May 17, 2023

SEC’s New Share Repurchase Rules Challenged

Last Friday, the U.S. Chamber of Commerce issued a press release that it has filed a lawsuit in the U.S. Court of Appeals for the Fifth Circuit challenging the SEC’s new Share Repurchase Disclosure Modernization rules:

The Chamber’s lawsuit challenges the SEC’s rule under the Administrative Procedure Act, as well as the U.S. Constitution. The agency’s mandatory disclosure requirements not only risk the public airing of important managerial decisions but also compel speech in violation of the First Amendment.

The Chamber worries that the rule will discourage buybacks and harm investors that benefit from them. As Dave blogged last week after the rules were adopted, the SEC acknowledged in the adopting release that repurchases, together with dividends, provide an avenue to return capital to shareholders and are often employed in a way that may be aligned with shareholder value maximization. And when Commissioner Peirce asked whether the Staff believed the level of buybacks was suboptimal, Corp Fin Director Erik Gerding responded that the release does not take a position but instead requires greater information to allow investors to do so. But, as Dave further notes, it seems the SEC still questions the motives behind repurchases and the “rationale here seems to be that the data dump of daily repurchase activity will facilitate speculative analysis as to the rationale for share repurchases based on the relative timing of those repurchases.”

Will this granular disclosure requirement discourage repurchases even though investors will still want them? I always think about how the plaintiffs’ bar will use new information, and I suspect any chilling effect on repurchases will depend on how that all plays out, as predicted in this Freshfields blog:

We also expect to see increased interest from the plaintiffs bar scrutinizing the issuer’s rationale for its share repurchases, the criteria used to determine the amount of repurchases as well as whether insiders can participate during the pendency of the repurchases, all information that was previously not readily available to the public.  Lastly, this information may be used by regulators—not just to determine compliance with these rules, but also as evidence of an issuer’s intent and views on the company and its valuation.

– Meredith Ervine

May 17, 2023

Private Companies: The SEC is Watching

With major corporate scandals involving private companies coming to light in recent years—from Theranos to FTX—it may not come as a surprise that the SEC seems poised to ramp up regulation and scrutiny to protect private investors in early-stage startup companies. This Perkins Coie alert advises that all privately held companies should be mindful of their representations to investors, sophisticated or not, given the following recent developments:

– The SEC’s April 2023 announcement of an action against the founder and CEO of a private startup company that was sold to a financial institution for $175 million based on alleged false and fabricated data concerning the number of customers

– Commissioner Crenshaw’s January 2023 speech at the 50th Annual Securities Regulation Institute where she called for increased disclosure and accountability for private companies that raise funds under the Rule 506 exemption

– SEC considering amending Form D

The alert goes on to suggest that private companies adopt some practices that are “par for the course” for public companies, including recruiting board members who will hold management accountable, creating a disclosure policy, keeping financial information up to date, and hiring independent technical experts.

Meredith Ervine

May 17, 2023

SEC Charges 10 Companies with Reg A Violations

Speaking of SEC scrutiny, yesterday the SEC announced that it has charged 10 microcap companies with failing to comply with Regulation A. As Liz recently blogged, Reg A offerings have increased in popularity after the JOBS Act but remain a lesser-used capital-raising alternative, possibly due to continued perception of high offering costs, no doubt driven by the number of hoops that companies still need to jump through under Reg A+. For any companies that have recently completed a Reg A offering or intend to in the future, these recent charges serve as an important reminder that the SEC is looking out for companies that circumvent the requirements or make fundamental changes after the offering statement has been qualified by the SEC:

According to the SEC’s orders, between December 2019 and May 2022, each of the 10 microcap companies obtained qualification from the SEC for their securities offerings using Regulation A, but they subsequently made one or more significant changes to their offerings without meeting the requirements of the exemption. The SEC’s orders found that such changes included improperly increasing the number of shares offered, improperly increasing or decreasing the price of shares offered, failing to file updated financial statements at least annually for ongoing offerings, engaging in prohibited at the market offerings, or engaging in prohibited delayed offerings. As a result, each of the microcap companies offered and sold securities in violation of the offering registration provisions.

Each of the 10 companies agreed to cease and desist from violations of Section 5 of the Securities Act and to pay civil penalties ranging from $5,000 to $90,000.

– Meredith Ervine

May 16, 2023

Material Weaknesses Trending Up

This report from PwC addresses a recent resurgence in material weaknesses with the number disclosed in 10-Ks increasing by 73% from 2021 to 2022 and 25% from the first quarter of 2022 to the first quarter of 2023. Here are some other statistics from the report:

– 62% of material weaknesses in 2022 are driven from smaller companies with revenue ranging from $100M – $500M. Contrary to this, there has been an improvement in the volume of material weaknesses for larger companies with revenue > $5B as material weaknesses have dropped 59% since 2020.

– 55% of material weaknesses reported relate to the following key areas:

  1. Financial close process, which includes a range of issues related to the timely gathering of data for use in the close process. It can also include issues with accounting policies and procedures that prevent timely, accurate or complete information from being reported.
  2. Personnel inadequacies and SOD issues, which relates to deficiencies in the number, training, qualifications, and conduct of resources. It also captures when issues associated with segregation of duties are raised.
  3. IT general controls, spanning the suite of controls across the IT domains (access to programs and data, computer operations, system change management, and system implementation). Deficiencies in IT general controls can be more pervasive in nature, and have a downstream impact on the reliability of business process controls or data.

The report attributes these trends to the following factors and suggests some key steps for remediation and prevention:

– Increase in IPOs and SPACs in recent years. Although IPOs and SPACs have recently slowed down, the effects of poor controls in transactions completed before 2022 can linger. These companies typically have fewer resources and a leaner operating model, which can result in weaknesses related to inadequate personnel, oversight and level of reviews. Forty-three percent of all US IPOs since 2017 disclosed at least one material weakness before going public. In addition to this, PwC’s research reveals that most de-SPAC companies are likely at greater risk for fraud within just two years of going public due to material weaknesses and internal control deficiencies in a number of key areas.

– Increase in digitization and technology investments. Companies often overlook risk mitigation measures and controls intended to address digital transformation initiatives such as cloud migration, greater automation, and increasing reliance on machine learning.

– Increase in turnover of resources. Whether related to restructuring efforts or resignations, there is often insufficient change management, transition, and transfer of knowledge to new control owners as turnover occurs.

Meredith Ervine

May 16, 2023

SEC Enforcement: Accounting Actions Up But Still Below Pre-Pandemic Levels

According to this recent Cornerstone Research report, SEC & PCAOB accounting and auditing enforcement actions increased by 55% in 2022 from 2021, but remained below pre-pandemic levels. Here’s an excerpt with some of the specifics:

Actions referring to announced restatements and/or material weaknesses in internal control climbed to the highest level in recent years, and actions involving alleged violations of Section 304 of the Sarbanes-Oxley Act of 2002 (the so-called “clawback” provision) increased sharply.

Total monetary settlements dropped substantially in FY 2022 due, in part, to the absence of any very large settlements (i.e., those over $1 billion). The SEC acknowledged that 24% of the 90 respondents who settled in FY 2022 offered cooperation and/or undertook remedial efforts, up from 20% in FY 2021.

The most common allegations in actions initiated in FY 2022 related to a company’s revenue recognition and internal control over financial reporting. One or both violations were alleged in 63% of FY 2022 actions.

Meredith Ervine

May 16, 2023

Sustainability-Linked Bonds: Structuring Issuances

Here’s a blog I wrote last week for our subscribers:

The market for sustainability-linked bonds has grown quickly in recent years, with issuances reaching $76.3 billion in 2022 according to Climate Bonds Initiative. The capital markets team at Mayer Brown recently released this insight providing practical considerations for documenting and structuring SLB issuances. For those new to sustainable finance, the article distinguishes SLBs from green bonds as follows:

SLBs are bonds where the financial and/or structural characteristics vary depending on whether or not predefined sustainability performance targets (“SPTs”), determined by reference to key sustainability performance indicators (“KPIs”), are met.

Unlike “green bonds”, there is no requirement that the proceeds be allocated to a sustainable project or purpose. The proceeds from an SLB may be used for general corporate purposes or, indeed, any other purpose.

The article goes on to review the following key points, specific to SLBs:

1. Align the SLB terms and conditions with the SLB framework
2. SLB specific risk factors and disclaimers
3. Redemption provisions
4. Failure to report need not be an event of default
5. Be clear with your recalculation language
6. Identify tax and accounting implications early on
7. Exercise caution with ECB eligibility
8. Seek to ensure credibility of KPIs, SPTs and implications of failing to hit SPTs
9. Manage your marketing material
10. Consider enhanced due diligence

It also notes that this is an evolving market and the Mayer Brown team is beginning to see other innovations that are presumably in early stages—including the increased use of “sustainability co-ordinator” mandate letters, step-down instruments and mechanisms linked to non-cash penalties, such as charitable donations and carbon credits.

For members, more information on SLBs and green bonds is available in our “Sustainable Finance/Bonds” subject area and in Lawrence’s book, Killing Sustainability (on the “Guidebooks” page).

– Meredith Ervine

May 15, 2023

Proposed 2023 DGCL Amendments Address Retail Voting Apathy

This recent alert from Richards Layton & Finger summarizes the 2023 proposed amendments to the DGCL expected to be considered by the General Assembly this year. As the alert describes, if adopted, the amendments would make a number of changes to Section 242, which governs procedures for amendments to a company’s certificate of incorporation:

Section 242 will be revised to (i) eliminate the need to obtain the default vote of stockholders for charter amendments effecting specified types of forward stock splits and associated increases in the authorized number of shares, and (ii) reduce the minimum stockholder vote required to authorize a charter amendment increasing or decreasing the authorized shares of a class, or effecting a reverse split of the shares of a class, in circumstances where the shares of such class are listed on a national securities exchange immediately before the amendment becomes effective and meet the listing requirements of such exchange after the amendment becomes effective.

You heard that right!  Here’s more:

New Section 242(d)(2) provides that a corporation may amend its certificate of incorporation to increase or decrease the authorized shares of a class of stock, or to effect a reverse stock split in respect of a class of stock, without obtaining the vote or votes otherwise required by Section 242(b) (i.e., at least a majority in voting power of the outstanding stock entitled to vote thereon) if (i) the shares subject to the reverse stock split are listed on a national exchange immediately before the amendment becomes effective and such corporation meets the listing requirement of such exchange relating to the minimum number of holders immediately after the amendment becomes effective, (ii) at a meeting of stockholders at which a vote is taken for and against the proposed amendment, the votes cast for the amendment exceed the votes cast against the amendment, and (iii) the amendment increases or decreases the number of shares of a class of stock that has not opted out of the class vote pursuant to the last sentence of Section 242(b)(2) (which sentence provides that an amendment to the certificate of incorporation to increase or decrease the authorized shares of a class, which would otherwise require a separate vote of the holders of the class, may be approved by the holders of the stock entitled to vote), the votes cast for the amendment by the holders of such class exceed the votes cast against the amendment by the holders of such class.

The proposed DGCL amendments would be a welcome development for Delaware companies with a large retail base to avoid any AMC-like legal Rummikub in the future!

Meredith Ervine

May 15, 2023

Chair Gensler Gives Dire Warning About Debt Ceiling

In his remarks before the International Swaps and Derivatives Association Annual Meeting on May 10, SEC Chair Gary Gensler gave his two cents on the debt ceiling, and I can’t say they’ll help me sleep better at night. Here’s what he said:

Before I close, I’d like to say a few words regarding the ongoing discussions in Washington around the debt ceiling.

While we at the SEC have no direct role in those discussions, the outcome is directly consequential to each part of our mission: protecting investors, facilitating capital formation, and maintaining fair, orderly, and efficient markets.

We’ve already seen an effect in the pricing and liquidity of short-dated Treasury bills and continue to monitor for any additional tremors.

If the U.S. Treasury as an issuer were actually to default, it would have very significant, hard to predict, and likely lasting effects on investors, issuers, and markets alike.

In a word, it would make the Cyclone Roller Coaster at the 1933 Chicago World’s Fair look like a kiddie ride.

Meredith Ervine

May 15, 2023

ISS E&S QualityScore—Change is Coming

Here’s a post I recently shared on our Proxy Season Blog for members of this site:

Since their launch, the ISS Environmental and Social (E&S) Disclosure QualityScores have been a source of heartburn for many companies. With their placement in ISS’s well-reviewed and highly-anticipated proxy reports, boards and management teams can’t help but focus on them, even in cases where other ESG ratings—like MSCI and Sustainalytics—may be used more by investors.

ISS recently announced that it plans a comprehensive update to the E&S Disclosure QualityScore scoring methodology in the third quarter. Here’s more info on what’s coming:

More than 150 factors will be revised for greater relevance, close to 50 factors retired, and more than 60 new factors will be added. These additions are driven by the expansion of current disclosure coverage and the addition of new material topics. As a result of this methodology update, the Environmental & Social Disclosure QualityScore will be supported by 360 comprehensive and refined factors. The update will also include a review of the model’s materiality assessment, comprising an adjustment of category and factor-specific weights to better capture the depth and the extent of disclosure. Issuers within the coverage universe will have an opportunity to verify the new data in July prior to which ISS ESG will provide more granular details on the nature and scope of the planned enhancement.

Meredith Ervine

May 12, 2023

Universal Proxy: Activist Success Story

It’s still too early to tell whether universal proxy is significantly changing the activism game, but it may at least be influencing smaller activists to move forward with campaigns. Here’s something that Meredith blogged yesterday on

Michael Levin recently shared another UPC development – the second activist success story:

An individual investor, Daniel Mangless, owns 2.3% of Zevra Therapeutics (ZVRA), since 2019. Other than a few Form 13Gs for ZVRA and one other holding, the preliminary proxy statement for ZVRA was his first-ever SEC filing and, it appears, activist project.

He rather quietly nominated three candidates for three available seats on the seven-person classified BoD. ZVRA nominated the three incumbents, including the CEO and a director first appointed in November 2022. He also proposed reversing any bylaw amendments from 2023, which the ZVRA BoD could have approved but not disclosed to shareholders.

At the ASM last week, all three challengers won by a significant margin over the three incumbents. The bylaw amendment reversal also prevailed by a similar margin.

What’s a significant margin? All three activists won 80% of the votes cast, with the bylaw proposal passing with 84% of the vote. So, while UPC may have helped encourage the activist, it doesn’t appear to have impacted the outcome:

Shareholders didn’t see the need to split votes among incumbent and activist candidates, one of the features of UPC. All three challengers each received approximately the same votes, as did the three incumbents.

The other notable feature of this campaign was the activist’s particularly low expenses, estimated at $250,000.

Liz Dunshee