During the last two weeks of 2019, the US Securities and Exchange Commission offered guidance and reminders relating to the role of audit committees, international intellectual property and technology risks, and confidential treatment applications. This Legal Update provides further detail on—and discusses practical considerations regarding—these pronouncements, which public companies should take into account as the new year begins.
Read our Legal Update.
On December 30, 2019, the Chair of the Securities and Exchange Commission, the SEC’s Chief Accountant, and the Director of the SEC’s Division of Corporation Finance issued a joint statement regarding the role of audit committees in financial reporting, as well as their oversight responsibilities. The statement reminds audit committees, in connection with year-end reporting, that:
The joint statement also reminds audit committees of the year-end financial reporting process under PCAOB AS 1301, Communications with Audit Committees, which requires the auditor to communicate with the audit committee regarding certain matters related to the conduct of the audit and to obtain certain information from the audit committee relevant to the audit. The statement also reminds audit committees and issuers that the SEC Staff remains focused on the use of non-GAAP measures, LIBOR discontinuation and transition related risks, and the critical audit matters (“CAMs”) requirement, which will require that audit committees engage in a discussion with the auditors regarding the standard and each of the identified matters.
The full text of the joint statement can be found here.
The American Institute of Certified Public Accountants (“AICPA”) Auditing Standards Board issued Statement on Auditing Standards No. 138 and Statement on Standards for Attestation Engagements No. 20 to amend the concept of materiality in the context of both audits of financial statements and attestation engagements. Under the previous standards, misstatements, including omissions, were considered to be material if they, individually or in the aggregate, “could reasonably be expected to influence the economic decisions of users.” The new standards require that there be “a substantial likelihood that [misstatements or omissions] would influence the judgment” made by certain users, which is in greater alignment with the definitions of materiality used by the Supreme Court, the Public Company Accounting Oversight Board, the Securities and Exchange Commission and the Financial Accounting Standards Board. The standards are effective for audits of financial statements for periods ending on or after December 15, 2020 and for practitioners’ examination and review reports dated on or after December 15, 2020.
The Securities and Exchange Commission announced the agenda for the upcoming meeting on January 24, 2020 of its Investor Advisory Committee. The Committee will hold a telephonic meeting and will consider the SEC’s proxy voting advice and Rule 14a-8 proposed rulemakings, as well as market structure issues related to rebate tier disclosure. For information on joining the meeting, click here. The agenda can be found here.
Recently, the SEC’s Office of the Investor Advocate released its report on its fiscal 2019 activities. The report cites staffing challenges that have impaired the ability of the SEC’s Ombudsmen to respond to matters brought by investors, which tripled in number during the fiscal year.
The report reviews the Office’s activities in nine areas: public company disclosure, equity market structure, fixed income market reforms, accounting and auditing, standards of conduct for broker-dealers and investment advisers, exchange traded funds, enhanced disclosure for funds and variable annuities, transfer agents, and the impact of Kokesh v. SEC on enforcement actions.
The Office did not object to the various disclosure effectiveness initiative related rulemakings undertaken during the fiscal year. However, the Office did raise concerns in its comment letter submitted in July 2019 in response to the SEC’s concept release on exempt offerings questioning assumptions implicit in the release that would in the view of the Office erode securities protections for investors were the SEC to adopt measures broadening the ability of retail investors to invest in exempt offerings. The Office also raises concerns relating to the SEC’s proposal to amend the definition of accelerated filer (and the impact of such a change on the Sarbanes-Oxley Section 404(b) requirement), urging that the SEC conduct additional economic analysis to address criticisms raised during the comment process.
The Report highlights problematic investment products, which include, among others: initial coin offerings, cryptocurrency and blockchain related investments, real estate related investments, social sentiment investing tools, affinity fraud, and variable annuities sales practices. The Report also comments on risks associated with dual-share class structures and the LIBOR transition.
On November 18, 2019, Securities and Exchange Commission (the “SEC”) Commissioner Robert Jackson sent a letter to Representative Carolyn Maloney attributing the lack of public disclosure regarding the political spending habits of public companies to the influence of institutional investors. Commissioner Jackson publicly supported imposing corporate political spending disclosure requirements on public companies prior to his joining the SEC in 2018. In the letter, Commissioner Jackson noted that institutional investors, which vote large blocks of public company securities, tend to vote against shareholder proposals that would require disclosure of a public company’s political spending practices. Institutional investors provide little explanation of their voting decisions or their voting track record on corporate political spending shareholder proposals to investors or the general public. Commissioner Jackson raised the concern that if investors do not understand how institutional investors vote on shareholder proposals that would require disclosure of corporate political spending then they will be unable to insist upon transparency and accountability. As a result, the letter advocates for legislation that would require public companies to disclose whether and how they spend money received from shareholders on politics. Commissioner Jackson’s term with the SEC expired in June and he is expected to leave the SEC in 2020. A copy of Commissioner Jackson’s letter can be found here.
The financing environment for startup companies in the technology sector has changed substantially over the last few years. As evidenced by findings in CB Insights’ latest report, The 2020 Tech IPO Pipeline, tech companies have raised more funding than ever before by accessing the private venture markets. These startups reach unicorn status well before completing an initial public offering or other exit.
Source: CB Insights
While private capital formation continues to rise exponentially, IPO levels have remained relatively stagnant since numbers dropped in 2015. The CB Insights report noted that 22 tech IPOs were completed in 2019. Compared to 19 IPOs in both 2018 and 2017, tech IPO numbers have not seen dramatic increases since dropping to 16 in 2015 from 33 in 2014. The median amount of private venture capital tech startups raise prior to an IPO has significantly increased between 2012 and 2019. In 2019, tech companies raised a median of $281 million prior to going public, compared to $239 million in 2018 and $64 million in 2012. In aggregate, tech companies have raised $26.3 billion in 209 deals in 2019, compared to $21.9 billion in 235 deals in 2018. By contrast, 2012 saw 111 private venture capital raises in the tech sector, yielding $1.6 billion in proceeds—a fraction of 2019 levels.
Not only are tech companies raising large sums of private capital, they are doing so through larger deals, including “mega-rounds”, which are capital raises of $100 million or more. Tech companies in the IPO pipeline completed 102 mega-rounds in 2019, compared to 68 in 2018. The number of tech mega-rounds has surpassed the number of tech IPOs.
Source: CB Insights
The volatility associated with next year’s U.S. election is anticipated to limit the window for companies, in and out of the tech sector, to complete an IPO. This will likely continue the trend of companies raising funds through the private markets, and also considering alternatives to the IPO, such as a direct listing or M&A transaction.
Yesterday, the Securities and Exchange Commission approved FINRA’s proposed amendments to its Corporate Financing Rule, which are intended to modernize, simplify, and streamline the rule. FINRA’s amendments address, among other things, (1) filing requirements; (2) filing requirements for shelf offerings; (3) exemptions from filing and substantive requirements; (4) underwriting compensation; (5) venture capital exceptions; (6) treatment of non-convertible or non-exchangeable debt securities and derivatives; (7) lock-up restrictions; (8) prohibited terms and arrangements; and (9) defined terms. FINRA states that these changes should lessen the regulatory costs and burdens associated with compliance.
See the SEC order, with the amendment. A Legal Update will follow.
The Office of the Advocate for Small Business Capital Formation published its annual report to the Committee on Banking, Housing and Urban Affairs of the U.S. Senate and the Committee on Financial Services of the US House of Representatives as required by the Exchange Act. 2019 was the first year of operations for the Office and, as indicated by the Report, many of the activities during the year were focused on outreach and investor education. The Report provides a number of useful statistics, including statistics on the amounts raised from July 1, 2018 through June 30, 2019 from data collected by the SEC’s Division of Economic and Risk Analysis, and how the offering methodology used varies by geography.
Source: Office of the Advocate for Small Business Capital Formation
Source: Office of the Advocate for Small Business Capital Formation
The Report also provides interesting data regarding the pool of accredited investors—13% of US households currently qualify as accredited investors—and geographic dispersion of investors based on household income and net worth. The report also addresses the late-stage market, as well as the issues facing smaller reporting companies.
The Report concludes by setting forth the Office’s recommendations relating to the SEC’s Concept Release, the definition of accredited investor, retail access to pooled investment vehicles, an exemption for finders, potential updates to the Regulation CF framework and continued scaling of the disclosure obligations for smaller reporting companies.
We previously blogged about the recent AICPA conference. At the conference, representatives from the Office of Chief Accountant also shared some views regarding the discontinuation of LIBOR. The Staff of the OCA joined in the July 2019 statement with the SEC Staff from the Division of Corporation Finance, the Division of Investment Management and the Division of Trading and Markets on LIBOR discontinuation. Since, the Staff of the OCA has been following emerging accounting issues related to LIBOR discontinuation. In particular, OCA Staff has been providing guidance relating to the treatment of cash flow hedge accounting involving LIBOR-based interest payments. The Staff pointed out that until the FASB accounting standards update relating to reference rate reforms become effective, the prior Staff guidance on testing the probability and the effectiveness of cash flow hedges that involve LIBOR-based interest payments remains relevant.
The speaker also addressed accounting for amendments to preferred stock that have periodic dividend payments based on a LIBOR rate. Specifically, the fact pattern that was addressed by the OCA Staff in a recent interpretation, which may have broad applicability, involved perpetual preferred stock instruments that are equity in legal form and classified in permanent equity by the issuer. For at least a portion of the life of the instrument, dividend payments on the instrument are based on a LIBOR rate. The sole business purpose of the amendments undertaken by the issuer will be to designate a replacement dividend rate index for LIBOR (in this case, the Secured Overnight Financing Rate – “SOFR”) upon the cessation of LIBOR. No cash will be exchanged in connection with the amendment of the terms. The first question that OCA Staff considered was whether the change represented a modification or extinguishment. The Staff did not object to the issuer applying a qualitative approach, in which the issuer assessed the business purpose for the amendments and the effect of the changes on an investor’s economic interests, which led to a conclusion that the amendments should be treated as a modification. The OCA Staff also addressed whether there was any accounting recognition on the modification date, which would result in the recognition of an increase in fair value of the modified instrument upon modification. Given that the modification was made solely to address LIBOR cessation and that the market is aware of this development and likely is pricing in the effect of LIBOR cessation for any LIBOR-based instrument, the fair value immediately prior to the modification would already consider the impact of the anticipated cessation event, minimizing any potential increase in fair value as a result of the modification the sole business purpose of which was to amend fallback language. The Staff did not object to the conclusion by the issuer that there is no recognition of any change in fair value as a result of the modification in the fact pattern presented.