It is important to remember that the SEC’s recent cybersecurity disclosure rulemaking did not supersede or replace all of the Staff and Commission guidance on cybersecurity disclosure, but rather augmented it. While the Commission’s February 2018 guidance regarding timely disclosure of cybersecurity incidents has now been clearly superseded by the adoption of new Item 1.05 of Form 8-K, the rest of the collective Staff and Commission guidance from CF Disclosure Guidance Topic No. 2 and Release No. 33-10459 continues to live on. As a result, when drafting your new risk management, strategy and governance disclosure for your upcoming Form 10-K, it also makes sense to go back and see how you have addressed the topic of cybersecurity in your business description, risk factors, MD&A, legal proceedings and financial statements and assess whether any tune-ups are necessary for your existing disclosure.
With regard to risk factor disclosure in particular, where most companies now have some discussion of cybersecurity risks, it may be necessary to align the disclosure in that section with the new risk management, strategy and governance disclosure when describing the threat environment that the company faces and the steps that the company takes to address those cybersecurity threats.
For more background on the overall disclosure expectations around cybersecurity, be sure to check out our “Cybersecurity” Practice Area. If you are not a member of TheCorporateCounsel.net, sign up today!
In its latest rulemaking focused on the operation of securities markets, last week the SEC proposed new Rule 6b-1 to address concerns with volume-based transaction pricing by the national securities exchanges. The SEC’s fact sheet for the rule proposals notes why the SEC believes that rulemaking action is appropriate now:
As self-regulatory organizations, exchanges are subject to unique principles and processes that do not apply to other businesses. Among other things, exchange rules, including transaction pricing schedules, may not be designed to permit unfair discrimination between brokers and may not impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. Through increasingly complex transaction pricing schedules, many exchanges offer their broker-dealer members lower fees or higher rebates as the number of shares the member executes on the exchange reaches successively higher predefined volume-based tiers. The large number of available pricing tiers, and the possible combinations of some tiers, make exchange transaction pricing schedules difficult to understand. Volume-based exchange transaction pricing raises competitive concerns among exchange members and among exchanges. Further, the desire to qualify for volume-based transaction pricing tiers exacerbates a conflict of interest between members and their customers when members route customers’ orders for execution because the member can economically benefit from its routing decision.
The proposed rule includes three main components:
1. A prohibition on volume-based exchange transaction pricing in connection with the execution of agency or riskless principal orders in NMS stocks;
2. A requirement that exchanges adopt rules, policies, and procedures to detect, deter, and facilitate compliance with the proposed agency-related volume prohibition; and
3. A requirement that exchanges disclose (in structured data format) on a monthly basis their volume-based transaction pricing tiers and the number of members that qualify for each.
The deadline for submission of public comments will be sixty days after the date of publication in the Federal Register.
It is hard to believe that preparations for the 2024 proxy season are already underway, and that means that we now must face the pay versus performance disclosure requirements yet again. I always like to point out that the process for new disclosure requirements is often an iterative one – we give it our best shot in the first year that the disclosure is required, and then we learn from what others have done and any guidance that the SEC provides to improve our disclosure in subsequent years. While consistency is an admirable quality for your SEC disclosures, it should not serve as a bar to making improvements when necessary.
Maybe it is just me, but I feel like our efforts toward complying with the pay versus performance disclosure requirements last proxy season were somewhat chaotic. The SEC did not give us a whole lot of time to get ready for the new disclosure requirements, although I am not too sure if more time would have helped all that much. The actual disclosure turned out to be pretty extensive, as compared to other disclosures related to executive compensation, and the valuation aspects turned out to be complex in some instances, adding to the overall burden. With all of that now behind us, we can now look to next proxy season’s disclosures with the wisdom of wizened veterans.
As Meredith recently noted in The Advisors’ Blog on CompensationStandards.com, the SEC Staff has been busy reviewing proxy statements from earlier this year to evaluate how we did with our first shot at pay versus performance disclosure. Overall, the critiques thus far have not been too bad. Compensation Advisory Partners released this summary of the first 16 comment letters. The comments focus on missing required disclosures and issues with calculating “compensation actually paid.” Here are the common topics noted in the memo, separated by disclosure issues and CAP calculation issues:
– Missing required elements of the disclosure, such as a description of the relationships between Compensation Actually Paid (CAP) and the metrics or the list of 3-7 financial performance measures used to link CAP with company performance;
– Including multiple Company-Selected Measures, or not including the Company-Selected Measure in the tabular list of 3-7 most important financial performance measures;
– Failing to provide a reconciliation of non-GAAP measures selected as the Company-Selected Measure (CSM) against GAAP financial statements;
– Using a TSR peer group that does not match either the industry group used for Regulation S-K in the 10-K performance graph or the compensation peer group disclosed in the CD&A; or
– Incorrect footnote descriptions to the table that suggest misinterpretation of the rules.
– Not including or not identifying all NEOs who served in each year in the table;
– Using partial compensation received for the year for individuals in the table (e.g., if an individual is promoted to a Named Executive Officer (NEO) role during the year, only including compensation earned for the period served as an NEO); and
– Footnotes indicating a “year over year” change in fair value for awards that should be valued as of the date of vesting, rather than at year end.
The memo then lists and summarizes each comment letter, ranked by the recipient company’s annual revenue.
Also, as I noted in the blog at the end of last month, the Staff issued nine new Regulation S-K Compliance and Disclosure Interpretations and updated one existing Regulation S-K Compliance and Disclosure Interpretation to provide guidance regarding the pay versus performance disclosure requirements.
Finally, I would like to point out the accumulation of knowledge that we have assembled in the “Pay-for-Performance” Practice Area on CompensationStandards.com, where we have posted the Treatise chapter on Item 402(v) of Regulation S-K along with many memos addressing the disclosure requirements and observations on the first round of disclosures. Armed with these resources, I hope that things will go smoothly with this next round of pay versus performance disclosures!
Speaking of complying with new disclosure requirements, I poured my heart and soul into the latest issue of The Corporate Executive, which has been sent to the printer. The latest issue is also available now online to members of TheCorporateCounsel.net who subscribe to the electronic format. The issue includes articles on:
– Getting Your Cybersecurity Disclosure Right: Our Annotated Sample
– Do Rule 10b5-1 Plans Still Make Sense?
– Generative AI: What Should You Be Thinking About Now?
Don’t miss out on the practical guidance that The Corporate Executive has to offer. Email sales@ccrcorp.com to subscribe to this essential resource.
On Wednesday, a panel of 5th Circuit judges rejected a challenge to Nasdaq’s board diversity rule. In Alliance for Fair Board Recruitment v. SEC, (5th. Cir.; 10/23), the Court was unpersuaded by the plaintiffs’ argument that the diversity rules violate the 1st and 14th Amendments to the U.S. Constitution and the SEC’s statutory obligations under the Exchange Act and the Administrative Procedure Act.
In order for the 1st & 14th Amendments to be implicated by Nasdaq’s rulemaking, the plaintiffs had to establish that the rules involved “state action.” The plaintiffs made two arguments in support of that position. The first was that Nasdaq was itself a governmental entity, and the second was that Nasdaq’s rules were attributable to the government, and that as a result constitutional constraints on its actions applied. As this excerpt from the opinion indicates, the Court wasn’t very impressed with the argument that Nasdaq should be regarded as a government entity:
Nasdaq is a private entity. It is a private limited liability company wholly owned by Nasdaq, Inc., a publicly traded corporation. Nasdaq’s board of directors is selected by its broker-dealer members and by Nasdaq, Inc., and companies wishing to list on Nasdaq do so by entering into contracts with Nasdaq. While Nasdaq must register with and is heavily regulated by the SEC, the Supreme Court has made clear that a private entity does not become a state actor merely by virtue of being regulated. “[T]he ‘being heavily regulated makes you a state actor’ theory of state action is entirely circular and would significantly endanger individual liberty and private enterprise.” Halleck, 139 S. Ct. at 1932.
The argument that Nasdaq’s rules were attributable to the government didn’t fare any better with the Court. It noted that in order for the actions of a regulated entity to be attributed to the government, there had to be a close nexus between the State and the challenged action. That nexus had been found to exist only in a few limited circumstances, “including, for example, (i) when the private entity performs a traditional, exclusive public function; (ii) when the government compels the private entity to take a particular action; or (iii) when the government acts jointly with the private entity.” The Court found that none of these circumstances were present in this case.
The Court also rejected claims that the SEC’s actions exceeded its authority under the Exchange Act and was arbitrary and capricious in approving Nasdaq’s diversity rule. One aspect of this part of the opinion that’s worth noting is that the Court specifically rejected a claim that the SEC lacked the authority to promulgate rules requiring disclosures that weren’t material to investors:
[A] disclosure rule can be “related to the purposes of [the Exchange Act],” 15 U.S.C. § 78f(b)(5), even if the SEC does not find that the disclosure rule is limited to information that would be “material” in the securities fraud context. The “fundamental purpose” of the Exchange Act is “implementing a philosophy of full disclosure,” Levinson, 485 U.S. at 230 (internal quotation marks and citation omitted)—not just the disclosure of information sufficient to state a securities fraud claim. Indeed, the Exchange Act gives the SEC “very broad discretion to promulgate rules governing corporate disclosure.”Nat. Res. Def. Council, Inc. v. SEC, 606 F.2d 1031, 1050 (D.C. Cir. 1979).
While the decision is a resounding win for Nasdaq and the SEC, it’s unlikely that this will be the last word on the case. As this Reuters article points out, the defendants drew a very favorable panel comprised entirely of Democratic appointed judges. If the plaintiffs appeal to the full 5th Circuit, the SEC & Nasdaq may well face a more hostile reception, because 12 of the 16 judges there were appointed by Republican presidents.
We’ve previously blogged about the Corporate Transparency Act, which requires non-exempt entities to disclose information about their beneficial owners to FinCEN. Well, the New York LLC Transparency Act, which is currently awaiting Gov. Hochul’s signature, could impose beneficial ownership disclosure obligations that go beyond those contemplated by the CTA. This excerpt from a BakerHostetler memo explains:
If it becomes law, the NYTA will require all LLCs formed or registered to do business in New York to disclose to the New York Department of State the same beneficial ownership information that such LLCs will need to disclose to the Financial Crimes Enforcement Network (FinCEN) under the CTA.
While both pieces of legislation have similar goals and impose similar disclosure obligations, they differ drastically in terms of the use and availability of the information submitted. Under the CTA, the beneficial ownership database is kept confidential and may be accessed only by law enforcement agencies and financial institutions in limited circumstances. But under the NYTA, the names and business addresses of the beneficial owners of LLCs will be made publicly available in a searchable database.
The New York Legislature passed this bill in June, and it’s been waiting on the Governor’s desk since then. The memo says that it is unclear whether she will sign it, but that if she vetoes it, the Legislature can override that action by a 2/3rds vote of both houses.
When I’m reduced to blogging about things like pending NY LLC transparency legislation, you know we’ve reached the end of a slow news week here at TheCorporateCounsel.net. Since that’s the case, I thought it might be fun to might close things out today by checking in with America’s most entrepreneurial hip-hop artists, The Wu-Tang Clan, to see whether they’re up to anything interesting on the business front.
That’s a dumb question to ask when it comes to The Wu-Tang Clan, because they’ve always got some interesting business deals going on. In recent years, the group’s entrepreneurial ventures have focused on digital assets, and I’ve blogged about things like Method Man’s NFT venture & Ghostface Killah’s ill-fated ICO deal. Now, however, it looks like the burgeoning legal cannabis market has caught the eye of at least a couple of Wu-Tang members.
According to this article, the Newark, NJ City Council has signed-off on Raekwon’s application to open a branch of his “Hashstoria” cannabis dispensary in the city, and Raekwon promises big things to potential customers:
When it’s complete, Hashstoria’s newest location in Newark will have “the finest greenery on the planet.” That’s the pledge from Raekwon, the Wu-Tang Clan rapper who is bringing a cannabis dispensary and smoking lounge to New Jersey’s largest city.
Raekwon previously posted a message on Instagram about the planning board’s approval of Hashstoria in Newark, saying that it will be a “culture-shifting endeavor” and it is “guaranteed to be the top tier consumption lounge / dispensary to hit the east coast period.”
Not to be outdone by his colleague, Method Man recently announced that his own cannabis-related venture would be expanding into New York State:
TICAL Official, the cannabis brand spearheaded by Wu-Tang Clan’s Method Man, has officially graced New York State’s adult-use cannabis shelves. Collaborating with Central Processors NY and Adirondack Hemp Company, the brand’s entrance into the market has been both highly anticipated and symbolically significant. Rapper, actor and entrepreneur, Method now hopes to bring a different kind of soothing relief with his TICAL Official cannabis brand to his home turf. The initial offering features Central Processors’s prerolls and edibles, with indications that the product line is set to expand over the subsequent months.
The potential upside of a vertical merger involving Method Man’s chronic brand and Raekwan’s smoke shops seem obvious enough to me that I expect that it won’t be too long before we add a conflict with FTC Chair Lina Khan & her antitrust enforcement team to the “Beefs” section of our “Wu-Tang Clan” Practice Area.
We’ve previously blogged about the split between the circuits over whether deficiencies in MD&A disclosures, standing alone, are sufficient to give rise to a private Rule 10b-5 claim & efforts to persuade the SCOTUS to address the issue. Late last month, the Court granted cert in Macquarie Infrastructure Corp. v. Moab Partners, L.P., a case from the 2nd Cir. where the ability to rely on non-compliance with Item 303’s requirements to state a securities fraud claim is front and center. This excerpt from Debevoise’s recent memo on the Court’s decision to review the case discusses what’s potentially at stake:
The Supreme Court’s decision could have a significant impact on private securities fraud litigation, should Item 303 omissions be allowed to serve as a basis for Section 10(b) liability. This change would enable plaintiffs to establish a duty to disclose when they otherwise may not be able to plead an omission case, potentially expanding Rule 10b-5 liability to more closely resemble Section 11 and 12(a)(2) liability for omissions of “a material fact required to be stated.”
Although expanding the private cause of action under Section 10(b) and Rule 10b-5 in this way could incentivize issuers to over-disclose in an effort to prevent costly shareholder suits, issuers are already subject to SEC review and enforcement action regarding omissions in MD&A, so the practical impact of the Supreme Court’s decision on issuer activity may be negligible.
However, if the Court determines that Item 303 violations can serve as a basis for Rule 10b-5 liability, the ruling may raise questions about whether other disclosure obligations under Regulation S-K should be afforded similar treatment. In light of the upcoming changes to Regulation S-K, including significant new requirements related to cybersecurity risk management and climate change disclosures, the Court’s decision in Macquarie could have broader implications for issuer liability.
The memo also provides background on the Macquarie litigation and reviews the divergent positions that the 9th Cir. and 2nd Cir. have taken on whether there is a private right of action for MD&A disclosure shortcomings, so it’s a great way to get up to speed on the issues before the SCOTUS.
A recent Audit Analytics blog discussed the results of its review of situations in which companies have repeatedly disclosed that their internal control over financial reporting, or ICFR, was ineffective. As this excerpt indicates, repeat negative ICFR assessments happen a lot more than you may have thought:
A repeat adverse disclosure is when a company that filed an adverse ICFR disclosure the prior year, files another for the current year. Over the 19-year period, we found that there were 4,892 companies that had at least one repeat adverse ICFR disclosure. Between 2004 – 2022, 3,636 companies filed between one and four repeat adverse disclosures each. On the other hand, 81 companies filed a repeat adverse disclosure between 13 and 16 times over the period.
The blog says that accounting documentation, policy and/or procedures was cited as a deficiency in 98% of repeated adverse disclosures between 2004 and 2022. Unspecified FASB/GAAP issues were the most common accounting issue, cited in 73% of repeated adverse disclosures. The blog goes on to identify the other commonly cited internal controls and accounting issues cited in repeated adverse disclosures.
Woodruff Sawyer recently published its annual D&O Market Update, which discusses the roller coaster ride that public companies have experienced when it comes to D&O insurance premiums over the past few years. The report notes that during the second half of 2021, 71% of public companies renewing the same year-over-year program experienced a price increase, while just a year later, 87% of public companies achieved a decrease in the cost of their renewal program.
Favorable market trends accelerated into the first half of 2023, and this excerpt suggests that in the short term at least, those favorable pricing trends will continue:
As we move into the second half of 2023 and look ahead to 2024 and beyond, 63% of underwriters predict that D&O rates will stay the same, with another 30% expecting that rates will continue to fall. Our own forecast is that public companies will continue to see savings—but on a more moderate basis—compared to the sizeable savings achieved in the second half of 2022 and so far in 2023.
The publication provides some color on the reasons for the significant price increases that D&O insurance buyers experienced during 2021 and the first half of 2022, and cautions that some underwriters are concerned that continued price decreases may lead to a “whipsaw” effect on premiums in a few years.
