I blogged yesterday about the SEC’s proposed amendments to the Rule 10b5-1 safe harbor. Orrick’s JT Ho, Carolyn Frantz and Soo Hwang kindly provided this guest post to outline what steps companies should consider taking right now, in light of this proposal:
Earlier this week, the SEC proposed amendments – subject to a 45-day comment period – to add new conditions to the availability of an affirmative defense under Rule 10b5-1 and add new disclosure requirements regarding insider trading policies and procedures of issuers as well as the timing of stock option grants. Many of the proposed amendments, such as a statutory cooling-off period for 10b5-1 plans, were expected and aligned with the recommendations issued by the Investor Advisory Committee in September 2021.
However, the proposed amendments requiring that companies publicly disclose their “insider trading policies and procedures,” as well as the timing of stock option grants to directors and officers, were not as widely expected. We expect that companies will likely wait for the SEC’s final rules before formally modifying their 10b5-1 guidelines, though they would be well advised to brief their treasury departments and individuals using those plans about the potential changes now. Outside of 10b5-1-specific issues, however, we believe there are several steps companies should take now in advance of potential required disclosure, including:
• Reviewing and updating their insider trading policies;
• Creating or reviewing formal written insider trading procedures; and
• Reviewing stock option grant timing practices, or creating stock option grant timing policies.
Potential Updates to Insider Trading Policies
The SEC’s proposed amendments do not precisely specify what types of information about company insider trading policies would need to be disclosed, though indications are that significant detail will be expected. The proposed rule contemplates that companies would provide detailed information to allow investors to assess the sufficiency of insider trading policies and procedures. Elaborating, the SEC explained:
“For example investors may find useful, to the extent it is included in the issuer’s relevant policies and procedures, information on the issuer’s process for analyzing whether directors, officers, employees, or the issuer itself when conducting an open-market share repurchase have material nonpublic information; the issuer’s process for documenting such analyses and approving requests to purchase or sell its securities; or how the issuer enforces compliance with any such policies and procedures it may have. Furthermore, the disclosure under proposed Item 408 could address not only policies and procedures that apply to the purchase and sale of the registrant’s securities, but also other dispositions of the issuer’s securities where material nonpublic information could be misused such as, for example, through gifts of such securities.”
Given the complexity and importance of insider trading policies, we believe companies should begin reviewing their policies before they must be described in SEC filings. Aside from 10b5-1 plan related issues, we note several issues that, in our experience, may need to be updated in company insider trading policies:
• Preclearance procedures – upcoming public and investor scrutiny may result in companies wishing to adopt preclearance procedures, or expand the scope of individuals covered by them, and may also occasion a reevaluation of issues like the length of time after pre-clearance during which a trade may be made.
• Scope of insider trading definitions – Especially in light of the SEC’s recent insider trading complaint against an employee of a biopharmaceutical company for trading in the stock of a competing company about which the employee did not have direct information, many companies are updating their definitions of insider trading.
• Gifts – some insider trading policies do not have clear guidance for whether, and when, gifts are subject to the policy’s restrictions. The SEC’s proposed rule specially calls out gifts as an area for disclosure.
• Definition of material non-public information (“MNPI”) – insider trading policies often include lists of examples of MNPI. Companies have recently been updating these lists to include issues of growing significance, such as cybersecurity and certain sustainability matters.
Formalization of Insider Trading Procedures
In addition to disclosure about insider trading policies themselves, the SEC’s proposed rule contemplates required disclosure about insider trading procedures. Many companies do not today have formal written procedures for insider trading. We anticipate that many companies will wish to adopt such procedures well in advance of any disclosure requirement, to provide an opportunity for multi-stakeholder review and to ensure that the procedures work well in practice before they are revealed publicly. Such procedures could include: a discussion of the availability of the insider trading policy, the type and frequency of training about that policy, the process for determining whether a potential trader possesses MNPI, the process for creating documentation about preclearance and other decisions, the process for creating and enforcing special blackout periods, the process for reporting and investigating potential violations, and principles guiding the consequences for violations.
Stock Option Grant Timing
Under the proposed rules, companies would be required to disclose in a new table any option awards to named executive officers or directors that are made within a certain timeframe within the release of material nonpublic information such as an earnings announcement. Such disclosure will likely lead to even more scrutiny regarding the timing of option grants. Companies should begin considering their practices now, and determine whether to adopt a formal policy regarding the timing of stock option grants, if they do not already have one. Such policies can help address the potential shareholder claims that can arise when stock options are granted during closed windows or just prior to the release of MNPI.
Earlier this week, BlackRock issued its 2022 Proxy Voting Guidelines. For the first time, the Guidelines establish a percentage target for the number of diverse board members at U.S. companies. This excerpt describes the new policy:
We expect boards to be comprised of a diverse selection of individuals who bring their personal and professional experiences to bear in order to create a constructive debate of a variety of views and opinions in the boardroom. We are interested in diversity in the board room as a means to promoting diversity of thought and avoiding “group think”.
We ask boards to disclose how diversity is considered in board composition, including demographic factors such as gender, race, ethnicity, and age; as well as professional characteristics, such as a director’s industry experience, specialist areas of expertise, and geographic location.
We assess a board’s diversity in the context of a company’s domicile, business model, and strategy. We believe boards should aspire to 30% diversity of membership and encourage companies to have at least two directors on their board who identify as female and at least one who identifies as a member of an underrepresented group.
BlackRock defines members of an underrepresented group to include, without limitation, “individuals who identify as Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, or Native Hawaiian or Pacific Islander; individuals who identify as LGBTQ+; individuals who identify as underrepresented based on national, Indigenous, religious, or cultural identity; individuals with disabilities; and veterans.”
While the policy speaks in aspirational terms, keep in mind that lack of board diversity was the top reason that BlackRock withheld votes from directors in 2021, accounting for 61% of negative votes.
BlackRock’s update of its voting policies was part of a broader policy update – check out Emily’s blog on CompensationStandards.com and Lawrence’s blog on PracticalESG.com for more on some of the important changes to BlackRock’s policies.
A new study from Notre Dame & Ohio U business school professors finds that the SEC’s demanding disclosure regime for auditor terminations is useless when it comes to determining the likelihood of restatements. Here’s an excerpt from an article on the study:
While most seasoned investors realize that companies tend to be cagey about their reasons for firing auditors, the research finds the disclosures are useless to an extreme. “Opaque Auditor Dismissal Disclosures: What Does Timing Reveal that Disclosures Do Not?” is forthcoming in the Journal of Accounting and Public Policy from Jeffrey Burks, the Thomas and Therese Grojean Family Associate Professor of Accountancy in Notre Dame’s Mendoza College of Business, and Jennifer Sustersic Stevens of Ohio University.
In a sample of some 1,400 auditor firings, company revelations of disagreements with the auditor or other auditor concerns exhibit no systematic ability to forecast whether the company will restate its financial statements.
“The lack of predictive ability suggests that companies’ decisions to disclose such auditor concerns are so inconsistent and uncommon — even though the regulation requires their disclosure — that no predictive power results,” said Burks, who researches financial accounting and misstatements.
The authors say that investors should focus on the timing of the dismissal rather than 8-K disclosure, because companies that fire auditors after the second quarter have a roughly 40% greater chance of a future restatement. A WSJ article on the study quotes one commentator as saying that the problem is the disclosure rules’ focus on disagreements with auditors, and that accounting firms “try hard to avoid differences of opinion escalating to the point that they have to be reported.”
Instead of tweaking disclosure rules, the study’s authors say that the PCAOB & SEC should inquire about the reasons for changes in auditors during the examination and comment letter process and cite Blue Wave Group’s extremely frank response to a 2010 SEC comment about its disclosures concerning a change in auditors as an example of the kind of disclosure such an inquiry might elicit.
Yesterday, the SEC issued proposed amendments to Rule 10b5-1 and related rules imposing new conditions & disclosure requirements for 10b5-1 plans and securities transactions by companies and insiders. Here’s a copy of the163-page proposing release & the two-page fact sheet on the proposed rules. The SEC’s press release also provides a good summary of the proposal:
The proposed amendments to Rule 10b5-1 would update the requirements for the affirmative defense, including imposing a cooling off period before trading could commence under a plan, prohibiting overlapping trading plans, and limiting single-trade plans to one trading plan per twelve month period. In addition, the proposed rules would require directors and officers to furnish written certifications that they are not aware of any material nonpublic information when they enter into the plans and expand the existing good faith requirement for trading under Rule 10b5-1 plans.
The amendments also would elicit more comprehensive disclosure about issuers’ policies and procedures related to insider trading and their practices around the timing of options grants and the release of material nonpublic information. A new table would report any options granted within 14 days of the release of material nonpublic information and the market price of the underlying securities the trading day before and the trading day after the disclosure of the material non-public information. Insiders that report on Forms 4 or 5 would have to indicate via a new checkbox whether the reported transactions were made pursuant to a Rule 10b5-1(c) or other trading plan. Finally, gifts of securities that were previously permitted to be reported on Form 5 would be required to be reported on Form 4.
For the most part, the proposed changes to Rule 10b5-1 track the recommendations made by the SEC’s Investor Advisory Committee, but the proposal does not include Form 8-K & proxy disclosure requirements relating to corporate & insider 10b5-1 plans that the IAC advocated. The portions of the proposed rules addressing disclosure of the timing of option grants follow up on the Staff’s recent guidance on accounting for “spring loaded” awards. Finally, in what’s become a very unusual event in recent years, the commissioners unanimously voted to approve the issuance of the rule proposal.
At yesterday’s open meeting, the SEC also issued proposed rules addressing disclosure requirements for issuer repurchases. Here’s the 101-page proposing release along with the two-page fact sheet. This excerpt from the SEC’s press release summarizes the proposal:
The proposed rules would require an issuer to provide a new Form SR before the end of the first business day following the day the issuer executes a share repurchase. Form SR would require disclosure identifying the class of securities purchased, the total amount purchased, the average price paid, as well as the aggregate total amount purchased on the open market in reliance on the safe harbor in Exchange Act Rule 10b-18 or pursuant to a plan that is intended to satisfy the affirmative defense conditions of Exchange Act Rule 10b5-1(c).
The proposed amendments also would enhance existing periodic disclosure requirements regarding repurchases of an issuer’s equity securities. Specifically, the proposed amendments would require an issuer to disclose: the objective or rationale for the share repurchases and the process or criteria used to determine the repurchase amounts; any policies and procedures relating to purchases and sales of the issuer’s securities by its officers and directors during a repurchase program, including any restriction on such transactions; and whether the issuer is making its repurchases pursuant to a plan that it intends to satisfy the affirmative defense conditions of Exchange Act Rule 10b5-1(c) and/or the conditions of the Exchange Act Rule 10b-18 non-exclusive safe harbor.
SEC Chair Gary Gensler mentioned that buybacks were on the SEC’s agenda when he discussed his desire to make changes to Rule 10b5-1, but the release notes that some of the disclosure proposals date back to the 2016 Reg S-K concept release. As Broc pointed out at the time, footnote 625 of that release noted that Australia required next day disclosure of buybacks. Well, G’day America! because it looks like that requirement may be heading your way.
Unlike the Rule 10b5-1 proposal, this one prompted a dissent from Commissioner Peirce (here’s her statement) and Commissioner Roisman (here’s his statement). Speaking of statements, the SEC acted on the PCAOB’s budget and proposed rule amendments on securities-based swaps & money market funds yesterday as well, and every commissioner issued a statement on every action. If you subscribe for updates from the SEC’s website, you already noticed this, because your inbox started exploding early yesterday afternoon.
As noted above, in a rather striking departure from the SEC’s recent rulemaking decisions, the commissioners unanimously voted in favor of the Rule 10b5-1 rule proposal. Despite the commissioners’ unanimity, I think there are still some things to take issue with in terms of the substance of the proposal. In an earlier blog, Liz cited comments from a number of in-house lawyers suggesting that some Rule 10b5-1 reforms – like a mandatory 120-day cooling off period – may represent a solution in search of a problem.
On that point, I think a recent back & forth between Commissioner Lee and three Democratic senators is kind of illuminating. Earlier this year, when Commissioner Lee was serving as Acting Chair, the senators sent her a letter on Rule 10b5-1 issues. Among other things, the senators asked for a response to the following question: “how many enforcement actions has the agency taken with regard to 10b5-1 plans in the past five years? Please provide a list and summary of all such actions.”
In her response, the best that Commissioner Lee apparently could come up with was a list of actions in which “public charging documents mention Rule 10b5-1 plans.” [Emphasis added.] This list included six actions, none of which directly addressed violations of the rules governing 10b5-1 plans themselves. Instead – with the exception of one action in which internal controls were at issue – these charging documents simply noted that during the pendency of the conduct in question, one of the alleged bad guys made sales under a 10b5-1 plan.
It’s an open secret that academic commentators think Rule 10b5-1 is a scam, and their concerns about the rule are cited liberally in the proposing release. But Commissioner Lee’s inability to cite a single enforcement action where a 10b5-1 plan was front & center suggests that either the SEC has been asleep at the switch for quite some time or – just maybe – Rule 10b5-1 generally works as intended.
I’ve read some of the academic commentary on Rule 10b5-1 plans, and their critique usually boils down to “the evidence irrefutably demonstrates that insiders with 10b5-1 plans outperformed other investors, so there’s obviously something fishy going on here.” I don’t necessarily agree with that generalization, particularly since 10b5-1 plans are adopted during window periods and, under most insider trading policies, must be pre-cleared by counsel.
The SEC seems to have relied heavily on a recent Stanford study in deciding to propose a mandatory cooling off period. But that study itself acknowledges that it’s the first one to attempt to empirically address the relationship between the length of cooling off periods & “red flags” relating to the avoidance of losses. A single non-peer reviewed study seems like a slender reed upon which to base a key component of a rule proposal.
I don’t think all of the proposed changes are a bad idea, but the cooling off period seems unreasonably long & the certification requirement is something that only a bureaucrat could love. On the other hand, I think that multiple plans are potentially abusive and that ensuring that the good faith requirement applies not only to the establishment, but also to the operation, of a 10b5-1 plan is an appropriate change. But what I mostly think is that the debate on 10b5-1 reform has been too heavily weighted toward the academic side, and that there’s a need for those with real world experience in working with these plans to weigh in. I hope they’ll do so during the comment process.
Not that I’m crying any crocodile tears for short sellers, but 2021 hasn’t been the greatest of years for them. The meme stock crowd handed short sellers their lunch last winter, and the gravity defying rise of the stock market for most of the year hasn’t made for many other big scores – well, aside from shorting SPACs, of course. Now, according to this Bloomberg report, the year may be getting even worse for short sellers. That’s because the DOJ has launched a large-scale investigation into short selling by hedge funds and research firms:
The U.S. Justice Department has launched an expansive criminal investigation into short selling by hedge funds and research firms, scrutinizing their symbiotic relationships and hunting for signs that they improperly coordinated trades or broke other laws to profit, according to people familiar with the matter. The probe, run by the department’s fraud section with federal prosecutors in Los Angeles, is digging into how hedge funds tap into research and set up their bets, especially in the run-up to publication of reports that move stocks.
Authorities are prying into financial relationships between hedge funds and researchers, and hunting for signs that money managers sought to engineer startling stock drops or engaged in other abuses, such as insider trading, said two of the people, asking not to be named because the inquiries are confidential.
Underscoring the inquiry’s sweep, federal investigators are examining trading in at least several dozen stocks, including well-known short targets such as Luckin Coffee Inc., Banc of California Inc., Mallinckrodt Plc and GSX Techedu Inc. And they’re scrutinizing the involvement of about a dozen or more firms — though it’s not clear which ones, if any, may emerge as targets of the probe. Toronto-based Anson Funds and anonymous researcher Marcus Aurelius Value are among firms involved in the inquiry, the people said. Other prominent firms that circulated research on stocks under scrutiny include Carson Block’s Muddy Waters Capital and Andrew Left’s Citron Research.
As Liz blogged recently, short reports can do long-lasting damage to companies, although those reports also have helped uncover some pretty massive frauds. However, short selling remains one of the market’s murkiest corners, and some pretty shady conduct involving the authors of short reports has been brought to light. Now that the DOJ’s on the case, things could get very interesting.
When it comes to meme stock apes’ enemies list, you can probably put Citadel Securities alongside hedge fund short sellers right at the very top. Earlier this year, retail investors sued Citadel & Robinhood, alleging that they colluded to prevent a short squeeze at AMC & GameStop. That lawsuit was dismissed last month, but not before one meme stock investor – a California bartender who made hundreds of thousands of dollars on meme stocks – really managed to get under the skin of Citadel’s CEO.
This Institutional Investor article tells the story of Katherine Larsen, a meme stock investor & bartender from Oceanside, CA. Despite turning a $120K investment into more than $500K, Larsen’s experience in the meme stock game left her suspicious of Wall Street trading practices. While Larsen wasn’t a plaintiff in the lawsuit against Citadel, the article says that she became an extremely enthusiastic cheerleader, whose activities included running a digital ad in Times Square asking “Do you believe #Ken Griffin lied?” Griffin, who is Citadel’s CEO, didn’t take kindly to Larsen’s campaign:
Larsen is not a party to the lawsuit, but she has taken up its cause. She has hired firms to run digital billboards and banners lambasting Citadel and its billionaire founder in the streets — and skies — of New York and elsewhere. Griffin’s lawyers have sent dozens of cease and desist letters. Two days after running the Times Square ad, Larsen, known on Twitter as Kat Stryker or @katstryker111, tweeted out one of those letters, which targeted an advertising firm she’d used. The letter claims an “online mob” led by Larsen was “disseminating unfounded conspiracy theories and debunked narratives” about Citadel Securities.
“[Larsen] has published a series of tweets containing pictures of these ads, which contained demonstrably false and defamatory statements about Mr. Griffin — including the inflammatory and outrageous claim that he perjured himself by lying under oath,” it continues.
That comment about falsely accusing Griffin of “lying under oath” refers to written testimony that he provided to Congress last February, in which he denied that Citadel played a rule in Robinhood’s decision to limit trading in certain meme stocks. Interestingly, the letters were not sent to Larsen, but to more than 25 firms that offer mobile billboard ads.
There’s no way that a CEO looks good letting a retail investor get so far under his skin that he decides to “release the hounds.” But I wonder if Ken Griffin’s situation isn’t a preview of what may be in store for a lot of meme stock CEOs? It seems to me that the same kind of populist rage that fuels campaigns like Ms. Larsen’s can easily be turned against CEOs who don’t deliver ever higher stock prices to the retail investors that they courted so assiduously. By the way, meme stocks are crashing, so we may not have to wait too long to see if my guess is right.
Tune in tomorrow for the CompensationStandards.com webcast – “Compensation Committee Responsiveness: How to Regain High Say-on-Pay Support” – to hear Aileen Boniface of Clermont Partners, Steve Day of Calfee, Halter & Griswold, Brad Goldberg of Cooley and Tara Tays of Pay Governance break down key 2021 lessons on say-on-pay and problematic pay designs, and discuss how to bring your “A game” to shareholder engagement for the upcoming proxy season.
If you attend the live version of this 60-minute program, CLE credit will be available! You just need to submit your state and license number and complete the prompts during the program.
Members of CompensationStandards.com are able to attend this critical webcast at no charge. The webcast cost for non-members is $595. If you’re not yet a member, subscribe now by emailing sales@ccrcorp.com – or call us at 800.737.1271.
A couple of years ago, Corp Fin initiated a policy under which some Rule 14a-8 no-action requests received an oral response only. Yesterday, Corp Fin announced that it was discontinuing that policy. Here’s an excerpt:
We have reconsidered this approach, and after review of the practice we believe that written responses will provide greater transparency and certainty to shareholder proponents and companies alike. Beginning with the publication of this announcement, we will return to our prior practice and the staff will once again respond to each shareholder proposal no-action request with a written letter, similar to those issued in prior years. Our response letters will be posted publicly on the Division’s website in a timely manner. We will no longer communicate our responses via a chart, but we expect to publish a chart upon completion of the proxy season.
The original decision to provide oral responses to some letters was prompted in part by Corp Fin’s desire to enhance the efficiency of the no-action process, but my guess is that this change in policy is likely to have the opposite effect. At the very least, it isn’t going to ease the burden on the Staff when it comes to processing no-action requests – which may well spike this year as a result of Corp Fin’s issuance of SLB 14L.