In September, California mandated women directors on corporate boards.  In a new paper titled “Mandating Women on Boards: Evidence from the United States,” authors Sunwoo Hwang, Anil Shivdasani, and Elena Simintzi review the effects of mandating the inclusion of women on boards.

The California law requires that public companies headquartered in the state of California have at least one female director by end of 2019.  By year-end 2021, companies with six or more directors must have three female directors, boards with five members must have two female directors, and boards with four or fewer directors, must have at least one female director.  Noncompliance would result in potential fines. There are approximately 450 public companies in the Russell 3000 index headquartered in California with a market cap of nearly $5 trillion.

The authors present evidence that mandating gender diversity through legislation is expensive for shareholders.  This results from heightened costs for female directors, because there is a small supply and public companies will be pressed to comply at the same time resulting in competition.  In addition, the authors find costs will increase as a result of the possibility that companies will expand their boards in part to comply with the requirements.   Although the paper concludes that there is a lack of a consensus on the impact of regulations mandating gender diversity, it raises concerns.

Separate from the paper, commentators have raised concerns regarding the constitutionality of the California law.

Partner Anna Pinedo joined IFR’s US ECM Roundtable for a panel discussion that assessed the current state of the market, discussed the latest trends and developments, and gave an outlook for the remainder of the year and beyond.  Topics included the state of the IPO market; private capital to public markets; JOBS Act 3.0; SPACs as an alternative to IPO; areas of success; and the convertible bond market renaissance.

Read IFR’s special report on the Roundtable here:

In a recent speech, Commissioner Kara Stein addressed a number of disclosure related concerns, including cyber disclosures and ESG disclosures.  Just as many of us had been reading about a decline in the number of SEC Staff comments regarding the use of non-GAAP measures in SEC filings, Commissioner Stein’s remarks seemed to focus renewed attention on this issue.  Commissioner Stein cited studies that show that approximately 97% of S&P 500 companies cite at least one non-GAAP metric in their reports.  In addition to echoing prior Staff concerns regarding the possibility that the use of non-GAAP measures may be misleading or may “disguise financial performance,” Commissioner Stein raised a new issue—the lack of uniform standards for non-GAAP measures.  Hopefully, such concerns can be allayed with more detailed disclosures, rather than prescriptive standards regarding frequently used non-GAAP measures.  Commissioner Stein also focused on “key performance indicators” (KPIs).  While remarks from Commission Staff representatives in recent months have indicated that attention is being paid during disclosure reviews on the use of “tailored” performance measures reported by registrants, Commissioner Steins’ comments appear to reflect some intensified focus.  Commissioner Stein noted that more and more companies are provided tailored measures of financial performance, which may include same store sales, sales per square foot, customer churn rates, sales conversion rates, customer retention, etc.  Stein also noted that non-GAAP measures and KPIs appear to be used in the private markets, with forward-looking adjustments, such as cost savings.  While noting that many of these measures may be used by the key decision makers within companies to track the companies’ performance and, therefore, may provide useful insights for investors, the lack of transparency regarding the calculation of many such measures, the lack of comparability as to such measures, and the possible selective use of such measures may raise investor protection concerns.  See the full text of the Commissioner’s remarks here.

As we previously blogged, The Nasdaq Stock Market filed with the Securities and Exchange Commission an amendment to its shareholder vote rule, often referred to as the 20% rule.  The amendment was recently approved by the Commission.  The amendments eliminate “book value” in the determination of what constitutes a dilutive transaction.  Shareholder approval is required in connection with a 20% issuance at a price less than the Minimum Price.  A 20% issuance is a transaction other than a public offering that involves the sale, issuance or potential issuance of a listed company’s common stock (or securities convertible or exercisable for common stock) that alone or together with sales by certain control persons equal 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance.  The Minimum Price is a price that is the lower of the closing price immediately preceding the signing of the definitive agreement or the average closing price for the five trading days immediately preceding the signing of that agreement.  While the amendment is limited and does not modify or affect other aspects of Rule 5635, which still requires shareholder approval in many instances, it is still helpful for listed companies.

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.