Last month, Dave blogged about the uncertainty surrounding whether Item 408(a) disclosure is required in periodic reports when no director or officer has adopted or terminated a Rule 10b5-1 trading arrangement or a non-Rule 10b5–1 trading arrangement during the quarter. The problem is baked into the language of Item 408(a)(1) itself – the line item calls on registrants to disclose “whether, during the registrant’s last fiscal quarter” any director or officer adopted or terminated a trading plan. The use of the word “whether” has prompted some practitioners to conclude that the line item may impose an affirmative obligation to disclose that no such plan has been entered into.
Unfortunately, that interpretive issue wasn’t addressed in the CDIs, but over on our Q&A Forum (Topic # 11752), a member shared the Staff’s informal guidance in response to a question on how to address this disclosure requirement in Item 5 of Part II of Form 10-Q:
I spoke to the Staff yesterday. The staff told me that their current view is that negative disclosure is not required notwithstanding the “whether” language. However, they said the Staff is still reviewing this and may issue some more definitive guidance. Meanwhile I did a quick survey of how companies completed Item 5, and many responded “none” or even omitted Item 5.
I suppose the fact that Corp Fin didn’t address this topic in this batch of CDIs may mean that the Staff is still kicking it around, so stay tuned.
The SEC issued its first fee rate advisory for the 2024 fiscal year and if you’re registering securities or engaging in another transaction for which a filing fee is required, you may get a serious case of sticker shock. Fiscal 2023 filing fees increased by 19% over the prior year, reversing several years of significant declines in filing fees. For fiscal 2024, the SEC says that filing fees will rise again – and by an even greater percentage than they did in fiscal 2023. Effective October 1, 2023, the filing fee will increase by 34%, from $110.20 per million dollars to $147.60 per million dollars.
The fee rate advisory points out that the SEC doesn’t set filing fees arbitrarily:
The Commission must set rates for the fees paid under Section 6(b) to levels that the Commission projects will generate collections equal to annual statutory target amounts. The Commission’s projections are calculated using a methodology developed in consultation with the Congressional Budget Office and the Office of Management and Budget. The Commission determined the statutory target amount for fiscal year 2024 to be $839,771,535 by adjusting the fiscal year 2023 target collection amount of $815,557,629 for the rate of inflation.
The SEC’s focus on the use of Rule 10b5-1 by insiders in rulemakings over the past couple of years has inevitably brought us to the point of asking the question: “Do Rule 10b5-1 plans still make sense for insiders?” It is hard to believe that is a question that we need to ask ourselves, given that Rule 10b5-1 has been so useful for insiders over the first couple decades of its existence.
When Rule 10b5-1 was adopted over twenty years ago, it was part of a larger effort to deal with the fact that the SEC was losing in the courts on insider trading cases. The courts had come out in ways the SEC did not like around the “awareness” standard that the SEC wanted to use when determining if someone was in possession of material nonpublic information at the time they traded. The main purpose of Rule 10b5-1 was to establish an awareness standard going forward that would be applied when bringing insider trading cases. Then, as part of the inevitable horse trading that goes on during the rulemaking process, Rule 10b5-1 trading plans were born. The main concept is that you would have an affirmative defense to an insider trading claim if, at the time when you are not aware of material nonpublic information, you enter into an arrangement to sell securities in the future, even if there are times in the future when you are aware of material nonpublic information. The beauty of Rule 10b5-1 plans as contemplated by the rule was just how straightforward the concept was, in that there were not a lot of conditions imposed by the rule. Essentially, once you have hardwired your trading plan, you would not be tagged with insider trading allegations when those trades happen in accordance with that hardwired plan.
It is important to keep in mind that Rule 10b5-1 was, and still is today, an affirmative defense. It’s not a safe harbor. For Rule 10b5-1 to do you any good, you must be accused of insider trading, and then, you come back with the defense of, “I traded pursuant to a Rule 10b5-1 arrangement. For that reason, I should not be held liable for trading while aware of material nonpublic information.”
The unfortunate dynamic that played out after adoption of Rule 10b5-1 was that academics, SEC staff, journalists and others were very critical of Rule 10b5-1. They thought something was amiss with the way that Rule 10b5-1 plans came to be used by executives, directors and companies in the course of their transactions. In short, for whatever reason, Rule 10b5-1 plans were subject to a smear campaign. While there were certainly some instances of abusive behavior associated with Rule 10b5-1 plans over the years, it was never my experience that they were used in a way that was inherently bad – if anything, Rule 10b5-1 plans proved to be a positive development in that insiders could plan for orderly transactions in company securities without running afoul of the insider trading laws. Companies generally had oversight of the plans through their insider trading policies, and the Rule 10b5-1 plan served as a useful tool for many companies from a governance perspective.
The conditions that the SEC has now added to Rule 10b5-1 plans, including the cooling-off period, the limitation on overlapping plans and the single trade limitation, have undoubtedly complicated the use of Rule 10b5-1 plans. The additional transparency around the use of Rule 10b5-1 plans raises their profile in a company’s SEC filings. There are some types of transactions that we historically relied on Rule 10b5-1 for that do not really work anymore, because of the imposition of the cooling off period and overlapping plan conditions. The SEC is now on record, in both the adopting release and proposing release for the Rule 10b5-1 rule amendments, citing the negative academic studies and press about Rule 10b5-1 plans.
By all accounts, I think Rule 10b5-1 is a survivor, despite all of these headwinds. In my practice, insiders are still utilizing Rule 10b5-1 plans for the same types of planned transactions that they implemented before the amendments. While companies may be less likely to actually mandate the use of Rule 10b5-1 plans, they are also not actively discouraging the use of such plans. Brokers have integrated the rule requirements into their standard Rule 10b5-1 plans, and generally those changes have been accepted. We had the first round of disclosure about the adoption or termination of Rule 10b5-1 plans with the second quarter Form 10-Qs, which did not appear to draw much attention. In situations where an insider is not able to conduct planned transactions through a Rule 10b5-1 plan due to the cooling-off period or the overlapping plan conditions, those transactions can be conducted through the normal pre-clearance and trading window process contemplated by a company’s insider trading policy. In the grand scheme of things, I still think Rule 10b5-1 plans make sense for insiders, when used for the purposes for which the rule was intended.
At the risk of sharing too much information, I have a recurring nightmare where I have to take an exam while I am in college or law school, and I never manage to get there on time. By the time I arrive, the classroom is empty and my hopes for completing the exam are dashed. This scenario never happened to me when I was actually in school, so I sometimes wonder whether this dream somehow relates to working in a profession where clients have strict deadlines with significant consequences when it comes to their SEC filings.
A company facing the prospect of missing their Exchange Act filing deadline is often gratified to learn that there is an ability to get some extra time for the filing through Exchange Act Rule 12b-25. But it is also important to keep in mind that a company must file a Form 12b-25 (denoted as “NT” and the filing type on EDGAR) whenever a periodic report is late, even if the company is not actually seeking the automatic extension of the deadline provided in the Rule 12b-25. As we noted in the January-February 2009 issue of The Corporate Counsel:
Rule 12b-25(a) requires the filing of Form 12b-25 within one business day after the due date whenever a periodic report is late. Exchange Act Rules CDI Question 135.02 confirms that the box in Part II of Form 12b-25 is to be checked only if the filing is expected to be made within the applicable, i.e., 15 or 5-day, extension period. This is consistent with the notion that the Form is required even where there is no expectation of meeting the deadline. But, if the box isn’t checked, there is no extension (see Rule 12b-25(b)(2)(ii)).
Moreover, companies need to be very careful about the accuracy and completeness of the description of reasons for the late filing that are given in the Form 12b-25. Rule 12b-25(a) states that the Form 12b-25 “shall contain disclosure of its inability to file the report timely and the reasons therefore in reasonable detail.” Form 12b-25 also requires the filer to confirm whether or not it anticipates that any significant change in results of operations from the corresponding period for the prior fiscal year will be reflected by the earnings statements to be included in the subject periodic report. If such change is anticipated, the filer must attach a narrative and quantitative explanation of the anticipated change and, if appropriate, state the reasons why a reasonable estimate of the results cannot be made. Way back in 2005, the Commission brought an action against a company for false and misleading disclosure in a Form 12b-25 about the reasons for the inability to file the periodic report in a timely manner, which I have often pointed to when companies are considering what to say in this very sensitive filing – the case was called In the Matter of FFP Marketing Company, Inc., Warner Williams, and Craig Scott, CPA, Rel. No. 34-51198 (February 14, 2005).
This week, the SEC gave me several new examples to point to! The SEC brought administrative proceedings against five companies – Vivic Corp., ReShape Lifesciences Inc., Omnia Wellness Inc., Alpine 4 Holding, Inc. and Black Spade Acquisition Co – for violating Rule 12b-25 by filing a Form 12b-25 with the Commission in which the company failed to disclose why, in sufficient detail under the circumstances presented, the periodic report could not be timely filed, and also failed to provide required disclosures about significant changes in results of operations. In these settled administrative proceedings, the subject companies were ordered to cease and desist from violating Rule 12b-25 and were required to pay civil money penalties.
While I am disclosing all of my deepest secrets today, I will note that the title of the panel that I write about in this blog involves one of my favorite foods – nuggets! Because I was so obsessed with Chicken McNuggets when McDonald’s first introduced them in the early 1980s, my brothers and friends nicknamed me “McDave.” Believe it or not, some still call me that to this day!
At the upcoming “20th Annual Executive Compensation Conference” on Friday, September 22, I am joining yet another line-up of SEC All-Stars to provide you with the most important executive compensation nuggets for the upcoming proxy season and beyond. Joining me for this panel will be Mark Borges, Brian Breheny, Meredith Cross and Ron Mueller, each of whom need no introduction to this community!
We will tackle a wide range of topics over the course of an hour, including pay versus performance, equity grant considerations, CD&A disclosures, the latest on perquisites and executive compensation shareholder proposals. I will be tackling the last topic, where we have observed some interesting trends during the 2023 proxy season.
As Meredith noted in The Advisors Blog on CompensationStandards.com (citing this Gibson Dunn memo), executive compensation shareholder proposals increased 108% from 2022. The increase was mostly related to numerous proposals focused on executive severance agreements, which were already a trending proposal topic in 2022. I will address the outcomes observed with these proposals, and I will also touch on proposals which requested that companies include, or report on the possibility of including, social or environmental performance measures in compensation programs.
Earlier this week, PwC released its latest Pulse Survey, “Focused on reinvention,” which asked 609 executives of US companies about managing risks and opportunities in the current business environment. Surprisingly, more than two-thirds of the executives surveyed indicated that they are prepared to comply with coming sustainability reporting requirements, and 66% “are actively engaging with or closely monitoring SEC regulatory activity and proposed disclosure rules.” Despite this level of readiness, the Survey notes:
The headlines in 2023 have been dominated by extreme weather events, but climate change remains relatively low on the list of business risks among respondents. Half of business executives in our survey cite it as a risk to their business. Only 19% cite it as a serious risk, down from 23% in 2022.
Companies are preparing for compliance, however. More than two-thirds of the executives (69%) say they’re prepared to comply with coming sustainability reporting requirements, and 66% are actively engaging with or closely monitoring SEC regulatory activity and proposed disclosure rules. Climate change is an extremely complex issue, but compliance is straightforward. It’s much easier for companies to adhere to externally generated guidance and requirements than it is to rethink business models and take other forward-looking steps to decarbonize.
Only 23% of executives in our survey are contingency planning for climate-related disruptions in the next 12 to 18 months. Some may already have taken steps related to climate and don’t plan to allocate more in the near term, while others may be playing catch-up. Given the 18 separate weather and climate disasters in 2022, each of which cost $1 billion in damage, it’s important for management to discuss the issue with their board and factor it into their strategy and risk management in order not to fall behind. It also presents an opportunity for companies to invest in greater resilience measures.
The Survey goes on to indicate that, within the C-suite, CHROs are the most likely to recognize the issues associated with climate change, with 62% of CHROs citing climate change as a “severe or moderate risk,” significantly more than 37% of CFOs and 50% of all respondents to the Survey. PwC notes that 35% of CHROs indicated that they are preparing contingency plans for climate-related disruptions in the next 12 to 18 months.
What are the biggest risks on the minds of these executives? The Survey notes:
Many risks remain, however. Cyber attacks present the biggest current potential risk, with 74% of executives saying this is either a moderate or serious risk. In addition, while the odds of a recession may be lower, economic growth is still likely to be uneven — at best. Nearly three-quarters (72%) point to an uncertain macroeconomic environment as a moderate or serious risk. A related risk is margin pressure (68% see it as a moderate or serious risk). Inflation is declining but remains above policymaker targets, and many companies may not have sufficient pricing power to sustain margins.
On the “glass half full” front, the Survey indicates that only 17% of business executives strongly anticipate a recession in the next six months, a drop from 35% in October 2022.
Earlier this month, eighty Democrats from the U.S. House of Representatives sent a letter to SEC Chair Gary Gensler, urging him to “finalize and adopt a credible mandatory disclosure rule as quickly as possible.” The letter notes:
The proposed rule is squarely within the Commission’s authority and mission to protect investors; maintain fair, orderly, and efficient markets; and facilitate the formation of capital. The SEC has “longstanding and indisputable authority to regulate the disclosure practices of public traded companies” to protect markets and market participants. It “has exercised its disclosure authority consistently—and without legislative override” for over ninety years, and “has now done so once more with the Proposal on climate-related disclosure.”
Increasingly frequent and severe extreme weather events have affirmed that climate change poses a significant financial risk, and developments in the past year have strengthened the case for finalizing a strong rule. Physical risk is scaling rapidly, accelerating direct damages and supply chain disruptions that impact public companies’ bottom lines. Last year, the cost of climate and weather disasters in the United States totaled more than $165 billion—the third most costly year on record. 2These events can materially affect the financial and operational wellbeing of companies around the world, including SEC registrants. The current patchwork of voluntary reporting requirements is inadequate and lacks rigor, consistency, and verifiability.
The letter also cites the European Union’s implementation of its Corporate Sustainability Reporting Directive, “which will increase climate-related reporting requirements on companies within the EU and those that have substantial activity within the EU.” The letter indicates that “recent estimates show that thousands of U.S. companies will be required to comply with these CSRD standards.”
By my count, this letter joins a dozen other letters from members of the U.S. House Representatives in the SEC’s comment file for the climate change disclosure proposal. Thirteen letters have also been sent from U.S. Senators. This rulemaking has certainly generated a significant amount of interest from Capitol Hill in the almost year and half that the proposal has been outstanding. I cannot recall a rulemaking that prompted so many letters from members of Congress.
This week, I am highlighting some of the topics that I will be speaking about at our September Conferences, and next on the line-up is climate disclosure. On Thursday, September 21, during the 2023 Proxy Disclosure Conference, I will be joined by an outstanding group of speakers to discuss “Climate Disclosures: Requirements & Risks.” Joining me for the program will be my Morrison & Foerster colleague Jina Choi, Mark Kronforst from Ernst & Young and Arden Phillips from Constellation Energy Corporation.
We plan to address the practical steps that you need to take to prepare for mandatory GHG emissions and climate risk reporting – and the new risks that mandatory disclosure creates for you, your company and your board. The focus of my remarks will be on describing the state of the SEC’s rulemaking, addressing the applicability and status of non-US standards (such as CSRD), and describing the gap analysis and compliance roadmap that companies should now be considering. My co-panelists will delve into issues around potential litigation, working with external auditors and the in-house perspective on implementing the new rules. This discussion will build on topics addressed at our “2023 Practical ESG Conference” – which is taking place on Tuesday, September 19th and can be bundled with the “Proxy Disclosure & 20th Annual Executive Compensation Conferences.” Don’t hesitate – register online today through our membership center, email sales@ccrcorp.com or call 1-800-737-1271 – so you will be able to hear all of the latest insights on this very important topic.
This summer, Meredith has been covering the decision in SEC v. Ripple Labs, (SDNY 7/23), which attracted quite a lot of attention in the crypto community given the outcome of the case with respect to programmatic sales of tokens. As Meredith more recently noted, the plot recently thickened with the outcome in the SEC v. Terraform Labs, (SDNY 8/23) case. Late last week, the Ripple Labs case took yet another interesting turn as U.S. District Judge Analisa Torres said that she would allow the SEC to move forward with a request for an interlocutory appeal of the July decision, setting up the potential for a review of the decision by the Court of Appeals for the Second Circuit. A WSJ article regarding the potential appeal notes:
Interlocutory appeals allow for part of a case to be reviewed before a court renders its final judgment and are relatively rare. If Judge Torres grants the SEC permission to seek review by the U.S. Court of Appeals for the Second Circuit, it could be a year or more before a final decision is rendered. Both Ripple and its co-defendants, Chief Executive Brad Garlinghouse and co-founder Christian Larsen, opposed the SEC’s request.
In its letter to Judge Torres, the SEC noted that another judge in the Second Circuit—Jed Rakoff, ruling in a separate case earlier this month—questioned the idea that one asset could be either a security or a non-security depending on the purchaser.
The prospect for an interlocutory appeal is perhaps good news in terms of bringing some clarity to a situation where too much attention was paid to the outcome. However, the amount of time needed for an appeal to be considered and decided in the Second Circuit is no doubt far too long in the crypto community, which continues to clamor for “clarity” on the application of the Howey test to digital assets.
At the end of last month, in remarks before the Financial Stability Oversight Council, SEC Chair Gary Gensler bid a not-so-fond farewell to LIBOR, the rate that I envisioned guys in bowler hats setting each business day morning in London. In fact, Gensler compared LIBOR to the Hans Christian Andersen folktale “The Emperor’s New Clothes,” in which of course the emperor had no clothes. Gensler noted in his remarks:
Policymakers worldwide, from central banks, including the Federal Reserve; to FSOC and the Financial Stability Board; to market regulators, including the SEC and CFTC; to Congress, came together to end LIBOR. In essence, we all knew we needed an emperor who was properly clothed.
It took a lot of work, but 15 years later, as of June 30, 2023, it finally ceased. In the United States, the main replacement for LIBOR is the Secured Overnight Financing Rate. We cannot, however, stop here.
There will be some pretenders, as there often are in the history of emperors.
It is important that any rate used to replace LIBOR be robust and not ill clad. Certain alternatives being considered in the markets, however, present many of the same flaws as LIBOR: thin markets—in times of stress scantily-clad—with few underlying transactions, creating a system vulnerable to collapse and manipulation.
Gensler reiterated his concerns with so-called “credit sensitive rates,” such as the Bloomberg Short-Term Bank Yield Index rate, which he believes “have infirmities that will not stand the test of time—and will not be good for financial stability or for future FSOC members.” He noted that IOSCO recently conducted a review of some alternatives to USD LIBOR, and the credit sensitive rates that IOSCO reviewed were not found to meet the organization’s principles for stable and reliable benchmarks in the areas of benchmark design, data sufficiency, and transparency.
Gensler closed his remarks noting that “the LIBOR story is a cautionary tale not to just trust something because it’s popular or ubiquitous.”