On February 6, 2019, the staff of the US Securities and Exchange Commission issued two identical Regulation S-K compliance and disclosure interpretations (C&DIs), which address the extent to which a director’s self-identified diversity characteristics need to be disclosed as director background or in connection with the discussion of a company’s policy with regard to the consideration of diversity in identifying director nominees. This Legal Update discusses the text of these C&DIs, along with related practical considerations.

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In a paper titled “The Effect of Enforcement Transparency: Evidence from SEC Comment-Letter Reviews,” authors Miguel Euro, Jonas Hesse and Gaizka Ormazabal study the effects of the change in policy by the Securities and Exchange Commission (SEC) in 2004 to make comment letters publicly available. The disclosure of comment letters allows market participants to impose market discipline. Institutional investors in particular are attentive to comment letters, especially those related to financial reporting matters. The authors test their thesis by reviewing changes in financial reporting in the earnings periods following the publication of comment letters. The authors look at all comment letter reviews from 1998 to 2013. Following receipt of comment letters that are subsequently publicly disclosed, earnings reports are more informative (for example, contain longer narratives), more transparent and have a lower likelihood of restatements. Also, interestingly, when comment letters were available only by FOIA request, the effect of comment letters was less pronounced. This suggests that market discipline results from companies knowing that institutional investors will monitor comment letters and ask questions, and, as a result, companies improve the quality of their reports. In effect, market discipline reinforces the regulatory scrutiny. The authors also comment in passing on the fact that following the change in policy by the SEC the number of comment letters and number of comments declined. The authors attribute this to the adoption of the Sarbanes-Oxley Act at around the same time. However, it may be attributable in part to the fact that preparers of SEC reports may be better informed by reviewing publicly available comment letters and considering the applicability of such comments to the filings they are preparing. Access to the full paper can be found here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3178609

The Office of the Investor Advocate released its “Report on Activities for the Fiscal Year 2018” (the “Report”). During the 2018 fiscal year, the Investor Advocate focused significant attention on proposed Regulation Best Interest and on the standard of conduct applicable to broker-dealers and investment advisers. In the Investor Testing section of the Report, the Office summarized some of the key findings from its survey, “Research on the Market for Investment Advice.” These findings, which are summarized below, should help inform the Commission’s consideration of proposed Regulation Best Interest:

Most investors do not currently receive financial advice regarding their assets. Consumers were asked whether they are currently consulting a financial professional regarding their investment strategies, the type of account to open, or specific financial investments. The aim of these questions was to determine the percentage of investors that receive financial advice from professionals. Only 38.7% of consumers responded “yes” to one or more of these questions. This research shows that the majority of investment decisions are not informed by professional advice. The cost associated with finding and screening an investment professional was among the leading reasons that investors cited for not seeking professional advice. The finding that the majority of investment decisions are not professionally informed may be a cause of concern for regulators.

Most consumers of investment advice turn to “dual-hatted” professionals. The majority of financial advice consumers receive is delivered by a dual registered broker-dealer and investment adviser. Only 3.8% of advice seekers work with a professional that is exclusively registered as a broker-dealer. The majority of consumers were unable to identify the correct legal status of their financial professional.

The general public does not understand the obligations arising from the requirement to act in the customer’s “best-interest.” A survey of investor understandings of the term “best interest” found that 73% of investors believe that the reference to “best interest” requires financial professionals to help them choose the lowest cost product; all else being equal, 6.1% thought that it required professionals to avoid taking higher compensation for selling one product when similar but less costly products are available, and 86% thought that it required professionals to monitor their account on an ongoing basis. However, the proposed best interest standard applies to broker-dealers who are generally not required to actively monitor accounts as part of their service offerings. Furthermore, it is unclear whether the best interest standard would require professionals to choose the lowest cost product.

 

On January 18, 2019, Congresswoman Maxine Waters and Congressman Patrick McHenry introduced legislation that would require the Securities and Exchange Commission (the “Commission”) to carry out a study of Rule 10b5-1 trading plans. Rule 10b5-1 trading plans are passive investment agreements that provide an affirmative defense for companies and insiders (directors, officers and affiliated shareholders) transacting in the relevant company’s securities from claims brought under the Exchange Act. Currently, any person or entity can establish a Rule 10b5‐1 trading plan to sell or buy a company’s securities at a time when the person or entity is not aware of any material non-public information relating to the company. The study would review whether Rule 10b5-1 should be amended to:

  • limit the ability to adopt a trading plan to a time when the company or insider is permitted to buy or sell securities during issuer-adopted trading windows;
  • limit the ability of companies and insiders to adopt multiple trading plans;
  • establish a mandatory delay between the adoption of a trading plan and the execution of the first trade made pursuant to such plan;
  • limit the frequency with which companies and insiders may modify or cancel trading plans;
  • require companies and insiders to file adopted trading plans with the Commission; and
  • require boards of companies to adopt policies covering trading plans and monitor trading plan transactions

The Commission would be required to issue a report within one year of the adopted legislation and revise Rule 10b5-1 based on the study’s results. A copy of the legislation can be found using the below link: https://financialservices.house.gov/uploadedfiles/waters_007_xml_hr_624.pdf.

 

On December 21, 2018, the Securities and Exchange Commission (the “SEC”) appointed Martha Legg Miller as the Advocate for Small Business Capital Formation. As the first individual appointed to the new role, Miller will assist small businesses in accessing and navigating capital markets and identify the challenges that they face in doing so. Additionally, Miller will suggest regulatory changes to better accommodate the interests of small businesses. The position was created along with the Office of the Advocate for Small Business Capital Formation under the SEC Small Business Advocate Act of 2016. The SEC created the new role and office to better represent the needs of small businesses in accessing capital, while continuing to ensure investor protection. The SEC press release covering the appointment can be found here.

Before the SEC shutdown, the Office of the Investor Advocate published the annual report on its activities during 2018. The report addresses non-GAAP financial measures and key performance indicators. The report notes that some investors find value in non-GAAP financial measures; however, others are troubled by inconsistent and changing disclosures and would like to see greater standardization that would permit comparisons to be more easily made. The report suggests continue attention be paid to the metrics used by public companies, and I how these are prepared and presented period to period. The report also addresses the Advocate’s focus during the year on problematic investment products, such as initial coin offerings, and increasing use of margin debt. The full report can be accessed here: https://www.sec.gov/advocate/reportspubs/annual-reports/sec-investor-advocate-report-on-activities-2018.pdf

 

In a recent cease and desist order accompanied by a $100,000 civil penalty, the US Securities and Exchange Commission (SEC) gave a strong reminder of the importance of providing equal or greater prominence to the most directly comparable financial measure calculated and presented in accordance with Generally Accepted Accounting Principles (GAAP) in disclosures containing non-GAAP financial measures, including earnings releases. This Legal Update discusses SEC rules and guidance applicable to this order.

To learn more, read our Legal Update.

In a recent cease and desist order accompanied by a $100,000 civil penalty, the US Securities and Exchange Commission (SEC) gave a strong reminder of the importance of providing equal or greater prominence to the most directly comparable financial measure calculated and presented in accordance with Generally Accepted Accounting Principles (GAAP) in disclosures containing non-GAAP financial measures, including earnings releases. This Legal Update discusses SEC rules and guidance applicable to this order.

To learn more, read our Legal Update.