In a recent paper, authors Onur Bayar, Thomas J. Chemmaur and Paolo Fulghieri consider whether allowing insiders with nonpublic information to disclose such information prior to selling their securities. The paper discusses the communications prohibitions applicable prior to, and in close proximity to, securities offerings, as well as some communications safe harbors. The authors set out a model for disclosures at different points in time prior to a securities offering. The paper concludes that even in the absence of an agency, like the Securities and Exchange Commission, that regulates disclosures, there are incentives for companies to self-regulate resulting in conservative disclosures. The authors further conclude that whether allowing disclosures prior to an equity offering is desirable depends on the proportion of Institutional investors who are able to verify the information (compared to retail investors that would not be able to test or verify disclosures). Finally, the authors also consider the nexus to the rules for bringing private securities lawsuits. Setting aside the authors’ thesis, it would seem prudent in light of the significant advances in technology since 2005 when securities offering reform last revamped the communications rules to revisit the safe harbors available to issuers.
On January 1, 2018, a European Union law regulating packaged retail insurance-based investment products (“PRIIPs”) went into effect targeting securities offered to retail investors by investment funds. If a security is considered a PRIIP, the issuer is required to publish a strictly regulated key information document (“KID”) that must be continuously updated during the distribution of the security. The liability for the content of the KID is assumed by the issuer by operation of law. The broadly drafted regulation has the potential to impact the ability of investors to purchase securities issued by U.S. exchange-listed real estate investment trusts (“REITs”). To determine whether the securities of a particular REIT should be considered PRIIPs and thereby subject to the regulation, all relevant operational facts and characteristics of the REIT must be reviewed in an analysis similar to the undertaking by REITs at the time the Alternative Investment Fund Managers Directive (“AIFMD”) was implemented throughout the European Union. Securities are considered PRIIPs if the amount repayable to the retail investor is subject to: (i) fluctuation because of exposure to reference values or (ii) the performance of one or more assets that are not directly purchased by the retail investor. Securities issued by REITs that are structured as alternative investment funds under AIFMD are considered PRIIPs.
The recently updated Securities and Exchange Commission agenda (see here and here) provides some insight on what to expect in upcoming months. The amendments to the smaller reporting company definition, which were widely supported when proposed, remain in the “final rule stage.” Likewise, the amendments to implement the FAST Act report and disclosure update and simplification (to eliminate outdated, redundant and otherwise repetitive requirements) remain in the final rule stage. It will be interesting to see whether the Commission takes action on these measures before Commissioner Piwowar’s departure. Consistent with Corporation Finance Division Director Hinman’s recent Congressional testimony about which we previously blogged, the agenda now includes in the “proposed rule stage” extending the test-the-waters provision to non-EGCs. Also in the proposed rule stage are changes to Industry Guide 3 (disclosures for banks and other financial institutions), disclosure of payments by resource extraction issuers, and additional changes to the Regulation S-K disclosure requirements. A new item was added that is referenced as “amendments to financial disclosures for registered debt security offerings.” It is not clear to what this relates. Sadly, the changes to various communications safe harbors and other Securities Act rules for business development companies are in the “long-term actions” category. The long-term actions category also includes a number of measures that have been the subject of recommendations by the Commission’s Investor Advisory Committee, such as disclosures regarding board diversity and changes to the accredited investor definition. Consistent with recent comments by representatives of the Commission, a measure relating to harmonizing private placement rules is added to the long-term actions list.
On May 11, 2018, the staff of the Division of Corporation Finance of the US Securities and Exchange Commission issued compliance and disclosure interpretations (C&DIs) on proxy rules and related Schedules 14A and 14C. These C&DIs replace the interpretations published in the Proxy Rules and Schedule 14A Manual of Publicly Available Telephone Interpretations and the March 1999 Supplement to the Manual of Publicly Available Telephone Interpretations (collectively, Telephone Interpretations). Generally, the new C&DIs are consistent with the Telephone Interpretations, although several reflect substantive or technical changes from the Telephone Interpretations. Our Legal Update discusses those changes as well as practical considerations for companies.
In recent remarks, Commissioner Peirce commented on capital formation, repeating some statistics about the decline in the number of IPOs in recent years and the relatively small number of public companies (about 4,500). She noted that many companies are able to raise capital in private placements or exempt offerings; however, fewer investors are able to share in the growth of such companies that stay private. She noted a few regulatory impediments that may make becoming a public company less compelling. Among these impediments, Commissioner Peirce included the Sarbanes-Oxley Section 404(b) attestation requirement and the burden it places, especially on pre-revenue companies, Dodd-Frank Act-mandated disclosure requirements, such as those on conflict minerals, Dodd-Frank Act executive compensation requirements like the pay ratio rule, and the lack of regulation of proxy advisory firms. The Commissioner also commented on Regulation A, noting that as of the end of 2017, 185 Regulation A offerings had raised approximately $670 million in offering proceeds, and noting that the current offering threshold for Regulation A offerings may still be too low to be a meaningful stepping stone to an IPO. The Commissioner also raised a suggestion that has been raised by Commissioner Piwowar from time to time; that is, abandoning the accredited investor standard and allowing all investors to participate in exempt offerings. The full text of the remarks are available here.
Recently, the Securities and Exchange Commission (the “SEC”) announced a settlement with a registrant relating to the registrant’s failure to disclose the occurrence of a cyber breach. The breach occurred in 2014 and was disclosed in 2016. A later discovered breach that took place in 2013 was disclosed in 2017. The SEC noted that the company did not fully assess the impact of the breach on its business nor whether the disclosures in its public filings, which addressed potential breaches, were rendered misleading by virtue of the actual breach. The SEC did note that it would not second-guess judgments regarding disclosures made by registrant’s acting in good faith.
The settlement, taken together with statements made by representatives of the SEC regarding the importance of assessing cyber breaches and related risks, and the recent guidance from the SEC regarding cybersecurity disclosures, serve to emphasize, among other things, the importance of disclosure controls and procedures that take into account cyber disclosures.
Over the past year, proxy advisory firms, major index providers, and the SEC’s Investor Advisory Committee have weighed in on the growing number of companies with dual-share classes. Today, 9% of the S&P 100 and 8% of the Russell 300 are comprised of companies with dual-class structures. The Council of Institutional Investors has assembled and published a list of public companies with dual-class structures. During a recent program hosted at the Weinberg Center, titled “Snap Judgment: The Legal and Investment Issues Associated with Non-Voting Stock,” participants debated whether courts should step in and consider dual-class structures.
Traditionally, courts will defer to the business decisions of a company with independent directors that act in good faith having undertaken reasonable care. However, some participants noted that the business judgment rule has been premised on the notion that stockholders could remove a board with which they disagreed. In instances in which stockholders cannot hold boards of directors accountable by exercising voting rights, participants argued that it might be appropriate for courts to take on greater responsibility for shareholder protection through more active intervention. Of course, it could be argued that stockholders could simply sell their securities.
Recently, the Ninth Circuit held that only negligence, not scienter, is required to be shown where a violation of the tender offer provisions of Section 14(e) is alleged. In Varjabedian v. Emulex Corp., the Ninth Circuit court remanded the case for reconsideration of the defendants’ motion to dismiss based on a negligence standard. The District Court had previously dismissed the complaint for failure to plead a strong inference of scienter in connection with the alleged Section 14(e) violations. The Ninth Circuit’s conclusion that only a negligence standard applies is at variance with decisions in various other circuits. In reaching its conclusion, the Ninth Circuit relied on the legislative history of the Williams Act, which it stated is intended to be broad and address the quality of the information provided to stakeholders in a tender offer. Perhaps the circuit split may at some point be addressed by the Supreme Court.
The Center for Audit Quality (CAQ) recently published “Non-GAAP Measures: A Roadmap for Audit Committees” (CAQ Roadmap), which examines themes that emerged from a series of 2017 roundtables hosted by CAQ with various stakeholders. The CAQ publication notes that audit committees have an important responsibility to oversee the financial reporting process and external audit.
The CAQ report notes that the audit committee can act as a bridge between management and investors, assess management’s reasons for presenting non-GAAP measures and evaluate the sufficiency of related disclosures. It adds that the audit committee can determine whether the measures present a fair and balanced view of company performance. CAQ lays out a three-fold roadmap for audit committee members: (1) identify key discussion topics with management, counsel and external auditors, (2) understand the external auditor’s role regarding non-GAAP measures and (3) adopt leading practices to support the presentation of high-quality non-GAAP measures. With respect to item (1), CAQ suggests that audit committee members consider topics for dialogue including: asking management whether it has internal guidelines for determining how non-GAAP measures are generated, calculated and presented; seeking the perspective of counsel on non-GAAP measures; asking the company to benchmark such measures to those of its peers; and finding out what disclosure controls and procedures are in place. With respect to item (2), while external auditors do not audit non-GAAP measures as part of their financial statement or ICFR audits, audit committees and management may consider external auditors as a resource when evaluating such measures and may ask them to perform certain procedures, such as testing controls related to the preparation and use of such measures in light of management’s polices, and to report such results to them. Last, the audit committee and management should consider adopting best practices, such as subjecting non-GAAP measures to robust disclosure controls, and adopting guidelines to follow when preparing and presenting non-GAAP measures to stakeholders.
On April 4, 2018, the staff of the SEC’s Division of Corporation Finance (Staff) updated its Compliance & Disclosure Interpretations on the use of non-GAAP financial measures (C&DIs), by issuing two new C&DIs (C&DI 101.02 and C&DI 101.03). These new C&DIs provide that, under certain conditions, financial measures included in forecasts used in business combination transactions are excluded from the definition of non-GAAP financial measures.
To recall, in October 2017, the Staff clarified in C&DI 101.01 that financial measures provided to a financial advisor would be excluded from the definition of non-GAAP financial measures, and therefore not subject to Item 10(e) of Regulation S-K and Regulation G, if and to the extent: (1) the financial measures are included in forecasts provided to the financial advisor for the purpose of rendering an opinion that is materially related to the business combination transaction; and (2) the forecasts are being disclosed in order to comply with Item 1015 of Regulation M-A or requirements under state or foreign law, including case law, regarding disclosure of the financial advisor’s analyses or substantive work.
New C&DI 101.02 now provides that a registrant can rely on the exemption provided by C&DI 101.01 if the same forecasts provided to its financial advisor are also provided to its board of directors or a board committee. In addition, new C&DI 101.03 clarifies that financial measures in forecasts provided by a registrant to bidders in business combinations would also be excluded from the definition of non-GAAP financial measures, if a registrant determines that such forecasts are material and that disclosure of such forecasts is required to comply with the anti-fraud and other liability provisions of the federal securities laws.
A copy of the updated C&DIs is available here.