I know my friends at the SEC had similar experiences on September 11, 2001. They were getting their work day started when the news of the crash of American Airlines Flight 11 broke, and when it became clear that New York and Washington were under attack, the agency evacuated the old office building at 450 Fifth Street and the staffers began a long trek home in a city that was in complete lockdown.
The New York attacks struck at the heart of the financial district, and so many financial firms were located in the Twin Towers and surrounding buildings that were impacted by the attack. As noted in this press release from then SEC Chair Harvey Pitt, the markets did not open for trading in New York on September 11. In fact, the devastation was so great that markets would not open again until the following Monday, September 17. As noted in this press release, the SEC took bold steps and used, for the first time, its emergency powers to ease certain regulatory restrictions so that the markets could open in an orderly manner. Amazingly, the markets did reopen thanks to the hard work of the SEC staff, the exchanges and all of the financial firms who pulled together in their darkest hour to show the world that the United States would not be defeated by terror. We should remember their efforts as one of the many ways the United States came together to demonstrate our strength and resilience in the face of these attacks.
The July-August issue of The Corporate Executive has been sent to the printer (sign up and order this essential resource today). It’s also available now online to members of TheCorporateCounsel.net who subscribe to the electronic format – an option that many people are taking advantage of in the “remote work” environment. In this issue, I am pleased to bring you articles on preparing for employee activism, the potential issues that could be addressed in a Rule 10b5-1 rulemaking and our compliance guide for the Nasdaq’s new diversity listing requirements.
As we roll into (and through) September, the attention of some non-listed issuers will inevitably turn to an impending SEC rule change that could cause the quotation of their securities in the over-the-counter markets to abruptly cease. Back in September 2020, the SEC adopted a number of amendments to Rule 15c2-11 that the Commission believed were necessary to protect investors in securities that are traded over-the-counter, and compliance with the amendments must generally be achieved by September 28, 2021. As this Baker & Hostetler memo notes:
The Amendment adds additional investor protections by mandating that investors have access to the current and publicly available information of issuers whose securities trade on the OTC markets, and it further requires broker-dealers to confirm that certain information about the issuer and its security is current and publicly available before quoting that security.
As amended, Rule 15c2-11 provides a broker-dealer with two ways to satisfy this obligation: (i) independently obtaining such information from issuers (or their agents) and reviewing it for material accuracy and reliability or (ii) relying on a publicly available determination by a qualified interdealer quotation system (an “IDQS”). OTC Link LLC (which is owned by OTC Markets Group, Inc., formerly known as Pink OTC Markets Inc.) is an IDQS, and the old OTC Bulletin Board (which is a facility of FINRA) is an IDQS (FINRA filed with the SEC to shutter the OTCBB back in September 2020, after the SEC adopted the Rule 15c2-11 amendments.
For the so-called “catch-all issuers” that are not subject to disclosure and reporting requirements under the federal securities laws, broker-dealers and the IDQSs will have to review an expanded list of financial and nonfinancial information about the catch-all issuers that is likely difficult for many such issuers to provide. Further, Rule 15c2-11 requires broker-dealers to be able to provide such information upon the request of any person who expresses an interest in a proposed transaction in the issuer’s security with the broker-dealer. SEC-reporting issuers that are delinquent in their filing obligations (and therefore without current, publicly available information) are also treated as catch-all issuers, but only for purposes of initiating or resuming a quoted market in such issuers’ securities.
With the compliance date of the rule fast approaching, catch-all issuers without current and publicly available information that broker-dealers and the IDQSs can review will find themselves in a position of no longer being quoted in the over-the-counter markets (unless some exception to Rule 15c2-11 applies), and the investors in such issuers will be in for a rude awakening when they are unable to get quotes such issuers’ securities.
Following adoption of the Rule 15c2-11 amendments, OTC Link LLC — responding to suggestions made by the Commission itself that a so-called “expert market” could “enhance liquidity for sophisticated or professional investors in grey market securities” — submitted a request on behalf of certain broker-dealers for an exemption from certain of Rule 15c2-11’s requirements for quotations made on electronic platforms where the distribution of such quotations is limited to sophisticated or professional investors. In December 2020, the SEC proposed to grant OTC Link LLC’s request for exemptive relief and issue a conditional exemptive order, and solicited public comment on that proposal.
The hopes for an expert market alternative were dashed last month, when the staff of the Division of Trading & Markets put out a statement which said:
This proposed order is not on the Chair’s agenda in the short term. Accordingly, on September 28, 2021, the compliance date for the amendments to Rule 15c2-11, we expect that broker-dealers will no longer be able to publish proprietary quotations for the securities of any issuer for which there is no current and publicly available information, unless an existing exception to Rule 15c2-11 applies.
Without the expert market alternative available, those issuers who fall into the category of “OTC Pink – No Information” (i.e., those issuers who cannot or will not provide current and publicly available information) will fall off the Rule 15c2-11 cliff later this month, with nowhere to land.
The present day electronic platform for over-the-counter stock quotations operated by OTC Link had its origins back in the early 1900s, when the National Quotation Bureau printed a weekly inter-dealer quotation service on pink paper. This paper publication continued through the years until the late 1990s, when an electronic quotation service was launched. I can still remember looking at the actual pink sheets, because the SEC subscribed to the service back in the day. It is hard to believe in today’s environment, where traders seek to exploit information imbalances lasting milliseconds, that there was actually a time when broker-dealers would wait a week for updated bid and ask quotes on over-the-counter securities!
BSR, which describes itself as “an organization of sustainable business experts that works with its global network of the world’s leading companies to build a just and sustainable world,” recently announced the launch of the Sustainable Public Equity Offering Framework. This new framework is described as follows:
The SPO Framework aims to apply well-established ESG principles to address a specific gap in today’s financial markets for companies who are transitioning from private to public or are newly public. A SPO is intended to identify public equity offerings by companies with ESG profiles that have been assessed by one or more independent third-parties as having satisfied objective and clearly defined ESG criteria. It is our hope that the creation of the SPO Framework will further focus attention on the fundamental importance of sustainability in business, and particularly in the public markets, and will provide a valuable tool for companies, investors and other market participants in their efforts to facilitate and support sustainability and ESG practices.
The criteria applied to issuers under the SPO Framework is based on six specific topic areas: ESG rating; mission and purpose; climate and environment; value chain; people; and governance. In order to qualify as an SPO, one or more independent third parties assesses the issuer’s compliance with the Issuer Criteria, and a report is issued confirming that the issuer has satisfied the relevant Issuer Criteria prior to the completion of the IPO.
Allbirds, a footwear maker, recently filed a Form S-1 with the SEC for its IPO, and announced that it was hoping to pioneer the SPO Framework. The Form S-1 includes extensive disclosure about the Issuer Criteria for the SPO Framework, and notes that Allbirds worked with ISS ESG to assess and evaluate the company’s performance against the Issuer Criteria. The Form S-1 notest that “ISS ESG completed a review of Allbirds’ ESG commitments, processes, and practices and concluded in an External Review issued on August 30, 2021 that Allbirds has met all of the Issuer Criteria.” Allbirds states in the Form S-1:
We hope that Allbirds’ initial public offering will be the first step in establishing a framework for future SPOs. It is our expectation that an issuer who has conducted an SPO according to the SPO framework and continues to maintain all applicable requirements of the SPO framework will be viewed as a Sustainable Public Company, or an SPC. We will encourage the Advisory Council to continue to refine the SPO framework so that more issuers take into consideration positive ESG outcomes. We believe the establishment and public disclosure of the Sustainable Public Equity Offering framework will help investors better identify public companies that are committed to sustainability and positive outcomes for all stakeholders.
We will see whether the new SPO Framework catches on, as more issuers look for ways to differentiate themselves based on their ESG approach.
Who knew that a global pandemic would be a great time to go public? Allbirds joins a growing list of companies seeking to go public in 2021. With the unofficial end of summer now behind us, we will likely see a rush to the finish line for companies seeking to go public by the end of the year. While SPACs had dominated the IPO market early in the year, all indications are that we will see a rush of operating companies seeking to enter the public markets in the coming months. Thus far, headwinds from the economic outlook and continuing pandemic complications do not seem to have a negative impact on the demand for newly-public companies. Comparisons are inevitably drawn to the dotcom boom of the late 1990s, but is this time different? Only time will tell.
On Friday, the SEC announced a $62 million settlement with The Kraft Heinz Company. The settlement resolved an alleged expense management scheme that the SEC says happened when the company was trying to aggressively cut costs after its 2015 merger.
The case underscores the importance of having strong internal controls that can catch irregularities. According to the SEC, the company had inadequate internal controls for its procurement division that caused gatekeepers to overlook warning signs of manipulated supply agreements and inaccurate reporting. The SEC also announcedcharges against the company’s former COO and former Chief Procurement Officer. Here’s more detail from the press release:
According to the SEC’s order, from the last quarter of 2015 to the end of 2018, Kraft engaged in various types of accounting misconduct, including recognizing unearned discounts from suppliers and maintaining false and misleading supplier contracts, which improperly reduced the company’s cost of goods sold and allegedly achieved “cost savings.” Kraft, in turn, touted these purported savings to the market, which were widely covered by financial analysts.
The accounting improprieties resulted in Kraft reporting inflated adjusted “EBITDA,” a key earnings performance metric for investors. In June 2019, after the SEC investigation commenced, Kraft restated its financials, correcting a total of $208 million in improperly-recognized cost savings arising out of nearly 300 transactions.
The company disclosed the investigation in an earnings release over two years ago. On Friday, it reported the settlement in a Form 8-K, under Item 8.01. The Form 8-K says that it recorded an accrual for the full amount of the penalty in the second quarter of this year.
In a statement published on Friday, SEC Commissioner Caroline Crenshaw says that the Kraft Heinz settlement shows why “corporate benefits” shouldn’t be part of SEC Enforcement’s penalty equation. She first caused a stir with this position at a March CII speech that called into question the 15-year enforcement policy.
Commissioner Crenshaw says that when Kraft announced the SEC investigation back in February 2019, it “bundled” that news with other negative information – a dividend cut and a $15.4 billion write down of goodwill. That makes it hard to tell whether any part of the resulting stock price drop was a reaction to the investigation news. She also says that the company initially estimated that the procurement issues would only increase cost of products sold by $25 million, but by mid-2019, the reporting errors ended up totaling $208 million.
Because this chain of events could make it more difficult for private litigants to recover damages, Commissioner Crenshaw believes that the SEC’s penalties should be more closely linked to misconduct & deterrence. Here’s her conclusion:
A recent analysis determined that it results in dramatically fewer successful recoveries by private securities litigants who, unlike the SEC, must prove that corporate stock price losses were directly attributable to the specific bad news. In this study researchers also concluded that information bundling resulted on average in $21.17 to $23.45 million lower recoveries for shareholders.
In considering the appropriate penalty to impose in actions brought by the SEC, I am concerned about corporate issuers benefiting from information bundling. To the extent corporations thereby make it more difficult to measure corporate benefit, that merely reinforces my inclination in setting penalties to focus more heavily on other factors, such as punishing misconduct and effectively deterring future violations.