burden of proof back to the plaintiff by either using a special committee comprised of members independent of the controlling stockholder to evaluate and approve the transaction, or approving the transaction by the affirmative vote of unaffiliated stockholders. If the controlling stockholder utilizes both shareholder protection measures – using a special committee and seeking a vote of unaffiliated stockholders – then the business judgment standard of review can apply.

The case involved the reverse spinoff of a company that acquired the business of Match.com. The acquiror remained the controlling shareholder of Match even after Match’s 2015 initial public offering, holding more than 98% of the voting power of Match. The reverse spinoff was approved by a special committee and a vote of unaffiliated shareholders. However, one of the members of the special committee was the former chief financial officer of the controlling shareholder. The Delaware Supreme Court ultimately determined that because one member of the special committee was not independent, the company had not met the requirements to shift the standard of review from entire fairness to business judgment.

US Supreme Court holds pure omissions not actionable under Rule 10b-5(b)

The US Supreme Court held that a pure omission – an omission that does not render an affirmative statement materially misleading – cannot form the basis of a securities fraud claim under Rule 10b-5(b). This decision resolves a circuit split regarding whether a company can be held liable under Rule 10b-5(b) solely for failing to make a disclosure required by Item 303 of Regulation S-K. With this decision, the Supreme Court held that such omissions cannot form the basis of a Rule 10b-5(b) claim if the omissions do not render the existing disclosure materially misleading. Companies should keep in mind that pure omissions can still trigger liability under Section 11 of the Securities Act of 1933, and the SEC can bring enforcement actions for violations of Item 303. For further reading, see this April 18 Cooley client alert.

Delaware judge reminds companies that good board minutes may reduce risk

Former Chief Justice of the Delaware Court of Chancery Leo Strine, Jr. reminds companies that, in a time when many plaintiffs are requesting books and records in connection with breach of fiduciary duty and securities law claims, good board minutes are paramount. Justice Strine’s article highlights some instances where having sufficient corporate records helped companies facing challenges in the Delaware Court of Chancery and the Delaware Supreme Court. This includes cases where having formal board documents prevented petitioners from accessing informal information, like texts and emails, and where having corporate records that show directors attempted to address a compliance risk allowed Caremark complaints to be dismissed. In addition to highlighting the benefits of good corporate recordkeeping, the article also provides suggestions for how to keep those corporate records in good order. Companies should consider implementing a specific protocol for recording minutes at meetings (ensuring that minutes cover key evolving issues and tie up loose ends), reviewing and approving minutes with an active, iterative and deliberative process (ideally no later than the next meeting), and using approved minutes to draft key disclosure documents, such as proxy statements and committee reports. See the full journal article.

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