I co-teach a course on exempt offering alternatives at Georgetown Law and we always have an open book exam at the end of the semester because it would be very difficult to expect students to remember all of the ins and outs of Securities Act exemptions for a closed-book exam. Obviously no one uses books anymore, but the term sticks!
In remarks at PLI’s SEC Speaks conference last week, Sebastian Gomez Abero, Deputy Director of the SEC’s Office of the Advocate for Small Business Capital Formation, described the efforts of his office to make capital raising an open book exam through the SEC’s Capital Raising Hub. This resource center now features the capital raising Navigator, which walks the user through a series of questions to point users in the direction of which exempt offering alternative to pursue, a series of Building Blocks that address discrete topics most relevant to entrepreneurs seeking capital and an easy-to-use glossary of securities law terms. I encourage everyone (including our students) to check out these resources, that are very user-friendly and comprehensive.
Over on the Proxy Season Blog, Liz recently blogged about the voting results from the 2022 proxy season on shareholder proposals requesting independent audits of racial equity and civil rights matters, which is a topic that companies and boards of directors should be closely monitoring these days. According to a proxy season recap by Alliance Advisors, the 22 proposals that were voted on averaged 44.9% support and achieved eight majorities. ISS backed 77% of the resolutions in 2022, compared to 22% in 2021. In addition to the success with proposals included in proxy statements, the proponents were successful in negotiating with some companies to achieve the result of having the companies undertake an audit without taking the proposal to a shareholder vote.
One obvious question that a company may have when it receives this sort of shareholder proposal or a letter from a shareholder on the topic is: “who would I hire to conduct this sort of audit?” A recent WSJ article describes how a number of large law firms are promoting specialized practices that conduct audits on race and diversity. The article notes:
The market for audit work has expanded rapidly over the past few years, driven by increasing shareholder pressure. Some companies are assessing their practices on hiring, compensation and promotions. Others are evaluating whether their policies, products and services might have contributed to discrimination or are vulnerable to bias.
We will no doubt see this practices continue to grow as the shareholder proposals, letter writing campaigns and other shareholder efforts continue to put pressure on companies to conduct these audits.
As John noted last month, we have been receiving questions from members in our Q&A Forum (see Topic #11109) and via email about when the SEC would adopt the inflation adjustment to the emerging growth company revenue cap required by the JOBS Act.
Last week, the SEC announced that it had finally adopted amendments to its rules to implement the inflation adjustments mandated by the JOBS Act. The SEC is required to make inflation adjustments to some of the JOBS Act rules at least once every five years. The new thresholds will become effective when they are published in the Federal Register.
The annual gross revenue amount used to determine emerging growth company status will increase from $1,070,000,000 to $1,235,000,000.
For Regulation Crowdfunding, the threshold for assessing an investor’s annual income or net worth to determine investment limits under Rules 100(a)(2)(i) and 100(a)(2)(ii) will increase from $107,000 to $124,000. The lower threshold of Regulation Crowdfunding securities permitted to be sold to an investor if annual income or net worth is less than $124,000 under Rule 100(a)(2)(i) will increase from $2,200 to $2,500. The maximum amount that can be sold to an investor under Regulation Crowdfunding in a 12-month period pursuant to Rule 100(a)(2)(ii) will increase from $107,000 to $124,000. Further, the three thresholds set forth in Rule 201(t) of Regulation Crowdfunding for determining the financial statements required for the offering will each increase by approximately 15%.
Back in March of last year, Regulation Crowdfunding’s offering limit increased from $1,070,000 to $5,000,000 as a result of the amendments adopted in the Exempt Offering Harmonization release. Given that this increase exceeded the inflation-based increase that would have otherwise been adopted in 2022, the SEC did not increase Regulation Crowdfunding’s offering limit, which will remain at $5,000,000.
On Friday, the SEC announced that Corp Fin will add an Office of Crypto Assets and an Office of Industrial Applications and Services to the Division’s Disclosure Review Program. These new offices will join the seven current industry offices operating in Corp Fin. The SEC notes that the Office of Crypto Assets will continue the work currently performed across the Division to review filings involving crypto assets, while the Office of Industrial Applications and Services will be responsible for the non-pharma, non-biotech, and non-medicinal products companies currently assigned to the Office of Life Sciences. The new offices are expected to be up and running later this year.
SEC Enforcement Director Gurbir Grewal spoke at PLI’s SEC Speaks last Friday, and he noted the efforts that the Division has recently undertaken to diversify the workforce and improve inclusion at the agency, and how that effort can help the SEC do its job better while building trust with the investors that the agency is seeking to protect.
Grewal’s speech further noted how individual investors have been drawn to crypto in recent years, and within that broader retail cohort, recent reports have indicated that the crypto collapse may have an outsized impact on investors from lower income brackets and underrepresented racial groups. On the topic of the SEC’s enforcement of the federal securities laws in connection with digital assets, he noted:
As I have stated publicly in the past, I believe the Howey and Reves tests remain vital and accurate means of identifying instruments that fall within the jurisdiction of the securities laws. When the evidence we obtain indicates that those laws have been violated, we will continue to bring actions regardless of what label is used or technology is involved (or not). Failure to do so would constitute an abdication of our responsibilities, and an abandonment of the investors who have been harmed in those markets, including through being denied essential disclosures and protections.
One overall takeaway from the conference was certainly that the SEC continues to ramp up its already ramped up efforts in this space!
Several hot topics and potential rulemaking items are getting air time with the SEC at an upcoming public meeting of the Investor Advisory Committee – scheduled for Wednesday, September 21st at 10am Eastern. The agenda includes:
1. Human Capital Management and Labor Valuation and Performance – This plenary session will consider the demand for labor-related performance data from the investor perspective, including investors’ views on the quality and decision-usefulness of currently-available data, and which information – if any – investors would use should it become available, and why.
2. Panel Discussion Regarding Schedules 13D and 13G Beneficial Ownership Reports – This panel will discuss the SEC’s proposals to shorten the reporting timeline around Schedule 13D and 13G and how that would affect shareholder activism. The panel will also discuss the current practices of certain shareholders disseminating not-yet-public large stakes with a select group of other shareholders, and how the SEC’s proposals around classifying them as a “group” would cut the existing information asymmetry between that group and other shareholders.
3. Panel Discussion Regarding ESG Fund Disclosure – This panel will focus on the importance of ESG and Greenwashing and the heightened role of ESG for investors seeking to understand their impact through investing. Our speakers will provide an overview of the definitions of ESG, sustainable investing, and greenwashing. Additionally, our speakers will discuss what investors should know about the proposed climate disclosure requirements and any observable effects of the proposal.
The agenda also includes time for discussing recommendations on cybersecurity disclosure, climate disclosure, and accounting modernization. That’s a lot of action.
Yesterday, EY announced that it is moving forward with partner votes to separate the firm into two distinct organizations, which it has been considering for several months and is aimed at helping avoid conflicts of interest between consulting and audit work. As I blogged in May, the breakup would be a big deal if it happens – but it is not completely novel. This NYT article explains how the split could be effected:
One way EY can achieve a split is by spinning off its consulting arm into a company that could file for an initial public offering. The auditing business would probably remain a private partnership.
One outcome of the split may be that, once separated from the accounting business, the advisory and consulting operations will be more profitable as they’re less constricted by conflict-of-interest rules that could limit the services they can provide to clients.
This WSJ article gives more detail on the dollars involved:
The firm’s 13,000 partners are expecting multimillion-dollar payouts from the split. To pay for that, EY is planning to raise about $11 billion in a public sale of a 15% stake in the consulting company, which will also borrow some $18 billion, according to Mr. Di Sibio. He said a large portion of this money would be used to pay partners, but declined to specify the amount.
It sounds straightforward, but this is going to be an exceedingly complex transaction due to auditor independence rules. Just last week, the SEC’s Acting Chief Accountant Paul Munter issued a statement about “critical points to consider when contemplating an audit firm restructuring” – so the SEC is watching. It’s not clear yet whether EY audit clients would have any reason to be skittish – there are probably decks already in the works to reassure everyone.
To move forward, in addition to regulatory approvals in some countries, EY’s 13,000 audit partners also need to approve the breakup. It will take some time to get the vote, but people are probably somewhat on board already since this has been socialized for several months. The WSJ reports that, at this time, the rest of the “Big 4” accounting firms are not planning to follow EY’s lead.
In remarks yesterday at SEC Speaks, Chair Gensler cut right to the chase about crypto tokens:
Of the nearly 10,000 tokens in the crypto market, I believe the vast majority are securities. Offers and sales of these thousands of crypto security tokens are covered under the securities laws.
Some tokens may not meet the definition of a security — what I’ll call crypto non-security tokens. These likely represent only a small number of tokens, even though they may represent a significant portion of the crypto market’s aggregate value.
This isn’t too surprising given recent enforcement activity. In July, I blogged that Coinbase submitted a rulemaking petition that called on the SEC to adopt rules that provide more clarity on the framework for digital assets as securities.
The fact that Coinbase’s petition is 32 pages long gives you a sense for how complex regulating crypto as a security could be. In his Bloomberg column yesterday, Matt Levine pointed out how difficult it would be for the SEC to simply apply pre-existing disclosure requirements to tokens. Here’s an excerpt:
I do not think that that sort of adaptation is trivial. Think about what you would want to know about a crypto project before investing in it. Some of what you would want to know — things like the qualifications of the founding team, their financial incentives and conflicts of interest, where the money is going, how the project is capitalized, how they see the market, what their business plan is, etc. — is very similar to what you’d want to know before investing in the stock of a company. But a lot would be different. You might care a lot less about the funding and capital structure of the entity that employs the developers to build the project, and a lot more about the structure and tokenomics of the decentralized project itself. You might care a lot about the decentralized self-executing code of that project, since DeFi projects are constantly getting hacked, and you might want some sort of high-level summary of that code and its vulnerabilities rather than just a GitHub repository. In a truly decentralized project, the people issuing the tokens might just not have access to some of the things — biographies of key players, audited financials — that are required in normal stock offerings.
And it’s not like most tokens these days are just sold by project developers for cash to retail investors to raise money to build the projects. This used to be true, in the “initial coin offering” boom of 2017, but the SEC shut that down pretty hard. Now tokens are more likely to be earned (by mining, by staking, by running a hotspot) by ordinary participants, and if developers want to raise money they sell tokens to venture capital firms with long lock-ups. (You can sell securities to “accredited investors,” like VCs, without registering them with the SEC.) Adapting the securities-law framework to crypto would mean looking at how crypto tokens actually come into the hands of retail investors, and thinking about what sorts of protections they need in those transactions.
The SEC understandably believes that tokens should be regulated as securities, but coming up with workable rules is a big undertaking, and there are no signs that a tailored crypto framework is in process.
Now that the SEC’s universal proxy rules are effective, everyone is anxious to see what impact they’ll have – and what issues the new process will create for companies facing a proxy contest. John shared a roundup of recent commentary yesterday on DealLawyers.com. One thing that a number of experts are pointing out is that battles will get more personal now that all of the candidates are on one card. Here’s a prediction from Okapi Partners’ Bruce Goldfarb in a recent Forbes article:
It is a near-certainty that future proxy campaigns are going to focus more on the personal attributes of the individual candidates. Each side will need to make a strong case for the qualifications of each person nominated for a board seat. This process may lead to each side publicly “dissing” the capabilities, experience, and perhaps even the integrity of the other side’s nominees.
This means you’ll want to carefully consider your director bios, skills, and all of the surrounding disclosures going in to 2023 – presenting your directors as personable & savvy candidates who bring important benefits to the company. What’s also important to remember is that this change isn’t happening in a vacuum – it is coming at a time when director skill-sets and oversight structures are already under the microscope. Aon’s Karla Bos sent me this pondering based on a post from Michael Levin at The Activist Investor:
Obviously just getting a director onto the ballot doesn’t mean it’s easy to get them elected, but it certainly could garner additional attention. I wonder if, as navigating the UPC process becomes clearer, there might be an increase in nominations of qualified “ESG directors” in lieu of submitting ESG shareholder proposals? Or will that possibility simply accelerate the trend of companies pursuing constructive shareholder engagement with “little-a” activists?
This may not be something we see right out of the gate, but it’s not outside of the realm of possibility. It was only a year ago that ExxonMobil lost board seats in a campaign that put “ESG” concerns in the spotlight. CalSTRS warned at the time that it was just the beginning of an “activist stewardship” trend – where “universal owners” will be prepared to replace directors if they feel that engagements are ineffective. I also blogged at that time about a playbook for responding to (or heading off) ESG-themed activist inquiries. More recently, Emily noted on our “Proxy Season Blog” that when looking at responsiveness to ESG proposals, large asset managers are also developing escalation pathways for director votes.
For practical insights on how to work with your shareholders and protect your board from activists, join us in October for “Next-Gen Activism: Are You Prepared?” – with Davis Polk’s Ning Chiu, Okapi Partners’ Bruce Goldfarb, SGP’s Rob Main, and Wachtell Lipton’s Sabastian Niles. This critical session is part of our “Proxy Disclosure & 19th Annual Executive Compensation Conferences” – happening virtually October 12th – 14th. Here’s the full agenda – 18 sessions over 3 days, including a dialogue with Corp Fin’s Renee Jones and essential guidance from lots of other heavy-hitters. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
In addition, check out the agenda for our “1st Annual Practical ESG Conference” – which is happening virtually on Tuesday, October 11th. This event will help you avoid ESG landmines and anticipate opportunities. You can bundle the Conferences together for a discount.
Across the pond, 54% of FTSE 100 companies now have voluntarily established a dedicated ESG committee, according to a recent Bloomberg article. Here’s what the article says about US practices:
Large US companies appear to be moving less quickly. An analysis for 2020-2021 showed that only 13% of S&P 500 companies assign responsibility to an ESG/sustainability committee, while 7% indicated that the full board has primary ESG responsibility, according to data compiled by Deloitte. Meanwhile, 53% of S&P 500 boards use the nominating and governance committee for primary oversight.
For more resources, see our the memos in our “ESG” Practice Area here on TheCorporateCounsel.net and the even more comprehensive page – including checklists, surveys & more – about “Board Oversight of E&S Issues” that we have going on PracticalESG.com. If you’re not already a member with access to this guidance, sign up now and take advantage of our no-risk “100-Day Promise” – During the first 100 days as an activated member, you may cancel for any reason and receive a full refund.