Over on the Proxy Season Blog, Liz recently highlighted a topic that comes up time and time again at this time of year – what rules apply to the annual letter to shareholders that is typically included as part of the Form 10-K wrap for the Rule 14a-3 annual report?
The letter to shareholders is not required by any SEC rule – instead, I classify it in the category of “free writing” communications that become integral to the disclosure process even though the SEC has not mandated the disclosure. Unfortunately, because the letter to shareholders is not required by any SEC rule, sometimes people are lulled into thinking that no rules apply to the letter to shareholders, which obviously could not be further from the truth. In general, my advice is to treat the annual letter to shareholders just as you would any other investor communication that is not filed with the SEC but is nonetheless subject to certain SEC rules.
First off, the annual letter to shareholders often includes non-GAAP financial measures as a means of describing the company’s performance over the past year or over a series of years. As with any other public communication (whether or not the communication is filed with the SEC), any non-GAAP financial measure included in the annual letter to shareholders is subject to Regulation G, and therefore the non-GAAP financial measure must be accompanied by the most directly comparable GAAP measure and a reconciliation must be provided. The additional requirements applicable to non-GAAP measures in Item 10(e) of Regulation S-K (and pursuant to Item 2.02 of Form 8-K) do not apply (e.g., equal or greater prominence in the presentation of the GAAP measure, a description of the reasons why the non-GAAP measure is useful), but the more fundamental requirements of Regulation G do apply. Depending on the non-GAAP measure that is used, sometimes the Regulation G requirements can be met using the Form 10-K contents that are included with the annual shareholders letter to make up the annual report to shareholders required under the proxy rules. However, if the annual letter to shareholders is intended to stand apart from the rest of the annual report and will be posted on the company’s website on a standalone basis, then it would need to comply with Regulation G on its own. Further, I find that the annual letter to shareholders often includes different non-GAAP measures and/or covers more periods than what is addressed by the Item 10(e) disclosures that are included in the annual report itself.
Second, the annual letter to shareholders often includes forward-looking information about the company’s plans and prospects, and therefore it is important to make sure that those forward looking statements are protected under the PSLRA safe harbor. How this is done may depend again on whether the letter is intended as a standalone document or is integrated with the annual report, but in any event it is important to consider whether the particular forward looking statements are identified as such and meaningful cautionary language is provided regarding such forward looking statements.
Finally, just like any communication, the annual letter to shareholders is subject to the antifraud provisions of the federal securities laws, so you want to make sure that the statements in the letter are consistent with other disclosures that are provided by the company, and that the statements do not verge too far into “marketing speak” that could get the company in trouble down the road. I often observe that this is not only an annual letter to shareholders, but also an annual letter to plaintiffs’ lawyers, so tread carefully!
As we have covered in this blog over the past year, the SEC and the PCAOB have been implementing the Holding Foreign Companies Accountable Act, which amended the Sarbanes-Oxley Act to prohibit listing on US exchanges of foreign companies for which the PCAOB has been unable to inspect audit work papers. Just last month, the SEC began identifying companies that use auditors that the PCAOB is unable to inspect or investigate completely because of a position taken by an authority of a foreign jurisdiction where the firm is located. Legislation that remains pending in Congress would accelerate the three-year time horizon for delisting under the Act to two-years, if enacted.
In a first sign toward an easing of the stalemate with China over audit work papers, last week the China Securities Regulatory Commission circulated draft revisions to its rules that would relax the restrictions on access to certain information about issuers in China and is soliciting public opinion on the draft. In particular, the draft revisions would provide that overseas competent authorities may request to investigate, including to collect evidence for investigation purpose under a cross-border regulatory cooperation mechanism, although no further details have been provided at this time.
The PCAOB recently released its report titled 2021 Conversations with Audit Committee Chairs, which shares observations derived from conversation with 240 audit committee chairs of U.S. public companies during 2021 PCAOB inspections. This is the third year that the PCAOB has published the report, which covers a wide range of topics that were on the minds of the participating audit committee chairs.
Hot topics for audit committee chairs that are addressed in the report include the use of technology in auditing, ESG, COVID-19, discussions of risks, communications with auditors, auditor strengths and areas for improvement, PCAOB inspection reports and information outside of the financial statements.
• Background on Ceres
• The factors that prompted this latest guidance from Ceres
• Key suggestions from the Ceres guidance
• How the issue of climate risk governance will play out in the 2022 proxy season
Thanks for listening to the Deep Dive with Dave podcast!
Yesterday, Corp Fin’s Accounting Staff issued SAB No. 121, which addresses the accounting treatment of safeguarded digital assets held by crypto platforms on behalf of customers who trade those securities digital assets. SAB 121 reflects the Staff’s view that “obligations associated with these arrangements involve unique risks and uncertainties not present in arrangements to safeguard assets that are not crypto-assets, including technological, legal, and regulatory risks and uncertainties.” Accordingly, it issued SAB 121 to provide guidance on the proper accounting treatment of those assets. This excerpt lays out the Staff’s position:
Facts: Entity A’s business includes operating a platform that allows its users to transact in crypto-assets. Entity A also provides a service where it will safeguard the platform users’ crypto-assets, including maintaining the cryptographic key information necessary to access the crypto-assets. Entity A also maintains internal recordkeeping of the amount of crypto-assets held for the benefit of each platform user. Entity A secures these crypto-assets and protects them from loss or theft, and any failure to do so exposes Entity A to significant risks, including a risk of financial loss. The platform users have the right to request that Entity A transact in the crypto-asset on the user’s behalf (e.g., to sell the crypto-asset and provide the user with the fiat currency (cash) proceeds associated with the sale) or to transfer the crypto-asset to a digital wallet for which Entity A does not maintain the cryptographic key information. However, execution and settlement of transactions involving the platform users’ crypto-assets may depend on actions taken by Entity A.
Question 1: How should Entity A account for its obligations to safeguard crypto-assets held for platform users?
Interpretive Response: The ability of Entity A’s platform users to obtain future benefits from crypto-assets in digital wallets where Entity A holds the cryptographic key information is dependent on the actions of Entity A to safeguard the assets. Those actions include securing the crypto-assets and the associated cryptographic key information and protecting them from loss, theft, or other misuse. The technological mechanisms supporting how crypto-assets are issued, held, or transferred, as well as legal uncertainties regarding holding crypto-assets for others, create significant increased risks to Entity A, including an increased risk of financial loss. Accordingly, as long as Entity A is responsible for safeguarding the crypto-assets held for its platform users, including maintaining the cryptographic key information necessary to access the crypto-assets, the staff believes that Entity A should present a liability on its balance sheet to reflect its obligation to safeguard the crypto-assets held for its platform users.
As Entity A’s loss exposure is based on the significant risks associated with safeguarding the crypto-assets held for its platform users, the staff believes it would be appropriate to measure this safeguarding liability at initial recognition and each reporting date at the fair value of the crypto-assets that Entity A is responsible for holding for its platform users. The staff also believes it would be appropriate for Entity A to recognize an asset at the same time that it recognizes the safeguarding liability, measured at initial recognition and each reporting date at the fair value of the crypto-assets held for its platform users.
SAB 121 also provides guidance on the disclosures with respect to these arrangements that would be required in the footnotes to the platform’s financial statements, and also points out that “disclosures regarding the significant risks and uncertainties associated with the entity holding crypto-assets for its platform users may also be required outside the financial statements under existing Commission rules, such as in the description of business, risk factors, or management’s discussion and analysis of financial condition and results of operation.”
In what’s become a tradition when it comes to SEC actions touching on crypto, the redoubtable crypto-evangelist Commissioner Hester Peirce (aka Crypto Mom) issued a statement expressing her displeasure with the decision to issue this guidance.
A recent article by Bloomberg Law’s Preston Brewer says that recent federal legislation banning mandatory arbitration claims in employment contracts may prompt more public companies to disclose information about these claims. This excerpt explains why that might be the case:
The new law puts a stop to the forced diversion of sexual harassment claims away from the courts. Companies will thus have to grapple with the uncertainty of potentially large judgments, including punitive damages. These potential scenarios will likely convince more and more public companies to describe the sexual harassment risk to their businesses in their SEC filings.
From a securities regulation perspective, the core determinant as to what a registered company should publicly disclose is whether the information would be material to an investor trying to make an informed investment decision. The greater the potential risk to the company, the more likely that such information needs to be disclosed in its SEC filings. The tension between this legal obligation and a company’s desire to present a positive public image is sure to increase.
Although the nature of this risk will vary from company to company, the risk isn’t simply the monetary costs of defending and paying settlements or judgments. A company may face significant reputational risks that can impair its brand and the company’s market value. Management may be distracted while defending against claims, thereby harming the business, and the greater public exposure of these court-litigated allegations (as opposed to closed-door arbitration) increases the risk that companies will lose key personnel who may be difficult to replace.
The article discusses the need for public companies to tailor risk factors to address this risk and notes out that industries with a track record of sexual harassment claims, such as tech, entertainment, & finance, may be more affected by the legislation than those in other industries.
We’ve blogged on several occasions about the phenomenon of “remote-first” public companies that claim to have no physical address. According to this Goodwin blog, however, the Staff has had its fill of these filings:
Numerous public companies have declared themselves a “remote-only” or “remote-first” company. Recently, we learned that the SEC Staff will not declare a registration statement effective unless the company provides a physical address on the cover page of its registration statement in response to the requirement to disclose the address of its principal executive offices. Based on our review of SEC comment letters, we think the Staff’s position is a result of various rules that require certain communications to be sent to a company’s principal executive offices, including Rules 14a-8 and 14d-3(a)(2)(i).
We understand that it is acceptable to the SEC Staff for a “remote-only” or “remote-first” company to provide a P.O. Box to meet the physical address requirement. We have also seen a company provide in response to an SEC Staff Comment that any stockholder communication required to be sent to its principal executive offices may be directed to its agent for service of process and such company had its related registration statement declared effective.
With apologies to all denizens of the metaverse, I have always thought this was a ridiculous position to take and I applaud the Staff’s decision. Frankly, the thing that’s surprised me most about the emergence of these allegedly homeless public companies is that the Corp Fin Staff has, at least until now, been willing to put up with this nonsense. If you enjoyed this curmudgeonly blog, stay tuned – I plan to address “you kids and your darn rock ‘n roll music” in an upcoming post. Also, get off my lawn.
Yesterday, the SEC announced rule proposals intended to enhance disclosure and investor protection in SPAC initial public offerings and in de-SPAC transactions. Here’s the 372-page proposing release & here’s the 3-page fact sheet. The SEC is pitching the proposal as a way to level the playing field between SPACs & traditional IPOs, which SEC Chair Gary Gensler emphasized in his statement on the proposal. This excerpt from the fact sheet summarizes the additional disclosure & investor protections for SPAC IPOs & de-SPACs that would be put in place under the proposed rules:
– Enhanced disclosures regarding, among other things, SPAC sponsors, conflicts of interest, and dilution;
– Additional disclosures on de-SPAC transactions, including with respect to the fairness of the transactions to the SPAC investors;
– A requirement that the private operating company would be a co-registrant when a SPAC files a registration statement on Form S-4 or Form F-4 for a de-SPAC transaction;
– A re-determination of smaller reporting company status within four days following the consummation of a de-SPAC transaction;
– An amended definition of “blank check company” to make the liability safe harbor in the Private Securities Litigation Reform Act of 1995 for forward-looking statements, such as projections, unavailable in filings by SPACs and certain other blank check companies; and
– A rule that deems underwriters in a SPAC initial public offering to be underwriters in a subsequent de-SPAC transaction when certain conditions are met.
The proposal would also add a new Rule 145a, which provides that a business combination involving a reporting shell company and another entity that is not a shell company constitutes a “sale” of securities to the reporting shell company’s shareholders. The proposal also addresses the status of SPACs under the Investment Company Act and would establish a non-exclusive “safe harbor” for SPACs that, among other things, enter into a de-SPAC agreement within 18 months of their IPO & complete the deal within 24 months following the IPO.
The proposed rules about the fairness of the transaction would require disclosure similar to that required in going private deals and, like the going private rules, are intended to incentivize sponsors to shape the transaction process in a more investor-favorable way. The biggest news in the rule proposal is probably the loss of the PSLRA safe harbor for projections in de-SPAC transactions, which is something that the Staff has telegraphed was coming for a long time. However, the extension of Section 11 liability to the de-SPAC target & the potential that the IPO underwriters might also face Section 11 liability for the de-SPAC are also significant. As usual, Tulane’s Ann Lipton has a Twitter thread that’s full of insights on some of the issues raised by the proposal
SPACs’ status under the Investment Company Act has been another hot topic in recent months, and the safe harbor approach came as a bit of a surprise to me in light of the publicly expressed views of the current head of the SEC’s Division of Investment Management. Frankly, if the SEC wanted to drive a stake through the heart of SPACs, this could have been the place to do it.
Commissioner Peirce once again dissented from the SEC’s decision, essentially arguing that the SEC came to bury SPACs, not to regulate them. She states that the rules would impose “a set of substantive burdens that seems designed to damn, diminish, and discourage SPACs because we do not like them, rather than elucidate them so that investors can decide whether they like them.”
As per the new normal for comment periods, this one expires 30 days after publication in the Federal Register or May 31, 2022, whichever is later.
While the SEC’s latest rule proposal has the greatest relevance to SPACs & shell companies, there’s one aspect of it that applies to all public companies – proposed tweaks to the agency’s guidance on the inclusion of projections in SEC filings (see p. 130 of the release). That guidance is laid out in Item 10(b) of Reg S-K and the proposal would inject some familiar concepts from Reg G into that guidance. Specifically, the SEC proposes to amend Item 10(b) to state that:
– Any projected measures that are not based on historical financial results or operational history should be clearly distinguished from projected measures that are based on historical financial results or operational history;
– It generally would be misleading to present projections that are based on historical financial results or operational history without presenting such historical measure or operational history with equal or greater prominence; and
– The presentation of projections that include a non-GAAP financial measure should include a clear definition or explanation of the measure, a description of the GAAP financial measure to which it is most closely related, and an explanation why the non-GAAP financial measure was used instead of a GAAP measure.
The SEC would also amend the guidance to clarify that it applies to the projections of any entity included in the filing, such as the target in a business combination transaction.
