November 10, 2020
12:00pm – 1:00pm EST
Register here.

Preparations are key to a successful proxy and annual report season, and autumn is not too early to begin. As companies evaluate the ramifications of COVID-19 that need to be discussed in various contexts in annual filings with the US Securities and Exchange Commission, advance planning will ensure a smoother process.

Join us for a complimentary webinar to discuss issues impacting the 2021 proxy season. Topics will include:

  • COVID-19 guidance
  • COVID-19 proxy statement and Form 10-K disclosure considerations
  • Virtual meetings
  • D&O questionnaires
  • Pay ratio disclosure
  • Say-on-pay
  • Human capital and ESG disclosures
  • Shareholder proposals
  • Proxy voting advice amendments
  • Amendments to business, risk factors and litigation S-K items
  • MD&A matters

We also invite you to read our Legal Update, “2021 Proxy and Annual Report Season: Time to Prepare.”

On October 7, 2020, the Securities and Exchange Commission (“SEC”) adopted a new rule designed to streamline and enhance the regulatory framework for funds that invest in other funds (“fund of funds arrangements”).  The new rule (Rule 12d1-4) will create a consistent framework for fund of funds arrangements to replace the existing regulatory approach that relied on various SEC exemptive orders and varied based on the type of acquiring fund.  The scope of permissible acquiring and acquired funds under Rule 12d1-4 is broader than that permitted by the SEC’s exemptive orders.  In particular, Rule 12d1-4 will permit a business development company (“BDC”) to acquire the securities of any registered investment company or other BDC in excess of the limits imposed by Section 12(d)(1) of the Investment Company Act of 1940, as amended.  BDCs will be able to rely on Rule 12d1-4 as both acquiring and acquired funds. However, Rule 12d1-4 will prohibit a BDC from controlling an acquired fund and will require a BDC that holds more than a certain percentage of an acquired fund’s outstanding voting securities to vote those securities in a prescribed manner in order to minimize the influence that the BDC may exercise over the acquired fund.  The effect of the final rule on the number of acquiring BDCs will likely be limited because BDCs are prohibited from making any investment unless, at the time of the investment, at least 70% of the BDC’s total assets are invested in securities of eligible portfolio companies, which do not include funds.  A detailed Legal Update will follow.  See the SEC’s adoption of the final rule here.

During the annual Practising Law Institute’s SEC Speaks, Commissioner Lee discussed the state of public markets and public offerings.  The Commissioner addressed the shift toward continued reliance on the private markets rather than the public markets for capital raising, as well as the decline in the number of IPOs.  While the Commissioner noted that many theories have been advanced to explain the decline in the number of IPOs and the decline in the number of smaller IPOs, she focused on the deregulation of private markets, but did not offer additional insights to support this view.

The Commissioner commented favorably on alternatives to the traditional IPO, including direct listings and mergers with SPACs.  With respect to direct listings, the Commissioner noted that the currently proposed changes that would allow an issuer to raise capital in conjunction with a direct listing bear close scrutiny.  The Commissioner highlighted two important issues: the extent to which financial advisers assisting issuers with direct listings undertake any gatekeeper functions like diligence and the “tracing” issues that have now been raised in the context of litigation.  The Commissioner noted that “the breadth of the statutory definition of “underwriter” may, depending on the facts and circumstances, be sufficient to encompass the activities of a financial advisor in a direct listing.”   She also noted that while one district court decision has held that the Securities Act Section 11 tracing requirement does not apply to a direct listing, the issue remains subject to appeal, and the SEC should consider whether investors are sufficiently protected under Section 11 when it comes to direct listings.

The Commissioner also addressed the issue du jour, SPACs.  She noted that the SEC should focus on SPAC risk disclosures and disclosures related to sponsor compensation.  These comments are similar to those made by Chair Clayton during a recent CNBC interview.  Commissioner Lee went further though, suggesting that the SEC should consider whether there are ways to align the interests of sponsors and investors to ensure that sponsors are incentivized by the quality of any potential target.  See the full text of the prepared remarks here.

On October 8, 2020, the staff of the SEC’s Division of Corporation Finance spoke at PLI’s The SEC Speaks in 2020 program, providing insights on recent developments, rulemakings, guidance and initiatives.

Among the developments over the past year that Division Director William Hinman highlighted was the recognition that digital assets can be registered in compliance with the Securities Act of 1933. Addressing another current topic of interest, Mr. Hinman emphasized that the use of SPACs does not offer a shortcut to the SEC review process, noting that the ultimate merger proxy/Form S-4 will be subject to an SEC review comparable to a traditional IPO review.

Mr. Hinman also focused on the importance of matters he characterized as “corporate hygiene,” urging companies to consider whether they have trading policies effective to prevent management from trading in company securities when they have inside knowledge, such as during the time shortly before a Form 8-K is filed to report a material development. Similarly, he expressed concerns about insiders stopping and starting Rule 10b5-1 trading plans to facilitate their trading in company securities. In addition, Mr. Hinman raised concerns about companies issuing options just before releasing material information, suggesting that this practice may be inconsistent with the concept of fair market value.

The presentation discussed guidance and interpretations arising from the COVID-19 pandemic. For example, forward-looking statements with respect to the impact of COVID-19 in public filings are encouraged in public statements and are more likely to be viewed by the SEC as being made in good faith to the extent that they are consistent with statements the company may be making to landlords and suppliers. The presentation also cautioned against making COVID-19 adjustments to financial measures to paint a rosy picture.

In addition to describing rulemaking that has already been finalized, the Division discussed upcoming developments. The Division is in the process of preparing recommendations to finalize the  proposal  to modernize, simplify, and enhance certain financial disclosure requirements in Regulation S-K, such as MD&A.  In the employee benefit context, the Division also indicated there will be an upcoming proposal to streamline Rule 701 and Form S-8. In the proxy area, the Division suggested that some “proxy plumbing” enhancements would be proposed, such as providing a method for a company to communicate effectively  with all shareholders, even objecting beneficial shareholders, perhaps by using an anonymous block chain.

The Division adopted a new procedure for the 2020 proxy season to review and respond to no-action requests for exclusion of shareholder proposals from company proxy statements, with most responses being noted on a chart rather than being the subject of a formal no-action letter. In the future, the Division would like to make this chart more interactive and sortable.

Covered Bonds Update Webinar
October 21, 2020 | 1:00pm – 2:00pm EDT
Register here.

During this webinar, partner Jerry Marlatt and RBC Capital Markets’ Laura Drumm will discuss the covered bond market in the US, recent developments for Canadian covered bond issuers and the globalization of the asset class. Topics include:

  • Brief overview of covered bonds
  • Recent issuance activity in the US
  • Impact of US government and policy measures to the external issuance of covered bonds
  • Recent EU legislative initiatives related to covered bonds and the impact on non-EU issuers
  • Covered bonds vs. TLAC funding for Canadian banks
  • Where is US legislation?

In statements made at SIFMA’s Virtual Compliance and Legal Forum, FINRA Chief Executive Officer, Robert Cook, indicated that FINRA may be reconsidering aspects of its cycle examinations in light of the challenges presented by the COVID-19 pandemic. FINRA conducts between 1,500 and 2,000 risk-based cycle examinations annually to assess identified risks and controls and determine whether firms are in compliance with federal securities laws, rules and regulations. These examinations typically have an on-site component to them, where FINRA staff arrive at a firm’s office to continue their assessment of the firm’s business.

Read the full Legal Update here.

In July  2020, a publicly traded pharmaceutical company entered into a settlement with the Securities and Exchange Commission, without admitting or denying findings, and agreed to pay a financial penalty relating to various charges of accounting misstatements, including violations of the antifraud provisions of Sections 17(a)(2) and (a)(3) of the Securities Act and Rule 100(b) of Regulation G. The pharmaceutical company, which relied on an acquisition strategy, supplemented its GAAP disclosures with non-GAAP financial measures, including same store organic growth (growth rates for businesses owned for one year or more) and cash EPS (excluding costs associated with business development, among other things), but was alleged to have failed to disclose to investors material information about these measures.  In addition, the pharmaceutical company helped establish a mail order pharmacy business, and entered into agreements with the mail order business to dispense its products.  Sales to the mail order business increased significantly but the pharmaceutical company failed to disclose for some time that it had an option to purchase the mail order business.  In response to investor interest in its relationship with the mail order business, the pharmaceutical company gave an investor presentation during which it discussed the details.  Shortly thereafter it restated its financial statements to reduce previously report revenue from sales to the mail order business due to such revenue having been recognized prematurely.  This led to disclosure of material weaknesses in internal control over financial reporting, and the pharmaceutical company disclosed for the first time the existence of price appreciation credits, or PACs.  However, it did not disclose the effect of these PACs on certain GAAP and non-GAAP financial measures.  The SEC order addresses the registrant’s failure to disclose certain required information in the MD&A section of various periodic reports, the improper recognition of revenue and net income relating to the mail order business, the use of misleading non-GAAP financial measures, and the issues relating to improper disclosures relating to the PACs.  The SEC order notes that the registrant did not design and maintain sufficient internal accounting controls, and had ineffective internal control over financial reporting and disclosure controls and procedures.   The company cooperated with the SEC to address these issues and took remedial measures.  See the order, available here.

In September 2020, the SEC charged a registrant in the LED lighting solutions sector in connection with an accounting fraud for falsely inflating its reported revenues over four years.  The company recognized revenue for sales earlier than permitted under accounting rules and under its own written revenue recognition policies.  The complaint alleges that as the company approached the end of each fiscal quarter during the period, it pressured certain officers and sales personnel to record improperly future sales as current “bill and hold” sales to the company’s auditor.  The company also failed to disclose its reliance on reporting uncompleted sales as bill and hold transactions.  The SEC order relates to violations of Section 17(a) of the Securities Act, as well as Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 (the “Exchange Act”).  See the order here.

In September 2020, the SEC settled accounting fraud charges related to an engine manufacturing company’s overstatement of revenues.  Former executives of a public company were alleged to have fraudulently inflated the company’s revenues in order to meet the company’s prior revenue guidance and analysts’ revenue expectations.  As a result of this, the company’s public filings contained materially misstated financial statements.  As revenue targets became harder to meet, the company pressured sales personnel to provide customers incentives to take additional product before the end of quarters, including creating incentives for customers to place additional product that they did not need and pushing customers to take delivery of ordered product earlier than desired, which resulted in sales being “pulled ahead” to current quarters.  The accounting misstatements came to light in various Forms 8-K.  The SEC order identifies violations of Section 10(b) and 13(a) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-11, and 13a-13 under the Exchange Act.  See the order here.

In September 2020, the SEC announced a settlement with a car maker.  Without admitting or denying the findings, the car maker agreed to payment of an $18 million penalty.  The order alleges that the company engaged in an effort to increase the number of publicly-reported retail vehicle sales in the United States.  Faced with shortfalls in connection with its internal retail sales volume targets, the company used various techniques to boost sales figures.  For example, the company offered its dealers financial incentives to report vehicles as demonstrators or service loaners, which were included in its reported retail sales.  In addition, during certain periods, the company used an excess reserve of previously unreported retail sales to manage its retail sales volume.  When total retail sales reported by dealers exceeded the internal retail sales targets, the company selected which  numbers to report publicly and held back the remaining retail sales.   The company is not subject to SEC reporting; however, it conducted various Rule 144A offerings in the United States.  As a result of its conduct, the company violated Section 17(a)(2) and 17(a)(3) of the Securities Act.  See the order here.

In conjunction with the publication of a staff report, “U.S. Credit Markets: Interconnectedness and the Effects of the COVID-19 Economic Shock,” the Securities and Exchange Commission announced a roundtable on October 14, 2020.  The Roundtable will include senior staff of the SEC, as well as international regulators and market participants.  The report discusses how interconnections in credit markets operated as the effects of the COVID-19 pandemic took hold.  See the press release here, the detailed agenda here, and the report here.

Lexis Practice Advisor

This practice note covers recent market trends affecting business development companies (BDCs), particularly focusing on various types of securities offerings undertaken by public and private BDCs. BDCs are closed-end investment management companies that are specially regulated by the Investment Company Act of 1940, as amended (the 1940 Act). BDCs provide capital to, and invest in, small and middle-market companies in the United States. As a result of this investment purpose, BDCs are exempt from certain regulatory constraints imposed by the 1940 Act on traditional investment companies and generally benefit from pass-through tax treatment (i.e., the entity is not taxed at the entity level and tax obligations pass to the owners of the entity).

Read the full article here.