On April 18, 2018, the Securities and Exchange Commission (SEC) introduced a package of proposals aimed at enhancing the quality and transparency of investors’ relationships with investment advisers and broker-dealers. The proposed Regulation Best Interest introduces three obligations for broker-dealers designed to require broker-dealers to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities: the disclosure obligation, the care obligation, and the conflict of interest obligation. Given that the Regulation Best Interest proposing release is well over 1,000 pages, we have summarized in a chart key aspects of the proposed rule. Our chart is available here.
There are a number of legislative proposals making their way through the House, including: H.R. 5054, the Small Company Disclosure Simplification Act of 2018, which provides EGCs and smaller reporting companies an exemption from xBRL requirements (referred to in our prior blog post), H.R. 6035, the Streamlining Communications for Investors Act, which is a measure that would direct the Securities and Exchange Commission to amend Rule 163 under the Securities Act in order to allow underwriters and dealers acting by or on behalf of a WKSI to engage in certain communications, and a measure that would direct the Commission to increase and align the smaller reporting company definition and the non-accelerated filer financial thresholds, and a measure requiring the Commission to conduct a study with respect to research coverage of small issuers before their initial public offerings.
All of these bills emanated from the recommendations contained in the report prepared by SIFMA and other trade associations titled “Expanding the On-Ramp: Recommendations to Help More Companies Go and Stay Public,” which we blogged about previously.
The Financial Services Committee has passed H.R. 6035 with some bipartisan consensus. This measure is similar in scope to the amendments to Rule 163 of the Securities Act that the Commission had proposed a few years ago and never adopted. Given the fact that most follow-on offerings are conducted on a wall-crossed basis these days, it would make sense to allow underwriters acting on a WKSI’s behalf to approach investors even prior to the WKSI filing an automatic shelf registration statement.
Yesterday, SEC Commissioner Robert Jackson spoke at the Center for American Progress. Commissioner Jackson focused on stock buybacks and reported on research undertaken by his staff regarding buyback activity. He noted that the recent tax law changes led to many companies buying back stock. In the first quarter of 2018, American corporations bought back $178 billion in stock. Commissioner Jackson noted that there is evidence that corporate executives use buybacks to cash out the shares of the company they receive in stock-based compensation. The Commissioner’s staff studied 385 buybacks over the last 15 months. The data collected shows that buyback announcements led to stock price increases. In half of the buybacks that were reviewed, at least one executive sold shares in the month following the buyback announcement. The Commissioner noted that while executive sales are permissible, the sales diminish an executive’s alignment of interests with those of the company’s stockholders. Commissioner Jackson noted that executives should have “skin in the game.” As a result of his findings, Commissioner Jackson called for an open comment period to review the Commission’s rules regarding buybacks, and for an update to existing rules in order to prevent executives from using stock buybacks to cash out. He appeared to suggest that the Rule 10b-18 safe harbor should be conditioned on preventing executive sales of stock in proximity to buyback activity. Please see the full text of the Commissioner’s remarks here. The study results are available here.
At the Wall Street Journal’s CFO Network annual meeting held in Washington DC on June 11, 2018, Securities and Exchange Commission Chair Jay Clayton provided some insights on areas of focus for the Commission. Chair Clayton noted that the Commission remains focused on measures designed to promote capital formation without sacrificing investor protection. Chair Clayton noted that the Commission continues to work on disclosure effectiveness reforms. He also noted that the Commission is working on amendments to the definition of “smaller reporting company,” and anticipates that the amendments will be released before October. The moderator asked Chair Clayton to comment on the increasing significance of private capital. Chair Clayton noted that the Commission is focused on the decline in the number of U.S. public companies and on the state of the U.S. initial public offering market. He noted that retail investors are being shut out of investment opportunities given that most private placements are available only to accredited investors. He noted that the Commission is looking at the private placement framework, and noted that, at present, the private placement is quite binary—if you are an accredited investor, you are able to participate in a private placement and potentially face significant losses, and if you are not an accredited investor, you are largely foreclosed from participating in the private placement market. Chair Clayton also discussed proposed Regulation Best Interest as well as a number of other priorities.
In their paper, authors Martijn Cremers, Beni Lauterbach, and Anete Pajuste review the valuation differences between single share class companies and dual share class companies over their life cycles. The paper finds that on average at the time of their IPOs, dual share class companies have higher valuations than comparable companies with a single share class. This may be attributable to any number of factors. However, over time (six to nine years following the IPO), this premium dissipates. The authors posit that the potential benefits of dual class structures decrease over time after the IPO, and the agency costs associated with dual class structures increase over time. The fact that there is an initial valuation premium associated with dual share class companies supports the authors’ view that these companies should not be excluded from popular indices. The authors also advance the view that the decline in the premium over time suggests that there are advantages to sunset provisions that would kick in within six years of a dual share class company’s IPO.
Today, the House Financial Services Committee advanced six bills for House consideration, including H.R. 5054, H.R. 5756, and H.R. 5877.
H.R. 5054, the Small Company Disclosure Simplification Act of 2018, which was introduced by Representative David Kustoff (R-TN), the “Small Company Disclosure Simplification Act of 2018” provides a voluntary exemption for emerging growth companies and other smaller companies from the requirements to use Extensible Business Reporting Language (xBRL) for financial statements and other periodic reporting. The bill passed 32-23.
H.R. 5756, to require the Securities and Exchange Commission to adjust certain resubmission thresholds for shareholder proposals, which was introduced by Representative Sean Duffy (R-WI), H.R. 5756 requires the Securities and Exchange Commission to adjust certain resubmission thresholds for shareholder proposals. The bill passed 34-22.
H.R. 5877, the Main Street Growth Act, which was introduced by Representative Tom Emmer (R-MN), the “Main Street Growth Act” amends the Securities Exchange Act of 1934 to allow for the registration of venture exchanges to provide a venue which will allow qualifying companies one venue in which their securities can trade. The bill passed 56-0.
In his paper, titled “The Role of Blue Sky Laws After NSMIA and the JOBS Act,” Rutheford B. Campbell, Jr. contends that state securities laws continue to impede capital formation. Campbell urges that at the federal level Congress must preempt completely the state registration authority. The National Securities Market Improvement Act of 1996, or NSMIA, did not result in full preemption. NSMIA preempted state authority in connection with offerings of securities by mutual funds, offerings by companies the securities of which are traded on a national securities exchange, and exempt offerings made pursuant to Rule 506 under the Securities Act. NSMIA delegated authority to the Securities and Exchange Commission to expand preemption by regulation in the case of any offering “to qualified purchasers, as defined by the Commission by rule.” The definition of a qualified purchaser must be “consistent with the public interest and the protection of investors.” The JOBS Act preempted state authority over crowdfunded offerings. The Commission, in its final rules implementing amendments to Regulation A, preempted state registration authority over Tier 2 offerings. As the author points out, many other securities offerings remain subject to state registration requirements, including registered offerings undertaken by issuers of securities that are not traded on a national exchange, private placements made pursuant to Section 4(a)(2) of the Securities Act, offerings made pursuant to Rule 504, Regulation A Tier 1 offerings, and intrastate offerings. It is not clear why state securities registration is required in each of these cases. For example, in the case of offerings that are made pursuant to a registration statement that has been reviewed by, and declared effective by, the Commission, state review does not add meaningfully to investor protection. Perhaps if Congress does not take action, the Commission might consider exercising its delegated authority in connection with the harmonization of exempt offering alternatives that has been discussed by Commission representatives and which now appears on the Commission’s regulatory agenda.
Chair Clayton recently provided Congressional testimony in connection with the review and approval of the Securities and Exchange Commission’s funding. In his prepared remarks, Chair Clayton focused on a number of the initiatives undertaken by the Commission to promote investor education and address investor protection issues. For example, he pointed to the Commission’s new tool, the SEC Action Lookup for Individuals, or SALI, which provides another means to identify bad actors. He identified the Commission’s areas of focus, which include: (1) leveraging technology and enhancing cybersecurity and risk management; (2) facilitating capital formation; (3) protecting Main Street investors, including through enforcement actions targeting insider trading, market manipulation and accounting fraud; and (4) maintaining market oversight. The Chair also noted that funds will be allocated to strengthening the Commission’s cybersecurity efforts and announced the creation of a new position, the Chief Risk Officer. Turning to capital formation, Chair Clayton noted as continuing priorities taking action on the definition of smaller reporting companies and completing the FAST Act-required rulemakings. The full prepared testimony may be found here.