From the Sox Up - Gardere Securities Law Blog - Law. Trends. Cases of Interest.

The Securities and Exchange Commission recently approved the NASDAQ listing rules (.PDF) to comply with the SEC's Rule 10C-1 under the Securities Exchange Act of 1934, as amended.  Rule 10C-1 (.PDF) was adopted, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, to require securities exchanges to adopt rules regarding the independence of compensation committees and advisers to compensation committees. The approved NASDAQ listing rules are not materially different than the proposed listing rules described in the Fromthesoxup entry on October 29, 2012, though those proposed rules were somewhat revised in December 2012 and early-January 2013.  Unlike as proposed, however, the approved or final listing rules are not immediately effective.

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A public company preparing, or beginning to prepare, the proxy statement for its 2013 annual shareholders’ meeting should be aware (or be reminded) of a new disclosure requirement adopted by the Securities and Exchange Commission last June. As part of its rulemaking under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC adopted a new Item of Regulation S-K, Item 407(e)(3)(iv) (.PDF), that requires disclosure regarding a compensation consultant whose work has raised any conflict of interest.

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The Securities and Exchange Commission’s Conflict Minerals Rule, Rule 13p-1 (.PDF), mandated by Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which added Section 13(p) to the Securities Exchange Act of 1934, was adopted on August 22, 2012, and became effective November 13, 2012.  The Rule will require a number of public reporting companies to, among other things, file with the SEC a new annual report, Form SD.  The initial Form SD is due by May 31, 2014, covering the 2013 calendar year.  Although the Rule’s required initial report now seems quite distant, and although there is a lawsuit filed by the National Association of Manufacturers and others challenging the Rule (.PDF), the time that may be necessary for many companies to comply with the Rule's requirements, and the effort and cost of that compliance, suggests that companies should consider application of the Rule sooner rather than later.

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This week, the SEC released a new Compliance and Disclosure Interpretation (“C&DI”) for Exchange Act Rule 14a-21.  This rule sets forth one of the say-on-pay requirements mandated by the Dodd-Frank Act.  It requires issuers to periodically afford shareholders the right to a nonbinding (i.e., advisory) vote on the compensation of the issuer’s named executive officers.

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The Securities and Exchange Commission announced on Dec. 21, 2011 that it has adopted amendments to its rules regarding the net-worth standard (PDF) for determining an individual “accredited investor” for purposes of certain exemptions from the registration requirements of the Securities Act of 1933, as amended.  As described in our post when the amendments were proposed by the SEC in January 2011, the amendments are required to conform the net-worth standard to one of the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

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An issuer with publicly traded securities listed on a national securities exchange, like the NYSE or the NASDAQ Global Market, is obligated to give advance notice of certain corporate actions to the exchange.  Because that obligation is part of the listing agreement with the exchange, the issuer is well-aware of it.  An issuer with publicly traded securities not listed on a national securities exchange, such as an issuer whose shares trade over the counter (a “non-exchange issuer”), is also obligated to give notice of certain corporate actions—even though the issuer did not enter into any agreement giving rise to the obligation, may not actually be supporting the trading of its securities and may not be aware of the obligation.  The non-exchange issuer must give notice of certain corporate actions to the Financial Industry Regulatory Authority (“FINRA”) under the SEC’s Rule 10b-17 and FINRA’s Rule 6490.

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Under a rule recently adopted by the Securities and Exchange Commission (PDF), various SEC-registered investment advisers that manage private funds will be obligated to periodically file new Form PF.  The rule and the Form have been adopted to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The information provided by the filed Form will be used by the Financial Stability Oversight Council (the “FSOC”) and other regulatory agencies to assess systemic risks to the United States financial system that may be posed by private funds.

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We reported in May 2011 about the future of capital formation—through testimony by the SEC Chairman before a Congressional committee and the Committee Chairman’s comments.  At the time Chairman Schapiro had asked the SEC staff to take a “fresh look” at the offering rules.  The next chapter appears to have now begun with the Chairman’s formation of an Advisory Committee on Small and Emerging Companies on Sept. 13, 2011.

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We posted on Jul. 29, 2011 that the U.S. Court of Appeals for the District of Columbia had vacated the SEC’s proxy access rule.  SEC Chairman Mary L. Schapiro confirmed on Sep. 6, 2011 that the SEC would not seek a rehearing or an appeal to the U.S. Supreme Court.

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Soon it may just be a little harder to go public through a reverse merger transaction.  The SEC published proposed rule changes from both the New York Stock Exchange (PDF) and NYSE Amex (PDF) on Aug. 4, 2011 that, if approved, may make you reconsider the reverse-merger route and probably makes the shell-company industry wince.

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In an October 2010 Gardere Public Securities Alert, we reported that the SEC had delayed the effectiveness of its new proxy access rule pending resolution of a lawsuit filed by the U.S. Chamber of Commerce and the Business Roundtable.  The U.S. Court of Appeals for the District of Columbia vacated the SEC’s rule on July 22, 2010.

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Each year, public companies send their shareholders an annual report along with their proxy statements.  In many cases, this annual report looks similar (if not identical in whole or part) to a Form 10-K and certainly includes similar information.  That begs the question:  Is a company required to provide its shareholders a paper copy of its Form 10-K?

Exchange Act Rule 14c-3 contains the requirements, specifically Rule 14c-3(a).  It provides that the proxy statement shall be accompanied or preceded by an annual report to security holders.  The annual report to security holders contains information that is similar, but not identical, to the Form 10-K filed by a company.  The information that the annual report to secuity holders is required to contain is specified in paragraphs (b)(1) through b(11) of Rule 14a-3.

Moreover, Rule 14c-3(c) and Rule 14a-3(e) also address the use of Notice of Internet Availability of Proxy Materials and annual report to security holders.

Thus, the SEC requires that a company send its shareholders its annual report, not its Form 10-K.  However, if a security holder requests a copy of the Form 10-K, the SEC requires that the company send a paper copy of its Form 10-K to the security holder.

OUR TAKE:  While a company is required to provide its shareholders an annual report, it is not required to provide its shareholders the Form 10-K - a paper copy or otherwise, unless a shareholder specifically requests a copy.

The SEC recently announced its implementation of a new whistleblower program designed to reward “individuals who provide the agency with high-quality tips that lead to successful enforcement actions.”  The new rules (PDF) – created pursuant to Section 922 of the Dodd-Frank Act – will become effective 60 days after they are published in the Federal Register or submitted to Congress. 

To be eligible for an award under the new program, a whistleblower must voluntarily provide original information leading to the successful enforcement by the SEC and monetary sanctions greater than $1 million.

As highlighted in our previous posts (available here and here), the final rules – much like the proposed rules (PDF) – do not require whistleblowers to first report allegations internally to qualify for bounties.  However, in an effort to encourage employees to utilize internal compliance programs when appropriate, the SEC has adopted a number of incentives, including:

• giving whistleblowers the benefit of an internal reporting date as their effective reporting date for award purposes – provided that the same information, first reported internally, is also reported to the SEC within 120 days; and
• for purposes of determining the amount of the award, taking into account the employee’s effective use or, when appropriate, misuse of their internal compliance program.

The final rules also adopt an anti-retaliation policy, which protects whistleblowers who provide information on reasonable belief that it “relates to a possible securities law violation that has occurred, is ongoing, or is about to occur.”

OUR TAKE:  The SEC’s dual system by which whistleblowers may report directly to the SEC or internally through existing programs may stifle companies’ efforts to minimize and resolve alleged compliance issues before any SEC involvement.  Whether whistleblowers will pursue SEC bounties over working through existing compliance programs, however, may depend on the how the SEC applies its rules, and pays bounties, over time.

*Many thanks to Josh McConkey, a Gardere summer associate and law student at the Georgetown University Law Center, for his contributions to this post.

In a February post, we talked about the SEC’s proposed rules to implement the “Securities Whistleblower Incentives and Protection” provisions (PDF) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Under the Dodd-Frank mandate, the proposed rules establish procedures for whistleblower award claims.  While the SEC has not yet adopted final rules, the Dodd-Frank requirement again was the subject of Congressional debate last week.

As reported by The Deal Pipeline on May 11, 2011, business leaders testified before the House Subcommittee on Capital Markets and Government Sponsored Enterprises that the “new whistleblower rewards program threatens to wreak havoc on corporate accountability systems, slowing fixes and burdening” the SEC.  Consistent with that message, Representative Michael G. Grimm (R-N.Y.) has drafted a proposed amendment  to make internal reporting a requirement for an award—before or at the same time as reporting to the SEC.  It also would exclude from awards employees who have a fiduciary duty or contractual obligation to investigate or respond to internal reports, as well as someone guilty of wrong-doing themselves.

In his testimony before the subcommittee, Ken Daly, President and CEO of the National Association of Corporate Directors, supported the changes proposed by Representative Grimm.  Mr. Daly added that the proposed “independent knowledge” requirement should exclude attorney communications, even when the attorney-client privilege has been waived, and companies should have appropriate recourse against employees who make false allegations.  NACD previously submitted its formal comment letter with respect to the proposed rules on Dec. 17, 2010.  Noting that the Sarbanes-Oxley Act of 2002 already mandates a whistleblower system for public companies, Mr. Daly encouraged Congress to study the issue further and ask the SEC to delay the proposed rulemaking.

Robert J. Kueppers, Deputy CEO of Deloitte LLP, and Marcia Narine on behalf of the U.S. Chamber of Commerce also testified about the potential harm of the Dodd-Frank requirement.

OUR TAKE:  The SEC is required to implement the Dodd-Frank whistleblower provision, even though it must recognize the fine line between the resulting harm and benefit.  While the SEC discarded the idea of requiring internal reporting in its proposed rules—to preserve anonymity and investigative flexibility—it did recognize that it might undercut the existing, well-established whistleblower programs that have appropriate protections.  The SEC also understands, however, that not all companies have met their obligation to create solid programs.  Both the business concerns and the enforcement objectives are real, and in any additional review Congress must attempt a balancing act.

The impact of the March 2011 earthquake and resulting tsunami in Japan and the region has caused many U.S. issuers to scramble, for example, to replace their manufacturing and supply capacities and otherwise respond to the crisis.  Retail companies especially have suffered, as Japanese consumers struggle to repair their shattered homes and care for loved ones rather than buying the latest products or technology on the market.

Back in the United States, executives and their consultants have responded by analyzing current and potential business disruptions, leaving company counsel to help determine what disclosure obligations, if any, the issuer may have with the SEC.

As issuers continue to respond to the crisis in Japan and the region, and other catastrophic events, such as the recent tornados in the southern United States, the following may help navigate applicable U.S. securities laws:

• Risk Factors – Risk factors generally describe the most significant factors that may affect the issuer’s business or future performance.  The SEC requires disclosure of risk factors in companies’ Annual Reports on Form 10-K, and any material changes to those factors must be disclosed in subsequent reports, such as Quarterly Reports on Form 10-Q.  When catastrophic events occur, companies should review their risk factors and consider what, if any, changes are appropriate.  It may be worthwhile to review the filings of other companies in similar industries to gauge how others have responded and disclosed these events.
• Current Reports on Form 8-K – A catastrophic event generally will not result in a Form 8-K disclosure obligation.  Depending on the potential impact of the catastrophic event, however, issuers should consider permissive disclosure—either directly on Form 8-K or by press release that is then filed as a Form 8-K exhibit.  In addition, as the implications of these events evolve, and companies are forced to engage new suppliers, manufactures, sourcers and other market participants, or modify arrangements with these participants, corresponding disclosure may be required on Form 8-K.

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The SEC recently (Mar. 2, 2011) proposed rule amendments (PDF) to remove references to credit ratings in rules and forms under the Investment Company Act of 1940.  The SEC announced the rule amendments in furtherance of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Specifically, the Dodd-Frank Act requires federal agencies to review rules that use credit ratings as an assessment of creditworthiness and to replace those credit-rating preferences with other appropriate standards in an effort to eliminate the over-reliance on credit ratings by both regulators and investors.

The rule proposal would amend Rule 2a-7 by eliminating a minimum credit rating as a required element in determining which securities are permissible investments for a money market fund.  In its place, the proposed amendment empowers the money market fund’s board (or its delegate) to make the determination regarding whether a security presents minimal credit risks and thus constitutes an eligible security for the fund.  Consistent with the current rule, money market funds will be required to invest at least 97% of their assets in securities that the board has determined present minimal credit risks from issuers with the highest capacity to meet their short term financial obligations.

The rule proposal also would remove credit ratings in three other areas: repurchase agreements (Rule 5b-3); certain business and industrial development company (BIDCO) investments (New Rule 6a-5); and shareholder reports (Forms N-1A, N-2 and N-3).

Comments to the proposed amendments must be submitted by Apr. 25, 2011.

OUR TAKE:  Similar to other efforts by the SEC to amend its rules in order to comply with the Dodd-Frank Act, these proposed rules address the perceived complacency of both regulators and investors in accepting the ratings provided by credit rating organizations as a substitute for more thorough evaluations.  By providing boards with a subjective measure of the creditworthiness of a security as opposed to an objective one that relies on the determination of a credit rating organization, boards should better understand the securities in which their fund invests and the risks that such securities present.

The SEC recently proposed rules to implement the “Securities Whistleblower Incentives and Protection” provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The proposed rules explain the scope of the whistleblower program to the public and to potential whistleblowers and provide a complete and self-contained set of rules, including an outline of the procedures for applying for awards and the SEC's procedures for making decisions on claims. 

Under the whistleblower program, the SEC is required to pay awards to whistleblowers who voluntarily provide the SEC with original information about a violation of securities laws or the Foreign Corrupt Practices Act ("FCPA") that leads to a successful SEC enforcement action brought with monetary sanctions exceeding $1,000,000.  The SEC will pay awards in totaling between 10% and 30% of the monetary sanctions that are collected in the action. 

Companies are concerned that the potential for paying cash incentives to whistleblowers may reduce the effectiveness of a company’s existing compliance, legal, audit and similar internal processes for investigating and responding to potential violations of the federal securities laws and the FCPA. In response to this concern, the proposed rules include several exclusions, including an exclusion that applies any time that information is obtained from or through a company's internal procedures for identifying, reporting and addressing potential non-compliance with applicable law.  It should be noted, however, that this exclusion is not applicable if the company does not disclose the information to the SEC within a reasonable time or if the company proceeds in bad faith. 

OUR TAKE:  Public companies should be aware of the whistleblower incentives and protections afforded by the “Securities Whistleblower Incentives and Protection” provisions of the Dodd-Frank Act, the heightened risk of investigations into their business practices and the impact on existing internal procedures.  In particular, public companies may see that it is more important than ever to take appropriate action with respect to any non-compliance with federal securities laws discovered through the company's compliance, legal, audit and similar internal processes.

The SEC has recently proposed rules to require advisors of hedge funds and other private funds to report information for use in monitoring risk to the U.S. financial system as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act

Under the proposed reporting requirements (PDF), private fund advisors would be required to file a new reporting form - Form PF - periodically with the SEC.  The amount of information reported and the frequency of reporting would depend on whether the reporting party constitutes a "large private fund adviser" or a "smaller private fund adviser."  

The proposed rules define a "large private fund adviser" as an adviser with $1 billion or more in hedge fund, liquidity fund (i.e., an unregistered money market fund) or private equity fund assets under management and a "smaller private fund adviser" as including all other private fund advisers.

As should be expected, large private fund advisers would be subject to heightened information reporting obligations.  Information to be reported by large private fund advisors would include, among other things, (1) exposures by asset class, geographical concentration and turnover, (2) the types of asets in each of their liquidity fund's portfolios and (3) certain information relevant to the risk profile of the funds, including the extent of leverage and/or bridge financing by the funds.  Smaller private fund advisors would report only basic information regarding the private funds they advise.

Large private fund advisers would be required to file their Form PF quarterly.  Smaller private fund advisers would be required to file their Form PF annually.

OUR TAKE:  If private fund advisers read the Dodd-Frank Act, they knew that new information reporting requirements were on the way.  In its proposed rules, the SEC appears to acknowledge that the benefits of additional reporting requirements should always be examined against the burdens that reporting imposes on the regulated community.  Specifically, by breaking private fund advisers into two groups for reporting purposes, the SEC places the majority of the burden on the limited number of large private fund advisers (the SEC estimates only around 200), which the SEC projects account for more than 80% of assets under management.  This seems to be a reasonable approach for the SEC to take to implement this component of the Dodd-Frank Act.

All U.S. public companies, except for smaller reporting companies, are now required to conduct three say-on-pay shareholder votes beginning in 2011 based upon rules adopted by the SEC on Jan. 25, 2011 (PDF).  Most of the requirements will not apply to smaller reporting companies until 2013.

The SEC's new rules implement the Dodd-Frank Wall Street Reform and Consumer Protection Act.  That legislation requires three kinds of say-on-pay shareholder advisory votes.  Two of those are votes at an annual meeting:  one regarding approval of compensation to the company's named executive officers, and one regarding how often that approval vote should occur.  The third is a vote regarding a company's golden parachute payments in connection with a change-in-control transaction; that vote would typically be at the time of the transaction.

The most significant departure from the proposed rules published by the SEC in Oct. 2010 is a delay in requiring smaller reporting companies to conduct the two annual-meeting advisory votes.  Those companies, with a public float of less than $75 million, will not have to conduct those votes until after Jan. 21, 2013.  Like all other public companies, however, smaller reporting companies will have to conduct the golden-parachute vote after Apr. 25, 2011.

OUR TAKE:  Public companies, other than smaller reporting companies, should plan on spending the additional time and effort on their proxy statements this year to comply with the annual-meeting say-on-pay requirements.  One of the key determinations that a company will need to make is whether to propose an advisory vote take place every year, or only every two or three years.  Smaller reporting companies will have a somewhat easier task in preparing this and next year's proxy statements and will have the benefit of other companies' experiences before they must comply.

On Oct. 21, 2010, the SEC announced enforcement actions against Office Depot, Inc. and its chief executive officer and former chief financial officer in connection with violations of the SEC’s Regulation FD, which restricts selective disclosure of material nonpublic information by public issuers. 

The SEC found that near the end of its second quarter in 2007, Office Depot investor relations made a series of one-on-one calls with analysts in which they signaled, but did not directly state, that Office Depot would not meet analysts’ expectations for the quarter.  Analysts then lowered their estimates for the quarter.  The SEC alleged that the communications were selective disclosures in violation of Regulation FD.  The CEO and CFO orchestrated the calls, but were aware of the changes in the analyst estimates.  Office Depot and the two executives agreed to settle the charges without admitting or denying the findings and allegations. 

Office Depot will pay a $1 million penalty, and the executives will each pay $50,000.  The company’s settlement included unrelated charges that it overstated earnings in 2006 and 2007.  The CEO and CFO also agreed to cease and desist from future violations of Regulation FD.

On Oct. 26, 2010, the Wall Street Journal reported that Office Depot’s CEO reached a mutual agreement with the board of directors to step down.

OUR TAKE:  Investors must receive information at the same time and Issuers will violate Regulation FD whether selective disclosure is express or indirect.  Issuers should ensure that executives and investor relations staffs are educated about Regulation FD and their compliance responsibilities, including the recognition of inadvertent selective disclosure, whether express or indirect.