Since the SEC adopted final climate disclosure rules, one of the most consequential interpretive issues raised to date relates to Scope 3 emissions — even though the proposed requirement to disclose Scope 3 emissions was omitted in the final rules and the release explicitly states that “the disclosure of Scope 3 emissions in Commission filings will remain voluntary.”
The issue is this: Item 1504 of Regulation S-K requires a company with one or more targets or goals that materially affected or are reasonably likely to materially affect its business, results of operations, or financial condition to report any (no materiality qualifier) progress made toward meeting those disclosed targets and goals. Well, what if a company has set and is required to disclose a science-based, net zero, Scope 3-specific or other target that covers Scope 3 emissions (especially if a majority of the company’s emissions are Scope 3)? How does it disclose progress without disclosing Scope 3 emissions? And could it be misleading to omit them, particularly if other indicators of progress are inconsistent with a company’s progress on Scope 3?
There are a few footnotes in the release that are worth noting. Footnote 947 cites comment letters suggesting that Scope 3 should be required if it’s implicated by targets and goals or transition plans, and footnote 356 (on an unrelated topic) reminds companies of their obligations under Rule 408 and Rule 12b-20 — not to make materially misleading statements or omissions and “to provide such additional information as is necessary to keep their disclosures from being misleading.”
On the other hand, footnote 2494 may be read to suggest that the rule’s requirements related to targets, goals and transition plans are not intended to trigger emissions disclosure that is not otherwise required by Item 1505:
All registrants subject to the final rules, including SRCs and EGCs, are not required to disclose GHG emissions metrics other than as required by Item 1505, including where GHG emissions are included as part of a transition plan, target or goal.
There’s no clarity or consensus on this yet. Some law firm alerts point to language in the release and anticipate that the rule will not be interpreted to require Scope 3 disclosures. Others note that targets and goals that cover Scope 3 come with a risk that the SEC Staff may take the position that emissions disclosures will be required.
John previously shared CAQ’s criticism of the PCAOB’s roundtable addressing the NOCLAR proposal, specifically that “the roundtable failed to address the concerns outlined in 78% of the comment letters the PCAOB received, including from those investors, audit committee members, auditors, academics and others who are concerned with the PCAOB’s proposal.” This Troutman Pepper memo goes into more detail on the issues that were raised during the roundtable.
Having missed the roundtable myself since I was engrossed in the SEC’s open meeting at the time, I was happy to read that some of the issues raised by lawyers in the earlier comment period were at least touched on during the roundtable. Here are snippets on a few topics from the memo:
– During the roundtable, a divergence of opinions emerged on whether the proposal’s “could reasonably have a material effect” threshold is overly broad. Ironically, even among proponents of this threshold, there was no consensus on its meaning, with some equating it to a “reasonably possible” scenario and others to a “reasonably likely” one. This lack of clarity underscores the argument that the proposed language might be too ambiguous, potentially leading to inconsistent application across audits.
– Remarks by several panelists and commenters emphasized PCAOB’s lack of detailed cost analysis. For example, the proposal itself states the anticipated additional costs will be “substantial,” but fails to put forth any meaningful economic analysis demonstrating the impact of the added costs. For some, this absence of specificity in outlining the financial implications of compliance raises questions about the feasibility and reasonableness of the proposed standards. Several roundtable panelist and commenter insights further illuminated the tangible impact of these costs, particularly on Emerging Growth Companies and other smaller and newly-public companies, as well as smaller audit firms, who have borne the brunt of increased auditing costs as a result of recent SEC rulemaking.
– The roundtable discussion underscored the inherently fact-intensive nature of privilege analysis. This complexity necessitates that auditors, in their efforts to comply with the proposal, may need to navigate the delicate task of assessing the credibility of sources, such as legal counsel, without infringing upon protected communications. This is particularly challenging given the proposal’s perceived requirement for auditors to independently evaluate NOCLAR and make definitive conclusions regarding such noncompliance.
– A critical issue often discussed in comment letters and during the roundtable is that the proposed standard would require auditors to delve into complex regulatory matters without the necessary expertise. As Nasdaq stated in its comment letter, ”[t]he Proposal would require auditors to duplicate a significant amount of work already done by a company’s legal and compliance team.” The proposal thus raises questions about the value such duplication would bring to investor protection or financial statement accuracy. Nasdaq’s comment letter also aptly articulates this concern, stating, ”[a]uditors will need to develop or hire legal experts in every area of law in virtually every country and jurisdiction in the world in order to fulfill their duties under the Proposal.”
Keep in mind that the roundtable isn’t the only way the PCAOB sought additional feedback. It also reopened the comment period through March 18, 2024. I count 43 more comment letters submitted in March 2024 (preceded by 140 in 2023).
In late March, NYSE filed a proposal with the SEC seeking to amend NYSE rules and the Listed Company Manual to conform to the recent changes to Rule 15c6-1(a) to shorten the standard settlement cycle to T+1. The SEC issued its notice of filing and immediate effectiveness of the amendments early this week. The amendments relate to Rules 235 (Ex-Dividend, Ex-Rights) & 236 (Ex-Warrants) and the following sections of the Listed Company Manual: Section 204.12 (Dividends and Stock Distributions), Section 703.02 (Stock Split/Stock Rights/Stock Dividend Listing Process) and Section 703.03 (Short-Term Rights Offerings Relating to Listed Securities Listing Process).
NYSE’s filing describes the amendments, and I’ve excerpted a few descriptions below:
Under Dealings and Settlements, Delivery Dates on Exchange Contracts currently provides that a “Regular Way” contract for sale of securities is due on the second business day following the day of the contract. The Exchange proposes to delete the word “second” from this rule to reflect settlement on T+1, rather than T+2.
Current Rule 235 provides that transactions in stocks shall be ex-dividend or ex-rights on the business day preceding the record date fixed by the corporation or the date of the closing of transfer books. The Exchange proposes to delete the phrase “the business day preceding,” such that the rule would provide that these transactions would be ex-dividend or ex-rights on the record date. The current rule further provides that if the record date or closing of transfer books occurs upon a day other than a business day, Rule 235 shall apply for the second preceding business day. The Exchange proposes to delete the word “second” from this portion of the rule to conform to a T+1 settlement cycle.
Current Section 204.12 of the Listed Company Manual (Dividends and Stock Distributions) requires the Exchange to arrange for and give advance notice of changes in dealings in the stock to an “ex-dividend” basis, which is generally two business days prior to the record date. The Exchange proposes to amend Section 204.12 to provide that an “ex-dividend” basis would generally be on the record date to reflect a T+1 settlement cycle.
The operative date for the rule change is May 28, with the following specific implementation schedule:
Accordingly, the Exchange proposes that Wednesday, May 29, 2024 would be the first date to which the proposed rules described herein would apply (i.e., the first record date to which the new ex-dividend date rationale will be applied). During the implementation of the T+1 settlement cycle, the Exchange proposes that the ex-dividend dates will be as follows:
Record Date Ex-Dividend Date
May 24, 2024 May 23, 2024
May 28, 2024 May 24, 2024
May 29, 2024 May 29, 2024
A record date of Friday, May 24, 2024 would be a date prior to the effective date of the amendments to Rule 15c6-1(a) of the Act to shorten the standard settlement cycle for most broker-dealer transactions from T+2 to T+1.8 The rules described above would apply to this record date in their current form and, thus, the “ex-dividend date” would be the first business day preceding the record date or Thursday, May 23, 2024. Monday, May 27, 2024 is Memorial Day, which is an Exchange holiday; accordingly, there would be no record date on a holiday. A record date of Tuesday, May 28, 2024 would also fall under the Exchange’s current rules, and the first business day preceding such record date would be Friday, May 24, 2024. On Wednesday, May 29, 2024, the proposed rules described above would apply, such that, for the record date of May 29, 2024, the “exdividend date” would be the same business day.
Yesterday, during a well-staffed Corp Fin Workshop — the last panel of the day at “The SEC Speaks in 2024” — each participating Staff member discussed a key disclosure topic highlighting 2023 trends and comments and 2024 considerations. This is always a very useful conversation! (Keep in mind that all Staff comments are subject to the standard disclaimer that the views are the person’s own in their official capacity and not necessarily reflective of the views of the Commission, the Commissioners, or members of the Staff, and our summaries are based on our real-time notes.) Two buzz-worthy topics addressed in this year’s panel were disclosures under the final cyber rules and discussions of AI in SEC filings.
With respect to cyber incident disclosures, the Staff stressed that the disclosure of the incident’s impact should be qualitative in addition to quantitative — including when the related harm can’t be quantified. For example, to the extent material, disclosures should discuss the impact of any data theft and of the incident generally on the company’s reputation, competitiveness and customer or vendor relationships, even if those can’t be linked to bottom line numbers on a quarterly or annual basis.
The Staff also discussed the concept of “without unreasonable delay.” If you have regular protocols and procedures in place, including ones that layer in the materiality assessment for the incident, any change to those procedures that delays or is done to delay or postpone the materiality determination might constitute “unreasonable delay.” The Staff also noted that companies might not need to wait for the investigation or fact gathering to be complete to make a materiality determination, and instruction 2 contemplates that possibility by allowing unavailable information to be provided later by amendment.
One of the key themes from yesterday — from the Corp Fin Staff at least — was their focus on transparency through a multi-pronged approach to engaging with companies using one-to-one and one-to-many communications, including speaking engagements and participation in conferences. The Staff’s thoughtful, specific and timely commentary supported this IMHO, and the panels were publicly available to all.
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.
