Earlier this year, the SEC prevailed on a “shadow trading” theory in SEC v. Panuwat. Although the outcome of that case was obviously fact-specific, many companies are considering the verdict as they continue to refine their insider trading policies & trainings.
Some folks were also holding out hope that the court would reconsider its verdict. Alas, it doesn’t appear that will happen, since the judge has now denied the defendant’s request for a new trial, which was premised in part on whether the jury should have been instructed that the SEC’s case was based on a new theory of liability. Bonnie Eslinger from Law360 recaps:
The relative rarity of the SEC enforcement action was not relevant to the jury’s determination, and framing it as such would have been prejudicial, Judge Orrick said. That’s why, he added, no one at trial was allowed to say the enforcement action as brought without fair notice, or characterize it as “unique,” “novel,” “highly unusual” or other such descriptors.
The SEC brought the case under a misappropriation theory of insider trading, not traditional insider trading, and the jury was told the difference, the judge said.
“That the jury found in the SEC’s favor is not a function of any prejudice arising from use of the term ‘insider trading’ throughout the trial, but rather a function of the jury finding that Panuwat misappropriated information for his own personal profit, in violation of the securities laws,” Judge Orrick wrote.
The former executive was fined $321k. The judge noted that the civil penalty would function as an appropriate deterrent to the defendant and others, and that the verdict wouldn’t “permanently damage his career” because it didn’t include a D&O bar.
The SEC Regulations Committee of the Center for Audit Quality recently posted these highlights from its June 2024 meeting with the SEC Staff. The discussion included this reminder about non-GAAP measures in earnings releases:
The Committee has observed recent staff comments on measures that are calculated in accordance with a company’s debt covenant indicating that a company should limit its discussion of these measures to the liquidity section of a filing (e.g., Form 10-K or Form 10-Q) and that these measures should not be discussed in a company’s earnings release.
The staff noted that it looks to Question 102.09 in the C&DIs on Non-GAAP Financial Measures which addresses the disclosures of material debt covenants. Disclosure of a covenant measure in an earnings release is not objectionable if it is clear that the information regarding the covenant is being presented only because it is material to the company’s financial condition or liquidity and is similar to the disclosure presented as part of the liquidity and capital resources section of the company’s MD&A.
However, if these disclosures appear to present the covenant measure as an indicator of performance rather than liquidity (e.g., highlighting it in the earnings release, comparing it to prior period results, and analyzing it like measures of the company’s performance), and that measure does not comply with the non-GAAP rules and regulations, the staff will comment and will likely object.
The meeting also covered:
– Staff feedback on cybersecurity annual disclosures (10-Ks) and incident reporting (8-Ks) since the new rules went into effect
– Regulation S-K C&DI 128D.18 – Stock and option awards subject to a dual vesting structure
– Applicability of S-X Rules 3-09, 4-08(g), 10-01(b)(1) and 8-03(b)(3) to investments accounted for under the Proportional Amortization Method
– Applicability of the non-GAAP rules to the presentation of more than one measure of a segment’s profit or loss
– Inventory Valuation Allowance
– Applicability of S-X Rule 3-01(c) [Rule 8-08, for SRCs] if the registrant has not been in existence for two full fiscal years preceding the most recently completed fiscal year
Don’t forget! Accelerated 13G reporting deadlines go into effect at the end of this month and will affect all categories of investors that use Schedule 13G to report their greater-than-5% beneficial ownership. Recent SEC comments show that the SEC is monitoring ownership filings. This Barnes & Thornburg memo summarizes how the rules are changing (also see this Skadden memo). Here are the key points:
1. Initial Filing Due Dates
– Qualified Institutional Investors (Rule 13d-1(b)(2)) – Within 45 calendar days after end of calendar quarter in which beneficial ownership exceeds 5% as of last day of such quarter; or within 5 business days after end of month in which beneficial ownership exceeds 10% as of last day of such month.
– Passive Investors (Rule 13d-1(c)) – Within 5 business days after acquiring more than 5% beneficial ownership.
– Exempt Investors (Rule 13d-1(d)) – Within 45 calendar days after end of calendar quarter in which beneficial ownership exceeds 5% as of last day of such quarter.
2. Interim Amendment Due Dates
– Qualified Institutional Investors (Rule 13d-2(c)) – Within 5 business days after end of month in which beneficial ownership exceeds 10% as of last day of such month; and thereafter, within 5 business days after end of month in which beneficial ownership increased or decreased by more than 5% of class as of last day of such month.
– Passive Investors (Rule 13d-2(d)) – Within 2 business days after acquiring more than 10% beneficial ownership; and thereafter, within 2 business days after increasing or decreasing beneficial ownership by more than 5% of class.
3. Quarterly Amendments for All Filers (Rule 13d-2(b)) – Due within 45 calendar days after end of calendar quarter if, as of the end of that calendar quarter, there are any material changes in the information reported in prior Schedule 13G.
For the quarterly amendments, the memo notes that if an investor that filed a Schedule 13G before September 30, 2024 concludes that a “material” change to its existing disclosure has occurred as of September 30, 2024, the investor will have to file a Schedule 13G amendment not later than November 14, 2024. While the SEC hasn’t expressly defined what will constitute a “material” change, it has pointed towards the “reasonable investor” test and Rule 13d-2(a) as instructive. Rule 13d-2(a) deems the acquisition or disposition of beneficial ownership of 1% or more of a covered class as a material change in the Schedule 13D amendment context.
The SEC’s Investor Advisory Committee is meeting a week from today – September 19th. According to the Sunshine Act notice, the agenda includes a panel discussion regarding key topics from securities litigation – including shareholder proposals & “tracing” in section 11 litigation. The meeting will be webcast on www.sec.gov and begins at 10 a.m. ET.
In addition, the SEC has announced 6 new members of the Investor Advisory Committee:
– George Georgiev, Associate Professor of Law, Emory Law School
– R. Craig Knocke, Principal, Turtle Creek Management
– Amy C. McGarrity, Chief Investment Officer/Chief Operating Officer, Colorado Public Employees’ Retirement Association
– Jennifer J. Schulp, Director of Financial Regulation Studies, Cato Institute’s Center for Monetary and Financial Alternatives
– Andrea Seidt, Ohio Securities Commissioner
– Alvin Velazquez, Associate Professor of Law, Indiana University Maurer School of Law
These new members are filling vacancies on the Committee and will join 17 current Committee members to serve a 4-year term. For those who threw their hat in the ring and didn’t make the team, the SEC says there’ll be another opportunity to apply in 2025.
Earlier this week, as part of an ongoing investigation that resulted in several settlements last year, the SEC announced settlements with 7 public companies that allegedly used employment, separation and other agreements that impeded whistleblowers from reporting potential misconduct to the SEC – in violation of Exchange Act Rule 21F-17(a). The companies agreed to pay penalties rainging from $19,500 to $1.4 million – and agreed to take steps to remediate the violations.
At 5-6 pages each, these latest orders are a pretty easy read and add to the body of knowledge that we have from prior enforcement actions. Here are a few things I noticed (also see this Cooley blog):
1. The Commission wasn’t aware of any instances in which the companies took action to enforce the provisions or in which the affected employees declined to speak with the SEC.
2. The SEC took issue with provisions where the employee waived their right to possible whistleblower awards – even though the provision didn’t prohibit the employee from communicating with the SEC and despite wording that the provision would apply only “to the maximum extent permitted by law.”
3. The SEC took issue with provisions that said individuals were free to disclose confidential information to government agencies, but with the caveats that the disclosure could not exceed the disclosure required by law, regulation or order, and that the individual provided written notice of any such order to a company officer in advance of making disclosure.
4. Some of the agreements were with contractors/consultants rather than employees.
5. The companies cooperated with the SEC after being contacted, by revising agreement templates and using reasonable efforts to notify affected employees that they were not limited from contacting the SEC or obtaining awards.
6. The Commission considered one company’s ability to continue as a going concern in determining the amount of the financial penalty.
For companies, there are also a couple of high-level takeaways from the SEC’s announcement:
1. Check your agreements & releases (again) – It’s time to revisit Meredith’s podcast about getting your existing & future agreements and policies in order (and this blog) – make sure to consult your in-house and/or outside employment law experts.
2. Consider your overall compliance & internal reporting environment – Remember that both the DOJ and the SEC are actively encouraging whistleblowers to contact government agencies and that once a whistleblower comes to light, you have to be very careful in taking any employment-related actions (in other words, make sure to talk to your employment counsel here too).
Important information if you’ve registered for our “Proxy Disclosure & 21st Annual Executive Compensation Conferences” – Be on the lookout for an email from “no-reply@events.ringcentral.com (our event platform). This email confirms your registration and contains your unique link to access the Conferences virtually, whether you are using that in real-time as a virtual attendee, or as an onsite resource for in-person attendance.
This link will also give you instant access to our Conferences platform once you have downloaded the RingCentral Events app (available for both iOS devices or Android devices). The conference app will include the live sessions, schedule, course materials, hotel maps and more! The app is also the best place to submit questions for speakers during sessions.
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A couple of weeks ago, Meredith shared thoughts on IPO readiness. An important part of the planning process for IPOs and other capital markets transactions is understanding when your financials will go stale. Luckily, Latham and KPMG have just released their handy “Desktop Staleness Calendar” for companies with December 31st FYEs. Issuers that have a different fiscal year end can use this calculator to find their dates. A couple of notes:
1. Remember that the staleness deadline is the close of business on the applicable date. That means your filing has to be accepted on EDGAR before 5:30 p.m. ET.
2. The cutoff date under PCAOB rules for comfort letter purposes may be earlier than the SEC’s cutoff date. PCAOB AS 6101 (paragraph 47) (which comes from SAS 74/PCAOB AU 634) permits accountants to give traditional negative assurance only up to 134 days after the end of the most recent period for which the accountant has performed an audit or review, although “pass through” comfort (procedures and findings comfort under PCAOB AS 6101) may still be an option. For a complete discussion of the “135-Day Rule” and the interplay with staleness of financial statements, see this Latham memo.
By a divided vote at its open meeting yesterday, the SEC approved the PCAOB’s new quality control standard, QC 1000 – A Firm’s System of Quality Control – and related amendments. Here’s the 85-page adopting release – and here’s an overview of what the new standard will require, from the SEC’s press release:
QC 1000, A Firm’s System of Quality Control, establishes an integrated, risk-based quality control standard that will require all registered public accounting firms to identify specific risks to their practice and design a quality control system that includes appropriate responses to guard against those risks. Registered firms that perform engagements under PCAOB standards will be required to implement and operate the QC system. The new quality control standard focuses on an audit firm’s accountability and continuous improvement of its audit practice and will require an annual evaluation of the firm’s QC system and related reporting to the PCAOB, certified by key firm personnel.
In addition, firms that annually issue audit reports for more than 100 issuers will be required to establish an external quality control function (EQCF) composed of one or more persons who can exercise independent judgment related to the firm’s QC system.
These new requirements will go into effect in December 2025. As Dave noted last week, QC 1000 replaces the existing AICPA standard that pre-dated the creation of the PCAOB.
The U.S. Chamber of Commerce had urged the SEC to reject QC 100, saying that the proposed requirement for an External Quality Control Function was “fundamentally flawed” and that the Standard would face “legal peril” in the absence of a full cost-benefit analysis. So, even though the adopting release does provide an economic analysis, we may see this standard challenged in court.
In his dissenting statement, Commissioner Uyeda took issue with the SEC’s process for approving the new standard, noting that the PCAOB had elaborated on the EQCF aspect of the standard in mid-August, which led to the SEC receiving new feedback within the past month. Meanwhile, the adopting release – and Commissioner Crenshaw’s supporting statement – position the rule as the culmination of a years-long initiative, which included a 2019 concept release and 2022 proposal. Whichever view you share, public companies are likely to experience both costs & benefits from the enhanced quality procedures that the standard will require.
The SEC has been busy with audit rules – in late August, it approved 3 important rule changes about auditors’ responsibilities, use of technology assisted data analysis in audits, and auditor liability.
Wow. As reported last week by Reuters, the SEC has moved to dismiss all active misconduct proceedings against accountants that had been pending before administrative law judges – 8 in total. This Jones Day memo gives more detail:
The Supreme Court recently held in SEC v. Jarkesy that the SEC’s in-house administrative proceedings violate the Seventh Amendment’s right to jury trial to the extent they adjudicate claims that are “legal in nature,” such as fraud charges and civil penalties. Jarkesy did not directly address, however, other kinds of enforcement actions the SEC historically adjudicates in-house, including proceedings under Rule 102(e) of the SEC Rules of Practice, which is the SEC’s primary tool for regulating the professionals appearing before it. Among other things, Rule 102(e) empowers the SEC to censure or bar professionals found to have engaged in “improper professional conduct,” which, for accountants, can include repeated violations of applicable professional standards. But Rule 102(e) proceedings can only be brought administratively.
The SEC seems now to believe that Jarkesy precludes litigating Rule 102(e) proceedings administratively. In August 2024, the SEC dismissed two contested Rule 102(e) proceedings against accountants who allegedly failed to conduct audits in accordance with professional standards. The SEC previously had moved to stay each case pending a decision in Jarkesy. Notably, while one of the cases involved a claim for civil penalties thus plainly implicating Jarkesy the other sought only remedial and cease-and-desist relief. It may also be significant that each accountant had sued the SEC in federal court to challenge its use of administrative proceedings.
Jones Day goes on to note that the SEC hasn’t publicly announced any policy against using ALJs for disciplinary proceedings. But the dismissal of all pending cases is a pretty big deal! It remains to be seen whether cases pending before the PCAOB will also be dropped. Interestingly, this move by the Enforcement Division came at the same time as the SEC approved PCAOB rule standards that lower the liability standard for individual auditors’ contributory liability (from recklessness to negligence) – which Commissioners Peirce and Uyeda opposed.
All of the recent actions on PCAOB rules had me wondering: what is going on with the NOCLAR proposal? Based on the PCAOB’s rulemaking page – which was last updated when the rule was proposed in June 2023 – the answer appears to be “not much.” At least, not publicly.
For now, a lot of folks are hoping that “no news is good news.” Compliance officers, executives, auditors and other concerned parties submitted nearly 200 unique comment letters – and the PCAOB received additional feedback via a roundtable in April. We’ll continue to watch for updates…
