E-Minders January 2020
In This Issue:
E-Minders is our monthly e-mail newsletter containing the latest developments and practical guidance for corporate & securities law practitioners.
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Right before the holidays, Corp Fin added to its "CF Disclosure Guidance Topic" series with two new topics. "Topic No. 8: Intellectual Property & Technology Risks Associated with International Business Operations" explains the Staff's views on what companies should consider disclosing about their reliance on technology & intangible assets if they conduct business in places that don't have robust IP laws - and where that disclosure would appear. Here's an excerpt:
Although there is no specific line-item requirement under the federal securities laws to disclose information related to the compromise (or potential compromise) of technology, data or intellectual property, the Commission has made clear that its disclosure requirements apply to a broad range of evolving business risks in the absence of specific requirements. In addition, a number of existing rules or regulations could require disclosure regarding the actual theft or compromise of technology, data or intellectual property if it pertains to assets or intangibles that are material to a company's business prospects. For example, disclosure may be necessary in management's discussion and analysis, the business section, legal proceedings, disclosure controls and procedures, and/or financial statements.
The guidance includes examples of risks that might arise from business relationships - e.g. idiosyncratic license terms that favor the other party or compromise the company's control over proprietary info, regulatory requirements that require companies to store data locally or use local services or technology. It also includes a laundry list of questions companies should ask themselves to assess risks. We'll be posting memos in our "Cybersecurity" Practice Area.
RIP, Staff Legal Bulletins No. 1 and 1A. Corp Fin's new "CF Disclosure Guidance Topic No. 7: Confidential Treatment Applications Under Rules 406 & 24b-2" supersedes that guidance. It addresses how and what to provide when submitting a "traditional" confidential treatment request - i.e. outside of the accommodations from earlier this year that now allow companies to simply redact immaterial confidential information from exhibits. The new disclosure guidance also applies to filings where traditional CTRs remain the only available method to protect private information - e.g. Schedule 13D or exhibits required by Item 1016 of Reg M-A.
After filing the exhibit on Edgar with redactions that show where confidential info is omitted, here's what companies now need to do for written applications (we'll be posting memos in our "Confidential Treatment Requests" Practice Area):
As anticipated, the SEC voted to propose amendments to the definition of "accredited investors." The proposed amendment, issued upon a 3-2 vote, will allow more investors to participate in private offerings by adding more natural persons that will qualify based on their professional knowledge, experience or certifications. Interestingly, the proposal contemplates that these categories could be established by the SEC by order, rather than the rule itself - which would allow the SEC to establish the criteria in the future without notice & comment. Also, the proposed amendments expand the list of entities that may qualify as accredited investors.
During the summer, Liz blogged about the SEC's concept release that included discussion of the accredited investor definition. As the concept release generated a flurry of comment letters, it's hard to say whether this proposal will please everyone. As this Cooley blog notes, the statements of dissent from Commissioners Rob Jackson and Allison Lee - compared to the statements of support from Commissioners Hester Peirce and Elad Roisman - highlight the differences in views that exist about the fundamental purposes of the securities laws.
The proposal doesn't raise the income and wealth thresholds that have existed since 1982 or suggest adjustments for inflation in the future. This WSJ article says that the lack of an inflation adjustment has contributed to the current number of qualifying households rising over time - from 1.3 million in 1983 to 16 million this year. And among the 69 questions that the SEC specifically requests people to comment on is whether the standards should be tied to geographic reasons to account for potentially lower costs of living.
We'll be posting memos in our "Accredited Investor" Practice Area to help everyone stay up to date with the latest on the proposed changes.
As mentioned in the press release about the proposed expansion of the "accredited investor" definition, the SEC also proposed expanding the definition of "qualified institutional buyers" under Rule 144A. The expanded definition would add LLCs and RBICs (Rural Business Investment Companies) to the types of entities eligible for QIB status if they meet the securities owned and investment threshold in the definition. There's also a new 'catch-all' category that would permit institutional accredited investors under Rule 501(a), of an entity type not already included in the QIB definition, to qualify as QIBs when they satisfy the $100 million threshold.
We'll post memos in our "Rule 144A" Practice Area as they come in.
In late December, the SEC announced proposed amendments to Rule 2-01 of Reg S-X that would "modernize" the auditor independence rules and codify Staff consultations - which have been influencing how the rules are interpreted since they were adopted in 2000 and last amended in 2003. If adopted, the proposed amendments would:
- Amend the definitions of affiliate of the audit client, in Rule 2-01(f)(4), and Investment Company Complex, in Rule 2-01(f)(14), to address certain affiliate relationships, including entities under common control
- Amend the definition of the audit and professional engagement period, specifically Rule 2-01(f)(5)(iii), to shorten the look-back period, for domestic first time filers in assessing compliance with the independence requirements
- Amend Rule 2-01(c)(1)(ii)(A)(1) and (E) to add certain student loans and de minimis consumer loans to the categorical exclusions from independence-impairing lending relationships
- Amend Rule 2-01(c)(3) to replace the reference to "substantial stockholders" in the business relationship rule with the concept of beneficial owners with significant influence
- Replace the outdated transition and grandfathering provision in Rule 2-01(e) with a new Rule 2-01(e) to introduce a transition framework to address inadvertent independence violations that only arise as a result of merger and acquisition transactions
- Make certain miscellaneous updates
The announcement runs through a couple of hypos that show how the proposal would address interpretive issues that have been popping up. As always, there'll be a 60-day comment period that runs from when the proposing release is published in the Federal Register. Also see the summary in this Cooley blog...
Keeping step with the fast-approaching year-end rush, the SEC also voted to propose rules requiring mining companies to disclose payments made to foreign governments or the U.S. government for the commercial development of oil, natural gas or minerals.
The Commission is statutorily obligated to issue a rule in this area. And, as outlined in the SEC press release about the proposed rules and in Broc's blog back a couple of years ago, the path to these new proposed rules has been anything but smooth. Here's an excerpt from the SEC press release:
The Commission first adopted rules in this area in 2012, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"). The 2012 rules were vacated by the U.S. District Court for the District of Columbia. The Commission then adopted new rules in 2016, which were disapproved by a joint resolution of Congress pursuant to the Congressional Review Act.
When the SEC raised the "smaller reporting company" threshold to $250 million last year, one point of contention was that it didn't make an analogous change to the "accelerated filer" definition. So as confirmed in a set of CDIs from Corp Fin, a company can now be both a "smaller reporting company" and an "accelerated filer." And although the SEC proposed amendments to both the "accelerated filer" and "large accelerated filer" definitions earlier this year, the proposed rules haven't been adopted and there would still be some overlap between the filer categories.
Our members have asked a lot of questions about this over the last year. It's hard to parse through all the rules! We were happy to see that this Ackerman memo lays out a chart for those companies that find themselves navigating this dual status.
For each Item of Reg S-K that applies to periodic reports, the chart compares general disclosure requirements to the rules that apply to smaller reporting companies - and shows whether or not "dual status" companies can take advantage of scaled disclosure accommodations. The memo also highlights that companies holding "dual status" need to comply with accelerated filer filing deadlines - i.e. 75 days after year end for their Form 10-K and 40 days after quarter end for their Form 10-Qs. Don't forget about our "Disclosure Deadlines" Handbook if you're looking for more in-depth info.
In early December, we blogged that the SEC had rejected the NYSE's proposed rule change to permit companies to sell newly issued primary shares via a direct listing - only 10 days after the exchange had submitted it. The SEC hasn't made any public statements about why it rejected the proposal, so we still don't know for sure whether it was because the Commission is fundamentally opposed to direct listings, believes that rulemaking is required, or if there was just something it wanted the NYSE to tweak. But the NYSE signaled that it would continue working on this initiative, and it's now submitted this revised proposal. As this Davis Polk memo explains, it's pretty similar to the original:
The new rule change proposal is substantially similar to the proposal the NYSE filed in November, except that issuers can meet the NYSE's market value requirement by selling $100 million of shares (rather than $250 million under the initial proposal). Consistent with the initial proposal, the revised rule change proposal would provide the same flexibility for an issuer to sell newly issued primary shares into the opening auction in a direct listing, and would also delay the requirement that an issuer have 400 round lot holders at the time of listing until 90 trading days after the direct listing (subject to meeting certain conditions).
Stay tuned as to whether this revision addresses the SEC's concerns. As Broc blogged when the original proposal was submitted, some are worried about investor protection issues for listings that occur outside of the traditional IPO process - but others note that there are a number of misconceptions about direct listings, including that a direct listing is even a "capital-raising" activity (see more from this Fenwick & West piece). We're continuing to post memos in our "Direct Listings" Practice Area.
As we blogged earlier, the NYSE proposal to allow "direct listings" for primary offerings has been revised and is back on the table, and it's led to a lot of chatter and head-scratching about how exactly this path would work. This 12-page memo from Gibson Dunn is a good up-to-date resource that outlines benefits, issues to consider and current rules that apply. The memo has a nice tabular overview of the various listing standards so that you can compare different alternatives (as Liz also blogged recently, Nasdaq now has a rule that allows secondary direct listings on its Global Select, Global and Capital Markets).
At this point, we still don't know why the SEC rejected the first NYSE proposal - was it something that the NYSE adequately addressed in its revised proposal, or does the SEC think there's a fundamental problem with primary direct listings, for investor protection or other reasons? Stay tuned, we'll be blogging more on this topic as it develops.
In early December, the SEC approved this recent Nasdaq proposal that will allow "resale" direct listings on the Nasdaq Global Market and the Nasdaq Capital Market - an extension of an already-existing rule that allows these types of direct listings on the Nasdaq Global Select Market.
This Wilson Sonsini memo summarizes the final rule - and explains how the valuation parameters for companies listing shares on Nasdaq's Global and Capital Markets differ slightly from what applies to the Nasdaq Global Select Market.
The exchanges have been busy. In November, Nasdaq filed this rule proposal that would require listed companies to provide Nasdaq with info about the number of their non-affiliate shares that are subject to trading restrictions - e.g. due to lockups or standstills, private offering restrictions, etc. - if the exchange observes unusual trading activity that implies limited liquidity.
Under the proposed rule, Nasdaq could also halt trading in connection with the request and could require companies with inadequate "unrestricted public float" to adopt a plan to increase the number of unrestricted shares. Nasdaq already has a similar rule for initial listings, but this would extend the concept to continued listing rules.
The SEC posted the rule for comment in mid-December, so we likely won't know for at least a couple of months whether this rule will be approved in current form or at all.
Recently, the SEC published its latest Reg Flex Agenda - both the "Active" agenda and the "Long-Term Actions" agenda (combined, they are also known as the "Unified Agenda"). When it comes to rulemaking that might be proposed over the next year, it was interesting to see that clawbacks made the list! But pay-for-performance did not. The near-term agenda includes:
Two years ago, the Reg Flex Agenda was changed so that it came in two flavors: "Existing Proposed & Final Rule Stages" (together known as "Active") - and "Long-Term Actions." That has now been slightly changed so that there are three categories - "Pre-Rule Stage" (only one item in this category); "Proposed Rule Stage"; and "Final Rule Stage" - in the "Active" bucket.
Note that there have been a number of proposals issued by the SEC in recent months and those are listed under the "Proposed Rule Stage" rather than the "Final Rule Stage" like other proposed rulemakings - perhaps because the comment periods for those more recent proposals are still open...
This statement from SEC Chair Jay Clayton, Chief Accountant Sagar Teotia and Corp Fin Director Bill Hinman was issued in late December to remind audit committees of their oversight responsibilities in financial reporting - and to remind companies that audit committees need adequate resources & support to fulfill their obligations. Here's an excerpt:
- Non-GAAP Measures - Non-GAAP measures and other metrics used to gauge company performance, when used appropriately in combination with GAAP measures, can provide decision-useful information to investors on the company's performance from management's perspective. It is important that audit committees understand whether—and how and why—management uses non-GAAP measures and performance metrics, and how those measures are used in addition to GAAP financial statements in the company's financial reporting and in connection with internal decision making. We encourage audit committees to be actively engaged in the review and presentation of non-GAAP measures and metrics to understand how management uses them to evaluate performance, whether they are consistently prepared and presented from period to period and the company's related policies and disclosure controls and procedures.
- Reference Rate Reform (LIBOR) - The expected discontinuation of LIBOR could have a significant impact on financial markets and may present a material risk for many companies. The risks associated with this discontinuation and transition will be exacerbated if the work necessary to effect an orderly transition to an alternative reference rate, a process often referred to as reference rate reform, is not completed in a timely manner. We encourage audit committees to understand management's plan to identify and address the risks associated with reference rate reform, and specifically, the impact on accounting and financial reporting and any related issues associated with financial products and contracts that reference LIBOR.
- Critical Audit Matters - Beginning in 2019, certain public companies' auditors are required to communicate critical audit matters (CAMs) in the auditor's report. While the independent auditor is solely responsible for writing and communicating CAMs, we encourage audit committees to engage in a substantive dialogue with the auditor regarding the audit and expected CAMs to understand the nature of each CAM, the auditor's basis for the determination of each CAM and how each CAM is expected to be described in the auditor's report. In short, we would expect that the discussion of the CAM in the auditor's report will capture and be consistent with the auditor-audit committee dialogue regarding the relevant matter. We encourage audit committees to continue their efforts to understand the new standard and remain engaged with auditors in the implementation process.
You likely saw this November WSJ article, detailing an SEC investigation into one company's end-of-quarter "earnings management" practices - e.g. leaning on customers to take early deliveries and rerouting products to book sales. The company says "everyone's doing it" - and according to a McKinsey survey described in this Cleary blog, that's not too much of an exaggeration:
Lest anyone think the SEC's focus on "pulling in" revenues is an issue of limited relevance, note that approximately 27% of US public companies provide quarterly guidance, and evidence of widespread earnings management is not merely anecdotal. A broad survey by McKinsey reveals that, when facing a quarterly earnings miss, 61% of companies without a self-identified "long-term culture" would take some action to close the gap between guided and actual earnings, with 47% opting to "pull-in" sales. 71% of those companies would decrease discretionary spending (e.g., spending on R&D or advertising), 55% would delay starting a new project, even if some value would be sacrificed, and 34% would delay taking an accounting charge.
But the widespread nature of these practices doesn't make the SEC more amenable to them - e.g. they imposed a $5.5 million fine and a cease-and-desist order in a recent enforcement action involving similar maneuvers. The blog notes:
The use of any of these techniques, if resulting in the obfuscation of a "known trend or uncertainty . . . that may have an unfavorable impact on net sales or revenues or income from continuing operations," would presumably be equally objectionable to the SEC.
Accordingly, for those companies that are still providing earnings guidance, it would be prudent to make sure that your disclosure committee is having frank and frequent discussions with management about exactly what, if any, earnings management tools are being used, whether these tools fit squarely within the company's revenue recognition policies, whether the company's auditors are aware of the scope and persistence of these practices, and, most importantly, whether the use of the tools is, intentionally or not, masking a trend of declining sales, a declining market share, declining margins, or other significant uncertainties.
In response to investor pressure to issue an earnings release within the same time frame as prior years, the company announced its 2017 year-end financial results on March 8th and furnished its earnings release on Form 8-K. The company issued the earnings release despite the departure of senior finance and accounting managers, pervasive ERP implementation and internal control issues, and a seven-week delay in the filing of its third quarter 2017 Form 10-Q.
According to the SEC, the earnings release materially misstated, among other things, the company's earnings for 2017.
On March 19th, the company filed a Form 8-K with the Commission disclosing that it expected its 2017 Financial Results to differ from what had been reported in the March 8th earnings release. The company's shares declined over eight percent that day.
The company settled with the SEC for $250,000. The pain of dealing with an Enforcement action - and the loss of credibility - was likely an even greater punishment...
In early December, the House passed the "Insider Trading Prohibition Act" by a vote of 410-13. John blogged about the bill back in June when it passed out of the House Financial Services Committee - it would broadly describe "wrongful" trading or communication of material non-public information by tying it to:
(A) theft, bribery, misrepresentation, or espionage (through electronic or other means);
(B) a violation of any Federal law protecting computer data or the intellectual property or privacy of computer users;
(C) conversion, misappropriation, or other unauthorized and deceptive taking of such information; or
(D) a breach of any fiduciary duty, a breach of a confidentiality agreement, a breach of contract, or a breach of any other personal or other relationship of trust and confidence.
The legislation would also require only that a defendant was aware or recklessly disregarded that the inside information was wrongfully obtained - rather than specific knowledge of how it was obtained or whether there was a "personal benefit" involved. It also leaves open the possibility that 10b5-1 transactions could be exempt from insider trading prosecution. Mostly, though, it pretty closely tracks current case law.
So what are the odds that this bill will become law? It appears to have "bipartisan" support - but it's also been floating around in some form since 2015 and hasn't made it to the finish line yet. The repetition certainly makes it easier to come up with headlines - we copied this headline from a 2017 write-up by John.
Among other new additions, during the last month we have posted:
TheCorporateCounsel.net Bids Farewell to Broc Romanek: Our veteran, well-loved Editor, Broc Romanek, departed on December 31st to pursue his "Epic Time of Yes." As John blogged, "If you seek his monument, look around you."
To build on Broc's extraordinary efforts to create community and incredibly practical resources, Liz Dunshee has been named Managing Editor, after training closely with Broc for several years as part of his succession plan. Along with our other well-respected experts, Dave Lynn and John Jenkins will also continue to provide their insights with enhanced roles as Senior Editors.
Paul Munter Appointed as Deputy Chief Accountant in Office of the Chief Accountant: The SEC announced in December that Paul Munter was appointed as Deputy Chief Accountant. Munter is a former KPMG partner and will lead the office's activities on international matters.
John Vanosdall Appointed as Deputy Chief Accountant in SEC's Office of the Chief Accountant: The SEC also announced in December that John Vanosdall was appointed as Deputy Chief Accountant. Vanosdall was a partner at PwC and will lead the activities of the office's accounting group.
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