According to this recent Audit Analytics blog, the trend toward fewer comment letters from the Staff not only continued last year, but accelerated:
The total amount of comment letters stemming from 10-K and 10-Q filings has once again decreased (as shown in the chart below). From 2017 to 2018, total comment letters decreased by roughly 26%, which is slightly steeper than the decline we’ve seen in the past (13% from 2016 to 2017 and 10% from 2015 to 2016). Similarly, the number of conversations largely followed the same declining pattern.
The blog says that the decline in 8-K comment letters was even sharper. Comment letters on 8-K filings plummeted 54.5% between 2017 and 2018, in comparison to 31.5% between 2016 and 2017 and an increase of 112.4% between 2015 and 2016. The 2016 spike in comment letters is attributable to the Staff’s focus on the use of non-GAAP financial data following Corp Fin’s issuance of updated guidance.
Audit Analytics suggests that the reasons for the decline in comments include a nearly 50% decline in the number of reporting companies since the early 2000s and the Staff’s principles-based approach to issuing comments. Last year’s government shutdown may also have contributed, since reviews weren’t performed during that time. But that probably didn’t move the needle much – since only the last 2 weeks of December were affected by the shutdown.
KPMG/PCAOB: Worse Than We Thought?
I consider myself pretty jaded, but if you read my blog when news broke about the scandal involving KPMG personnel’s misappropriation of PCAOB data, you know I was pretty shocked by the magnitude of what was alleged to have happened. The SEC thought this was pretty serious stuff too. Last week, the agency announced that it had reached a settlement with the firm under the terms of which KPMG admitted wrongdoing & agreed to a $50 million civil monetary penalty – which matches the largest fine ever imposed against an audit firm.
As bad as the KPMG situation appeared when it was first revealed, this recent article by MarketWatch.com’s Francine McKenna notes that the SEC’s announcement suggests that the scandal is even worse than originally reported:
The SEC revealed Monday a much larger scandal than was previously known: KPMG auditors, including some senior partners in charge of public company audits, cheated on internal tests related to mandatory ethics, integrity and compliance training, sharing answers with other partners and staff to help them also attain passing scores. In addition, for a period of time up to November 2015, some audit professionals, including one partner, manipulated the system for their exams to lower the scores required to pass.
Twenty-eight of these auditors did so on four or more occasions. Certain audit professionals lowered the required score to the point of passing exams while answering less than 25% of the questions correctly, the SEC says.
Egads. The SEC’s announcement of the settlement indicated that the agency’s investigation was ongoing. Yeah, I bet it is.
SEC Revises Procedure for Authenticating Form ID
Here’s something that Alan Dye recently posted on his “Section 16.net” Blog:
The SEC has announced enhancements to the EDGAR system, one of which affects the submission of Form ID. New filers will now complete an updated online version of Form ID, which is accessible via a hyperlink from sec.gov. Filers will print out the completed version, for manual signature and notarization, and then upload the signed version for submission with the Form ID. The old “courtesy pdf copy” of Form ID previously available for use as an authenticating document has been removed from the SEC’s website.
PCAOB Rule 3526 requires auditors to communicate with audit committees concerning relationships that might impact their independence. Last week, the PCAOB issued guidance concerning the communications that are required under this rule when the auditor identifies one or more violations of applicable independence rules – but doesn’t think the violations disqualify it from continuing to serve as the auditor. The PCAOB also issued this summary of the guidance. This excerpt from the guidance document details the disclosures required by the rule:
The Firm would comply with Rule 3526 by:
a. summarizing for the audit committee each violation that existed during the year;
b. summarizing for the audit committee the Firm’s analysis of why, for each violation and notwithstanding the existence thereof, the Firm concluded that its objectivity and impartiality with respect to all issues encompassed within its engagement had not been impaired, and why the Firm believes that a reasonable investor with knowledge of all relevant facts and circumstances would have concluded that the Firm was capable of exercising objective and impartial judgment on all issues encompassed within the Firm’s engagement;
c. if more than one violation existed during the year, providing to the audit committee a separate analysis of why, notwithstanding all of the violations taken together, the Firm concludes that its objectivity and impartiality with respect to all issues encompassed within its engagement has not been impaired, and why the Firm believes that a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the Firm was capable of exercising objective and impartial judgment on all issues encompassed within the Firm’s engagement;
d. engaging in dialogue with the audit committee regarding the violation(s) and the Firm’s related analyses (as described in (a)-(c) above);
e. documenting the substance of the Firm’s discussion(s) with the audit committee (as described in (d) above); and
f. affirming in writing to the audit committee that, except for the violation(s) expressly identified, the Firm would be independent in compliance with Rule 3520.
In a nutshell, the auditor must consider the impact of the violation or violations on its objectivity and impartiality. It then communicates that analysis to the audit committee, which makes its own decision about whether to continue to retain the audit firm.
There are several other components to the guidance, and one of the more interesting is the PCAOB’s view that in this situation, the auditor “should not state in its required annual affirmation that the auditor is independent, but instead indicate that the auditor would be independent except for the violation or violations that it has identified and discussed with the audit committee.”
However, the auditor may issue its report without altering the required title: “Report of Independent Registered Public Accounting Firm.” The PCAOB views this as stating a legal requirement, and not a specific assertion of compliance with the applicable PCAOB rule.
Internal Controls: More ICFR Risk Factors in Wake of SEC Enforcement Action
I’ve blogged a few times (here’s the most recent) about the SEC’s enforcement action against a handful of companies that couldn’t get their acts together when it came to addressing material weaknesses in ICFR. Now, this Audit Analytics blog says that some companies with material weakness disclosures extending over multi-year periods are including “Risk Factor” disclosure specifically addressing the risk of SEC enforcement resulting from their inability to resolve those issues.
This excerpt suggests that we’re likely to see more disclosure along these lines as the year progresses:
It appears public companies are taking notice of the SEC’s January statement that merely disclosing ICFR material weakness is not enough. This year we may see more companies disclose ineffective controls, and this is meaningful because of the SEC’s scrutiny.
In conclusion, analysts and investors need to be on guard for more companies disclosing material weakness with ICFR. Further, they need to consider that admission of weak internal controls doesn’t necessarily mean 2018 was the first year the firm had problems. It’s possible historical filings could show years of ineffective ICFR.
Transcript: “How to Handle an SEC Enforcement Inquiry Now”
We have posted the transcript for our recent webcast: “How to Handle an SEC Enforcement Inquiry Now.”
Here are the results of our recent survey on drafting annual reports, proxy statements, glossy annual reports & Form 10-Ks:
1. At our company, the lead for drafting our proxy statement is (ie. running the master):
– Corporate secretary’s department – 20%
– Legal department – 70%
– Accounting department – 2%
– IR department – 0%
– Outside counsel – 8%
– None of the above – 0%
2. At our company, the lead for drafting our glossy annual report is:
– Corporate secretary’s department – 4%
– Legal department – 7%
– Accounting department – 6%
– IR department – 46%
– Outside counsel – 2%
– None of the above – 35%
3. At our company, the lead for drafting our 10-K is:
– Corporate secretary’s department – 2%
– Legal department – 6%
– Accounting department – 90%
– IR department – 0%
– Outside counsel – 1%
– None of the above – 1%
4. At our company, the lead group for conducting our disclosure committee meetings for our proxy statement is:
– Corporate secretary’s department – 14%
– Legal department – 48%
– Accounting department – 18%
– IR department – 0%
– Outside counsel – 4%
– None of the above – 16%
5. At our company, the lead group for conducting our disclosure committee meetings for our 10-K and 10-Q is:
– Corporate secretary’s department – 2%
– Legal department – 17%
– Accounting department – 73%
– IR department – 1%
– Outside counsel – 1%
– None of the above – 6%
Please take a moment to participate anonymously in these surveys:
Whistleblowers: Can In-House Lawyers Walk the Ethical Tightrope?
Under the attorney conduct rules adopted by the SEC following Sarbanes-Oxley, there are limited circumstances under which attorneys may be obligated to “report out” – i.e., blow the whistle to the SEC – on client misconduct. These obligations are not consistent with many states’ ethics rules, but the SEC brushed those concerns aside by saying that its rules preempted those standards. Now, according to this recent “Dimensions” article, the federal courts are starting to weigh in:
A California federal court held that in-house counsel could be a whistleblower under the federal statutes because the SEC rules preempt the state’s very strict duty of confidentiality. The case is on appeal and, the authors surmise, the holding will be limited because counsel reported internally, not to the SEC, before being fired (and thus falling outside the Dodd-Frank definition of a whistleblower).
Timing is also key to a case now pending in the Eastern District of Pennsylvania. In-house counsel seeks Dodd-Frank protection from retaliation for reporting to the SEC while still an employee. The company has counterargued that, prior to the report, it gave notice that counsel would be fired. A decision in the District of New Jersey denied Dodd-Frank protection to an attorney fired for reporting to FINRA, rejecting the argument that this was tantamount to reporting to the SEC, which supervises FINRA, while still employed.
The article notes that the 9th Circuit subsequently remanded the California federal court’s decision, affirming it in part and remanding it in part. This Sheppard Mullin blog has more details on the case.
Whistleblowers: Internal Whistleblower Rings the Bell for $4.5 Million
While lawyers may get tied-up in ethical knots for decades over whistleblower issues, for those who are unencumbered by such concerns, the SEC recently provided another example of just how lucrative whistleblowing can be. Late last month, it announced a $4.5 million award to a whistleblower, but as this excerpt from the SEC’s press release points out, this award had a unique fact pattern:
The whistleblower sent an anonymous tip to the company alleging significant wrongdoing and submitted the same information to the SEC within 120 days of reporting it to the company. This information prompted the company to review the whistleblower’s allegations of misconduct and led the company to report the allegations to the SEC and the other agency. As a result of the self-report by the company, the SEC opened its own investigation into the alleged misconduct.
Ultimately, when the company completed its internal investigation, the results were reported to the SEC and the other agency. This is the first time a claimant is being awarded under this provision of the whistleblower rules, which was designed to incentivize internal reporting by whistleblowers who also report to the SEC within 120 days.
As I blogged at the time, in 2018 the SCOTUS held that purely internal whistleblowers weren’t entitled to the protections of Dodd-Frank. Concerns were subsequently expressed that the decision would incentivize people to go to the SEC before the company was even aware of the potential problem.
That didn’t happen here – but because the whistleblower dropped a dime on the company to the SEC within 120 days of making an internal report, the person was credited with the results of the company’s investigation. As the SEC’s release noted, the policy establishing that 120 reporting period was intended to promote internal reporting, and in this case, it seems to have worked.
This WSJ article says that whistleblower lawyers are skeptical that this will be anything more than a one-off event, and that since internal whistleblowers are at risk for retaliation without Dodd-Frank’s protections, blowing the whistle to the SEC first is likely to remain the preferred path.
Yesterday, the SEC announced an enforcement proceeding against Kik Interactive, which allegedly has engaged in a $100 million unregistered token offering. Here’s the SEC’s complaint. Ordinarily, the SEC’s decision to bring an enforcement action is the big news, but I’ve kind of buried the lede here. Why? Because this Forbes article says that Kik & its affiliated entity, the Kin Ecosystem Foundation, are positively itching for a fight:
Two years ago, messaging app Kik raised about $100 million in an initial coin offering for the Kin token. Three days later, the SEC reached out, and after much back and forth, finally notified Kik last fall that it intended to pursue an enforcement action against both Kik and the Kin Ecosystem Foundation.
However, Kik and Kin made a surprise move: It published its response to the SEC, detailing what seems like a pretty strong case for why their token sale was not an offering of securities and why their token currently does not meet the definition of a security. They also announced in the Wall Street Journal their plan to fight this out in court.
In order to fund their defense, these crypto folks did a very crypto thing – they started a legal defense fund called “Defend Crypto” to which people can contribute bitcoin & other cryptocurrencies. What’s the sales pitch? In short, they say that “the future of crypto is on the line,” & they’re fighting Cryptomageddon:
For the future of crypto, we all need Kin to win. This case will set a precedent and could serve as the new Howey Test for how cryptocurrencies are regulated in the United States. That’s why Kin set up the Defend Crypto fund to ensure that the funds are there to do this the right way.
The message seems to be resonating with its intended audience. The fund raised over $4.5 million even before the SEC filed its action. What’s more, these guys seem positively thrilled that they’ve been sued. This WSJ article quotes KiK’s CEO as saying in reaction to the SEC’s complaint that what’s “exciting” to him “is that this industry is finally going to get the clarity it so desperately needs.”
“Clarity” is a word that crypto-evangelists use a lot when it comes to the securities laws. Sure, there are aspects of the SEC’s position on digital assets that are murky, but every time I hear somebody from the crypto crowd speak, I get the sense that they believe “clarity” means having regulators tell them what they want to hear. Anyway, enjoy the heck out of your enforcement proceeding. . .
Endangered Species: Quarterly Guidance on the Way Out?
It wasn’t all that long ago that most public companies seemed to view providing quarterly forecasts as just one of the costs of being public. That sure doesn’t seem to be the case anymore. In fact, this recent OZY article reports that the practice of providing quarterly guidance may be going the way of the Dodo:
The number of American companies releasing guidance every three months has dropped from 75 % in 2003 to 27% in 2017, according to a new report by the nonprofit FCLT Global, which advocates against quarterly earnings guidance. The phenomenon is even rarer outside the United States. Among listed companies on the Euro Stoxx 300, less than 1 percent issued quarterly guidance between 2010 and 2016.
Several publicly listed companies that release quarterly sales and revenue information are joining the chorus against short-term financial thinking. Large publicly traded companies such as Cisco, GSK, Barclays and Unilever, along with some state pension funds and global investment firms, are among the members of FCLT, an acronym for Focusing Capital on the Long Term. The group presents data showing that such forecasting does not, as many argue, reduce stock price volatility.
Despite this research and the calls of prominent investor & corporate advocates to end quarterly guidance, I suspect that the practice will remain pretty resilient at the lower end of the food chain. Smaller caps are often desperate to please analysts and maintain whatever coverage they may have, so until securities analysts jump on the bandwagon, some of these companies are likely to still keep sticking their necks out.
More On “NYSE Proposes to Tweak Equity Compensation Plan Rules”
Last week, I blogged about the NYSE’s proposed changes to the definition of “fair market value” in Rule 303A.08. Troutman Sanders’ Brink Dickerson points out that there seems to be a bit of a disconnect between the NYSE’s proposal & the approach taken by Item 402 of S-K:
The change to 303A.08 is interesting in that it does not reconcile nicely with S-K 402(d)(2)(vii), which requires a separate column when the exercise price is “les than the closing market price of the underlying security.” A lot of my clients now use the closing price on the date of grant (1) to avoid this extra disclosure, and (2) because they would prefer the stock price to be unknown at the time of grant to minimize bullet-dodging, etc. Surprising that the NYSE would not go with the SEC’s default approach. Under the NYSE construct, you can only avoid the extra column with certainty if you make a grant after the market closes but not on the next day.
You’ve got to hand it to college fraternities – their members have an uncanny knack for getting themselves into serious trouble. Most fraternity misconduct is the predictable result of their often over-the-top drinking culture & reckless hazing practices. But while that kind of stuff has become a cliché, it doesn’t mean that frat boys are incapable of more innovative misconduct.
Here’s a case in point: according to this SEC press release, one enterprising young man has allegedly been running a Ponzi scheme out of a University of Georgia frat house! This excerpt from the press release indicates that the Division of Enforcement decided that when it comes to dealing with this kind of alleged misconduct, Dean Wormer had it right – “the time has come for somebody to put his foot down, and that foot is me”:
The Securities and Exchange Commission today announced an emergency action charging a recent college graduate with orchestrating a Ponzi scheme that targeted college students and young investors. The SEC is seeking an asset freeze and other emergency relief.
The SEC’s complaint alleges that Syed Arham Arbab, 22, conducted the fraud from a fraternity house near the University of Georgia campus in Athens, Georgia. Arbab allegedly offered investments in a purported hedge fund called “Artis Proficio Capital,” which he claimed had generated returns of as much as 56% in the prior year and for which investor funds were guaranteed up to $15,000.
Arbab also allegedly sold “bond agreements” which promised investors the return of their money along with a fixed rate of return. The SEC’s complaint alleges that at least eight college students, recent graduates, or their family members invested more than $269,000 in these investments.
According to the SEC’s complaint, no hedge fund existed, Arbab’s claimed performance returns were fictitious, and he never invested the funds as represented. Instead, as money was raised, Arbab allegedly placed substantial portions of investor funds in his personal bank and brokerage accounts, which he used for his own benefit, including trips to Las Vegas, shopping, travel, and entertainment.
As noted in the press release, the SEC is seeking an asset freeze & a whole bunch of other emergency relief. Still, I was a little disappointed to find no reference to “double secret probation” in the SEC’s complaint.
SCOTUS Punts on “Duty to Update”
The SCOTUS has managed to dodge some pretty controversial issues in recent weeks, and according to this D&O Diary blog, the question of whether the securities laws impose a “duty to update” is another controversy that you can add to the list. Here’s an excerpt:
In a little noticed-development last week, the U.S. Supreme Court denied the petition for a writ of certiorari in Hagan v. Khoja, in which former officials of a bankrupt pharmaceutical company sought to have the Court review a decision by the Ninth Circuit to revive a securities class action lawsuit against them.
Had the petition been granted, the Court would have been called upon to consider the controversial question of whether public companies have a duty to update prior disclosures that were accurate when made. The Court’s cert denial leaves the Ninth Circuit’s ruling standing and the questions surrounding the existence and requirements of a duty to update remain unsettled.
Insider Trading: Don’t Look Now, But Here Comes Congress. . .
This NYT DealBook article reports on “The Insider Trading Prohibition Act,” which recently cleared the House Financial Services Committee. The proposed legislation is intended to eliminate some of the uncertainty surrounding insider trading law – and expand the government’s ability to bring insider trading cases. This excerpt provides an example of the greater flexibility the legislation would provide to prosecutors:
The legislation also would move insider trading law away from its focus on a duty to keep information confidential by more broadly describing what constituted “wrongful” trading or transmission of confidential information. There would be four ways to show that the information had been obtained wrongfully: by theft, bribery or espionage; by violation of any federal law protecting computer data; by conversion, misappropriation or unauthorized and deceptive taking of information; and by breach of a fiduciary duty or breach of “any other personal or other relationship of trust and confidence.”
By expressly including a breach of a federal data privacy law or theft of information, the legislation would eliminate some of the uncertainties surrounding the application of insider trading law to the kind of “outsider trading” schemes exemplified by the 2016 hack on the SEC’s Edgar database.
This WilmerHale memo suggests that prosecutors have already found a work-around for some of the issues that Congress is trying to address with this legislation – a federal statute that was added to their arsenal as part of the Sarbanes-Oxley Act.
Check out the latest report from BarkerGilmore – a boutique executive search firm – about in-house counsel compensation trends. Among the findings:
– The average annual salary increase rate for all positions across industries increased to 4.4%, up 0.6% from the previous year.
– 41% of all respondents believe their compensation is below or significantly below that of their peers in other organizations, with labor & employment lawyers and insurance reporting the greatest dissatisfaction.
– 38% of respondents indicate that they would consider a new position within the next year due to compensation issues, 3% less than the previous year.
– Public company lawyers make more than private company lawyers, and public company GCs make a lot more – 41% more to be precise.
– On average, female in-house counsel earn 85% of what male in-house counsel earn. The disparity is largest at the General Counsel level, with a 17% gap, 5% smaller than the previous year.
On a completely unrelated note, when I saw BarkerGilmore’s press release on the study, I noticed that they were headquartered in Fairport, NY. This charming canal town is the hometown of the late Philip Seymour Hoffman, who once described it as being “like Kansas, if Kansas was in New York.” Why do I know so much about this little upstate New York burg? Well, Mr. Hoffman isn’t the only one who grew up there. (Hi Mom!)
“Finders”: Lawsuit Pushes Back Against SEC on Broker Registration
The SEC has historically taken a very limited view of the role that “finders” who are not registered broker-dealers can play in financings. But this recent blog from Andrew Abramowitz notes that one company has filed a lawsuit that pushes back against the SEC’s position. Here’s an excerpt:
A company proposing to do business as an unregistered finder, Platform Real Estate Inc., has now filed suit in the Southern District of New York against the SEC, seeking a declaratory judgment to the effect that broker-dealer registration is not required for the plaintiff and similar companies acting as a finder on behalf of private companies.
The essence of Platform Real Estate’s argument is that the Exchange Act generally, and Section 15(a) (the section requiring registration of those acting as broker-dealers) in particular, are intended to protect investors in the secondary market, like those purchasing shares traded on an exchange. The transactions that Platform Real Estate would be involved in, in contrast, are primary transactions, where a company issues and sells new shares to accredited investors who represent as to their intent to hold the shares potentially indefinitely.
In discussing the case, Andrew makes a point that I think a lot of lawyers representing small companies would agree with – most registered broker-dealers don’t want to deal with this segment of the market. There’s just not enough money to be made in these financings to justify their commitment of resources. That means there’s a real market need that is being filled by finders, and makes it critical to get some clear rules governing what they can and can’t do.
Our June Eminders is Posted!
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Yesterday, Corp Fin Director Bill Hinman issued an exemptive order permitting a company that was unable to provide the audited financial statements required under Rule 14a-3(b) to nevertheless solicit proxies for its upcoming annual meeting. Companies that don’t have audited financials are in a tough spot if they need to hold an annual meeting. Rule 14a-3(b) requires them to provide an annual report containing that information along with the proxy materials, and if they can’t do that, they can’t solicit proxies.
Many companies in this position opt to delay their annual meeting until they can comply with the proxy rules, but that’s not a viable strategy if you’ve received a court order compelling an annual meeting. That’s the situation in which Mimedx Group found itself & what prompted it to seek the exemptive order. Companies finding themselves in this kind of a bind should note both the potential availability of exemptive relief & the existence of the following conditions upon which the Mimedx Group order was premised:
– MiMedx is required to hold the Delayed 2018 Meeting as a result of an action taken by security holders pursuant to Florida law and the Florida Court ordering such meeting to be held on June 17, 2019;
– The company has made good-faith efforts to furnish the audited financial statements required by Rule 14a-3(b) before holding the Delayed 2018 Meeting but is unable to comply with this requirement;
– MiMedx has made a determination that it disclosed to security holders all available material information necessary for security holders to make an informed voting decision in accordance with Regulation 14A;
– Absent the grant of exemptive relief, MiMedx would be forced to violate either Florida law or the rules and regulations administered by the Commission; and
– The company faces a proxy contest with respect to the matters to be presented at the Delayed 2018 Meeting, with certain MiMedx security holders filing a definitive proxy statement soliciting proxies for, among other things, the election of their own director nominees.
These conditions weren’t pulled out of thin air. With the exception of the reference to the proxy contest, they mirror the requirements of Rule 30-1(f)(18), which sets forth the circumstances under which the Director of Corp Fin has been delegated authority to grant exemptive relief from the requirements of Rule 14a-3(b).
Chief Accountant Wes Bricker to Leave SEC
The SEC announced yesterday that Chief Accountant Wes Bricker is leaving the agency. It also announced that Deputy Chief Accountant Sagar Teotia will serve as Acting Chief Accountant when Bricker leaves next month.
Enforcement: What’s in a Name?
I was kind of taken aback a few days ago when I saw the SEC’s litigation release announcing an enforcement proceeding against “Henry Ford.” Obviously, the SEC isn’t bringing an action against the long-dead father of the Model T, but as a Clevelander, the case made me think of the great Harvey Pekar & his famous “What’s in a Name?” story. I know the connection with securities law is pretty tenuous, but hey, it’s Friday.
Last week, the SEC published its latest Reg Flex Agenda, and it looks like the Commissioners may wade into some pretty controversial areas in the near future – including proposing rules relating to proxy advisory firms & shareholder proposals. This excerpt from a recent Gibson Dunn blog highlights the significant additions to the agenda:
Notably, the Reg Flex Agenda for the first time now identifies the following four rulemaking projects as among those that the SEC expects to address over the coming year:
– Proposing rule amendments regarding the thresholds for shareholder proposals under Rule 14a‑8;
– Proposing rule amendments to address certain advisors’ reliance on the proxy solicitation exemptions in Rule 14a-2(b);
– Proposing rule amendments to modernize and simplify disclosures regarding Management’s Discussion & Analysis (MD&A), Selected Financial Data and Supplementary Financial Information; and
– Proposing rule amendments to Securities Act Rule 701, the exemption from registration for securities issued by non-reporting companies pursuant to compensatory arrangements, and Form S-8, the registration statement for compensatory offerings by reporting companies (previously listed as a longer term project.).
The blog says that the SEC is generally expected to propose increases in the ownership & resubmission thresholds under Rule 14a-8. What the SEC is going to propose about the ability of proxy advisors to continue rely on exemptions from proxy solicitation rules is less clear – but some commenters have called for the SEC to reconsider those exemptions as part of a broader initiative to regulate the proxy advisory industry.
Potential changes to the shareholder proposal regime & the possible regulation of proxy advisors are likely to garner the most attention from the media, but my guess is that most of us will take an equal or greater interest in what the SEC proposes to do with MD&A, Rule 701 & Form S-8.
NYSE Proposes to Tweak Equity Compensation Plan Rules
Under NYSE rules, equity compensation plans are generally subject to shareholder approval. However, plans that allow participants to buy shares at a price equal to their “fair market value” are excluded from that requirement. Last week, the NYSE filed a proposed rule change with the SEC that would codify its long-standing practice for determining fair market value for purposes of this exclusion. This excerpt from a recent Steve Quinlivan blog summarizes the proposed change:
For purposes of the above exclusion from the definition of equity compensation plan, the Exchange has always interpreted “current fair market value” as requiring that the price used be the most recent official closing price on the Exchange. For the avoidance of doubt, the Exchange now proposes to include in Section 303A.08 text specifying how the fair market value of the issuer’s common stock should be calculated for this purpose. “Fair market value” will be defined as the most recent official closing price on the Exchange, as reported to the Consolidated Tape, at the time of the issuance of the securities.
The blog says that this means if the securities are issued after the close on a Tuesday, then Tuesday’s official closing price will be used. If they are issued at any time between the time of Monday’s close and Tuesday’s close, then Monday’s official closing price will be used.
Nasdaq Proposes to Tighten Initial Listing Standards
Since we’re on the topic of amendments to stock exchange rules, I confess that I somehow overlooked proposed rule changes that Nasdaq originally filed in March. In any event, Nasdaq wants to tighten its original listing standards and help assure adequate liquidity for listed securities. Here’s an excerpt from the proposal explaining what it’s proposing to do:
– First, Nasdaq proposes to revise its initial listing criteria to exclude restricted securities from the Exchange’s calculations of a company’s publicly held shares, market value of publicly held shares and round lot holders (“Initial Liquidity Calculations”). To do so, Nasdaq proposes to add three new definitions to define “restricted securities”, “unrestricted publicly held shares” and “unrestricted securities” and proposes to amend the definition of “round lot holder”.
– Second, Nasdaq proposes to impose a new requirement that at least 50% of a company’s round lot holders must each hold shares with a market value of at least $2,500.
– Third, Nasdaq proposes to adopt a new listing rule requiring a minimum average daily trading volume for securities trading over-the-counter (“OTC”) at the time of their listing.
No changes to continued listing standards are being proposed. I don’t feel too bad about missing this rule proposal when it was initially filed, because the SEC just extended the comment period to July 8th.
Last August, when the SEC adopted its disclosure simplification rules, it referred to FASB certain Reg S-X & S-K line items that overlapped with GAAP but called for incremental disclosure, and asked FASB to consider incorporating those additional disclosure requirements into GAAP. Here’s an excerpt from this SEC Institute blog describing FASB’s recent response:
On May 6, 2019, the FASB issued an exposure draft related to this “referral” from the SEC. The proposed amendments in the exposure draft would modify disclosure or presentation requirements in a variety of topics in the Codification, ranging from removing the impracticability exception, to the requirement to disclose revenues for each product and service or each group of similar products and services, to adding disclosure of where derivative instruments and their related gains and losses are reported in the statement of cash flows.
A chart summarizing the proposed changes to GAAP appears on page 5 of the exposure draft. FASB also decided not to implement some of potential changes referred by the SEC. These include changes to GAAP that would have required financial statement disclosure of:
– The formula for calculating the number of shares available for issuance under an equity comp plan required Item 201(d) of Reg S-K
– The identity of 10% customers required by Item 101(c) of Reg S-K
– Discounts on shares as a deduction from equity accounts either on the face of the balance sheet or in the notes as required by Rule 4-07 of Reg S-X
– Significant changes in the authorized or issued debt since the date of the latest balance sheet as required by Rule 4-08(f) of Reg S-X
– Amounts of related party transactions on the face of the financial statements as required by Rule 4-08(k)(1) of Reg S-X.
Comments on the proposed changes laid out in FASB’s exposure draft are due by June 28, 2019.
“Test the Waters” for All: Comments on SEC Proposal
In February, the SEC issued a proposal to expand expand the “test-the-waters” accommodation from EGCs to all companies. So far, about 20 comments have been submitted on the rule proposal. This “Corporate Secretary” article says that the bulk of them have been supportive, but comments submitted by the non-profit Better Markets questioned several aspects of the proposal. Here’s an excerpt from the article describing the organization’s concerns about the rule’s potential impact on unsophisticated investors:
Better Markets, which was founded following the financial crisis with an eye on reforming Wall Street, raises concerns about the SEC’s plan. For one thing, the group argues that the SEC proposal creates ‘a dangerous loophole’ by not requiring issuers, and those authorized to act on their behalf such as underwriters, to validate the status of the investor – to make sure the investor is truly a QIB or an IAI – before a solicitation is made.
‘This loophole would permit solicitations to retail and other investors that either lack financial sophistication or cannot bear the financial risks associated with investing in highly risky investments such as those offered by, for example, penny stock issuers, leveraged business development companies or asset-backed security issuers,’ writes Better Market president and CEO Dennis Kelleher.
Better Markets also wants companies that “test the waters” prior to an offering & decide to move forward to file their testing-the-water communications with the SEC.
SEC Signs Off On Silicon Valley Stock Exchange
Last November, Broc blogged about efforts by some Silicon Valley heavy hitters to establish a new stock exchange for startup tech companies. While efforts to obtain regulatory approval for the new exchange hit a snag at the time, the SEC approved the application of the Long-Term Stock Exchange last Friday. This Reuters article summarizes some of the features of the new exchange that are designed to promote long-term thinking on the part of companies that list there:
The new exchange would have extra rules designed to encourage companies to focus on long-term innovation rather than the grind of quarterly earnings reports by asking companies to limit executive bonuses that award short-term accomplishments.
It would also require more disclosure to investors about meeting key milestones and plans, and reward long-term shareholders by giving them more voting power the longer they hold the stock.
It’s that final point – time phased voting – that prompted the CII to file a letter opposing the LTSE’s application. While the CII doesn’t like “tenure voting,” this TechCrunch article notes that it’s an old concept that’s picked up a number of advocates in recent years. In the end, the SEC approved the application, noting that its rules do not mandate that an exchange impose a “one-share, one-vote” requirement on listed issuers.
There are few non-chargeable events that law firms fret about more than their CLE programs for clients & potential clients. Of course, that fretting usually focuses more on the PowerPoint slides than things like actually seeking input from prospective attendees about what they’re looking for and who they would like to see participate in the program.
This recent In-House Focus survey of in-house lawyers concerning their own experiences with law firm CLE provides some interesting perspectives on these topics. For example:
– 70% of survey respondents said CLE programming should feature diverse lawyers, presenters and faculty. But just 30% of respondents agreed that diversity is adequately represented in current CLE content. At the same time, nearly two-thirds of respondents believe that participating in CLE programming is an effective way for law firms to connect diverse lawyers to clients.
– 52% of respondents to IHF’s survey agreed that law firms should do a better job of facilitating introductions of their diverse lawyers to their clients, while just 5% disagreed. Further, 62% believe CLE programming is a good way to cultivate relationships between diverse lawyers and clients.
– 62% of respondents believe law firm CLE is not adequately tailored to in-house lawyers. Additionally, two-thirds agree that CLE content is more tailored to law firm practitioners than in-house lawyers. In fact, another 79% of respondents said they would be more inclined to watch a CLE program that included in-house lawyers as presenters who speak to their issues.
– When asked what are some things that would make CLE more pertinent to in-house lawyers, many responses revolved around the need for real-world examples. Some responses included: “concepts to reduce outside legal expenses,” “when to involve outside counsel and how to engage them,” and “case studies and sample scenarios from current in-house lawyers.”
You should really check out the whole survey. As somebody who has spent his entire career in a law firm environment, I thought it was pretty eye-opening.
Crypto Mom Wants SEC to Wear “Reasonableness Pants”
You may agree or disagree with her remarks, but a speech by SEC Commissioner Hester Peirce – aka “Crypto Mom” – is always bloggable Her recent speech at Rutgers-Camden Law School is no exception. In discussing the SEC’s enforcement program, she makes no bones about her opposition to the enforcement approach favored during the tenure of former Chair Mary Jo White:
Most enforcement recommendations the Commission receives from the staff are legally straightforward and not controversial, but a small subset causes me to ask whether we are wearing our reasonableness pants.
In particular, I am not a fan of the so-called “broken windows” philosophy, a more-is-always-better, punish-the-small-violations approach to enforcement. Instead, I assess, when reviewing an enforcement recommendation from our staff, whether the recommendation is using our enforcement resources wisely. I ask, was there a meaningful violation? Is this a matter that could have been handled by our exam program? Are there other appropriate responses in lieu of an enforcement action, such as a rulemaking, interpretative guidance, or an educational bulletin for investors?
While she devotes much of her discussion to the SEC’s enforcement program, her “reasonableness pants” comments extend to the agency’s approach to rulemaking & interpretive guidance as well:
Lots of people want the SEC to wade into a whole range of issues that are not properly within our purview. Increasingly, we are urged to tell companies how many women to have on their boards, to limit the ways companies and their shareholders may resolve disputes, to direct financial firms to avoid providing capital for certain industries, or to prohibit investors from getting access to certain products we think investors should not have in their portfolios.
We do not have the time, resources, or authority to do these things. We have other things to do that are not headline-grabbers, but are neatly within our core mission.
Issues that should take priority in her view include things like updating transfer agent rules, disclosure modernization, fixed income & equity market structure, and ensuring that companies and investors across the country can participate in the capital markets. Peirce said these issues may not be as “trendy” as those that the SEC is being urged to undertake , but “subsequent generations will look back at us in disgust and wonder why we sacrificed the health of our capital markets for the chance to look cool for a moment.”
Rookies of the Year: Do New Activist Directors Add Greater Value Than Other Newbies?
According to this recent study, “rookie activist directors” – unseasoned independent directors appointed at the prompting of activists – add greater value to a company than other unseasoned independent directors. Here’s the abstract:
We examine the value-enhancing role of unseasoned independent directors nominated through shareholder activism events (Activist UIDs). Firms appointing Activist UIDs experience a larger value increase than those appointing Nonactivist UIDs, particularly when Activist UIDs have relevant experience, when they sit on the monitoring committees, and when their sponsors hold large target ownership.
Most of the companies in the study seem to have been small caps, and I think that needs to be taken into account when considering the study’s results. Established activist investors are likely to have access to a deeper and higher quality pool of director candidates than most small caps could find on their own.
