With respect to AI disclosures, the Staff participating in the Corp Fin Workshop at “The SEC Speaks in 2024” said that 59% of annual reports filed by large accelerated filers made some mention of AI this year, up from 27% the prior year. Discussions were included in risk factors, the business section or MD&A, and 33% of filings included disclosures in both the business and risk factors sections. The Staff also identified the financial statements, disclosure controls and procedures and the board’s role in risk oversight as other areas where AI-related disclosures may be required under existing rules.
In considering what to address in AI disclosures, the Staff highlighted the following considerations:
– Whether use of AI exposes the company to additional operational or regulatory risks, including risks related to data privacy, discriminatory results or bias, IP, consumer protection, regulatory compliance and macroeconomic conditions
– Whether the company’s disclosure on its use and development of AI and material AI risks are tailored to its facts and circumstances
– Whether the company has support for its claims when disclosing AI opportunities
– Whether disclosure of the board’s role in AI oversight is warranted
– Whether investors would benefit from disclosure of the company’s use of any AI risk management framework—like NIST or any industry specific guidance (similar to cybersecurity disclosures)
– Whether the company faces risks related to the EU AI Act and whether current general disclosure, if any, should be more tailored to address how a company will be impacted based on its particular facts and circumstances
In a morning panel at “The SEC Speaks in 2024” featuring senior members of Corp Fin, Chief Counsel Michael P. Seaman discussed the Staff’s interpretation of the definition of “shell company” particularly in the context of reverse mergers and particularly where the public company allocates potential future profits of its legacy business (including any proceeds from the sale of that business) through the issuance of contingent value rights (CVRs) to existing pre-transaction shareholders. Where what is being sold is the opportunity for the private company to go public through a company with some cash but little else remaining because the business has been signed away with a CVR, the SEC Staff considers this a merger with a shell company with all the attendant consequences.
This Goodwin alert from January has more on this based on comment letters Corp Fin Staff has issued in the life sciences reverse merger context. It identifies these considerations from those comment letters:
– Does the combined company intend to continue any operations of the public company? Does the combined company intend to retain any of the public company’s employees for a meaningful period of time following the closing? Did the pre-closing public company stockholders receive a CVR entitling them to the value of legacy assets of the public company to be sold following the closing of the RM?
– The Staff did not provide specific guidance as to what would constitute more than “nominal other assets” to avoid being characterized as a shell company under its broadened interpretation of the Rule 12b-2 definition.
– The Staff indicated that accounting for a RM as a reverse recapitalization (as opposed to a reverse asset acquisition) is a strong indication that the public company should be viewed as a “shell company.”
The alert continues with some high-level implications of that status for both the combined company and the investors. At closing, the company will have to consider whether shell-company-related 8-K disclosure is required, and going forward, deal with the following, many of which Michael raised during the panel and recommended that folks reach out to the Office of Chief Counsel with questions.
– Delayed Form S-3 Eligibility: the post-merger combined company will not be Form S-3 eligible until 12 full calendar months after closing of the RM (e.g., similar to an IPO, the combined company needs “seasoning” through 12 calendar months of SEC reporting).
– Delayed Filing of Form S-8: the post-merger combined company will need to wait at least 60 calendar days post-closing of the RM to file a Form S-8 for any equity plans or awards.
– “Ineligible Issuer” Status: the post-merger combined company will be an ineligible issuer for three years following the closing of the RM (e.g., no free writing prospectus, no WKSI status despite public float, etc.).
– No Incorporation by Reference: although Form S-1 is available for offerings (including for a resale shelf registration statement), the post-merger combined company will be ineligible to use incorporation by reference until Form S-3 becomes available (e.g., manual updates will be required to keep a resale shelf prospectus current).
– No Rule 145(c) Securities on the Form S-1 Resale Shelf: investors who were affiliates of the private company and receive securities of the public company in the RM (i.e., Rule 145(c) securities) will be statutory underwriters with respect to resales of those securities and, as such, the Staff has indicated that such securities may not be included in the Form S-1 resale shelf and instead may be sold only in a fixed price offering in which such investors are named as underwriters in the prospectus.
– Rule 144(i)(2) Compliance: applies to all public resales of Rule 145(c) securities per Rule 145(d), as well as “restricted” or “control” securities of the issuer per Rule 144 (e.g., holders of restricted securities and any affiliates of the public company are also affected).
NAVEX recently announced the release of its 2024 Whistleblowing & Incident Management Benchmark Report. In 2023, internal reporting programs were used at record levels, and the substantiation rate (rate of reports found to be true) was at an all-time high at 45%. Those combined statistics gave me pause — but NAVEX says this is good news. “For those with trusted and effective internal reporting programs, this added up to greater visibility into the trends of risk, ethics and culture playing out in their organizations’ operations – real-time intelligence to inform business decision-making.” They also noted that more companies are taking action.
Highlighting the seriousness with which organizations are taking reports received, more substantiated reports (18%) resulted in separation from employment in 2023, up significantly from 14% in 2022 and 12% in 2021. The share of reports resulting in no action – effectively the opposite end of the outcome spectrum – fell from 17% in 2022 to 14% in 2023.
NAVEX reported information for employees versus third parties for the first time, and the results of this analysis may surprise you.
Third parties as a group delivered a far greater median share of reports related to Business Integrity matters than employees in 2023 (50% versus 17%). Encompassing topics like conflicts of interest, vendor issues, fraud, global trade and human rights, this category of issues can manifest in various elements of a supply chain.
Third-party reporters also showed twice the median share of Accounting, Auditing & Financial Reporting reports as employees in 2023 (10% versus 4.5%).
If you’re looking to assess your own reporting program, NAVEX notes that a “diverse array of topics, inquiries, and allegations in internal reporting” usually indicates that a company’s program is robust and “even minor efforts to promote internal reporting significantly improve the mix of report types received.”
In December, the WSJ reported that “557 stocks listed on U.S. exchanges were trading below $1 a share, up from fewer than a dozen in early 2021, according to Dow Jones Market Data. The majority of these stocks—464 of them—are listed on the Nasdaq Stock Market.” As John shared in December, the article attributed the increase to the SPAC market and Nasdaq’s grace period for compliance with the minimum bid price rule:
Many of today’s sub-$1 stocks went public in 2020 and 2021 during a boom in initial public offerings and deals with special-purpose acquisition companies. Mergers with SPACs were a popular way for startups to go public until a regulatory crackdown in 2021 slowed the SPAC craze. […]
Under Nasdaq rules, a company whose shares fall below $1 for 30 days gets a warning stating that it is noncompliant and has 180 days to get its share price back above the threshold. At the end of that period, many companies get an additional 180-day grace period if they say they are considering a reverse split or some other way to get back above $1.
Last August, Nasdaq filed a proposed rule with the SEC to establish listing standards related to notification and disclosure of reverse stock splits, citing the significant increase in reverse splits the exchange has seen in the last two years, often involving issuers trying to regain compliance with the minimum bid price requirement. The SEC approved that proposal in November.
Since all signs point to reverse stock splits remaining popular, and August 2023 DGCL amendments are also at play here, companies in this conundrum should check out this Honigman memo on reverse stock splits, which includes a post-shareholder approval implementation timeline with helpful reminders of all the third parties that need to be contacted or coordinated with in addition to Delaware and Nasdaq — like DTC, CUSIP Global Services and, of course, your transfer agent.
Keith Bishop recently shared thoughts on the application of state securities laws — specifically in California — to reverse stock splits.
Happy April! If you’re one of the many companies finalizing their proxy statements (including the beneficial ownership table) and turning to annual meeting preparation, check out this 2024 Annual Meeting Handbook from Broadridge covering the nuts and bolts of the annual meeting process & sharing helpful tips — like what documents Corporate Secretaries should have in their annual meeting binders.
We also have a great “Conduct of the Annual Meeting” webcast lined up for Thursday, April 11, from 2 to 3 pm Eastern. We’re excited to hear Peter Farah, Deputy General Counsel and Assistant Secretary, The J.M. Smucker Company, Carl Hagberg, Independent Inspector of Elections and Editor of The Shareholder Service Optimizer, William Kennedy, VP – Product, Broadridge Corporate Issuer Solutions, and Erick Rivero, Senior Assistant General Counsel, Intuit, provide practice pointers and discuss trends in meeting format & logistics, rules of conduct, and other matters companies will confront at their 2024 annual meetings.
After other jurisdictions, including the EU and California, adopted climate-related disclosure requirements, many in-scope companies stopped worrying quite as much about the looming specter of final SEC climate disclosure rules. It seemed like those jurisdictions were already requiring a heavy lift that could be leveraged for SEC reporting. And, as expected, when the final rules were adopted, they were significantly scaled back from the proposal. But now that we are almost a month out from adoption and companies and their advisors have further digested the 885-page adopting release, they recognize just how prescriptive some of the requirements are (in ways that may differ from other reporting regimes) and how many complicated materiality judgments will need to be built into the climate reporting process — not to mention the work that will be involved for DCPs and ICFR.
As John and others have suggested, companies facing multiple reporting regimes should be engaging in a scoping exercise to determine what requirements apply to their operations and comparing what they will need to disclose in each jurisdiction. To that end, Kristina Wyatt of Persefoni recently addressed this topic in our related webcast, and now the ESG and Sustainability Advisory team at Cooley prepared this resource identifying key differences between the EEU’s Corporate Sustainability Reporting Directive (CSRD), California’s three climate disclosure laws (Senate Bills 253 and 261 and Assembly Bill 1305), and International Financial Reporting Standards (IFRS) S1 and IFRS S2 (which legislation in numerous jurisdictions may mandate). The alert includes helpful tables comparing the requirements and the timelines of each.
As the alert describes, the patchwork will only get more complicated. Check out the map of corporate sustainability disclosure requirements in this HLS blog from the ISS team. While the SEC said in the adopting release that “jurisdictions have not yet integrated the ISSB standards into their climate-related disclosure rules,” Cooley says that additional complication is imminent:
The reporting landscape is likely to become increasingly complex, with numerous jurisdictions, including Australia, Hong Kong, Singapore and the United Kingdom, planning to adopt, or having already adopted, legislation to integrate the climate-related disclosure framework developed by the International Sustainability Standard Board (ISSB) – International Financial Reporting Standards (IFRS) S1 and IFRS S2 – into their corporate reporting.
Companies will need to assess how global regulatory developments impact their SEC disclosures related to transition risk and in other, more specific ways. Here’s an example from the alert:
In addition, on March 15, 2024, the EU’s Corporate Sustainability Due Diligence Directive (CSDDD) was approved by the Council of the EU. Subject to final approval by the European Parliament, expected in April, the CSDDD will become law and will apply to certain companies as early as 2027. For in-scope US companies, the CSDDD will generate additional climate-related obligations, including a mandatory requirement to adopt and put into effect a climate transition plan that aims to ensure, through best efforts, that their business models and strategies are compatible with the limiting of global warming to 1.5 °C. In addition to potentially impacting SEC climate target and transition plan disclosures, these CSDDD obligations may also impact how companies analyse climate risk and emissions materiality in future SEC disclosure.
As if the regulatory patchwork wasn’t complex enough, you can’t lose sight of investor demands, which the Cooley alert noted may drive further utilization of ISSB’s IFRS S-1 and S-2. You may also need to consider what tools investors use when assessing their own exposure to climate-related risk and how their investments in portfolio companies impact their risk exposure — even if you’re not using or disclosing how you use those tools. For example, ISS ESG, the sustainable investment arm of ISS STOXX, just announced last week that it’s expanding its suite of suite of Climate Solutions, which are intended to “help investors gain a better understanding of their exposure to climate-related risks and gain insights in managing their investment portfolios,” with a new Scenario Analysis Dataset.
The new dataset covers around 30,000 issuers. The outputs, such as Implied Temperature Rise or cross point year metrics, are based on the comparison of Scope 1, 2 and 3 emissions projections with sector- and region-specific pathways. The different approaches to emissions projections and the range of pathways contribute to an in-depth forward-looking analysis of climate-related risks and opportunities, at medium and long-term time horizons. For instance, ‘realized’ emissions and emissions projections that include issuers’ targets will allow investors to assess the level of ambition of, and progress towards, their own disclosed GHG reduction target.
Leading public climate pathways incorporated in the new Scenario Analysis Dataset include the International Energy Agency’s World Energy Outlook 2022 (IEA), The United Nations Environment Programme’s One Earth Climate Model (OECM) and the Network for Greening the Financial System (NGFS) Climate Scenarios Phase 3. The set also captures the Net Zero emissions by 2050 scenarios based on the Glasgow Financial Alliance for Net Zero (GFANZ) recommendations.
Companies that incorporate scenario analysis to assess the impact of climate-related risks or are considering doing so may want to dig deeper on the new Climate Scenario Analysis dataset to understand what information will be provided to ISS clients and how this may impact their portfolios.
Here’s something John shared last Friday on the DealLawyers.com blog:
The Chancery Court’s recent decisions in Crispo, Moelis, and Activision Blizzard have caused a lot of angst in the M&A community. Yesterday, the Delaware Bar took steps to calm the storm by recommending proposed amendments to the DGCL designed to address the uncertainty created by these decisions. Here’s an excerpt from this Richards Layton memo summarizing some of the proposed changes:
– Section 122, which enumerates express powers that a corporation may exercise, is being amended in response to the Delaware Court of Chancery’s opinion in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co., — A.3d —, 2024 WL 747180 (Del. Ch. Feb. 23, 2024), to provide that a corporation may enter into governance agreements with stockholders and beneficial owners where the corporation agrees, among other things, to restrict itself from taking action under circumstances specified in the contract, require contractually specified approvals before taking corporation action, and covenant that it or one or more persons or bodies (which persons or bodies may include the board or one or more current or future directors, stockholders or beneficial owners of stock) will take, or refrain from taking, contractually specified actions.
– New Section 147 is being added in light of the Delaware Court of Chancery’s opinion in Sjunde AP-Fonden v. Activision Blizzard, Inc., 2024 WL 863290 (Del. Ch. Feb. 29, 2024), to provide that, where the DGCL requires the board of directors to approve an agreement, document or other instrument, the board may approve the document in final form or substantially final form. The new section will also provide that, where the board has previously taken action to approve an agreement, document or other instrument that is required to be filed with the Delaware Secretary of State (or required to be referenced in a certificate so filed (e.g., a certificate of merger or certificate of amendment)), the board may ratify the agreement, document or other instrument before the instrument effecting the act becomes effective.
– New Section 261(a)(1) is being added in light of Crispo v. Musk, 304 A.3d 567 (Del. Ch. 2023), to provide, among other things, that a target company may include in a merger agreement a provision that allows the target to seek damages, including damages attributable to the stockholders’ loss of a premium, against a buyer that has failed to perform its obligations under the merger agreement, including any failure to cause the merger to be consummated.
– New Section 261(a)(2) is being added to provide that stockholders may, through the adoption of a merger agreement, appoint a person to act as stockholders’ representative to enforce the rights of stockholders in connection with a merger, including rights to payment of merger consideration or in respect of escrow or indemnification arrangements and settlements.
Other proposed amendments would address additional concerns raised by these decisions. In response to Activision, Section 232 of the DGCL would be amended to provide that any materials included with a notice to stockholders would be deemed to be part of that notice, and a new Section 268 would be added to address ministerial matters relating to the adoption of a merger agreement.
Yesterday, the SEC’s climate disclosure rules made it into the Federal Register. That means that the rules will be effective on May 28th (although compliance with the rules will not be required until the various dates specified in the rules for different types of information and issuers). The timing of this publication diminishes the risk that any change in Presidential Administration would result in the undoing of the rules. Rather, as Dave blogged last week and discussed in our webcast earlier this week, a resolution under the Congressional Review Act would be going to President Biden for review (and likely would be vetoed).
Of course, as everyone knows, this does not mean the rule is out of the woods. This Cooley blog details the latest twists & turns in the 8th Circuit litigation, which involve petitioners requesting a new administrative stay and the SEC submitting a request that the stay be denied, as well as reporting that a new petition was submitted in the 5th Circuit after the consolidation order was issued.
Companies, meanwhile, are gearing up for compliance. I shared a redline of the rule text in yesterday’s blog. I’ve now been alerted to a streamlined alternative that weighs in at a breezy 63 pages (it strips out the intro language for each rule). It also provides coloring for each type of edit – e.g., red for deletion, blue for addition, green for movement. The redline is an appendix to Holland & Knight’s client alert on the new rules. At this stage, we are all continuing to get our arms (and minds) wrapped around the new requirements, and you really cannot have too many resources to help with that. We are continuing to post memos in our “Climate Change” Practice Area!
Earlier this month, Meredith blogged about a federal district court case out of Alabama that held that the Corporate Transparency Act is unconstitutional. She also wrote about FinCEN’s statement in response to this holding – which said that the government will continue to enforce CTA requirements against everyone except the specific plaintiffs in this case – and she predicted that the DOJ would appeal.
Sure enough, the DOJ has filed this notice of appeal. We do not yet know when the 11th Circuit will hear this case, what the decision will be, and whether a ruling will be issued before December 31, 2024, which is the compliance deadline for entities formed before January 1, 2024. This Denton’s blog points out that FinCEN could seek a stay of the District Court’s ruling on top of its previously issued statement – which may help companies read the tea leaves of where the court ultimately will come down.
Remember that public companies need to conduct a compliance review despite appearing to have an exemption from this statute. And this King & Spalding memo says it’s too early to write off the CTA. It encourages everyone to keep marching ahead – at least with respect to conducting the compliance review and establishing processes.
