In early May, the SEC’s Office of Investor Education and Advocacy released an Investor Alert entitled Private Oil and Gas Offerings (PDF). This follows the release in late March 2013 by the North American Securities Administrators Association, an association of state securities regulators, of a paper entitled Oil & Gas Investment Fraud. Each of these papers includes warnings to potential investors in oil-and-gas investment opportunities and advice regarding questions that potential investors should pose, and information that potential investors should obtain and review, when presented with oil-and-gas investment opportunities.
As we highlighted at the end of last year, the SEC issued a Wells notice to Netflix Inc. regarding a post by Netflix CEO Reed Hasting on his personal Facebook page. On April 2, 2013, the SEC issued a report of investigation (PDF) stating that the SEC would not pursue enforcement action against Netflix and addressing the application of Regulation FD to a public company’s use of social media websites (the “Report”).
In approving a public company’s use of social media channels, the Report confirms that the SEC’s August 2008 Guidance on the Use of Company Websites (PDF) applies to social media channels and further highlights that “the investing public should be alerted to the channels of distribution a company will use to disseminate material information.” The SEC further noted in the Report that “in light of the direct and immediate communication from issuers to investors that is now possible through social medial channels, such as Facebook and Twitter, we expect issuers to examine rigorously the factors indicating whether a particular channel is a ‘recognized channel of distribution’ for communicating with investors.”
The SEC recently posted to its website a slide deck (PDF) from a staff presentation at the Forums on Auditing in the Small Business Environment. The slides describe, among other things, some of the issues that the SEC frequently encounters in periodic filings made by smaller reporting companies.
When commenting on the periodic reports of smaller reporting companies, the SEC generally requests:
- additional information;
- additional or clarifying disclosure in future filings; or
- filing amendments to revise financial statements or disclosure.
Section 13(r) of the Securities Exchange Act of 1934 requires any issuer obligated to file periodic reports with the Securities and Exchange Commission after February 6, 2013 to disclose certain business transactions and other activities related to Iran. New Section 13(r) is the result of the Iran Threat Reduction and Syria Human Rights Act of 2012 (the “ITR Act”) (.PDF), legislation that increased economic and other sanctions against Iran to persuade Iran to cease its pursuit of nuclear weapons and support for terrorism. Section 13(r) did not require any rulemaking by the SEC, but in a set of Compliance and Disclosure Interpretations issued on December 4, 2012, the SEC addressed certain questions regarding the obligations imposed on reporting issuers.
A reporting issuer must include in each of its periodic reports (such as a Form 10-K or Form 10-Q) disclosure regarding certain transactions and other activities related to Iran of the issuer or any of its affiliates (such as a subsidiary or a director or an executive officer) at any time during the period covered by the report. The disclosure applies only to a transaction or activity that is or was “knowingly” engaged in; and “knowingly” is defined in the ITR Act as a person’s actual knowledge or that he “should have known ... of the conduct, the circumstance, or the result.” But the disclosure is required even if a transaction or activity is or was not material, even if it was engaged in before the ITR Act became law, and even if the transaction or activity is concluded or discontinued by the date of the filing of the periodic report.
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.
Netflix and its CEO Reed Hastings received a Wells notice from the SEC on December 5 relating to a social media post that Mr. Hastings made on his Facebook page back in July. A “Wells notice” is a letter that the SEC issues to individuals or companies to warn them that the SEC intends to bring an enforcement action against them. In this case, the SEC staff has informed Netflix that they are recommending that the SEC bring a civil action against Netflix for a Facebook post by Mr. Hastings related to Netflix members reaching one billion hours a month in video streaming. The SEC is asserting that Netflix violated Regulation FD (Fair Disclosure) as a result of this posting.
Much has been recently written regarding the impending “fiscal cliff” facing the U.S. economy if the President and Congress do not act before the end of the year to strike a deal. Pundits predict that scheduled tax increases and spending cuts, if allowed to occur, will materially and adversely affect the U.S. economy. And now, public companies are taking notice.
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.
The Securities and Exchange Commission recently published the proposed NASDAQ listing rules to comply with the SEC's Rule 10C-1 under the Securities Exchange Act of 1934, as amended. Rule 10C-1, adopted as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, requires the national securities exchanges, including NASDAQ, generally to prohibit the listing of any equity security of an issuer that does not comply with specified requirements regarding compensation committees. This is an instance of Congress directing the SEC to direct the national securities exchanges to adopt legal requirements. The SEC is still in its review period applicable to, and is still accepting comments on, the proposed rules, but the rules might be approved within the next month. The effects of that approval are described below.
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.
We had occasion to review the civil and criminal penalties for violating SEC regulations and the Sarbanes-Oxley Act of 2002 and thought a quick post may serve to remind our readers of the severity of securities law violations.
As previously described, the Securities and Exchange Commission has, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, adopted a rule to exclude “family offices” from the definition of “investment adviser” under the Investment Advisers Act of 1940, as amended (the “Rule”).
New Calls to Eliminate the Prohibition of General Solicitation or General Advertising in Private Securities Offerings
Within the last two weeks, there have been two new calls for the Securities and Exchange Commission to amend its Rule 502(c) of Regulation D to eliminate the prohibition of “general solicitation or general advertising” (the “Prohibition”) with respect to certain exempt, private securities offerings.
There has been a high volume of bankruptcy filings over the last three years of the economic downturn and they do not show any signs of letting up. Whether it is Hostess Brands—with the future of Twinkies at risk, the prospect of iconic Kodak in the Bankruptcy Court or AMR Corp.’s flight into Chapter 11 reorganization. Notwithstanding the broad scope of the United States Bankruptcy Code and the power of the Bankruptcy Courts, there are still securities issues to be considered.
New Year’s resolutions come in all shapes and sizes. This year, investors may seek refuge in the adage “older but wiser” with respect to the flurry of questionable financial reporting during 2011 at Chinese companies listed in the United States.
Auditors have been caught directly in the crossfire. As we highlighted last quarter, the SEC is seeking to compel a Chinese affiliate of Deloitte to produce documents in connection with allegations of accounting fraud at Longtop Financial Technologies, Ltd. In early January 2012, a federal judge ordered the affiliate to appear in court on February 1, 2012 in order to defend against such production.
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.
A question posed occasionally at this time of year is whether a director or an officer may make a gift of his or her company’s securities to a charitable organization without exposing the director or officer to insider-trading liability under SEC Rule 10b-5. Although the question is relevant whenever the insider has material non-public information, it is particularly relevant for most insiders at this time of year, when charitable gifts are frequent and when the insiders have material non-public information regarding fiscal-year-end and fourth-quarter company performance and are subject to a black-out period under the company’s insider-trading policy.
A federally registered investment adviser must formulate, adopt and maintain, and implement, certain policies specified by SEC rules. That obligation applies regardless of the adviser’s size or scope of activities. Although certain of the policies may seem cumbersome or irrelevant, particularly to an adviser with only a few employees, the SEC will insist on them. The SEC will enforce an adviser’s obligation regarding those policies even in the absence of any material client complaints or any connection with allegedly fraudulent activities.
The SEC announced a modification to its filing review correspondence program on Dec. 1, 2011. Since a policy change in 2005, the SEC has been publicly releasing its correspondence, including comment letters and response letters, “no earlier than 45 days” after completion of the disclosure filing review process. The SEC will accelerate its release schedule to “no earlier than 20 business days” after review completion effective Jan. 1, 2012. The SEC’s stated purpose is to enhance the transparency of the review process.
OUR TAKE: While reporting companies have become accustomed over the last six years to the availability on EDGAR of comment and response correspondence, this policy change means that the temporarily private exchange between the SEC staff and the reporting company will become available to the public more quickly than ever. Depending on the nature of comments and responses, this may have an impact on a company’s public disclosures. And although not quite real-time, it will also give other issuers and the public generally quicker insight into staff positions on filing issues and the resolution of those issues.
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.
In August 2011, we commented on proposals by the major national securities exchanges to impose additional listing requirements on companies completing a reverse merger with a shell company. The SEC announced earlier this month that it approved each of the rule changes, as amended, on an accelerated basis. It just became significantly harder for the shares of a reverse-merger shell company to become listed.
The SEC recently issued new disclosure guidance about cyber security risks. Peter Vogel’s Internet, Information Technology, & e-Discovery Blog last week featured a guest blog on the new guidance by James F. Brashear, Vice President, General Counsel and Corporate Secretary of Zix Corporation (NASDAQ: ZIXI). (Peter Vogel is a partner with Gardere Wynne Sewell LLP.)
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.
Audit firms are smack in the middle of the tension between U.S. and Chinese regulators with respect to allegations of accounting fraud at Chinese companies traded on U.S. exchanges. At present, a Chinese affiliate of Deloitte is in the uncomfortable limelight for its work auditing Longtop Financial Technologies.
On October 12, 2011, the Securities and Exchange Commission joined the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation in proposing for comment the so-called “Volcker Rule” to implement Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. That section of the Dodd-Frank Act in effect requires regulated banking institutions to cease proprietary trading and certain investment activities. The proposed rule and its corresponding explanations and questions for comment are too extensive, complex, and detailed to be adequately described in a blog post or entry. But because the rule will likely be a topic of considerable comment and debate, it seems worthwhile to provide a very brief description of it.
Crowdfunding as a method of raising capital for business ventures has received a fair amount of attention over the last year or so. It has been advocated – in principle, at least – by a number of bloggers and internet commentators. The obstacles to it posed by the securities-registration requirements of the federal Securities Act of 1933 and of the various state securities laws have been the subject of a number of blog posts or entries and even scholarly papers. The Chairman of the Securities and Exchange Commission promised, in a letter to Representative Darrell Issa dated April 6, 2011, that the SEC staff would study and address crowdfunding as part of its review of the SEC’s capital-formation regulations. (On this point, also see the post “SEC Takes a Look at Capital Raising.”)
Recent business or financial news has been filled with reports of insider-trading cases that the Securities and Exchange Commission has been or is pursuing. Many of those cases involve large amounts of money, well-known persons or companies, and interesting factual questions. But they do not necessarily raise questions about the theory of insider-trading liability. In mid-July, the SEC settled an insider-trading case against an individual, engaged solely in personal trading activities, in which the disgorged profits were less than $90,000, and the facts of the case point to the limits of the “misappropriation” theory of insider-trading liability.
On September 14, 2011, the SEC issued guidance regarding the filing of Forms 8-K to report transactions by which companies listed on U.S. exchanges cease to be shell companies, such as reverse merger transactions. This type of guidance is the first of its kind, and arises in connection with proposed rule changes concerning going public through reverse mergers (as we discussed in August 2011), a method used by many Chinese companies criticized for fraud and accounting irregularities (as we discussed in June 2011, July 2011 and August 2011).
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.
We recently commented on the SEC’s decision not to challenge the court ruling vacating its proxy access rule. The Council of Institutional Investors had quickly registered its disappointment. Global Pensions reported yesterday that a number of pension funds are now urging the SEC to issue a new rule.
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.
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.
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.
Bank of America’s announcement on June 29, 2011 that it would take mortgage-related charges of $20.6 billion during the second fiscal quarter has drawn increased scrutiny from the SEC. Under FASB Accounting Standards Codification 450, companies are required to disclose litigation contingencies if the event of loss is at least “reasonably possible” to occur. Disclosure of such an event must include an estimate of the possible loss, range of loss or a statement that such an estimate cannot be made. The announcement by Bank of America of greater than expected mortgage-related liabilities has spurred the SEC to closely review the filings of banks to ensure that disclosures provided to shareholders are fair representations of anticipated liabilities. As reported in the Wall Street Journal, the SEC has sent letters to a number of banks asking for improvements to their disclosures and explanations for increases in previously disclosed litigation-related liabilities.
OUR TAKE: Determining the level of exposure and related disclosure for pending litigation, especially when there is little certainty regarding the outcome, is a difficult analysis. When the litigation involves a significant monetary claim, rather than risking increased scrutiny after the fact from the SEC, a company may be better served by disclosing the litigation matter and stating whether it believes the case has any merit.
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.
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.
Groupon announced on Jun. 2, 2011 that it would be going public. It is rumored that the long-awaited IPO could possibly raise around $3 billion. That size of IPO would give the social buying site a valuation estimated at $30 billion, a stark difference from the $5 billion that Google offered to purchase it for just months ago.
And that’s not the only interesting aspect of the IPO. Following the likes of LinkedIn, Renren and Google, Groupon also announced that it will use a dual-class share structure. In its SEC filing, Groupon disclosed that while co-founder and chief executive officer Andrew Mason only owns 7.7% of the company’s Class A stock, he additionally owns 41.7% of Groupon’s Class B stock. Eric Lefkovsky, another co-founder, owns another 41.7% of the Class B Stock. While the rights of the Class B shares were not disclosed in the filing, they typically allow founders to retain control, through greater voting power, of the company while still having shares traded in the public market.
With the recent announcements of both LinkedIn (see our earlier post) and Groupon using the dual-class share structure, we can see that investors and owners have strong opinions, both positive and negative, about this corporate governance structure.
To most investors, two classes of shares are simply seen as unfair. By creating a class of shareholders with super-voting rights, power is given to a select group of shareholders. Typically, senior management is part of the higher voting power class, so there may be less accountability to the publicly traded class, and certainly the publicly traded class has less of a voice. Dual-class IPOs also tend to be priced at lower price-per-earnings and price-per-sales ratios than comparable single-class IPOs. In addition, research shows that shareholders with super-voting rights dislike raising cash through the sale of additional shares or using shares as currency for acquisitions because this might dilute their voting power influence. Thus, these companies may tend to have more debt than companies with single-class structures. Consequently, this research also shows that shares of companies with dual-class structures underperform the stock market.
Nevertheless, the dual-class share structure does have its benefits, at least from a management and founder perspective. Many praise it because it allows management to ignore all kinds of short and medium-term noise in the market to which most public companies fall prey. Thus, the dual-class structure allows managers to create and follow long-term goals that can in turn create long-term value. Additionally, this structure can prevent hostile takeovers that may bring an end to any opportunity of a long-term franchise. All in all, if both classes of shareholders’ goals are aligned, long-term success might be more likely than with a single-class structure.
OUR TAKE: An IPO with dual-class share structures presents a host of benefits and challenges for investors and founders/owners alike. When considering an IPO, companies should know their options and weigh the good and bad to determine which structure will best set their company on a positive trajectory. This decision will not only make a long-term impact in how the company operates, but likely also its success. Investors must weigh the impact of a super-class of stock, and the resulting lack of control, against potential long-term benefits.
*Many thanks to Lamar Dowling, a Gardere summer associate and JD/MBA student at Southern Methodist University, for his contributions to this post.
The SEC recently initiated stop order proceedings against China Intelligent Lighting and Electronics Inc. and China Century Dragon Media Inc. on suspicion of accounting fraud. As reported by The New York Times, both companies failed to disclose that their independent auditors resigned after asking questions about the accuracy of the companies’ financial statements.
A number of Chinese companies have come under fire for accounting fraud stemming from corporate governance issues according to Forbes: “[i]n the past six months alone, more than 25 [NYSE and Nasdaq]-listed Chinese companies have disclosed accounting discrepancies or seen their auditors resign.” In light of these discrepancies and departures, the need for increased transparency, strong risk management and broad financial oversight is greater than ever. In particular, Chinese companies have been criticized for their relatively low number of independent directors (33% of the directors of Chinese-listed companies compared to 75% of the directors of U.S.-listed companies) and the lack of relevant industry experience these independent directors offer.
In one recent case involving Chinese financial software company Longtop Financial Technologies Limited, auditor Deloitte Touche Tohmatsu handed Longtop a resignation letter, included as an exhibit to a Form 6-K filed by Longtop, that asserted financial statement fraud, bank corruption and threats against the auditors. The New York Times explained the breakup as an investigation by Deloitte, after six years of clean audit opinions, into Longtop’s cash balances. Longtop blocked Deloitte from following up with bank headquarters regarding cash balances (that bank branches had already confirmed) by telling the bank that Deloitte was not the company’s auditor and threatening to hold Deloitte staff captive unless Deloitte allowed Longtop to retain Deloitte’s audit files. As described in the resignation letter, Longtop’s chairman Jia Xiao Gong, explained to a Deloitte partner why Deloitte could not find the cash: “there were [sic] fake revenue in the past so there were [sic] fake cash recorded on the books.” That is a disturbing clarification.
OUR TAKE: Sound accounting practices and the independence and experience of directors are of paramount importance to sound corporate governance. Foreign companies, which bring with them different regulatory, governance and financial backgrounds and standards, may pose unique risks for U.S. investors. Investors should pay close attention to corporate governance and accounting issues generally, but especially with respect to less familiar foreign companies. Reports identifying trends with respect to corporate governance deficiencies and/or accounting fraud especially raise investment red flags.
Determining Whether Beneficial Ownership of a Master Limited Partnership's Subordinated Units Should be Reported Under Section 16
A master limited partnership, or MLP, is a limited partnership that is publicly traded. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities. MLPs are limited by the U.S. Tax Code to only apply to enterprises that engage in certain businesses, mostly pertaining to the use of natural resources, such as petroleum and natural gas extraction and transportation. To qualify for MLP status, a partnership must generate at least 90 percent of its income from what the Internal Revenue Service deems "qualifying" sources. For many MLPs, these sources include all manner of activities related to the exploration, production, processing, refining or transportation of any mineral or natural resource, such as oil, natural gas and coal.
The limited partnership interests of an MLP are typically called common units and are analogous to common stock of a corporation. The MLP common units represent equity or ownership interests in the MLP. MLPs also have subordinated units, which also represent equity or ownership interests in the MLP. The MLP common and subordinated units generally provide limited voting rights and entitle the holder to a share of the company's success through distributions and capital appreciation.
What is the proper date for a written consent of a Board of Directors? Whether it be for record keeping, corporate formalities, public disclosure or to avoid the perception of option backdating, this question is an important one.
The U.S. Attorney General's and the Securities and Exchange Commission's case against former Comverse executives provides that it is improper to treat a unanimous written consent as being effective "as of" a date earlier than the date the last signature was obtained. The Comverse case involved a unanimous written consent for the proposed stock option grant by the Compensation Committee. No written consent that was signed in connection with a stock option grant identified the specific date on which any Committee member had signed his or her name to the consent. No written consent identified the date on which any stock option grant had officially been acted upon by the Committee. The sole date reflected on the unanimous written consents was the "as of" date. The SEC has taken the position that the grant date for stock option grants is the date on which the directors sign the consent and cannot be some earlier date specified in an "as of" sentence in the consent.
Also, it appears that the SEC is questioning the practice of not including a date line next to each signature line. It is perceived as a practice that is intended to facilitate backdating.
As a best practice, companies should make written consents of directors effective as of the date that the last signature is obtained. After all, under Delaware law, a written consent of directors is not effective unless all directors sign it.
- Given all the attention over the last few years on stock option grants, the best practice with written consents generally is not to date a written consent a prior date and make it look like it was done as of that prior date.
- Do not treat a unanimous written consent as being effective "as of" an earlier date than the date the last signature was obtained.
- Make a written consent of directors effective as of the date that the last signature is obtained.
- Use date lines.
- If a resolution legitimately needs to have retroactive effect, and that is appropriate (e.g., it would not be appropriate for a stock option grant), expressly provide for the retroactive effect in the text of the specific resolution, while still showing the date or dates the consent was actually signed.
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.
On May 25, 2011, the SEC announced a proposed rule to implement Section 926 of the Dodd Frank Act, which would make the Rule 506 registration exemption unavailable to offerings involving certain felons and other “bad boys.” The SEC’s release states that Rule 506 offerings account for more than 90 percent of all securities offerings made, and the majority of capital raised, under the SEC’s Regulation D – hence the increased scrutiny.
Under the proposed rule (PDF), Rule 506 will be unavailable if the issuer, its directors, officers and certain other insiders and affiliates, including brokers, finders and 10% beneficial owners, have a “disqualifying event.” These events include, among others:
- certain felony and misdemeanor convictions in connection with the purchase or sale of a security, involving false filings with the SEC or arising out of the conduct of certain financial intermediaries (convictions must occur within ten years before a sale of securities, or five years in the case of issuers and their affiliates);
- court injunctions and restraining orders within the past five years in connection with the purchase or sale of a security, involving false filings with the SEC or arising out of the conduct of certain financial intermediaries;
- final orders from state securities, insurance, banking, savings association or credit union regulators, federal banking agencies or the National Credit Union Administration that bar the issuer from associating with a regulated entity, engaging in the business of securities, insurance or banking, or engaging in savings association or credit union activities, or orders that are based on fraudulent, manipulative or deceptive conduct and issued within ten years before the proposed sale of securities; and
- certain state and federal disciplinary orders relating to brokers, dealers, municipal securities dealers, investment companies and investment advisers and their associated persons.
The proposed rule contains an exemption from disqualification if the issuer did not know and, in the exercise of reasonable care, could not have known of a disqualification.
The SEC will receive public comments on its proposed rule until July 14, 2011.
OUR TAKE: In addition to other due diligence, issuers should be vetting their covered persons for “disqualifying events” before conducting any private offerings under Rule 506. For issuers contemplating a Rule 506 offering, the proposed rule may dictate that issuers present questionnaires to covered persons to confirm the absence of any “disqualifying events.” In addition, these issuers may include in their form investor documents appropriate representations from covered persons to protect against any “bad boy” participation in the offering.
Nasdaq recently announced SEC approval of its BX Venture Market. According to Nasdaq, this new exchange will provide smaller issuers, including over-the-counter traded issuers and issuers failing to meet the listing standards of other national exchanges, with a transparent and well-regulated listing alternative.
To qualify for listing on the BX Venture Market, issuers must meet numerous listing standards, which are set forth in the SEC’s release (PDF). These standards will be lower than that of Nasdaq, the NYSE and other national exchanges, attracting smaller, less liquid companies. Among other requirements, including quantitative listing requirements, these listing standards will require:
- three independent directors;
- an independent audit committee;
- independent director oversight of executive compensation;
- review of related party transactions by independent directors;
- shareholder approval of equity compensation;
- annual shareholder meetings; and
- a code of conduct for all directors, officers and employees.
The BX Venture Market anticipates receiving listing applications in the third quarter of 2011, and currently plans to launch in the fourth quarter of 2011.
OUR TAKE: The BX Venture Market may provide emerging businesses and other smaller issuers with an attractive alternative to the OTC Bulletin Board and Pink Sheets, or the more stringent standards of other national exchanges. Whether the BX Venture Market will spawn a new age of IPOs for smaller and venture-backed issuers remains to be seen. But the emergence of the BX Venture Market, combined with the SEC’s efforts to review impediments to capital formation, is a step forward for smaller issuers.
The SEC has scheduled a public roundtable on July 7, 2011 to discuss the benefits and challenges in potentially incorporating International Financial Reporting Standards (IFRS) into the final reporting system for U.S. issuers.
The July 7 event will feature separate panels representing investors, smaller public companies and regulators. The panel discussions will focus on topics such as investor understanding of IFRS and the impact on smaller public companies and on the regulatory environment of incorporating IFRS.
The SEC has requested topic suggestions to address at the roundtable, as well as potential roundtable participants. Please review the SEC's announcement for submission requirements.
The roundtable will be held in the auditorium at the SEC’s headquarters at 100 F Street, N.E., Washington, D.C. The SEC will publish a final agenda including a list of participants and moderators closer to the event date.
OUR TAKE: It’s great to see the SEC moving forward on this project and trying to get interested parties involved. We’re hopeful that the SEC takes care in assembling the panels to encourage a lively discussion. The SEC previously released a progress report on its review of IFRS, which we discussed in a prior post entitled "SEC Review of IFRS Making Progress."
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.
SEC Chairman Mary L. Schapiro testified on the future of capital formation before the U.S. House of Representatives Committee on Oversight and Government Reform in a visit to Capitol Hill on May 10, 2011. Committee Chairman Darrell Issa (R-Cal.) had previously raised concerns to Chairman Schapiro about rules that he believes are restricting capital formation in the United States.
In her testimony, Chairman Schapiro recognized the need to facilitate access to investment capital, but at the same time satisfy the SEC’s obligation to protect investors and U.S. public markets. She has instructed the SEC staff to “take a fresh look at some of our offering rules to develop ideas for the Commission to consider that would reduce the regulatory burdens on small business capital formation in a manner consistent with investor protection.” Schapiro focused on two of the rules that Representative Issa finds at fault: the ban on general solicitation in connection with most private offerings; and the 500-shareholder threshold for public reporting requirements.
Under Section 4(2) of the Securities Act of 1933 and Regulation D, general solicitation and advertising is prohibited except in connection with Rule 504 offerings, which are limited in size. According to a report by The Deal Pipeline on May 11, 2011, the general solicitation ban has been criticized for years. Some argue that the ban is unnecessary because those who do not purchase a security are not harmed by a general solicitation. On the other hand, the ban may make it more difficult for “fraudsters to attract investors.” According to Chairman Schapiro, the SEC has to balance these considerations. Representative Issa went so far as to raise the question whether the ban violates the First Amendment. However, there does not appear to be any real support for that position.
Section 12(g) of the Securities Exchange Act of 1934 requires a company to register its securities, and thereby become a public reporting company, if at the end of its fiscal year the securities are “held of record” by 500 or more persons. Chairman Schapiro believes that both the threshold number and how holders of record are determined needs to be reviewed. She acknowledged that the securities markets have changed significantly since the threshold was established. It is not clear that 500 is a relevant number today or whether certain types of shareholders should be excluded. Also, the way shares are held today may result in inequitable treatment between public and private companies. Most public shares are held in street name, so a public company may actually have thousands of beneficial shareholders, but only a relatively small number of holders of record. On the other hand, private company shareholders hold shares directly and are all deemed to be holders of record. The public company could go “dark” if it has less than 500 holders of record, while the private company that hits the 500 threshold must begin public reporting.
Chairman Schapiro did note that the SEC has addressed the 500-shareholder threshold with regulatory relief in the past, including providing an exemption to the threshold for compensatory stock options in Rule 12h-1(f). According to an AP report on May 10, 2011, Representative Issa has asked the SEC to consider additionally exempting company employees who own stock from counting toward the threshold.
OUR TAKE: Capital formation is key to the economy. It is critical that the SEC and Congress recognize the impact of changing markets and practices in determining what rules and restrictions should reasonably be in place to protect the investing public and the integrity of our public markets. The reality is that many very large and successful companies are postponing or foregoing IPOs. The ability to facilitate capital raising by private companies, therefore, takes on even greater importance. The SEC’s review should result in proposals to modernize the rules while maintaining its investor-protection mission.
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.
The SEC has recently indicated that it may well delay, to the first quarter of 2012, the date by which certain exempt investment advisers will have to register with the SEC and certain SEC-registered advisers will have to switch to state registration.
The SEC continues to face a daunting task to propose, adopt and implement various rules to effect the changes in the status of investment advisers required by the Dodd-Frank Act. Those required changes include:
- The deletion of the so-called “private adviser” exemption in Section 203(b)(3) of the Investment Advisers Act and the adoption of new exemptions for advisers to family offices, venture capital funds and private funds of less than $150 million, with the result that more advisers will be required to register; and
- Switching “mid-sized” advisers, which generally have between $25 million and $100 million in assets under management, from registration with the SEC to registration with the states.
The Dodd-Frank Act contemplates those changes to occur by July 21, 2011. The SEC indicated that it expects to complete and adopt final rules regarding those changes by that date, but that it is considering permitting investment advisers affected by those changes to wait until the first quarter of 2012 to register with the SEC or to switch from SEC-registration to state-registration, as the case may be.
OUR TAKE: The delay in the compliance date(s) appears likely, so that investment advisers affected by those changes will have more time to comply with the final rules, when adopted by the SEC. Nevertheless, investment advisers that are likely to be affected by the changes should be prepared to review the final rules promptly and then work diligently to prepare and make the necessary filings.
While Congress is still working to avoid a federal government shutdown at midnight on Friday, Apr. 8, 2011, there is no certainty of success. In the event of a shutdown, all nonessential services and workers would be affected. That would include at least some of the SEC’s functions.
As reported by CNBC yesterday, the SEC has indicated that “certain enforcement and market surveillance activities will continue,” it would stop performing “many of its functions” if the federal government shut downs. These functions could include securities registrations, accepting and publishing public company filings, and reviewing proxy statements, including merger proxies, and tender offer filings. As CNBC noted, initial public offerings “may be impossible.” The exact scope of the shutdown’s impact, however, is still not clear.
OUR TAKE: Reporting companies should prepare themselves for the potential impact on the EDGAR filing system, including both ability to file and acceptance of filing, and upon review of registration statements. However long a shutdown may be, it could have a ripple effect on SEC activities and could result in delays for a longer period, as well as adversely impacting the entire investment community.
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.
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.