The Securities and Exchange Commission’s Investor Advisory Committee (the “Committee”) will meet on Tuesday, December 10, 2024, in an open meeting, that will stream on the SEC’s website.  The Committee will first hear from two panels.   The first panel, “Examining the Use of Mandatory Arbitration Clauses by Registered Investment Advisers,” will examine the use and scope of mandatory arbitration clauses by registered investment advisers (RIAs) and examine the impact of such clauses from the perspectives of various stakeholders. The panel will compare the use of mandatory arbitration clauses by state registered-RIAs and FINRA registered broker-dealers. The second panel, “Mainstreaming of Alternative Assets to Retail Investors,” will examine the various ways retail investors, who typically are not able to directly invest in alternative asset classes, are now able to do so through, among other vehicles, closed-end funds, interval funds, business development companies, non-traded REITs, and exchange traded funds.

The Committee meeting will close with a discussion and recommendation regarding the protection of investors in their interactions with “finfluencers”—individuals who leverage social media platforms to offer financial advice and promote investment opportunities. In its draft recommendation, the Committee recommends that the SEC:

  1. Engage in rulemaking and advocacy to close existing regulatory gaps in finfluencer oversight, which would include adopting a rule requiring certain disclosures related to finfluencer activity in providing investment advice regarding securities and advocating for Section 12 liability for misleading, deceptive, or fraudulent finfluencer conduct;
  2. Gather and publish data related to finfluencer misconduct;
  3. Issue guidance related to finfluencer activities;
  4. Provide and encourage investor education;
  5. Cooperate with other regulators and stakeholders to improve investor protection; and
  6. Study whether existing anti-fraud anti-manipulation provisions are sufficient to protect investors.

This is likely to be the last of the recommendations from the Committee during the Gensler SEC.  Read the meeting agenda and the draft recommendation.

Webinar | Wednesday, December 11, 2024
1:00 p.m. – 2:00 p.m. EST
Register here.

Join experts from Mayer Brown and Georgeson as they discuss key issues companies should consider while preparing for the 2025 proxy and annual report season during this time of regulatory uncertainty. Topics will include new and evolving disclosure requirements, as well as a discussion of the 2024 proxy season and what may be on the horizon for the upcoming season.

Agenda

  • Recent proxy statement and annual report developments, including new insider trading policy disclosures
  • Executive compensation disclosure requirements, clawbacks, and pay versus performance
  • Proxy voting matters and trends in shareholder proposals
  • Changing focus on environmental and social matters, and more

Broker-dealers had been preparing for the sunset of the prior time-based relief that the staff of the Securities and Exchange Commission provided in respect of compliance with Rule 15c2-11 as to certain fixed income securities, which expires on January 4, 2025.  The SEC had separately provided exemptive relief with respect to Rule 144A securities; however, this still left broker-dealers with burdensome requirements to address for other fixed income securities.  Now, the staff of the SEC has provided further relief in a no-action letter that was issued just yesterday for fixed income securities, which allows broker-dealers to continue to provide quotes to the extent that either the issuer or the fixed income securities meet one of seven specified criteria.  Among others, relief is available for asset-backed securities, securities of an issuer that files call reports with a banking agency, and securities of an issuer that is an SEC-reporting company.  See the no-action letter relief.

A more detailed alert will follow.

At the Practising Law Institute’s 56th Annual Institute on Securities Regulation, panelists discussed how public companies are addressing cybersecurity and artificial intelligence (AI) related issues.

Cybersecurity Disclosure Landscape

As cyber threats continue to evolve and challenge companies, the SEC has honed its focus on corporate disclosures related to cybersecurity incidents, risk management, and governance practices.  In July 2023, the SEC adopted specific disclosure requirements to ensure consistent and comparable disclosures across different companies.

Recent SEC comments emphasize the importance of disclosing management’s expertise in cybersecurity oversight and ensuring clear, accurate disclosures.  Companies are advised to avoid overstating compliance with cybersecurity frameworks, such as the National Institute of Standards and Technology (NIST), unless they are fully compliant.  This can be achieved through ongoing collaboration with the information security team, which can help ensure the appropriate terminology is used and efforts are accurately represented.  Finally, companies should ensure consistency in their disclosures, particularly regarding third-party involvement in cybersecurity efforts.  Risk factors should also be updated regularly to reflect actual incidents, rather than hypothetical risks that may no longer be relevant.

Although the SEC’s cybersecurity disclosure rule does not require disclosures in proxy or registration statements, it remains relevant in those filings.  For example, cybersecurity issues may need to be addressed, if relevant, in various sections of a registration statement, such as risk factors, MD&A, or the business description.  Additionally, given the SEC’s heightened focus on insider trading, companies should consider how their insider trading policies would apply in the event of a cybersecurity incident.

AI Disclosures

Companies embracing generative AI face the challenge of balancing innovation with responsible disclosure, while avoiding pitfalls like overstating AI capabilities (sometimes known as “AI-washing”).  The SEC is also focusing on emerging risks related to AI and its evolving role in corporate operations.  Thus far, the regulatory approach to AI disclosure generally emphasizes avoiding AI-washing and addressing the potential risks associated with the technology. 

As companies consider whether and how to disclose AI-related risks in their filings, AI-related disclosures are becoming more common in S&P 500 and Fortune 100 filings. These risks typically fall into five categories: (a) cybersecurity and AI risks, (b) regulatory risks, (c) ethical and reputational risks, (d) operational risks, and (e) competition risks. Companies providing AI-related disclosure should review their disclosure processes to avoid inaccuracies and inconsistencies in their public statements and regularly revisit AI disclosures to reflect evolving risks, industry developments, and regulatory expectations. Companies also should consider whether a specific committee or the Board should be responsible for overseeing AI-related risks.  As illustrated by cases like SEC v. Raz and recent FTC enforcement actions, inaccurate AI-related claims could lead to SEC enforcement actions, securities class action lawsuits, and even criminal proceedings.

On November 13, 2024, during the Practicing Law Institute’s 56th Annual Institute on Securities Regulation, a panel of experts discussed recent disclosure developments for public companies. The main topics of discussion included Insider Trading Policies and 10b5-1 Plans, Non-GAAP Measures, Cybersecurity, and ESG.

Navigating the Updated SEC Rules for 10b5-1 Plans

The SEC’s recent amendments to Rule 10b5-1, aimed at tightening regulations on trading plans for company insiders, took effect last year.

Practical Impact on Company and Insider Practices

Despite initial concerns, many companies have observed minimal change in day-to-day operations.  Companies continue to operate as they did before, but with a heightened emphasis on implementation of formalized disclosure controls and procedures to track and report 10b5-1 plans accurately.  The panel recommended that companies proactively discuss and align their approaches to cooling-off periods and other compliance measures with their treasury and finance teams, as well as their CFOs.

Option Grant Practices and New Disclosure Requirements under Item 402

Item 402(x) of Regulation S-K requires companies to disclose option grants made to named executive officers either within four business days before or one business day after filing a 10-K, 10-Q or a Form 8-K that contains material non-public information (MNPI).  Concerns initially arose that the requirement to disclose such grants would place companies under increased scrutiny. However, most companies are opting to maintain their existing option grant schedules, with a narrative disclosure explaining that they do not time their grants around MNPI disclosures. This approach has led most companies to refrain from adopting a policy, opting instead to document existing practices.

Disclosure Requirements under Item 408

Under Item 408(b) of Regulation S-K, companies are required to file their insider trading policies as exhibits to Form 10-K. For those companies that have not already filed their policies, the panel suggested some tips to ensure the policies are ready for public scrutiny, including reviewing and removing any internal company jargon, administrative details, or personally identifiable information (e.g., compliance officer contact details) from the policy, and considering the treatment of other materials referred to in the insider trading policy, such as FAQs and similar documents. Companies should also be mindful of the requirement that they disclose whether their insider trading policies apply to the company’s own transactions in its securities, and consider including a provision in the policy to address this concern.

Non-GAAP Measures

The SEC’s comment letters continue to focus intensively on non-GAAP measures. Companies are focused on strict compliance with Reg G and Item 10(e) requirements, ensuring that GAAP measures maintain “equal or greater prominence” relative to non-GAAP figures. Key considerations include accurate reconciliation from GAAP to non-GAAP measures, consistent application of exclusions across reporting periods, and a clear explanation of the value of non-GAAP metrics to both investors and management.  New non-GAAP adjustments or tailored metrics should be carefully vetted with the audit and disclosure committees to preempt potential SEC concerns. While companies may see a shift in the enforcement tone as new leadership influences the SEC’s approach, vigilance around these disclosures remains crucial.

Cybersecurity Disclosures

The SEC has recently increased its focus on cybersecurity disclosures, issuing comment letters instead of broader guidance or “Dear CFO” letters. A key area of scrutiny has been the adequacy of disclosures regarding management’s cybersecurity expertise, including detailed qualifications and oversight responsibilities. Other areas of comment include the adequacy of disclosures about third-party risk, enterprise risk management integration, and board oversight of cybersecurity and data privacy risks. Companies should consider collaborating closely with their Chief Information Security Officer (CISO) to ensure that disclosures are robust and specific.

ESG Disclosures

As the United States prepares for a shift in presidential administrations, the path forward regarding ESG disclosures has become less clear. The SEC’s final rule requiring registrants to provide certain climate-related information in their registration statements and annual reports remains under a voluntary stay by the SEC as it defends the final rule from various legal challenges. The future of that rule, including whether the incoming SEC leadership will continue defending the rule, is uncertain. However, even without an effective climate-related disclosure rule from the SEC, public companies will still need to consider disclosure developments in California, Europe, and other jurisdictions as applicable, and should be mindful of the accuracy of any environmental claims they make in their disclosures.

On November 14, 2024, the Practising Law Institute’s 56th Annual Institute on Securities Regulation featured a panel discussion that provided valuable insights into the initial public offering (IPO) landscape for 2025. 

The IPO Market

The outlook for IPOs in 2025 appears generally positive, with several key indicators suggesting a robust environment for equity issuance.  IPO volumes have surged to nearly $30 billion this year to date, a significant increase from $18 billion last year, with 60 IPOs priced year to date, marking a 130% increase.  Broader market indices are up around 25%, indicating a healthier market overall.  Notably, the focus has shifted from the MAG-7 stocks to a broader cohort of companies benefiting from the market uptick.  As companies prepare for their public debut, there is an expectation that they will do so when they are more scaled, leading to larger IPO sizes in terms of dollars raised.  Looking ahead, the panel anticipates that IPO volumes could grow to $40 billion in 2025, with 80-85 new listings expected, driven by a more favorable macroeconomic backdrop and potential interest rate cuts.  While these improvements are promising, we have not returned to the average IPO levels of the past 15 years.  Many companies are optimizing operations in private markets, leading to increased private capital activity.  This trend allows firms to stay private longer, which could impact the number of IPOs in 2025.

IPOs in Specific Industries

The panel highlighted trends across specific industries that are shaping the IPO landscape.  In the technology sector, there has been a notable shift in focus to the “Rule of 40,” which combines revenue growth and profit margins.  Previously, the emphasis was heavily on top-line growth, often prioritizing revenue increases of 60% or more, even at the expense of profitability.  Now, investors are seeking a more balanced approach, favoring companies that demonstrate sustainable growth (around 30%) alongside a reasonable profit margin (at least 10%), with many aiming for breakeven or better.  This evolution reflects a broader understanding of long-term value creation.  In the artificial intelligence sector, enthusiasm remains high, with investors eager for companies that show strong potential in this transformative field.  The life sciences sector is stabilizing, with IPO activity cautious as companies enter the public market at earlier stages, particularly those with Phase 1 or 2 candidates.  Conversely, the retail sector faces challenges, with fewer profitable companies going public due to economic headwinds, including inflation and decreased consumer spending.

Pre-IPO Liquidity Programs

The panel emphasized the critical importance of designing effective liquidity programs, particularly for companies with expiring restricted stock units (RSUs).  Many companies are currently facing challenges with RSUs that have not vested due to delayed IPOs, which can lead to financial loss and decreased employee morale.  To address these issues, companies can consider waiving liquidity triggers to allow RSUs to vest, thereby facilitating options such as secondary sales and tender offers—both issuer and third-party.  

SEC Comments

Proactive management of SEC comments is crucial for a successful IPO process.  Recently, SEC comments have increasingly focused on accounting issues, particularly concerning revenue recognition, internal control issues and compliance with non-GAAP guidelines.  Companies in specialized sectors, such as mining and natural resources, have faced heightened scrutiny regarding their financial disclosures and operational practices.  Additionally, China-based issuers, cryptocurrency issuers and special purpose acquisition companies (SPACs) have encountered significant challenges, with the SEC issuing repeated comments that complicate the clearance process for their IPOs.  

Conclusion

As we approach 2025, the evolving landscape presents both challenges and opportunities for companies considering going public.  Emphasizing sustainable growth, strategic positioning and effective liquidity management will be crucial for navigating this dynamic market.

The Securities and Exchange Commission recently announced that its Small Business Capital Formation Advisory Committee will be meeting later this week on November 13th in an open meeting. The meeting includes a discussion of how venture capital fund managers are raising capital. The Committee will hear from an academic on venture capital fund manager use of relationship-based versus general solicitation approaches to fund-raising. The Committee also will discuss the exemptions from Investment Company Act and Advisers Act registration requirements relied on by funds and managers. Robert Holowka, Branch Chief, and John Cavanagh, Senior Counsel, of the Private Funds Branch of the Investment Adviser Regulation Office, Division of Investment Management, will provide a brief overview of the registration framework applicable to private fund advisers and their funds. See the detailed agenda.

REIT capital raising in 2024 has surpassed 2023 and 2022 levels after having undergone a substantial decline after the COVID pandemic. According to the National Real Estate Investment Trust Association (Nareit), US REITs raised $23.3 billion from secondary debt and equity offerings in the third quarter of 2024 and approximately $65 billion in debt and equity in 2024 through the third quarter, surpassing 2023’s total $61.7 billion and 2022’s $51.8 billion raised by REITs. REITs are increasingly attracting significant capital from institutional investors, including pension funds, insurance companies, and sovereign wealth funds. These investors seek stable income and long-term growth, making REITs an appealing option. Global capital flows are increasingly finding their way into the U.S. real estate market, with foreign investors seeking opportunities in REITs. This trend is influenced by favorable currency exchange rates and the perceived stability of US assets. 

Recently many REITs have explored non-traditional financing methods, such as preferred equity or mezzanine debt issuances, in order to supplement their funding. These instruments can offer flexibility and potentially lower costs compared to conventional debt. Many REITs are also partnering with private equity firms and debt funds to secure capital for acquisitions and developments. This collaboration allows REITs to leverage additional expertise and financial resources while sharing risks.  REITs have raised $9.9 billion in follow-on common stock offerings, $931 million in preferred share offerings, and $7.4 billion in at-the-market (ATM) offerings in 2024 to date. In 2023, REITs raised $11.6 billion in common stock offerings, $1.1 billion in preferred stock offerings, and $19.6 billion in ATM offerings.

M&A activity has been notably calm in 2024, with one deal completed for $9.2 billion, and no M&A transactions in the third quarter of 2024. Over the past three years, deals for 37 REITs were either announced or completed. REITs are instead more frequently forming joint ventures with other real estate firms or institutional investors to pursue larger projects or enter new markets. These partnerships can provide necessary capital and shared expertise, reducing risk.

Read Nareit’s market commentary and access Nareit’s market data for additional information.

Priorities Include Artificial Intelligence and Other Emerging Technologies, Complex Products, Reg BI, Cybersecurity, Outsourcing, Private Funds and Compliance with New and Amended SEC Rules

On October 21, 2024, the Division of Examinations (the “Division”) of the U.S. Securities and Exchange Commission (“SEC”) released its examination priorities for fiscal year 2025 (which started October 1, 2024). Over the course of 2025, the Division intends for its examinations to focus on the use of artificial intelligence and other emerging technologies (including digital engagement practices, complex products, cybersecurity, outsourcing, private fund advisers, and compliance with new and amended SEC rules, such as the recent amendments to Regulation S-P and SEC rule changes relating to the securities industry’s transition to a T+1 standard settlement cycle for most securities transactions.

In this Legal Update, we provide a brief overview of the Division’s 2025 priorities, with a focus on topics relevant to broker-dealers and investment advisers. Broker-dealers, investment advisers and other SEC registrants should review the priorities closely and evaluate their own compliance efforts and examination preparedness, including by raising awareness within their organizations and identifying and addressing opportunities to strengthen internal controls and compliance procedures.

On October 16, 2024, the New York State Department of Financial Services (DFS) issued an industry letter, Cybersecurity Risks Arising from Artificial Intelligence and Strategies to Combat Related Risks, providing guidance on the cybersecurity risks associated with the use of artificial intelligence (AI) and strategies for entities regulated by DFS (“Covered Entities”) to mitigate these risks.

The guidance reviews the AI-cybersecurity risk landscape and provides a broad overview of controls to mitigate that risk.  Although NYDFS states that this guidance does not impose new requirements, companies would be wise to pay attention. The letter does not impose any new rules, instead addressing how Covered Entities should use the framework in 23 NYCRR Part 500 (“Cybersecurity Regulation”) to assess and mitigate AI-related cybersecurity risks. But, as a practical matter, the guidance will certainly shape how NYDFS evaluates companies’ cybersecurity programs. And as with other early NYDFS cybersecurity initiatives, this guidance will likely influence how other regulators approach AI-cybersecurity risk.

We provide a summary of the guidance in our Legal Update.