Earlier this week, the SEC’s Small Business Capital Formation Advisory Committeeannounced the agenda for its meeting to be held next Tuesday. The Committee will discuss alternative approaches to private company financing, the Commission’s February 2022 proposal regarding private fund advisers, and the role of equity research for smaller public companies and investors. The meeting will be open to the public via webcast on www.sec.gov. The announcement notes:
The Committee, which provides advice and recommendations to the Commission on rules, regulations, and policy matters relating to small businesses, will start the morning session by exploring revenue-based financing and other alternatives to traditional bank or venture capital funding for smaller private companies. The Committee will finish the morning session by discussing the Commission’s proposed new rules and amendments related to the regulation of private fund advisors and hear from invited panelists about how the proposal may impact early-stage venture capital funds.
In the afternoon session, the Committee will examine the current availability of public company investment research prepared by broker-dealer firms, including what impact its availability has on liquidity for smaller public companies, how the analysis reaches investors, and the value of that research for investors. Panelists will share market data and insights with the Committee.
If you are interested in the work of the Small Business Capital Formation Advisory Committee, the period for nominations is now open. Last month, the SEC announced that it is seeking candidates for appointment to the Committee. To be considered timely, submissions must be received by February 17, 2023. The SEC notes that relevant experience may include: (i) representing emerging companies engaging in private and limited securities offerings or considering an initial public offering (IPO), professional advisors of such companies, and investors in such companies; (ii) service as an officer or director of minority-owned small businesses or women-owned small businesses; (iii) representing smaller public companies, the professional advisors of such companies, and the pre-IPO and post-IPO investors in such companies; and (iv) representing participants in the marketplace for the securities of emerging companies and smaller public companies.
During a panel yesterday featuring the Corp Fin Senior Staff, Erik Gerding, who has been named Director of Corp Fin effective February 3rd, noted that the Staff is planning to issue Compliance and Disclosure Interpretations on the pay versus performance disclosure requirements soon. While any Staff guidance will certainly be welcome on the new rules, the timing of the guidance may require many issuers to revisit disclosures that they have already drafted.
What types of topics might this guidance address? It is difficult to predict which topics ultimately may be addressed by the Staff in the CDIs, but some of the possibilities include:
– The potential use of the CD&A peer group for the TSR comparison, as I covered in the blog recently;
– How to determine which named executive officers are included in the average calculations, including “voluntary” named executive officers;
– Valuation approaches for options and performance-based equity awards when calculating compensation actually paid;
– Addressing equity awards that fail to vest but remain outstanding and situations where an executive departs and forfeits equity awards;
– Addressing modified equity awards in the compensation actually paid calculation;
– Applying the market capitalization weighting requirement when calculating peer group TSR;
– Addressing changes in peer groups over time;
– Dealing with unusual situations such as IPOs, spin-offs, mergers and acquisitions and bankruptcy when calculating peer group TSR;
– The time periods addressed by the required footnotes to the pay versus performance table;
– Disclosure required regarding assumptions for the pay versus performance table;
– Various issues with selecting measures for the tabular list and the Company Selected Measure;
– Presentation issues for newly public companies, merged companies and spun off companies; and
– Issues with presenting supplemental measures.
We understand that the Staff has been collecting a lot of questions on the pay versus performance disclosure requirements, so the Staff will no doubt have to be selective in which issues are ultimately addressed. Given the uncertainty as to when this guidance might be provided, it is advisable for issuers to keep moving forward with preparing the pay versus performance disclosure and then consider what adjustments may be necessary once the guidance is available.
At this year’s Securities Regulation Institute, I served as a moderator for a panel that focused on three areas of SEC rulemaking – the cybersecurity rule proposal, the share repurchase rule proposal and the new Rule 10b5-1 and insider trading disclosure rules. In talking about how to get ready for the adoption of the proposed cybersecurity disclosure rules – which the SEC has said could occur between now and April of this year – there are a number of things that companies can do now in anticipation of the new rules. Here is my list:
1. The SEC’s cybersecurity proposals are somewhat unique in that at least part of the proposed rules contemplate codifying existing interpretive guidance regarding real-time Form 8-K reporting of material cybersecurity incidents, so many companies often have a process already in place as part of their disclosure controls and procedures for escalating cybersecurity incidents within the organization so that disclosure decisions can be made.
2. As a result, companies can now look at those controls and procedures and evaluate how they might change when the SEC adopts the proposed rules. For example, companies often are focused on disclosure of single-time material cybersecurity events, while the final rules may require disclosure about a series of previously undisclosed individually immaterial cybersecurity incidents that become material in the aggregate.
3. An important tool for being able to make rapid judgments about whether a Form 8-K must be filed to disclose a material cybersecurity event is having a framework in place for how materiality will be evaluated, so companies should consider establishing that framework if they have not already done so. When significant cybersecurity events occur, they often do not neatly fit into specific categories and the ultimate impact of the events may be very hard to judge, so the framework is a way of articulating the specific factors that management will use when making the materiality determination.
4. It is also important to integrate the disclosures controls and procedures for disclosing material cybersecurity incidents with the company’s overall incident response plan, so that processes do not get “siloed” which could result in incidents being missed.
5. It is possible to work now on developing a workplan to obtain the information that will need to be disclosed in periodic reports.
6. With respect to governance and risk management around cybersecurity, it is not too early before the rules are adopted to consider potential changes to these matters. In many ways, the SEC’s disclosure rules around these topics seem to articulate expectations that the SEC has about the governance approach.
7. When working on a policy for escalating cybersecurity incidents for disclosure purposes, it is also appropriate to consider developing a policy for when cybersecurity incidents should be escalated to the board or a committee of the board, even when those cybersecurity incidents may not ultimately need to be disclosed in SEC filings.
8. It is not too early to think about disclosure regarding cybersecurity expertise and what current and potential board members bring to the board on this particular topic, so that the company can provide the disclosure that may be required by the new rules.
9. These rules will require a great deal of cooperation among different departments and individuals within the organization, so now is a good time to establish or strengthen those relationships.
1. The changes to Rule 10b5-1 adopted by the SEC are significant enough that companies now need to step back and consider how insiders should use Rule 10b5-1 going forward:
– Are Rule 10b5-1 plans with long cooling off periods and restrictions on overlapping plans too restrictive to be useful for some or all of the transactions that insiders regularly engage in?
– How will the brokers that insiders use for executing Rule 10b5-1 plans implement these rules, and will they allow the use of non-Rule 10b5-1 trading plans in some instances?
– If you have a policy that says all insider transactions must be conducted through Rule 10b5-1 plans, should you now revisit that policy given how Rule 10b5-1 has become more restrictive?
– Should the company encourage insiders to engage in transactions in the window period, rather than rely on Rule 10b5-1 transactions?
– Should you revise who are your Section 16 insiders in light of the increased transparency around Rule 10b5-1 plans?
2. Given the increased transparency around insider trading policies, it makes sense to review and update your insider trading policies now to make sure it is ready for “prime time.”
– Are your window periods appropriate, or are they too aggressive and might subject your company to scrutiny when they are made public?
– Are your preclearance procedures appropriate?
– Is the group that you subject to preclearance and window period procedures the right group?
– Do you need to revisit your approach to gifts of securities, in light of the SEC’s interpretive guidance indicating that gifts could, under certain circumstances, be treated as a trade or sale?
– What actually constitutes your policies and procedures relating to insider trading and are you comfortable with filings those materials as an exhibit to the Form 10-K?
3. Should you now consider putting in place a policy around the company’s repurchase of its own securities and dealing with material nonpublic information in light of the requirement to discuss whether such a policy exists?
4. The new disclosure required in Item 402 of Regulation S-K regarding the grant of options in an around the time of release of material nonpublic information is obviously disclosure that companies want to avoid. As a result, do you need to adopt or amend equity grant policies to ensure that you won’t have situations going forward where this disclosure would be required?
5. With respect to the SEC’s share repurchase disclosure rule proposal, a lot depends on how rapidly the SEC ends up requiring the disclosure of share repurchases.
– A one day reporting requirement would obviously create logistical difficulties, so it would make sense to try to “automate” the process as much as possible.
– A whole new series of disclosures controls and procedures will be necessary to ensure that accurate reporting is done in a timely manner.
– The decision will have to be made internally as to who “owns” this disclosure requirement, Legal or Treasury?
– Once the disclosure is required, there will need to be a coordinated effort because these disclosures could be potentially closely watched, and Treasury, Investor Relations and Legal will need to be prepared to respond to inquiries regarding the company’s share repurchase patterns.
The Corp Fin Staff published the latest update to the Division of Corporation Finance’s Financial Reporting Manual (affectionately known as the “FRM”), which is dated as of December 31, 2022. The FRM is the “go to” resource for so many things related to the presentation of financial statements and financial information, so it is always exciting to see the FRM get an extensive refresh.
The updated FRM has been revised to:
– Reflect amendments to Rules 3-10 and 3-16 and addition of new Rules 13-01 and 13-02 of Regulation S-X;
– Clarify the implementation date of ASU 2018-12, Financial Services – Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts for certain registration statements;
– Update the contact information for Corp Fin’s Office of Chief Accountant;
– Update the EGC revenue threshold based on the inflation-related adjustment announced in September 2022; and
– Remove certain outdated information, such as guidance on the adoption of ASC 606.
As the Staff notes in its disclaimer for the FRM, the manual was originally prepared by the Corp Fin Staff to serve as internal guidance, and in 2008, in an effort to increase transparency of informal Staff interpretations, Corp Fin posted a version of the FRM to its website. I can still remember carrying around my original hard copy FRM, which we always called the “Training Manual” back in the day. It was easily identifiable by the bright orange cover, which the PDF version retains to this day. The FRM includes critical interpretive nuggets and explanations that are always useful in your day-to-day practice.
While we are considering potential changes to corporate insider trading policies in the wake of the SEC’s recent Rule 10b5-1 amendments, the SEC will considering changes to its rules around employee trading in securities. Yesterday the SEC proposed amendments to its ethics rules to strengthen and modernize its ethics compliance program related to trading in securities. As noted in the SEC’s announcement:
The amendments, which are being proposed jointly with the Office of Government Ethics, would update the SEC’s Supplemental Ethics Rules, 5 CFR Part 4401.102, Supplemental Standards of Conduct for Members and Employees Securities and Exchange Commission. Specifically, if adopted, the amendments would:
– Expand the existing prohibited holdings restrictions to ban employees from investing in financial industry sector funds;
– Authorize the SEC to collect data on employees’ covered securities transactions and holdings directly from financial institutions through an automated electronic system; and
– Exempt diversified mutual funds from the Supplemental Ethics Rule’s requirements, given that they generally pose a low risk of conflicts of interest, misuse of nonpublic information for personal gain, or appearance problems. Mutual funds that concentrate investments in a particular sector, industry, business, state, or country other than the United States would remain subject to the rules.
In general, SEC employees are required to preclear securities transactions and comply with minimum holding periods. All employees are prohibited from, among other things, transacting in securities of companies the agency is investigating, engaging in short selling, transacting in derivatives, participating in initial public offerings for seven calendar days, or purchasing or carrying securities on margin.
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One of the disclosure requirements from the SEC’s recently adopted clawback rules is a set of new checkboxes for the cover page of the Form 10-K, Form 20-F and Form 40-F, with one of those checkboxes indicating whether the financial statements included in the report reflect the correction of an error to previously issued financial statements, and another checkbox indicating whether any of the error corrections require a recovery analysis under the company’s clawback policy. The text associated with those checkboxes is as follows:
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Question: The form amendments adding check boxes to the cover page of Form 10-K, Form 20-F, and Form 40-F indicating whether the form includes the correction of an error in previously issued financial statements and a related recovery analysis are effective January 27, 2023. However, the listing standards are not required to be effective until November 28, 2023 and issuers subject to such listing standards will not be required to adopt a recovery policy for 60 days following the date on which the applicable listing standards become effective. Will issuers be required to mark the check boxes in 2023 before an issuer is required to adopt a recovery policy and comply with the applicable listing standards?
Answer: In the adopting release, the Commission indicated that it does not expect compliance with the disclosure requirements until issuers are required to have a recovery policy under the applicable exchange listing standard. While the check boxes and other disclosure requirements will be in the rules and forms in 2023, we do not expect issuers to provide such disclosure until they are required to have a recovery policy under the applicable listing standard. [January 27, 2023]
This new Compliance and Disclosure Interpretation provides some much needed guidance just in the nick of time for filers who were trying to interpret the transition provisions for the clawback-related disclosure rules.
Under the SEC’s new clawback disclosure rules, in a situation when a company completes the financial restatement that triggered the company’s clawback policy, the company will be required to disclose certain details about the pending recovery of erroneously awarded compensation, including, for each current or former named executive officer, the amounts of incentive-based compensation that are subject to clawback that are still outstanding for more than 180 days since the date the company determined the recoverable amount.
In a series of Compliance and Disclosure Interpretations published on Friday, the Staff addressed how the term “named executive officer” is to be interpreted for foreign private issuers filing on Forms 20-F and 40-F, given that foreign private issuers do not provide disclosure under Item 402 of Regulation S-K, which includes the definition of “named executive officer.” Two of the representative Exchange Act Rules Compliance and Disclosure Interpretations are as follows:
Question 121H.02
Question: Which persons will be considered named executive officers for purposes of determining the parties for whom individualized disclosure pursuant to Item 6.F of Form 20-F must be provided? Answer: Item 6.F of Form 20-F provides for individualized disclosure for an issuer’s named executive officers. Foreign private issuers that file on domestic forms and provide executive compensation disclosure under Item 402 of Regulation S-K should provide individualized disclosure for their named executive officers to the extent required by Form 20-F. For foreign private issuers that use Form 20-F, individualized disclosure is required about members of their administrative, supervisory, or management bodies for whom the issuer otherwise provides individualized compensation disclosure in the filing. [January 27, 2023]
Question 121H.03
Question:Which persons will be considered named executive officers for purposes of determining the parties for whom individualized disclosure pursuant to Item B.(19) of Form 40-F must be provided?
Answer: Item B.(19) of Form 40-F provides for individualized disclosure for an issuer’s named executive officers. Such individualized disclosure is required about executive officers for whom the issuer otherwise provides individualized compensation disclosure in the filing. [January 27, 2023]
The Staff also published these same interpretations in Exchange Act Forms Compliance and Disclosure Interpretations Questions 110.08 and 112.03.
