Back in August, I blogged about an upcoming FASB proposal to tweak segment disclosures. Earlier this month, FASB issued its proposed ASU laying out the details of the changes it wants to make. This excerpt from FASB’s press release summarizes those proposed changes:
The amendments in the proposed ASU respond to feedback received from investors and other allocators and would improve reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses. The key amendments in the proposed ASU would:
1. Require that a public entity disclose, on an annual and interim basis, significant segment expenses that are regularly provided to the chief operating decision maker (CODM) and included within each reported measure of segment profit or loss.
2. Require that a public entity disclose, on an annual and interim basis, an amount for other segment items by reportable segment and a description of its composition. The other segment items category is the difference between segment revenue less the significant expenses disclosed and each reported measure of segment profit or loss.
3. Require that a public entity provide all annual disclosures about a reportable segment’s profit or loss and assets currently required by Topic 280, Segment Reporting, in interim periods.
4. Clarify that if the CODM uses more than one measure of a segment’s profit or loss, at least one of the reported segment profit or loss measures (or the single reported measure if only one is disclosed) should be the measure that is most consistent with the measurement principles used in measuring the corresponding amounts in a public entity’s consolidated financial statements.
5. Require that a public entity that has a single reportable segment provide all the disclosures required by the amendments in the proposed ASU and all existing segment disclosures in Topic 280.
The amendments would apply to all public companies that are required to report segment information. Fortunately, however, they would not change how those companies identify their operating segments, aggregate those operating segments, or apply the quantitative thresholds to determine reportable segments. FASB’s deadline for comments on the proposal is December 20, 2022.
Turbulent market conditions have made this a tough year for many public companies looking for additional financing. This Cooley blog explores two alternative methods of financing that may be attractive options for some of those companies – PIPEs and Registered Direct Offerings (RDOs). This excerpt discusses underwritten and non-underwritten RDOs:
Non-Underwritten RDOs. In non-underwritten RDOs, the issuer sells the securities directly to the investor in a share purchase agreement (SPA), just as in a PIPE. The primary differentiating factor relative to a PIPE is that the securities are sold pursuant to an effective registration statement, meaning that they are unrestricted and freely tradable out of the gate.
As a result, an RDO is conducted as a fully documented deal – a prospectus supplement, comfort letters and 10b-5 letters from multiple law firms all have the potential to increase legal and auditor costs, as compared to the relatively leaner PIPE. The RDO also requires having an effective registration statement or the ability to a file an automatically effective registration statement (i.e., be a well-known, seasoned issuer).
Underwritten RDOs. The primary difference between an underwritten and non-underwritten RDO is that the shares in an underwritten offering will settle through the banking syndicate instead of directly with third-party investors. The deal is marketed and conducted just like a non-underwritten RDO, with the banks wall-crossing investors and the shares being taken down off an effective S-3 shelf. But instead of the company contracting directly with investors through an SPA, the deal is papered on an underwriting agreement, with the banks purchasing the share block and settling onwards to their accounts.
The blog points out that although there are many similarities between PIPEs and RDOs, the advantage of the latter is the issuer’s ability to avoid the illiquidity discount associated with a PIPE by issuing registered shares to RDO investors.
Now that the Twitter case is over, we can all turn our attention to the things in Delaware corporate law that really matter to us. Francis Pileggi recently provided a reminder about one of them:
The Delaware Court of Chancery prefers “stockholder” as the term uniformly used in the Delaware General Corporation Law for those owning a corporation, though in the past, especially prior to the 2010 DGCL amendments, there were inconsistent references–and court decisions in the past have not always been scrupulous in observing the distinction. See generally In Re Adams Golf Shareholder Litigation, C.A. No. 7354-VCL, transcript (Del. Ch. Oct. 3, 2012) (yes, that’s 10 years ago.)
Does this matter? Well, kind of, I suppose. But I think we lawyers all have a tendency to get a little goofy about this type of thing. For example, I used to have a partner who would absolutely freak out when he saw accountants use the term “common stock” in an Ohio corporation’s financial statements (we’re a “common shares” jurisdiction).
Once, my former colleague was so flummoxed by an accounting firm’s repeated sloppiness in this area that he wrote a letter to the partner at the firm correcting him. This has gone down in firm lore as the “red birds/blue birds” letter. That’s because, in explaining the distinction between common stock and common shares to the accountant, he said something like “there are red birds and blue birds, but although they are both birds, red birds aren’t blue birds, and blue birds aren’t red birds.”
We were subsequently working on an IPO in another city with an accountant from this same firm. One of the other lawyers made a comment about common stock and common shares, and the accountant made the correction and then smiled and said something about how only lawyers care. He then said “Oh, you know there’s this letter that’s been passed around our firm for years that some crazy lawyer wrote about red birds not being blue birds. . .” I didn’t have the heart to tell my colleague of his notoriety among multiple offices of a Big 4 accounting firm.
I had been collecting various cryptocurrency-related updates for this blog, but then Bloomberg’s Matt Levine wrote a 40,000-word essay for the latest issue of Businessweek that says it all – and then some. This is only the second time in Businessweek’s 93-year history that a single author has written the entire issue, so kudos to Matt, who is one of my favorite opinion columnists and lunch valuation analysts.
Matt’s article pretty much nails why – even if you’re not a “crypto enthusiast” – you’ll still learn a lot by keeping up with the happenings. And for capital markets lawyers, much of it will even be useful! Here’s an excerpt that explains why:
I don’t have strong feelings either way about the value of crypto. I like finance. I think it’s interesting. And if you like finance—if you like understanding the structures that people build to organize economic reality—crypto is amazing. It’s a laboratory for financial intuitions. In the past 14 years, crypto has built a whole financial system from scratch. Crypto constantly reinvented or rediscovered things that finance had been doing for centuries. Sometimes it found new and better ways to do things.
Often it found worse ways, heading down dead ends that traditional finance tried decades ago, with hilarious results.
Often it hit on more or less the same solutions that traditional finance figured out, but with new names and new explanations. You can look at some crypto thing and figure out which traditional finance thing it replicates. If you do that, you can learn something about the crypto financial system—you can, for instance, make an informed guess about how the crypto thing might go wrong—but you can also learn something about the traditional financial system: The crypto replication gives you a new insight into the financial original.
Matt walks through how this asset class came about, the similarities & differences from traditional finance, and shares predictions about where it could be going. He shares an important reminder on DAOs that the members will be treated like general partners if the entity isn’t incorporated – i.e., liable for its debts.
The essay doesn’t delve too far into securities regulation issues – if you’re practicing in this area, that’s what our “Crypto Financings” & “Blockchain” Practice Areas are for. Another Bloomberg article reported this week that SEC enforcement activity is making both retail and professional investors feel more likely to “invest” in cryptocurrency, so there could be more work coming for securities lawyers on all sides of this:
Almost 60% of the 564 respondents to the latest MLIV Pulse survey indicated they viewed the recent spate of legal action in crypto as a positive sign for the asset class, whose trademark volatility has all but dissipated in recent months. Major interventions include the US regulatory investigations of bankrupt crypto firms Three Arrows Capital and Celsius Network, as well as an SEC probe into Yuga Labs, the creators of the Bored Ape collection of nonfungible tokens, or NFTs.
Like Matt, I don’t have strong feelings about the value of crypto. I find it puzzling in many ways, but also fascinating and informative from several angles: finance, securities regulation, and sociologically. And if people are going to be out there using this ecosystem, I do think there have to be some rules and guidance around it. Thankfully, there are very bright securities lawyers out there who are navigating this – a few of them just spoke on our recent webcast.
In full disclosure, I own a nominal amount of crypto. Because I’m writing about it, I wanted to see how it worked to get into the system and to buy a web3 domain name. I found it confusing and complicated, I don’t even know if I accomplished my goal, and I don’t expect to ever see that money in dollar form again. But if the target audience right now is gamers and people who enjoy internet hype, financial engineering and gambling, that’s…not me. I’m just a 40-something professional who needs a type of currency that can buy snacks for my kids.
Regardless of where you stand on cryptocurrency, we can probably all agree that companies that hold these digital assets need to be able to properly value them on their balance sheets, and that it is probably something more than “0” and maybe also different than the current trading value, which is difficult to predict.
Some companies have treated digital assets as indefinite-lived intangibles. At a meeting earlier this month, the FASB reached a different (tentative) conclusion on how to account for digital assets, which is part of its project on this topic. Here’s an excerpt from the notes on “tentative Board decisions”:
The Board decided to require an entity to:
1. Measure crypto assets at fair value, using the guidance in Topic 820, Fair Value Measurement.
2. Recognize increases and decreases in fair value in comprehensive income each reporting period.
3. Recognize certain costs incurred to acquire crypto assets, such as commissions, as an expense (unless the entity follows specialized industry measurement guidance that requires otherwise).
The Board also considered:
1. Various measurement alternatives for crypto assets with inactive markets and decided not to pursue those alternatives.
2. Whether to provide implementation guidance relative to the application of fair value measurement of crypto assets and decided not to provide additional measurement guidance as part of this project.
3. Whether there should be a difference for private companies for the measurement of crypto assets and decided that the measurement and recognition requirements should be the same for all entities.
The Board will consider presentation, disclosure, and transition at a future meeting.
Crypto folks have been saying that they want the SEC to regulate these assets and related transactions with tailored rules. That was a theme in our recent webcast, “Cryptocurrency: Making Sense of the State of Play” – with Ava Labs’ Lee Schneider, Liquid Advisors’ Annemarie Tierney, Cooley’s Nancy Wojtas, and Coinbase’s Jolie Yang.
The transcript for that program is now available, which will be a helpful guide to anyone looking to responsibly navigate the securities law complexities of this work. Lee, Annemarie, Nancy & Jolie covered:
1. Overview of Regulatory Issues & Risks
2. Structuring Deals, Resales & Products in the Current Regulatory Environment
3. How to Handle Cryptocurrency Use in Transactions
4. Learnings from Recent High-Profile Token Collapses
5. Will the Ethereum Merge Affect the SEC’s Analysis?
6. Predictions & How to Prepare
One recurring takeaway was that practicing in this space is best suited for people who like a challenge.
Yesterday, the SEC adopted the clawback rules contemplated by Section 10D of the Exchange Act, which was added over a dozen years ago by the Dodd-Frank Act. Not surprisingly, the vote on the final rulemaking action was 3-2. As this Fact Sheet notes, the final rules ended up being broader than originally proposed, as foreshadowed by the reopening of the comment period in October 2021 and June 2022. When all is said and done with the implementation of the rules – which will require further action by the stock exchanges – most exchange-listed companies will have to adopt and comply with a clawback policy that conforms to these new rules, and will also have to provide disclosure in proxy and information statements and annual reports about the policies and how they are being implemented. A listed company will be subject to delisting if it does not adopt and comply with a clawback policy that meets the requirements of the to-be-adopted listing standards.
The clawback policy contemplated by the final rules is, in all likelihood, going to differ significantly from the clawback policies that most companies have adopted over the course of the past two decades. While clawback policies tend to focus on recovering incentive compensation that was based on misstated financial statements arising from fraud where the executive from whom the compensation is being recovered had some culpability in making the misstatements, the listing standards that the stock exchanges are directed to adopt will call for a clawback policy that requires no culpability on the part of current or former executives, the recovery of incentive compensation received during the three-year period preceding the date the company is required to prepare the accounting restatement, and recovery will be triggered by a broad range of accounting restatements, including the now quite popular “little ‘r’ restatement.”
The amount of recoverable compensation will be the amount of incentive-based compensation received by the executive officer or former executive officer that exceeds the amount of incentive-based compensation that otherwise would have been received had it been determined based on the restated financial statements. The SEC’s rules contemplate that the listing standards can provide for very limited impracticability exceptions.
Of course new listing standards are not enough, so the SEC will require enhanced disclosure about the compensation recovery policy (to be tagged using inline XBRL), as a well as a requirement to file the policy as an exhibit to the annual report and two new check boxes on the cover of Form 10-K, with one indicating whether the financial statements included in the filing reflects the correction of an error to previously issued financial statements, and another indicating whether any of those error corrections are restatements that required a compensation recovery analysis.
For a more information about the new clawback rules, stay tuned to our continuing coverage over on CompensationStandards.com. If you do not have access to all of the great resources that are available on CompensationStandards.com, now might be a good time to think about becoming a member of that site. You know the drill by now – sign up today online, email firstname.lastname@example.org or call 1-800-737-1271.
The focus on clawback policies dates back to the post-Enron era and the enactment of Section 304 of Sarbanes-Oxley, which permits the SEC to order the disgorgement of bonuses and incentive-based compensation earned by the CEO and CFO in the year following the filing of any financial statement that the issuer is required to restate because of misconduct. Following the lead from Sarbanes-Oxley and the fundamental concern that executives should not be able to keep incentive compensation paid based on misstated financial statements that had to be restated, companies began adopting clawback policies as a good governance practice. The ensuing couple of decades of “private ordering” largely led to clawback policies which focused on the consequences of a full-blown accounting restatement (usually arising from some sort of fraud or other misconduct) which requires the company to amend its prior periodic reports to correct the errors in the financial statements included in those reports. Essentially, these are restatements that lead to the filing of an Item 4.02 Form 8-K. As originally proposed, the SEC’s Dodd-Frank Act era clawback appeared to follow suit.
But then, a funny thing happened on the way to adoption of the final clawback rules. In recent years, full-blown accounting restatements have not been happening quite as often as they once did, for a variety of reasons. While such restatements have by no means gone the way of the dinosaur, they are certainly not the fixture of public company reporting that they once were. At the same time, we have seen an increase in what is often referred to as a little “r” restatement, which requires no Item 4.02 Form 8-K and which allows a company to fix its prior periods in a periodic report with no amendment of previously filed reports. Little “r” restatements are required to correct errors that were not material to previously issued financial statements, but would result in a material misstatement if: (i) the errors were left uncorrected in the current report; or (ii) the error correction was recognized in the current period. The SEC staff has been focused on little “r” restatements over the past decade or so, raising comments on filings to test whether a purported little “r” restatement should have been a full-blown accounting restatement under GAAP, so there has certainly been some skepticism about this approach.
Incorporating little “r” restatements as a triggering event in the final clawback rules will certainly expand the reach of clawback policies adopted pursuant to the listing standards that the stock exchanges are obligated to promulgate. The concept moves clawback policies even farther away from the original concern that executives should return their incentive compensation earned based on misstated financial statement where the misstatements arose due to some sort of fraud or misconduct, toward the more mundane world of recovering compensation erroneously earned due to run-of-the-mill accounting errors. The change also required the Commission to consider ways to make the little “r” restatement more visible, thus necessitating the check box approach on the cover of the annual report. All in all, the change means that compensation recovery policies are going to be invoked much more often, and perhaps for much smaller recoveries.
Thankfully, you will not have to come up with a new clawback policy quickly in response to the new rules. The SEC’s Fact Sheet notes the following timetable for the new rules and exchange listing standards:
The rules and amendments will become effective 60 days following publication of the release in the Federal Register. Exchanges will be required to file proposed listing standards no later than 90 days following publication of the release in the Federal Register, and the listing standards must be effective no later than one year following such publication. Issuers subject to such listing standards will be required to adopt a recovery policy no later than 60 days following the date on which the applicable listing standards become effective and must begin to comply with these disclosure requirements in proxy and information statements and the issuer’s annual report filed on or after the issuer adopts its recovery policy.
The adopting release states, “We would not expect compliance with the disclosure requirement until issuers are required to have a policy under the applicable exchange listing standard.”
I have been out speaking about all of the new SEC rules that have been adopted, are being adopted and that remain to be considered, and one thing is clear – we will all have a lot of extra work to do in the coming months and years. One persistent concern that I hear from others is that companies are struggling to prepare for the largely unknown costs associated with all of these new rules in their budgets for 2023 and beyond. Further, the increased compliance burdens are coming at a time when many companies are seeking to tighten their belts in light of rising costs and the prospect of recession.
With these concerns in mind, I compiled the following list of things to consider as you enter the budgeting process:
1. Educating Your Company. Now is a critical time to educate the Board of Directors, management and others within the company about the increased compliance burden from new SEC rules. Developing buy-in from the top and from others in the organization will be crucial to ensuring an allocation of appropriate resources to the compliance function. I believe that this should include education about proposed rules, even though we do not ultimately know how the final rules will come out. In addition, keep everyone updated as new requirements become effective so they can be aware of when it may be necessary to reallocate or add resources to the compliance function.
2. Leveraging Internal Resources. Assess the resources that you already have access to internally in order to determine whether you could use these resources when new rules come into effect. For example, many companies have found that their internal audit and/or finance function can be helpful when formulating or improving controls regarding climate change reporting in anticipation of SEC rules requiring mandatory reporting of climate change matters. It is helpful to develop an inventory of available internal resources and how those resources can be useful to the compliance function, and then develop relationships with the individuals in those functions so they will be ready to assist when the time comes.
3. Evaluating Outside Advisors. Some new SEC requirements will require the use of outside advisors, while, in other cases, outside advisors may be useful to the compliance process. For example, many companies are finding out now that they will need to engage valuation firms to value equity awards for the purposes of complying with the SEC’s new Pay versus Performance rules. You may have an existing relationship with a valuation firm, or you may need to establish a relationship with a valuation firm for this purpose – in either case, it is critical to have a dialogue with them now, given the increased demand for their services as a result of the rule. In another example, the SEC’s proposed climate change disclosure rules contemplate the use of a third party for attestation of GHG emissions metrics, so it is important to understand now what such services will cost and to begin mapping out the process for engaging such advisors. Further, some companies may find it more efficient to utilize outside advisors for developing their compliance approach, particularly for something as big as the SEC’s climate change rules, so the potential cost of such outside resources should be factored into the planning process now.
4. Keeping up to Speed. Now more than ever, it is important to keep up to speed on what the SEC is doing and planning for the future. Our resources – including this website and all of the other CCRcorp websites and publications – are a great option for you to consider as you try to find the most cost-effective way to stay abreast of the developments and obtain actionable advice from the experts. I encourage you to reach out to email@example.com or call 1-800-737-1271 to discuss your options.