Recent Developments for Directors — August 2024

Internal Accounting Controls Provide All-Purpose SEC Enforcement and Continued Focus on Cyber

Last month, the SEC announced another enforcement action emphasizing the need for early disclosure of cybersecurity events. In the recent action, the company had taken three weeks to act on internal alerts of malware on its network and experienced a ransomware attack that did not affect the company’s accounting systems. The SEC charged the company with failing to maintain internal accounting controls to limit unauthorized access to company assets and failing to maintain effective disclosure controls and procedures. The enforcement action continues the SEC’s pattern of enforcement based on an expansive view of internal accounting controls, following two prior cases alleging accounting controls violations for stock buyback authorizations that failed to satisfy the conditions for trading plans under Rule 10b5-1.

Delaware Court Scrutinizes Conflicted-Controller Cases

Recent decisions by the Delaware Chancery Court highlight the need for transparent disclosure to obtain a fully informed vote in a conflicted-controller transaction. Earlier this year, the court rescinded Tesla’s $55.8 billion performance-based stock option award to Elon Musk, despite the award’s approval by a unanimous board of directors and by 73% of the non-affiliated stockholders. The court found that stockholder approval was not fully informed because the proxy statement described some directors as independent despite extensive personal and professional relationships with Musk. Since then, Delaware decisions in the acquisition context have determined that stockholder approval was not fully informed due to financial advisors’ undisclosed interests, such as an economic interest in the controlling stockholder or fees earned in the past and to be earned in the future from transaction participants. In any conflicted-controller transaction context, companies continue to review the independence of directors and financial advisors to support a fully informed stockholder vote.

Activist Campaigns Focus on Board Composition

To date, the 2024 season has seen an increase in settlements and limited full-scale proxy contests with a targeted approach to board change. As expected under the new universal proxy card regime, activists have shifted towards board-refreshment attacks on individual directors rather than full slates. Companies have experienced parallel campaigns by multiple activists, bringing even more complexity, expense, and management distraction. Even those campaigns that fail at the ballot box can achieve some momentum toward their desired changes. Boards are working to identify their companies’ vulnerabilities and prepare an activism readiness plan. Preparedness steps include monitoring early warning signs of activism, engaging with stockholders, reviewing stock ownership filings, monitoring websites and deploying market intelligence resources.

“Far Reaching” Supreme Court Rulings “Roll Back Agency Authority”

The US Supreme Court concluded its term with blockbuster rulings affecting the SEC and administrative law. In three cases, the Court held:

• courts must exercise independent judgment to decide whether an agency has exceeded its statutory authority, overruling the Chevron doctrine that required courts to defer to an agency’s interpretation of statutory ambiguities (Loper Bright Enterprises v. Raimondo);

• the Seventh Amendment prevents the SEC from using its own in-house courts, boasting a 90% success rate, to impose civil penalties against securities fraud defendants, contrary to Congress’s authorization in the Dodd-Frank Act of 2010 (SEC v. Jarkesy); and

• the six-year statute of limitations for lawsuits against an agency begins when final agency action injures a plaintiff, rather than when the agency action occurs (Corner Post, Inc. v. Board of Governors).

The dissenting justices described these cases, each decided on a 6–3 vote, as “a massive sea change” reflecting “the Court’s resolve to roll back agency authority” with “far-reaching” consequences. For more information, see Latham’s Client Alert on Loper Bright and its companion case, Relentless, Inc. v. Department of Commerce, successfully argued by Latham’s appellate team.