When participating in the SEC Historical Society’s SOX anniversary program a few weeks ago, I was struck by one topic in particular – the changes to the SEC review process that SOX brought about. Section 408 of the Sarbanes-Oxley Act required that the SEC review every public company no less frequently than once of every three years, and that directive resulted in a significant expansion of Corp Fin and reinvention of the work of the Division in a way that lives with us to this day.
The events that led up to the enactment of the Sarbanes-Oxley Act principally involved accounting fraud, so Corp Fin inevitably became a very accounting-focused Division, with the review of public company filings becoming particularly focused on the financial statements and related disclosure. It was very interesting to hear Shelley Parratt and Alan Beller recount the Herculean efforts that were necessary to actually hire the right people to build out a reconstituted Corp Fin and to quickly stand up a review program that could meet the SOX directive.
Looking back, the ramped up SEC reviews of periodic reports really changed the relationship between public companies and the SEC, as the prospect for a comment letter significantly increased. At the same time, the enhanced review program and the enhanced disclosures in SOX’s wake meant that the SEC could adopt the Securities Offering Reform changes just a few years later, which I think everyone can agree has made things much easier when larger companies want to raise capital. It is all an important legacy that is useful to remember today now that SOX has turned 20 years old.
Last week, the SEC released a report to Congress that outlined the policy recommendations from the 41st Annual Government-Business Forum on Small Business Capital Formation that took place virtually on April 4-7. The SEC’s report provides a summary of the proceedings, as well as a series of recommendations for changes needed to the capital raising framework that were developed by the Forum participants and recommend by the Commission.
The wide-ranging policy recommendations highlighted in the report include the following:
Ensure capital-raising rules provide equitable access to capital for underrepresented founders and investors.
Support entrepreneurs who lack the technical assistance to understand how to access traditional capital.
Utilize technology and educational resources to help facilitate small business capital markets and decentralize and democratize capital markets.
In considering any changes to the private capital markets, ensure companies have viable pathways to access capital to allow growth and innovation.
Revise Regulation Crowdfunding to permit investment companies to conduct a Regulation Crowdfunding offering.
Expand the accredited investor definition to achieve greater diversity among startup investors and entrepreneurs.
Expand the accredited investor definition to include additional measures of sophistication.
Expand the accredited investor definition to include any person who invests not more than 10% of the greater of his/her annual income or net assets.
In considering changes that raise the wealth thresholds in the accredited investor definition, consider the unintended consequences on access to capital in under-resourced and underrepresented communities.
Finalize the Commission’s finders order.
Create a new private fund exemption to allow states to foster intrastate and regional funds focused on community-based investing that is open to non-accredited investors.
Increase the thresholds (number of investors and cap on fund size) allowed in 3(c)(1) funds to achieve greater diversity among startup investors and entrepreneurs.
Support underrepresented emerging fund managers—specifically minorities and women—building funds that diversify capital allocators, engage sophisticated investors, and challenge pattern-matching trends.
Increase the number of investors allowed in 3(c)(1) funds above 99 investors.
Support underrepresented and emerging fund managers and their investors through targeted resources, in collaboration with other federal agencies.
Modernize Section 17(b) of the Securities Act to warn against pump-and-dump schemes by requiring additional disclosure about paid stock promotion.
Consider the impact of the proposed environmental, social, or governance (ESG) regulations on small and medium-sized companies, including whether such requirements will discourage companies from going public.
Modernize regulation of transfer agents in response to technological and market advancements to increase disclosures made available to broker-dealers to facilitate liquidity for smaller public companies while continuing to protect investors.
Increase transparency around short selling activities and improve short sale data.
Collaborate with NSCC, DTCC, clearing firms, and broker-dealers to improve the clearing and settlement process for small public companies.
In the morning session, the Committee plans to discuss challenges and opportunities for small business capital formation as a result of current economic conditions. In the afternoon session the Committee will address secondary market liquidity issues faced by investors in companies that have raised money using Regulation A and Regulation Crowdfunding and whether there are changes that could facilitate increased secondary market liquidity for these investors. The Committee will also discuss secondary market liquidity challenges affecting smaller publicly-traded companies.
Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse recently published their latest report, Securities Class Action Filings—2022 Midyear Assessment. The report finds that the number of securities class-action filings remains steady in the first half of 2022, with plaintiffs filing 110 new securities class-action lawsuits in federal and state courts in the first half of 2022, which is on par with the 107 cases filed in the second half of 2021.
The report notes that new SPAC cases continue to be a dominant trend, with the 18 SPAC filings in the first half of 2022 indicating a pace that could exceed 2021’s all-time high of 33 filings. Cryptocurrency-related filings are also on pace to reach an all-time high.
Earlier this month, the SEC delighted proxy advisors and many investors by adopting amendments that – among other things – reversed two of the “new” conditions governing proxy voting advice that were adopted just two years ago and never made it into effect. The new 2022 amendments and the rescission of related guidance are slated to become effective this September 19th and apply during the upcoming proxy season.
Yesterday, the US Chamber of Commerce, the Business Roundtable and the Tennessee Chamber of Commerce & Industry announced that they had joined together as plaintiffs to file this complaint (in Tennessee district court) that accuses the SEC of not following proper procedures or providing adequate justification for the rollback under the Administrative Procedure Act. Here’s the relief they’re seeking:
– A declaratory judgment that the Amended Rule at issue in this lawsuit is arbitrary, capricious, or otherwise contrary to law within the meaning of the Administrative Procedure Act, see 5 U.S.C. § 706(A);
– An order vacating and setting aside the Amended Rule in its entirety pursuant to the Administrative Procedure Act, see 5 U.S.C. § 706(2);
– An order issuing all process necessary and appropriate to delay the effective date and implementation of the Amended Rule pending the conclusion of this case;
– An order setting aside Defendants’ suspension of the compliance date for the 2020 Rule;
– An order awarding Plaintiffs their reasonable costs, including attorneys’ fees, incurred in bringing this action; and
– Any other relief as the Court deems just and equitable.
The 2020 rules were the result of a long effort on the corporate side to bring more lead-time, transparency and accuracy to proxy advisor recommendations. The newly adopted amendments – while not a total surprise – confirm that predicting votes & correcting inaccuracies will remain very difficult for many corporate secretaries. Maybe even more difficult than when this rulemaking saga began, since ISS stopped providing draft reports to the S&P 500 in the wake of the 2020 rules.
For those keeping track at home, this is at least the third lawsuit relating to the rules – and boy has there been a lot of drama along the way. ISS sued the SEC in 2019 over guidance that foreshadowed the 2020 proposal – which was then stayed and then back on. Then, NAM sued the SEC when the SEC suspended the compliance date. The CII also jumped in along the way.
Update: An eagle-eyed member alerted me that NAM also filed another complaint last week, in Texas. So, this Chamber/BRT complaint is at least the FOURTH lawsuit these rules have drawn.
Last week, the SEC posted this order instituting proceedings on a proposed NYSE rule change to modify pricing limitations for securities listed on the Exchange via a primary direct listing. The proposal was filed back in April and the Commission had only received one comment when it instituted these proceedings, despite an extension of the consideration period. Here’s more detail:
The Exchange has proposed to modify the Price Range Limitation to provide that a Direct Listing Auction for a Primary Direct Floor Listing may be conducted if the Auction Price is outside of the price range established by the company in its effective registration statement (the Issuer Price Range) but is either (i) at or above the price that is 20% below the lowest price or at or below the price that is 20% above the highest price of the Issuer Price Range or (ii) above the price that is 20% above the highest price of the Issuer Price Range.
The NYSE believes that this pricing flexibility would make direct listings more attractive, and that investors would continue to be adequately protected. Companies would have to make certain public disclosures & certifications to the Exchange to be able to take advantage of the flexibility.
Although last week’s order doesn’t indicate that the Commission has reached any conclusions on the proposal, it starts the process for additional analysis & input and gives notice of the grounds of disapproval under consideration. Yesterday, the CII submitted this comment letter in response to the order and the specific questions raised therein. The CII opposes the rule change. In February, the SEC rejected a Nasdaq proposal on the same topic.
We’re sad to bid farewell this week to our friend & colleague Emily Sacks-Wilner, who is rejoining the Big Law ranks as a leader in securities practice management. During her tenure here, Emily has enhanced our team in every way and has kept our members front-of-mind every single day. She created our “cheat sheet” to keep everyone grounded during the SEC’s rulemaking deluge, spearheaded our virtual Women’s 100, diligently updated all of our handbooks (thousands of pages), and opened my eyes to what it’s like to be a “cat person” (in a good way!). Emily, we wish you continued success – we have been lucky to have you on our team!
Dave blogged last fall that the SEC paid out more whistleblower awards in fiscal 2021 than in all prior years combined since the whistleblower program began in 2011. While he noted that the trend in Europe was similar, what has continued to draw criticism here in the US is the lack of transparency around the circumstances of each award, and how the process even works. This new Bloomberg article shares findings from their 5-month pursuit & review of records obtained through a FOIA request and more than a dozen interviews. Here’s an excerpt that describes the screening process:
About 12,000 tips came in the last fiscal year. They first go through an internal screening process that is supposed to select only the best for full investigations, which can last five years.
A separate group of attorneys review the records once the investigation is completed and makes a decision on which whistleblowers get paid. The agency has 13 full-time and three temporary attorneys who determine how much each claimant should get. The SEC refused to provide more detailed information on how decisions are made.
It has rejected claims because applicants hadn’t followed program rules while approving claims under similar circumstances.
For example, the law says the program can only make awards to people who provide original information that leads directly to a sanctions of $1 million or more.
But in March the commission overruled staff and awarded about $14 million to someone who SEC lawyers ruled “was not a whistleblower within the meaning of the statute” and that the claimant’s information did not lead to the success of the investigation.
It disagreed with some staff conclusions, and wrote it was in the “public interest” to waive the 30-day requirement for filing. The whistleblower waited four years.
The program’s defenders argue that the screening process considers relevant facts & circumstances – which can lead to the appearance of inconsistencies. But the reporting leaves the overall impression that when it comes to winning a whistleblower award or having a successful whistleblower practice, the old adage applies: “it’s who you know, not what you know.”
This article underscores the need for companies to have robust whistleblower programs and procedures for handling whistleblower complaints. You don’t want an employee calling up one of the lawyers named in here! Visit the transcript from our February webcast – “Whistleblowers: Best Practices in the New Regime” – for practical guidance on effective programs, the board’s role, documentation, and more. It’s available along with lots of other resources in our “Whistleblowers” Practice Area.
In remarks yesterday to the Center for Audit Quality, SEC Chair Gary Gensler marked the 20-year anniversary of the Sarbanes-Oxley Act, as well as the Enron and WorldCom debacles that preceded it. Among other SOX-related initiatives that are still a work in progress, Chair Gensler’s speech highlights current PCAOB initiatives – e.g., updating almost all of its remaining interim standards – the ongoing importance of auditor independence, the recently reopened comment file on proposed clawback rules, CEO & CFO certifications, and the commitment to the Holding Foreign Companies Accountable Act of 2020.
The SOX/Enron/WorldCom era yielded wide-ranging and enduring lessons for auditors – but there were also plenty of takeaways for legal counsel. This blog from Bryan Cave Leighton & Paisner pulls out findings by the Examiner in the WorldCom bankruptcy and explains why they’re still relevant today. It’s worth reading the blog in it’s entirety – here’s the high-level guidance:
1. Remember when advising clients that attorney-client privilege can be waived or lost
2. Avoid fragmented reporting lines in law department
3. Ensure appropriate advice to board on fiduciary duties for material transactions
4. Confirm receipt of proper corporate approvals before executing material agreements
5. Build an appropriate record when directors act by written consent, and limit its use to appropriate circumstances
6. Apply independent judgment and consider yellow flags when clearing stock trades instead of deferring to management
Protiviti recently released its annual “Sarbanes-Oxley Compliance Survey,” which benchmarks companies’ compliance efforts, associated costs & hours, and the impact of current business conditions. This year’s survey says that SOX compliance hasn’t been immune to the Pandora’s Box of market disruptions we’ve experienced over the past two years. Twenty years in, the costs for many companies are still on the upswing – and the hours commitment continues to grow.
Here’s an excerpt with some of the key takeaways:
– Costs continue to climb due to a range of factors: A combination of internal and external factors creating volatility — technology-driven transformation and innovation, talent shortages, strategic pivots and more — is contributing to rising SOX compliance costs. More companies spend $2 million or more on compliance while fewer spend $500,000 or less. A surge in the number of smaller companies spending $2 million or more in SOX compliance costs likely reflects last year’s significant increase in initial public offerings (IPOs), driven by special
purpose acquisition companies (SPACs).
– Hours on the rise as well: A majority of organizations increased the number of hours logged for SOX compliance during their most recent fiscal year. This growth is driven by the same factors contributing to rising compliance costs. SOX compliance teams are also spending more time responding to higher volumes of more detailed information requests from external auditors, whose scrutiny is intensifying in response to actions of and guidance from the Public Company Accounting Oversight Board (PCAOB).
– A growing number of companies are deploying automation to support SOX work; more should follow suit: Automation platforms and applications bring greater efficiency to SOX compliance activities. The deployment of process mining, advanced analytics, robotic process automation (RPA) and continuous monitoring, along with other advanced technological tools, can significantly reduce the volume of manual compliance tasks as well as retention risks associated with subjecting internal full-time staff to heavy loads of repetitive, task-driven work.
– A widespread desire for efficiency is kindling interest in centers of excellence and alternate sourcing strategies: The ongoing goal to moderate SOX compliance cost increases makes alternative delivery models for SOX compliance services more appealing. In addition to investing in supporting automation, efficiency-minded compliance and internal audit leaders are evaluating and adopting internal shared services models as well as partnerships with third parties that operate external centers of excellence for controls testing.
Protiviti remains optimistic that automation and technology will eventually bring down (or at least slow the increase in) compliance costs. I don’t doubt that there’s been more adoption since I wrote about that same optimism three years ago, but at this juncture it seems like the improvements from automation have been outweighed by new complexities and challenges.
If you’ve been able to rein in your compliance costs and have words of wisdom for others who are looking to do the same, shoot me an email at liz@thecorporatecounsel.net. I would love to collect & share real-world pointers as we head into the even more demanding compliance environment that will accompany anticipated SEC rulemaking on climate & human capital disclosure.
