For some reason, I can’t get that song “The Final Countdown” from Europe out of my head this morning, as the clock ticks down to the end of the federal government’s fiscal year. As has happened so many times in the past, it is still possible that we could see Congress reach an eleventh-hour deal to kick the can down the road, but that outcome appears to be increasingly unlikely.
As this Washington Post article notes, the U.S. government notified federal workers yesterday that a government shutdown appears to be imminent. If there is a lapse in appropriations, approximately 2.1 million federal workers and 1.3 million active duty troops will stop receiving their paychecks. As we know from the Corp Fin guidance that I blogged about yesterday, there would be inevitable disruptions in capital markets transactions (including the recently reawakened IPO market) and other matters that the SEC staff is involved with if the SEC has to furlough its employees as a result of a government shutdown, and similar disruptions in government services will play out across Washington and beyond.
As we gird ourselves for what could potentially be a long shutdown, I try to recall some of the brighter spots from the almost month-long government shutdown in 2018-2019. As we noted in the blog back then:
But if you live in Washington DC, the government shutdown is big news as many of your friends & neighbors are nervously sitting at home. Or maybe they have run out to one of Jose Andres’ restaurants, as the famous chef is handing out free food if you can flash a government ID. Some DC bars are offering speciality cocktails, such as as “Nothing Really Mattis” (Mad Dog 20/20 and Vodka) and “Mexico Will Pay for This” (Montezuma Blue tequila, orange juice and grenadine).
As we go into this weekend, all we can do now is hope for the best and prepare for the worst.
At this point in my life, I think that I have come to accept a lot of things. This is what we call “growth.” I accept that I may never see a day when Congress does not turn every budget cycle into a political football and when members of Congress actually work together in a bipartisan manner to pass legislation that benefits the American people. I accept that the SEC may never revert to some sort of pre-politicized version of itself (if in fact that version of itself ever really existed). I accept that I am probably not going to get a chance to do a third tour at the SEC, particularly given that I have committed the cardinal sin of having represented clients in private practice. I accept that I am likely not going to be able own (or even drive) all of those dream cars that I have had on my list. And, perhaps most grudgingly, I accept that XBRL is here to stay.
As a self-avowed XBRL skeptic from the get-go, there was certainly a time when I hoped against hope that XBRL was just some sort of fad. With an EDGAR filing system that has always seemed to be just barely hanging on by a thread, I felt that the introduction of clunky XBRL files was inevitably just going to make a bad problem worse, with little upside in terms of the actual utility of the XBRL data to the SEC and outside parties.
I accept today that I was wrong – XBRL was not a fad. The requirements to tag data using Inline XBRL are coming in fast and furious these days, and now XBRL tagging is required in more filings than ever before – including the proxy statement, thanks to the pay versus performance disclosure requirements. This proliferation of XBRL requirements creates more opportunities for errors, which could have significant consequences for companies.
With a lot of skeptics like me out there, the SEC obviously needed a “stick” to compel XBRL compliance, and it landed on making the failure to provide the required XBRL data with a filing an error that impacts whether the company is considered current for the purposes of short-form eligibility (e.g., Forms S-3 and S-8) and the current public information requirement of Rule 144. While this consequence of non-compliance was adopted way back in 2009, to this day I think this comes as a surprise to companies when they come across a failure to comply with the XBRL requirements. The good news is that the filing of the required XBRL data will cause the filer to immediately regain compliance for these purposes, so it is a problem that can be easily remedied with an amendment to the deficient report.
As Liz noted in the blog earlier this month, Corp Fin recently provided some XBRL guidance in the form of a sample comment letter that identified several common areas of concern that the Staff comes across in the course of reviewing of filings, including: (i) filings that do not include the required Inline XBRL presentation in accordance with Item 405 of Regulation S-T, which must be amended to include the required Inline XBRL presentation; (ii) situations where the common shares outstanding reported on the cover page and on the balance sheet are tagged with materially different values (e.g., presenting the whole amount in one instance and the same amount in thousands in the second). (iii) pay versus performance disclosure must tagged using in Inline XBRL; (iv) while it is permissible to combine one or more sets of pay versus performance relationship disclosures into one graph, table, or other format, an issuer must still provide separate XBRL tags for each required item; using different XBRL elements to tag the same reported line item on the income statement from period to period; and (v) in situations where an issuer uses a custom tag, the Staff may requests an explanation of why the current U.S. GAAP tag is not applicable or asks the issuer to correctly tag the disclosure.
I do not think that the Staff’s sample comment letter is some indication that the Staff has undertaken a comprehensive effort to review XBRL compliance, but rather I think it is meant more as a reminder to companies that, in the face of so many new disclosure requirements that include an XBRL element, it is really time to get you XBRL house in order. Given the aforementioned consequences of non-compliance, there should be heightened awareness within the organization as to the importance of accurate and complete XBRL tagging. To an outside adviser like me, the XBRL process at clients is a black box – I do not have any visibility into the tagging process, which is by necessity often left to the very end of the filing process, when mistakes are more likely to occur.
The renewed focus on XBRL tagging presents a great opportunity to pull XBRL out of the black box and make sure appropriate steps are being taken as part of the company’s disclosure controls and procedures to get the XBRL tagging right and to avoid the sort of unforced errors that the SEC staff has observed – because XBRL is not a fad, and the scope of disclosure that must be tagged is only going to continue to increase.
Earlier this week, Alan Dye noted on the Section16.net blog that the SEC announced cease and desist orders against five issuers and six individuals based on violations of Section 16(a), Section 13(d) and Item 405 disclosure obligations. Alan’s blog notes:
[I]t looks like:
All of the five issuers were charged with “causing” Section 16(a) violations by undertaking but failing to assist insiders with Section 16(a) reporting requirements
Three of the issuers also were charged with violating the proxy and 10-K disclosure requirements by failing to disclose insiders’ reporting violations under Item 405
Three of the individuals were officers or directors and were charged with violating Section 16(a)
The other three individuals were 10% owners of one or more companies and were charged with failure to comply with Sections 13(d) and 16(a).
All of the respondents consented to the orders and civil money penalties. Most of the alleged violations occurred in the 2017-2022 timeframe, but the SEC’s press release suggests that there may be more to come—it says today’s orders are part of “the SEC’s ongoing investigation of potential beneficial ownership violations.”
You may recall that we last saw a series of Section 16 and beneficial ownership reporting sweep cases way back in 2014.
Yesterday, Corp Fin issued nine new Regulation S-K Compliance and Disclosure Interpretations and updated one existing Regulation S-K Compliance and Disclosure Interpretation to provide guidance regarding the pay versus performance disclosure requirements specified in Item 402(v) of Regulation S-K. The new CDIs address the following areas:
Question 128D.14 – Awards granted in fiscal years prior to an equity restructuring (such as a spin-off) that are retained by the holder must be included in the calculation of executive compensation actually paid.
Question 128D.15 – The change in fair value of awards granted prior to the date of an issuer’s IPO must be based on the fair value of those awards as of the end of the prior fiscal year for purposes of determining executive compensation actually paid (not based on other dates, such as the date of the IPO.
Question 128D.16 – In accordance with FASB ASC Topic 718, the effect of a market condition should be reflected in the fair value of share-based awards with such a condition. In addition, for purposes of the table required by Item 402(v)(1) of Regulation S-K, market conditions should also be considered in determining whether the vesting conditions of share-based awards have been met.
Question 128D.17 – The fair value of an award that did not meet vesting conditions during the year because the performance or market conditions were not met, but for which there is still potential for the award to vest in the future, should not be subtracted under Item 402(v)(2)(iii)(C)(1)(v) of Regulation S-K because it failed to vest in the current year.
Question 128D.18 – If retirement eligibility is the only vesting condition for a stock or option award, that condition would be considered satisfied for purposes of the pay versus performance disclosures and calculation of executive compensation actually paid in the year that the holder becomes retirement eligible.
Question 128D.19 – A performance-based vesting condition is considered satisfied when the applicable condition is achieved; however, a provision which requires the compensation committee to certify the level of performance attained should be analyzed to determine if it creates an additional substantive vesting condition, such as an employee does not vest in the award unless and until they remain employed through the date such certification occurs, in considering whether the award is vested for purposes of the Item 402(v) of Regulation S-K disclosures at the end of the fiscal year-end.
Question 128D.20 – An issuer may satisfy the requirement in Item 402(v)(2)(iii)(C)(3) of Regulation S-K with respect to the fair value of all equity awards being computed in a manner consistent with the methodology used to account for share-based payments under GAAP by using a valuation technique that differs from the one used to determine the grant date fair value of the equity-based awards that are classified as equity in the financial statements, as long as the valuation technique would be permitted under FASB ASC Topic 718, including that it meets the criteria for a valuation technique and the fair value measurement objective.
Question 128D.21 – To comply with Item 402(v)(2)(iii)(C)(3) of Regulation S-K, the methodology used to compute the fair value amounts of all equity awards must be consistent with the methodology used to account for share-based payments in the financial statements under GAAP. It is not acceptable to value these awards as of the end of a covered fiscal year based on methods not prescribed by GAAP.
Question 128D.22 – If the assumptions disclosure required by Item 402(v)(4) would involve confidential trade secrets or confidential commercial or financial information, the disclosure of which would result in competitive harm for the issuer, the issuer may omit such information to the extent such information would be subject to the confidentiality protections of Instruction 4 to Item 402(b) of Regulation S-K. However, the issuer must provide as much information responsive to the Item 402(v)(4) requirement as possible without disclosing the confidential information, such as a range of outcomes or a discussion of how a performance condition impacted the fair value. In addition, consistent with Instruction 4 to Item 402(b), the issuer should also discuss how the material difference in the assumption affects how difficult it will be for the executive or how likely it will be for the issuer to achieve undisclosed target levels or other factors.
The Staff also updated Regulation S-K CDI Question 118.08, which addresses the approach for satisfying Item 10(e) of Regulation S-K and Regulation G with respect to non-GAAP financial measures that are presented in pay-related circumstances in the proxy statement. The same principles articulated in Question 118.08 continue apply, where an issuer can refer to annex or cross-reference the non-GAAP financial measure disclosure in the Form 10-K, but the Staff updated the language in the CDI to replace references to “the relationship between pay and performance” with “how pay is structured and implemented to reflect the registrant’s or a named executive officer’s performance.”
With only three days left until the end of the federal government’s fiscal year, we appear to be no closer to seeing Congress act on an appropriations bill or an interim funding measure, so that means I am going to keep blogging about government shutdown developments!
Yesterday, Corp Fin issued an announcement titled Division of Corporation Finance Actions in Advance of a Potential Government Shutdown, providing guidance on Corp Fin’s operations during the shutdown and various considerations for filing matters that would inevitably arise in the event of a lapse in appropriations and the resulting furlough of the SEC Staff during the pendency of a shutdown. This guidance may seem very familiar, because it closely tracks the guidance that we have received from the Staff in past government shutdown situations.
My top ten takeaways from the Staff’s guidance include:
1. In the event that a government shutdown occurs, Corp Fin intends to provide as much advance notice as possible of any change of its operating status.
2. EDGAR will continue to accept registration statements, offering statements and any other required filings, regardless of the SEC’s operating status.
3. Once the SEC’s operations cease due to a government shutdown, the Staff will not be able to declare registration statements effective (including post-effective amendments to registration statements) and the Staff will not be able to qualify Form 1-A offering statements.
4. Given the uncertainty as to the timing of when the SEC’s operating status will change, the Staff suggests that an issuer may want to submit a request for acceleration or qualification while the SEC is open and operating, if that issuer has a pending registration statement or Form 1-A offering statement that is substantially complete, and that has met all the statutory requirements to request acceleration of the effective date or qualification.
5. The Staff indicates that, in a situation where the required “no objections” statement from FINRA has not yet been obtained, the Staff will consider granting requests for acceleration or qualification if the underwriters confirm in their request that they will not execute the underwriting agreement or confirm sales of the registered securities until they receive that statement from FINRA.
6. During a government shutdown, the issuer can file a post-effective amendment on EDGAR, but the Staff will not be in a position to declare that post-effective amendment effective. Issuers will have to decide for themselves if they can update a registration statement by prospectus supplement, which requires no action on the part of the Staff.
7. If an issuer does not price an offering within the 15-day time period provided in Rule 430(a), the Staff indicates that the issuer may file post-effective amendments, as necessary, under Rule 462(c) to restart the 15-business-day period so that, at the time of pricing, the issuer will be able to include the pricing information in a Rule 424(b) prospectus supplement.
8. The Staff notes that an issuer can elect to amend to remove a delaying amendment while the SEC is open or while the SEC is shut down; however, the Staff may request that the issuer amend the filing to include the delaying amendment if and when the SEC is operational.
9. An issuer does not need to hear from the Staff regarding a preliminary proxy statement during the ten-day period before the issuer may file definitive proxy materials; however, the Staff notes that it may review the issuer’s preliminary proxy statement when the SEC is operational.
10. During a government shutdown, the Staff will not be able to respond to any written or oral guidance for legal or interpretative questions, including Rule 14a-8 no-action letters. The Staff may consider a request for emergency relief under Rule 3-13 of Regulation S-X.
Perhaps the biggest takeaway here is that if you have a registration statement or a post-effective amendment to a registration statement that you need to get declared effective in the near term, or some other filing or interpretive issue that you need to get resolved, I suggest that you give the Staff a call first thing this morning, because they will no doubt be inundated with requests to resolve pending matters in advance of a potential September 30 shutdown date.
Now, if you want a blast from the past on the topic of government shutdowns, check out this Dave and Marty Radio Show from April 8, 2011. The discussion that I had with Marty way back then tends to prove the point that the more things change, the more they stay the same!
Yesterday, SEC Chair Gensler may have wished that the government shutdown had come a few days early as he faced some hostile members of the House Financial Services Committee at an oversight hearing. Chair Gensler’s written testimony highlighted the Commission’s efforts on a wide range of regulatory fronts.
Yesterday, the SEC announced the release of a report to Congress summarizing policy recommendations made during the 42nd Annual Government-Business Forum on Small Business Capital Formation. The SEC’s announcement notes that “[t]he report provides a summary of the forum proceedings, including the recommendations developed by participants for changes to the capital raising framework and the Commission’s responses to those recommendations.”
The report includes numerous recommendations and Commission responses, including:
– Expand the accredited investor definition to achieve greater diversity among startup investors and entrepreneurs.
– Expand the accredited investor definition to include additional measures of sophistication.
– Harmonize the annual reporting requirements for issuers that utilize different exempt pathways, such as Regulation Crowdfunding and Regulation A.
– Expand the accredited investor definition to include any person who invests not more than 10% of the greater of his/her annual income or net assets.
– Do not revise the accredited investor definition to make it more difficult to qualify based on wealth thresholds.
– Ensure capital-raising rules provide equitable access to capital for underrepresented founders and investors.
– Collaborate with market experts to establish a regulatory framework for finders that includes an exemption from broker-dealer registration and helps facilitate small business capital formation.
– Support entrepreneurs, including underrepresented founders, who lack the technical assistance to understand how to access capital from investors.
– Improve the exempt offering framework to reduce concentration and increase diversity – access to capital should not be practically limited to only rich people the company knows.
– Create a new private fund exemption to allow states to foster intrastate and regional funds focused on community-based investing that is open to non-accredited investors.
– Support underrepresented emerging fund managers—specifically minorities and women—building funds that diversify capital allocation, engage sophisticated investors, and challenge pattern matching trends.
– Allow non-accredited investors to participate in venture capital funds.
– Increase the number of investors allowed in 3(c)(1) funds (private funds structured in the traditional manner under Section 3(c)(1) of the Company Act above 100 investors.
– Increase the number of investors and the capital limit for funds structured under Section 3(c)(1), including traditional 3(c)(1) funds as well as Qualified Venture Capital Funds to achieve greater diversity among startup investors and entrepreneurs.
– Incentivize investors to invest in funds that support startup founders.
– Revise Exchange Act Section 12(g) to increase the number of holders that are non-accredited investors and increase the asset threshold.
– Before considering any changes that increase the smaller public company requirements, narrowly tie any changes to an identified problem so smaller public companies can have a stable and predictable regulatory environment.
– Facilitate the creation of venture markets that provide investors with a transparent and regulated environment for trading in stocks of smaller companies.
– Revise the proposed 2022 Climate-Related Disclosure rules to exempt smaller reporting companies, non-accelerated filers, emerging growth companies, and other midsized companies. If any of these issuers are subject to the rules, scale and delay the rules.
– Improve public trading for small companies by requiring more disclosures about short selling, institutional holdings, insider and affiliate holdings and transactions, paid stock promotion, and information about the security from transfer agents.
Well, I was hoping that I would not have to circle back to the topic of the looming government shutdown, but the situation does not seem to have improved on Capitol Hill since I last blogged about this topic. There is obviously still time for a resolution, as well as for the SEC Staff to provide some further guidance, but I thought it still might be useful to dust off some of the key considerations to keep in mind if there is a lapse in appropriations at the SEC. Today, I address what we can expect from an operational standpoint.
Operations – In some of the past shutdown situations, the SEC was able to maintain its operations for some period of time after other parts of the government were shut down, but there is no assurance this will happen if there is a lapse in appropriations this time around. If the SEC is forced to shut down, the Antideficiency Act – which dates back to the late 1800s – prohibits federal agencies from incurring obligations or expending federal funds in advance or in excess of an appropriation, and from accepting voluntary services. Government employees can face significant consequences for violating these restrictions, so do not expect any Staff members to be checking their emails or responding to telephone calls during the pendency of a shutdown. There is an exception to the restrictions in the Antideficiency Act which allow some limited staffing to address emergencies involving “the safety of human life or the protection of property.” During the 2019 shutdown, Corp Fin staff was available to address filing fee questions and emergency securities matters, which was generally subject to a very high bar. Keep in mind that the Antideficiency Act makes a government shutdown much different from a “snow day” at the SEC.
Status of Commissioners – Presidential appointees, such as the SEC’s Chairman and the other Commissioners, are not subject to furlough during the shutdown because their salary is an obligation incurred by the year, without consideration of hours of duty required, so they cannot be furloughed. As a result, the SEC Commissioners continue to report for duty during a shutdown, although they are limited in acting individually or as a Commission as long as no appropriation bill is enacted.
Status as a “Business Day” – While during a government shutdown the SEC is, for all intents and purposes, not conducting any business, the days that the SEC is subject to the shutdown should nonetheless be counted as business days for the purposes of, e.g., filing deadlines, Rule 430A. Rule 13e-3, Rule 13e-4, Regulation 14D, Regulation 14E and Regulation M.
EDGAR Soldiers On – While the Staff is furloughed, an issuer can still make all of its EDGAR filings, because EDGAR operates under a continuing contract that is not affected by the lapse in appropriations. Depending on the length of the shutdown, it is possible that EDGAR could cease operations, but as long as EDGAR remains up and running, issuers, investors, insiders and others must continue submitting their filings in accordance with existing deadlines. It should still be possible to submit a Form ID and thereby receive EDGAR codes during a shutdown, and in our experience the turnaround time for that function during the 2019 shutdown was pretty consistent with when the SEC is not in shutdown mode. Filer support personnel should also available to perform password resets, answer questions about fee-bearing EDGAR filings and other emergency questions regarding EDGAR submissions.
Rulemaking – The SEC continues to accept comment letters on rule proposals and concept releases during a federal government shutdown, but given the limited Staff, posting such letters to the SEC website could be delayed. Obviously, the limited Staff and the restrictions on the agency’s operations would prevent any rulemaking activities during the pendency of a government shutdown, including meeting with outside parties and the scheduling of open meetings to consider the proposal or adoption of rules.
Stop Order Database – The SEC’s online stop order database, which issuers have come to rely on in order to confirm that no stop order has occurred when closing a registered offering, would remain up and running during a shutdown and would in all likelihood continue to be updated, although any SEC stop order action during a shutdown would appear to be unlikely unless it meets the protection of “life or property” threshold.
In the latest episode of MoFo’s Above Board podcast, I am joined by my colleagues Adam Braverman, Jina Choi, and Christine Wong to address the latest developments coming out of the DOJ, the SEC, and the U.S. Attorneys’ Offices regarding voluntary self-disclosure policies, the preservation of electronic communications and corporate compensation and clawback policies. Be sure to check it out!
Last Thursday, the SEC’s Investor Advisory Committee met, and on the agenda was a discussion of exempt offerings under Rule 506 of Regulation D and the definition of “accredited investor.” This discussion comes about when the SEC has had “Regulation D and Form D Improvements” on the Reg Flex Agenda for some time now, and Commissioner Crenshaw caused a stir at this year’s Northwestern Securities Regulation Institute by noting several areas of concern with Rule 506 and the rise of unicorns that utilize the exemption, including those related to investor protection, inflated valuations, corporate governance and the impact on small businesses. Earlier this year, the Investor Advisory Committee also explored the growth of private markets at one of its meetings. This Mayer Brown Free Writings & Perspectives blog describes the proceedings at last week’s meeting:
Panelists examined the increased use of Rule 506 and provided recommendations regarding potential changes to improve information asymmetry and provide better investor protections. Craig McCann noted the increasing popularity of exempt securities offerings: at least $15 trillion of Reg D securities were sold from 2009 through 2020, compared to $16.4 trillion of registered securities sold and at least $4.4 trillion of Reg D securities were sold in 2021 and 2022, 13% more than the $3.9 trillion proceeds from public offerings. Panelists further discussed the background, purpose and effect of Form D filings and noted that Form D filings are intended to provide notice of exempt offerings and to allow the SEC to collect empirical data on these filings. However, while a Form D filing is a rule requirement, it is not a condition to the exemption. Panelists noted that some issuers may not make Form D filings, causing the data available to the SEC to be incomplete. Additionally, panelists discussed how Form D filings themselves can sometimes be a vehicle for fraud, as some investors do not understand that Form D filings are not reviewed and assessed by SEC staff and that the SEC stamp on the form can provide the contents therein with legitimacy for investors. Potential suggestions from panelists to alleviate these concerns would be to include a link on Form D filings to standard risk disclosure regarding start-ups already readily available on the SEC’s website, including a statement on Form D that the contents are self-reported or including a legend with standard risk disclosure on the form. Last, panelists suggested the SEC examine its rules and regulations covering the public market in order to make the market more accessible.
The Investor Advisory Committee also took up the topic of the accredited investor definition. The agenda for the Investor Advisory Committee stated that “under current securities regulations, individuals qualifying as “accredited investors” are permitted to invest in unregistered securities that, by nature, lack many of the protections provided by the regulatory disclosure requirements and attendant accountability through traditional public markets. Over the years, the SEC has continued to evolve standards on these qualifications, with the overarching goal of ensuring ‘accredited investors’ possess sufficient financial sophistication and necessary financial resources to participate in these inherently riskier and often highly illiquid markets.” On this topic, the Mayer Brown blog notes:
Panelists discussed the origins and intent of the “accredited investor” definition and considered whether the “accredited investor” qualifications remain fit-for-purpose. The panel explored whether updates to the rule may be necessary to ensure the SEC can balance the needs of investors through its tripartite mission of investor protection, ensuring fair, orderly, and efficient markets, and facilitating capital formation. While providing a background of the current “accredited investor” framework, Professor Usha Rodrigues cited stating the SEC’s 2015 Report on the Review of the Definition of “Accredited Investor” stating, “the accredited investor definition is a cornerstone of Regulation D” and “the concept intended to encompass those persons and entities whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protection of the Securities Act’s registration process unnecessary.” The panelists discussed the growing number of persons captured by the definition of “accredited investor” – 2% in 1982 and over 10% today. Multiple panelists further noted that wealth is not a proxy for financial sophistication and that accredited investors should possess both financial sophistication and wealth to allow them to better assess investment opportunities and isolate themselves from potential losses. Some suggestions proposed by panelists to limit the number of persons falling within the definition of an “accredited investor” include: excluding retirement income from the calculation of wealth; adjusting income levels for current inflation and including a financial acumen threshold; and including tiered pathways to participation for various Regulation D offerings.
It remains to be seen whether the Commission will have the bandwidth to propose changes to Rule 506 in the coming months. Reading the tea leaves a bit, the Investor Advisory Committee’s consideration of this topic may indicate that a proposal is closer to seeing the light of day. My only hope is that the Commission will choose to tread lightly here, given that Rule 506 is such an important linchpin of the capital markets.