At their scheduled open meeting yesterday, the SEC Commissioners unanimously approved changes to Reg M to remove and replace references to “credit ratings” from the existing exceptions provided in Rule 101 and Rule 102, which had referred to certain securities being rated “investment grade” by at least one nationally recognized statistical rating organization and will now refer to alternative standards of creditworthiness. Specifically, according to the SEC’s Fact Sheet, the amendments:
– Remove existing rule exceptions that reference credit ratings for nonconvertible debt securities, nonconvertible preferred securities, and asset-backed securities included in Rule 101 and Rule 102 of Regulation M;
– Replace those rule exceptions with new standards that are based on alternative standards of creditworthiness; and
– Add an amendment to a recordkeeping rule applicable to broker-dealers in connection with their reliance on the new exceptions.
As Dave blogged last week, this is the culmination of years of consideration, dating all the way back to the Dodd-Frank Act, and that history is also mentioned in the SEC’s press release and the various Commissioner statements about the rule change. The amendments fulfill the mandate from Section 939A(b) of the Dodd-Frank Act.
You may be wondering what “alternative standards of creditworthiness” actually means. The Fact Sheet explains:
New Rule 101(c)(2)(i) and Rule 102(d)(2)(i) except nonconvertible debt securities and nonconvertible preferred securities of issuers having a probability of default of 0.055 percent or less, as estimated as of the sixth business day immediately preceding the determination of the offering price, over the horizon of 12 full calendar months from such day, as determined and documented in writing by the distribution participant acting as the lead manager, using a “structural credit risk model,” as newly defined in Rule 100 of Regulation M. In addition, new Rules 101(c)(2)(ii) and 102(d)(2)(ii) except asset-backed securities that are offered pursuant to an effective shelf registration statement filed on the Commission’s Form SF-3.
Clear as mud, right? My first thought was that this seems to just move reliance from credit ratings agencies to distribution participants. I admittedly have not parsed through the entire adopting release – certainly not as deeply as the Staff who put this together. And I am not familiar with credit assessment services, although I’m sure I’ll come to know and love them. Point being though, that on its face, I am not sure that legal counsel, investors or others have the skills (or desire?) to figure out structural credit risk models, even if they are “commercially or publicly available” – or to easily determine whether a model meets the requirements to be used under the rule.
While all the Commissioners supported the rule, they acknowledged it wasn’t perfect – and in her statement, Commissioner Peirce raised three questions that seem worth considering:
– One commenter suggested that the Commission’s proposed use of a structural credit risk model for determining eligibility for the exception under Rule 101(c)(2)(i) was unnecessarily complex and suggested using a simpler alternative, such as whether the securities are offered pursuant to an effective registration statement filed on one of several specific forms. Another alternative this commenter suggested was to limit the exception to securities issued by well-known seasoned issuers. Why doesn’t the final rule take one of these approaches?
– How confident is the staff that we’ve gotten the threshold right for this exception?
– The International Institute of Law and Finance submitted a comment letter that asked the Commission to consider allowing market participants more flexibility in estimating probability of default. Among the alternatives IILF suggested would be appropriate were statistical models and market measures of credit risk, such as debt security prices and yields, credit spreads, and credit default swap spreads. Why doesn’t the final rule provide this extra flexibility?
The final rules go effective 60 days following the date of publication of the adopting release in the Federal Register (which usually takes about a month, depending on the volume of what needs to get published). For those who are gluttons for punishment, here’s the 120-page adopting release. We’ll be posting memos in our “Regulation M” Practice Area.
Following up on the NYSE amendment that I blogged about yesterday, Nasdaq has now also posted an amendment to its Dodd-Frank clawback listing standard proposal. Just like the NYSE amendment, the amendment that Nasdaq has proposed would set an October 2nd effective date and a December 1st compliance date (60 days after the effective date). As amended, the proposed listing standard would say:
Effective Date. Each Company is required to (i) adopt a policy governing the recovery of erroneously awarded compensation as required by this rule no later than 60 days following October 2, 2023, (ii) comply with its recovery policy for all incentive-based compensation received (as such term is defined in Rule 5608(d)) by executive officers on or after October 2, 2023, and (iii) provide the disclosures required by this rule and in the applicable Commission filings on or after October 2, 2023. Notwithstanding the look-back requirement in Rule 5608(b)(1)(i)(D), a Company is only required to apply the recovery policy to incentive-based compensation received on or after October 2, 2023.
That’s the only change that Nasdaq has proposed, and it comes as welcome news! We’ll stay tuned for the SEC notice of these amendments.
I’ve been dragging my feet on writing about the SEC’s big crypto enforcement actions & related news because I had a feeling that there would be more to come. Now there’s been more activity than I bargained for, so I’m just going to recap what’s happened in the past week or so:
– Last week: The SEC announced that former Coinbase manager and his brother agreed to settle insider trading charges.
– Also last week: The Chairs of the House Committees on Financial Services & Agriculture published a 162-page discussion draft of legislation that would define CFTC and SEC jurisdiction over cryptoassets (commodities vs. investment contracts, respectively), create a new disclosure regime specific to the risks surrounding digital assets, define conditions for registration off-ramps and exemptions, establish a joint CFTC-SEC advisory committee, and more. Here’s the 8-page summary.
– Monday: The SEC announced 13 charges against Binance – the world’s largest crytpo exchange – along with its US arm and its founder. Here’s the 136-page complaint. You have probably seen the quote.
– Tuesday: The SEC announced charges against Coinbase – the largest crypto exchange in the US and the petitioner in a detailed request for rulemaking – for operating as an unregistered securities exchange, broker and clearing agency. Here’s the 101-page complaint. Unlike Binance, the SEC hasn’t alleged much in the way of fraud. Matt Levine’s column has a good comparison of the Binance and Coinbase approaches to compliance and the SEC’s complaints against each of them.
– Also Tuesday: The SEC announced that it had filed an emergency motion for a TRO to freeze certain Binance assets and prevent destruction of records, among other requests. Here is commentary from John Reed Stark, who was formerly with the SEC and has been calling for enforcement on crypto from various regulators for quite some time.
Here is Matt Levine again on the evolution of the SEC’s crypto enforcement since 2017. He describes the early days as:
The SEC’s 2017ish ICO crackdown was very much a ’33 Act crackdown: People were raising money by selling scammy stock-like tokens, and the SEC shut down their scams, one at a time.
And one result of this approach is that Coinmarketcap.com lists 10,408 crypto tokens, and only a handful of them have been sued by the SEC for doing illegal securities offerings. Maybe that’s fine! Maybe the SEC’s crackdown on ICOs deterred 30,000 other, scammier crypto projects from launching; maybe the 10,000 current crypto tokens are all pretty good and not scammy.
That’s different than today’s approach, which is coming under the ’34 Act:
What can the SEC do about it? Well, it can go sue thousands of crypto projects, but that is hard not only because there are thousands of them but because many will be decentralized and/or foreign enough that they are hard to sue.
Also some of them didn’t do anything wrong: Solana, let’s say, did do a securities offering of SOL tokens, but legally, selling them to venture capitalists in private placements subject to appropriate SAFTs and lockups. The fact that those tokens now trade publicly, with less disclosure and fewer investor safeguards than the SEC would like, is, from the SEC’s perspective, unfortunate. But it’s not exactly Solana’s fault, or rather it is Solana’s fault but in a perfectly legal way.
But what the SEC can do is sue crypto exchanges. What it can do is try to shut down Coinbase Inc., the biggest US crypto exchange, and shut Binance, the biggest global crypto exchange, out of the US market. And it can go after other companies — Bittrex, Kraken, Gemini — that offer crypto trading to US customers. Because if it is illegal to operate a crypto exchange in the US, then US customers won’t be able to trade crypto, which means that they will be protected from the bad aspects — the scams, the lack of disclosure, the lack of investor protections — of crypto.
The column goes on to explain that while the ’33 Act analysis is still important to the current enforcement arguments, there may be nuances that affect where all this lands. John Reed Stark and lots of others think the SEC’s cases are strong. This Reuters article reports that counsel for the defendants in this week’s cases includes lawyers from Wachtell Lipton, Sullivan Cromwell, Latham, Gibson Dunn and Wilmer Hale. So for those of us watching from the sidelines who enjoy the technicalities of securities law, there may be opportunities to geek out when we see the arguments.
If you’re at an NYSE-listed company and you’ve been panicking about fitting approval of a Dodd-Frank clawback policy into full compensation committee agendas this summer, we’ve got good news: the NYSE has filed an Amendment to its proposed listing standard, which sets an October 2nd effective date. If the Amendment is approved by the SEC as proposed, that means that NYSE companies will have until Friday, December 1st to adopt a compliant Dodd-Frank clawback policy and that the policy would cover incentive-based compensation received by executives on or after October 2, 2023.
Nasdaq hasn’t filed a corresponding amendment (yet) – we’ll see whether that happens before the end of this week when the original proposal is currently scheduled to go effective. The SEC also hasn’t posted the notice for the NYSE Amendment yet, which would clarify the process for this Amendment being approved.
This Wilson Sonsini blog highlights commentary from the Amendment to support this extended effective date – which is that the SEC’s adopting release for the Dodd-Frank clawback rules said:
…we note that issuers will have more than a year from the date the final rules are published in the Federal Register to prepare and adopt compliant recovery policies.
So, the Amendment recognizes that many folks had been expecting the compliance date to fall sometime after November 28, 2023, which would be the one-year anniversary of the rules being published in the Federal Register.
In addition, the NYSE Amendment changes the proposal to allow for a cure period when the Exchange believes that a company has failed to enforce the policy. It still requires NYSE companies to provide notice to the Exchange if they haven’t adopt a compliant clawback policy before the compliance date (and the proposal continues to provide a cure period for late adoption scenarios). NYSE’s changes to the delisting procedures align with comments on the proposal and the Nasdaq approach to delistings for lack of clawback policy enforcement. The Wilson Sonsini blog also provides color here:
Other than the change to the effective date, proposed Section 303A.14 of the NYSE Listed Company Manual is the same as proposed in the NYSE’s initial filing and as noted above, closely follow the requirements outlined in Rule 10D-1. Notably, this means that, similar to Nasdaq’s proposed listing standards, proposed Section 303A.14 does not include any guidance or factors that the NYSE will consider when making a determination as to whether the issuer has recovered “reasonably promptly” the amount of erroneously awarded incentive-based compensation.
However, the blog goes on to highlight that in Amendment No. 1, the NYSE stated the following:
“The issuer’s obligation to recover erroneously awarded incentive based compensation reasonably promptly will be assessed on a holistic basis with respect to each such accounting restatement prepared by the issuer. In evaluating whether an issuer is recovering erroneously awarded incentive-based compensation reasonably promptly, the [NYSE] will consider whether the issuer is pursuing an appropriate balance of cost and speed in determining the appropriate means to seek recovery, and whether the issuer is securing recovery through means that are appropriate based on the particular facts and circumstances of each executive officer that owes a recoverable amount.”
We’ve posted several very helpful sample policies on CompensationStandards.com, where we are covering all the ins & outs of clawbacks. In our “Proxy Season Post-Mortem: The Latest Compensation Disclosures” webcast coming up on June 27th on that site, Morrison Foerster’s Dave Lynn, Gibson Dunn’s Ron Mueller and Compensia’s Mark Borges will be sharing even more practical insights on how to finalize your policy. If you don’t already have access to CompensationStandards.com, email sales@ccrcorp.com to start a no-risk membership or sign up online.
Long-time SEC Staff member Sebastian Gomez Abero recently shared that he’s returning to Corp Fin – as Associate Director of the Disclosure Review Program. Sebastian joined the SEC in 2007 and among other roles, he previously led the Division’s Office of Small Business Policy before being named Deputy Director of the SEC’s Small Business Advocacy Office in 2020. Congrats on being back in Corp Fin, Sebastian!
As a reminder on a somewhat related “small business” topic, the SEC’s Small Business Capital Formation Advisory Committee Meeting is scheduled to meet next Wednesday, June 14th. Here’s Dave’s blog with more detail and here’s the agenda.
Dave blogged last month that the SEC has been posting a lot of job openings lately. I have great respect for everyone who currently works (or has previously worked) at the Commission, and I know I’m not alone in our community in feeling that way. Plus, it’s a great place to work. This week, the agency has posted about an OASB opening and a Corp Fin informational session:
– The Office of the Advocate for Small Business Capital Formation (OASB) is hiring an Attorney-Adviser to support small business capital formation policy evaluation and analysis. This position will help advance the interests of small businesses, small business investors, and work to address the particular challenges that women-owned and minority-owned small businesses & their investors face. The posting closes on June 20th, so apply today!
– Corp Fin is seeking new-hires in DC and its 11 regional offices – both accountants and attorneys. The Division is hosting a Virtual Information Session on Wednesday, June 14, 2023 from 1pm-3pm ET. To attend this session and learn more about what it’s like to work in Corp Fin and how to apply, you can register here.
Your next IPO may be a direct listing, thanks in part to a unanimous opinion issued by the US Supreme Court last week in Slack Technologies v. Pirani. In the ruling, which we’ve been anticipating for a long time (here’s Meredith blog from last month about the case’s insurance implications), the Court determined that a plaintiff pursuing a liability claim under Section 11 of the Securities Act for alleged misstatements in an offering must be able to trace their shares to issuance under a registration statement in order to move forward with the claim.
That may be difficult in the context of the “direct listing” process that Slack used to go public back in 2019. When Slack began trading, a portion of the newly listed shares were registered for resale (restricted securities held by affiliates and others) – but an even larger portion of the newly listed shares were not registered and simply became available for secondary transactions. This Morrison Foerster memo gives a refresher on the implications of this case for IPO-related liability:
The federal securities laws impose strict liability for misleading statements made in connection with initial public offering documents. As a result, if a newly public company’s stock price falls below its IPO price, for whatever reason, the company is likely to face a securities class action. In recent years, direct listings have become more popular, in part as a way to avoid litigation and potential liability under Section 11 of the Securities Act of 1933. That is because, under long-standing precedent, only shareholders who purchased securities registered under the challenged registration statement had standing to sue. In a direct listing, registered and unregistered shares are issued simultaneously, making it difficult, if not impossible, for investors to show that the securities they purchased were registered.
This isn’t the end of the road for this particular case or the broader issue of liability in direct listings. For one thing, the Court noted that Congress could change the language of the statute if it wanted to allow claims to proceed – potentially, the SEC could even adopt interpretive rules to clarify the issue. (And of course, even if that didn’t happen, plaintiffs can sue companies for securities fraud at any time under Section 10 of the Exchange Act without the tracing requirement – but those claims are more difficult because they require a showing of scienter).
Here, SCOTUS remanded the case to the 9th Circuit to decide whether the plaintiff’s pleadings can satisfy Section 11(a) as construed by the Court, as well as whether the plaintiff’s Section 12 claim can move forward. As Cooley’s Cydney Posner blogged, the plaintiff may be able to plead that some of his purchased shares can be traced to the registration statement:
Can Pirani trace his shares? During oral argument, Slack counsel contended that it was not really possible for Pirani to trace his shares to the registration statement. He noted, however, that there was a pending state case in which plaintiffs claim they can trace, and that was being litigated. In addition, Slack counsel referred to an amicus brief submitted by law and business professors that suggested “that a recent regulatory change after this case, the creation of the consolidated audit trail, may facilitate tracing in the future.” Counsel for Pirani pointed out that they had indicated in the pleadings that the shares were traceable—meaning not every share, but a percentage of them, a question that he thought should be left to the lower courts. Justice Gorsuch agreed that all they would “need to do is plead facts suggesting that you can trace consistent with the Twiqbal standard [Iqbal and Twombly], as my friends like to call it. (Laughter.)… And—and then you’re off to the races and it really just becomes a matter of damages, as I think you also alluded to.” As a result, he continued “if we were to rule against you on what §11 means, it still would enable you to plead…that there are traceable shares.”
On the Section 12 claim, which looks at false or misleading statements in a prospectus or oral communication rather than a registration statement, the Court said:
The Ninth Circuit said that its decision to permit Mr. Pirani’s §12 claim to proceed “follow[ed] from” its analysis of his §11 claim. 13 F. 4th 940, 949 (2021). And because we find that court’s §11 analysis flawed, we think the best course is to vacate its judgment with respect to Mr. Pirani’s §12 claim as well for reconsideration in the light of our holding today about the meaning of §11. In doing so, we express no views about the proper interpretation of §12 or its application to this case. Nor do we endorse the Ninth Circuit’s apparent belief that §11 and §12 necessarily travel together, but instead caution that the two provisions contain distinct language that warrants careful consideration.
If you need to get up to speed on the mechanics of direct listings, we’ve got a “Direct Listings” Practice Area for that. Or, as Bloomberg’s Matt Levine pointed out, some companies might also take this holding as a reason to loosen lockups for traditional IPOs:
One possible conclusion here is that, if you are a company considering an IPO, a direct listing reduces your potential liability (and that of your underwriters): If you do a direct listing, no one can sue you under section 11 for misstatements in your prospectus; they have to meet the higher bar of proving fraud.
Another possible conclusion here is that, if you are a company considering an IPO, and you don’t want to do a direct listing, you can maybe get these benefits anyway? Just don’t sign a lockup! Let some of your employees or other existing shareholders sell stock immediately, as soon as the IPO prices. Then anyone who buys stock after the IPO can’t prove that they bought stock from the IPO, instead of from your employees.
Whether the SCOTUS holding – and the ultimate outcome of this case – will change the dynamics for public offerings remains to be seen. Please participate in this anonymous poll to share your thoughts:
Cboe Global Markets – which, as the “rebranded” Chicago Board Options Exchange, continues to be one of the world’s largest option exchanges – announced last week that it is going to begin listing corporate stocks in the US. All Cboe-listed stocks in the US and Canada can also be made available for trading in the Netherlands and the UK, with Australia to follow.
Cboe has been around for 50 years as an options exchange, but when it comes to listing company stocks, it is a new player. It joins upstart national securities exchanges like the Long-Term Stock Exchange (all 24 national securities exchanges are listed on the SEC’s “Self-Regulatory Organizations” page). It says it is not aiming to compete with the existing large exchanges – rather, it wants to focus on the “purpose-driven innovation economy.” Here’s more detail:
Uniquely focused on powering the purpose-driven Innovation Economy, Cboe Global Listings aims to serve growth companies – particularly those with novel business models operating in nascent, high-growth industries – and innovative investment products that are addressing world challenges and shaping the economies of tomorrow.
Abaxx Technologies, a fintech company, will be the first issuer listed on Cboe’s global platform. Abaxx went public on Cboe Canada in December 2020.
Hang on to your hats! In advance of the more detailed disclosure requirements that will apply to share repurchases conducted later this year and in the future, a 6-page order posted last week shows that the SEC’s Enforcement Division is already on the lookout for shortcomings under the disclosure rules as they currently exist. The Commission instituted cease-and-desist proceedings and reached a $600k settlement with a regional bank based on its purported findings that:
1. FGBI failed to disclose repurchases of its common stock on the open market in its Forms 10-Q and 10-K in connection with an employee stock grant program (“Stock Grant Program” or “Program”) for employees of its wholly-owned subsidiary, First Guaranty Bank (“FGB”), and for annual stock bonus awards made to FGB executives, including FGB’s Chief Executive Officer (“CEO”) and Chief Financial Officer, (“CFO”).
2. From September 2016 through February 2021, FGB used an outside third party, who was not an employee of either FGB or FGBI, to purchase shares of FGBI common stock each quarter on the open market using his own brokerage account. Once the shares were purchased, the third party worked with FGB’s administrative personnel to effectuate the sale of shares to FGB. FGB never took possession of the shares, instead distributing them directly from the third party’s account held at FGB to select employees for that quarter and to its senior executives at year-end. In total, the third party purchased 119,020 shares of FGBI common stock for approximately $2.5 million under these programs.
3. Pursuant to Item 703 of Regulation S-K, 17 C.F.R. § 229.703, FGBI was required to disclose these quarterly and annual purchases made by the third party in FGBI’s Forms 10-Q and 10-K filed with the Commission between March 30, 2017 and May 10, 2021. However, FGBI never disclosed this required information in its quarterly and annual filings. Moreover, FGBI failed to implement controls, policies, or procedures designed to ensure compliance with the disclosure requirements under Item 703.
4. As a result of the conduct described above, FGBI violated Section 13(a) of the Exchange Act and Rules 13a-1, 13a-13, and 13a-15(a) thereunder.
Although this order involves a corner of the market that’s been under significant scrutiny this year, there’s no reason to think that the Enforcement Division isn’t also watching for compliance issues at companies from other industries. In addition to the specific repurchase disclosures that resulted in the alleged violation, the order also says that the company lacked appropriate disclosure controls – which has been an enforcement theme as of late. Here’s an excerpt:
Although FGBI maintained written procedures and checklists pertaining to disclosures required by the federal securities laws, FGBI had no controls or procedures in place for FGBI’s annual filings designed to ensure FGBI disclosed the quarterly share purchases in its Forms 10-K under Item 703. With respect to FGBI’s quarterly filings on Forms 10-Q, FGBI maintained a Form 10-Q checklist that had only the one question pertaining to Item 703. However, FGBI’s controls and procedures were not designed to ensure that the quarterly purchases made by the third party, an affiliated purchaser of FGBI, would be disclosed under Item 703.
Since the share repurchase disclosure requirements are only going to get more detailed & complex from here, now is the time to revisit disclosure controls and ensure that all checklists and form checks are broad enough to capture all repurchases covered by the rules. Check out the memos – and our recent webcast – about the new rules that we’ve posted in our “Buybacks” Practice Area, to make sure that you and your clients are prepared.
