Yesterday, the SEC announced that it had adopted amendments to its ethics rules that govern the securities holdings and transactions of all agency employees, their spouses, and minor children. As one might expect, the SEC already had in place very robust ethics requirements around trading in securities by SEC personnel and related persons, which instilled in me to this day a reluctance to ever trade in any individual company stocks, even if permitted by my firm’s trading policy. The SEC describes its recent amendments as follows:
The amendments update the SEC’s Supplemental Ethics Rules, 5 CFR Part 4401.102, Supplemental Standards of Conduct for Members and Employees Securities and Exchange Commission.
Prohibitions Against Financial Industry Sector Funds
While the Commission has long prohibited employees from investing in stocks of entities directly regulated by the Commission, such as broker-dealers and investment advisers, the rule amendments expand the prohibited holdings restrictions to ban employees from investing in financial industry sector funds, as employee ownership of financial industry sector funds poses similar risks of conflicts of interest and appearance concerns.
Enhancements to Data Collection
The amendments permit employees to comply with existing reporting requirements by authorizing financial institutions to transmit data on their covered securities transactions and holdings directly to the SEC through an automated electronic system. This amendment is expected to enhance internal compliance controls by facilitating the detection and remediation of violations in real time, reducing burdensome manual processes for transaction confirmations and reporting, and providing an independently verifiable source for compliance monitoring and testing.
Optimizing Efficient and Effective Use of Agency Resources
Finally, the amendments facilitate the efficient and effective use of agency resources to monitor compliance of securities investments and transactions that involve significant ethics risks. Specifically, because diversified mutual funds generally pose a low risk of conflicts of interest, misuse of nonpublic information for personal gain, or appearance problems as compared to other types of securities, the rule amendments exempt diversified mutual funds from the Supplemental Ethics Rule’s requirements. However, mutual funds that concentrate investments in a particular sector, industry, business, state, or country other than the United States remain subject to the rules.
I would say the biggest takeaway for me from my years being subject to the SEC’s trading restrictions (and subsequent experience with law firm and public company insider trading policies) is that even the appearance of impropriety is often just as problematic as actually violating the law or a policy, so if it seems close to the line, just don’t do it. Some trade that is going to yield you a short-term gain is not worth jeopardizing your career or your freedom. Another thing that always sticks with me is the line “ethics is a team sport.” If you have questions, ask them, even if they seem obvious. Maintaining an open line of communication is always one of the most critical pieces of any effective compliance program, and that is most certainly the case in the securities trading context.
I recognize that, like me, you may now be numb to the shenanigans that are going on in Congress these days, but word this week that Republicans are expecting a government shutdown as noted in this Axios article has prompted concern that the SEC Staff could be furloughed as early as March 8, which is just two weeks away. By now, we should all know the drill – if you have matters pending with Corp Fin that may require the Staff’s attention two weeks from now (e.g., declaring a registration statement effective, clearing comments on a proxy statement or receiving no-action relief), you should contact the Staff as soon as possible to discuss the plan going forward. To this end, I shall incorporate by reference my blog from last September where I provided my top ten takeaways from the Staff’s updated government shutdown guidance. I will highlight one particular point that is relevant to this time of year – the Staff’s September 2023 government shutdown guidance specifically noted:
Will the Division provide a response to my Rule 14a-8 no-action request if I need to print my proxy materials during the shutdown?
No. The staff will not be able to review or respond to 14a-8 materials during a shutdown. We ask that companies and proponents work together to resolve questions to the best of their ability. It is important to note that the staff’s no-action responses to Rule 14a-8(j) submissions reflect only informal staff views.
The staff will return to reviewing no-action requests when our operating status changes.
Undoubtedly for those companies that have Rule 14a-8 no-action requests pending with the Staff that do not get answered in the next two weeks, some tough calls will have to be made in the event that the government gets shut down in early March as proxy mailing deadlines approach.
The SEC’s amendments to Rule 10b5-1 back at the end of 2022 spawned quite a few interpretive questions that are still being sorted out to this day. One of the areas that prompted questions is the scope of the exception to the limitation on overlapping open-market trading plans and the limitation on single-transaction trading plans that is provided for “eligible sell-to-cover” transactions. Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) defines an “eligible sell-to-cover” transaction as one where an agent is authorized to sell “only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award” where the employee does not otherwise exercise control over the timing of such sale.
Last summer, the ABA’s Joint Committee on Employee Benefits submitted a request for interpretive guidance to the Corp Fin Staff seeking clarification as to what actually qualifies as an “eligible sell-to-cover” transaction. There was a concern among practitioners that the language of the definition would limit the amount of securities to only the amount required to satisfy statutory minimum tax withholding rates, when some companies allow employees to designate a higher expected effective tax rate as the rate at which their employer will withhold taxes upon the vesting of a compensatory award. The group proposed the following interpretive Q&A to the Staff:
Question: Can a contract, instruction, or plan qualify as one providing for the sale of “only such securities as are necessary to satisfy tax withholding obligations arising exclusively from the vesting of a compensatory award,” and thus be an “eligible sell-to-cover transaction” under Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3), if it provides for the sale of shares at the rate identified by the employee as the employee’s expected effective tax rate, provided such rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates applicable to the employee, as permitted under tax and accounting rules?
Suggested Answer: An “eligible sell-to-cover” transaction under Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) means the sale of shares up to the tax rate designated by the employee for withholding, provided such rate does not exceed the aggregate of the maximum applicable federal, state, and local tax rates applicable to the employee, as permitted under tax and accounting rules.
In a memorandum to the members of the ABA Subcommittee on Employee Benefits, Executive Compensation, and Section 16 posted in our “Rule 10b5-1” Practice Area, Mark Borges, Alex Bahn and Ron Mueller describe their discussions with the Staff on this interpretive question, and note:
As a result of our informal discussion with the SEC Staff, we understand that the reference in Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3) to “only such securities as are necessary to satisfy tax withholding obligations” is not intended to mean only the number of shares required to satisfy minimum tax withholding requirements and that the rule is not intended to use technical tax language or to disrupt practice with respect to legitimate tax arrangements. Put another way, the focus of the SEC Staff appears to be on whether the arrangement is designed to pay the tax obligation arising in connection with the vesting event, which can take into account the expected effective tax rate and is not focused on only the required tax withholding rate. It appears the SEC Staff agrees with our proposed response and will interpret the provision to allow sales of shares to satisfy an employee’s expected effective tax rate. This interpretation, however, does not apply if any of the proceeds from the sale are intended to satisfy taxes relating to income from sources other than the vesting of a compensatory award. The SEC Staff thus cautioned that persons could not characterize a sale as an “eligible sell-to-cover” transaction where shares are sold with the intent of covering taxes for events unrelated to the vesting event. For example, selling shares in an “eligible sell-to-cover” transaction where the proceeds are intended in part to cover taxes for the sale of property other than the shares received in the vesting event would not be considered an “eligible sell-to-cover” transaction.
It is very helpful to know that the Staff is not reading the “eligible sell-to-cover” transaction exception so narrowly as to exclude the many situations where an expected effective tax rate is used to determine the amount of securities to be sold rather than the statutory minimum tax withholding rate, thus making this exception more useful to avoid running afoul of the overlapping plan and single trade restrictions.
The JCEB also asked the Staff whether a non-employee director can rely on the eligible sell-to-cover transaction exception even though a non-employee director is not subject to tax withholding obligations. The memorandum to the members of the ABA Subcommittee on Employee Benefits, Executive Compensation, and Section 16 posted in our “Rule 10b5-1” Practice Area notes:
Similarly, we understand that the SEC Staff will not object to a non-employee director establishing a similar contract, instruction, or plan as an “eligible sell-to-cover” transaction despite the fact that non-employee directors are not subject to tax withholding obligations. Again, if the non-employee director’s sale in this scenario is designed to cover the person’s withholding tax obligation arising exclusively from the vesting of a compensatory award, the same rationale would apply. Similar to employees, we believe the SEC Staff will not consider a non-employee director’s sale to qualify as an “eligible sell-to-cover” transaction if the sale is intended to also cover taxes that may be owed from sources of income other than the vesting event.
Question: May a non-employee director, for whom there is no tax withholding obligation, be permitted to sell shares on the same basis as an “eligible sell-to-cover” transaction applicable to employees?
Suggested Answer: A non-employee director’s contract, instruction, or plan providing only for the sale of shares in connection with the vesting of a compensatory award for the purpose of satisfying such individual’s expected effective tax rate arising from the vesting event will qualify as an “eligible sell-to-cover” transaction for purposes of Exchange Act Rule 10b5-1(c)(1)(ii)(D)(3).
This is also a helpful interpretation for utilizing the “eligible sell-to-cover” transaction exception going forward. You can find more on the numerous interpretive issues arising with the Rule 10b5-1 amendments in our “Rule 10b5-1” Practice Area and Q&A Forum.
We have posted the transcript for our recent webcast – “The Latest: Your Upcoming Proxy Disclosures,” during which I was joined by Mark Borges from Compensia and CompensationStandards.com, Alan Dye from Hogan Lovells and Section16.net and Ron Mueller from Gibson Dunn for our annual breakdown of all you need to know for the upcoming proxy season. The webcast covered the following topics:
1. Clawbacks
2. Pay vs. Performance Disclosures
3. CD&A Enhancements & Trends
4. Shareholder Proposals
5. Proxy Advisor & Investor Policy Updates
6. Perquisites Disclosure
7. ESG Metrics & Disclosures
8. Say-on-Pay & Equity Plan Trends, Showing “Responsiveness” to Low Votes
9. Status of Related Rulemaking
This webcast was a doozy – we spoke for over 90 minutes and covered quite a lot of ground, so you will definitely want to check this out as we enter the proxy season.
We are thrilled to announce our return to in-person conferences in 2024! Join us for these timely conferences taking place in San Francisco on October 14-15, 2024, or join us virtually.
The SEC’s regulatory agenda continues in 2024, but uncertainty abounds as we head into an election year. Make sure you are getting the practical guidance and expert knowledge you need (and expect!) from our conferences as rules, regulations and procedures continue to evolve. We will be posting the conference agendas and announcing the speakers soon, so stay tuned.
You can register now by one of two methods: by visiting our online store or by calling us at 800-737-1271. Sign up now for our early bird in person Single Attendee Price of $1,750, which is discounted from the regular $2,195 rate!
I am excited about this year’s return to in-person conferences in San Francisco, and I hope you are excited about it as well. It is hard to believe that we have been holding virtual-only conferences for four years now, and it seems like a lifetime ago when we were last in New Orleans in September 2019, where the sort of shenanigans depicted in the picture below were taking place. While I think we did an outstanding job in the intervening years delivering great content and practical guidance in a virtual format, there is truly no substitute for getting together with the community in person, where we have a chance to network and catch up with old friends. I hope you will take advantage of this great opportunity to get the band back together again later this year in San Francisco!
The SEC announced that the Small Business Capital Formation Advisory Committee will meet next Tuesday to discuss the accredited investor definition (again) and the state of the IPO market. The public can watch the live meeting via webcast on www.sec.gov. As the agenda for the meeting notes, after the opening and remarks and an update from SEC’s Office of the Advocate for Small Business Capital Formation, as a follow up to the Committee’s November 29, 2023 discussion, the Committee will deliberate possible recommendations related to the accredited investor definition. In the afternoon, following remarks from Allison Wise, Acting Director, SEC’s Office of Minority and Women Inclusion, the speakers plan share data and their views on the state of the IPO market, trends, and factors that may be at play in the decline in IPOs. As part of this discussion, the Committee will address how decreased IPO activity and market shifts are impacting smaller companies (including growth and exit strategies) and related capital raising challenges.
I don’t know about you, but I have been fielding my fair share of questions this reporting season regarding the SEC’s changes to the share repurchase disclosure rules that were vacated late last year by the United States Court of Appeals for the Fifth Circuit. I think the problem primarily stems from the fact that the rule text reflecting the amendments to Item 703 of Regulation S-K and other disclosure items is still reflected in a number of online resources, so unless you realize that those amendments have been vacated, it would appear that companies have to comply with the broader range of disclosure requirements contemplated by the amendments adopted last summer.
On December 19, 2023, the U.S. Court of Appeals for the Fifth Circuit issued an opinion in Chamber of Com. of the USA v. SEC, No. 23-60255 (5th Cir.) vacating the Share Repurchase Disclosure Modernization rule (the “Final Rule”). As a result of the vacatur, the disclosure requirements revert to those in effect prior to the Final Rule’s effective date.
Please direct any questions to the Division of Corporation Finance at (202) 551-3100.
I sure hope that the various online sources of SEC rules and forms get cleaned up over time so that this confusion does not persist past the current reporting season.
In my spare time, I have been working with the SEC Historical Society to create a gallery addressing the SEC’s regulation of corporate disclosure that will be located in the Society’s virtual museum and archive. As part of this effort, I recently had the good fortune to moderate a program covering the evolution of materiality, featuring an all-star panel of experts that included: Trevor Barton from Deloitte; Meredith Cross from WilmerHale; Dan Goelzer, former SEC General Counsel and PCAOB board member; Rich Levine from Whistleblower Advocates PLLC; and Joan McKown from Jones Day.
The panel covered a wide range of questions, including:
1. How does the concept of materiality continue to evolve and what is the role of the SEC in that evolution?
2. What are the considerations around the application of the “reasonable investor” and “total mix” and “probability/magnitude” standards?
3. What is the importance of materiality in SEC enforcement actions and private securities litigation?
4. How is materiality assessed from a financial statement perspective, including the impact of Staff’s guidance in SAB 99 on the consideration of materiality in financial reporting?
5. How does the concept of “what information is material to a reasonable investor” continue to evolve in areas beyond financial performance and business development, such as climate change, governance, cybersecurity and sustainability matters, and what are the implications?
I have always enjoyed exploring the history of the SEC. In my mind, it is difficult to provide good advice today if you do not understand where the laws, rules and standards have come from, and that is why it is so important for me to try to chronicle some of these key developments.
