Shortly before the holidays, the SEC announced that General Counsel Dan Berkovitz will leave the agency and that Principal Deputy General Counsel Megan Barbero will assume the GC position effective January 23, 2023. This excerpt from the SEC’s press release provides more details on Megan Barbero’s background:
Ms. Barbero joined the SEC in July 2021 and currently advises the Commission on complex legal issues relating to rulemaking initiatives and litigation strategy. Before joining the SEC, Ms. Barbero served as Deputy General Counsel for the U.S. House of Representatives, where she managed strategic litigation for the House.
Prior to her work at the House, Ms. Barbero served as an attorney for the U.S. Department of Justice Civil Appellate staff, where she represented the United States and its agencies as lead counsel in the federal courts of appeals. Ms. Barbero previously worked in the Supreme Court and appellate litigation practice at WilmerHale. Ms. Barbero clerked for Judge Rymer on the U.S. Court of Appeals for the Ninth Circuit. She is a graduate of Harvard University and Stanford Law School.
– John Jenkins
In August, the PCAOB reached a tentative deal with China’s securities regulators to permit the PCAOB to fully inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong. Although the PCAOB was willing to move forward on the basis of the deal, they didn’t exactly sound optimistic about its outcome. But because implementation of the Holding Foreign Companies Accountable Act could ultimately result in the wholesale delisting of China-based companies, Chinese authorities presumably had some incentive to play ball.
Yesterday, PCAOB Chair Erica Williams issued a statement about actions taken by the PCAOB based on its experience to date inspecting China-based firms under the accord. That statement took a slightly more optimistic tone. Here’s an excerpt:
For the first time in history, the PCAOB has secured complete access to inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong. And this morning the Board voted to vacate the previous determinations to the contrary.
This historic and unprecedented access was only possible because of the leverage Congress created by passing the Holding Foreign Companies Accountable Act. Congress sent a clear message with that legislation that access to U.S. capital markets is a privilege and not a right, and China received that message loud and clear.
Investors are more protected today because of Congress’ leadership, and I want to thank Members of the House and the Senate for their ongoing work to hold China accountable.
I want to be clear: this is the beginning of our work to inspect and investigate firms in China, not the end. The PCAOB is continuing to demand complete access in mainland China and Hong Kong moving forward. Our teams are already making plans to resume regular inspections in early 2023 and beyond, as well as continuing to pursue investigations.
The Board does not have to wait another year to reassess its determinations. Should PRC authorities obstruct or otherwise fail to facilitate the PCAOB’s access – in any way and at any point in the future – the Board will act immediately to consider the need to issue a new determination.
It is important to understand: today’s announcement is about one question and one question only – is the PCAOB able to inspect and investigate firms in mainland China and Hong Kong completely at this time? The answer, following thorough and systematic testing, is yes.
The statement goes on to say that the PCAOB found numerous potential deficiencies in its inspection, but that these results weren’t out of line with what would be expected for firms in other jurisdictions being subjected to inspection for the first time.
– John Jenkins
The SEC has brought enforcement actions against a number of companies offering digital assets in which it has alleged that the assets are a “security” within the meaning of Section 2(a)(1) of the Securities Act. Much to the consternation of the crypto bros, the answer to that question is often a straightforward “yes”, based upon application of the Howey test. But the answer isn’t so simple when it comes to other digital assets.
To get a sense for the complexity of this issue for some digital assets, check out the comment letter exchange that David Kitchin & Jay Knight recently flagged on Bass Berry’s Securities Law Exchange Blog. The Staff issued a comment (see comment No. 2) on a Form 10 filing by Graystone Horizen Trust, which was organized to hold the ZEN cryptocurrency, requesting it to furnish the Staff with its analysis as to why ZEN wasn’t a security. The company’s response letter included a 30-page analysis (featuring more than 130 footnotes) of the issue from its outside counsel that reached the following conclusion:
The SEC could claim that ZEN is a security on the basis that holders would rely on the efforts of the Foundation or the Company. Even so, while not free from doubt, the Sponsor could make arguments to the contrary that, in light of the full facts and circumstances, ZEN does not meet all the elements of Howey such that it would be an investment contract.
The Staff and the company engaged in several more rounds of comments in which it requested additional disclosure concerning ZEN’s potential classification as a security. But at the end of the process, the Staff decided to kick the can down the road and issued this final comment:
Refer to your responses to comment 2 in our June 13, 2022 letter and related comments. While we do not have any further comments at this time regarding your responses, please confirm your understanding that our decision not to issue additional comments should not be interpreted to mean that we either agree or disagree with your responses, including any conclusions you have made, positions you have taken and practices you have engaged in with respect to this matter.
The result of this exchange isn’t surprising – after all, the resolution of the status of a particular cryptocurrency under the Securities Act is likely an issue that will ultimately need to be decided by the courts or by more senior SEC officials. But it does illustrate just how complicated the issues surrounding whether some digital assets are securities can be.
– John Jenkins
The SEC’s Office of the Advocate for Small Business Capital Formation just issued its 2022 Annual Report, which highlights the OASB’s activities during the year and discusses the overall state of capital formation, the capital needs of early stage and more mature businesses, and other matters. There’s a lot of interesting data in the report, but one thing in particular that I’d like to note is that on p. 6 of the Report, the OASB singles out Deputy Director Sebastian Gomez Abero’s appearance on our own Dave Lynn’s “Deep Dive with Dave” podcast as one of the year’s highlights. Check it out!
– John Jenkins
Yesterday, the SEC adopted amendments to Rule 10b5-1 imposing new conditions & disclosure requirements for 10b5-1 plans and securities transactions by companies and insiders. Here’s the 252-page adopting release, and here’s the two-page fact sheet. According to the fact sheet, the changes amend the Rule 10b5-1(c)(1) affirmative defense to include:
– A cooling-off period for directors and officers of the later of: (1) 90 days following plan adoption or modification; or (2) two business days following the disclosure in certain periodic reports of the issuer’s financial results for the fiscal quarter in which the plan was adopted or modified (but not to exceed 120 days following plan adoption or modification) before any trading can commence under the trading arrangement;
– A cooling-off period of 30 days for persons other than issuers or directors and officers before any trading can commence under the trading arrangement or modification;
– A condition for directors and officers to include a representation in their Rule 10b5-1 plan certifying, at the time of the adoption of a new or modified plan, that: (1) they are not aware of material nonpublic information about the issuer or its securities; and (2) they are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5;
– A limitation on the ability of anyone other than issuers to use multiple overlapping Rule 10b5-1 plans;
– A limitation on the ability of anyone other than issuers to rely on the affirmative defense for a single-trade plan to one such plan during any consecutive 12-month period; and
– A condition that all persons entering into a Rule 10b5-1 plan must act in good faithwith respect to that plan.
In addition to the amendments to Rule 10b5-1, the SEC added new disclosure requirements, including annual disclosure relating to a company’s insider trading policies and procedures, quarterly disclosure concerning the use of Rule 10b5-1 plans by its directors & officers, and disclosure about awards of options in proximity to the release of MNPI and related policies and procedures. The new rules will also require Form 4 and 5 filers to indicate by a checkbox that a reported transaction was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c)
The final rules contain a few tweaks to the SEC’s original proposal. These include modifying the duration of the mandatory cooling off period (and eliminating the proposed cooling off period for issuers), allowing officer & director certifications to be included in the plan itself rather than being separately delivered to the issuer, and permitting issuers (but not insiders) to use multiple overlapping 10b5-1 plans. Overall, however, the amendments largely track the original proposal.
I said last month that we’d let you know if the SEC adopted anything by other than a 3-2 partisan vote, so I want to note for the record that the commissioners voted unanimously to approve the amendments. We’ll be posting memos in our “Rule 10b5-1” Practice Area.
The rules go into effect 60 days after publication in the Federal Register, and we’re scheduling a webcast for next month on the implications of the changes for companies & insiders. Stay tuned for more details.
– John Jenkins
I’ve been keeping an eye out for law firm memos explaining to me what’s particularly significant about the SEC’s settlement with AT&T over alleged Reg FD violations – other than the fact that it involved the largest financial penalty ever assessed in an FD enforcement action. It’s been a week since the settlement was announced, but I still haven’t seen anything along those lines. I can’t say I’m surprised. After all, from the outset, the SEC’s allegations appeared to involve textbook examples of the kind of practices that it had long cautioned companies against.
AT&T’s 1st Amendment challenge to Reg FD was probably the most interesting part of the case, but after the SDNY shot that down along with the other arguments the defendants submitted in their motion for summary judgment, so you can see why the company was interested in settling the case. On the other hand, the SEC had something to lose if a trial went forward as well. That’s because the Court found that a jury could reasonably find for either side when it came to the issue of whether the defendants acted with scienter.
Reg FD requires companies to simultaneously make public disclosure of any MNPI that is intentionally selectively disclosed and defines the term “intentional” to include recklessness. The Court’s discussion of the scienter issue begins on p.120 of its opinion, and among the various things it pointed to in concluding that a jury might reasonably find that the defendants didn’t act recklessly was the complete absence of any inkling among AT&T personnel and the analysts who received the selective disclosure that those communications risked violating Reg FD.
What are the key takeaways from the AT&T enforcement action? This MoFo memo on the SDNY’s decision suggests the following:
Policies and procedures alone may not be enough: At AT&T, the relevant policies, procedures, and training expressly prohibited the disclosures at issue. Nevertheless, the IR defendants and executives involved apparently understood that their actions did not violate Reg FD. Companies should consider whether changes or updates are warranted in their compliance programs to help mitigate the risk of unintended Reg FD violations. Such changes could include additional targeted trainings for those employees who communicate directly with analysts.
Timing: One way that companies can reduce the risk of possible Reg FD violations is to impose a “quiet period” late in the quarter during which company employees to whom Reg FD applies are prohibited from speaking with investors and analysts.
Utilize scripts: Where IR professionals speak with analysts, they should consider using scripts to guide their conversations. Such scripts can be reviewed by counsel and senior leadership to help ensure compliance with Reg FD.
To this list, I’d add one more item. I think the Court’s comments that nobody involved had any idea that there was a Reg FD issue in their communications are important. The Court said that went to scienter, but it’s also relevant to materiality, because it indicates that none of the sophisticated market professionals involved thought they were dealing with MNPI. I think the lesson is that materiality is always a judgment call, and one that the SEC is very willing to second guess when it comes to selective disclosure. That might just be the most important thing to keep in mind when it comes to Reg FD.
– John Jenkins
Join us today at 2pm Eastern for the webcast, “SEC Clawback Rules: What To Do Now.” We’ll be hearing practical guidance from Cooley’s Ariane Andrade, Hunton Andrews Kurth’s Tony Eppert, Orrick’s JT Ho, Pay Governance’s Mike Kesner, and Kirkland’s Abigail Lane about what to do to prepare for the SEC’s new Dodd-Frank clawback rules that go into effect next month. Among other topics, this program will cover:
– Overview of rules
– Differences from existing requirements & practices
– Specific action items
– Compliance timeframe
– State law issues
– Interplay between ISS guidelines, institutional investor expectations and DOJ enforcement policies
– Enforcement of clawbacks
– Disclosure implications
We’re also continuing to post memos on this topic in our “Clawbacks” Practice Area. As a member of CompensationStandards.com, you get access to the live webcast, plus the on-demand archive & transcript, and all of the other resources on this topic – which we’ll be continuing to update as the compliance date nears.
– John Jenkins
Yesterday, Corp Fin issued 7 Non-GAAP Financial Measures CDIs. Several of these CDIs update or replace the language of existing CDIs, while the remainder are new. Hanukkah and Christmas are just around the corner, so as a gift I’m going to do what the Staff doesn’t & provide a markup showing the changes. Additions are in bold, while deletions are presented as strikethroughs:
Question 100.01
Question: Can certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading?
Answer: Yes. Certain adjustments may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading. Whether or not an adjustment results in a misleading non-GAAP measure depends on a company’s individual facts and circumstances.
Presenting a non-GAAP performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business is one example of a measure that could be misleading.
When evaluating what is a normal, operating expense, the staff considers the nature and effect of the non-GAAP adjustment and how it relates to the company’s operations, revenue generating activities, business strategy, industry and regulatory environment.
The staff would view an operating expense that occurs repeatedly or occasionally, including at irregular intervals, as recurring. [December 13, 2022]
Question 100.04
Question: A registrant presents a non-GAAP performance measure that is adjusted to accelerate revenue recognized ratably over time in accordance with GAAP as though it earned revenue when customers are billed. Can this measure be presented in documents filed or furnished with the Commission or provided elsewhere, such as on company websites? Can a non-GAAP measure violate Rule 100(b) of Regulation G if the recognition and measurement principles used to calculate the measure are inconsistent with GAAP?
Answer: No. Non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP could violate Rule 100(b) of Regulation G. Other measures that use individually tailored recognition and measurement methods for financial statement line items other than revenue may also violate Rule 100(b) of Regulation G. [May 17, 2016]. Yes. By definition, a non-GAAP measure excludes or includes amounts from the most directly comparable GAAP measure. However, non-GAAP adjustments that have the effect of changing the recognition and measurement principles required to be applied in accordance with GAAP would be considered individually tailored and may cause the presentation of a non-GAAP measure to be misleading. Examples the staff may consider to be misleading include, but are not limited to:
– changing the pattern of recognition, such as including an adjustment in a non-GAAP performance measure to accelerate revenue recognized ratably over time in accordance with GAAP as though revenue was earned when customers were billed;
– presenting a non-GAAP measure of revenue that deducts transaction costs as if the company acted as an agent in the transaction, when gross presentation as a principal is required by GAAP, or the inverse,
– presenting a measure of revenue on a gross basis when net presentation is required by GAAP; and
– changing the basis of accounting for revenue or expenses in a non-GAAP performance measure from an accrual basis in accordance with GAAP to a cash basis. [December 13, 2022]
Question 100.05
Question: Can a non-GAAP measure be misleading if it, and/or any adjustment made to the GAAP measure, is not appropriately labeled and clearly described?
Answer: Yes. Non-GAAP measures are not always consistent across, or comparable with, non-GAAP measures disclosed by other companies. Without an appropriate label and clear description, a non-GAAP measure and/or any adjustment made to arrive at that measure could be misleading to investors. The following examples would violate Rule 100(b) of Regulation G:
- Failure to identify and describe a measure as non-GAAP.
- Presenting a non-GAAP measure with a label that does not reflect the nature of the non-GAAP measure, such as:
– a contribution margin that is calculated as GAAP revenue less certain expenses, labeled “net revenue”;
– non-GAAP measure labeled the same as a GAAP line item or subtotal even though it is calculated differently than the similarly labeled GAAP measure, such as “Gross Profit” or “Sales”; and
– non-GAAP measure labeled “pro forma” that is not calculated in a manner consistent with the pro forma requirements in Article 11 of Regulation S-X. [December 13, 2022]
Question 100.06
Question: Can a non-GAAP measure be misleading, and violate Rule 100(b) of Regulation G, even if it is accompanied by disclosure about the nature and effect of each adjustment made to the most directly comparable GAAP measure?
Answer: Yes. It is the staff’s view that a non-GAAP measure could mislead investors to such a degree that even extensive, detailed disclosure about the nature and effect of each adjustment would not prevent the non-GAAP measure from being materially misleading. [December 13, 2022]
Question 102.10
Question 102.10(a): Item 10(e)(1)(i)(A) of Regulation S-K requires that when a registrant presents a non-GAAP measure it must present the most directly comparable GAAP measure with equal or greater prominence. This requirement applies to non-GAAP measures presented in documents filed with the Commission and also earnings releases furnished under Item 2.02 of Form 8-K. Are there examples of disclosures that would cause a non-GAAP measure to be more prominent?
Answer: Yes. Although whether a non-GAAP measure is more prominent than the comparable GAAP measure generally depends on the facts and circumstances in which the disclosure is made, the staff would consider the following examples of disclosure of non-GAAP measures as more prominent: Yes. This requirement applies to the presentation of, and any related discussion and analysis of, a non-GAAP measure. Whether a non-GAAP measure is more prominent than the comparable GAAP measure generally depends on the facts and circumstances in which the disclosure is made. The staff would consider the following to be examples of non-GAAP measures that are more prominent than the comparable GAAP measures:
Presenting a full income statement of non-GAAP measures or presenting a full non-GAAP income statement when reconciling non-GAAP measures to the most directly comparable GAAP measures; Presenting an income statement of non-GAAP measures. See Question 102.10(c).Omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures; Presenting a non-GAAP measure before the most directly comparable GAAP measure or omitting the comparable GAAP measure altogether, including in an earnings release headline or caption that includes a non-GAAP measure.- Presenting a ratio where a non-GAAP financial measure is the numerator and/or denominator without also presenting the ratio calculated using the most directly comparable GAAP measure(s) with equal or greater prominence.
- Presenting a non-GAAP measure using a style of presentation (e.g., bold, larger font, etc.) that emphasizes the non-GAAP measure over the comparable GAAP measure.
A non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline or caption); Describing a non-GAAP measure as, for example, “record performance” or “exceptional” without at least an equally prominent descriptive characterization of the comparable GAAP measure.- Presenting charts, tables or graphs of a non-GAAP financial measures without presenting charts, tables or graphs of the comparable GAAP measures with equal or greater prominence, or omitting the comparable GAAP measures altogether.
- Providing discussion and analysis of a non-GAAP measure without a similar discussion and analysis of the comparable GAAP measure in a location with equal or greater prominence. [December 13, 2022]
Question 102.10(b): Are there examples of disclosures that would cause the non-GAAP reconciliation required by Item 10(e)(1)(i)(B) of Regulation S-K to give undue prominence to a non-GAAP measure?
Answer: Yes. The staff would consider the following examples of disclosure of non-GAAP measures as more prominent than the comparable GAAP measures:
- Starting the reconciliation with a non-GAAP measure.
- Presenting a non-GAAP income statement when reconciling non-GAAP measures to the most directly comparable GAAP measures. See Question 102.10(c).
- When presenting a forward-looking non-GAAP measure, a registrant may exclude the quantitative reconciliation if it is relying on the exception provided by Item 10(e)(1)(i)(B) of Regulation S-K. A measure would be considered more prominent than the comparable GAAP measure if it is presented without disclosing reliance upon the exception, identifying the information that is unavailable, and its probable significance in a location of equal or greater prominence. [December 13, 2022]
Question 102.10(c): The staff considers the presentation of a non-GAAP income statement, alone or as part of the required non-GAAP reconciliation, as giving undue prominence to non-GAAP measures. What is considered to be a non-GAAP income statement?
Answer: The staff considers a non-GAAP income statement to be one that is comprised of non-GAAP measures and includes all or most of the line items and subtotals found in a GAAP income statement. [December 13, 2022]
I’d have to check with Broc to be sure, but I think this may be the longest blog in the history of this blog. Anyway, Happy Holidays!
– John Jenkins
Yesterday, the SCOTUS granted Slack Technologies’ cert petition in a case raising the issue of whether Section 11 and Section 12(a)(2) of the 1933 Act require a plaintiff to be able to trace their shares to those sold in the registered offering at issue. Slack asserted this tracing requirement – which has been recognized by several circuit courts – as a defense to Section 11 claims arising out if its 2019 direct listing.
That defense was rejected by a California federal court and by the 9th Circuit, but now Slack will get another bite of the apple in the Supreme Court. The stakes are very high here – if the tracing requirement survives, then the high-profile companies for which a direct listing is a viable alternative will have significant advantages over those that take the traditional IPO route. If it doesn’t survive, then we may see a lot more Section 11 litigation involving follow-on offerings by public companies.
– John Jenkins
When Audit Analytics last looked at the universe of going concern opinions, it found that they reached an all-time low in 2020, but according to the firm’s latest report, 2021 was a very different story. Here’s an excerpt with the highlights:
The number of companies that received a going concern opinion during fiscal year (FY) 2021 increased to1,674, around the number of going concerns last seen in FY2016. The percentage of companies that received a going concern opinion during FY2021 was 21.3%, higher than the 18.4% seen in FY2020. Going concern opinions have been declining since they peaked during FY2008 with 2,853 – during the height of the financial crisis. FY2008 also saw a high of 28.3% of companies that received a going concern opinion.
The report says that the percentage of non-accelerated filers reporting a going concern qualification rose by 3.9%, while the percentage of large accelerated filers included in this group increased by 0.7%. Those were the largest increases experienced by those groups of companies in more than a decade. In contrast, going concern qualifications among accelerated filers declined by 5.6% – which was the biggest decline among the members of that group in 15 years.
The report’s most jarring statistic is that while the number of newly public companies increased by 54% last year, the number of going concern opinions issued to those companies increased by 148% over the prior year and was the driving force behind the overall increase in the number of going concern opinions.
– John Jenkins
