Yesterday, Corp Fin announced an update to the Division’s Financial Reporting Manual. The Manual is updated as of October 30, 2020 and sections with updates are marked with the date tag “Last updated: 10/30/2020.” Here’s a summary of some of the changes this update includes:
– Revised to reflect changes to smaller reporting company, accelerated filer and large accelerated filer definitions and amendments from Disclosure Update and Simplifications;
– Clarified the application of Rule 3-13 to Form 8-K and the income test for Rule 3-09 financial statements when there is more than one equity method investee;
– Clarified audit requirements for a special-purpose acquisition company target in Form S-4/F-4;
– Described the substantial deficiency situation impact on certain rule and eligibility standards;
– Included another example of a “To Be Issued” accountant’s report; and
– Removed outdated references and updated for changes to GAAP, guidance issued by the PCAOB, Division of Corporation Finance, and SEC’s Office of Chief Accountant in the last few years.
We’ll be on the lookout for more guidance coming from Corp Fin, given Director Bill Hinman’s upcoming departure. Back in 2016 when Keith Higgins prepared for his departure, Corp Fin issued 35 new CDIs in a single day.
Sold! ISS Changes Ownership (Again)
Earlier this week, ISS announced a change in its majority ownership – it seems like that just happened not too long ago, but looking back it’s been about 3 years since the firm last changed hands. Deutsche Börse AG is buying approximately 80% of ISS from current private-equity owner Genstar Capital. Genstar and ISS’ current management will continue to hold the remaining 20%. The ISS press release says the Deutsche Börse purchase is based on an ISS valuation of almost $2.3 billion. Here’s an excerpt with additional info:
The transaction is expected to close in the first half of 2021 subject to customary closing conditions and regulatory approvals. After the closing, ISS will continue to operate with the same editorial independence in its data and research organisation that is in place today. The current executive leadership team with CEO Gary Retelny will co-invest in the transaction and will also lead the business of ISS after the closing.
PCAOB Issues Audit Committee Resource on Auditing Estimates & Use of Specialists
It’s been almost two years since the PCAOB adopted a new requirements related to auditing accounting estimates, including fair value measurements, and using the work of specialists. With those requirements set to take effect for audits of financial statements for fiscal years ending on or after December 15, 2020, last week the PCAOB issued a resource aimed at helping audit committees understand the requirements. The PCAOB’s memo provides a list of questions for audit committees to consider asking their auditors, here’s the memo’s key takeaways:
– The effects of the new requirements will not be uniform across all audits
– The extent of effects of the new requirements will depend on the nature and extent of accounting estimates included in the company’s financial statements, and also on whether the company uses a specialist
– The new standard and amendments do not change the requirements for the auditor’s communications with audit committees, including those communications related to critical accounting estimates
– Auditors are applying these new requirements in extraordinary times and in situations that continue to evolve due to the Covid-19 pandemic
Yesterday, the SEC announced that it adopted rules to facilitate electronic submission of documents. Welcome news to many, the Commission adopted rule amendments to permit the use of electronic signatures used in connection with many documents filed with the Commission. The Commission also adopted rule amendments to require electronic filing and service of documents in administrative proceedings. Here’s an excerpt from the Commission’s press release about use of electronic signatures:
Today’s amendments permit a signatory to an electronic filing who follows certain procedures to sign an authentication document through an electronic signature that meets certain requirements specified in the EDGAR Filer Manual. In addition, the Commission amended certain rules and forms under the Securities Act, Exchange Act, and Investment Company Act to allow the use of electronic signatures in authentication documents in connection with certain other filings when these filings contain typed, rather than manual, signatures.
Back in April, I blogged about the rulemaking petition requesting the Commission amend rules under Reg S-T to permit use of electronic signatures when filing documents with the SEC – the SEC’s press release says that nearly 100 public companies joined in support of the petition. With electronic signatures being more the norm these days, these amendments will make things simpler, especially as many continue working remotely. See this Fenwick memo for more. The electronic signature rule amendments will be effective upon publication in the Federal Register.
UK Leads Way with Impact of Climate Risk Reporting, Will U.S. Follow?
As reported in the WSJ, last week the UK announced that it will require large companies and financial institutions to report the financial impact of climate risk in alignment with the Taskforce on Climate-Related Financial Disclosures (TCFD) framework by 2025. The TCFD recommendations are widely recognized as authoritative guidance for reporting climate-related information. Many have called for increased reporting of the impact of climate risk and Larry Fink, BlackRock’s CEO, is among those that say the U.S. should take action too. Reuter’s reported that Fink welcomed the UK’s announcement for mandatory climate reporting and said ‘the U.S. should move faster so we can achieve greater coordination.’ He also said the DOL could make it ‘easier, not harder’ for asset managers to integrate sustainability issues into their investment strategies.
Some may recall that earlier this year, a subcommittee of the SEC’s Investor Advisory Committee approved a recommendation encouraging the SEC to begin addressing ESG disclosure. With the incoming Biden administration, climate change has been identified as among the top priorities and some are predicting the SEC may be more receptive to ESG-related disclosure requirements. When it comes to climate risk disclosure, SEC Commissioner Allison Lee has advocated for mandatory disclosure, most recently she stressed the need to address it in a keynote address at PLI’s securities law conference – Cydney Posner’s blog provides a good overview of the address. For now, it remains to be seen if the U.S. moves forward on climate risk reporting and if so, how quickly that might happen.
Tomorrow’s Webcast: “Pay Equity – What Compensation Committees Need to Know”
Tune in tomorrow for the CompensationStandards.com webcast – “Pay Equity: What Compensation Committees Need to Know” – to hear Anne Bruno of Mintz, Tanya Levy-Odom of BlackRock, Josh Schaeffer of Equity Methods and Heather Smith of Impax Asset Management | Pax World Funds discuss pay equity – including why it’s in the spotlight, the difference between “pay equity” & “pay gap”, shareholder expectations, disclosure trends on pay gaps & pay equity, pay ratio interplay, mechanics of board & committee oversight and preparing for shareholder engagements & proposals.
Yesterday, the SEC announced that Chairman Jay Clayton intends to conclude his tenure at the end of the year, slightly ahead of his June 2021 term expiration date. As noted in the SEC’s press release, Chairman Clayton led the agency through a period of historically productive rulemaking – during his tenure, the agency advanced more than 65 final rules, many of which modernized rules that hadn’t been updated in decades.
Last summer, things got interesting when news spread of President Trump’s intention to nominate Chairman Clayton as the United States Attorney for the Southern District of New York, which hasn’t come to pass. Even with the commotion from that announcement, Chairman Clayton continued to move forward with notable rulemaking — including rules enhancing the Commission’s whistleblower program, modernizing Regulation S-K and the shareholder proposal process. In addition to all the rulemaking, the SEC’s press release highlights impacts from enforcement actions, which since 2017 have resulted in the SEC obtaining more than $14 billion in financial remedies.
With the incoming administration, there’s been a fair amount of speculation about who will lead the Commission. In the past, the most senior Commissioner of the current President’s party has served as interim Chair until a new Chair is confirmed. If that tradition is followed this time around, Commissioner Hester Peirce would be interim Chair following Jay’s departure and continue in that role for a while after President-elect Biden’s inauguration. This Bloomberg piece names several contenders for a Biden appointment, including former head of the CFTC, Gary Gensler, former U.S. Attorney for the Southern District of New York, Preet Bharara, and Michael Barr, who is a former aide to ex-Treasury Secretary Timothy Geithner.
Comment Letter Trends: Top 10 Topics in Reviews
Deloitte recently issued a 218-page roadmap on comment letter trends that includes developments on financial reporting topics through November 6, 2020. In terms of insights about comments related to the Covid-19 pandemic, the report says that early trends indicate that MD&A and risk factor trends have been main focus areas. Good news included in the report is that over the last five years, there’s been a notable decline in the number of reviews with comment letters and the number of comment letters issued. For those beginning to prepare for year-end reporting, it’s helpful to be aware of the leading areas for comment and the report lists these as the “top 10”:
1. MD&A – comments increased on results of operations, highlighting the Staff’s continuing focus on greater transparency and specificity in disclosures about operating results. Comments on Covid-19 have focused on the pandemic’s impact on future operating results and future financial condition, known trends or uncertainties related to COVID-19 that will have a material favorable or unfavorable impact on income from continuing operations, and discussions of current liquidity and availability of financial resources
2. Non-GAAP measures – the report lists several areas of continued focus, including whether there is undue prominence of non-GAAP measures, enhancing disclosure related to the purpose and use of the measures, identification and clear labeling and reconciliation requirements
3. Revenue recognition – largest volume of comments focused on disclosure of significant judgments used in applying the standard
4. Segment reporting – identification and aggregation of operating segments, changes in reporting segments, considerations for entities with a single reportable segment and entity-wide disclosures about products or services
5. Signatures, exhibits and agreements – form and content of certifications, and material contracts, including requests for them to be filed as exhibits
6. ICFR – among others, evaluation of severity of control deficiencies, including those related to immaterial misstatements and disclosures of material changes in ICFR, including the impact and remediation of material weaknesses
7. Fair value – valuation techniques and inputs used, use of third-party pricing services and fair value estimates related to revenue recognition, goodwill impairment and share-based payments
8. Contingencies – focus on specificity of disclosures and amounts accrued, estimates for reasonably possible losses and disclosures related to loss contingencies and whether they have been updated over time as circumstances change
9. Intangible assets and goodwill – goodwill impairment disclosures, including early-warning disclosures and the specific circumstances that led to the charge in the period of impairment rather than general market factors, asset groupings for impairment testing and whether or why an interim impairment test was performed and the results of the test
10. Inventory and cost of sales – accounting policy disclosures regarding inventory valuation, including adjustments related to excess and obsolete inventories
Transcript: “Virtual Annual Meetings: What To Do Now”
We’ve posted the transcript for our recent webcast: “Virtual Annual Meetings: What To Do Now” – it covered these topics:
– Baseline Best Practices for Virtual Shareholder Meetings
– Getting Remote Technology in Order
– How to Ensure Your Platform Allows for Shareholder Entry & Participation
– Virtual “Rules of Conduct”
– Voting & Tabulation Issues
– Contingency Planning
Broadridge is gearing up for next year’s annual meeting season and just yesterday announced the first phase of its enhanced virtual shareholder meeting platform – a press release says the enhanced platform will enable Broadridge to validate beneficial shareholders who log on to other virtual meeting platforms. For more information to help with planning for upcoming virtual annual meetings, check out our “Virtual Annual Meetings” Practice Area – there you’ll find the latest memos and sample transcripts, rules of conduct and video replays from several 2020 meetings.
Also, take advantage of this special offer available to our members from Carl Hagberg who doles out lots of practical advice in his quarterly newsletters: If you sign up now for a 2021 subscription to The Shareholder Service Optimizer, you’ll get two 2020 quarterly issues added to your subscription for free. You can use this link and mention that you’re a member of TheCorporateCounsel.net in the “order notes” box on the subscription page.
With a subscription, you get access to www.optimizeronline.com, which has the complete text of 13 years of back issues, a searchable index of important articles, and a list of “Pre-Vetted Service Suppliers to Publicly-Traded Companies” – with introductory articles to describe the kinds or services rendered, the current competitive environment and the most important things to consider in selecting a service provider. The subscription also comes with “Some free consulting on any shareholder relations or shareholder servicing matter to ever cross your desk.”
On Friday, Corp Fin updated one and withdrew several Securities Act CDIs. These CDIs relate to equity line financing arrangements and PIPEs that can raise issues under Securities Act Section 5 – CDI 139.13 has been updated and CDIs 139.15, 139.16, 139.17, 139.18, 139.19 and 139.20 have been withdrawn. Here’s updated CDI 139.13, which clarifies when a company may file a resale registration statement:
Question 139.13
Question: In many equity line financings, the company will rely on the private placement exemption from registration to sell the securities under the equity line and will then seek to register the “resale” of the securities sold in the equity line financing. When may a company file a registration statement for the resale by the investors of securities sold in a private equity line financing?
Answer: In these types of equity line financings, the company’s right to put shares to the investor in the future and the lack of market risk resulting from the formula price differentiate private equity line financings from financing PIPEs (private investment, public equity). We, therefore, analyze private equity line financings as indirect primary offerings, even though the “resale” form of registration is sought in these financings.
The at-the-market limitations contained in Rule 415(a)(4) would otherwise prohibit market-based formula pricing for issuers that are not eligible to conduct primary offerings on Form S-3 or Form F-3. Nevertheless, we will not object to such companies registering the “resale” of the securities prior to the exercise of the equity line put if the transactions meet the following conditions:
the company and the investor have entered into a binding agreement with respect to the private equity line financing at the time the registration statement is filed;
the “resale” registration statement is on a form that the company is eligible to use for a primary offering;
there is an existing market for the securities, as evidenced by trading on a national securities exchange or alternative trading system, which is a registered broker-dealer and has an active Form ATS on file with the Commission; and
the equity line investor is identified in the prospectus as an underwriter, as well as a selling shareholder.
We will not object to the filing of a registration statement for a private equity line financing prior to the issuance of securities by the company under the equity line even when there are contingencies attached to the investor’s obligation to accept a put of shares from the company, as long as the above conditions are satisfied and the following terms of the investment have been agreed upon by both parties and disclosed by the company at the time that the resale registration statement is filed:
the number of shares registered for resale;
the maximum principal amount available under the equity line agreement;
the term of the agreement; and
the full discounted price (or formula for determining it) at which the investor will receive the shares.
[November 13, 2020]
SEC’s Private Offering Rules: Updated Chart of Registration Alternatives
Last spring, John blogged about the chart Stan Keller, Jean Harris and Rich Leisner kindly sent along reflecting the proposed changes to the private offering framework. Now that the amendments have been adopted, Stan, Jean and Rich sent along an updated Chart of Alternatives to Registration reflecting the final amendments to those alternatives – and included very helpful printing instructions to ensure the chart is printable in its most useful form as a handy reference booklet. Check it out!
Tomorrow’s Webcast: “Doing Deals Remotely”
Tune in tomorrow for the DealLawyers.com webcast – “Doing Deals Remotely” – to hear Joseph Bailey of Perkins Coie, Murad Beg of Provariant Equity Partners and Avner Bengara of Hughes Hubbard & Reed discuss adjusting to doing deals remotely, including lessons learned and emerging best practices for completing a successful transaction in this strange new environment.
Yesterday, I blogged about a letter writing campaign focused on climate lobbying disclosure. With diversity disclosure getting a lot of attention these days, there’s now another effort focused on that too. The “Russell 3000 Board Diversity Disclosure Initiative” issued a press release saying the group is calling on Russell 3000 companies to disclose the racial/ethnic and gender composition of their boards in 2021 proxy statement filings. The initiative is being led by the State Treasurers of Illinois and Connecticut and includes investors representing over $3 trillion in assets under management. Here’s an excerpt about the initiative from the Illinois Treasurer’s website:
Many institutional investors, including the Illinois Treasurer, have advocated for gender diversity on corporate boards through proxy voting policies and through direct shareholder-company engagement. These actions, now broadly adopted by institutional investors across the world, have helped generate an increase in gender diversity on corporate boards. The lack of data on racial/ethnic composition, however, makes it difficult to apply the same tools and creates unnecessary barriers to investment analysis and academic study.
The Black Lives Matter movement and the widespread outrage sparked by the murder of George Floyd have prompted a national conversation on issues of racial equity and inclusion. Many companies have issued statements in support of racial justice, and in some cases announced responsive efforts at their operations. This initiative urges companies to harness this national movement and the momentum on gender diversity to consider publicly reporting the racial/ethnic and gender composition of the Board of Directors in their annual proxy statement for the 2021 filing.
Members of the initiative have or are examining policies to vote against nominating committees with no reported racial/ethnic diversity in their proxy statements and expanding more direct shareholder engagement. Members agree that voluntary corporate reporting in the proxy statement is the most reliable data source.
The website includes a sample letter sent to Russell 3000 companies and the letter includes a proxy statement excerpt as an example of the disclosure the group would like to see. The example shows racial/ethnic and gender information by director as additional information at the bottom of a “director skills matrix.” We’ve blogged before about potentially gathering some of this information as part of annual D&O questionnaires and it looks like more companies could be headed down that path…
Trillium Engages to “Get Out the Vote”
With the election right around the corner, a recent press release from Trillium Asset Management says it has engaged with 20 companies to understand and influence their civic engagement policies and practices. With most shareholder engagement meetings focused on governance matters, executive compensation and various social issues, civic engagement seems like a new one – then again, if there was a year for it, 2020 might be it.
Those familiar with Trillium know that the socially responsible asset manager is a frequent proponent of various social matters – it has led initiatives relating to workplace diversity, plastics, LGBT issues and others. In this most recent engagement effort, Trillium released a report back in July intended to encourage companies to provide paid time off for employees to vote. Here’s an excerpt:
Trillium is pressing the companies that can make a difference, to take this opportunity and to become part of the solution. Support for civic engagement can benefit our democracy, can increase employee satisfaction, and we believe, improve the bottom line.
We wanted to know what companies with large numbers of hourly workers are doing to support civic engagement, so we asked each of these companies: Is there a company-wide policy that provides employees with time off to vote? Who does this policy extend to? Full-time, part-time, salaried, seasonal, and hourly employees? Contractors? How much time off is provided? If time off is provided, is it paid? In states with existing time off laws does the company do more than comply with state law? What kind of education is provided to make employees aware of this benefit? We also gathered information about how companies make employees aware of these benefits and any other education they offer around civic engagement.
The report includes a “Democracy Scorecard” and praises several companies, while also noting others have room for improvement. Companies that exhibited what we believe are “best practices” on this issue have robust policies that provide employees with paid time off to vote. Many also have strong engagement programs that provide employees important information about voting locations and deadlines. Some companies provided paid time off while others deferred to adhoc conversations with managers in order to schedule time off. Companies that rely on vacation time and the structure of employee schedules are not showing a sincere commitment to employee engagement.
Some states require that employers give employees time off to vote but the laws vary. When the mid-term elections come up in a couple of years, it’ll be interesting to see if this topic makes its way into engagement meetings again. Separately from this engagement initiative, some companies have begun offering paid time off to ensure employees have time to vote – here are a few stories I saw – including Coca-Cola’s tweet in response to Sarah Silverman’s call for time off and news from Goldman Sachs and Symetra Life Insurance Company.
September-October Issue of “The Corporate Executive”
The September-October issue of The Corporate Executive was just posted – & also sent to the printer. It’s available now electronically to members of TheCorporateCounsel.net who also subscribe to the electronic newsletter (try a no-risk trial). This issue includes articles on:
– Companies Changing Incentive Compensation Plan Performance Targets or Metrics Due to Covid-19
– ISS Releases Preliminary Guidance on the Pandemic and Pay Decisions
In a recent letter writing campaign, a group of institutional investors sent letters to CEOs and board chairs of 47 U.S. companies urging the companies to disclose how their climate lobbying aligns with the Paris Agreement and to take action when there’s misalignment. Earlier this week, Ceres issued an announcement about the initiative. As stated in the investors’ letter, it’s follow-up to letters on climate lobbying sent last year and is being sent in advance of benchmarking on climate progress that’s slated for public release next year:
Earlier this year, all 161 focus companies of the Climate Action 100+, including the 47 notified this month, were informed that they would be benchmarked on their climate progress against a set of key indicators that reflect the goals of the initiative. Paris-aligned corporate lobbying is a key indicator in which corporate progress will be assessed. The full assessment — Climate Action 100+ Net- Zero Company Benchmark — is set to be released in early 2021.
The letter directs these companies to this Ceres document outlining recommendations on how companies can establish systems that address climate change as a systemic risk and integrate this understanding into their direct and indirect lobbying on climate policies.
Investors signing this most recent letter campaign include BNP Paribas Asset Management, Boston Trust Walden, CalPERS, CalSTRS, Mercy Investment Services, NYC Comptroller’s Office, New York State Common Retirement Fund and Wespath Benefits & Investments.
Looking Back at 16 Years of ICFR
Section 404 of the Sarbanes-Oxley Act requires companies to review internal control over financial reporting and report whether it’s effective. John recently blogged about how newly public companies have fared with ICFR and Audit Analytics recently issued its annual recap of negative auditor attestations and management-only assessments of ICFR. The report takes a look at how public companies have fared more broadly by looking back at the last 16 years since SOX 404 first applied to U.S. accelerated filers. The report shows differing trends for accelerated filers disclosing adverse auditor attestations versus adverse management-only attestations filed by non-accelerated filers.
After starting out at 15.9% for fiscal year 2004, adverse auditor attestations declined to 3.5% for fiscal year 2010 and now have been hovering between 5 – 7%, which is where they’ve been for the last several years. Conversely, adverse management-only assessments rose steadily for seven years from 2008 to 2014 and are much higher than accelerated filers, peaking at 40.9% before declining, although adverse management-only assessments have remained between 39 – 42% since. Here’s an excerpt for reasons behind 2019 adverse attestations and assessments:
– The most common internal control reason auditors indicated as leading to conclusions about ineffective ICFR were issues requiring year-end adjustments, followed by a need for more highly trained accounting personnel
– The most common accounting issue that triggered an adverse ICFR determination was revenue recognition issues, which was followed by accounts receivable and other cash issues
– For management-only assessments, the most common internal control reason given to support a conclusion about ineffective ICFR was that accounting personnel within the company were not adequately trained, followed by a lack of personnel necessary to implement proper segregation of duties
– The most common accounting issue that triggered a conclusion about ineffective ICFR was accounts receivable and cash issues, although it was only identified and disclosed 69 times – the report notes that non-accelerated filers tend to disclose deficiencies absent an identified accounting error
Transcript: CFIUS After FIRRMA: Navigating the New Regime
Yesterday, the SEC issued a press release announcing that Corp Fin Director Bill Hinman intends to leave the SEC later this year. The range of rulemaking adopted under Director Hinman’s leadership has been impressive. As high-lighted in the press release:
The Division advanced nearly 50 mission-oriented initiatives during Director Hinman’s tenure, including efforts to modernize, streamline and improve public company disclosures, the proxy process and the securities offering framework. Mr. Hinman also guided the Division and the agency in addressing emerging issues and providing timely guidance to market participants. For example, Mr. Hinman led efforts regarding the rapid innovation in digital assets, including by providing a framework that market participants could use to evaluate whether digital assets are offered and sold as securities. In addition to these proactive engagement and modernization efforts, Mr. Hinman’s oversight of the Division’s core functions, including the disclosure review program, addressed a number of novel and complex issues leading to substantial benefits for investors.
SEC Chairman Jay Clayton released a statement commending Director Hinman for all that he’s accomplished at the agency during his tenure and thanked him for his sage advice.
Upon Director Hinman’s departure, Deputy Director Shelley Parratt will serve as Acting Director as she has done in previous transitions…
SEC Open Meeting: Harmonization of Private Offerings on the Agenda for Monday
Benjamin Franklin has been credited with many famous quotes, here’s one: “don’t put off until tomorrow what you can do today.” Keeping with that mantra, sort of, the SEC continued its forward march and scheduled an open meeting for Monday, November 2nd. The topic will be of interest to those that have been waiting for action on the proposed amendments to the private offering framework – we blogged about the proposal when it was announced back in March. Here’s an excerpt from the Sunshine Act Notice:
The Commission will consider whether to adopt rule amendments to facilitate capital formation and increase opportunities for investors by expanding access to capital for small and medium-sized businesses and entrepreneurs across the United States. Specifically, the Commission will consider whether to adopt rule amendments to simplify, harmonize, and improve certain aspects of the framework for exemptions from registration under the Securities Act of 1933 to promote capital formation while preserving or enhancing important investor protections and reducing complexities in the exempt offering framework that may impede access to investment opportunities for investors and access to capital for businesses and entrepreneurs.
Tomorrow’s Webcast: “Virtual Annual Meetings: What To Do Now”
Tune in tomorrow for our webcast – “Virtual Annual Meetings: What To Do Now” – to hear Amy Borrus of CII, Doug Chia of Soundboard Governance, Dorothy Flynn of Broadridge, Carl Hagberg Independent Inspector of Elections and Editor of The Shareholder Service Optimizer and Kate Kelly of Bristol-Meyers Squibb discuss baseline best practices for virtual shareholder meetings, investor views, getting remote technology in order, how to ensure your platform allows for shareholder entry & participation, virtual “rules of conduct”, voting & tabulation issues and contingency planning.
One open question from the Supreme Court’s Liu decision relates to determining “legitimate expenses” that must be deducted from disgorgement awards so the “net profits” can be distributed to victims. At a recent SEC Speaks conference, Enforcement Division Chief Counsel Joseph Brenner and Chief Litigation Counsel Bridget Fitzpatrick provided insight for those trying to understand what might constitute “legitimate expenses” in context of a disgorgement award. This McGuireWoods memo summarizes remarks from the conference, including these relating to determining legitimate expenses:
Chief Counsel Brenner noted that the Enforcement Division would be on the lookout for “expenses” that in its view were just wrongful gains under another name, such as expenses that furthered the scheme, or deductions for the defendant’s personal services to the fraudulent enterprise. If defense counsel believe there are legitimate expenses that should be deducted from a potential disgorgement amount, Chief Counsel Brenner recommended counsel to consider the following questions:
1. What makes the expense legitimate within Liu’s framework — in particular, did the expense provide actual value to investors, was the expense consistent with how investors understood their money would be used, or is the expense really just disguised profits?
2. If the expenses are legitimate, how closely were those expenses tied to the unlawful profits? Thus, the Enforcement Division may not view all “legitimate” expenses as deductible if they were in furtherance of the violation.
3. What is the right amount of the offset?
With respect to the third point, Chief Counsel Brenner stated that, in the Enforcement Division’s view, counsel must come prepared to demonstrate both the entitlement to a deduction for a legitimate expense and its amount. Based on practical experience gained since Liu, the Staff stated that counsel can make a more persuasive case for a reduction from the full amount of disgorgement by doing the work up front to support both the basis for the deductible legitimate expense and, critically, its amount. In the Staff’s view, it is not sufficient for counsel to claim it is too difficult or resource-intensive to quantify the expense, or to claim that the analysis supporting a request was work product that the Staff could not review.
NYSE Proposes Changes to Shareholder Approval Requirements for Certain Equity Issuances
In early October, the NYSE proposed changes to its rules on shareholder approval requirements relating to certain equity issuances set forth in Section 312.03 of the NYSE Listed Company Manual. In the proposed amendments, the NYSE notes that the changes would make the NYSE’s rules for cash sales to related parties substantively identical to those of Nasdaq. This Mayer Brown blog walks through the proposed amendments that would affect Section 312.03(b) and 312.03(c), here’s an excerpt:
The NYSE proposes to amend Section 312.03(b) to limit the class of related parties that would require shareholder approval. Section 312.03(b) as amended would require prior shareholder approval only for sales to directors, officers and substantial security holders and would no longer require approval for sales to such related party’s subsidiaries, affiliates or other persons closely related or to entities in which a related party has a substantial interest. Further, Section 312.03(b) as amended would no longer require shareholder approval of issuances of more than 5% of outstanding shares to a related party so long as they are issued at a minimum price. The NYSE proposes to require that any listed company obtain shareholder approval for a transaction in which a director, officer or substantial security holder has a 5% or greater interest (or such persons collectively have a 10% or greater interest) in the company or assets to be acquired or in the consideration to be paid in the transaction and the issuance of shares could result in an increase in outstanding shares of 5% or more.
With respect to Section 312.03(c), the NYSE proposes to replace the reference to “bona fide private financing” with “other financing in which the company is selling securities for cash.” This change would effectively eliminate the 5% limit for any single purchaser but retain the minimum price requirement.
Refreshing Governance Documents – Recent Trends
As companies start preparing now for the coming proxy season, a common to-do item involves reviewing governance documents for any potential updates. Many companies monitor peer companies for governance document changes and a recent Sullivan & Cromwell memo provides a good recap of recent trends in governance documents. The memo acknowledges that many companies have revised governance documents in response to Covid-19 to ensure they’re able to operate remotely.
Among other provisions, the memo discusses refreshment trends for advance notice bylaws, ESG oversight, and federal exclusive forum provisions. One area getting a lot of attention these days is board composition. As companies take steps to ensure governance documents are current and say the right things, the memo is a good reminder to make sure the governance provisions synch with your company’s actual practices. Here’s an excerpt about provisions relating to board leadership and evaluation guidelines:
Shareholders, institutional investors and proxy advisors are now calling for enhanced transparency around why a company’s independent board leadership structure is appropriate for the company. In response, many companies are providing more detail in their corporate governance guidelines regarding their processes for determining their leadership structures, the roles and responsibilities of their board leader(s) and their board evaluation practices.
Acknowledging several of the recent board diversity lawsuits, the memo notes that the plaintiffs’ complaints referenced statements that were included in corporate governance documents, including committee charters and proxy statements. The plaintiffs allege these disclosures do not accurately represent the companies’ practices. As more companies consider whether to provide enhanced transparency around their leadership structures and evaluation practices in their corporate governance guidelines and other governing documents, it is important to ensure that any disclosures remain consistent not only with the company’s other public disclosures, but also with the company’s actual practices.
Earlier this fall, Liz blogged about Corp Fin’s increased scrutiny of supply-chain finance arrangements. Last June, in Topic 9A Disclosure Guidance, Corp Fin called out supply-chain finance arrangements and now last week, this WSJ article reports that the FASB voted to add a project to its agenda to explore greater disclosure on the use of supply-chain finance arrangements. Cydney Posner posted a blog entry detailing some of the recent focus on supply-chain finance disclosure and suggests that companies engaged in this type of financing might want to take the opportunity now to revisit the adequacy of their disclosure.
The WSJ article says a joint letter from the Big Four accounting firms is what led to the FASB’s decision to work on the matter as more transparency could lead to a better understanding of a company’s financial position. It’s unclear exactly what additional disclosure would entail but today there are questions about whether the arrangements should be classified as debt or accounts payable and it’s generally understood that disclosure is lacking:
Board members during Wednesday’s meeting highlighted the growing use of supply-chain finance among companies as well as the lack of disclosure. Fewer than 5% of the nonfinancial companies that Moody’s Investors Service rates globally disclose supply-chain financing in their financial statements, the ratings firm said last year. Companies generally aren’t required currently to disclose that information.
One result could be requiring companies to add footnotes to their financial statements explaining the nature of the programs they use.
ISS’ Proposed Board Diversity Policy Change: Aggregated Data Won’t Cut It
The comment period for ISS’ policy changes closes at 5 pm Eastern Time today and when Liz blogged about the potential changes a couple of weeks ago, one U.S. change that has received a fair amount of attention is the proposed change relating to board diversity. Under that proposed policy, beginning in 2022, at companies where there are no identified racial or ethnically-diverse board members, the proposed U.S. policy will be to recommend voting against the chair of the nominating committee (or other relevant directors on a case-by-case basis). If the proposed policy is adopted, all companies in the Russell 3000 and S&P 1500 indexes would be subject to it.
As stated in ISS’ proposed policy changes document, as of Sept. 21, 2020, 1,260 of the Russell 3000 companies, 492 of the S&P 1500 and 71 of the S&P 500 do not have minority ethnic and/or racial board representation. The document also states that in 2021, ISS research reports will highlight boards that lack racially or ethnically diverse board members (or lack disclosure of such) to help investors identify companies they may want to engage with to foster dialogue on the topic. A recent AgendaWeek piece (subscription required) includes commentary from Marc Goldstein, head of U.S. research at ISS, that sheds more light on information ISS wants to see:
‘The real problem for us is when companies disclose diversity and then aggregate race, ethnicity and gender all together and say, for example, that ‘30% of our board is diverse,’ but then they don’t say what that means,’ says Goldstein. ‘We don’t consider that good enough.’
Instead, says Goldstein, ISS wants to see companies that haven’t provided specific disclosure to disclose what percentage of the board is composed of women, what percentage is racially diverse, and what percentage is ethnically diverse. ‘We want to see gender diversity separated out from racial and ethnic diversity. And obviously, there are other ways to define diversity too, including background, thought, nationality — lots of things. But we’re specifically interested in racial and ethnic diversity for the purposes of this policy.’
ISS expects to announce its final 2021 benchmark policy changes in the first half of November, so we’ll find out soon if the proxy advisory firm adopts this board diversity policy. In the event ISS adopts this policy change, given that ISS research reports will begin flagging companies for lack of disclosure in 2021, even companies that have historically included aggregated director diversity information in their proxy statements might want to consider updating their disclosure or prepare for potential questions from investors.
ISS to Expand QualityScore with FICO Cyber Risk Score
For more on ISS, the proxy advisory firm issued a press release late last week announcing it entered into an agreement to acquire FICO cyber risk score business. With FICO cyber risk score, ISS’ announcement says that institutional investors will be able to use cyber risk scores as part of ISS’ Governance QualityScore ratings in 2021 to evaluate portfolio company risk. ISS also says that it will integrate the cyber risk score into other product offerings such as ISS ESG ratings.
On June 15, 2020, we lost a valued friend, counselor, mentor, colleague, and legend of the securities bar when Marty Dunn was taken from us far too soon. Many people have expressed an interest in participating in a celebration of Marty’s life. Given the limitations on physical gatherings, a virtual celebration of Marty’s life will be held on Friday, October 16, 2020 at noon eastern time via Zoom. Speakers will share their memories of Marty, followed by an opportunity for the participants to pay their respects.
Please feel free to share this invitation, and we look forward to seeing you at the event. We ask that you not post information about how to access the meeting on social media or other public channels so that only those who wish to honor Marty will attend the event.
Please let Lillian Brown (Lillian.Brown@wilmerhale.com), Keir Gumbs (keir@uber.com), Scott Lesmes (slesmes@mofo.com) or David Lynn (dlynn@mofo.com) know if you are interested in attending and one of them will send you more information about the event.
If you would like to make a donation in honor of Marty’s memory, his family has asked that you support The Bail Project. More information about The Bail Project can be found at www.bailproject.org.
Insider Trading Enforcement: Effect of Supreme Court’s Liu Decision
Last summer, the U.S. Supreme Court’s decision in Liu v. SEC reaffirmed the SEC’s authority to seek disgorgement as an equitable remedy in enforcement actions. But, the Court placed limits on that authority. The Court’s decision said that courts must deduct “legitimate expenses” from disgorgement awards and an award must be distributed to the victims. Several questions were left open by the decision and this Davis Polk memo discusses the possible effect of Liu on insider trading cases when victims aren’t easy to identify and such distribution is basically infeasible.
The memo says it will take time before we fully understand the consequences of Liu but there are indications that when distribution of disgorgement awards is infeasible, the SEC may choose to forgo disgorgement and instead seek greater penalties:
The memo notes a recent speech by Director of Enforcement Stephanie Avakian in which she suggested the SEC might compensate for potential limitations on its disgorgement authority by seeking increased penalties.
Also, in recent weeks, the SEC has settled several insider trading cases without obtaining any disgorgement and, instead, imposed a penalty equivalent to two-times the wrongful gains/losses avoided. The SEC has taken this approach in both district court actions and administrative proceedings, even though the holding in Liu concerned only district court actions. We note, however, that the SEC is still seeking disgorgement in some insider trading actions filed post-Liu, most notably in U.S. v. Bohra, a district court action in which the SEC is seeking disgorgement of ill-gotten gains and civil penalties in a case concerning alleged trading in advance of earnings releases.
Convertible Debt Deal Trends: Deal Size Ticks Up in Q2
This Fenwick survey reviews terms of 100 convertible debt deals last year – it covers first-money and early- and late-stage bridge deals. The report covers the 15-month period, January 2019 – March 2020, and it also includes a comparison to Q2 2020 as an addendum. Here’s some of the high-lights:
– Compared to the prior year, deal size is down overall from $1.62 million to $1.58 million, although late stage deals are an exception
– Conversion discounts continue to be used frequently, even in late-stage debt issuances. Pairing conversion discounts with valuation caps are common in first-money issuance and less so in later-stage deals
– Only 12% of deals used a valuation cap as a standalone provision in the absence of a conversion discount
– In change-of-control situations, such as the sale of the company, most deals provide for a premium payout that’s a multiple on top of the repayment of the principal balance. When compared to last year, despite a decline in the number of deals giving a premium, the low end of the premium spectrum increased from 10% to 20%
– Data from Q2 2020 stood out compared to the prior period with noticeable skewing toward larger, later-stage deals. For Q2 2020 deals, interest rates were slightly higher, more deals used conversion discounts and less used valuation caps. In change-of-control situations, fewer of the Q2 2020 deals provided for a premium but more deals had an option to convert on a change-in-control