Among the reports circulating last week about the SEC’s climate disclosure rule were a few – e.g., from Reuters and the WSJ – that the draft that is being internally circulated does not include a reporting requirement for Scope 3 emissions.
Eliminating the proposed “Scope 3” disclosure requirement would not be too surprising based on the comments that emphasized what a heavy lift this would be for private companies in the supply chain, the questions on whether there are reliable ways to collect & calculate these emissions, and the signals that major asset managers have been sending since the time the rules were proposed. But at many companies, “Scope 3” is the biggest part of their emissions. So, dropping that aspect of the rule would make a big difference in what’s reported – at least, in the US. Here’s more detail from Reuters:
If adopted, the new draft would represent a win for many corporations and their trade groups that lobbied to water down the rules. But it would also deviate from European Union rules which make Scope 3 disclosures mandatory for large companies starting this year and potentially complicate compliance for some global corporations.
The SEC’s original draft proposed mandatory disclosure of emissions for which companies are more directly responsible, dubbed Scope 1 and Scope 2. Some lobbyists pushed the SEC to require such disclosures only if they are material to a company’s business. Reuters could not ascertain whether the latest draft changed the Scope 1 and 2 requirement threshold.
See this blog from Cooley’s Cydney Posner for more detail on the back & forth on Scope 3. Stay tuned!
The SEC’s final rules on SPACs (and de-SPACs) – which were adopted almost exactly a month ago – have been published in the Federal Register. That means that the compliance date for most of the rules is July 1st of this year, and the compliance date for iXBRL tagging is June 30, 2025. The final rules will require additional disclosures in SPAC IPOs and de-SPAC transactions and heighten liability risks for those involved.
Of course, the rule also included guidance on “investment company” status, which is already in play. As I blogged last month, that aspect of the release – and the part about projections – is something that all companies should care about.
The SEC’s novel shadow insider trading theory is back in the spotlight again thanks to an article appearing in the Wall Street Journal earlier this week. The SEC’s case is going to trial next month, which will test the SEC’s theory that an individual can commit an insider trading violation when trading in the stock of an unrelated company based on material nonpublic information that the individual has about his or her own company. The article notes:
No court has ever tackled the idea that executives can go too far when they deploy their specialized knowledge or expertise to trade in the shares of rivals, said Karen Woody, a professor at the Washington and Lee University School of Law.
“I do think this is a push of the law and they are seeing if they can get a court to bless what is a bit of a stretch of the existing parameters,” Woody said of the SEC’s case.
The SEC says two facts about Panuwat’s trading show it was illegal. First, his employer, Medivation, had a policy that forbade trading other companies’ shares when employees had material nonpublic information about Medivation. And second, Panuwat traded on his work computer just seven minutes after he allegedly learned that Pfizer would buy his company.
The press attention to the case has prompted questions again as to what changes should be made to insider trading policies as a result of the SEC’s shadow insider trading case.
The panel that I moderated at the Northwestern Pritzker School of Law’s Securities Regulation Institute last month delved into this topic in some depth, and I was surprised to learn that a significant number of companies that were the subject of a recent academic study had very broad language in their insider trading policies that prohibited trading in other companies’ securities based on material nonpublic information, rather than more targeted language that prohibited trading in the securities of other companies with which the employer did business or was negotiating a potential transaction. Those companies that have the very broad formulation in their insider trading policies should revisit those policies to tighten up the prohibited conduct, so as not to create duties for employees that could potentially be seen as breached under the shadow insider trading concept. Here is our coverage of the topic from the January-February 2023 issue of The Corporate Counsel:
The SEC has been pushing the envelope on quite a few things these days, and one of those areas is with insider trading law. Back in January 2022, a federal district court denied a motion to dismiss a novel insider trading enforcement action brought by the SEC based upon a theory now known as “shadow insider trading.” In SEC v. Panuwat, No. 4:21-cv-06322 (N.D. Cal. Aug. 17, 2021), the SEC took the position that the insider trading laws apply where an insider uses material nonpublic information about his or her own company to trade securities of another company, such as a competitor or peer company in the same industry.
As noted in the court’s decision, the defendent, Panuwat, had a role at his company that included following the stock prices of certain peer companies. Shortly after receiving an internal email stating that his company would be acquired, Panuwat bought short-term out-of-the-money options of one of his company’s peers. Shortly after the acquisition of Panuwat’s company was announced, the stock price of the peer company increased, and Panuwat made more than $100,000 in profits from the options trade. The SEC alleged that Panuwat’s conduct constituted insider trading.
In the decision, the court’s determination of whether the SEC adequately alleged that Panuwat had breached his duty to his employer turned entirely upon the broad wording of his employer’s insider trading policy. The court did not consider whether Panuwat’s conduct would have been unlawful absent the written insider trading policy that prohibited it. The court concluded that the company’s insider trading policy, which prohibited employees from using the company’s confidential information to trade in the securities of “another publicly traded company,” was broad enough to prohibit trading in the securities of any public company based upon the company’s confidential information.
While it is hard to say how far the SEC’s shadow insider trading theory will go, the Panuwat case highlights a need to avoid overbroad language in the insider trading policy that could potentially broaden the scope of liability for those who are subject to the policy. With that in mind, we have revised the language in the Model Insider Trading Policy regarding trading of securities of other companies while aware of material nonpublic information to be more specific as to the relationship with those companies and how the information is obtained by the individual in the course of their work for their employer.
In our model insider trading policy materials that were included as a special supplement to the January-February 2023 issue, we tightened up the language on this topic to now read:
In addition, it is the policy of the Company that no director, officer or other employee of the Company (or any other person designated as subject to this Policy) who, in the course of working for the Company, learns of material nonpublic information about a company (1) with which the Company does business, such as the Company’s distributors, vendors, customers and suppliers, or (2) that is involved in a potential transaction or business relationship with Company, may engage in transactions in that company’s securities until the information becomes public or is no longer material.
It will be interesting to see how this first shadow insider trading case goes at trial, but even if the SEC does not prevail in the litigation, I think it makes sense to adopt the more specific policy language identified above.
Yesterday, the SEC announced that it had adopted amendments to its ethics rules that govern the securities holdings and transactions of all agency employees, their spouses, and minor children. As one might expect, the SEC already had in place very robust ethics requirements around trading in securities by SEC personnel and related persons, which instilled in me to this day a reluctance to ever trade in any individual company stocks, even if permitted by my firm’s trading policy. The SEC describes its recent amendments as follows:
The amendments update the SEC’s Supplemental Ethics Rules, 5 CFR Part 4401.102, Supplemental Standards of Conduct for Members and Employees Securities and Exchange Commission.
Prohibitions Against Financial Industry Sector Funds
While the Commission has long prohibited employees from investing in stocks of entities directly regulated by the Commission, such as broker-dealers and investment advisers, the rule amendments expand the prohibited holdings restrictions to ban employees from investing in financial industry sector funds, as employee ownership of financial industry sector funds poses similar risks of conflicts of interest and appearance concerns.
Enhancements to Data Collection
The amendments permit employees to comply with existing reporting requirements by authorizing financial institutions to transmit data on their covered securities transactions and holdings directly to the SEC through an automated electronic system. This amendment is expected to enhance internal compliance controls by facilitating the detection and remediation of violations in real time, reducing burdensome manual processes for transaction confirmations and reporting, and providing an independently verifiable source for compliance monitoring and testing.
Optimizing Efficient and Effective Use of Agency Resources
Finally, the amendments facilitate the efficient and effective use of agency resources to monitor compliance of securities investments and transactions that involve significant ethics risks. Specifically, because diversified mutual funds generally pose a low risk of conflicts of interest, misuse of nonpublic information for personal gain, or appearance problems as compared to other types of securities, the rule amendments exempt diversified mutual funds from the Supplemental Ethics Rule’s requirements. However, mutual funds that concentrate investments in a particular sector, industry, business, state, or country other than the United States remain subject to the rules.
I would say the biggest takeaway for me from my years being subject to the SEC’s trading restrictions (and subsequent experience with law firm and public company insider trading policies) is that even the appearance of impropriety is often just as problematic as actually violating the law or a policy, so if it seems close to the line, just don’t do it. Some trade that is going to yield you a short-term gain is not worth jeopardizing your career or your freedom. Another thing that always sticks with me is the line “ethics is a team sport.” If you have questions, ask them, even if they seem obvious. Maintaining an open line of communication is always one of the most critical pieces of any effective compliance program, and that is most certainly the case in the securities trading context.
I recognize that, like me, you may now be numb to the shenanigans that are going on in Congress these days, but word this week that Republicans are expecting a government shutdown as noted in this Axios article has prompted concern that the SEC Staff could be furloughed as early as March 8, which is just two weeks away. By now, we should all know the drill – if you have matters pending with Corp Fin that may require the Staff’s attention two weeks from now (e.g., declaring a registration statement effective, clearing comments on a proxy statement or receiving no-action relief), you should contact the Staff as soon as possible to discuss the plan going forward. To this end, I shall incorporate by reference my blog from last September where I provided my top ten takeaways from the Staff’s updated government shutdown guidance. I will highlight one particular point that is relevant to this time of year – the Staff’s September 2023 government shutdown guidance specifically noted:
Will the Division provide a response to my Rule 14a-8 no-action request if I need to print my proxy materials during the shutdown?
No. The staff will not be able to review or respond to 14a-8 materials during a shutdown. We ask that companies and proponents work together to resolve questions to the best of their ability. It is important to note that the staff’s no-action responses to Rule 14a-8(j) submissions reflect only informal staff views.
The staff will return to reviewing no-action requests when our operating status changes.
Undoubtedly for those companies that have Rule 14a-8 no-action requests pending with the Staff that do not get answered in the next two weeks, some tough calls will have to be made in the event that the government gets shut down in early March as proxy mailing deadlines approach.
The SEC’s amendments to Rule 10b5-1 back at the end of 2022 spawned quite a few interpretive questions that are still being sorted out to this day. One of the areas that prompted questions is the scope of the exception to the limitation on overlapping open-market trading plans and the limitation on single-transaction trading plans that is provided for “eligible sell-to-cover” transactions. Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) defines an “eligible sell-to-cover” transaction as one where an agent is authorized to sell “only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award” where the employee does not otherwise exercise control over the timing of such sale.
Last summer, the ABA’s Joint Committee on Employee Benefits submitted a request for interpretive guidance to the Corp Fin Staff seeking clarification as to what actually qualifies as an “eligible sell-to-cover” transaction. There was a concern among practitioners that the language of the definition would limit the amount of securities to only the amount required to satisfy statutory minimum tax withholding rates, when some companies allow employees to designate a higher expected effective tax rate as the rate at which their employer will withhold taxes upon the vesting of a compensatory award. The group proposed the following interpretive Q&A to the Staff:
Question: Can a contract, instruction, or plan qualify as one providing for the sale of “only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award,” and thus be an “eligible sell-to-cover transaction” under Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3), if it provides for the sale of shares at the rate identified by the employee as the employee’s expected effective tax rate, provided such rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates applicable to the employee, as permitted under tax and accounting rules?
Suggested Answer: An “eligible sell-to-cover” transaction under Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) means the sale of shares up to the tax rate designated by the employee for withholding, provided such rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates applicable to the employee, as permitted under tax and accounting rules.
In a memorandum to the members of the ABA Subcommittee on Employee Benefits, Executive Compensation, and Section 16 posted in our “Rule 10b5-1” Practice Area, Mark Borges, Alex Bahn and Ron Mueller describe their discussions with the Staff on this interpretive question, and note:
As a result of our informal discussion with the SEC Staff, we understand that the reference in Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) to “only such securities as are necessary to satisfy tax withholding obligations” is not intended to mean only the number of shares required to satisfy minimum tax withholding requirements and that the rule is not intended to use technical tax language or to disrupt practice with respect to legitimate tax arrangements. Put another way, the focus of the SEC Staff appears to be on whether the arrangement is designed to pay the tax obligation arising in connection with the vesting event, which can take into account the expected effective tax rate and is not focused on only the required tax withholding rate. It appears the SEC Staff agrees with our proposed response and will interpret the provision to allow sales of shares to satisfy an employee’s expected effective tax rate. This interpretation, however, does not apply if any of the proceeds from the sale are intended to satisfy taxes relating to income from sources other than the vesting of a compensatory award. The SEC Staff thus cautioned that persons could not characterize a sale as an “eligible sell-to-cover” transaction where shares are sold with the intent of covering taxes for events unrelated to the vesting event. For example, selling shares in an “eligible sell-to-cover” transaction where the proceeds are intended in part to cover taxes for the sale of property other than the shares received in the vesting event would not be considered an “eligible sell-to-cover” transaction.
It is very helpful to know that the Staff is not reading the “eligible sell-to-cover” transaction exception so narrowly as to exclude the many situations where an expected effective tax rate is used to determine the amount of securities to be sold rather than the statutory minimum tax withholding rate, thus making this exception more useful to avoid running afoul of the overlapping plan and single trade restrictions.
The JCEB also asked the Staff whether a non-employee director can rely on the eligible sell-to-cover transaction exception even though a non-employee director is not subject to tax withholding obligations. The memorandum to the members of the ABA Subcommittee on Employee Benefits, Executive Compensation, and Section 16 posted in our “Rule 10b5-1” Practice Area notes:
Similarly, we understand that the SEC Staff will not object to a non-employee director establishing a similar contract, instruction, or plan as an “eligible sell-to-cover” transaction despite the fact that non-employee directors are not subject to tax withholding obligations. Again, if the non-employee director’s sale in this scenario is designed to cover the person’s withholding tax obligation arising exclusively from the vesting of a compensatory award, the same rationale would apply. Similar to employees, we believe the SEC Staff will not consider a non-employee director’s sale to qualify as an “eligible sell-to-cover” transaction if the sale is intended to also cover taxes that may be owed from sources of income other than the vesting event.
Question: May a non-employee director, for whom there is no tax withholding obligation, be permitted to sell shares on the same basis as an “eligible sell-to-cover” transaction applicable to employees?
Suggested Answer: A non-employee director’s contract, instruction, or plan providing only for the sale of shares in connection with the vesting of a compensatory award for the purpose of satisfying such individual’s expected effective tax rate arising from the vesting event will qualify as an “eligible sell-to-cover” transaction for purposes of Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3).
This is also a helpful interpretation for utilizing the “eligible sell-to-cover” transaction exception going forward. You can find more on the numerous interpretive issues arising with the Rule 10b5-1 amendments in our “Rule 10b5-1” Practice Area and Q&A Forum.
We have posted the transcript for our recent webcast – “The Latest: Your Upcoming Proxy Disclosures,” during which I was joined by Mark Borges from Compensia and CompensationStandards.com, Alan Dye from Hogan Lovells and Section16.net and Ron Mueller from Gibson Dunn for our annual breakdown of all you need to know for the upcoming proxy season. The webcast covered the following topics:
1. Clawbacks
2. Pay vs. Performance Disclosures
3. CD&A Enhancements & Trends
4. Shareholder Proposals
5. Proxy Advisor & Investor Policy Updates
6. Perquisites Disclosure
7. ESG Metrics & Disclosures
8. Say-on-Pay & Equity Plan Trends, Showing “Responsiveness” to Low Votes
9. Status of Related Rulemaking
This webcast was a doozy – we spoke for over 90 minutes and covered quite a lot of ground, so you will definitely want to check this out as we enter the proxy season.
We are thrilled to announce our return to in-person conferences in 2024! Join us for these timely conferences taking place in San Francisco on October 14-15, 2024, or join us virtually.
The SEC’s regulatory agenda continues in 2024, but uncertainty abounds as we head into an election year. Make sure you are getting the practical guidance and expert knowledge you need (and expect!) from our conferences as rules, regulations and procedures continue to evolve. We will be posting the conference agendas and announcing the speakers soon, so stay tuned.
You can register now by one of two methods: by visiting our online store or by calling us at 800-737-1271. Sign up now for our early bird in person Single Attendee Price of $1,750, which is discounted from the regular $2,195 rate!
I am excited about this year’s return to in-person conferences in San Francisco, and I hope you are excited about it as well. It is hard to believe that we have been holding virtual-only conferences for four years now, and it seems like a lifetime ago when we were last in New Orleans in September 2019, where the sort of shenanigans depicted in the picture below were taking place. While I think we did an outstanding job in the intervening years delivering great content and practical guidance in a virtual format, there is truly no substitute for getting together with the community in person, where we have a chance to network and catch up with old friends. I hope you will take advantage of this great opportunity to get the band back together again later this year in San Francisco!
