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Authors Zhaoxin Lin, Travis R.A. Sapp, Jackie Rees Ulmer, and Rahul Parsa examine insider trading data in order to assess the significance of this issue.

In their article, “Insider Trading Ahead of Cyber Breach Announcements,” the authors report on their review of stock price responses following 258 announced cyber breaches that occurred from 2011 to 2016.  Based on historical insider sales, the authors catalogue sales as routine or opportunistic, to the extent data is available. The authors identify a statistically significant sample of sales prior to announcements of breaches.   Opportunistic sales, or sales occurring in close proximity to a cybersecurity breach announcement by insiders that do not have an established trading program, produced significant abnormal savings for the insider sellers.  Of course, the study cannot confirm that such trades were made in violation of the securities laws, but perhaps does suggest that companies reviewing their cybersecurity-related policies and procedures ought to give thought to information handling.

In a recent paper, author Brian Cheffins contends that the concerns about the death of the US public company are overstated. Although there has been a decline in the number of public companies since 2000, public companies continue to play an important role in the US economy. In assessing the role of public companies, Cheffins considers the ratio of aggregate market capitalization of publicly traded stocks to gross domestic product. The ratio is now near an all time high. Public companies are now larger than in prior periods. For example, he notes that in 2017, the market capitalization of listed US companies averaged almost $7 billion, which is more than ten times as much on an inflation-adjusted basis as the 1976 average.

Cheffins attributes the decline in the number of US IPOs (measured against historical levels) to market factors rather than regulatory burdens. The author notes that promising companies are exiting through M&A transactions, rather than IPOs. Unless the availability of private capital and M&A opportunities dry up, he notes that the current trend should be expected to continue. While his thesis may be accurate, the concerns expressed by representatives of the Securities and Exchange Commission that a smaller percentage of American investors now has the opportunity to benefit from the periods of the most significant growth of promising emerging companies also is true.

It is already that time of year when public companies should be thinking about the 2019 proxy and annual reporting season. Advance planning greatly contributes to a successful proxy season, culminating with the annual meeting of shareholders. This Legal Update highlights issues of importance to the upcoming 2019 proxy season.

We discuss the following topics:

  • Pay Ratio
  • Say-on-Pay
  • Compensation Litigation and Compensation Disclosure
  • Board Diversity
  • Investor Stewardship Group
  • Voluntary Proxy Statement Disclosure
  • Shareholder Proposal Guidance
  • ESG Shareholder Proposals
  • Notice of Exempt Solicitations
  • Proxy C&DIs
  • Examination of Proxy Process
  • Virtual Meetings
  • Disclosure Update and Simplification
  • Cybersecurity Disclosure
  • Risk Factors
  • Accounting Impact of Tax Reform
  • Auditor Report Requirements
  • Iran Disclosures
  • Changes to Form 10-K Cover Page
  • Exhibit Hyperlinks

Speaking at a session at the American Bar Association’s annual meeting, a representative of the Securities and Exchange Commission’s Division of Corporation Finance (Michael Seaman) provided guidance for attendees regarding areas of focus in the coming months.  After reviewing some of the Commission’s recent rulemaking initiatives, including the Concept Release regarding Rule 701 and Form S-8, the recent changes to Regulation S-K to address outdated, duplicative and other similar rules, and the proposed amendments to the disclosures required by Regulation S-X Rule 3-10 and Rule 3-16, Mr. Seaman commented on ongoing and upcoming priorities.  He noted that the staff is working on proposed rules that would address the statutory change that permits Exchange Act-reporting companies to undertake Regulation A offerings.  There appears to be significant interest on the part of smaller public companies in relying on the exemption.  Mr. Seaman cautioned that the exemption is not available to such companies until the Commission adopts final rules.  He noted that the staff continues its work on proposed changes to Industry Guide 3 for financial services companies.  Guide 3 requirements may be simplified in light of the disclosures required of regulated financial institutions as a result of Basel III and other standards, as well as disclosures otherwise already contained in financial statements and the accompanying notes.  Consistent with remarks made by other Commission representatives, Mr. Seaman noted that the staff also is working on a concept release related to private offering exemptions intended to harmonize conditions for such exemptions.  When asked whether there would be additional rulemaking in furtherance of the Commission’s disclosure-effectiveness initiative, Mr. Seaman noted that the staff continues to review other aspects of the Regulation S-K requirements, including those on which comment was sought in the Concept Release on Business and Financial Disclosure required by Regulation S-K.

As far as areas of staff comment, Mr. Seaman noted that the staff was reviewing issuer disclosure related to cyber breaches and cybersecurity and commenting on risks that were generic and did not address issuer-specific facts and circumstances, as well as on disclosures related to incidents of breaches.  He also noted that the staff was reviewing dispute-resolution provisions in governing documents that may have the effect of limiting investors’ rights, such as provisions requiring mandatory arbitration, waiver of jury trial provisions, provisions related to class-action waivers, and provisions requiring a minimum ownership threshold in order to bring certain claims.  In this regard, the staff was commenting on issuer disclosures related to the inclusion of such provisions in the governing documents with a focus on ensuring that such provisions are clearly explained and investors understand the risks associated with such provisions, including the limitations on remedies, as well as ensuring that issuers are addressing in their disclosures whether such provisions are enforceable and comply with the securities laws.

Mr. Seaman also mentioned a new initiative, led by the Chief Counsel’s office, with the support and involvement of other groups, to review all of the Compliance & Disclosure Interpretations for any required updates, as well as to eliminate any C&DIs that may no longer be relevant or applicable.  He encouraged practitioners to provide their views regarding any C&DIs that may be confusing or problematic, as well as any areas or topics that may be appropriate to address in new C&DIs.

The Securities and Exchange Commission (SEC) has announced a decrease in the filing fees to be paid by public companies and other issuers. Effective October 1, 2018, the first day of the SEC’s 2019 fiscal year, the filing fee rate will decrease 2.7 percent from the current rate of $124.50 per million dollars to $121.20 per million dollars for:

  • The registration of securities under the Securities Act of 1933;
  • The repurchase of securities in going private transactions pursuant to Section 13(e) of the Securities Exchange Act of 1934 (Exchange Act);
  • Certain proxy solicitations and statements in corporate control transactions pursuant to Section 14(g) of the Exchange Act; and
  • The payment of fees in connection with the Annual Notice of Securities Sold Pursuant to Rule 24f-2 under the Investment Company Act of 1940.

The fiscal year 2019 filing fee decrease follows two years of filing fee increases. Companies that are planning on submitting filings later in 2018 for which a filing fee will be paid at the time of filing may want to consider whether they have the flexibility to file after October 1, 2018, to take advantage of the filing fee decrease.

New filing and transaction fee rates for the SEC’s 2020 fiscal year will be announced by August 31, 2019.

Securities and Exchange Commission Chair Clayton addressed attendees at the Nashville 36|86 Entrepreneurship Festival regarding the Commission’s capital formation agenda.  Clayton noted that the Commission has taken a number of steps to reduce the regulatory burdens for smaller companies, pointing to the amendments to the definition of “smaller reporting company,” the recently adopted disclosure modernization and simplification amendments to Regulation S-K and Regulation S-X, and the Division of Corporation Finance’s guidance extending the confidential submission process for registration statements to non-emerging growth companies.  That being said, Clayton outlined his views regarding the need to reverse the decline in the number of public companies that has occurred over the last two decades.  While many would contend that there is sufficient private capital available to fund the growth of promising privately held emerging companies, Clayton once again noted that “Main Street investors” generally are foreclosed from investing in high quality private companies.

Clayton noted that the Commission is considering suggestions and comments made at a Commission roundtable regarding supporting smaller public company secondary market liquidity.  Of course, the roundtable did not address changes to the regulatory framework for equity research, which most smaller public companies would observe is the key to secondary market liquidity.

He noted that the Commission intends to consider the thresholds that trigger Sarbanes-Oxley Section 404(b) auditor attestation.  Clayton used the example of biotech companies with little or no revenue that must devote considerable resources away from research and development and toward professional fees related to the attestation process.  This is interesting as JOBS Act 3.0 currently contains a measure that would provide for a Section 404(b) exemption for “low-revenue” issuers, such as biotech companies.  Perhaps the bill will inspire the Commission.  Chair Clayton also noted that the Staff of the Commission is working on a recommendation to expand the ability to “test the waters” to non-emerging growth companies.  This measure also would be addressed if JOBS Act 3.0 were to be passed.

Chair Clayton also discussed revisiting the exempt offering framework.  This has come up a few times in public remarks and also is included in the Commission’s regulatory flexibility agenda.  Clayton mentioned a “comprehensive review of our exemptive framework to ensure that the system, as a whole, is rational.”  He suggested a number of questions that may be raised in a concept release to be issued by the Commission, such as whether we have overlapping securities offering exemptions that may create confusion for companies, and whether we have gaps in the exempt offering framework.  He also noted that consideration ought to be given to the rules that “limit who can invest in certain offerings” and to expanding the focus to taking into account “the sophistication of the investor, the amount of the investment, or other criteria rather than just the wealth of the investor.”  Finally, he mentioned examining integration issues.

Many recent press articles lamenting “short-termism” in corporate America blame research analysts for focusing on quarterly earnings.  In a recent paper titled, “Analyst Coverage and the Quality of Corporate Investment Decisions” authors Thomas To, Marco A. Navone and Eliza Wu demonstrate a causal connection between analyst coverage and good investment decisions.  The authors assess the impact of financial analyst coverage on corporate investments by evaluating corporate total factor productivity (or efficiency gains) for US listed companies from 1991 to 2013.  Their “information hypothesis” postulates that analyst coverage delivers information about companies to the market and may therefore provide those companies with access to funding that permits companies to make capital expenditures and other investments.  Also, as a result of analysts monitoring companies and revealing negative information and assessments to the market, it ensures that company management’s will undertake the most productive projects.  In this latter case, analysts effectively serve as monitors prompting companies to improve capital allocation efficiency.   The study also shows that a reduction in analyst coverage reduces capital expenditures and institutional monitoring.  In this light, perhaps the claims that analysts contribute to short-termism should be reevaluated.

As we previously blogged, Nasdaq Stock Market LLC filed a proposed rule change with the Securities and Exchange Commission to change their listing requirements under Nasdaq Rule 5635(d), which relates to shareholder approval.

On August 16, 2018, the SEC announced that it would further extend its deadline to approve or reject the rule change to October 18, 2018, or 240 days from the date the proposed rule change was published for notice and comment in the Federal Register. The SEC noted that it would use the action deadline extension to review the proposed change and the comment letters it has received.

Even before the Trump tweet, discussions regarding interim reporting requirements for U.S. public companies had been ongoing for several years.  In fact, going back to 2015, the Securities and Exchange Commission’s Advisory Committee on Small and Emerging Companies considered the advantages and disadvantages associated with discontinuing quarterly reporting.  In 2016, the Director of the Commission’s Division of Corporation Finance addressed the issue in a speech in Europe, noting that, “The United Kingdom has stopped mandating that companies provide quarterly financial reports to investors. Lately, some commentators have asked the Commission to re-think the need for quarterly reporting by U.S. issuers, which has been a staple of the U.S. regulatory system since 1970, advocating that this frequency leads to short-term thinking by investors and company management. These commentators note that financial reporting that focuses on short-term performance is not conducive to building sustainable businesses because it steers management to focus on short-term goals and performance.”  Flash forward a few years, and Title XXII Section 2201 of the JOBS Act 3.0 requires that the Securities and Exchange Commission conduct an analysis regarding the costs and benefits of quarterly reporting on Form 10-Q, especially for emerging growth companies.  This provision may have been influenced by a report published by various trade groups, including SIFMA, about which we recently blogged.  In that trade group report, a recommendation is made that emerging growth companies be given the option to issue a press release with their quarterly results rather than be required to file a quarterly report on Form 10-Q.  The trade group report states that quarterly reports have become longer and more detailed, and therefore producing such reports has become more expensive.  In the trade group report, the focus was on costs and reporting burdens.

At the same time, the debate relating to quarterly earnings guidance has been reinvigorated.  Some have argued that quarterly reporting distracts managers from focusing on long-term goals and observe that public companies are all too concerned with short-term gains at the expense of long-term investments. The same commentators have focused in particular on the potential detrimental effects of providing quarterly earnings guidance.  Perhaps these concerns are overstated.  It seems that over time, fewer and fewer companies continue to provide quarterly earnings guidance.  According to a recent study, approximately one-third of public companies issue quarterly earnings guidance.  Nonetheless, in a piece titled “Short-Termism is Harming the Economy,” Jamie Dimon and Warren Buffett joined the Business Roundtable in calling for companies to refrain from giving quarterly guidance. The National Association of Corporate Directors and the National Investor Relations Institute joined in the call to eliminate earnings guidance. However, the Business Roundtable report does not advocate terminating the filing of quarterly reports on Form 10-Q.  Regardless of whether quarterly reports on Form 10-Q are mandated or not, it would still be the case that companies would report quarterly results.  The two issues—quarterly filings and quarterly guidance—appear to have been conflated making it more difficult to parse the real issues.

Thursday, October 4, 2018
8:00 a.m. – 8:30 a.m. Registration & Breakfast
8:30 a.m. – 4:30 p.m. Program
4:30 p.m. – 5:30 p.m. Cocktail Reception

Location
Mayer Brown
71 South Wacker Drive
Chicago, IL 60606

Please join Mayer Brown in Chicago for our 1st Annual Executive Compensation University.

During this full-day program, we will explore tax and securities issues impacting executive compensation and hear from leading Mayer Brown lawyers about the changing regulatory landscape as they provide practical, business-focused guidance on dealing with these challenges. This program will cover such areas as the taxation of equity awards, disclosure issues and hot topics and current trends in executive compensation, including updates on issues related to say on pay, proxy disclosure, institutional shareholders and tax reform. The event will include an ethics program focused on issues relevant to in-house counsel dealing with executive compensation and securities issues. We plan to conclude the day with a cocktail reception.

We look forward to open dialogues with our guests.

A detailed program agenda can be found here.

Registration is available here.

CLE credit is pending.