The Corp Fin Staff published the latest update to the Division of Corporation Finance’s Financial Reporting Manual (affectionately known as the “FRM”), which is dated as of December 31, 2022. The FRM is the “go to” resource for so many things related to the presentation of financial statements and financial information, so it is always exciting to see the FRM get an extensive refresh.
The updated FRM has been revised to:
– Reflect amendments to Rules 3-10 and 3-16 and addition of new Rules 13-01 and 13-02 of Regulation S-X;
– Clarify the implementation date of ASU 2018-12, Financial Services – Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts for certain registration statements;
– Update the contact information for Corp Fin’s Office of Chief Accountant;
– Update the EGC revenue threshold based on the inflation-related adjustment announced in September 2022; and
– Remove certain outdated information, such as guidance on the adoption of ASC 606.
As the Staff notes in its disclaimer for the FRM, the manual was originally prepared by the Corp Fin Staff to serve as internal guidance, and in 2008, in an effort to increase transparency of informal Staff interpretations, Corp Fin posted a version of the FRM to its website. I can still remember carrying around my original hard copy FRM, which we always called the “Training Manual” back in the day. It was easily identifiable by the bright orange cover, which the PDF version retains to this day. The FRM includes critical interpretive nuggets and explanations that are always useful in your day-to-day practice.
While we are considering potential changes to corporate insider trading policies in the wake of the SEC’s recent Rule 10b5-1 amendments, the SEC will considering changes to its rules around employee trading in securities. Yesterday the SEC proposed amendments to its ethics rules to strengthen and modernize its ethics compliance program related to trading in securities. As noted in the SEC’s announcement:
The amendments, which are being proposed jointly with the Office of Government Ethics, would update the SEC’s Supplemental Ethics Rules, 5 CFR Part 4401.102, Supplemental Standards of Conduct for Members and Employees Securities and Exchange Commission. Specifically, if adopted, the amendments would:
– Expand the existing prohibited holdings restrictions to ban employees from investing in financial industry sector funds;
– Authorize the SEC to collect data on employees’ covered securities transactions and holdings directly from financial institutions through an automated electronic system; and
– Exempt diversified mutual funds from the Supplemental Ethics Rule’s requirements, given that they generally pose a low risk of conflicts of interest, misuse of nonpublic information for personal gain, or appearance problems. Mutual funds that concentrate investments in a particular sector, industry, business, state, or country other than the United States would remain subject to the rules.
In general, SEC employees are required to preclear securities transactions and comply with minimum holding periods. All employees are prohibited from, among other things, transacting in securities of companies the agency is investigating, engaging in short selling, transacting in derivatives, participating in initial public offerings for seven calendar days, or purchasing or carrying securities on margin.
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One of the disclosure requirements from the SEC’s recently adopted clawback rules is a set of new checkboxes for the cover page of the Form 10-K, Form 20-F and Form 40-F, with one of those checkboxes indicating whether the financial statements included in the report reflect the correction of an error to previously issued financial statements, and another checkbox indicating whether any of the error corrections require a recovery analysis under the company’s clawback policy. The text associated with those checkboxes is as follows:
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Question: The form amendments adding check boxes to the cover page of Form 10-K, Form 20-F, and Form 40-F indicating whether the form includes the correction of an error in previously issued financial statements and a related recovery analysis are effective January 27, 2023. However, the listing standards are not required to be effective until November 28, 2023 and issuers subject to such listing standards will not be required to adopt a recovery policy for 60 days following the date on which the applicable listing standards become effective. Will issuers be required to mark the check boxes in 2023 before an issuer is required to adopt a recovery policy and comply with the applicable listing standards?
Answer: In the adopting release, the Commission indicated that it does not expect compliance with the disclosure requirements until issuers are required to have a recovery policy under the applicable exchange listing standard. While the check boxes and other disclosure requirements will be in the rules and forms in 2023, we do not expect issuers to provide such disclosure until they are required to have a recovery policy under the applicable listing standard. [January 27, 2023]
This new Compliance and Disclosure Interpretation provides some much needed guidance just in the nick of time for filers who were trying to interpret the transition provisions for the clawback-related disclosure rules.
Under the SEC’s new clawback disclosure rules, in a situation when a company completes the financial restatement that triggered the company’s clawback policy, the company will be required to disclose certain details about the pending recovery of erroneously awarded compensation, including, for each current or former named executive officer, the amounts of incentive-based compensation that are subject to clawback that are still outstanding for more than 180 days since the date the company determined the recoverable amount.
In a series of Compliance and Disclosure Interpretations published on Friday, the Staff addressed how the term “named executive officer” is to be interpreted for foreign private issuers filing on Forms 20-F and 40-F, given that foreign private issuers do not provide disclosure under Item 402 of Regulation S-K, which includes the definition of “named executive officer.” Two of the representative Exchange Act Rules Compliance and Disclosure Interpretations are as follows:
Question 121H.02
Question: Which persons will be considered named executive officers for purposes of determining the parties for whom individualized disclosure pursuant to Item 6.F of Form 20-F must be provided? Answer: Item 6.F of Form 20-F provides for individualized disclosure for an issuer’s named executive officers. Foreign private issuers that file on domestic forms and provide executive compensation disclosure under Item 402 of Regulation S-K should provide individualized disclosure for their named executive officers to the extent required by Form 20-F. For foreign private issuers that use Form 20-F, individualized disclosure is required about members of their administrative, supervisory, or management bodies for whom the issuer otherwise provides individualized compensation disclosure in the filing. [January 27, 2023]
Question 121H.03
Question:Which persons will be considered named executive officers for purposes of determining the parties for whom individualized disclosure pursuant to Item B.(19) of Form 40-F must be provided?
Answer: Item B.(19) of Form 40-F provides for individualized disclosure for an issuer’s named executive officers. Such individualized disclosure is required about executive officers for whom the issuer otherwise provides individualized compensation disclosure in the filing. [January 27, 2023]
The Staff also published these same interpretations in Exchange Act Forms Compliance and Disclosure Interpretations Questions 110.08 and 112.03.
The Staff also addressed in a new Exchange Act Rules Compliance and Disclosure Interpretation published on Friday the extent to which a Rule 10D-1-compliant clawback policy could reach compensation in a variety of compensation plans other than tax-qualified retirement plans. The new Compliance and Disclosure Interpretation is as follows:
Question 121H.04
Question: Because the clawback rule applies broadly to incentive-based compensation, would the rules affect compensation that is in any sort of plan, other than tax-qualified retirement plans, including long term disability, life insurance, SERPs, or any other compensation that is based on the incentive-based compensation?
Answer: The rule is intended to apply broadly. For plans that take into account incentive-based compensation, an issuer would be expected to claw back the amount contributed to the notional account based on erroneously awarded incentive-based compensation and any earnings accrued to date on that notional amount. [January 27, 2023]
This new Compliance and Disclosure Interpretation should prompt companies to take a broader look at whether incentive-based compensation is present in their various plans and whether the language of the clawback policy that is ultimately adopted should be more specific on this point.
On Wednesday, the Delaware Chancery Court declined to dismiss fiduciary duty claims against a corporate officer arising out alleged oversight failures that allowed “a corporate culture to develop that condoned sexual harassment and misconduct.” The decision marks the first time that a Delaware Court has applied Caremark’s oversight duties to a corporate officer. This Debevoise memo summarizes the basis for the court’s decision:
In a January 25, 2023 decision (In Re McDonald’s Corp. S’Holder Litig., C.A. No. 2021- 0324-JTL (Del. Ch. Jan. 25, 2023)), the Delaware Court of Chancery declined to dismiss claims that a corporate officer, who led the company’s human resources function, breached his fiduciary duties by “allowing a corporate culture to develop that condoned sexual harassment and misconduct.” The plaintiffs claimed that the officer breached a “Caremark” duty by consciously ignoring “red flags” signaling misconduct. Despite the fact that no prior Delaware case had applied Caremark duties to an officer, the court declined to dismiss the claims, finding as a general matter that corporate officers owe a duty of oversight to an equal, if not greater, extent than corporate directors.
In this case, the court held that the bad faith necessary to support a Caremark claim was supported by particularized factual allegations that the officer had himself engaged in acts of sexual harassment, making it reasonable to infer, in the context of a corporate culture that allegedly condoned sexual harassment, that he consciously ignored red flags about similar behavior by others at the company. Moreover, the court declined to dismiss the claim that the officer’s misconduct itself constituted a breach of the duty of loyalty.
While Delaware recently amended the DGCL to permit corporations to ask stockholders to approve amendments to their charter documents eliminating in some cases officers’ liability in damages for breaches of the duty of care, because Caremark claims involve alleged breaches of the duty of loyalty, those charter amendments aren’t much use when it comes to them.
Kevin LaCroix posted a detailed analysis of this case on the D&O Diary this morning in which he raises some concerns about its potential implications:
My concern here is that in light of this decision, it may be easier for plaintiffs to sustain claims that both officers and directors have breached their duty of oversight. In that regard, I note that academic commentators had already raised the alarm that oversight duty breach claims are not in fact the most difficult kind of claim to sustain, and in fact they increasingly are being sustained with alarming frequency.
But that is not my biggest concern about Vice Chancellor Laster’s opinion. My biggest concern is his brief but nonetheless explosive conclusion that allegations of sexual harassment against a corporate officer can state a claim for breach of fiduciary duty. The possibilities for this conclusion to do mischief are incalculable – they raise the possibility that every sexual misconduct claim will become a Delaware Chancery Court D&O claim brought by shareholders in addition to an employment practices liability claim brought by the victim of the alleged misconduct.
NERA Economic Consulting recently released its annual report on securities class actions. Class action filings declined for the 4th consecutive year. Kevin LaCroix recently summarized the NERA report over on the D&O Diary, and here’s an excerpt:
According to the NERA report, there were 205 federal court securities class action lawsuit filed in 2022, down slightly from 210 federal court securities suits filed in 2021. (The NERA report counts multiple suits filed in different circuits against the same defendant as separate lawsuits, as a result of which the NERA count may differ from other published tallies. The NERA report also only counts federal court securities suits, it does not count state court securities filings.)
The recent decline in the number of lawsuit filings relative to the years 2017-2019, when there were annual filings of over 400 new lawsuits, is largely due to “lower levels of merger-objection cases and cases with Rule 10b-5 claims.” The decline in the number of federal court securities suit filings in 2022 represents the fourth consecutive year in the decline in the number of filings.
Lawsuits against companies in the Electronic Technology/Technology & Health Technology and Services sector accounted for 54% of last year’s filings. More than 1/3rd (36%) of federal class action filings involved unregistered crypto offerings, SPACs or COVID-19-related claims.
It’s important to keep in mind that while merger objection lawsuits aren’t being filed as class actions, they aren’t going away. This Bloomberg Law article notes that in recent years, plaintiffs have preferred filing these claims in state court, where they can often avoid judicial scrutiny of their settlements as well as the PSLRA’s limitations on the number of times a person can serve as lead plaintiff.
Earlier this month, I blogged about how we’re going to be changing the way we send out our email distributions of this blog and our other ones. I said we’d give you a heads up in advance of the changeover, and that’s what I’m doing this morning. On February 1st, our daily blog email for TheCorporateCounsel.net will no longer come from Liz’s account. Instead, our blog email will come from Editorial@TheCorporateCounsel.net.
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If you haven’t had a chance to listen to Tuesday’s webcast on the Rule 10b5-1 amendments, be sure to check it out. Our panel of experts had terrific insights into what the new regime requires and addressed many of the interpretive issues raised by the amendments & new disclosure requirements. We continue to post lots of memos in our “Rule 10b5-1” Practice Area – including this one from Latham & Watkins, which addresses a number of questions arising under the amended rule.
One area of uncertainty is how amended Rule 10b5-1 will apply to an entity affiliated with an insider who has a 10b5-1 plan. Here’s what the memo says about that issue:
I am a director or officer, and I want to establish a trust with its own Rule 10b5-1 trading plan. What cooling-off period applies to the trust, and would the trust’s trading plan be viewed as an overlapping plan in relation to my personal Rule 10b5-1 plan?
It depends on whether you have investment influence or control over the trust. If you do, the trust’s plan should be treated like the plan of a director or officer, subject to the longer cooling-off period of 90–120 days, the limitation against overlapping plans, and all other conditions under amended Rule 10b5-1 applicable to a director or officer. If you do not, then the trust should be treated like a person other than the issuer, director, or officer, thereby subject to the shorter 30-day cooling-off period and not treated as one of your own plans in determining whether you have an overlapping plan.
While this question addresses an insider’s trust, the question of whether the insider influences or controls any entity’s investment decisions is likely to be a key consideration in assessing how the rule applies to other insider-affiliated entities. That’s because when an insider influences an entity’s investment decisions, the entity has the ability to capitalize on MNPI in the insider’s possession.